10-Q 1 d01-35198.txt FORM 10-Q 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, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File number: 0-13063 SCIENTIFIC GAMES CORPORATION (FORMERLY AUTOTOTE CORPORATION) (Exact name of registrant as specified in its charter) Delaware 81-0422894 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 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 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 |_| APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock as of November 9, 2001: Class A Common Stock: 40,463,333 Class B Common Stock: None Page 1 of 30 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND OTHER INFORMATION QUARTER ENDED SEPTEMBER 30, 2001 PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements: Balance Sheets as of December 31, 2000 and September 30, 2001 3 Statements of Operations for the Three Months Ended September 30, 2000 and 2001 4 Statements of Operations for the Nine Months Ended September 30, 2000 and 2001 5 Statements of Cash Flows for the Nine Months Ended September 30, 2000 and 2001 6 Notes to Consolidated Financial Statements 7-18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19-28 PART II. OTHER INFORMATION Item 1. Legal Proceedings 29 Item 2. Changes in Securities and Use of Proceeds 29 Item 4. Submission of Matters to a Vote of Stockholders 29 Item 6. Exhibits and Reports on Form 8-K 29 2 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited, in thousands)
December 31, September 30, 2000 2001 ------------ ------------- ASSETS Current assets: Cash and cash equivalents .................................................................... $ 6,488 6,614 Accounts receivable, net of allowance for doubtful accounts .................................. 56,819 47,744 Inventories .................................................................................. 27,608 23,965 Prepaid expenses, deposits and other current assets .......................................... 16,581 16,239 --------- --------- Total current assets .................................................................... 107,496 94,562 --------- --------- Property and equipment, at cost ................................................................... 323,732 350,923 Less accumulated depreciation ................................................................ 139,121 161,109 --------- --------- Net property and equipment .............................................................. 184,611 189,814 --------- --------- Goodwill, net ..................................................................................... 157,591 198,016 Operating right, net .............................................................................. 12,681 11,931 Other intangible assets, net ...................................................................... 118,598 49,698 Other assets and investments ...................................................................... 53,964 48,673 --------- --------- Total assets ......................................................................... $ 634,941 592,694 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current installments of long-term debt ....................................................... $ 6,636 8,709 Accounts payable ............................................................................. 27,176 26,089 Accrued liabilities .......................................................................... 59,142 52,803 Interest payable ............................................................................. 11,112 3,716 --------- --------- Total current liabilities ............................................................... 104,066 91,317 --------- --------- Deferred income taxes ............................................................................. 59,093 27,803 Other long-term liabilities ....................................................................... 9,585 18,592 Long-term debt, excluding current installments .................................................... 434,044 430,479 --------- --------- Total liabilities ....................................................................... 606,788 568,191 --------- --------- Stockholders' equity: Convertible preferred stock, par value $1.00 per share, 2,000 shares authorized, 1,149 and 1,201 shares outstanding at December 31, 2000 and September 30, 2001, respectively ......................................................... 1,149 1,201 Class A common stock, par value $0.01 per share, 99,300 shares authorized, 40,156 and 40,431 shares outstanding at December 31, 2000 and September 30, 2001, respectively ......................................................... 373 376 Class B non-voting common stock, par value $0.01 per share, 700 shares authorized, none outstanding .............................................................. -- -- Additional paid-in capital ................................................................... 266,917 273,206 Accumulated losses ........................................................................... (234,910) (239,118) Treasury stock, at cost ...................................................................... (102) (105) Accumulated other comprehensive loss ......................................................... (5,274) (11,057) --------- --------- Total stockholders' equity .............................................................. 28,153 24,503 --------- --------- Total liabilities and stockholders' equity .............................................. $ 634,941 592,694 ========= =========
See accompanying notes to consolidated financial statements. 3 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended September 30, 2000 and 2001 (Unaudited, in thousands, except per share amounts)
2000 2001 --------- --------- Operating revenues: Services ..................................................................................... $ 54,210 93,418 Sales ........................................................................................ 9,187 13,785 --------- --------- 63,397 107,203 --------- --------- Operating expenses (exclusive of depreciation and amortization shown below): Services ..................................................................................... 36,411 57,603 Sales ........................................................................................ 6,350 9,367 --------- --------- 42,761 66,970 --------- --------- Total gross profit ...................................................................... 20,636 40,233 Selling, general and administrative expenses ...................................................... 10,035 13,166 Depreciation and amortization ..................................................................... 8,222 13,778 --------- --------- Operating income ........................................................................ 2,379 13,289 --------- --------- Other deductions: Interest expense ............................................................................. 15,367 12,322 Other income ................................................................................. (498) (72) --------- --------- 14,869 12,250 --------- --------- Income (loss) before extraordinary items and income tax expense (benefit) ......................... (12,490) 1,039 Income tax expense (benefit) ...................................................................... 229 (483) --------- --------- Income (loss) before extraordinary items ..................................................... (12,719) 1,522 Extraordinary items ............................................................................... 12,567 -- --------- --------- Net income (loss) ............................................................................ (25,286) 1,522 Convertible preferred stock paid-in-kind dividend ................................................. 439 1,790 --------- --------- Net loss available to common stockholders .................................................... $ (25,725) (268) ========= ========= Basic and diluted net income (loss) per share: Basic net income (loss) before extraordinary items per share ................................. $ (0.34) 0.04 ========= ========= Diluted net income (loss) before extraordinary items per share ............................... $ (0.34) 0.03 --------- --------- Extraordinary items per share ................................................................ (0.34) -- --------- --------- Basic net income (loss) per share ............................................................ $ (0.68) 0.04 ========= ========= Diluted net income (loss) per share .......................................................... $ (0.68) 0.03 ========= ========= Basic and diluted net loss per share available to common stockholders ........................ $ (0.70) (0.01) ========= ========= Weighted average number of shares used in per share calculations: Basic shares ................................................................................. 36,931 40,383 ========= ========= Diluted shares ............................................................................... 36,931 46,067 ========= =========
See accompanying notes to consolidated financial statements. 4 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Nine Months Ended September 30, 2000 and 2001 (Unaudited, in thousands, except per share amounts)
2000 2001 --------- --------- Operating revenues: Services ..................................................................................... $ 130,754 273,098 Sales ........................................................................................ 31,409 58,786 --------- --------- 162,163 331,884 --------- --------- Operating expenses (exclusive of depreciation and amortization shown below): Services ..................................................................................... 85,912 173,664 Sales ........................................................................................ 19,810 36,088 --------- --------- 105,722 209,752 --------- --------- Total gross profit ...................................................................... 56,441 122,132 Selling, general and administrative expenses ...................................................... 23,310 41,812 Depreciation and amortization ..................................................................... 18,661 40,954 --------- --------- Operating income ........................................................................ 14,470 39,366 --------- --------- Other deductions: Interest expense ............................................................................. 24,008 38,610 Other (income) expense ....................................................................... (687) 109 --------- --------- 23,321 38,719 --------- --------- Income (loss) before extraordinary items and income tax expense (benefit) ......................... (8,851) 647 Income tax expense (benefit) ...................................................................... 750 (378) --------- --------- Income (loss) before extraordinary items ..................................................... (9,601) 1,025 Extraordinary items ............................................................................... 12,567 -- --------- --------- Net income (loss) ............................................................................ (22,168) 1,025 Convertible preferred stock paid-in-kind dividend ................................................. 439 5,233 --------- --------- Net loss available to common stockholders .................................................... $ (22,607) (4,208) ========= ========= Basic and diluted net income (loss) per share: Basic net income (loss) before extraordinary items per share ................................. $ (0.26) 0.03 ========= ========= Diluted net income (loss) before extraordinary items per share ............................... $ (0.26) 0.02 --------- --------- Extraordinary items per share ................................................................ (0.34) -- --------- --------- Basic net income (loss) per share ............................................................ $ (0.60) 0.03 ========= ========= Diluted net income (loss) per share .......................................................... $ (0.60) 0.02 ========= ========= Basic and diluted net loss per share available to common stockholders ........................ $ (0.62) (0.10) ========= ========= Weighted average number of shares used in per share calculations: Basic shares ................................................................................. 36,761 40,252 ========= ========= Diluted shares ............................................................................... 36,761 44,423 ========= =========
See accompanying notes to consolidated financial statements. 5 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, 2000 and 2001 (Unaudited, in thousands)
