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, 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 October 28, 2011:

 

Class A Common Stock: 92,137,470

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, 2011

 

PART I.

FINANCIAL INFORMATION

4

 

 

 

Item 1.

Financial Statements

4

 

 

 

 

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

4

 

 

 

 

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

5

 

 

 

 

Consolidated Statements of Operations for the Nine Months Ended September 30, 2011 and 2010

6

 

 

 

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 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

29

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

42

 

 

 

Item 4.

Controls and Procedures

42

 

 

 

PART II.

OTHER INFORMATION

42

 

 

 

Item 1A.

Risk Factors

42

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

 

Item 6.

Exhibits

44

 

2



Table of Contents

 

Forward-Looking Statements

 

Throughout this Quarterly Report on Form 10-Q we make “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements describe future expectations, plans, results or strategies and can often be identified by the use of terminology such as “may,” “will,” “estimate,” “intend,” “continue,” “believe,” “expect,” “anticipate,” “could,” “potential,” “opportunity,” or similar terminology. The forward-looking statements contained in this Quarterly Report on Form 10-Q are generally located in the material set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” but may be found in other locations as well. These statements are based upon 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 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 September 30, 2011 and December 31, 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

September 30,

 

December 31,

 

 

 

2011

 

2010

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

86,879

 

$

124,281

 

Accounts receivable, net of allowance for doubtful accounts of $6,469 and $2,175 as of September 30, 2011 and December 31, 2010, respectively

 

187,236

 

178,179

 

Inventories

 

79,396

 

68,744

 

Deferred income taxes, current portion

 

2,339

 

2,448

 

Prepaid expenses, deposits and other current assets

 

52,435

 

40,013

 

Total current assets

 

408,285

 

413,665

 

Property and equipment, at cost

 

780,930

 

776,367

 

Less: accumulated depreciation

 

(342,631

)

(325,786

)

Net Property and equipment

 

438,299

 

450,581

 

Goodwill, net

 

766,288

 

763,915

 

Intangible assets, net

 

88,792

 

70,613

 

Other assets and investments

 

494,677

 

452,764

 

Total assets

 

$

2,196,341

 

$

2,151,538

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt payments due within one year

 

$

9,391

 

$

8,431

 

Accounts payable

 

64,640

 

50,642

 

Accrued liabilities

 

160,241

 

136,925

 

Total current liabilities

 

234,272

 

195,998

 

Deferred income taxes

 

61,382

 

60,858

 

Other long-term liabilities

 

57,517

 

53,765

 

Long-term debt, excluding current installments

 

1,382,393

 

1,388,259

 

Total liabilities

 

1,735,564

 

1,698,880

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, 97,877 and 97,474 shares issued and 92,128 and 91,725 shares outstanding as of September 30, 2011 and December 31, 2010, respectively

 

979

 

975

 

Additional paid-in capital

 

689,861

 

674,691

 

Accumulated loss

 

(135,058

)

(131,021

)

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

 

(74,460

)

(74,460

)

Accumulated other comprehensive (loss)

 

(20,545

)

(17,527

)

Total stockholders’ equity

 

460,777

 

452,658

 

Total liabilities and stockholders’ equity

 

$

2,196,341

 

$

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 September 30, 2011 and 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended September 30,

 

 

 

2011

 

2010

 

Revenue:

 

 

 

 

 

Instant tickets

 

$

126,693

 

$

115,968

 

Services

 

81,429

 

92,813

 

Sales

 

14,617

 

12,280

 

Total revenue

 

222,739

 

221,061

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (1)

 

71,785

 

67,138

 

Cost of services (1)

 

42,562

 

57,723

 

Cost of sales (1)

 

10,332

 

7,977

 

Selling, general and administrative expenses

 

47,660

 

36,435

 

Write-down of assets held for sale

 

 

2,155

 

Employee termination and restructuring costs

 

1,030

 

602

 

Depreciation and amortization

 

27,994

 

27,284

 

Operating income

 

21,376

 

21,747

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

26,297

 

24,617

 

Earnings from equity investments

 

(8,895

)

(13,031

)

Loss on early extinguishment of debt

 

4,185

 

2,236

 

Other (income) expense, net

 

1,711

 

(3,011

)

 

 

23,298

 

10,811

 

Net (loss) income before income taxes

 

(1,922

)

10,936

 

Income tax expense

 

2,202

 

2,232

 

Net (loss) income

 

$

(4,124

)

$

8,704

 

 

 

 

 

 

 

Basic and diluted net (loss) income per share:

 

 

 

 

 

Basic net (loss) income per share

 

$

(0.04

)

$

0.09

 

Diluted net (loss) income per share

 

$

(0.04

)

$

0.09

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

92,125

 

91,844

 

Diluted shares

 

92,125

 

92,240

 

 


(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, 2011 and 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

Nine Months Ended September 30,

 

 

 

2011

 

