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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A-1
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Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
for the fiscal year ended December 31, 1995
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Commission file number 000-22298
SCIENTIFIC GAMES HOLDINGS CORP.
A Delaware Corporation
IRS No. 13 361 5274
1500 Bluegrass Lakes Parkway, Alpharetta, Georgia 30201
(770) 664-3700
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Securities registered pursuant to Section 12(b) of the Act
and listed on the NASDAQ/NMS
Common Stock, $.001 Par Value
Securities registered pursuant to Section 12(g) of the Act:
None
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in proxy or information statements incorporated
by reference in Part III of this Form 10-K or any amendment to this Form
10-K.[X]
The aggregate market value of the Common Stock of the Registrant held by non
affiliates of the Registrant on March 21, 1996 was $346,213,093. The aggregate
market value was computed by reference to the closing price of the stock on the
NASDAQ Stock Market on such date. For the purposes of this response, executive
officers and directors are deemed to be the affiliates of the Registrant and
the holding by non affiliates was computed as 12,561,839 shares.
The number of shares outstanding of the Registrant's Common Stock as of March
21, 1996 was 13,064,645 shares.
Documents Incorporated by reference:
The Registrant's proxy statement for its Annual Meeting of
Stockholders, to be held May 3, 1996, which will be filed pursuant to
Regulation 14A within 120 days of the close of Registrant's fiscal year, is
incorporated by reference in answer to Part III of this report but only to the
extent indicated in Part III herein. In addition, pages 14 through 31 of
Scientific Games Holdings Corp.'s 1995 Annual Report to Stockholders is
incorporated by reference in answer to Items 6, 7 and 8 of Part II and Item
14(a) of Part IV of this report.
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PART 1
The Company hereby amends its Form 10-K for the year ended
December 31, 1995 solely to correct the inadvertent misidentification of the
only customer accounting for 10% or more of its revenues in 1995.
ITEM 1. BUSINESS
GENERAL
Scientific Games Holdings Corp. (the "Company" or "Scientific Games")
through its wholly owned subsidiaries, principally, Scientific Games Inc., is
the leading worldwide manufacturer of instant lottery tickets based upon the
number of instant lottery tickets sold. The Company has production facilities
in Alpharetta, Georgia (suburban Atlanta), Gilroy, California and Albert Lea,
Minnesota and employs approximately 758 people in total. Scientific Games'
business consists primarily of manufacturing and selling instant lottery
tickets to domestic and foreign governmental lottery authorities and licensees
and providing lottery services to such customers. The Company also offers its
customers a full range of instant lottery services under cooperative services
contracts, including some or all of the following services: designing and
installing game management software, ticket production, telemarketing, field
sales, accounting, ticket distribution, training sales staff, estimating ticket
needs, managing staff, advising with respect to security, ticket validation and
provision of computer hardware, validation terminals, maintenance,
communication network and sales agent hot-line service. Through the
acquisition of a pull-tab ticket business, GameTec, in June 1994, the Company
now also manufactures and sells pull-tab tickets to lotteries and charities.
The facility is located in Albert Lea, Minnesota.
INDUSTRY OVERVIEW
Lotteries are operated by domestic and foreign governmental
authorities and their licensees in approximately 200+ jurisdictions. Currently,
39 jurisdictions sell instant lottery tickets in the United States. Governments
typically authorize lotteries as a means of generating revenues from non-tax
sources with lottery revenues frequently being set aside for particular public
purposes, such as education, aid to the elderly, conservation, transportation
and economic development. As lottery ticket sales have become a significant
source of funding for such programs, many jurisdictions have come to rely on
the revenues generated by such sales.
Although there are many types of lotteries worldwide, government
authorized lotteries may generally be categorized in three principal groups:
instant lotteries, on-line lotteries and the traditional draw-type lotteries.
An instant lottery is one which is typically played by removing a coating from
a preprinted ticket to determine whether it is a winner. On-line lotteries are
generally pari-mutuel in nature (although fixed prizes are also offered) and
are conducted through a computerized lottery system in which lottery terminals
are connected to a central computer, usually by dedicated telephone lines.
Internationally, the older form of traditional draw-type lottery games, in
which players purchase tickets which are manually processed for a future
drawing for prizes of a fixed amount, is the prevalent form of play. In
addition to the foregoing types of lotteries, there are video lotteries played
on electronic machines featuring keno, "line-up" (cherries, bars, plums, etc.)
and similar video games. Video lotteries are typically targeted to locations
such as horse and dog racing tracks, athletic arenas, certain bars, clubs and
similar establishments.
To date, only approximately 50% of the foreign, governmentally
operated or sanctioned lotteries currently sell instant tickets. Of the
approximately 8.2 billion tickets sold by the Company in 1995, approximately
33% were sold outside the United States.
