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, 2011

 

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 3, 2011:

 

Class A Common Stock: 92,125,024

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, 2011

 

PART I.

FINANCIAL INFORMATION

4

 

 

 

Item 1.

Financial Statements

4

 

 

 

 

Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010

4

 

 

 

 

Consolidated Statements of Operations for the Three Months Ended June 30, 2011 and 2010

5

 

 

 

 

Consolidated Statements of Operations for the Six Months Ended June 30, 2011 and 2010

6

 

 

 

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010

7

 

 

 

 

Notes to Consolidated Financial Statements

9

 

 

 

Item 2.

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

28

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

38

 

 

 

Item 4.

Controls and Procedures

38

 

 

 

PART II.

OTHER INFORMATION

38

 

 

 

Item 1A.

Risk Factors

38

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

39

 

 

 

Item 6.

Exhibits

40

 

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 headings “Management’s Discussion and Analysis of Financial Condition and Results of Operations” but may be found in other locations as well. These statements are based upon management’s current expectations, assumptions and estimates and are not guarantees of future results or performance. Actual results may differ materially from those projected in these statements due to a variety of risks and uncertainties and other factors, including, among other things: competition; material adverse changes in economic and industry conditions; technological change; retention and renewal of existing contracts and entry into new or revised contracts; 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 complete the proposed acquisition of Barcrest Group Limited and Cyberview Technology CZ s.r.o.; inability to benefit from, and risks associated with, joint ventures and strategic investments and relationships; failure of the Company’s Northstar joint venture to meet the net income targets or otherwise realize the anticipated benefits under its private management agreement with the Illinois Lottery; 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 included 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.

 

You should also note that this Quarterly Report on Form 10-Q may contain various references to industry market data and certain industry forecasts. Industry market data and industry forecasts are obtained from publicly available information and industry publications. Industry publications generally state that the information contained therein has been obtained from sources believed to be reliable, but that the accuracy and completeness of that information is not guaranteed. Similarly, industry forecasts, while we believe them to be accurate, are not independently verified by us and we do not make any representation as to the accuracy of that information. In general, there is less publicly available information concerning the international lottery industry than the lottery industry in the U.S.

 

3



Table of Contents

 

PART 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of June 30, 2011 and December 31, 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

127,256

 

$

124,281

 

Accounts receivable, net of allowance for doubtful accounts of $2,150 and $2,175 as of June 30, 2011 and December 31, 2010, respectively

 

166,771

 

178,179

 

Inventories

 

69,229

 

68,744

 

Deferred income taxes, current portion

 

2,528

 

2,448

 

Prepaid expenses, deposits and other current assets

 

50,095

 

40,013

 

Total current assets

 

415,879

 

413,665

 

Property and equipment, at cost

 

787,604

 

776,367

 

Less accumulated depreciation

 

(350,920

)

(325,786

)

Net Property and equipment

 

436,684

 

450,581

 

Goodwill, net

 

780,927

 

763,915

 

Intangible assets, net

 

78,659

 

70,613

 

Other assets and investments

 

502,542

 

452,764

 

Total assets

 

$

2,214,691

 

$

2,151,538

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt payments due within one year

 

$

9,479

 

$

8,431

 

Accounts payable

 

55,872

 

50,642

 

Accrued liabilities

 

134,260

 

136,925

 

Total current liabilities

 

199,611

 

195,998

 

Deferred income taxes

 

63,376

 

60,858

 

Other long-term liabilities

 

61,344

 

53,765

 

Long-term debt, excluding current installments

 

1,381,335

 

1,388,259

 

Total liabilities

 

1,705,666

 

1,698,880

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, 97,863 and 97,474 shares issued and 92,114 and 91,725 shares outstanding as of June 30, 2011 and December 31, 2010, respectively

 

979

 

975

 

Additional paid-in capital

 

682,093

 

674,691

 

Accumulated earnings

 

(130,934

)

(131,021

)

Treasury stock, at cost, 5,749 shares held as of June 30, 2011 and December 31, 2010

 

(74,460

)

(74,460

)

Accumulated other comprehensive income (loss)

 

31,347

 

(17,527

)

Total stockholders’ equity

 

509,025

 

452,658

 

Total liabilities and stockholders’ equity

 

$

2,214,691

 

$

2,151,538

 

 

See accompanying notes to consolidated financial statements

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended June 30, 2011 and 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended June 30,

 

 

 

2011

 

2010

 

Revenue:

 

 

 

 

 

Instant tickets

 

$

130,419

 

$

118,439

 

Services

 

82,096

 

101,010

 

Sales

 

7,733

 

13,584

 

Total revenue

 

220,248

 

233,033

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (1)

 

72,133

 

68,227

 

Cost of services (1)

 

41,460

 

55,171

 

Cost of sales (1)

 

5,361

 

9,600

 

Selling, general and administrative expenses

 

43,426

 

40,552

 

Write-down of assets held for sale

 

 

5,874

 

Depreciation and amortization

 

29,004

 

27,078

 

Operating income

 

28,864

 

26,531

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

26,409

 

24,845

 

Earnings from equity investments

 

(9,224

)

(13,631

)

Other (income) expense, net

 

(876

)

6,584

 

 

 

16,309

 

17,798

 

Net income before income taxes

 

12,555

 

8,733

 

Income tax expense

 

5,536

 

13,076

 

Net income (loss)

 

$

7,019

 

$

(4,343

)

 

 

 

 

 

 

Basic and diluted net income (loss) per share:

 

 

 

 

 

Basic net income (loss) per share

 

$

0.08

 

$

(0.05

)

Diluted net income (loss) per share

 

$

0.08

 

$

(0.05

)

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

92,069

 

93,552

 

Diluted shares

 

92,565

 

93,552

 

 


(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 OPERATIONS

Six Months Ended June 30, 2011 and 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Revenue:

 

 

 

 

 

Instant tickets

 

$

244,279

 

$

227,538

 

Services

 

155,843

 

194,714

 

Sales

 

16,782

 

27,120

 

Total revenue

 

416,904

 

449,372

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (1)