2010

 

Revenue:

 

 

 

 

 

Instant tickets

 

$

370,972

 

$

343,506

 

Services

 

237,272

 

287,527

 

Sales

 

31,399

 

39,400

 

Total revenue

 

639,643

 

670,433

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (1)

 

211,151

 

199,282

 

Cost of services (1)

 

122,944

 

167,336

 

Cost of sales (1)

 

21,383

 

27,843

 

Selling, general and administrative expenses

 

130,640

 

115,543

 

Write-down of assets held for sale

 

 

8,029

 

Employee termination and restructuring costs

 

1,030

 

602

 

Depreciation and amortization

 

87,902

 

82,017

 

Operating income

 

64,593

 

69,781

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

79,161

 

74,176

 

Earnings from equity investments

 

(27,469

)

(42,474

)

Loss on early extinguishment of debt

 

4,185

 

2,236

 

Other (income) expense, net

 

(159

)

9,555

 

 

 

55,718

 

43,493

 

Net income before income taxes

 

8,875

 

26,288

 

Income tax expense

 

12,912

 

17,040

 

Net (loss) income

 

$

(4,037

)

$

9,248

 

 

 

 

 

 

 

Basic and diluted net (loss) income per share:

 

 

 

 

 

Basic net (loss) income per share

 

$

(0.04

)

$

0.10

 

Diluted net (loss) income per share

 

$

(0.04

)

$

0.10

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

92,027

 

93,122

 

Diluted shares

 

92,027

 

93,648

 

 


(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, 2011 and 2010

(Unaudited, in thousands, except per share amounts)

 

 

 

Nine Months Ended September 30,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) income

 

$

(4,037

)

$

9,248

 

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

 

 

 

 

 

Depreciation and amortization

 

87,902

 

82,017

 

Change in deferred income taxes

 

2,326

 

11,541

 

Stock-based compensation

 

15,293

 

17,383

 

Non-cash interest expense

 

6,122

 

5,276

 

Undistributed earnings from equity investments

 

2,611

 

(8,062

)

Write-down of assets held for sale

 

 

8,029

 

Loss on extinguishment of debt

 

4,185

 

2,236

 

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

 

 

 

 

 

Accounts receivable

 

9,380

 

7,012

 

Inventories

 

(827

)

(2,375

)

Accounts payable

 

(2,125

)

(8,970

)

Accrued liabilities

 

14,671

 

(3,463

)

Other current assets and liabilities

 

16,163

 

22,886

 

Other

 

963

 

483

 

Net cash provided by operating activities

 

152,627

 

143,241

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(5,863

)

(6,873

)

Lottery and gaming systems expenditures

 

(33,972

)

(45,257

)

Other intangible assets and software expenditures

 

(28,536

)

(26,335

)

Change in other assets and liabilities, net

 

(11,356

)

(571

)

Net equity investments

 

(37,878

)

(127,314

)

Business acquisitions, net of cash acquired

 

(50,177

)

(12,493

)

Net cash used in investing activities

 

(167,782

)

(218,843

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

 

355,541

 

Payments on long-term debt

 

(6,232

)

(242,758

)

Payments of financing fees

 

(9,186

)

(12,969

)

Purchases of treasury stock

 

 

(26,334

)

Net proceeds from issuance of common stock

 

(1,426

)

(2,067

)

Net cash (used in) provided by financing activities

 

(16,844

)

71,413

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(5,403

)

(8,965

)

Decrease in cash and cash equivalents

 

(37,402

)

(13,154

)

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

124,281

 

260,131

 

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

 

 

2,593

 

Cash and cash equivalents, end of period

 

$

86,879

 

$

249,570

 

 

See accompanying notes to consolidated financial statements

 

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Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2011 and 2010

(Unaudited, in thousands, except per share amounts)

 

Non-cash investing and financing activities

 

For the nine months ended September 30, 2011 and 2010

 

Our total investment in International Terminal Leasing (“ITL”), which is described in Note 3 of the Notes to Consolidated Financial Statements, was $35,961 as of September 30, 2011 which includes a non-cash investment of $4,859 during the nine months ended September 30, 2011.  There were no significant non-cash investing and financing activities for the nine months ended September 30, 2010.

 

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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, 2011, the Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010, and the Consolidated Statements of Cash Flows for the nine months ended September 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 September 30, 2011, the results of our operations for the three and nine months ended September 30, 2011 and 2010 and our cash flows for the nine months ended September 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 nine months ended September 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 September 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 nine months ended September 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 (loss) income per share available to common stockholders for the three and nine months ended September 30, 2011 and 2010:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(4,124

)

$

8,704

 

$

(4,037

)

$

9,248

 

 

 

 

 

 

 

 

 

 

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Weighted-average basic common shares outstanding

 

92,125

 

91,844

 

92,027

 

93,122

 

Effect of dilutive securities-stock rights

 

 

396

 

 

526

 

Weighted-average diluted common shares outstanding

 

92,125

 

92,240

 

92,027

 

93,648

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net (loss) income per share

 

$

(0.04

)

$

0.09

 

$

(0.04

)

$

0.10

 

Diluted net (loss) income per share

 

$

(0.04

)

$

0.09

 

$

(0.04

)

$

0.10

 

 

There were no dilutive stock rights for the three and nine months ended September 30, 2011 due to the net loss reported for the periods. 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.