There are many commercial game suppliers (including the Company) in
the United States which produce tickets for both sales promotion companies and
their end users. Management believes Scientific Games is the only company which
also offers the commercial market a full line of support and services similar
to what the Company offers to the government lottery market. Management
believes the total potential commercial game market may be larger than the
instant lottery market and that such market has shown extensive growth in
recent years. Whereas potential lottery customers in the United States are
limited to the 39 jurisdictions where such games are legally permitted,
commercial
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games are believed permitted in substantially all states. Commercial
games are used to promote a manufacturer's or retailer's products and typically
do not involve a cumbersome bidding/procurement process. Orders for commercial
games may vary in quantity from less than 50,000 to more than 500 million
tickets. Commercial games are subject to a variety of state laws which regulate
promotional games of chance. A significant difference between lottery games and
commercial games is the lower level of security requirements associated with
commercial games which typically offer less valuable prizes. Tickets for
commercial games may not require foil, laminated or similar paper stock or
overprint inks.
BUSINESS STRATEGY
The Company is the leading worldwide supplier of instant lottery
tickets and support services. Scientific Games intends to expand this
leadership position by (i) pursuing new instant ticket printing opportunities
in both the domestic and foreign marketplaces, (ii) emphasizing and marketing
Scientific Games' capabilities in cooperative services, (iii) continuing the
Company's emphasis on customer service and responsiveness to customer needs
both before and after delivery of products and services, (iv) investing in its
facilities while aggressively pursuing practices and methods which reduce
operating costs, and (v) funding research and development costs that continue
to provide innovations for the Company's customers.
As state governments face budgetary pressures, they increasingly seek
methods of reducing state spending. A method of reducing spending which is
often considered by states is privatization or outsourcing of various
operating tasks associated with lottery operations. This trend is evidenced by
the fact that three out of the last four new domestic lotteries, including
Georgia and Nebraska, the two newest lottery states, have elected to utilize
cooperative services. Many of a lottery's routine processes are related to the
management of the instant ticket games. The Company has significant experience
in this field and is well positioned to offer this privatization or outsourcing
option to the industry. Furthermore, many foreign governments are recognizing
the sales potential of the instant ticket and are increasingly utilizing
outsourcing to implement instant ticket sales rather than attempting to develop
this capability on their own. The Company intends to continue to emphasize and
invest in its growing cooperative services business.
The increased application of computer-based and communications
technologies (including proprietary technologies) to the manufacturing and
servicing of instant tickets (See "Business-New Product Development") continues
to separate the instant ticket from conventional forms of printing. The Company
is generally recognized within the lottery industry as the leader in applying
these technologies to the manufacturing and sale of instant tickets. In order
to maintain its position as a leading innovator within the lottery industry,
the Company intends to continue to explore and develop new technologies and
their application to instant lottery tickets and systems.
In addition to the internal development of new products, the Company
intends to leverage its management expertise, reputation, and contacts in the
lottery industry by pursuing joint ventures and considering acquisitions which
will provide access to lottery related products and services that the Company
does not currently provide. The Company is presently evaluating various
opportunities to enter other areas of the lottery business by either utilizing
its in-house expertise or by acquisition of, or combining with, another entity
engaged in such areas, or some combination of the foregoing.
PRODUCTS AND SERVICES
In 1974, the Company introduced the first "secure" instant game
ticket. Today, instant tickets manufactured by the Company are typically
printed on recyclable ticket stock by a series of computer controlled presses
and ink-jet imagers and are believed by management to incorporate the most
advanced technology and security currently available in the industry. Tickets
range in size from 1.5 inches by 3 inches to ticket sizes as large as some
greeting cards and normally are played by removing a coating to determine if
they are winning tickets. The Company markets tickets to domestic lottery
jurisdictions, foreign lottery jurisdictions and commercial customers. The
Company has contracts with 23 of the 39 states/jurisdictions in the U.S. which
currently sell instant lottery tickets. These domestic contracts are typically
at a fixed price per thousand tickets and range from one to three years in
duration, although they typically have
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one or more extension options. Customers of Scientific Games have seldom
failed to exercise extension options in domestic lottery contracts with the
Company. In 1995, the Company sold approximately 8.2 billion tickets. Such
instant ticket sales included more than 50% of all instant lottery tickets sold
by all companies to domestic lotteries and approximately twice as many instant
tickets as were sold by the Company's next largest domestic competitor.
The Company currently manufactures limited amounts of tickets for the
commercial game market. Examples of commercial games produced by the Company
include games for major oil companies and a major U.S. hotel chain and games
for various other commercial customers. In the past, Scientific Games was not
in a position to penetrate this market fully because of, among other factors,
very short lead times and plant capacity constraints. The Company believes its
installation in 1995 of a third press better suited to shorter press runs than
its two existing gravure presses provides it with the capacity and flexibility
necessary to better compete in this market. For information concerning the new
press and its attributes, see "Properties."
Scientific Games pioneered the idea of cooperative services as a means
of reducing the operating costs of lotteries while increasing lottery revenues
and is the only instant ticket manufacturer which has a separate lottery ticket
cooperative support services business to supplement its manufacturing
operations. Cooperative services consist of lottery ticket distribution and
support services involving the performing of selected key sales, distribution,
marketing and/or data processing services for lottery jurisdictions. While most
lottery jurisdictions to date have chosen to control the distribution and sales
of tickets, Scientific Games has been successful in demonstrating to a number
of jurisdictions that the Company can perform these functions effectively and
at a lower cost.