 

139,366

 

132,144

 

Cost of services (1)

 

80,382

 

109,613

 

Cost of sales (1)

 

11,051

 

19,866

 

Selling, general and administrative expenses

 

82,980

 

79,108

 

Write-down of assets held for sale

 

 

5,874

 

Depreciation and amortization

 

59,908

 

54,733

 

Operating income

 

43,217

 

48,034

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

52,864

 

49,559

 

Earnings from equity investments

 

(18,574

)

(29,443

)

Other (income) expense, net

 

(1,870

)

12,566

 

 

 

32,420

 

32,682

 

Net income before income taxes

 

10,797

 

15,352

 

Income tax expense

 

10,710

 

14,808

 

Net income

 

$

87

 

$

544

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income per share

 

$

0.00

 

$

0.01

 

Diluted net income per share

 

$

0.00

 

$

0.01

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

91,978

 

93,771

 

Diluted shares

 

92,518

 

94,364

 

 


(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

Six Months Ended June 30, 2011 and 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

87

 

$

544

 

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

 

 

 

 

 

Depreciation and amortization

 

59,908

 

54,733

 

Change in deferred income taxes

 

768

 

11,611

 

Stock-based compensation

 

9,702

 

12,533

 

Non-cash interest expense

 

4,107

 

3,396

 

Undistributed earnings from equity investments

 

10,186

 

4,133

 

Write-down of assets held for sale

 

 

5,874

 

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

 

 

 

 

 

Accounts receivable

 

13,664

 

16,131

 

Inventories

 

191

 

2,220

 

Accounts payable

 

(8,587

)

(13,818

)

Accrued liabilities

 

1,052

 

(8,711

)

Other current assets and liabilities

 

6,297

 

14,491

 

Other

 

208

 

(1

)

Net cash provided by operating activities

 

97,583

 

103,136

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(3,613

)

(3,329

)

Lottery and gaming systems expenditures

 

(22,191

)

(31,502

)

Other intangible assets and software expenditures

 

(18,372

)

(18,009

)

Change in other assets and liabilities, net

 

(9,323

)

(767

)

Net equity investments

 

(33,799

)

(126,810

)

Business acquisitions, net of cash acquired

 

 

(5,906

)

Net cash used in investing activities

 

(87,298

)

(186,323

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

 

105,541

 

Payment on long-term debt

 

(4,661

)

(91,507

)

Payment of financing fees

 

(2,623

)

(6,778

)

Purchases of treasury stock

 

 

(18,227

)

Net proceeds from issuance of common stock

 

(1,353

)

(394

)

Net cash (used in) provided by financing activities

 

(8,637

)

(11,365

)

Effect of exchange rate changes on cash and cash equivalents

 

1,327

 

(14,753

)

Increase (decrease) in cash and cash equivalents

 

2,975

 

(109,305

)

Cash and cash equivalents, beginning of period

 

124,281

 

260,131

 

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

 

 

627

 

Cash and cash equivalents, end of period

 

$

127,256

 

$

151,453

 

 

See accompanying notes to consolidated financial statements

 

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Non-cash investing and financing activities

 

For the six months ended June 30, 2011 and 2010

 

During the six months ended June 30, 2011 we contributed approximately $37,000 to International Terminal Leasing (“ITL”) which is described in Note 3 of the Notes to Consolidated Financial Statements herein, including a non-cash investment of $8,200 out of our total investment in ITL of approximately $37,000 as of June 30, 2011.  There were no significant non-cash investing and financing activities for the six months ended June 30, 2010.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

Notes to Consolidated Financial Statements

 

(1) Consolidated Financial Statements

 

Basis of Presentation

 

The Consolidated Balance Sheet as of June 30, 2011, the Consolidated Statements of Operations for the three and six months ended June 30, 2011 and 2010, and the Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010, 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 the opinion of management, all adjustments necessary to present fairly our consolidated financial position as of June 30, 2011, the results of our operations for the three and six months ended June 30, 2011 and 2010 and our cash flows for the six months ended June 30, 2011 and 2010 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 2010 Annual Report on Form 10-K. The results of operations for the three and six months ended June 30, 2011 are not necessarily indicative of the results of operations for the full year.

 

Significant Accounting Policies

 

We describe our significant accounting policies in Note 1 of the Notes to Consolidated Financial Statements in our 2010 Annual Report on Form 10-K. There have been no changes to our significant accounting policies during the period ended June 30, 2011 except as discussed below.

 

In September 2009, the Financial Accounting Standards Board (“FASB”) amended the Accounting Standards Codification (“ASC”) as summarized in Accounting Standards Update (“ASU”) 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. As summarized in ASU 2009-14, ASC Topic 985 has been amended to remove from the scope of industry-specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. As summarized in ASU 2009-13, ASC Topic 605 has been amended: (1) to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of the selling price; and (3) to eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. The accounting changes summarized in ASU 2009-14 and ASU 2009-13 are both effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. Adoption may either be on a prospective basis or by retrospective application.

 

We adopted these amendments to the ASC on January 1, 2011 on a prospective basis as applicable to our revenue generated from licensing branded properties that are coupled with a service component, where we also purchase and distribute prizes on behalf of lottery authorities. The impact of these accounting changes was not material to our consolidated financial statements for the three and six months ended June 30, 2011.

 

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Basic and Diluted Net Income (Loss) Per Share

 

The following represents a reconciliation of the numerator and denominator used in computing basic and diluted net income (loss) per share available to common stockholders for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

7,019

 

$

(4,343

)

$

87

 

$

544

 

 

 

 

 

 

 

 

 

 

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Weighted-average basic common shares outstanding

 

92,069

 

93,552

 

91,978

 

93,771

 

Effect of dilutive securities-stock rights

 

496

 

 

540

 

593

 

Weighted-average diluted common shares outstanding

 

92,565

 

93,552

 

92,518

 

94,364

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

0.08

 

$

(0.05

)

$

0.00

 

$

0.01

 

Diluted net income (loss) per share

 

$

0.08

 

$

(0.05

)

$

0.00

 

$

0.01

 

 

The weighted-average diluted common shares outstanding for the three and six months ended June 30, 2011 excludes the effect of approximately 7,967 and 7,690 weighted-average stock rights outstanding, respectively, because their effect would be anti-dilutive.  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.