2000 2001 --------- --------- Cash flows from operating activities: Net income (loss) ............................................................................ $ (22,168) 1,025 --------- --------- Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization ........................................................... 18,661 40,954 Change in deferred income taxes, net of effects of businesses acquired .............................................. 238 (2,614) Non-cash interest expense ............................................................... 7,511 -- Extraordinary items ..................................................................... 12,567 -- Changes in operating assets and liabilities, net of effects of acquisitions/dispositions of businesses .............................................. (7,503) (243) Other ................................................................................... 1,322 2,242 --------- --------- Total adjustments .................................................................. 32,796 40,339 --------- --------- Net cash provided by operating activities ......................................................... 10,628 41,364 --------- --------- Cash flows from investing activities: Capital expenditures ......................................................................... (3,077) (5,103) Wagering systems expenditures ................................................................ (20,994) (25,329) Increase in other assets and investments ..................................................... (3,974) (9,635) Business acquisitions, net of cash acquired .................................................. (316,242) -- Business disposals, net of cash .............................................................. -- (669) Other ........................................................................................ (5,163) 528 --------- --------- Net cash used in investing activities ............................................................. (349,450) (40,208) --------- --------- Cash flows from financing activities: Net borrowings under revolving credit facility ............................................... (1,070) 3,000 Proceeds from issuance of long-term debt ..................................................... 441,009 -- Payments on long-term debt ................................................................... (189,976) (4,392) Payment of financing fees .................................................................... (16,792) -- Net proceeds from issuance of common stock ................................................... 1,612 552 Net proceeds from issuance of convertible preferred stock .................................... 106,378 -- --------- --------- Net cash provided by (used in) financing activities ............................................... 341,161 (840) --------- --------- Effect of exchange rate changes on cash ........................................................... (411) (190) --------- --------- Increase in cash and cash equivalents ............................................................. 1,928 126 Cash and cash equivalents, beginning of period .................................................... 3,662 6,488 --------- --------- Cash and cash equivalents, end of period .......................................................... $ 5,590 6,614 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest paid ................................................................................ $ 17,246 44,209 ========= ========= Net income taxes paid ........................................................................ $ 2,192 490 ========= ========= Non-cash financing activity during the period: Convertible preferred stock paid-in-kind dividends ........................................... $ 439 5,233 ========= ========= Issuance of common stock warrants in payment of non-cash interest expense .................... $ 7,511 -- ========= =========
See accompanying notes to consolidated financial statements. 6 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited, in thousands, except per share amounts) (1) Consolidated Financial Statements Name Change Effective April 27, 2001, the Company changed its corporate name from Autotote Corporation to Scientific Games Corporation and its stock symbol to SGM [AMEX: SGM]. Basis of Presentation On December 20, 2000, the Company determined to change its fiscal year from an October 31 year-end to a calendar year-end, beginning with the year ending December 31, 2001. This report on Form 10-Q covers the three-month and nine-month periods ended September 30, 2001, compared to the three-month and nine-month periods ended September 30, 2000. The consolidated balance sheets as of December 31, 2000 and September 30, 2001 and the consolidated statements of operations for the three-month and nine-month periods ended September 30, 2000 and 2001, and the consolidated statements of cash flows for the nine months then ended, have been prepared by the Company without audit. In the opinion of management, all adjustments necessary consisting of normal recurring entries to present fairly the financial position of the Company at December 31, 2000 and September 30, 2001 and the results of its operations for the three-month and nine-month periods ended September 30, 2000 and 2001 and its cash flows for the nine months ended September 30, 2000 and 2001 have been made. In the third quarter of 2001, the Company reversed reserves of $1.5 million in connection with litigation that was settled during the quarter. Certain information and footnote disclosures, normally included in 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 the Company's 2000 Annual Report on Form 10-K. The results of operations for the period ended September 30, 2001 are not necessarily indicative of the operating results for the full year. Certain items in prior period's consolidated financial statements have been classified to conform with the current year presentation. 7 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited, in thousands, except per share amounts) (1) Consolidated Financial Statements--(Continued) 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 for the three-month and nine-month periods ended September 30, 2000 and 2001:
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- --------------------------- 2000 2001 2000 2001 ----------- ----------- ----------- ----------- Income (numerator) Income (loss) before extraordinary items ........................... $ (12,719) 1,522 (9,601) 1,025 Extraordinary items ................................................ 12,567 -- 12,567 -- ----------- ----------- ----------- ----------- Net income (loss) .................................................. (25,286) 1,522 (22,168) 1,025 Convertible preferred stock paid-in-kind dividend .................. 439 1,790 439 5,233 ----------- ----------- ----------- ----------- Net income (loss) available to common stockholders ................. $ (25,725) (268) (22,607) (4,208) =========== =========== =========== =========== Shares (denominator) Basic weighted average common shares outstanding ................... 36,931 40,383 36,761 40,252 Effect of diluted securities-stock options, warrants, and deferred shares ............................................... -- 5,684 -- 4,171 ----------- ----------- ----------- ----------- Diluted weighted average common shares outstanding ................. 36,931 46,067 36,761 44,423 =========== =========== =========== =========== Basic and diluted per share amount Basic income (loss) per share before extraordinary items ........... $ (0.34) 0.04 (0.26) 0.03 =========== =========== =========== =========== Diluted income (loss) per share before extraordinary item .......... $ (0.34) 0.03 (0.26) 0.02 =========== =========== =========== =========== Extraordinary items per share ...................................... (0.34) -- (0.34) -- ----------- ----------- ----------- ----------- Basic net income (loss) per share .................................. $ (0.68) 0.04 (0.60) 0.03 =========== =========== =========== =========== Diluted net income (loss) per share ................................ $ (0.68) 0.03 (0.60) 0.02 =========== =========== =========== =========== Basic and diluted net income (loss) per share available to common stockholders ........................................ $ (0.70) (0.01) (0.62) (0.10) =========== =========== =========== ===========
(a) Potential common shares are not included in the calculation of dilutive net loss per share, since the inclusion would be anti-dilutive. 8 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Unaudited, in thousands, except per share amounts) (1) Consolidated Financial Statements--(Continued) At September 30, 2001, the Company had outstanding stock options, warrants, convertible preferred shares and deferred shares, which could potentially dilute basic earnings per share in the future. (See Notes 13 and 14 to the Consolidated Financial Statements for the year ended October 31, 2000 in the Company's 2000 Annual Report on Form 10-K.) Interest Rate Agreements Statement of Financial Accounting Standards No. 133, Accounting For Derivative Instruments and Hedging Activities ("SFAS 133"), as amended by SFAS 138, establishes accounting and reporting standards for derivative instruments and hedging activities. It requires entities to record all derivative instruments on the balance sheet at fair value. Changes in the fair value of derivatives are recorded in each period in current operations or other comprehensive income (loss), based on whether a derivative is designated as part of a hedge transaction and the type of hedge transaction. The ineffective portion of all hedges is recognized in operations. Pursuant to the terms of the Company's credit facility, the Company is required to maintain interest rate hedges for a notional amount of not less than $140,000 for a period of not less than two years. In satisfaction of this requirement, the Company entered into three interest rate swap agreements in November 2000 which obligate the Company to pay a fixed LIBOR rate and entitle the Company to receive a variable LIBOR rate on an aggregate $140,000 notional amount of debt. The Company has structured these interest rate swap agreements and intends to structure all such future agreements to qualify for hedge accounting pursuant to the provisions of SFAS 133. Accumulated other comprehensive losses resulting from the changes in fair value of the interest rate hedge instruments were $2,395 and $8,052 at December 31, 2000 and September 30, 2001, respectively. For the nine months ended September 30, 2001, the Company recorded a $5,657 charge to other comprehensive loss for the change in fair value of the interest rate hedge instruments. (2) Acquisition of Scientific Games Holdings Corp. On September 6, 2000, the Company completed the acquisition of Scientific Games Holdings Corp. ("SGHC"), a world-leading supplier of lottery products, integrated lottery systems and support services, and pre-paid telephone cards. The acquisition was completed through a merger in which SGHC became a wholly-owned subsidiary of the Company, at a cost of approximately $308,000 in aggregate merger consideration to SGHC stockholders, plus related fees and expenses. The acquisition was recorded using the purchase method of accounting. The acquired assets and liabilities were recorded at their estimated fair value at the date of acquisition. In the third quarter of fiscal 2001, the Company finalized the allocation of the purchase price previously allocated on a preliminary basis to the estimated fair value of the assets acquired and liabilities assumed in connection with the acquisition of SGHC, which was consummated on September 6, 2000. The finalization of the allocation of the purchase price resulted in the reclassification of $73.9 million of previously identified intangible assets, including capitalized software, and $29.5 million of related deferred income tax liabilities, or approximately $44.4 million to goodwill. The reclassifications were the result of the consideration of additional information regarding available products and costs of services, and the refinement of certain assumptions used in the determination of the estimated fair values of the acquired assets. The Company has accounted for the reclassification of the intangible assets, including capitalized software, and related deferred income taxes as a change in estimate, and accordingly has reduced capitalized software by $9.8 million, patents by $13.9 million and customer lists by $50.2 million having estimated useful lives of 10, 15 and 20 years, respectively. Goodwill is being amortized over a period of 20 years. Accordingly, the accompanying consolidated balance sheet at September 30, 2001 and the consolidated statement of operations for the three months ended September 30, 2001 have been adjusted to reflect the reclassification and the resulting affect on operations from the date of the revision. Had the reclassification been made at the beginning of the year, the positive affect on net income for the nine month period ended September 30, 2001 would not have been material. 9 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Unaudited, in thousands, except per share amounts) (2) Acquisition of Scientific Games Holdings Corp. --(Continued) The following table presents unaudited pro forma results of operations as if the SGHC acquisition and related financing transactions had occurred at the beginning of the period presented after giving effect to certain adjustments, including amortization of goodwill and other identifiable intangible assets, additional depreciation expense, increased interest expense, convertible preferred stock dividends and related income tax effects. These unaudited pro forma results include amortization and deferred tax benefit computations based on the estimated identifiable intangible assets and related deferred income tax amounts recorded prior to the reclassifications made in the third quarter of 2001, described above, because such reclassifications would not have a material effect on the pro forma results. Additionally, these unaudited pro forma results were presented using current generally accepted accounting principles. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 becomes effective immediately and SFAS 142, which will become effective for the Company in year 2002, will change the accounting and reporting for goodwill and intangible assets. Consequently, beginning January 1, 2002, amortization of goodwill and intangibles with indefinite lives will cease. The amount of amortization of all goodwill and intangible assets with indefinite lives included in the pro forma information shown below for this business combination, as well as other purchased intangible assets previously recorded by the Company, is $4.7 million and $14.0 million, respectively, for the three-month and nine-month periods ended September 30, 2000. The Company has not completed its analysis, including the required impairment testing, but expects that the majority of this amortization will not continue in future periods. These pro forma results have been prepared for comparative purposes and do not purport to be indicative of what would have occurred had the acquisition been made at the beginning of the three-month and nine-month periods ended September 30, 2000 or the results that may occur in the future.