Domestically, the Company has cooperative services agreements with the
states of Georgia, Nebraska, Maine and West Virginia and with the U.S. Virgin
Islands. Under cooperative services contracts, the Company typically provides
selected management, distribution services and/or data processing for the
jurisdiction's instant lottery game business and is paid a percentage of the
lottery's total instant ticket revenues. Customers select those services which
they desire to privatize from a menu of services offered, including: designing
and installing game management software, ticket production, telemarketing,
field sales, accounting, ticket distribution, sales staff training, estimating
ticket needs, managing staff, advising with respect to security, ticket
validation, and provision of computer hardware, validation terminals,
maintenance, communication network and sales agent hot-line service.
Cooperative services contracts can be associated with large switching costs for
the lottery, as the lottery would have to hire and/or retrain its staff and
redesign and install a software system to control the instant ticket lottery
business.
In addition to laminated scratch off instant tickets, the Company's
business also includes the manufacture and sale of pull-tab tickets, a business
the Company entered through the June 1994 acquisition of the assets of GameTec,
a pull-tab manufacturer located in Albert Lea, Minnesota. The Company
currently sells pull-tab tickets to five lotteries in the U.S. and to
distributors who sell them to charities.
During the period from 1983 to 1991, the Company's predecessor also
developed on-line lotto systems for state lotteries. Since 1991, the Company
has not offered on-line gaming. Scientific Games, however, has experience in
this aspect of the lottery industry, a characteristic typically lacking in
other instant lottery ticket suppliers.
NEW PRODUCT DEVELOPMENT
Since its inception, Scientific Games has provided many of the
innovations in instant ticket technology, in both manufacturing and game
development, which subsequently became the industry standard. Past examples of
new products developed by Scientific Games include the ink-jet printed instant
ticket, cooperative services (lottery privatization), bar coding on the front
and back of tickets (which facilitates validation), the IL/MVS instant ticket
accounting management and ticket validation software technology and Terra
2000(R) tickets. The Terra 2000(R) ticket is a recyclable and biodegradable
paper ticket, which meets the rigorous security standards demanded by the
lottery industry. The Company's latest innovation is SciScan(TM), a keyless
validation system for retailers which significantly reduces the time
requirements of ticket validation while at the same time improving security of
the game. This technology will also open other opportunities for advanced
ticket play-styles and may also have applications in other industries where
currency,
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check, credit and debit card and bearer documents verification is
required.
Certain of the technology associated with these innovations are the
subject of issued patents and patent applications currently pending with the
United States Patent Office and selected other countries outside the United
States. The Company also holds a number of other patents and licenses with
respect to certain technology used in its business. The loss of any such patent
or license, however, would not in the opinion of management have a material
adverse effect on the Company's overall business. Scientific Games is
continually looking for ways to apply its expertise in specialty printing
technologies and security/randomization knowledge to develop commercially
viable products for both the lottery industry as well as for other commercial
applications.
CUSTOMER SERVICE
The Company has an active professional Customer Service Department
which works closely with its account managers, the lotteries, and Scientific
Games' Graphics and Game Programming Departments in the area of initial game
design. Artwork concepts, game play style and prize structure are assembled,
proposed, and refined. Important manufacturing information is also assembled
and documented in the "working papers" by the Company's customer service
representatives. This information, when approved by the lottery, becomes the
technical manufacturing specifications for specific ticket orders.
MARKETING
Scientific Games has been instrumental in the development of marketing
strategies for instant games for domestic and foreign lotteries, including some
of the most successful lotteries in North America. The Company's involvement
includes all phases of instant game marketing support including: marketing
strategies, prize structures, game rules, delivery schedules, play styles,
telemarketing, ticket ordering and billing, field sales support, research, game
design, working papers, retailer manuals, instant game concepts, ticket
quantities, delivery and promotions. Scientific Games or its predecessor has
prepared market research analyses of gaming tendencies in almost every new
state lottery since 1982 and the company can provide customers with a bank of
lottery-specific consumer and market research data derived from these years of
analyses.
Instant tickets are believed to have the broadest consumer appeal of
any lottery product. Consumers are generally split equally between men and
women, are equally distributed between ages 25 and 65, and cover a broad range
of socioeconomic and psychographic groupings. This broad-based market is
highly affected by appropriate advertising and promotion. The most successful
lotteries have discovered that instant lottery products are largely an impulse
item which must be marketed like any other consumer product.
Sales of instant lottery tickets are based on, among other factors,
the quality of the lottery product, prize structure design and the existence of
large retail distribution systems which allow maximum convenience to consumers.
Scientific Games, with its large game library and extensive research into
product design and consumer purchasing habits, has been an industry leader in
producing new products, distribution methodologies and consumer promotions to
enhance sales.