 

(2) Operating Segment Information

 

We operate in three segments: Printed Products Group; Lottery Systems Group; and Diversified Gaming Group. During the first quarter of 2011 we reviewed the allocation of overhead expenses to our reportable segments in light of the realignment of our management structure. Based on this review, we determined to no longer allocate certain overhead expenses to our reportable segments. This change, which was effective January 1, 2011, had no impact on the Company’s consolidated balance sheets or its statements of operations, cash flows or changes in stockholders’ equity for any periods. Prior period segment information has been adjusted to reflect the change in segment reporting.

 

The following tables represent revenue, cost of revenue, depreciation, amortization, selling, general and administrative expenses and operating income for the three and six months ended June 30, 2011 and 2010, by reportable segments. Corporate expenses, including interest expense, other (income) expense and corporate depreciation and amortization, are not allocated to the reportable segments.

 

10


 


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Three Months Ended June 30, 2011

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenue:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

130,419

 

$

 

$

 

$

130,419

 

Services

 

 

51,196

 

30,900

 

82,096

 

Sales

 

2,087

 

5,634

 

12

 

7,733

 

Total revenue

 

$

132,506

 

$

56,830

 

$

30,912

 

$

220,248

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

72,133

 

$

 

$

 

$

72,133

 

Cost of services (1)

 

 

26,220

 

15,240

 

41,460

 

Cost of sales (1)

 

1,238

 

4,123

 

 

5,361

 

Selling, general and administrative expenses

 

13,112

 

5,524

 

3,636

 

22,272

 

Depreciation and amortization

 

8,208

 

11,879

 

8,789

 

28,876

 

Segment operating income

 

$

37,815

 

$

9,084

 

$

3,247

 

$

50,146

 

Unallocated corporate costs

 

 

 

 

 

 

 

21,282

 

Consolidated operating income

 

 

 

 

 

 

 

$

28,864

 

 

 

 

Three Months Ended June 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

118,439

 

$

 

$

 

$

118,439

 

Services

 

 

53,517

 

47,493

 

101,010

 

Sales

 

2,731

 

8,666

 

2,187

 

13,584

 

Total revenue

 

$

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

 

11,730

 

6,858

 

5,181

 

23,769

 

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

 

$

30,815

 

$

12,663

 

$

(40

)

$

43,438

 

Unallocated corporate costs

 

 

 

 

 

 

 

16,907

 

Consolidated operating income

 

 

 

 

 

 

 

$

26,531

 

 


(1) Exclusive of depreciation and amortization.

 

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Six Months Ended June 30, 2011

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

244,279

 

$

 

$

 

$

244,279

 

Services

 

 

100,412

 

55,431

 

155,843

 

Sales

 

3,857

 

12,807

 

118

 

16,782

 

Total revenue

 

$

248,136

 

$

113,219

 

$

55,549

 

$

416,904

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

139,366

 

$

 

$

 

$

139,366

 

Cost of services (1)

 

 

52,188

 

28,194

 

80,382

 

Cost of sales (1)

 

2,244

 

8,772

 

35

 

11,051

 

Selling, general and administrative expenses

 

23,492

 

9,796

 

6,562

 

39,850

 

Depreciation and amortization

 

16,568

 

23,246

 

19,837

 

59,651

 

Segment operating income

 

$

66,466

 

$

19,217

 

$

921

 

$

86,604

 

Unallocated corporate costs

 

 

 

 

 

 

 

43,387

 

Consolidated operating income

 

 

 

 

 

 

 

$

43,217

 

 

 

 

Six Months Ended June 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

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

 

21,970

 

12,239

 

11,554

 

45,763

 

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

 

$

58,082

 

$

20,234

 

$

3,310

 

$

81,626

 

Unallocated corporate costs

 

 

 

 

 

 

 

33,592

 

Consolidated operating income

 

 

 

 

 

 

 

$

48,034

 

 


(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

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Reported segment operating income

 

$

50,146

 

$

43,438

 

$

86,604

 

$

81,626

 

Unallocated corporate costs

 

(21,282

)

(16,907

)

(43,387

)

(33,592

)

Consolidated operating income

 

28,864

 

26,531

 

43,217

 

48,034

 

Interest expense

 

(26,409

)

(24,845

)

(52,864

)

(49,559

)

Earnings from equity investments

 

9,224

 

13,631

 

18,574

 

29,443

 

Other income (expense), net

 

876

 

(6,584

)

1,870

 

(12,566

)

Income before income taxes

 

$

12,555

 

$

8,733

 

$

10,797

 

$

15,352

 

 

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, earnings from equity investments, unallocated 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 the Notes to Consolidated Financial Statements in our 2010 Annual Report on Form 10-K).

 

(3) Equity Method Investments

 

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

 

We are a 20% equity owner in Lotterie Nazionali S.r.l. (“LNS”), a joint venture comprised principally of us, Lottomatica Group S.p.A. (“Lottomatica”) and Arianna 2001, a company owned by the Federation of Italian Tobacconists, that was awarded the concession from the Italian Monopoli di Stato to be the exclusive operator of the Italian Gratta e Vinci instant ticket lottery beginning on October 1, 2010. The 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. LNS succeeded Consorzio Lotterie Nazionali (“CLN”), a consortium comprised of essentially the same group that owns LNS, as holder of the concession. Under the new concession, we are the primary supplier of instant lottery tickets for the joint venture, as we were under the prior concession. CLN, which had held the concession since 2004, is being wound up and the bulk of its assets have been transferred to LNS. LNS paid €800,000 in upfront fees under the terms of the new concession. We paid our pro rata share of these fees in 2010 (€160,000). The upfront fees associated with the new concession are amortized by LNS (anticipated to be approximately €89,000 each year of the new concession on a pre-tax basis), which reduces our earnings from our equity investment in LNS. Our share of the amortization is expected to be approximately €18,000 each year on a pre-tax basis. In light of the corporate structure of LNS, we record our earnings from our equity investment in LNS on an after-tax basis under applicable accounting rules, which impacts the comparability of our results of operations associated with LNS with our results of operations associated with CLN, since we recorded earnings from our equity investment in CLN on a pre-tax basis. 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. In April 2011, we received a dividend of $22,012 from CLN. In May 2011, we received $10,504 from LNS comprised of a dividend of $4,238 and a return of capital payment of $6,266.