 

(2) Reportable Segment Information

 

We operate in three reportable 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 as a result 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 reportable segment information has been adjusted to reflect the change in reportable segment reporting.

 

The following tables set forth revenue, cost of revenue, depreciation, amortization, selling, general and administrative expenses, write-down of assets held for sale, employee termination and restructuring costs, and operating income for the three and nine months ended September 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 and are presented as unallocated corporate costs.

 

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Three Months Ended September 30, 2011

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenue:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

126,693

 

$

 

$

 

$

126,693

 

Services

 

 

49,944

 

31,485

 

81,429

 

Sales

 

2,953

 

9,640

 

2,024

 

14,617

 

Total revenue

 

$

129,646

 

$

59,584

 

$

33,509

 

$

222,739

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

71,785

 

$

 

$

 

$

71,785

 

Cost of services (1)

 

 

26,899

 

15,663

 

42,562

 

Cost of sales (1)

 

1,906

 

6,813

 

1,613

 

10,332

 

Selling, general and administrative expenses

 

13,029

 

6,626

 

4,238

 

23,893

 

Employee termination and restructuring costs

 

 

 

1,030

 

1,030

 

Depreciation and amortization

 

8,177

 

11,939

 

7,744

 

27,860

 

Segment operating income

 

$

34,749

 

$

7,307

 

$

3,221

 

$

45,277

 

Unallocated corporate costs

 

 

 

 

 

 

 

23,901

 

Consolidated operating income

 

 

 

 

 

 

 

$

21,376

 

 


(1) Exclusive of depreciation and amortization.

 

 

 

Three Months Ended September 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenue:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

115,968

 

$

 

$

 

$

115,968

 

Services

 

 

46,630

 

46,183

 

92,813

 

Sales

 

1,024

 

6,141

 

5,115

 

12,280

 

Total revenue

 

$

116,992

 

$

52,771

 

$

51,298

 

$

221,061

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

67,138

 

$

 

$

 

$

67,138

 

Cost of services (1)

 

 

26,450

 

31,273

 

57,723

 

Cost of sales (1)

 

954

 

4,063

 

2,960

 

7,977

 

Selling, general and administrative expenses

 

10,269

 

5,772

 

6,117

 

22,158

 

Write-down of assets held for sale

 

 

 

2,155

 

2,155

 

Employee termination and restructuring costs

 

 

 

602

 

602

 

Depreciation and amortization

 

8,184

 

10,969

 

8,005

 

27,158

 

Segment operating income

 

$

30,447

 

$

5,517

 

$

186

 

$

36,150

 

Unallocated corporate costs

 

 

 

 

 

 

 

14,403

 

Consolidated operating income

 

 

 

 

 

 

 

$

21,747

 

 


(1) Exclusive of depreciation and amortization.

 

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Nine Months Ended September 30, 2011

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenue:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

370,972

 

$

 

$

 

$

370,972

 

Services

 

 

150,356

 

86,916

 

237,272

 

Sales

 

6,810

 

22,447

 

2,142

 

31,399

 

Total revenue

 

$

377,782

 

$

172,803

 

$

89,058

 

$

639,643

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

211,151

 

$

 

$

 

$

211,151

 

Cost of services (1)

 

 

79,087

 

43,857

 

122,944

 

Cost of sales (1)

 

4,150

 

15,585

 

1,648

 

21,383

 

Selling, general and administrative expenses

 

36,521

 

16,422

 

10,800

 

63,743

 

Employee termination and restructuring costs

 

 

 

1,030

 

1,030

 

Depreciation and amortization

 

24,745

 

35,185

 

27,581

 

87,511

 

Segment operating income

 

$

101,215

 

$

26,524

 

$

4,142

 

$

131,881

 

Unallocated corporate costs

 

 

 

 

 

 

 

67,288

 

Consolidated operating income

 

 

 

 

 

 

 

$

64,593

 

 


(1) Exclusive of depreciation and amortization.

