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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
COMMISSION FILE NUMBER 000-22298
SCIENTIFIC GAMES HOLDINGS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3615274
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1500 BLUEGRASS LAKES PARKWAY, ALPHARETTA, GEORGIA 30004
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (770) 664-3700
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Common Stock, $.001 Par Value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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 [ ].
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 a definitive 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 22, 1999 was $196,981,969. For the
purposes of this response, executive officers and directors are deemed to be
affiliates of the Registrant and the holding by non affiliates was computed as
11,296,457 shares.
The number of shares outstanding of the Registrant's Common Stock as of
March 22, 1998 was 11,883,962 shares.
DOCUMENTS INCORPORATED BY REFERENCE:
The Registrant's proxy statement for its Annual Meeting of
Stockholders, to be held May 21, 1999, 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 40 of
Scientific Games Holdings Corp.'s 1998 Annual Report to Stockholders are
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
ITEM 1. BUSINESS
GENERAL
Scientific Games Holdings Corp. (the "Company" or "Scientific Games")
is a leading provider of lottery products, systems and services worldwide.
Except as the context otherwise requires, references to "Scientific Games," the
"Company," "we," "our," and "us" refer to the consolidated business and
operations of the Company. We operate through our wholly owned subsidiaries and
our joint ventures, principally, Scientific Games Inc. ("SGI") Scientific Games
International Limited ("SGIL"), Scientific Games Kommunikations - und
Computersysteme GmbH ("SG Austria") and SciGames France SAS ("SG France"). Our
corporate headquarters and our primary manufacturing facility are located in
Alpharetta, Georgia (suburban Atlanta) and we employ approximately 1,180 people
worldwide. We also have production and/or operating facilities in California,
the United Kingdom and South Africa and software and hardware development and
maintenance facilities in Georgia, Austria, France and Germany. Our business
consists of sales of products or services to governmentally operated or
sanctioned lotteries worldwide and, to a lesser extent, to non-lottery entities
both in the United States and worldwide. The Company's business is comprised of
two business segments: (1) Instant Ticket and Related Services (hereinafter
sometimes referred to as the "ITRS" segment) and (2) Systems. In the Instant
Ticket and Related Services segment, we primarily supply game design, sales and
marketing training and support, instant ticket manufacturing and delivery,
inventory management and distribution, advising with respect to security, and
retailer telemarketing and field services. In addition, this segment includes
promotional instant tickets and pull-tab tickets sold to both lottery and
non-lottery customers and prepaid phone cards sold to telecommunications
companies. In the Systems segment, we primarily supply transaction processing
software that accommodates instant ticket accounting and validation and on-line
lottery games, point-of-sale terminal hardware which connects to these systems,
central site computers and communication hardware which run these systems, and
on-going support and maintenance services for these products. This segment also
includes software, hardware and support for sports betting and credit card
processing systems for non-lottery customers. In addition, we refer to
cooperative services agreements in various sections of this report. Cooperative
services is our branded marketing name given to the combination of any of the
products and services offered by both the Instant Ticket and Related Services
segment and Systems segment under one customer contract. The Instant Ticket and
Related Services revenues accounted for approximately 78.9% of the Company's
gross revenues in 1998 versus 87.4% in 1997.
Our acquisition in April 1997 of Vienna, Austria based TeleControl
Kommunications - und Computersysteme Gesellschaft m.b.h., an on-line lottery and
transaction processing company now known as SG Austria, enabled us to expand our
systems offerings and make available on-line lottery technology. Scientific
Games' predecessor company had previously developed and operated on-line lottery
systems from 1985 until 1991. During that period, it supplied and operated
on-line lottery systems in Iowa, Maine, New Hampshire, Vermont, West Virginia
and sold an on-line system to the Virginia Lottery. Following our 1997
acquisition of SG Austria, we entered into a joint venture agreement in 1998
with La Francaise des Jeux ("FDJ"), the operator of the French National Lottery,
to develop a new generation of on-line terminals. Such agreement also provides
for the assumption by the joint venture of FDJ's terminal and software
maintenance contracts with six German State Lottery customers and terminal
software maintenance for FDJ. Related agreements between the Company and FDJ
also provide for the initial supply of 13,500 SciScan Technology(R) terminals,
the installation of an SGI-NET instant ticket validation system, a central site
computer system and on-going maintenance of the system. In addition, the Company
has received contracts to provide systems software and hardware and related
support services from Western Canada Lottery Corporation ("WCLC") and Golden
Casket Lottery Corporation, the state operated lottery in Queensland, Australia
(through Praxa Limited, the prime contractor). The WCLC contract was our first
on-line lottery contract in North America since our 1997 re-entry into the
on-line systems segment of the lottery industry after previously exiting this
business line in 1991. The Company sold an initial order of 400 SciScan
terminals to Instant Lottery, S.A., the operator of the national lottery in
Greece.