 

Northstar Lottery Group, LLC

 

We are a 20% equity owner in Northstar Lottery Group, LLC (“Northstar”), a joint venture with GTECH Corporation, a subsidiary of Lottomatica, that was formed to bid for the agreement to be the private manager for the Illinois lottery for a ten-year term. Northstar was selected as the private manager following a competitive procurement and entered into a private management agreement with the State of Illinois on January 18, 2011 (the “PMA”). As the private manager, Northstar will, subject to the oversight of the Illinois lottery, manage the day-to-day operations of the lottery including lottery game development and portfolio management, retailer recruitment and training, supply of goods and services and overall marketing strategy. Under the terms of the PMA, Northstar is entitled to receive annual incentive compensation payments to the extent it is successful in increasing the lottery’s net income above specified target levels, subject to a cap of 5% of the applicable year’s net income. Northstar will be responsible for payments to the State to the extent such targets are not achieved, subject to a similar cap. Northstar is expected to be reimbursed on a monthly basis for most of its operating expenses under the PMA. Under our agreement with Northstar, 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.

 

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On January 26, 2011, the Appellate Court of Illinois upheld a constitutional challenge to the revenue statute that, among other things, amended the lottery law to facilitate the PMA on grounds that the statute impermissibly addressed more than one subject. On July 11, 2011, the Illinois Supreme Court reversed the Appellate Court decision and upheld the revenue statute.  Operations under the PMA commenced on July 1, 2011. We contributed $10,000 to Northstar in March 2011 and additional $2,000 in July 2011.  We account for our interest in Northstar under the equity method of accounting.

 

International Terminal Leasing

 

As contemplated by our strategic agreements with Video B Holdings Limited (“Video B”), a subsidiary of Playtech Limited, relating to our license of Video B’s back-end technology platform for our gaming machines, we formed ITL with Video B in the first quarter of 2011. The purpose of ITL is to acquire gaming terminals using funds contributed to the capital of ITL by each partner. The gaming terminals, which will employ Video B’s software, will be leased to whichever Company subsidiary is to provide the terminals to third-party customers. We account for our interest in ITL under the equity method of accounting. The equity interest of each partner is expected to vary based on the respective capital contributions from the partners; however, each partner has joint control regarding operating decisions of ITL. Intra-entity profits and losses will be eliminated as necessary. As of June 30, 2011 our investment in ITL was $37,002 which is included in Other Assets and Investments. The impact of ITL on our Consolidated Statements of Operations for the three or six months ended June 30, 2011 was not material.

 

Sportech Plc

 

Upon the closing of the sale of our racing and venue management businesses (the “Racing Business”) to Sportech Plc (“Sportech”) on October 5, 2010, we received an equity interest in Sportech of approximately 20% of the shares then outstanding. Sportech operates football pools and associated games through various distribution channels including direct mail and telephone, agent-based collection and via the Internet. Sportech also operates a portfolio of online casino, poker, bingo and fixed-odds games through its e-Gaming division. Our interest in Sportech is accounted for under the equity method of accounting. We record our equity interest in Sportech on a 90-day lag as allowed under Accounting Standards Codification 323, Investments—Equity Method and Joint Ventures.

 

Shandong Inspur Scientific Games Technology, Ltd.

 

On April 16, 2007, we invested approximately $750 to establish Shandong Inspur Scientific Games Technology, Ltd. (“SIST”). On February 1, 2011, we sold our interest in SIST resulting in a gain of $397.

 

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(4) Comprehensive Income (Loss)

 

The following presents a reconciliation of net income (loss) to comprehensive income (loss) for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net income (loss)

 

$

7,019

 

$

(4,343

)

$

87

 

$

544

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation (loss) gain

 

13,342

 

(34,384

)

47,962

 

(63,248

)

Gain on derivative financial instruments (1)

 

462

 

321

 

912

 

287

 

Total other comprehensive income (loss)

 

13,804

 

(34,063

)

48,874

 

(62,961

)

Comprehensive income (loss)

 

$

20,823

 

$

(38,406

)

$

48,961

 

$

(62,417

)

 


(1) For the three and six months ending June 30, 2011, the change is net of income taxes of approximately $308 and $608, respectively.  For the three and six months ending June 30, 2010, the change is net of income taxes of approximately $217 and $194, respectively.

 

(5) Inventories

 

Inventories consist of the following:

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

Parts and work-in-process

 

$

25,646

 

$

23,224

 

Finished goods

 

43,583

 

45,520

 

 

 

$

69,229

 

$

68,744

 

 

Parts and work-in-process includes costs for equipment expected to be sold. Costs incurred for equipment associated with specific lottery and gaming 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

 

The Company and its wholly owned subsidiary, Scientific Games International, Inc. (“SGI”), entered into a credit agreement, dated as of June 9, 2008 and amended and restated as of February 12, 2010 (as amended from time to time, the “Credit Agreement”), among SGI, the Company, the several lenders from time to time party thereto and JPMorgan Chase Bank, N.A., as administrative agent. The Credit Agreement provides for a $250,000 senior secured revolving credit facility and senior secured term loan credit facilities under which $566,409 of borrowings are outstanding as of June 30, 2011. The Credit Agreement is scheduled to mature on June 9, 2013.