SECURITY
Scientific Games recognizes that security and integrity are the
foundation of successful lottery organizations. As the incidence and severity
of publicly reported cases of physical and computer crime continue to escalate,
major lotteries are seriously reassessing key security questions concerning the
vulnerability of lottery games. Attempts to penetrate security measures may
come from various combinations of customers, retailers, vendors, lottery
officials and others. Because the integrity of a lottery is believed essential
to its successful operation, both the vendor and lottery must guard their
systems against unauthorized actions. The Company is unaware of any practical,
economically feasible way to breach the security of its instant lottery tickets
which could result in a material loss to any of its customers, nor is it aware
of any breach thereof which has resulted in any material loss to any of its
lottery customers.
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Scientific Games constantly assesses the adequacy of its security
systems, incorporating various improvements, bar coding and additional layers
of protection. There must be well-planned security measures in place at every
stage of the lottery operation. Scientific Games has pioneered and enacted
extensive security safeguards in all areas of ticket specifications,
production, packaging, delivery, distribution and accounting. Also, computer
function safeguards, including secure ticket data, control number encryption,
winner file data, and ticket stock control have been incorporated in the
Company's data processing and the computer operations phase.
MANUFACTURING PROCESS
Using a series of computer-controlled presses and ink-jet imagers,
management believes Scientific Games' tickets incorporate the most advanced
technology and security methodology available in the industry. Its facilities
are designed for efficient, secure production of instant game tickets and
support ink-jet image tape generation, printing, packaging and storage.
The dedicated computer-controlled printing process is specifically
designed for producing instant lottery game tickets for government sanctioned
lotteries and high volume commercial games. The process is not a business forms
press or a direct mail press temporarily diverted to lottery work. The
Company's specialized equipment contributes to the underlying superior
manufacturing and product quality. Instant ticket games are delivered
completely finished and ready for distribution by the lottery, or by Scientific
Games in the jurisdictions which are part of a cooperative services contract
with Scientific Games.
Paper and ink are the principal raw materials consumed in the
Company's manufacturing operations. The Company has a number of sources for
both paper and ink and should, therefore, not be dependent on any particular
supplier.
PERSONNEL
As of December 31, 1995, the Company had approximately 758 full-time
employees. None of Scientific Games' employees are represented by a labor union
and the Company believes that its employee relations are good. At the
California Facility (See "Properties"), ticket packaging is performed
exclusively by a MBE/W (minority business enterprise/woman) owned
subcontractor, the employees of which are unionized. Scientific Games is, at
present, the subcontractor's only customer.
EXECUTIVE OFFICERS
The following table sets forth certain information regarding the
executive officers of the Company as of March 1, 1996:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
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<S> <C> <C>
William G. Malloy . . . . . . . . 49 Director, Chairman, President and Chief Executive Officer
William F. Behm . . . . . . . . . 50 Director and Executive Vice President
Thomas F. Little . . . . . . . . 51 Senior Vice President-International
Cliff O. Bickell . . . . . . . . 53 Vice President, Treasurer and Chief Financial Officer
C. Gray Bethea, Jr. . . . . . . 51 Vice President, Secretary and General Counsel
David A. Bausch . . . . . . . . . 61 Vice President
James R. Culver . . . . . . . . . 63 Vice President-Marketing and Sales
John J. Kriz . . . . . . . . . . 54 Vice President-Manufacturing
Terry D. Mangold . . . . . . . . 55 Vice President-Instant Game Services
</TABLE>
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WILLIAM G. MALLOY transferred from the corporate staff of Bally
Manufacturing Company to the Company in 1987 and became President and Chief
Executive Officer in 1990. Mr. Malloy was elected a Director and Chairman of
the Board in October 1991 when Centre Partners L.P. and certain executive
officers of the Company purchased substantially all of the assets of the
instant lottery ticket sales business, the instant ticket cooperative sales
business and the video lottery business of the predecessor to the Company in a
leveraged buy-out transaction ("Acquisition"). Prior to becoming the Company's
President and Chief Executive Officer, Mr. Malloy served as Vice President,
Treasurer and Chief Financial Officer. Mr. Malloy has over twenty years of
experience in the coin-operated amusement and gaming industry. Mr. Malloy's
term of office as a director expires with the annual meeting in 1996.
WILLIAM F. BEHM joined the Company in 1978 and was promoted to
Executive Vice President in 1988 and was elected a Director in 1992. Mr. Behm
has overall management responsibility for Scientific Games' research and
business development projects. In addition, he is also responsible for all the
Company's product security issues. Prior to joining Scientific Games, Mr. Behm
was an aerospace engineer with McDonnell Douglas Corporation. Mr. Behm was
instrumental in the development of the Company's former on-line lottery system,
the invention of instant lottery bar codes, and the development of the
Company's new environmental instant ticket. He is co-named with the Company
in several issued patents and pending applications and is a regular speaker at
trade shows and conferences on the subject of technology in the lottery
industry.
THOMAS F. LITTLE joined the Company in 1975 and was promoted to Senior
Vice President-International in 1991. Mr. Little has overall management
responsibility for Scientific Games' international marketing and sales efforts.
In addition, he is also responsible for the Company's marketing and sales
efforts in the commercial game industry. Prior to joining the Company, Mr.
Little was Manager of Data Processing for First National Bank of Atlanta. Mr.
Little's experience includes the introduction of the first video lottery test
in Illinois, the development of the Company's former on-line lottery system and
extensive contacts with the international lottery industry.