INDUSTRY OVERVIEW
Lotteries are operated by domestic and foreign governmental authorities
and their licensees in approximately 200 jurisdictions throughout the world.
Although there are many types of lotteries worldwide, governmentally authorized
lotteries may generally be categorized into three principal groups: instant
lotteries, on-line lotteries and the traditional draw-type lotteries. An instant
lottery is typically played by removing a coating from
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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 a popular 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.
Currently, 38 jurisdictions in the United States sell instant lottery
tickets. Of the approximately 8.4 billion instant tickets sold by the Company in
1998, approximately 24% were sold outside the United States. Based on industry
information, it is estimated that 1998 U.S. on-line lottery retail sales were
approximately $19.7 billion compared to 1998 international on-line lottery
retail sales of approximately $60.3 billion. Currently, 38 jurisdictions in the
United States sell on-line lottery tickets. Governments typically authorize
lotteries as a means of generating revenues without the imposition of additional
taxes. Lottery revenues are frequently 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.
There are many promotional (i.e., commercial) game suppliers (including
the Company) which produce instant tickets for both sales promotion companies
and their end users. Management believes Scientific Games is the only company
which also offers the promotional market a full line of support and services
similar to those which the Company offers to the government lottery market.
While potential instant ticket lottery customers in the United States currently
are limited to the 38 jurisdictions where such games are legally permitted,
promotional games are believed permitted in substantially all states. A
significant difference between lottery games and promotional games is the lower
level of security requirements associated with promotional games, which
typically offer less valuable prizes. The Company also provides several
international telecommunications companies with pre-paid phone cards.
As previously disclosed in the Company's periodic reports, the lottery
industry (both instant ticket and on-line) is highly competitive and is in a
period of intense price-based competition, particularly in the Instant Ticket
and Related Services segment. This price-based competition has resulted in
certain contracts being awarded or re-awarded at lower equivalent prices than
charged in the previous contracts. The Company expects significant competition
on the basis of price to continue in 1999 in both the instant ticket and on-line
lottery industry.
BUSINESS STRATEGY
Scientific Games is a leading provider of lottery products, integrated
systems and support services to lotteries worldwide. We intend to expand our
leadership position by (i) pursuing new instant ticket printing and systems
opportunities in both the domestic and foreign marketplaces, (ii) emphasizing
and marketing our expertise in lottery service capabilities, (iii) growing our
on-line lottery business by utilizing our SGI-NET technology, a high
performance, configurable hardware and software-redundant transaction processing
system that can accommodate both instant and on-line lottery operations, (iv)
continuing the our emphasis on customer service and responsiveness to customer
needs both before and after delivery of products and services, (v) investing in
our facilities while aggressively pursuing practices and methods which reduce
operating costs, (vi) increasing the funding of research and development costs
that continue to provide innovations for our customers such as SGI-NET, (vii)
partnering with respected local corporations to establish new lotteries in
foreign countries, (viii) selling SciScan terminals to new and existing
customers both domestically and internationally, (ix) promoting the sales
advantages of our Winner's Choice(TM) probability tickets to new and existing
customers, and (x) expanding our role in the provision of prepaid telephone
cards to international telecommunications customers.
As state governments face budgetary pressures, they increasingly seek
methods of reducing state spending. One method of reducing spending which is
often considered by states is privatization or outsourcing of various operating
tasks associated with lottery operations. We have contracts that contain
expanded services, sometimes referred to as cooperative services, with eight
domestic lotteries. These lotteries have elected to privatize certain operating
functions related to the management of instant ticket games. We expect that more
state or foreign governments will decide to privatize or outsource various
lottery operations. We have significant experience in this field and are well
positioned to offer this privatization or outsourcing option to the industry. We
intend to continue to
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emphasize and invest in the provision of expanded services to both our instant
ticket customers and systems customers.
The increased application of computer-based and communications
technologies (including proprietary technologies) to the manufacturing and
servicing of instant tickets (See - "New Product Development") continues to
separate the instant ticket from conventional forms of printing. We are
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 our position as a leading innovator within the lottery industry, we
intend 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, we intend to
leverage our management expertise, reputation, and contacts in the lottery
industry by pursuing joint ventures and marketing agreements which will provide
access to lottery customers to whom we do not currently provide products or
services.