 

 

 

Nine Months Ended September 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenue:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

343,506

 

$

 

$

 

$

343,506

 

Services

 

 

148,334

 

139,193

 

287,527

 

Sales

 

6,625

 

24,518

 

8,257

 

39,400

 

Total revenue

 

$

350,131

 

$

172,852

 

$

147,450

 

$

670,433

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

199,282

 

$

 

$

 

$

199,282

 

Cost of services (1)

 

 

78,760

 

88,576

 

167,336

 

Cost of sales (1)

 

4,931

 

17,708

 

5,204

 

27,843

 

Selling, general and administrative expenses

 

32,239

 

18,011

 

17,671

 

67,921

 

Write-down of assets held for sale

 

 

 

8,029

 

8,029

 

Employee termination and restructuring costs

 

 

 

602

 

602

 

Depreciation and amortization

 

25,150

 

32,622

 

23,872

 

81,644

 

Segment operating income

 

$

88,529

 

$

25,751

 

$

3,496

 

$

117,776

 

Unallocated corporate costs

 

 

 

 

 

 

 

47,995

 

Consolidated operating income

 

 

 

 

 

 

 

$

69,781

 

 


(1) Exclusive of depreciation and amortization.

 

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The following table provides a reconciliation of reportable segment operating income to income (loss) before income taxes for each period:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Reported segment operating income

 

$

45,277

 

$

36,150

 

$

131,881

 

$

117,776

 

Unallocated corporate costs

 

(23,901

)

(14,403

)

(67,288

)

(47,995

)

Consolidated operating income

 

21,376

 

21,747

 

64,593

 

69,781

 

Interest expense

 

(26,297

)

(24,617

)

(79,161

)

(74,176

)

Earnings from equity investments

 

8,895

 

13,031

 

27,469

 

42,474

 

(Loss) on early extinguishment of debt

 

(4,185

)

(2,236

)

(4,185

)

(2,236

)

Other income (expense), net

 

(1,711

)

3,011

 

159

 

(9,555

)

Income (loss) before income taxes

 

$

(1,922

)

$

10,936

 

$

8,875

 

$

26,288

 

 

In evaluating financial performance, we focus on operating income as a segment’s measure of profit or loss. Segment operating income is income before other income (expense), net, interest expense, earnings from equity investments, loss on early extinguishment of debt, 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 in accordance with 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. During 2011, we have received $10,870 from LNS comprised of a dividend of $4,238 received in the second quarter and return of capital payments of $6,266 and $366 received in the second and third quarter, respectively.

 

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 process 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

 

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monthly basis for most of its operating expenses under the PMA. Under our agreement with Northstar, we are responsible for the design, development, manufacturing, warehousing and distribution of instant lottery tickets and will be compensated based on a percentage of retail sales.

 

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 an 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 September 30, 2011 our investment in ITL was $35,961. The impact of ITL on our Consolidated Statements of Operations for the three and nine months ended September 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.

 

(4) Comprehensive (Loss) Income

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net (loss) income

 

$

(4,124

)

$

8,704

 

$

(4,037

)

$

9,248

 

Other comprehensive (loss) income

 

 

 

 

 

 

 

 

 

Foreign currency translation (loss) gain

 

(52,397

)

56,592

 

(4,435

)

(6,656

)

Gain on derivative financial instruments (1)

 

505

 

27

 

1,417

 

315

 

Other comprehensive (loss) income

 

(51,892

)

56,619

 

(3,018

)

(6,341

)

Comprehensive (loss) income

 

$

(56,016

)

$

65,323

 

$

(7,055

)

$

2,907

 

 


(1) For the three and nine months ended September 30, 2011, the gain on derivative financial instruments is net of income taxes of approximately $337 and $944, respectively.  For the three and nine months ended September 30, 2010, the gain on derivative financial instruments is net of income taxes of approximately $285 and $479, respectively.

 

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(5) Inventories

 

Inventories consist of the following:

 

 

 

September 30,

 

December 31,

 

 

 

2011

 

2010

 

Parts and work-in-process

 

$

33,765

 

$

23,224

 

Finished goods

 

45,631

 

45,520

 

 

 

$

79,396

 

$

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

 

We are party to a credit agreement, dated as of June 9, 2008, as amended and restated as of February 12, 2010, and amended as of December 16, 2010, March 11, 2011 and as further amended and restated as of August 25, 2011 (as so amended, the “Credit Agreement”), among Scientific Games International, Inc. (“SGI”), as borrower, the Company, as a guarantor, the several lenders from time to time parties thereto and JPMorgan Chase Bank, N.A. (“JPMorgan”), as administrative agent. 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, is included in Note 8 of the Notes to Consolidated Financial Statements in our 2010 Annual Report on Form 10-K.

 

On March 11, 2011, the Company and SGI entered into an 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. This add-back was revised pursuant to the subsequent amendment described below to permit up to $993 of non-cash compensation expense accrued prior to August 25, 2011 to be added back notwithstanding that cash payments may be required to be made in respect thereof prior to the scheduled maturity of the borrowings under the Credit Agreement.  “Consolidated EBITDA” is relevant 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. In connection with the amendment, SGI paid approximately $2,600 of fees and expenses to (or for the benefit of) the consenting lenders. For more information regarding the March 11, 2011 amendment, see our Current Report on Form 8-K filed with the SEC on March 14, 2011.