CLIFF O. BICKELL joined the Company as Vice President, Treasurer and
Chief Financial Officer in January of 1995. Mr. Bickell has overall management
responsibility for Scientific Games' corporate financial, accounting, and
administrative affairs, including the Company's human resource function. Prior
to joining Scientific Games, Mr. Bickell was Vice President, Chief Financial
Officer and Treasurer of Paragon Trade Brands, a multi-national consumer
products manufacturer where he had similar financial responsibilities. In
addition, Mr. Bickell has held the positions as Senior Vice President,
Corporate Administration - Chief Financial Officer of the W. A. Krueger Co., a
commercial printing company, and Treasurer of Dataproducts Corporation, a
multinational electronics manufacturer.
C. GRAY BETHEA, JR. joined the Company in 1985 as Vice President,
Secretary and General Counsel. Mr. Bethea has overall management responsibility
for Scientific Games' legal compliance, statutory interpretation, corporate
matters, governmental affairs, and contract preparation. Throughout his
corporate and private practice of law, Mr. Bethea has had extensive experience
in corporate and contract law. Prior to joining Scientific Games, Mr. Bethea
was a partner with the firm of Smith, Gambrell & Russell in Atlanta, Georgia.
DAVID A. BAUSCH joined the Company in 1988 and has served as Vice
President since that time. Mr. Bausch has overall management responsibility for
Scientific Games' efforts in software systems development, video lottery
operations, and cooperative services operations. Prior to joining Scientific
Games, Mr. Bausch served as Deputy Director of the Illinois Lottery where he
implemented both its instant and on-line games. He was more recently the
Assistant Secretary of the Florida Lottery where he was responsible for that
lottery's overall start-up and ongoing operations.
JAMES R. CULVER joined the Company in 1984 as an Account Executive and
was promoted to Vice President-Marketing and Sales in 1990. Mr. Culver has
overall management responsibility for Scientific Games' North American
marketing and sales efforts. In addition, he is also the Company's Public
Relations Officer. Prior to joining Scientific Games, Mr. Culver was with the
Michigan Lottery for over eight years where he served as Marketing Director and
later Acting Director. Mr. Culver has over twenty years of lottery experience
specializing in all phases of marketing including, advertising, promotions,
sales training and motivation. He is the developer of several industry
standards including the
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Scientific Games Key Account Program which is currently used by several
lotteries as a model of key account and chain store sales management. Mr.
Culver also has twelve years of television experience both as a producer and
performer and regularly speaks at lottery trade shows and conferences.
JOHN J. KRIZ joined the Company in 1990 as Vice
President-Manufacturing. Mr. Kriz has overall management responsibility for
Scientific Games' instant ticket printing operations. Prior to joining
Scientific Games, Mr. Kriz spent twenty-six years with Ringier American
(formerly W. A. Krueger Co.) in various executive, operational and technical
positions. As Vice President for Manufacturing Services, Mr. Kriz directed all
manufacturing activities for three divisions for this major publication,
commercial and book printer. His experience includes the design, construction
and implementation of printing operations.
TERRY D. MANGOLD joined the Company in 1975 and was promoted to Vice
President-Instant Games Services in 1987. Mr. Mangold has overall management
responsibility for Scientific Games' instant ticket game programming
operations, i.e., the generation of games with the proper distribution of
winning and non-winning tickets. Prior to joining Scientific Games, Mr. Mangold
was responsible for computerized systems at First National Bank of Atlanta.
THE FOLLOWING DISCUSSION OF ASPECTS OF THE COMPANY'S BUSINESS ALSO
CONSTITUTES A CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
The Company wishes to caution readers that the following important
factors, among others, in some cases have affected, and in the future could
affect, the Company's actual results and could cause the Company's actual
consolidated results for the first quarter of 1996, and beyond, to differ
materially from those expressed in any forward-looking statements made by, or
on behalf of, the Company:
GOVERNMENTAL REGULATION
Lotteries are not permitted in the various states/jurisdictions of the
United States unless expressly authorized by law. The ongoing operations of
authorized lotteries in the United States typically are extensively regulated.
Applicable legislation varies from jurisdiction to jurisdiction but, in
addition to authorizing the lottery and creating the applicable authority, the
lottery statues generally dictate certain broad parameters of lottery
operation, including the percentage of lottery revenues which must be paid out
in prized and a variety of other features of the lottery, Lottery authorities
typically exercise significant control as to the selection of vendors (such as
the Company) and awards of lottery contracts, ticket prices, types of games
played and marketing strategy, all of which can affect the Company's operating
results.
Prior to and after granting of a lottery contract, governmental
authorities generally conduct an investigation of the Company and its employees
and such authorities may require removal of any employee deemed to be
unsuitable. The Company has not been disqualified from a lottery contract as a
result of any such investigation. Certain states also require extensive
personal and financial disclosure (including, among other things, submission of
fingerprints, personal financial statements and federal and state income tax
returns) and background checks of control persons and entities beneficially
owning a specified percentage (typically 5% or more) of the Company's
securities. The failure of such beneficial owners to submit to such background
checks and provide such disclosure could jeopardize the award of a lottery
contract to the Company or provide the basis for cancellation of existing
lottery contracts.