Three Months Ended Nine Months Ended September 30, 2000 September 30, 2000 ------------------ ------------------ (unaudited) (unaudited) Operating revenues ................................................... $ 99,879 319,155 Operating income ..................................................... 2,042 22,902 Loss before income tax benefit and extraordinary items ............... (10,293) (14,392) Net loss before extraordinary items .................................. (9,379) (12,575) Extraordinary item ................................................... 12,567 12,567 Net loss ............................................................. (21,946) (25,142) Convertible preferred stock paid-in-kind dividend .................... 1,691 5,073 ------------ ------------ Net loss available to common stockholders ............................ $ (23,637) (30,215) ============ ============ Basic and diluted loss per share: Net loss before extraordinary items per share ........................ $ (0.25) (0.34) ============ ============ Extraordinary items per share ........................................ (0.34) (0.34) ------------ ------------ Net loss per share ................................................... $ (0.59) (0.68) ============ ============ Net loss per share available to common stockholders .................. $ (0.64) (0.82) ============ ============
10 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Unaudited, in thousands, except per share amounts) (3) Business Segments The following tables represent revenues and profits by business segments for the three-month and nine-month periods ended September 30, 2000 and 2001. Operating income reflects an allocation of corporate expenses among business segments. Interest expense and other (income) deductions are not allocated to business segments.
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- --------------------------- 2000 2001 2000 2001 ----------- ----------- ----------- ----------- Service revenue and product sales: Lottery Group ................................................. $ 23,694 60,559 41,491 177,838 Pari-mutuel Group ............................................. 22,176 22,551 72,045 76,576 Venue Management Group ........................................ 15,689 15,164 46,789 46,489 Telecommunications Group ...................................... 1,838 8,929 1,838 30,981 ----------- ----------- ----------- ----------- $ 63,397 107,203 162,163 331,884 =========== =========== =========== =========== Gross profit: Lottery Group ................................................. $ 6,445 23,621 11,457 64,895 Pari-mutuel Group ............................................. 9,187 9,337 31,356 31,157 Venue Management Group ........................................ 4,223 4,441 12,847 13,618 Telecommunications Group ...................................... 781 2,834 781 12,462 ----------- ----------- ----------- ----------- Total gross profit ....................................... $ 20,636 40,233 56,441 122,132 =========== =========== =========== =========== Operating income (loss): Lottery Group ................................................. $ (778) 6,604 1,321 14,400 Pari-mutuel Group ............................................. 916 2,552 6,519 9,786 Venue Management Group ........................................ 2,105 2,750 6,491 8,374 Telecommunications Group ...................................... 136 1,383 139 6,806 =========== =========== =========== =========== $ 2,379 13,289 14,470 39,366 =========== =========== =========== =========== Depreciation and amortization included in operating income (loss): Lottery Group ................................................. $ 3,304 9,272 4,525 26,471 Pari-mutuel Group ............................................. 4,187 3,675 12,059 11,316 Venue Management Group ........................................ 624 681 1,970 2,003 Telecommunications Group ...................................... 107 150 107 1,164 ----------- ----------- ----------- ----------- Total depreciation and amortization ...................... $ 8,222 13,778 18,661 40,954 =========== =========== =========== =========== A reconciliation of operating income to consolidated income (loss) before income tax expense and extraordinary items is as follows: Segment operating income ........................................... $ 2,379 13,289 14,470 39,366 Other deductions: Interest expense .............................................. 15,367 12,322 24,008 38,610 Other (income) expense ........................................ (498) (72) (687) 109 ----------- ----------- ----------- ----------- Income (loss) before income tax expense and extraordinary items ....................................... $ (12,490) 1,039 (8,851) 647 =========== =========== =========== ===========
11 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (Unaudited, in thousands, except per share amounts) (3) Business Segments--(Continued)
December 31, 2000 September 30, 2001 ----------------- ------------------ Assets: Lottery Group ............................. $ 330,138 305,124 Pari-mutuel Group ......................... 232,990 218,784 Venue Management Group .................... 34,055 33,044 Telecommunications Group .................. 37,758 35,742 =============== =============== $ 634,941 592,694 =============== ===============
Nine Months Ended September 30, -------------------------------- 2000 2001 --------------- --------------- Capital and wagering systems expenditures: Lottery Group ............................. $ 10,205 25,405 Pari-mutuel Group ......................... 12,083 3,051 Venue Management Group .................... 1,497 759 Telecommunications Group .................. 286 1,217 =============== =============== $ 24,071 30,432 =============== ===============
(4) Comprehensive Income (Loss) The following presents a reconciliation of net income (loss) to comprehensive income (loss) for the three months and nine months ended September 30, 2000 and 2001:
Three Months ended Nine Months ended September 30, September 30, --------------------------- --------------------------- 2000 2001 2000 2001 ----------- ----------- ----------- ----------- Net income (loss) .................................................. $ (25,286) 1,522 (22,168) 1,025 Other comprehensive income (loss): Foreign currency translation ..................................... (299) 1,719 (1,051) 120 Unrealized gain (loss) on investments ............................ 611 (461) 611 (246) Unrealized gain (loss) on interest rate swap contracts ........... -- (3,035) -- (5,657) ----------- ----------- ----------- ----------- Other comprehensive income (loss) .................................. 312 (1,777) (440) (5,783) ----------- ----------- ----------- ----------- Comprehensive loss ................................................. $ (24,974) (255) (22,608) (4,758) =========== =========== =========== ===========
12 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Unaudited, in thousands, except per share amounts) (5) Inventories Inventories consist of the following:
December 31, September 30, 2000 2001 --------------- --------------- Parts and work-in-process ................... $ 16,193 9,605 Finished goods .............................. 11,415 14,360 --------------- --------------- $ 27,608 23,965 =============== ===============
Parts and work-in-process include costs for equipment expected to be sold. Costs incurred for equipment associated with specific wagering system service contracts not yet placed in service are classified as construction in progress in property and equipment. (6) Debt At September 30, 2001, the Company had approximately $36,697 available for borrowing under the Company's revolving credit facility (the "Facility"). There were approximately $12,000 of borrowings outstanding under the Facility and approximately $16,303 in letters of credit were issued under the Facility at September 30, 2001. At December 31, 2000, Scientific Games' available borrowing capacity under the Facility was $46,591, subject to limitations imposed by the debt covenants. The Company's financing arrangements impose certain limitations on the operations of the Company and its subsidiaries, including the maintenance of certain financial, liquidity and net worth ratios. As a result of both the financial performance of SGHC prior to the Company's acquisition of SGHC, principally reflecting transitional and operational matters occurring through December 31, 2000, and the timing of certain anticipated capital expenditures and associated borrowings in 2001, management and our lenders amended certain limitations to be less restrictive. Among other changes, the Facility was modified so that the planned step-downs in fixed charge coverage ratios and leverage ratios were delayed by up to nine months through September 30, 2002. The Company is in compliance with the amended covenants as of September 30, 2001 and expects to remain so during the next twelve months. (7) Financial Information for Guarantor Subsidiaries and Non-Guarantor Subsidiaries The Company conducts substantially all of its business through its domestic and foreign subsidiaries. The Facility and the Company's 12 1/2% Series B Senior Subordinated Notes due 2010 (the "Notes") issued in connection with the acquisition of SGHC, are jointly and severally guaranteed by substantially all of the Company's wholly owned domestic subsidiaries (the "Guarantor Subsidiaries"). Presented below is condensed consolidating financial information for (i) Scientific Games Corporation (the "Parent Company"), which includes the activities of Scientific Games Management Corporation, (ii) the Guarantor Subsidiaries and (iii) the wholly owned foreign subsidiaries and the non-wholly owned domestic and foreign subsidiaries (the "Non-Guarantor Subsidiaries") as of December 31, 2000 and September 30, 2001 and for the three months and nine months ended September 30, 2000 and 2001. 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, Guarantor Subsidiaries and Non-Guarantor Subsidiaries assuming the guarantee structure of the Notes was in effect at the beginning of the periods presented. Separate financial statements for Guarantor Subsidiaries are not presented based on management's determination that they would not provide additional information that is material to investors. 