PRODUCTS AND SERVICES
In 1974, we introduced the first "secure" instant game ticket. Today,
the instant tickets we manufacture are typically printed on recyclable ticket
stock by a series of computer controlled presses and ink-jet imagers, which we
believe incorporate the most advanced technology and security currently
available in the industry. Instant tickets generally range in size from 2 inches
by 3 inches to ticket sizes as large as some greeting cards; instant tickets are
normally played by removing a coating to determine if they are winning tickets.
We market instant tickets and related services to domestic lottery
jurisdictions, foreign lottery jurisdictions and commercial customers. The
Company currently has contracts with 28 of the 38 states/jurisdictions in the
U.S. which currently sell instant lottery tickets. These U.S. Instant Ticket and
Related Services contracts are typically at a fixed price per thousand tickets
or a percentage of lottery sales to the public and typically range from one to
five years in duration, although they usually have one or more extension
options. Our customers have exercised extension options in domestic lottery
contracts with us a majority of the time. See - "Markets" for additional
information.
The Company currently manufactures instant tickets and prepaid phone
cards for the promotional game market and international telecommunications
customers. The majority of the Company's promotional games and prepaid phone
cards are produced at our United Kingdom subsidiary, SGIL. Examples of
promotional games produced by the Company include games for European newspapers,
major food and beverage companies, and games for various other commercial
customers. Prepaid phone cards are supplied to international telecommunications
customers. The Company is not in the business of providing telecommunications
services, but rather in the production of the prepaid phone cards used by the
telecommunications industry. Sales of promotional game products and services,
including prepaid phone cards accounted for less than 10% of the Company's
consolidated revenues in 1998.
Scientific Games pioneered the idea of privatizing lottery functions,
sometimes referred to as cooperative services, as a means of reducing the
operating costs of lotteries while increasing lottery revenues and is the only
instant ticket manufacturer which offers separate lottery ticket cooperative
support services to supplement its manufacturing operations. Cooperative
services may consist of designing and installing game management software,
instant ticket production, telemarketing, field sales, accounting, instant
ticket distribution, sales staff training, estimating ticket needs, managing
staff, advising with respect to security, instant ticket validation, and
provision of computer hardware, validation terminals, SciScan Technology
validation terminals, maintenance, communication network and sales agent
hot-line service for lottery jurisdictions. While the majority of 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 now has contracts for expanded services with
the states of Delaware, Florida, Georgia, Kentucky, Maine, Nebraska,
Pennsylvania and West Virginia. Under such contracts, we typically provide
selected management, distribution services and/or data processing for the
jurisdiction's instant ticket lottery game business and we are paid a percentage
of the lottery's total instant ticket revenues. Customers select those services
which they desire to privatize from a menu of cooperative services offered.
Replacement of these agreements may be associated with large conversion costs
incurred by the lottery to hire and/or retrain staff and redesign and install a
software system and other protocols to manage its instant ticket business.
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In addition to scratch off instant tickets, our Instant Ticket and
Related Services business also includes the sale of pull-tab tickets to our
lottery customers. In October 1997, we sold substantially all of the assets of
our pull-tab manufacturer subsidiary, GameTec Inc. to International Gamco, Inc.
("Gamco"). However, we continue to sell pull-tab tickets to lotteries in the
U.S. through a marketing agreement with Gamco.
In its Systems segment, the Company primarily supplies transaction
processing software that accommodates instant ticket accounting and validation
and on-line lottery games, point-of-sale terminal hardware which connects to
these systems, central site-computer and communication hardware which runs these
systems, and ongoing support and maintenance services for these products. This
segment also includes software, hardware and support for sports betting, credit
card processing systems for non-lottery customers, SciScan Technology and
SGI-NET. SciScan Technology is 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. SGI-NET is a high-performance,
configurable hardware and software-redundant transaction processing system that
can accommodate both instant and on-line lottery operations. SGI-NET's
configurability and software-driven architecture enables it to operate with
virtually any type or number of terminals and provides flexibility to adapt to
unique characteristics of almost any lottery.
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, ticket validation software technology, Terra 2000(R)
tickets, SciScan Technology(R) and SGI-NET. The Terra 2000 ticket is a
recyclable and biodegradable paper ticket, which meets the rigorous security
standards demanded by the lottery industry.