Scientific Games generally retains governmental affair representatives
is various states of the United States to advise legislators and the public
concerning its views on lottery legislation, to monitor any such legislation
and to advise the Company on contract proposals to lottery authorities.
Scientific Games also makes campaign contributions to various political parties
and political candidates. The Company believes it has complied with applicable
laws and regulations concerning campaign contributions and lobbying
disclosures.
The award of lottery contracts and ongoing operations of lotteries in
international jurisdictions also are
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extensively regulated, although this regulation usually varies from that
prevailing in the United States. Restrictions are frequently imposed on foreign
corporations seeking to do business in such jurisdictions and, as a
consequence, the Company has, in a number of instances, allied itself with a
local company when seeking foreign lottery contracts. Laws and regulations
applicable to lotteries in the United States and foreign jurisdictions are
subject to change and the effect of such changes on the Company's ongoing and
potential operations cannot be predicted with certainty.
LOTTERY CONTRACTS: PROCUREMENT PROCESS AND REQUIREMENTS
Lotteries in the United States typically select an instant ticket
supplier by issuing a Request for Proposals ("RFP") which outlines contractual
obligations as well as products and services to be delivered. An evaluation
committee frequently comprised of key lottery staff evaluates responses based
on various criteria. These criteria usually include quality of product,
security plan and features, experience in the industry, quality of personnel
and services to be delivered and price. The Company believes that the quality
of its personnel, technical expertise and manufacturing efficiency give it many
advantages relative to the competition when responding to state lottery RFPs.
However, many lotteries still award the contract to the vendor with the lowest
price. Contract awards by lottery authorities in the United States are
sometimes challenged by unsuccessful competitors which can result in costly
legal proceedings for all concerned.
The Company's domestic lottery contracts typically contain provisions
for payment of liquidated damages for late delivery of tickets or delivery of
defective tickets, which in the aggregate could result in several million
dollars or more per day in penalties to the Company. Although the incurrence of
liquidated damages with respect to on-line lotteries may not be uncommon, the
Company believes it is uncommon for instant lotteries. Scientific Games has not
paid any material liquidated damages under an instant lottery contract,
although it has on occasion negotiated customer allowances which management
does not consider material.
Substantially all of the Company's revenues are derived from its
lottery and service contracts. The Company's domestic lottery contracts
typically have an initial term of from one to three years and usually provide
the customer with options to extend the contract one or more times under the
same terms and conditions for additional periods generally ranging from one to
three years. The Company's international lottery contracts are less likely to
have firm contract periods and, historically, international lottery ticket
customers have sought competitive bids for such contracts more frequently.
Lottery contracts to which the Company is party typically contain exacting
implementation schedules and performance requirements. Failure to meet these
schedules and requirements can result in substantial monetary liquidated
damages, as well as possible contract termination.
The Company maintains a bonding program for its bid bonds, litigation
bonds and performance bonds through the Continental Insurance Company. As of
December 31, 1995, $30.4 million was outstanding in aggregate face amount of
surety bonds issued. One or more of these bonds is generally required by a
lottery customer in order to participate in a lottery procurement or to enter
into a contract with the lottery following successful bid. Failure to be able
to provide such bonds would materially and adversely affect the Company's
ability to do business. The Company's bonding program is backed by a blanket
indemnity. In the past, the Company has secured the performance of certain of
its indemnity obligations with letters of credit. Currently, none of the
Company's indemnity obligations is secured by a letter of credit.
Lottery contracts of the Company periodically expire and/or reach
optional extension dates. Upon the expiration of a contract (including any
extensions thereof), lottery authorities may award new contracts through a
competitive procurement process. There can be no assurance that the Company's
contracts will be extended or that the Company will be awarded new contracts as
a result of competitive procurement processes in the future. The Company's
lottery contracts typically permit a lottery authority to terminate the
contract at any time for failure to perform and other specified reasons, and
many of such contracts permit the lottery authority to terminate the contract
at will without penalty. Depending upon, among other factors, the amount of
new revenue derived by the Company thereunder, the termination, expiration or
failure to renew one or more instant lottery contracts could have a material
adverse effect on the Company's business or prospects.
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MARKETS
With 37 states, the District of Columbia and The U.S. Virgin Islands
currently operating lotteries, the Company's growth in the domestic market
depends primarily on expanded activities of existing lotteries as well as
winning new contract awards, re-bids and contract extensions. Contrasted with
the domestic market, the international market is far from mature, with more and
more countries viewing lotteries as a source of revenue for a variety of
governmental programs.