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. In addition, corporate interest and administrative expenses have not been allocated to the subsidiaries. 13 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET December 31, 2000 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ ASSETS Cash and cash equivalents .............................. $ 867 (50) 5,671 -- 6,488 Accounts receivable, net ............................... -- 39,554 20,555 (3,290) 56,819 Inventories ............................................ -- 21,602 6,470 (464) 27,608 Other current assets ................................... 186 13,421 2,944 30 16,581 Property and equipment, net ............................ 2,002 142,446 40,452 (289) 184,611 Investment in subsidiaries ............................. 202,980 -- -- (202,980) -- Goodwill ............................................... 190 154,313 3,088 -- 157,591 Intangible assets ...................................... -- 109,232 22,047 -- 131,279 Other assets ........................................... 19,832 75,698 1,077 (42,643) 53,964 --------- --------- --------- --------- --------- Total assets ....................................... $ 226,057 556,216 102,304 (249,636) 634,941 ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current installments of long-term debt ................. $ 6,012 8 616 -- 6,636 Current liabilities .................................... 25,663 51,811 22,866 (2,910) 97,430 Long-term debt, excluding current installments ......... 433,180 19 5,492 (4,647) 434,044 Other non-current liabilities .......................... 5,786 56,851 21,491 (15,450) 68,678 Intercompany balances .................................. (272,737) 245,226 27,809 (298) -- Stockholders' equity ................................... 28,153 202,301 24,030 (226,331) 28,153 --------- --------- --------- --------- --------- Total liabilities and stockholders' equity .......... $ 226,057 556,216 102,304 (249,636) 634,941 ========= ========= ========= ========= =========
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET September 30, 2001 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ ASSETS Cash and cash equivalents .............................. $ 1,079 732 4,803 -- 6,614 Accounts receivable, net ............................... -- 31,344 16,400 -- 47,744 Inventories ............................................ -- 19,695 4,805 (535) 23,965 Other current assets ................................... 716 9,997 5,496 30 16,239 Property and equipment, net ............................ 2,097 148,786 39,278 (347) 189,814 Investment in subsidiaries ............................. 250,840 -- -- (250,840) -- Goodwill ............................................... 185 195,227 2,604 -- 198,016 Intangible assets ...................................... -- 55,248 6,381 -- 61,629 Other assets ........................................... 19,326 44,217 4,464 (19,334) 48,673 --------- --------- --------- --------- --------- Total assets ....................................... $ 274,243 505,246 84,231 (271,026) 592,694 ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current installments of long-term debt ................. $ 8,262 8 439 -- 8,709 Current liabilities .................................... 10,435 51,147 20,227 799 82,608 Long-term debt, excluding current installments ......... 429,984 12 483 -- 430,479 Other non-current liabilities .......................... 11,795 29,514 5,271 (185) 46,395 Intercompany balances .................................. (210,736) 183,844 27,840 (948) -- Stockholders' equity ................................... 24,503 240,721 29,971 (270,692) 24,503 --------- --------- --------- --------- --------- Total liabilities and stockholders' equity .......... $ 274,243 505,246 84,231 (271,026) 592,694 ========= ========= ========= ========= =========
14 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS Three Months Ended September 30, 2000 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ Operating revenues ........................................ $ -- 49,599 17,457 (3,659) 63,397 Operating expenses ........................................ -- 33,044 13,413 (3,696) 42,761 --------- --------- --------- --------- --------- Gross profit .......................................... -- 16,555 4,044 37 20,636 Selling, general and administrative expenses .............. 3,244 5,198 1,596 (3) 10,035 Depreciation and amortization ............................. 66 7,050 1,133 (27) 8,222 --------- --------- --------- --------- --------- Operating income (loss) ............................... (3,310) 4,307 1,315 67 2,379 Interest expense .......................................... 15,333 13 318 (297) 15,367 Other (income) expense .................................... (624) 74 (280) 332 (498) --------- --------- --------- --------- --------- Income (loss) before equity in income of subsidiaries and income taxes ......................... (18,019) 4,220 1,277 32 (12,490) Equity in income of subsidiaries .......................... 5,262 -- -- (5,262) -- Income tax expense (benefit) .............................. 7 (33) 255 -- 229 --------- --------- --------- --------- --------- Net income (loss) before extraordinary items .............. (12,764) 4,253 1,022 (5,230) (12,719) Extraordinary items: Write-off of deferred finance fees and debt call premium ................................. 12,522 45 -- -- 12,567 --------- --------- --------- --------- --------- Net income (loss) ......................................... $ (25,286) 4,208 1,022 (5,230) (25,286) ========= ========= ========= ========= =========
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS Three Months Ended September 30, 2001 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ Operating revenues ........................................ $ -- 84,712 25,559 (3,068) 107,203 Operating expenses ........................................ -- 52,036 17,809 (2,875) 66,970 --------- --------- --------- --------- --------- Gross profit .......................................... -- 32,676 7,750 (193) 40,233 Selling, general and administrative expenses .............. 2,392 8,008 2,985 (219) 13,166 Depreciation and amortization ............................. 77 12,685 1,037 (21) 13,778 --------- --------- --------- --------- --------- Operating income (loss) ............................... (2,469) 11,983 3,728 47 13,289 Interest expense .......................................... 12,170 80 540 (468) 12,322 Other (income) expense .................................... 203 (742) 78 389 (72) --------- --------- --------- --------- --------- Income (loss) before equity in income of subsidiaries and income taxes ......................... (14,842) 12,645 3,110 126 1,039 Equity in income of subsidiaries .......................... 16,364 -- -- (16,364) -- Income tax expense (benefit) .............................. -- (1,059) 576 -- (483) --------- --------- --------- --------- --------- Net income ................................................ $ 1,522 13,704 2,534 (16,238) 1,522 ========= ========= ========= ========= =========
15 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS Nine Months Ended September 30, 2000 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ Operating revenues ........................................ $ -- 131,770 41,918 (11,525) 162,163 Operating expenses ........................................ -- 84,735 32,746 (11,759) 105,722 --------- --------- --------- --------- --------- Gross profit ........................................... -- 47,035 9,172 234 56,441 Selling, general and administrative expenses .............. 7,998 11,562 3,760 (10) 23,310 Depreciation and amortization ............................. 209 15,761 2,768 (77) 18,661 --------- --------- --------- --------- --------- Operating income (loss) ............................... (8,207) 19,712 2,644 321 14,470 Interest expense .......................................... 23,490 380 715 (577) 24,008 Other (income) expense .................................... (873) (141) (285) 612 (687) --------- --------- --------- --------- --------- Income (loss) before equity in income of subsidiaries and income taxes ......................... (30,824) 19,473 2,214 286 (8,851) Equity in income of subsidiaries .......................... 21,285 -- -- (21,285) -- Income tax expense ........................................ 107 350 293 -- 750 --------- --------- --------- --------- --------- Net income (loss) before extraordinary items .............. (9,646) 19,123 1,921 (20,999) (9,601) Extraordinary items:: Write-off of deferred finance fees and debt call premium.................................: 12,522 45 -- -- 12,567 --------- --------- --------- --------- --------- Net income (loss) ......................................... $ (22,168) 19,078 1,921 (20,999) (22,168) ========= ========= ========= ========= =========
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS Nine Months Ended September 30, 2001 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ Operating revenues ........................................ $ -- 254,387 87,104 (9,607) 331,884 Operating expenses ........................................ -- 158,360 60,546 (9,154) 209,752 --------- --------- --------- --------- --------- Gross profit ........................................... -- 96,027 26,558 (453) 122,132 Selling, general and administrative expenses .............. 9,048 23,854 9,164 (254) 41,812 Depreciation and amortization ............................. 229 36,751 4,035 (61) 40,954 --------- --------- --------- --------- --------- Operating income (loss) ................................ (9,277) 35,422 13,359 (138) 39,366 Interest expense .......................................... 38,363 202 1,594 (1,549) 38,610 Other (income) expense .................................... (335) (1,777) 768 1,453 109 --------- --------- --------- --------- --------- Income (loss) before equity in income of subsidiaries and income taxes .......................... (47,305) 36,997 10,997 (42) 647 Equity in income of subsidiaries .......................... 47,705 -- -- (47,705) -- Income tax expense (benefit) .............................. (625) (2,917) 3,164 -- (378) --------- --------- --------- --------- --------- Net income ................................................ $ 1,025 39,914 7,833 (47,747) 1,025 ========= ========= ========= ========= =========