Scientific Games and its partner TeleCom Productions, Inc. introduced
The Daily Race Game(TM) in January 1997. The Daily Race Game is a
player-selection game that combines on-line, virtual reality horse racing with a
popular "pick your numbers" format to draw the winning numbers for an on-lottery
game. Players choose three horses from a field of 12 in a 55-second animated
horse race that can be shown on either commercial or closed-circuit television.
The Delaware Lottery was the first to license the game and rolled it out during
the 4th quarter of 1998.
Another recent innovation, which we introduced in 1997, is our
probability-game ticket, Winner's Choice. Winner's Choice(TM) is a scratch-off
instant ticket lottery game in which every ticket is a potential winner (unlike
existing tickets, where winning tickets are pre-determined before a player
scratches). Winner's Choice combines some of the best features of instant and
on-line games, and possesses three important player benefits - choice,
instant-win opportunities and appealing play styles. Probability games have been
discussed within the lottery industry for years, but have never been viable
because secure validation could not be assured. The Company's new SciScan
Technology provides secure validation to enable probability tickets to be sold.
Winner's Choice games are currently undergoing field testing in Maine and
Kentucky conducted by Scientific Games in cooperation with the respective
lotteries.
Scientific Games is continually looking for ways to apply its expertise
in specialty printing technologies and security/randomization techniques to
develop commercially viable products for both the lottery industry as well as
for other commercial applications. We are committed to new product development
and we will continue to explore new means of delivering our products, possibly
via the internet and new opportunities to market new products and services to
new and existing customers.
TRADEMARKS AND PATENTS
We own rights in the following trademarks, which include certain
federally registered marks: Winner's Choice(TM), Terra 2000(R), SciScan
Technology(R). We believe our marks are valuable and, accordingly intend to
maintain our marks and the related registrations. We are not aware of any
pending claims of infringement or other challenges to our right to use our marks
in the lottery business in the United States. Certain technology associated with
our products is 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
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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.
CUSTOMER SERVICE
We have an active professional customer service team which works
closely with lotteries in instant ticket 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 our customer service representatives. This information, when approved
by the lottery, becomes the technical manufacturing specifications for specific
instant 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, instant 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 analysis of gaming tendencies in most new state
lotteries 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 and on-line games are believed to have a broad consumer
appeal throughout the world. Consumers are generally split equally between men
and women, are distributed evenly between ages 25 and 65, and cover a broad
range of socioeconomic groupings. This broad-based market is significantly
affected by appropriate advertising and promotion activities. The most
successful lotteries have found that lottery products are largely an impulse
item, which must be marketed like other consumer products.
Sales of lottery products are based on, among other factors, the
quality of the lottery product, prize structure design and the existence of
efficient 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, major lotteries
periodically reassess key security questions concerning the vulnerability of
lottery games. Attempts to penetrate security measures may come from various
combinations of customers, retailers, vendors, lottery employees 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 or on-line
games 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.
Scientific Games constantly assesses the adequacy of its security
systems, incorporating various improvements, such as bar coding and additional
layers of protection in our instant tickets. There must be well-planned security
measures in place at every stage of the lottery operation. Scientific Games has
pioneered and effected security safeguards in 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. The Company retains
a major public accounting firm to perform agreed upon procedures for each game
produced before it is sent to the customer.
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. Our facilities
are
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designed for efficient, secure production of instant game tickets and support
ink-jet image tape generation, printing, packaging and storage of instant game
tickets.
The Company's dedicated computer-controlled printing process is
specifically designed for producing instant lottery game tickets for
governmentally sanctioned lotteries and promotional games. The process is not a
business forms press or a direct mail press temporarily diverted to lottery
work. Our specialized equipment contributes to the underlying superior
manufacturing and product quality. Instant ticket games are delivered finished
and ready for distribution by the lottery, or by Scientific Games in the
jurisdictions which are part of an instant ticket contract with cooperative
services provided by Scientific Games.
Paper and ink are the principal raw materials consumed in the Company's
ticket manufacturing operations. The Company has a variety of sources for both
paper and ink and should, therefore, not be dependent on any particular
supplier.