In 1995, only one state, Massachusetts, accounted for more than 10% of
the revenues of the Company. The Company has four domestic contracts which are
scheduled to expire in 1996. Management believes new contracts for those states
will be awarded through a competitive procurement process in which the Company
will participate. The Company's management estimates that these four states had
aggregate ticket sales equaling approximately 11% of the Company's ticket
shipments in 1995. In contrast, management believes that lottery contracts with
five domestic states currently serviced by its competitors also will expire or
extensions will not be granted in 1996 and expects that new contracts for such
states will be awarded through the competitive procurement process in which the
Company also expects to participate. The Company's management estimates that
these five states aggregate ticket sales equaling approximately 15% of the
Company's tickets shipped in 1995. Management anticipates that lottery
contracts expiring in 1996 could be subject to strong price competition in the
cprocurement process. Depending on the number of contracts awarded or reawarded
to the Company in 1996 and the level of orders thereunder, as well as the level
of orders from existing customers or new international customers, production
efficiencies and other economies of scale could offset, in whole or in part,
any pressure on profit margins associated with potential lower pricing which
may arise in connection with competition for such contracts. While Scientific
Games has frequently been awarded new contracts when its prior domestic
contracts and extensions have expired, there can be no assurance, however, that
any of the Company's contracts will be extended or that it will be awarded new
contracts as a result of competitive procurement processes in the future. Nor
can any assurances be given with respect to the Company's ability to offset, in
whole or in part, the effects of any intensified price competition.
COMPETITION
The instant lottery business is highly competitive, and the Company
business faces competition from a number of domestic and foreign instant and
pull-tab manufacturers and other competitors.
In particular, Scientific Games currently has two primary domestic
instant lottery ticket competitors: Dittler Brothers, Inc. ("Dittler") and
Webcraft Games, Inc. ("Webcraft"). In addition, several Canadian owned
companies provide limited competition for instant tickets in the United States.
In 1995, the Company shipped approximately 8.2 billion tickets, which included
approximately 50% of all instant lottery tickets for the domestic market -
approximately twice as many as its next largest competitor. Except as permitted
by the applicable provisions of the North American Free Trade Act with respect
to Canada and Mexico, it is currently illegal to import lottery tickets into
the United States from a foreign country. The Company's business could be
adversely affected should additional foreign competitors be allowed to operate
in the U.S. market.
Internationally, there are many instant lottery ticket vendors which
provide competition to the Company, including, among others, BABN Technologies,
Group Francois-Charles Oberthur, Pollard Banknote Limited, government owned
printers in Scandinavia, GPS Honsel, Ciccone Y Limos, Dittler, Webcraft,
Creative Games International Inc., and various other vendors.
Both in the domestic market and internationally, factors which
influence the award of lottery contracts are believed to include, among others,
the ability to optimize lottery revenues through game design and technical
capability, quality of the product, dependability, production capacity,
marketing experience, financial condition and reputation of the bidder, the
security and integrity of the bidder's production operations, products and
services and the satisfaction of various other requirements and qualifications
imposed by specific jurisdictions.
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Scientific Games' position as a leading worldwide producer of instant
lottery tickets and its reputation as a developer of state-of-the-art
technology and marketing concepts, as well as its years of experience in the
industry, are believed to enhance significantly the Company's competitive
position. The large capital investment necessary to purchase, customize and
install an instant ticket printing operation, the high level of security
required in the lottery industry and the fact that all states in the U.S. which
have lotteries have typically required potential suppliers to have prior
lottery experience are all factors which tend to limit the number of firms
which are willing to, or are in the position to, enter the instant lottery
ticket production business. The Company's business could be adversely affected
should its competitor's research and development activities result in reduced
technological differentiation between the products of the Company and its
competitors. Similarly, in the event technological developments materially
reduce the capital investment required to finance secure lottery ticket
printing operations, the Company's business could be adversely affected by
increased competition. Management does not anticipate any material reduction in
the level of capital financing required for entry into the lottery ticket
product business in the foreseeable future.
In the cooperative services business, the Company believes it has no
current competitor in the U.S. market which both produces instant lottery
tickets and provides cooperative services to state lotteries. Competitors have
either manufactured only instant tickets or provided only certain services
which comprise cooperative services, such as software for the management
systems, marketing assistance or other specific duties. However, an on-line
vendor in cooperation with an instant ticket supplier may be considered a
competitor or potential competitor in cooperative services. In addition, an
on-line vendor not in cooperation with an instant ticket supplier may
nonetheless provide various cooperative services, including data processing
services. Scientific Games has two primary domestic and international
competitors in this regard: G-Tech Corporation and Video Lottery Technologies,
Inc.
The Company's pull-tab ticket business is subject to competition from
a number of competitors. Pull-tab tickets are primarily marketed to the charity
industry. Although the Company is not yet a significant supplier of pull-tab
tickets, it currently has 5 contracts with state lotteries for pull-tab tickets
and, based on increase in its pull-tab ticket business since the acquisition of
its GameTec operations, the Company believes it has the ability to become a
significant supplier of pull-tab tickets both to the charity industry and to
other markets for such tickets.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
The Company's operating results can vary significantly from period to
period. Revenues and capital expenditures can be difficult to forecast because
the Company's sales cycle can vary and depend upon facts such as the size and
timing of awarded contracts, changes in customer budgets, delays in customer
orders, changes in lottery marketing strategies and ticket ordering patterns
and general economic conditions. Contracts with governmental entities operating
newly authorized instant lotteries tend to generate higher levels of ticket
sales in the initial months.