16 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED STATEMENT OF CASH FLOWS Nine Months Ended September 30, 2000 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ Net income (loss) ......................................... $ (22,168) 19,078 1,921 (20,999) (22,168) Depreciation and amortization .......................... 209 15,761 2,768 (77) 18,661 Equity in income of subsidiaries ....................... (21,285) -- -- 21,285 -- Extraordinary items .................................... 12,492 75 -- -- 12,567 Non cash interest expense .............................. 7,511 -- -- -- 7,511 Other non-cash adjustments ............................. 1,014 266 238 42 1,560 Changes in operating assets and liabilities ............ 2,146 (4,317) (5,719) 387 (7,503) --------- --------- --------- --------- --------- Net cash provided by (used in) operating activities ....... (20,081) 30,863 (792) 638 10,628 --------- --------- --------- --------- --------- Cash flows from investing activities: Capital and wagering systems expenditures .............. (118) (19,980) (4,035) 62 (24,071) Business acquisitions, net of cash acquired ............ (111,305) (205,010) 73 -- (316,242) Other assets and investments ........................... (120,519) 110,444 995 (57) (9,137) --------- --------- --------- --------- --------- Net cash used in investing activities ..................... (231,942) (114,546) (2,967) 5 (349,450) --------- --------- --------- --------- --------- Cash flows from financing activities: Net borrowing (repayments) under lines of credit ....... (1,070) -- -- -- (1,070) Proceeds from issuance of long-term debt ............... 440,000 -- 1,009 -- 441,009 Payments on long-term debt ............................. (155,000) (34,277) (971) 272 (189,976) Payment of finance fees ................................ (16,792) -- -- -- (16,792) Net proceeds from common stock issue ................... 1,612 -- -- -- 1,612 Net proceeds from preferred stock issue ................ 106,378 -- -- -- 106,378 Other, principally intercompany balances ............... (128,483) 124,300 4,822 (639) -- --------- --------- --------- --------- --------- Net cash provided by financing activities ................. 246,645 90,023 4,860 (367) 341,161 --------- --------- --------- --------- --------- Effect of exchange rate changes on cash ................... -- 378 (513) (276) (411) --------- --------- --------- --------- --------- Increase (decrease) in cash and cash equivalents .......... (5,378) 6,718 588 -- 1,928 Cash and cash equivalents, beginning of period ............ 5,284 (8,294) 6,672 -- 3,662 --------- --------- --------- --------- --------- Cash and cash equivalents, end of period .................. $ (94) (1,576) 7,260 -- 5,590 ========= ========= ========= ========= =========
17 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONDENSED STATEMENT OF CASH FLOWS Nine Months Ended September 30, 2001 (unaudited, in thousands)
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------- ------------ ------------- ----------- ------------ Net income ................................................ $ 1,025 39,914 7,833 (47,747) 1,025 Depreciation and amortization .......................... 229 36,751 4,035 (61) 40,954 Equity in income of subsidiaries ....................... (47,705) -- -- 47,705 -- Changes in operating assets and liabilities ............ (12,733) 11,746 (202) 946 (243) Other non-cash adjustments ............................. 2,301 (3,295) 622 -- (372) --------- --------- --------- --------- --------- Net cash provided by (used in) operating activities ....... (56,883) 85,116 12,288 843 41,364 --------- --------- --------- --------- --------- Cash flows from investing activities: Capital and wagering systems expenditures .............. (239) (25,215) (5,191) 213 (30,432) Proceeds from sale of business ......................... -- 1,550 (2,219) -- (669) Other assets and investments ........................... (978) (8,069) (117) 57 (9,107) --------- --------- --------- --------- --------- Net cash used in investing activities ..................... (1,217) (31,734) (7,527) 270 (40,208) --------- --------- --------- --------- --------- Cash flows from financing activities: Net borrowing under lines of credit .................... 3,000 -- -- -- 3,000 Payments on long-term debt ............................. (3,946) (7) (632) 193 (4,392) Proceeds from stock issue .............................. 552 -- -- -- 552 Other, principally intercompany balances ............... 58,650 (52,224) (5,120) (1,306) -- --------- --------- --------- --------- --------- Net cash provided by (used in) financing activities ....... 58,256 (52,231) (5,752) (1,113) (840) --------- --------- --------- --------- --------- Effect of exchange rate changes on cash ................... 56 (369) 123 -- (190) --------- --------- --------- --------- --------- Increase (decrease) in cash and cash equivalents .......... 212 782 (868) -- 126 Cash and cash equivalents, beginning of period ............ 867 (50) 5,671 -- 6,488 --------- --------- --------- --------- --------- Cash and cash equivalents, end of period .................. $ 1,079 732 4,803 -- 6,614 ========= ========= ========= ========= =========
18 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2001 Background Effective April 27, 2001, the Company changed its corporate name from Autotote Corporation to Scientific Games Corporation and its stock symbol to SGM [AMEX: SGM]. The Company changed its fiscal year from an October 31 year-end to a calendar year-end, beginning with the year ending December 31, 2001. As a result, the Company is filing this report for the third quarter and first nine months of year 2001, which ended on September 30, 2001, compared to the three-month and nine-month periods ended September 30, 2000. The following discussion addresses the financial condition of the Company as of September 30, 2001 and the results of its operations for the three-month and nine-month periods ended September 30, 2001, compared to the same periods in the prior year. This discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended October 31, 2000, included in the Company's 2000 Annual Report on Form 10-K. We operate in four business segments: Lottery Group, Pari-mutuel Group, Venue Management Group and Telecommunications Group. Our Lottery Group consists of two product lines: Instant Tickets and Related Services ("ITRS") and Lottery Systems. ITRS includes ticket design and manufacturing as well as value-added services, including game design, sales and marketing support, inventory management and warehousing and fulfillment services. In addition, this division includes promotional instant tickets and pull-tab tickets that we sell to both lottery and non-lottery customers. Lottery Systems includes the supply of transaction processing software for the accounting and validation of both instant ticket and on-line lottery games, point-of-sale terminal hardware sales, central site computers and communication hardware sales, and ongoing support and maintenance services for these products. This product line also includes software and hardware and support service for sports betting and credit card processing systems. Our Pari-mutuel Group is comprised of our North American and international on-track, off-track and inter-track pari-mutuel services, simulcasting and communications services, and video gaming, as well as sales of pari-mutuel systems and equipment. Our Venue Management Group is comprised of the Connecticut off-track betting operations, and the Company's Netherlands on-track and off-track betting operations. Our Telecommunications Group is comprised of the prepaid cellular phone cards business, which was acquired by the Company as part of the SGHC acquisition. In the second quarter of fiscal 2000, the Company completed the sale of its SJC Video business, which had previously been reported as a separate segment. Until the SGHC acquisition on September 6, 2000, our Lottery Group consisted solely of the Lottery Systems product line, exclusive of sports betting and credit card processing services. Thereafter, the Lottery Group includes the ITRS and the portion of the Lottery Systems business that were acquired with SGHC. In addition, the Telecommunications Group's operations are from September 6, 2000, the date of the SGHC acquisition. The Company's revenues are derived from two principal sources: service revenues and sales revenues. Service revenues are earned pursuant to multi-year contracts to provide ITRS and wagering systems and services; or are derived from wagering by customers at facilities owned or leased by the Company. Sales revenues are derived from sales of prepaid phone cards and from contracts for the sale of wagering systems, equipment, and software licenses. The first calendar quarter and the fourth calendar quarter of the year traditionally comprise the weakest season for the Company's pari-mutuel wagering service revenue. Wagering equipment sales and software license revenues usually reflect a limited number of large transactions that do not recur on an annual basis. Consequently, revenues and operating results can vary substantially from period to period as a result of the timing of revenue recognition for major equipment sales and software license revenue. In addition, instant ticket and prepaid phone card sales may vary depending on the size and timing of contract awards, changes in customer budgets, inventory ticket position, lottery retail sales and general economic conditions. 19 Operating results may also vary significantly from period to period depending on the addition or disposition of business units in each period. The acquisition of SGHC in 2000, which was accounted for as a purchase, affects the comparability of operations from period to period (see Note 3 to the Consolidated Financial Statements for the year ended October 31, 2000 included in the Company's 2000 Annual Report on Form 10-K). The following tables and discussion present actual data for the three-month and nine-month periods ended September 30, 2000 and 2001, and pro forma data for three-month and nine-month periods ended September 30, 2000, as if the Company had acquired SGHC on January 1, 2000.