 

On March 11, 2011, the Company and SGI entered into an amendment (the “Amendment”) to the Credit Agreement. Under the Amendment, from and after December 31, 2010, “consolidated EBITDA” (as such term is defined in the Credit Agreement) will generally include the Company’s share of the earnings of the Company’s joint venture that holds the Italian instant ticket concession, whether or not such earnings have been distributed to the Company, before interest expense (other than interest expense in respect of debt of such joint venture if such debt exceeds $25,000), income tax expense and depreciation and amortization expense, provided that the amount of “consolidated EBITDA” attributable to the Company’s interest in such joint venture that would not have otherwise been permitted to be included in “consolidated EBITDA” prior to giving effect to the Amendment will be capped at $25,000 in any period of four consecutive quarters (or $30,000 in the case of any such period ending on or prior to June 30, 2012). Prior to giving effect to the Amendment, “consolidated EBITDA” generally included only the Company’s share of the earnings of such joint venture that was distributed to the Company. In addition, under the terms of the Amendment, any cash compensation expense incurred but not paid in a particular period will be added back for purposes of determining “consolidated EBITDA” so long as no cash payment in respect thereof is required prior to the scheduled maturity of the borrowings under the Credit Agreement. “Consolidated EBITDA” is relevant

 

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Table of Contents

 

for determining whether the Company is in compliance with the financial ratios required to be maintained under the terms of the Credit Agreement.

 

The Amendment also provides that up to $100,000 of unrestricted cash and cash equivalents of the Company and its subsidiaries in excess of $15,000 will be netted against “consolidated total debt” for purposes of determining the Company’s “consolidated leverage ratio” and “consolidated senior debt ratio” (as such terms are defined in the Credit Agreement) as of any date from and after December 31, 2010.

 

A summary of the terms of the Credit Agreement, including the financial ratios that the Company is required to maintain under the terms of the Credit Agreement (which ratios were not adjusted by the Amendment), is included in Note 8 of the Notes to Consolidated Financial Statements in our 2010 Annual Report on Form 10-K. For more information regarding the Amendment, see our Current Report on Form 8-K filed with the SEC on March 14, 2011.

 

As of June 30, 2011, we had approximately $196,604 available for additional borrowing or letter of credit issuances under our revolving credit facility. There were no borrowings and $53,396 in outstanding letters of credit under our revolving credit facility as of June 30, 2011. Our ability to borrow under the Credit Agreement will depend on us remaining in compliance with the covenants contained in the Credit Agreement.

 

We were in compliance with our covenants under the Credit Agreement as of June 30, 2011.

 

Outstanding Debt and Capital Leases

 

As of June 30, 2011, we had total debt outstanding of $1,390,814 including $566,409 outstanding under our term loan facilities under the Credit Agreement, $345,365 in aggregate principal amount of SGI’s 9.25% senior subordinated notes due 2019 (the “2019 Notes”), $200,000 in aggregate principal amount of SGI’s 7.875% senior subordinated notes due 2016 (the “2016 Notes”), $250,000 in aggregate principal amount of the Company’s 8.125% senior subordinated notes due 2018 (the “2018 Notes”), and loans denominated in Chinese Renminbi Yuan (“RMB”) totaling RMB178,500 of which RMB116,000 matures in December 2012 and RMB62,500 matures in January 2013.

 

On May 6, 2011, we paid the remaining £628 aggregate principal amount outstanding of the promissory notes we issued to defer a portion of the earn-out payable in connection with our acquisition of The Global Draw Limited (“Global Draw”) in 2006.

 

(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, 2011, the Hedge was measured at a fair value of $968 using Level 2 valuation techniques of the fair value hierarchy and included in accrued 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 Statements of Operations. During the three and six months ended June 30, 2011, we recorded a gain of approximately $462 and $912, respectively, in other comprehensive income (loss). 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). There was no ineffective portion of the Hedge recorded in the Consolidated Statements of Operations in either period. 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.

 

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Table of Contents

 

(8) Goodwill and Intangible Assets

 

The following disclosure presents certain information regarding our intangible assets as of June 30, 2011 and December 31, 2010. 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, 2011

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

12,394

 

$

4,809

 

$

7,585

 

Customer lists

 

29,903

 

19,573

 

10,330

 

Licenses

 

77,123

 

52,427

 

24,696

 

Intellectual property

 

18,273

 

18,217

 

56

 

Lottery contracts

 

1,500

 

1,144

 

356

 

 

 

139,193

 

96,170

 

43,023

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

37,754

 

2,118

 

35,636

 

Total intangible assets

 

$

176,947

 

$

98,288

 

$

78,659

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2010

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

12,106

 

$

4,321

 

$

7,785

 

Customer lists

 

30,083

 

19,009

 

11,074

 

Licenses

 

62,124

 

46,381

 

15,743

 

Intellectual property

 

17,833

 

17,719

 

114

 

Lottery contracts

 

1,500

 

1,093

 

407

 

 

 

123,646

 

88,523

 

35,123

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

37,608

 

2,118

 

35,490

 

Total intangible assets

 

$

161,254

 

$

90,641

 

$

70,613

 

 

The aggregate intangible amortization expense for the three and six months ended June 30, 2011 was approximately $3,700 and $7,500, respectively. The aggregate intangible amortization expense for the three and six months ended June 30, 2010 was approximately $3,300 and $7,500, respectively.

 

The table below reconciles the change in the carrying amount of goodwill, by reporting segment, for the period from December 31, 2010 to June 30, 2011. In the six months ended June 30, 2011, we recorded an increase in goodwill of approximately $17,000 as a result of foreign currency translation.

 

Goodwill

 

Printed
Products
Group

 

Lottery
Systems
Group

 

Diversified
Gaming
Group

 

Totals

 

Balance as of December 31, 2010

 

$

335,481

 

186,944

 

241,490

 

763,915

 

Adjustments

 

2,614

 

7,355

 

7,043

 

17,012

 

Balance as of June 30, 2011

 

$

338,095

 

194,299

 

248,533

 

780,927

 

 

(9) Pension and Other Post-Retirement Plans

 

We have defined benefit pension plans for our U.K.-based union employees and certain Canadian-based employees (the “U.K. Plan” and the “Canadian Plan,” respectively). 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.