Operating results also may be affected by the working capital
requirements associated with preparing facilities and equipment, establishing
the distribution system and printing tickets for a recently awarded contract,
and by the amount of time elapsing before the receipt and/or recognition of
revenues from the sale of instant lottery tickets and the provision of
cooperative services. In addition, operating results may be affected by
utilization of overtime labor and the Company's ability to smoothly generate
new and/or upgraded production equipment with its existing production
operations. Revenues from the sale of tickets, cooperative services, software
and hardware development may be recognized based upon ticket shipment, a
percentage of the lottery's sales to the public, a contracted price or any
combination of the foregoing. Accordingly, quarter to quarter fluctuations in
revenues may be expected.
Additionally, circumstances encountered in international markets,
including the substantial amount of time involved in bidding on any
international contract, the evaluation of such bid and the resultant contract
award or rejection can vary significantly from that originally anticipated when
the bid is prepared. All of these factors can make it difficult to forecast
revenues and expenditures related to the Company's operations over extended
periods and can result in fluctuations in the Company's quarterly financial
results.
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RELIANCE ON SENIOR MANAGEMENT
The Company believes it has benefited and continues to benefit
substantially from the skills, experience and efforts of its senior management.
The loss of the services of members of the Company's senior management could
have a material adverse effect on the Company's business and prospects.
ADDITIONAL RISK FACTORS AND INVESTMENT CONSIDERATIONS
Additional or related factors which could affect the Company's actual
results and could cause the Company's actual consolidated results for the first
quarter of 1996, and beyond, to differ materially from those expressed in any
forward-looking statement made by, or on behalf of, the Company include:
Continued or increased pressure to change the selling prices for the
Company's products, and the resulting effects on margins, the Company's actions
in connection with continued and increasing competition in many product areas,
including, but not limited to, price competition and fluctuating demand for
certain lottery tickets products by one or more lottery customers;
Difficulties or delays in the development, production, testing and
marketing of products, including, but not limited to, a failure to ship new
products utilizing SciScan(TM) technology and/or other technologies when
anticipated, the failure of customers to accept these products or technologies
when planned, any defects in products and a failure of manufacturing economies
to develop when planned;
Occurrences affecting the Company's ability to reduce product and
other costs, and to increase productivity;
Inability to offset pricing competition with production efficiencies
and economies of sales; underutilization of the Company's plants and factories
resulting in production inefficiencies and higher costs; start-up expenses and
inefficiencies and delays and increased depreciation costs in connection with
the start of production in new plants and expansions;
The amount, and rate of growth in, the Company's selling, general and
administrative expenses, and the impact of unusual items resulting from the
Company's ongoing evaluation of its business strategies, asset valuations and
organizational structures;
The compromise or breach or perceived compromise or breach of the
Company's production security and integrity or the security and integrity of
its products or services;
Difficulties in obtaining raw materials, supplies, power and natural
resources and any other items needed for production of lottery tickets and
other products;
The acquisition of fixed assets and other assets, including
inventories and receivables, and the making or incurring of any expenditures
and expenses, including, but not limited to, depreciation and research and
development expenses, any revaluation of assets or related expenses and the
amount of, and any changes to, tax rates;
The effects of, and changes in, trade, monetary and fiscal policies,
laws and regulations, other activities of governments, agencies and similar
organizations, and social and economic conditions, such as trade restrictions
or prohibitions, inflation and monetary fluctuations, import and other changes
or taxes, the ability or inability of the Company to obtain, or hedge against,
foreign currency, foreign exchange rates and fluctuations in those rates, loss
of international contracts or lower international revenue resulting from
increased expenses associated with overseas operations, the impact of foreign
labor laws and disputes, adverse effects arising out of political unrest,
terrorist activity, nationalizations and unstable governments and legal
systems, and intergovernmental disputes, as well as actions affecting
frequency, use and availability, of lottery products and licensing of lotteries
for business;
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The costs and other effects of legal or administrative cases and
proceedings (whether civil, such as environmental and product-related, or
criminal), settlements and investigations, claims, and changes in those items,
developments or assertions by or against the Company relating to intellectual
property rights and intellectual property licenses, adoptions of new, or
changes in, accounting policies and practices and the application of such
policies and practices;
The effects of changes within the Company's organization or in
compensation and benefit plans, any activities of parties with which the
Company has an agreement or understanding, including any issues affecting any
investment or joint venture in which the Company has an interest, the amount,
type and cost of the financing which the Company has, and any changes to that
financing; and
The ability to integrate acquisitions into the Company's existing
operations and unexpected difficulties or problems with such acquired entities
including inadequate production equipment, inadequate production capacity or
quality, outdated or incompatible technologies or an inability to realize
anticipated synergies and efficiencies, whether within anticipated time frames
or at all.
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SIGNATURE PAGE
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant, Scientific Games Holdings
Corp. has duly caused this Amendment No. 1 to its report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized in the City
of Alpharetta, and State of Georgia on this 27th day of September, 1996.
Scientific Games Holdings Corp.
By: /s/ Cliff O. Bickell
----------------------------------
Cliff O. Bickell
Vice President, Chief Financial Officer and
Treasurer
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