 

On August 25, 2011, the Company and SGI entered into an amendment to the Credit Agreement. In connection with the amendment, the scheduled maturity date of approximately $247,000 (or 99%) of the revolving credit facility commitments and approximately $555,800 (or 98%) of the outstanding term loans under the Credit Agreement was extended from June 9, 2013 to June 30, 2015.  Under the amended Credit Agreement, SGI has the flexibility to extend the maturity date of, or reduce or prepay without premium or penalty (other than break-funding costs), the approximately $16,400 of revolving credit facility commitments and outstanding term loans that were not extended in connection with the amendment, subject to certain conditions set forth in the amendment or the Credit Agreement, as applicable.  Under the terms of the amendment, we will be required to maintain the following

 

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revised financial ratios:

 

·                  a “consolidated leverage ratio” (as such term is defined in the Credit Agreement) as of the last day of each fiscal quarter no more than the ratio set forth below with respect to the period during which such fiscal quarter ends:

 

·                  5.75 to 1.00 (through December 31, 2013);

 

·                  5.50 to 1.00 (January 1, 2014 through December 31, 2014); and

 

·                  5.25 to 1.00 (January 1, 2015 and thereafter); and

 

·                  a “consolidated senior debt ratio” (as such term is defined in the Credit Agreement) as of the last day of each fiscal quarter no more than 2.75 to 1.00.

 

The “consolidated interest coverage ratio” (as such term is defined in the Credit Agreement) that we are required to maintain (i.e., not less than 2.25 to 1.00 for any period of four consecutive quarters) was not changed by the amendment. .

 

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, (b) the federal funds effective rate plus 0.50% and (c) the LIBOR rate for a deposit in dollars with a maturity of one month plus 1.00%, or (2) a reserve-adjusted LIBOR rate, in each case plus an applicable margin based on the consolidated leverage ratio as set forth in a grid.  Under the terms of the amendment, the two lowest applicable margin levels in the grid were eliminated such that the applicable margin now varies based on the consolidated leverage ratio from 1.50% to 2.50% above the base rate for base rate loans, and from 2.50% to 3.50% above LIBOR for LIBOR-based loans.

 

The amendment provides for additional refinancing flexibility in the form of (1) permitted bank debt or debt securities that may be unsecured or secured on a pari passu or junior basis with the collateral securing the obligations under the Credit Agreement and (2) replacement facilities under the Credit Agreement that can be used to refinance either the term loans or the revolving commitments under the Credit Agreement in whole.  In addition, SGI will have the capability to request one or more additional tranches of term loans, increase the existing tranche of term loans, or increase the revolving commitments in an amount not to exceed $200,000 after the effective date of the amendment (the “Incremental Facility”).  In lieu of incurring additional indebtedness pursuant to the Incremental Facility, the amendment also provides SGI with the flexibility to incur additional incremental indebtedness in the form of one or more series of debt securities in an aggregate principal amount not to exceed the amounts allowed to be incurred under the Incremental Facility.

 

In addition, the amendment renews most of the negative covenant baskets as of the effective date of the amendment and provides investment flexibility for SGI by allowing the borrower to move capital stock, property and cash from non-guarantor subsidiaries to loan parties and then back to non-guarantor subsidiaries, subject to certain limitations set forth in the Credit Agreement.  The amendment also provides SGI the ability to use an existing restricted payment basket comprised of $200,000 plus a permitted expenditure amount that is based in part on the cumulative consolidated net income of the Company for investments and prepayments of certain indebtedness. In connection with the amendment, SGI paid an aggregate of approximately $6,300 of fees and expenses to (or for the benefit of) the consenting and new lenders of which approximately $5,800 was capitalized as deferred financing fees. The Company recorded a loss on early extinguishment of debt of approximately $4,185 as a result of writing off deferred financing fees related to those lenders that chose not to extend the maturity date of their loans. For more information regarding the August 25, 2011 amendment, see our Current Report on Form 8-K filed with the SEC on August 31, 2011.

 

As of September 30, 2011, we had approximately $188,883 available for additional borrowing or letter of credit issuances under our revolving credit facility. There were no borrowings and $61,117 in outstanding letters of credit under our revolving credit facility as of September 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 September 30, 2011.

 

Senior Subordinated Notes

 

On October 27, 2011, SGI completed a consent solicitation commenced on October 19, 2011 in which SGI sought and obtained consents from the holders of a majority in aggregate principal amount of SGI’s 7.875% senior subordinated notes due 2016 (the “2016 Notes”) to certain amendments to the indenture governing the 2016 Notes (the “Indenture”).  SGI paid consenting holders $5,000 in the aggregate in connection with the consent solicitation.