 

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Table of Contents

 

The following table sets forth the combined amount of net periodic benefit cost recognized for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

462

 

$

471

 

$

923

 

$

943

 

Interest cost

 

1,173

 

1,237

 

2,347

 

2,473

 

Expected return on plan assets

 

(1,162

)

(1,226

)

(2,324

)

(2,451

)

Amortization of actuarial gains

 

95

 

140

 

189

 

280

 

Amortization of prior service costs

 

(3

)

11

 

(5

)

22

 

Net periodic cost

 

$

565

 

$

633

 

$

1,130

 

$

1,267

 

 

We have a 401(k) plan for U.S.-based employees who are not covered by a collective bargaining agreement. We contribute 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 44.1% and 99.2%, respectively, for the three and six months ended June 30, 2011 were determined using an estimated annual effective tax rate and after considering any discrete items for such periods. Due to a valuation allowance against our U.S. deferred tax assets, the effective tax rate for the three and six months ended June 30, 2011 does not include the benefit of the current year forecasted U.S. tax loss. Income tax expense for the three and six months ended June 30, 2011 is primarily due to income tax expense in foreign jurisdictions.

 

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.

 

In 2010, we established a valuation allowance of $149,583 against the U.S. deferred tax assets that, in the judgment of management, are more likely than not to expire before they can be utilized. In assessing the recoverability of our deferred tax assets, we analyzed all evidence, both positive and negative. We considered, among other things, our deferred tax liabilities, our historical earnings and losses, projections of future income, and tax-planning strategies available to us. We have not changed our assessment regarding the recoverability of our U.S. deferred tax assets for the three and six months ended June 30, 2011.

 

(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, 2011 and during the fiscal year ended December 31, 2010:

 

 

 

Six Months

 

Twelve Months

 

 

 

Ended

 

Ended

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

Shares outstanding as of beginning of period

 

91,725

 

93,883

 

Shares issued as part of equity-based compensation plans and the Employee Stock Purchase Plan (“ESPP”), net of RSUs surrendered

 

389

 

461

 

Shares repurchased into treasury stock

 

 

(2,619

)

Shares outstanding as of end of period

 

92,114

 

91,725

 

 

(12) Stock-Based Compensation

 

We offer stock-based compensation through the use of stock options and restricted stock units (“RSUs”). We grant stock options to employees and directors under our equity-based compensation plans with exercise prices that are not less than the fair

 

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market value of our common stock at the date of grant. The terms of the stock option and RSU awards, including the vesting schedule of such awards, are determined at our discretion subject to the terms of the applicable equity-based compensation plan. Options granted over the last several years have generally been exercisable in four or five equal installments beginning on the first anniversary of the date of grant with a maximum term of ten years. RSUs typically vest in four or five equal installments beginning on the first anniversary of the date of grant or when certain performance measures are met. There are 13,500 shares of common stock authorized for awards under our 2003 Incentive Compensation Plan (the “Plan”) plus available shares from a preexisting equity-based compensation plan, which plans were approved by our stockholders. We also have outstanding stock options granted as part of inducement stock option awards that are not approved by stockholders prior to being granted. We record compensation cost for all stock options and RSUs based on the fair value at the grant date.

 

The Company may grant certain awards that are contingent upon the Company achieving certain performance targets. Upon determining the performance target is probable, the fair value of the award is recognized over the service period. Certain equity awards may be settled in cash or shares. The fair value of these awards is measured each reporting period and recorded as a liability and corresponding compensation expense. As the fair value changes each reporting period, the corresponding liability and compensation expense are adjusted, such that the liability and cumulative compensation expense equal the total fair value of the obligation upon the reporting date.

 

In connection with A. Lorne Weil becoming Chief Executive Officer, the Company entered into an amendment to his employment agreement effective December 2, 2010. Pursuant to the amendment, the Company awarded to Mr. Weil sign-on equity awards consisting of 1,000 stock options with an exercise price of $9.00 per share (representing an approximately 12% premium to the market value of our common stock on the date of grant) and a ten-year term and 1,000 RSUs, which awards have a four-year vesting schedule, with 25% scheduled to vest on December 31, 2011 and on each of the next three anniversaries of such date (such options and RSUs, the “time-vesting equity awards”). Mr. Weil was also awarded additional performance-conditioned awards consisting of 1,000 stock options with an exercise price of $8.06 per share (representing the market value of our common stock on the date of grant) and 1,000 RSUs, which awards have a five-year vesting schedule, with 20% of such options and RSUs scheduled to vest each year if specified performance targets are met (subject to certain “carryover” vesting provisions as described in the employment agreement amendment) (such performance-conditioned stock options and RSUs, the “performance-conditioned equity awards”).

 

The performance-conditioned stock options will expire, and the performance-conditioned RSUs will be forfeited, on March 15, 2016 to the extent that such awards remain unvested on such date. Any performance-conditioned stock options that have vested by March 15, 2016 will expire ten years from the date of grant. Delivery of shares in respect of vested performance-vesting RSUs will occur on March 15, 2016, provided that such RSUs will be forfeited to the extent that sufficient shares are not available under the Plan for such delivery. The performance-vesting stock options will not be exercisable to the extent that sufficient shares are not available under the Plan for the delivery of the shares issuable upon such exercise. In addition, to the extent that sufficient shares are not available under the Plan for the delivery of the shares underlying the 500 time-vesting RSUs that are scheduled to vest on December 31, 2013 and December 31, 2014 or the delivery of the shares issuable upon the exercise of 200 of the time-vesting stock options that are scheduled to become exercisable on December 31, 2014, the Company will settle such delivery in cash. See the Company’s Current Report on Form 8-K filed with the SEC on December 3, 2010 for additional information regarding these sign-on equity awards, including information regarding the performance targets with respect to the performance-conditioned equity awards.

 

In January 2011, the Company awarded an aggregate of 475 equity awards to certain officers consisting of approximately 113 performance-conditioned stock options, approximately 113 time-vesting stock options (with an exercise price of $10.02 per share and a ten-year term) and 250 time-vesting stock options (with an exercise price of $9.98 per share and a ten-year term), which options will not be exercisable to the extent that sufficient shares are not available under the Plan for the delivery of the shares issuable upon such exercise.