Three Months Ended Nine Months Ended Results of Operations: September 30, September 30, ------------------------------------ ------------------------------------ Actual Pro Forma Actual Actual Pro Forma Actual 2000 2000 2001 2000 2000 2001 ---------- ---------- ---------- ---------- ---------- ---------- Lottery Group Operating Revenues: Service revenue ........................... $ 16,982 46,601 57,201 22,888 146,679 165,952 Sales revenue ............................. 6,712 7,716 3,358 18,603 24,911 11,886 ---------- ---------- ---------- ---------- ---------- ---------- Total Revenue ........................ $ 23,694 54,317 60,559 41,491 171,590 177,838 ========== ========== ========== ========== ========== ========== Gross Profit (excluding depreciation and amortization) ............................ $ 6,445 14,665 23,621 11,457 52,267 64,895 ========== ========== ========== ========== ========== ========== Pari-mutuel Group Operating Revenues: Service revenue ........................... $ 21,539 21,539 21,053 61,077 61,077 60,657 Sales revenue ............................. 637 637 1,498 10,968 10,968 15,919 ---------- ---------- ---------- ---------- ---------- ---------- Total Revenue ........................ $ 22,176 22,176 22,551 72,045 72,045 76,576 ========== ========== ========== ========== ========== ========== Gross Profit (excluding depreciation and amortization) ............................ $ 9,187 9,187 9,337 31,356 31,356 31,157 ========== ========== ========== ========== ========== ========== Venue Management Group Operating Revenues: Service revenue ........................... $ 15,689 15,689 15,164 46,789 46,789 46,489 ========== ========== ========== ========== ========== ========== Gross Profit (excluding depreciation and amortization) ............................ $ 4,223 4,223 4,441 12,847 12,847 13,618 ========== ========== ========== ========== ========== ========== Telecommunications Group Operating Revenues: Sales revenue ............................. $ 1,838 7,697 8,929 1,838 28,731 30,981 ========== ========== ========== ========== ========== ========== Gross Profit (excluding depreciation and amortization) ............................ $ 781 3,182 2,834 781 12,311 12,462 ========== ========== ========== ========== ========== ========== Company Total Operating Revenues: Service revenue ........................... $ 54,210 83,829 93,418 130,754 254,545 273,098 Sales revenue ............................. 9,187 16,050 13,785 31,409 64,610 58,786 ---------- ---------- ---------- ---------- ---------- ---------- Total Revenue ........................ $ 63,397 99,879 107,203 162,163 319,155 331,884 ========== ========== ========== ========== ========== ========== Gross Profit (excluding depreciation and amortization) ............................ $ 20,636 31,257 40,233 56,441 108,781 122,132 ========== ========== ========== ========== ========== ==========
20 Three Months Ended September 30, 2001 Compared to Three Months Ended September 30, 2000 Revenue Analysis Lottery Group revenue of $60.6 million in the three months ended September 30, 2001 improved $36.9 million from the same period in 2000 due to the addition of SGHC in September 2000, and the start-up of on-line Iowa and Maine lotteries in July 2001. Partially offsetting this increase were the non-recurring EXTREMA(R) terminal sales to a foreign customer in the third quarter of 2000. On a pro forma basis, total service revenue in the three months ended September 30, 2001 of $57.2 million, increased $10.6 million or 23% from the same period in 2000 largely due to the addition of new on-line lotteries in Iowa and Maine and solid growth in recurring instant ticket and cooperative services revenue. On a pro forma basis, total sales revenue of $3.4 million declined $4.4 million as a result of the previously mentioned non-recurring equipment sales in 2000. Pari-mutuel Group service revenue of $21.1 million in the three months ended September 30, 2001 decreased $0.5 million from the same period in 2000. This decrease is attributable to lower revenues in the French and German operations due to lower pari-mutuel Handle and unfavorable foreign exchange impact as a result of the strengthening of the dollar versus the European currencies. Partially offsetting this decrease are revenue improvements in the North American pari-mutuel, simulcasting and NASRIN(TM) service operations despite the lost revenue caused by the temporary closure of a number of major racetracks immediately following the September 11, 2001 terrorist attack. Sales revenue of $1.5 million in the three months ended September 30, 2001 increased $0.9 million from same period in 2000 due to higher systems and equipment sales to foreign customers. Venue Management Group service revenue of $15.2 million in the three months ended September 30, 2001 was $0.5 million lower than in the same period in 2000, reflecting lower revenues in the Netherlands operations as a result of the strengthening of the dollar and lower Handle-related revenue in the Connecticut OTB operations due to the loss of racing programs following the September 11, 2001 attack and increased return to bettors for races held at New York Racing Association tracks. Telecommunications Group sales revenue of $8.9 million in the three months ended September 30, 2001 increased $7.1 million as the result of the acquisition of SGHC on September 6, 2000. On a pro forma basis, revenues in the three months ended September 30, 2001 increased $1.2 million over the prior year period as a 17% increase in volume was partially offset by price decreases. Gross Profit Analysis The total gross profit earned, exclusive of depreciation and amortization, of $40.2 million in the three months ended September 30, 2001 increased $19.6 million from the same period in 2000 as a result of the acquisition of SGHC on September 6, 2000. On a pro forma basis, the gross profit earned, exclusive of depreciation and amortization, increased $9.0 million, primarily because of revenue improvements and significant cost reductions. These improvements were partially offset by lower margins on systems and equipment sales reflecting the absence of year 2000 non-recurring terminal sales and lower selling prices on phone cards. On a pro forma basis, gross profit as a percentage of service revenues increased to 38% in the three months ended September 30, 2001 compared to 31% in the same period in 2000. This gross profit increase results primarily from revenue improvements and cost control measures in the Lottery Group and from cost reduction programs in Europe. On a pro forma basis, gross profit as a percentage of sales revenues in the three months ended September 30, 2001 was 32%, equal to the gross profit percentage earned in the same period in 2000. Improvements in gross profit from the mix of systems and equipment sold in the two periods was partially offset by lower margins on phone card sales due to lower selling prices. The Lottery Group gross profit of $23.6 million, or 39% of revenues, increased 61% on a pro forma basis in the three months ended September 30, 2001 from $14.7 million, or 27% of revenues, in the same period in 2000. Gross margin improvements were realized as a result of revenue improvements coupled with cost reduction programs discussed above. These margin improvements were partially offset by non-recurring year 2000 terminal sales. Pari-mutuel Group gross profit of $9.3 million, or 41% of revenues in the three months ended September 30, 2001, was comparable to the $9.2 million, or 41% of revenues, in the same period in 2000. Cost reduction savings in the European service businesses offset the decrease in Handle-related margin attributable to the lost racing programs immediately following the September 11, 2001 attack. 21 Venue Management Group gross profit of $4.4 million, or 29% of revenues, in the three months ended September 30, 2001, improved $0.2 million from $4.2 million, or 27% of revenues, in the same period in 2000. This improvement primarily reflects reduced operating costs in the Netherlands operation under a recently renegotiated operating agreement, partially offset by the immediate effect of the September 11, 2001 attack. The Telecommunications Group gross profit of $2.8 million in the three months ended September 30, 2001, decreased $0.4 million from $3.2 million on a pro forma basis in the same period in 2000. Gross profit in the three months ended September 30, 2001 was 32% of revenues as compared to 41% of revenues on a pro forma basis in the same period in 2000 resulting from phone card sales price reductions. Expense Analysis Selling, general and administrative expenses of $13.2 million in the three months ended September 30, 2001 were $3.1 million higher than in the same period in 2000 primarily as a result of the acquisition of SGHC on September 6, 2000. On a pro forma basis, selling, general and administrative expenses were $3.6 million lower in the three months ended September 30, 2001 than in the same period in 2000, primarily as a result of cost reduction programs, merger-related synergies and the absence of prior year acquisition-related expenses. Depreciation and amortization expense of $13.8 million in the three months ended September 30, 2001 increased $5.6 million from $8.2 million in the same period in 2000 as a result of the SGHC acquisition, coupled with the start-up of on-line Iowa and Maine lotteries in July 2001. On a pro forma basis, depreciation and amortization expenses were $1.4 million higher in the three months ended September 30, 2001 than in the same period in 2000, primarily as a result of the expanded domestic lottery business. Interest expense of $12.3 million in the three months ended September 30, 2001 decreased $3.1 million from $15.4 million in the same period in 2000. One-time, non-cash acquisition related financing expense of $7.5 million recorded in the prior year period was partially offset by the impact of three months of SGHC acquisition-related debt expense in the third quarter of 2001, compared to less than one month of such expense in the prior year period. Income Tax Expense The Company recorded an income tax benefit of $0.5 million in the third quarter of 2001 as compare to a tax expense of $0.2 million in the third quarter of 2000. State and foreign taxes were offset by three months of deferred tax benefit in the third quarter of 2001 and partially offset by one month of deferred tax benefit in the third quarter of 2001. Deferred tax benefit results from reversal of deferred taxes provided in connection with the acquisition of SGHC. No current tax benefit has been recognized on domestic operating losses in either period. Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30, 2000 Revenue Analysis Lottery Group revenue of $177.8 million in the nine months ended September 30, 2001 improved $136.3 million from the same period in 2000 due to the addition of SGHC on September 6, 2000, the start-up of the on-line Vermont and new Hampshire lotteries in July 2000 and the Iowa and Maine lotteries in July 2001, the sale of a pari-mutuel system and terminals to a customer in Turkey and the sale of terminals to the Jamaica Lottery. Partially offsetting these improvements was the absence of the non-recurring EXTREMA(R) terminal sales to a foreign customer in the nine months of year 2000. On a pro forma basis, lottery service revenue in the nine months ended September 30, 2001 of $166.0 million, increased $19.3 million from the same period in 2000 largely due to the growth in the world-wide on-line lottery business, particularly the new on-line lotteries in Vermont, New Hampshire, Iowa and Maine, and solid growth in recurring domestic instant ticket and cooperative service revenue. On a pro forma basis, total sales revenue of $11.9 million, declined $13.0 million reflecting the absence of the previously mentioned non-recurring, year 2000 equipment sales to a foreign customer. Pari-mutuel Group service revenue of $60.7 million in the nine months ended September 30, 2001 decreased $0.4 million from the same period in 2000. This decrease is attributable to lower revenues in the French and German operations due to lower pari-mutuel Handle and the strengthening of the dollar. Partially offsetting the decrease are revenue improvements in the North American pari-mutuel, simulcasting and NASRIN(TM) service operations despite the loss of racing programs following the September 11, 2001 attack. Sales revenue of $15.9 million in the nine months ended September 30, 2001 increased $5.0 million from same period in 2000 due to higher systems and equipment sales to foreign customers. 22 Venue Management Group service revenue of $46.5 million in the nine months ended September 30, 2001 was $0.3 million lower than in the same period in 2000, reflecting lower revenues in the Netherlands operations as a result of the strengthening of the dollar, and lower revenues in Connecticut OTB immediately following the September 11, 2001 attack. Telecommunications Group sales revenue of $31.0 million in the nine months ended September 30, 2001 is the result of the acquisition of SGHC on September 6, 2000. On a pro forma basis, revenues in the nine months ended September 30, 2001 increased $2.3 million over the prior year period as a 21% growth in volume was partially offset by price decreases. Gross Profit Analysis The total gross profit earned, exclusive of depreciation and amortization, of $122.1 million in the nine months ended September 30, 2001 increased $65.7 million from the same period in 2000 as a result of the acquisition of SGHC on September 6, 2000. On a pro forma basis, the gross profit earned, exclusive of depreciation and amortization, increased $13.4 million or 12%, primarily because of revenue improvements described above and significant cost reductions. These improvements were partially offset by lower margins on systems and equipment sales reflecting the absence of year 2000 non-recurring terminal sales. On a pro forma basis, gross profit as a percentage of service revenues increased to 36% in the nine months ended September 30, 2001, compared to 33% in the same period in 2000. This gross profit increase results primarily from revenue improvements and cost control measures across all segments of the Company's service businesses. On a pro forma basis, gross profit as a percentage of sales revenues was 39% in the nine months ended September 30, 2001 compared to 38% in the same period in 2000, reflecting the change in the mix of systems and equipment sold in the two periods. The Lottery Group gross profit of $64.9 million, or 37% of revenues, increased $12.6 million or 24% on a pro forma basis in the nine months ended September 30, 2001 from $52.3 million or 31% of revenues in the same period in 2000. Gross margin improvements were largely due to the growth in the world-wide on-line lottery business, particularly the addition of the Vermont and New Hampshire lottery contracts in July 2000 and the Iowa and Maine lotteries in July 2001, and to revenue improvements in the cooperative services and the domestic instant tickets businesses. These margin improvements were partially offset by non-recurring year 2000 terminal sales. Pari-mutuel Group gross profit of $31.2 million or 41% of revenues in the nine months ended September 30, 2001, decreased from $31.4 million or 44% of revenues in the same period in 2000. The decrease in gross margin percentage is primarily attributable to the mix of systems and equipment sales, mostly offset by the benefits of cost reduction programs in simulcasting and NASRIN(TM) services. Venue Management Group gross profit of $13.6 million or 29% of revenues in the nine months ended September 30, 2001, improved $0.8 million from $12.8 million or 28% of revenues in the same period in 2000. This improvement primarily reflects higher Handle and reduced operating costs in the Connecticut OTB operation and lower expenses in the Netherlands due to a revised operating agreement. The Telecommunications Group gross profit of $12.5 million or 40% of revenues in the nine months ended September 30, 2001, improved $0.2 million from $12.3 million or 43% of revenues on a pro forma basis in the same period in 2000. This improvement reflects the effect of higher volume and cost savings initiatives, offset by price pressures in the industry. Expense Analysis Selling, general and administrative expenses of $41.8 million in the nine months ended September 30, 2001 were $18.5 million higher than in the same period in 2000 primarily as a result of the acquisition of SGHC in September 2000. On a pro forma basis, selling, general and administrative expenses were $7.8 million lower in the nine months ended September 30, 2001 than in the same period in 2000, primarily as a result of cost reduction programs and merger-related synergies. Depreciation and amortization expense of $41.0 million in the nine months ended September 30, 2001 increased $22.3 million from $18.7 million in the same period in 2000 as a result of the SGHC acquisition, coupled with the expanded domestic lottery business. On a pro forma basis, depreciation and amortization expenses were $4.7 million higher in the nine months ended September 30, 2001 than in the same period in 2000, primarily as a result of depreciation on the year 2000 expansion of the Alpharetta, Georgia printing facility and construction of the new Leeds, United Kingdom printing facility, new computer systems and terminals for the expanded domestic lottery business. 23 Interest expense of $38.6 million in the nine months ended September 30, 2001 increased $14.6 million from $24.1 million in the same period in 2000 due to nine months of SGHC acquisition-related debt expense in the year 2001 period, compared to less than one month of SGHC acquisition-related debt expense and the one-time, non-cash acquisition related financing expense of $7.5 million recorded in the prior year period. Income Tax Expense The Company recorded an income tax benefit of $0.4 million in the nine months ended September 30, 2001 as compare to a tax expense of $0.8 million in the same period in 2000. State and foreign taxes were offset by nine months of deferred tax benefit in the year 2001 period, but only partially offset by one month of deferred tax benefit in the nine months of 2000. Deferred tax benefit results from reversal of deferred taxes provided in connection with the September 6, 2000 acquisition of SGHC. No current tax benefit has been recognized on domestic operating losses in either period. Liquidity, Capital Resources and Working Capital In order to finance the SGHC acquisition and refinance substantially all of the then existing indebtedness of the Company, we conducted a series of financings in September 2000. As a result, our capital structure changed significantly and, among other things, we are a significantly leveraged company. As a result of the acquisition and debt refinancing, we have total indebtedness outstanding of approximately $439.2 million at September 30, 2001. We have also recorded a substantial increase in goodwill and other intangible assets in connection with the SGHC acquisition and a corresponding increase in amortization expense. At September 30, 2001, the Company's available cash and borrowing capacity totaled $43.3 million compared to $53.1 million at December 31, 2000. Net cash provided by operating activities was $41.4 million for the nine months ended September 30, 2001. In this period, we spent $30.4 million for wagering systems and capital expenditures, $9.6 million in software and other asset expenditures and repaid $4.4 million on long-term debt. These cash expenditures were funded primarily with net cash provided by operating activities and increased borrowings under our revolving credit facility. A significant portion of our cash flows from operations must be used to pay our interest expense and repay our indebtedness, which will reduce the funds that would otherwise be available to us for our operations and capital expenditures. We believe that our cash flow from operations, available cash and available borrowings under our revolving credit facility will be sufficient to meet our liquidity needs, including anticipated capital expenditures, for the foreseeable future; however, we cannot assure you that this will be the case. While we are not aware of any reason to do so, if we need to refinance all or part of our indebtedness, including the Notes, on or before their maturity, we cannot assure you that we will be able to refinance any of our indebtedness, including our Facility and the Notes, on commercially reasonable terms or at all. The Company's financing arrangements impose certain limitations on the operations of the Company and its subsidiaries, including the maintenance of certain financial, liquidity and net worth ratios. As a result of both the financial performance of SGHC prior to the Company's acquisition of SGHC, principally reflecting transitional and operational matters occurring through December 31, 2000, and the timing of certain anticipated capital expenditures and associated borrowings in 2001, in the first quarter of 2001, management and our lenders amended certain limitations to be less restrictive. Among other changes, the Facility was modified so that the planned step-downs in fixed charge coverage ratios and leverage ratios were delayed by up to nine months through September 30, 2002. The Company is in compliance with the amended covenants as of September 30, 2001 and expects to remain so during the next twelve months. 24 Forward-Looking Statements Throughout this Report on Form 10-Q we make "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements include the words "may," "will," "estimate," "intend," "continue," "believe," "except" or "anticipate" and other similar words. The forward-looking statements contained in this 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 forward-looking statements generally relate to plans and objectives for future operations and are based upon management's reasonable estimates of future results or trends. Although we believe that the plans and objectives reflected in or suggested by such forward-looking statements are reasonable, such plans or objectives may not be achieved. Actual results may differ from projected results due, but not limited, to unforeseen developments, including developments relating to the following: o the availability and adequacy of our cash flow to satisfy our obligations, including our debt service obligations and our need for additional funds required to support capital improvements and development; o economic, competitive, demographic, business and other conditions in our local and regional markets; o changes or developments in the laws, regulations or taxes in the gaming and lottery industries; o actions taken or omitted to be taken by third parties, including customers, suppliers, competitors, members and shareholders, as well as legislative, regulatory, judicial and other governmental authorities; o changes in business strategy, capital improvements, development plans, including those due to environmental remediation concerns, or changes in personnel or their compensation, including federal, state and local minimum wage requirements; and o the loss of any license or permit, including the failure to obtain an unconditional renewal of a required gaming license on a timely basis. Actual future results may be materially different from what we expect. We will not update forward-looking statements even though our situation may change in the future. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our products and services are sold to a diverse group of customers throughout the world. As such, we are subject to certain risks and uncertainties as a result of changes in general economic conditions, sources of supply, competition, foreign exchange rates, tax reform, litigation and regulatory developments. The diversity and breadth of our products and geographic operations mitigate the risk that adverse changes in any event would materially affect our financial position. Additionally, as a result of the diversity of our customer base, we do not consider ourselves exposed to concentration of credit risks. These risks are further minimized by setting credit limits, ongoing monitoring of customer account balances, and assessment of the customers' financial strengths. Inflation has not had an abnormal or unanticipated effect on our operations. Inflationary pressures would be significant to our business if raw materials used for instant lottery ticket production, prepaid phone card production or terminal manufacturing are significantly affected. Available supply from the paper and electronics industries tends to fluctuate and prices may be affected by supply. For fiscal 2000, inflation was not a significant factor in our results of operations, and we were not impacted by significant pricing changes in our costs, except for personnel related expenditures. We are unable to forecast the prices or supply of substrate, component parts or other raw materials for the balance of 2001, but we currently do not anticipate any substantial changes that will materially affect our operating results. In certain limited cases, our lottery contracts with our customers contain provisions to adjust for inflation on an annual basis, but we cannot be assured that this adjustment would cover raw material price increases or other costs of services. While we have long-term and generally satisfactory relationships with most of our suppliers, we also believe alternative sources to meet our raw material and production needs are available. In the normal course of business, the Company is exposed to fluctuations in interest rates and equity market risks as the Company seeks debt and equity capital to sustain its operations. At September 30, 2001, approximately one-third of the Company's debt was in fixed rate instruments. We consider the fair value of all financial instruments to be not materially different from their carrying value at year-end. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. 25 The table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Principal Amount by Expected Maturity - Average Interest Rate September 30, 2001 Expected Maturity Date (Dollars in $000)
There- 2001 2002 2003 2004 2005 After Total Fair Value ---------- --------- ----------- ---------- ---------- ---------- ---------- ----------- Long-term debt: Fixed interest rate debt..... $ 150,000 150,000 147,375 Interest rate................ 12.5% Variable interest rate debt.. $ 2,050 8,950 11,950 14,950 17,200 231,700 286,800 279,630 Average interest rate........ 7.44% 7.42% 7.37% 7.34% 7.32% 7.97% 7.85%
In November 2000, to reduce the risks associated with fluctuations in market interest rates and in response to requirements in the Facility (see Note 9 to the Consolidated Financial Statements for the year ended October 31, 2000 in the Company's 2000 Annual Report on Form 10-K) the Company entered into three interest rate swap contracts for an aggregate notional amount of $140,000. The following table provides information about the Company's derivative financial instruments. The table presents notional amounts and weighted-average swap rates by contractual maturity dates. The Company does not hold any market risk instruments for trading purposes. Notional Amount by Expected Maturity - Average Swap Rate Expected Maturity Date (dollars in $000)
There- 2001 2002 2003 2004 2005 After Total Fair Value ---------- --------- ----------- ---------- ---------- ---------- ---------- ----------- Interest rate swaps: Fixed to variable............ $ -- -- 140,000 -- -- -- 140,000 131,948 Receive fixed-3-month LIBOR..................... -- -- 6.52% -- -- -- 6.52%
The Company is also exposed to fluctuations in foreign currency exchange rates as the financial results of its foreign subsidiaries are translated into U.S. dollars in consolidation. Assets and liabilities outside the United States are primarily located in the United Kingdom, Germany, Netherlands, France and Austria. The Company's investment in foreign subsidiaries with a functional currency other than the U.S. dollar are generally considered long-term investments. Accordingly, the Company does not hedge these net investments. Translation gains and losses historically have not been material. We manage our foreign currency exchange risks on a global basis by one or more of the following: (i) securing payment from our customers in U.S. dollars, when possible, (ii) utilizing borrowings denominated in foreign currency, and (iii) entering into foreign currency exchange contracts. In addition, a significant portion of the cost attributable to our foreign operations is incurred in the local currencies. We believe that a 10% adverse change in currency exchange rates would not have a significant adverse effect on the net earnings or cash flows of the Company. We may, from time to time, enter into foreign currency exchange or other contracts to hedge the risk associated with certain firm sales commitments, anticipated revenue streams and certain assets and liabilities denominated in foreign currencies. We do not engage in currency speculation. Our cash and cash equivalents and investments are in high-quality securities placed with a wide array of financial institutions with high credit ratings. This investment policy limits our exposure to concentration of credit risks. 26 Impact Of Recently Issued Accounting Standards In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 141, "Business Combinations", ("SFAS 141") and Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") and in August 2001 the FASB issued statement No. 144, "Accounting for the Impairment or Deposal of Long-lived Assets" ("SFAS 144"). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after September 30, 2001. SFAS 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized. Instead, they will be tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS 144. The Company is required to adopt the provisions of SFAS 141 immediately, and SFAS 142 and SFAS 144 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that is acquired in a purchase business combination completed after September 30, 2001 will not be amortized, but will be evaluated for impairment in accordance with the appropriate pre-SFAS 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized during the period prior to January 1, 2002. SFAS 141 requires that upon adoption of SFAS 142, the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment within the first interim period in accordance with SFAS 144. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. In connection with the transitional goodwill impairment evaluation, SFAS 142 and SFAS 144 will require the Company to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. To the extent a reporting unit's carrying amount (as defined in SFAS 142) exceeds its fair value, the Company must perform the second step of the transitional impairment test. In the second step, the Company must compare the implied fair value of the reporting unit's goodwill, determined by allocating the reporting unit's fair value to all of it assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with SFAS 141, to its carrying amount, both of which would be measured as of the date of adoption. This second step is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the Company's consolidated statement of operations. The Company expects to have unamortized goodwill in the amount of approximately $195 million and unamortized identifiable intangible assets in the amount of $60 million, all of which will be subject to the transition provisions of SFAS 141 and 142. Because of the extensive effort needed to comply with adopting SFAS 141, SFAS 142, and SFAS 144, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company's consolidated financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized, however, as of the date of adoption, the Company expects that a majority of the amortization of goodwill and purchased intangible assets will not continue in future periods. In June 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. This Statement amends FASB Statement No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies", and it applies to all entities. The Company is required to adopt SFAS 143, effective for calendar year 2003. Management does not expect the adoption of SFAS 143 to have a material impact on the future consolidated operations or financial position of the Company, as it is now constituted. 27 SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of". However, the Statement retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS 144 supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. However, this Statement retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in distribution to owners) or is classified as held for sale. This Statement also amends ARB No. 51, "Consolidated Financial Statements", to eliminate the exception to consolidation for a temporarily controlled subsidiary. 28 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES Quarter Ended September 30, 2001 PART II. OTHER INFORMATION Item 1. Legal Proceedings No significant changes have occurred with respect to legal proceedings as disclosed in Part I, Item 3, of the Company's 2000 Annual Report on Form 10-K. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Stockholders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.29 Employment Agreement effective November 1, 2000 between A. lorne Weil and Scientific Games Corporation Reports On Form 8-K On October 2, 2001, the Company filed a Current Report on Form 8-K for purposes of Regulation FD disclosures. Because the Company changed its fiscal year-end to a calendar year-end, beginning with the year ending December 31, 2001, and acquired a significant subsidiary on September 6, 2000, management believed it would be informative to disclose the calendar year operating results, calendar year pro forma operating results and calendar year pro forma segment operating results so that appropriate comparisons may be made to calendar year 2001 actual operating results. 29 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES Quarter Ended September 30, 2001 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SCIENTIFIC GAMES CORPORATION ---------------------------- (Registrant) By: /s/ DeWayne E. Laird -------------------- Name: DeWayne E. Laird Title: Vice President & Chief Financial Officer (principal financial and accounting officer) Dated: November 14, 2001 30