 

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SGI, the Company, as a guarantor, the other guarantors party thereto and The Bank of Nova Scotia Trust Company of New York, as trustee, entered into a supplemental indenture (the “Supplemental Indenture”) implementing the amendments to the Indenture.  The Supplemental Indenture amends the Indenture to conform certain provisions of the Indenture to those contained in the indenture governing the Company’s 8.125% senior subordinated notes due 2018 (the “2018 Notes”) and thereby provides the Company with additional flexibility for investment opportunities that it may decide to pursue, including potential strategic partnerships, joint ventures and other acquisitions.

 

In particular, the Supplemental Indenture amends the definition of “consolidated net income” in the Indenture to exclude certain items, including net after-tax impairment charges and asset write-offs, which will, among other things, increase the Company’s capacity to make additional “restricted investments” under the Indenture.  In addition, the Supplemental Indenture amends the definition of “permitted investments” to include certain investments relating to the Italian instant ticket concession held by the Company’s joint venture.  The primary effect of this amendment is to “grandfather” the investments the Company made in 2010 to cover the Company’s portion of the upfront fees associated with the new concession for purposes of determining the Company’s capacity to make additional “restricted investments” under the Indenture.

 

For more information regarding the consent solicitation and the Supplemental Indenture, see our Current Report on Form 8-K filed with the SEC on October 28, 2011.

 

Outstanding Debt and Capital Leases

 

As of September 30, 2011, we had total debt outstanding of $1,391,784 including $567,134 outstanding under our term loan facilities under the Credit Agreement, $345,449 in aggregate principal amount of SGI’s 9.25% senior subordinated notes due 2019 (the “2019 Notes”), $200,000 in aggregate principal amount of the 2016 Notes, $250,000 in aggregate principal amount of 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, which expired on October 17, 2011. Under the Hedge, which was designated as a cash flow hedge, SGI paid interest on a $100,000 notional amount of debt at a fixed rate of 3.49% and received interest on a $100,000 notional amount of debt at the then prevailing three-month LIBOR rate. The objective of the Hedge was 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, 2011, the Hedge was measured at a fair value of $126 using Level 2 valuation techniques of the fair value hierarchy and included in accrued liabilities on the Consolidated Balance Sheet.

 

Hedge effectiveness was 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 were compared to the cumulative changes in the cash flows of the hypothetical swap. The effective portion of the Hedge was recorded in other comprehensive (loss) income and any ineffective portion of the Hedge was recorded in the Consolidated Statements of Operations. During the three and nine months ended September 30, 2011, we recorded a gain of approximately $505 and $1,417, respectively, in other comprehensive (loss) income. During the three and nine months ended September 30, 2010, we recorded a gain of approximately $27 and $315, respectively, in other comprehensive (loss) income. There was no ineffective portion of the Hedge recorded in the Consolidated Statements of Operations in either period. Amounts recorded in other comprehensive (loss) income that were deferred on the effective hedged forecasted transactions were reclassified to earnings when the interest expense related to the hedged item affected earnings.

 

(8) Intangible Assets and Goodwill

 

The following presents certain information regarding our intangible assets as of September 30, 2011 and December 31, 2010. Amortizable intangible assets are amortized over their estimated useful lives with no estimated residual values.

 

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Intangible Assets

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net Balance

 

Balance as of September 30, 2011

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

12,755

 

$

5,024

 

$

7,731

 

Customer lists

 

36,248

 

19,684

 

$

16,564

 

Licenses

 

77,340

 

55,319

 

$

22,021

 

Intellectual property

 

23,396

 

17,832

 

$

5,564

 

Lottery contracts

 

1,500

 

1,170

 

$

330

 

 

 

151,239

 

99,029

 

52,210

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

38,700

 

2,118

 

36,582

 

Total intangible assets

 

$

189,939

 

$

101,147

 

$

88,792

 

 

 

 

 

 

 

 

 

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 nine months ended September 30, 2011 was approximately $3,800 and $11,300, respectively. The aggregate intangible amortization expense for the three and nine months ended September 30, 2010 was approximately $3,400 and $10,900, respectively.

 

The table below reconciles the change in the carrying amount of goodwill, by reporting segment, for the period from December 31, 2010 to September 30, 2011. In the nine months ended September 30, 2011, we recorded an increase in goodwill of approximately $4,700 as a result of acquisitions and a decrease of approximately $2,300 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

 

(1,968

)

2,511

 

1,830

 

2,373

 

Balance as of September 30, 2011

 

$

333,513

 

189,455

 

243,320

 

766,288

 

 

(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 applicable tax 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, 2011 and 2010:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

589

 

$

478

 

$

1,512

 

$

1,421

 

Interest cost

 

1,114

 

1,226

 

3,461

 

3,699

 

Expected return on plan assets

 

(1,161

)

(1,243

)

(3,485

)

(3,695

)

Amortization of actuarial gains

 

95

 

124

 

284

 

403

 

Amortization of prior service costs

 

(54

)

6

 

(59

)

28

 

Net periodic cost

 

$

583

 

$

591

 

$

1,713

 

$

1,856

 

 

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 (114.6)% and 145.5%, respectively, for the three and nine months ended September 30, 2011 were determined using an estimated annual effective tax rate 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 nine months ended September 30, 2011 does not include the benefit of the current year forecasted U.S. tax loss. Income tax expense for the three and nine months ended September 30, 2011 is primarily due to income tax expense in foreign jurisdictions.