 

The equity awards that will be forfeited or not exercisable and the equity awards that will be settled in cash, as the case may be, to the extent that sufficient shares are not available under the Plan at the time of delivery of the underlying shares, are not deemed to be granted for accounting purposes as stock-based equity awards (and are not reflected as granted in 2011 or 2010, as the case may be, or outstanding as of June 30, 2011 or December 31, 2010 in the tables below). Excluding the awards described in the preceding sentence, we had approximately 972 and 2,119 shares available for grants of equity awards under our equity-based compensation plans (excluding 480 and 514 shares available under our employee stock purchase plan) as of June 30, 2011 and December 31, 2010, respectively.

 

On July 19, 2011, we commenced a stockholder-approved exchange offer to allow eligible employees and directors the opportunity to exchange all (but not less than all) of their outstanding stock options with an exercise price greater than $11.99 that were granted before July 19, 2010, whether vested or unvested, for a lesser number of new RSUs. The exchange ratios were established in order to comply with the terms of the option exchange approved by our stockholders and so that we are unlikely to incur accounting expense as a result of the option exchange.  The exchange offer is currently set to expire on August 15, 2011.  New RSUs granted in the exchange offer will be scheduled to vest on the later of the first anniversary of the acceptance date of exchange offer

 

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and the date on which the corresponding option would have vested.  Eligible options granted under the Plan that are surrendered and accepted by us for exchange will be returned to the pool of available shares under the Plan.

 

Stock Options

 

A summary of the changes in stock options outstanding under our equity-based compensation plans during the six months ended June 30, 2011 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, 2010

 

6,751

 

6.0

 

$

20.72

 

$

1,814

 

Granted

 

754

 

 

 

 

 

 

 

Exercised

 

(2

)

 

 

 

 

15

 

Cancelled

 

(307

)

 

 

 

 

 

 

Options outstanding as of March 31, 2011

 

7,196

 

6.4

 

19.42

 

654

 

Granted

 

20

 

 

 

 

 

 

 

Exercised

 

(2

)

 

 

 

 

11

 

Cancelled

 

(51

)

 

 

 

 

 

 

Options outstanding as of June 30, 2011

 

7,163

 

6.1

 

19.41

 

3,288

 

Options exercisable as of June 30, 2011

 

4,444

 

4.5

 

$

23.36

 

$

1,132

 

 

The weighted-average grant date fair value of options granted during the three months ended June 30, 2011 and March 31, 2011 was $4.61 and $4.62, respectively. For the three and six months ended June 30, 2011, we recognized stock-based compensation expense of approximately $1,700 and $3,400, respectively, related to the vesting of stock options and the related tax benefit of approximately $630 and $1,260, 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.

 

As of June 30, 2011, we had unearned compensation of approximately $13,900 relating to stock option awards that will be amortized over a weighted-average period of approximately two years.

 

Restricted Stock Units

 

A summary of the changes in RSUs outstanding under our equity-based compensation plans during the six months ended June 30, 2011 is presented below:

 

 

 

Number of
Restricted
Shares

 

Weighted
Average Grant
Date Fair
Value Per
Share

 

Non-vested units as of December 31, 2010

 

2,440

 

$

15.13

 

Granted

 

917

 

8.92

 

Vested

 

(482

)

18.43

 

Cancelled

 

(16

)

15.52

 

Non-vested units as of March 31, 2011

 

2,859

 

$

12.58

 

Granted

 

32

 

9.47

 

Vested

 

(44

)

25.31

 

Cancelled

 

(26

)

13.66

 

Non-vested units as of June 30, 2011

 

2,821

 

$

12.34

 

 

For the three and six months ended June 30, 2011, we recognized stock-based compensation expense of approximately $3,300 and $6,200 related to the vesting of RSUs and the related tax benefit of approximately $1,240 and $2,240, respectively. 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.

 

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As of June 30, 2011, we had unearned compensation of approximately $32,300 relating to RSUs that will be amortized over a weighted-average period of approximately two years.

 

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

 

We conduct substantially all of our business through our domestic and foreign subsidiaries. SGI’s obligations under the Credit Agreement, 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”). Our 2018 Notes, which were issued by the Parent Company, are fully and unconditionally and jointly and severally guaranteed by our 100% owned domestic subsidiaries, including SGI.

 

Presented below is condensed consolidating financial information for (i) the Parent Company, (ii) SGI, (iii) the Guarantor Subsidiaries and (iv) our 100%-owned foreign subsidiaries and our non-100%-owned domestic and foreign subsidiaries (collectively, the “Non-Guarantor Subsidiaries”) as of June 30, 2011 and December 31, 2010 and for the three and six months ended June 30, 2011 and 2010. 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 our obligations as disclosed in Note 8 of the Notes to Consolidated Financial Statements in our 2010 Annual Report on Form 10-K for all periods presented. The condensed consolidating financial information has also been recast for all periods presented to reflect entities included in the sale of the Racing Business as non-guarantors.

 

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, 2011

 

 

 

Parent Company

 

SGI

 

Guarantor 
Subsidiaries

 

Non-Guarantor 
Subsidiaries

 

Eliminating 
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

30,903

 

$

137

 

$

 

$

103,394

 

$

(7,178

)

$

127,256

 

Accounts receivable, net

 

 

51,295

 

41,924

 

73,552

 

 

166,771

 

Inventories

 

 

26,375

 

14,388

 

28,466

 

 

69,229

 

Other current assets

 

14,382

 

3,337

 

6,466

 

28,438

 

 

52,623

 

Property and equipment, net

 

2,617

 

167,434

 

37,003

 

229,630

 

 

436,684

 

Investment in subsidiaries

 

606,561

 

706,241

 

 

856,910

 

(2,169,712

)

 

Goodwill

 

 

273,656

 

78,618

 

428,653

 

 

780,927

 

Intangible assets

 

 

41,655

 

28,838

 

8,166

 

 

78,659

 

Intercompany balances

 

136,895

 

 

202,139

 

 