 

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 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.

 

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 nine months ended September 30, 2011.

 

(11) Stockholders’ Equity

 

The following demonstrates the change in the number of shares of our Class A common stock outstanding during the nine months ended September 30, 2011 and during the fiscal year ended December 31, 2010:

 

 

 

Nine Months

 

Twelve Months

 

 

 

Ended

 

Ended

 

 

 

September 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

 

403

 

461

 

Shares repurchased into treasury stock

 

 

(2,619

)

Shares outstanding as of end of period

 

92,128

 

91,725

 

 

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(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 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 targets 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 were not approved by stockholders as permitted by applicable stock exchange rules. 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 the vesting of which is contingent upon the Company achieving certain performance targets. Upon determining that the performance target is probable, the fair value of the award is recognized over the service period, subject to potential adjustment.

 

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”). Delivery of shares in respect of any vested performance-vesting RSUs will occur on March 15, 2016. 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.

 

In light of the shares that have been returned to the pool of available shares under the Plan as a result of the completion of the stock option exchange offer described below, on August 18, 2011, the Company entered into an amendment to its employment agreement with Mr. Weil to eliminate (1) the Company’s cash settlement obligation in respect of 200 time-vesting stock options and 500 time-vesting RSUs granted to Mr. Weil on December 2, 2010 that would have been triggered by the unavailability of shares under the Plan and (2) the non-exercisability and forfeiture provisions in respect of the 1,000 performance-conditioned stock options and the 1,000 performance-conditioned RSUs granted to Mr. Weil on December 2, 2010 that would have been triggered by the unavailability of shares under the Plan.  All other terms of Mr. Weil’s employment agreement relating to such equity awards (including the service and performance-based conditions to vesting, exercise and settlement thereof), as set forth in Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on December 3, 2010, are unchanged and remain in full force and effect.

 

The elimination of the cash settlement obligation in respect of certain of Mr. Weil’s awards as described above resulted in the re-classification of such awards from liability awards (i.e., where the award’s fair value, which determines the measurement of the liability on the balance sheet, is re-measured at each reporting period until the award is settled, with fluctuations in the fair value recorded as increases or decreases in compensation expense) to equity awards (i.e., where the compensation expense related to the award is fixed at the grant date based on the award’s grant-date fair value).  The Company began recognizing compensation expense associated with Mr. Weil’s performance-conditioned equity awards during the third quarter.  Neither the performance targets associated with such awards nor the expensing of such awards is necessarily indicative of the Company’s future results generally or for any period.

 

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). In light of the shares that have been returned to the pool of available shares under the Plan as a result of the completion of the stock option exchange offer described below, on August 18, 2011, the Company entered into amendments to its employment agreements with such officers to eliminate the non-exercisability and forfeiture provisions of such awards that would have been triggered by the unavailability of shares under the Plan.  As a result of the elimination of such non-exercisability and forfeiture provisions, the Company began recognizing the compensation expense of the approximately 363 time-vesting stock options, which was not material to our Consolidated Statements of Operations.

 

The equity awards that otherwise would have been forfeited or not exercisable and the equity awards that otherwise would have been settled in cash, as the case may be, to the extent that sufficient shares were not available under the Plan at the time of

 

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delivery of the underlying shares, were not deemed to be granted for accounting purposes as stock-based equity awards until the elimination of such forfeiture, non-exercisability and cash settlement provisions effective on August 18, 2011 (and were not reflected in the tables below as granted or outstanding prior to such date). We had approximately 1,334 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 September 30, 2011 and December 31, 2010, respectively.

 

Stock Option Exchange Program

 

On August 16, 2011, pursuant to its stockholder-approved stock option exchange offer, the Company accepted for exchange (and cancelled) options to purchase an aggregate of 4,918 shares of the Company’s common stock (representing 97% of the total number of options eligible for exchange in the exchange offer) and, in exchange therefor, granted a total of 663 RSUs under the Plan.  Under the terms of the exchange offer, eligible employees (including executive officers) and directors could 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 based on the exchange ratios that were established in order to comply with the terms of the option exchange approved by our stockholders. The RSUs granted in connection with the exchange offer are scheduled to vest on the later of August 16, 2012 or the date on which the corresponding option would have vested.  The option exchange offer did not result in significant incremental stock-based compensation expense.  For additional information regarding the stock option exchange offer, see the Tender Offer Statement on Schedule TO filed by the Company with the SEC on July 19, 2011, as amended on August 5, 2011 and August 16, 2011, and the Current Report on Form 8-K filed by the Company with the SEC on August 18, 2011.

 

Stock Options

 

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

 

Granted

 

1,720

 

 

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Cancelled

 

(4,967

)

 

 

 

 

 

 

Options outstanding as of September 30, 2011

 

3,916

 

8.2

 

9.72

 

150

 

Options exercisable as of September 30, 2011

 

551

 

1.7

 

$

14.26

 

$

150

 

 

The weighted-average grant date fair value of options granted during the three months ended September 30, 2011, June 30, 2011 and March 31, 2011 was $3.90, $4.61 and $4.62, respectively. For the three and nine months ended September 30, 2011, we recognized stock-based compensation expense of approximately $1,500 and $4,900, respectively, related to the vesting of stock options and the related tax benefit of approximately $600 and $1,800, 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.

 

As of September 30, 2011, we had unrecognized compensation expense of approximately $12,000 relating to stock option awards that will be amortized over a weighted-average period of approximately two years.

 

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Restricted Stock Units

 

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

 

Granted

 

2,305

 

8.38

 

Vested

 

(22

)

18.31

 

Cancelled

 

(52

)

13.10

 

Non-vested units as of September 30, 2011

 

5,052

 

$

10.50

 

 

For the three and nine months ended September 30, 2011, we recognized stock-based compensation expense of approximately $4,100 and $10,300 related to the vesting of RSUs and the related tax benefit of approximately $1,600 and $3,900,  respectively. 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.

 

As of September 30, 2011, we had unrecognized compensation expense of approximately $42,000 relating to RSUs that will be amortized over a weighted-average period of approximately two years.

 

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

 

We conduct substantially all of our business through our domestic and foreign subsidiaries. SGI’s obligations under the Credit Agreement, the 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 September 30, 2011 and December 31, 2010 and for the three and nine months ended September 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 September 30, 2011

 

 

 

Parent Company

 

SGI

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

20,680

 

$

106

 

$

 

$

68,705

 

$

(2,612

)

$

86,879

 

Accounts receivable, net

 

 

47,902

 

46,924

 

92,410

 

 

187,236

 

Inventories

 

 

26,840

 

14,589

 

37,967

 

 

79,396

 

Other current assets

 

15,247

 

3,586

 

5,755

 

30,186

 

 

54,774

 

Property and equipment, net

 

2,998

 

168,613

 

36,166

 

230,522

 

 

438,299

 

Investment in subsidiaries

 

571,939

 

726,496

 

 

908,216

 

(2,206,651

)

 

Goodwill

 

 

273,657

 

78,618

 

414,013

 

 

766,288

 

Intangible assets

 

 

41,686

 

26,215

 

20,891

 

 

88,792

 

Intercompany balances

 

125,579

 

 

217,193

 

 

(342,772

)

 

Other assets

 

17,009

 

80,456

 

11,858

 

391,455

 

(6,101

)

494,677

 

Total assets

 

$

753,452

 

$

1,369,342

 

$

437,318

 

$

2,194,365

 

$

(2,558,136

)

$

2,196,341

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

 

$

6,280

 

$

 

$

3,111

 

$

 

$

9,391

 

Other current liabilities

 

34,829

 

62,174

 

26,577

 

103,914

 

(2,613

)

224,881

 

Long-term debt, excluding current installments

 

250,000

 

1,106,303

 

 

26,090

 

 

1,382,393

 

Other non-current liabilities

 

7,846

 

40,362

 

15,711

 

54,980

 

 

118,899

 

Intercompany balances

 

 

48,728

 

 

294,045

 

(342,773

)

 

Stockholders’ equity

 

460,777

 

105,495

 

395,030

 

1,712,225

 

(2,212,750

)

460,777

 

Total liabilities and stockholders’ equity

 

$

753,452

 

$

1,369,342

 

$

437,318

 

$

2,194,365

 

$

(2,558,136

)

$

2,196,341

 

 

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 September 30, 2011

 

 

 

Parent
Company

 

SGI

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

 

$

95,742

 

$

19,976

 

$

107,357

 

$

(336

)

$

222,739

 

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

 

 

29,288

 

39,379

 

57,417

 

(1,405

)

124,679

 

Selling, general and administrative expenses

 

15,476

 

14,710

 

2,404

 

15,096

 

(26

)

47,660

 

Employee termination and restructuring costs

 

 

 

 

1,030

 

 

 

1,030

 

Depreciation and amortization

 

134

 

7,449

 

4,734

 

15,677

 

 

27,994

 

Operating income (loss)

 

(15,610

)

44,295

 

(26,541

)

18,137

 

1,095

 

21,376

 

Interest expense

 

5,351

 

20,535

 

 

411

 

 

26,297

 

Other (income) expense

 

(529

)

48,233

 

(46,473

)

(5,325

)

1,095

 

(2,999

)

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

 

(20,432

)

(24,473

)

19,932

 

23,051