(339,034

)

 

Other assets

 

17,836

 

77,161

 

10,892

 

402,754

 

(6,101

)

502,542

 

Total assets

 

$

809,194

 

$

1,347,291

 

$

420,268

 

$

2,159,963

 

$

(2,522,025

)

$

2,214,691

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

 

$

6,280

 

$

 

$

3,199

 

$

 

$

9,479

 

Other current liabilities

 

39,800

 

46,479

 

29,428

 

81,604

 

(7,179

)

190,132

 

Long-term debt, excluding current installments

 

250,000

 

1,105,494

 

 

25,841

 

 

1,381,335

 

Other non-current liabilities

 

10,369

 

40,287

 

15,751

 

58,313

 

 

124,720

 

Intercompany balances

 

 

37,668

 

 

301,367

 

(339,035

)

 

Stockholders’ equity

 

509,025

 

111,083

 

375,089

 

1,689,639

 

(2,175,811

)

509,025

 

Total liabilities and stockholders’ equity

 

$

809,194

 

$

1,347,291

 

$

420,268

 

$

2,159,963

 

$

(2,522,025

)

$

2,214,691

 

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

As of December 31, 2010

 

 

 

Parent Company

 

SGI

 

Guarantor 
Subsidiaries

 

Non-Guarantor 
Subsidiaries

 

Eliminating 
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

62,639

 

$

150

 

$

 

$

62,770

 

$

(1,278

)

$

124,281

 

Accounts receivable, net

 

 

72,830

 

45,541

 

59,808

 

 

178,179

 

Inventories

 

 

29,416

 

16,210

 

23,118

 

 

68,744

 

Other current assets

 

14,997

 

2,783

 

4,564

 

20,117

 

 

42,461

 

Property and equipment, net

 

1,730

 

150,130

 

43,859

 

254,862

 

 

450,581

 

Investment in subsidiaries

 

510,260

 

670,471

 

 

386,690

 

(1,567,421

)

 

Goodwill

 

 

273,656

 

78,843

 

411,416

 

 

763,915

 

Intangible assets

 

 

42,170

 

20,481

 

7,962

 

 

70,613

 

Intercompany balances

 

133,483

 

 

164,982

 

 

(298,465

)

 

Other assets

 

18,457

 

98,933

 

6,046

 

335,429

 

(6,101

)

452,764

 

Total assets

 

$

741,566

 

$

1,340,539

 

$

380,526

 

$

1,562,172

 

$

(1,873,265

)

$

2,151,538

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

 

$

6,280

 

$

 

$

2,151

 

$

 

$

8,431

 

Other current liabilities

 

29,363

 

48,074

 

32,601

 

78,817

 

(1,288

)

187,567

 

Long-term debt, excluding current installments

 

250,000

 

1,110,573

 

 

27,686

 

 

1,388,259

 

Other non-current liabilities

 

9,545

 

43,188

 

8,141

 

53,749

 

 

114,623

 

Intercompany balances

 

 

27,292

 

 

271,186

 

(298,478

)

 

Stockholders’ equity

 

452,658

 

105,132

 

339,784

 

1,128,583

 

(1,573,499

)

452,658

 

Total liabilities and stockholders’ equity

 

$

741,566

 

$

1,340,539

 

$

380,526

 

$

1,562,172

 

$

(1,873,265

)

$

2,151,538

 

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

Three Months Ended June 30, 2011

 

 

 

Parent 
Company

 

SGI

 

Guarantor 
Subsidiaries

 

Non-Guarantor 
Subsidiaries

 

Eliminating 
Entries

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

 

$

99,042

 

$

16,278

 

$

105,357

 

$

(429

)

$

220,248

 

Cost of instant ticket revenue, cost of services and cost of sales (1)

 

 

29,506

 

36,854

 

53,988

 

(1,394

)

118,954

 

Selling, general and administrative expenses

 

14,891

 

12,199

 

2,517

 

15,247

 

(1,428

)

43,426

 

Depreciation and amortization

 

128

 

7,548

 

4,664

 

16,664

 

 

29,004

 

Operating income (loss)

 

(15,019

)

49,789

 

(27,757

)

19,458

 

2,393

 

28,864

 

Interest expense

 

5,357

 

20,624

 

 

427

 

1

 

26,409

 

Other (income) expense

 

(998

)

48,420

 

(50,615

)

(9,299

)

2,392

 

(10,100

)

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

 

(19,378

)

(19,255

)

22,858

 

28,330

 

 

12,555

 

Equity in income (loss) of subsidiaries

 

30,019

 

22,752

 

 

 

(52,771

)

 

Income tax expense

 

3,622

 

(4

)

8

 

1,910

 

 

5,536

 

Net income

 

$

7,019

 

$

3,501

 

$

22,850

 

$

26,420

 

$

(52,771

)

$

7,019

 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

Three Months Ended June 30, 2010

 

 

 

Parent 
Company

 

SGI

 

Guarantor 
Subsidiaries

 

Non-Guarantor 
Subsidiaries

 

Eliminating 
Entries

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

 

$

99,750

 

$

10,919

 

$

122,733

 

$

(369

)

$

233,033

 

Cost of instant ticket revenue, cost of services and cost of sales (1)

 

 

31,160

 

34,800

 

67,414

 

(376

)

132,998

 

Selling, general and administrative expenses

 

11,917

 

15,352

 

2,078

 

11,196

 

9

 

40,552

 

Write-down of assets held for sale

 

 

 

 

 

5,874

 

 

5,874

 

Depreciation and amortization

 

124

 

8,270

 

4,573

 

14,111

 

 

27,078

 

Operating income (loss)

 

(12,041

)

44,968

 

(30,532

)

24,138

 

(2

)

26,531

 

Interest expense

 

3,270

 

20,449

 

 

1,126

 

 

24,845

 

Other (income) expense

 

9,700

 

41,269

 

(54,020

)

(3,994

)

(2

)

(7,047

)

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

 

(25,011

)

(16,750

)

23,488

 

27,006

 

 

8,733

 

Equity in income (loss) of subsidiaries