PERSONNEL
As of December 31, 1998, we had approximately 1,180 full-time
employees. Four of Scientific Games' employee groups are represented by a labor
union. At the California Facility (See "Properties"), ticket packaging is
performed by approximately 60 employees who are members of the Service Employees
International Union Local 1877. SG Austria's employees are represented by a
Worker's Council, which is typical in many European companies. At the Leed's
Facility in the United Kingdom, approximately 173 employees are members of the
GPMU union. Approximately eleven employees who work at a facility in Harrisburg,
Pennsylvania are members of the Chauffers, Teamsters and Helpers Local Union
776. The Company believes that its employee relations are good.
EXECUTIVE OFFICERS
The following table sets forth certain information regarding the
executive officers of the Company who are considered executive officers by the
Company for the purposes of Rule 3b-7, as of March 1, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
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<S> <C> <C>
William G. Malloy.................... 52 Director, Chairman, President and Chief
Executive Officer
William F. Behm...................... 53 Director and Executive Vice President
Thomas F. Little..................... 54 Senior Vice President
Cliff O. Bickell..................... 56 Vice President, Treasurer and Chief Financial Officer
C. Gray Bethea, Jr. ................. 54 Vice President, Secretary and General Counsel
Bruce H. Longhurst................... 58 Vice President, International Sales and Marketing
Howard H. Roath...................... 46 Vice President-U.S. Sales and Marketing
William C. Christie.................. 50 Managing Director-Scientific Games International
Limited
James H. Edwards, Jr. ............... 53 Director of Manufacturing
Christian Rosner..................... 42 Managing Director-Scientific Games Austria
Donald N. MacLean.................... 54 Director- Human Resources
Kenneth W. Taylor.................... 38 Corporate Controller
William R. Murphy.................... 45 Senior Director MIS Support
Lynn A. Becker....................... 37 Senior Director Business Information Systems
John J. Walsh........................ 39 Vice-President, Operations
</TABLE>
WILLIAM G. MALLOY has been President and Chief Executive Officer since
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
production and 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 joined the
Company in 1987 when he transferred from the corporate staff of Bally
Manufacturing Company. Mr. Malloy has over twenty-four years of experience in
the coin-operated amusement and gaming industry.
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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 the
Company's product security. 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, the development of the Company's environmental
instant ticket and the development of the Company's recent SciScan Technology
and Winner's Choice product lines. He is co-named as the inventor of various
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 in 1991. Mr. Little has overall management responsibility for
Scientific Games' Systems Division, which includes the Company's on-line lottery
systems business. 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, and contract documents. 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 law firm of
Smith, Gambrell & Russell in Atlanta, Georgia.
BRUCE H. LONGHURST joined the Company in 1997 as Vice President,
International Sales and Marketing. Mr. Longhurst has overall management
responsibility for Scientific Games international marketing and sales efforts.
Prior to joining Scientific Games, Mr. Longhurst was Vice President,
International and Strategic Planning for Autotote Corporation and Managing
Director of its subsidiary TeleControl, which was acquired in 1997 by Scientific
Games. Mr. Longhurst held these and other positions with Autotote from
1993-1997. From 1988 - 1992, Mr. Longhurst held the position of Executive Vice
President of the Worldwide Wagering Division of General Instrument Corporation.
In addition, Mr. Longhurst was one of the founders and served as Executive Vice
President and General Manager of Ticketron, including its AWI subsidiary.
HOWARD H. ROATH joined the Company in 1987 and was promoted to Vice
President, U.S. Sales and Marketing in 1997. Mr. Roath has overall management
responsibility for Scientific Games' U.S. marketing and sales efforts. Prior to
joining Scientific Games, Mr. Roath served as Director of Marketing of the
Pennsylvania Lottery, Director of Pharmaceutical Assistance Program for the
Elderly for the Pennsylvania Department of Aging and Director of the Division of
State Employment for the Pennsylvania's Governor's Office of Administration.
WILLIAM C. CHRISTIE joined the Company in 1996 as Managing Director for
the Company's subsidiary SGIL in the United Kingdom. Mr. Christie has overall
management responsibility for ticket production and printing for SGIL's
production facilities. Prior to joining the Company, Mr. Christie was the
Managing Director of Lottery Products for De La Rue in the United Kingdom.
During his 26 years with De La Rue, Mr. Christie held various other management
positions.
JAMES H. EDWARDS, JR. joined the Company in 1991 as Plant Manager and
was promoted to Director of Manufacturing in 1998. Mr. Edwards has overall
management responsibility for ticket production and printing for the
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<PAGE> 9
Company's United States production facilities. Prior to joining the Company, Mr.
Edwards held various management positions with Quebecor Printing, Inc. for over
20 years.
CHRISTIAN ROSNER joined the Company in 1999 as Managing Director for
the Company's subsidiary SG Austria in Vienna, Austria. Mr. Rosner has overall
management responsibility for SG Austria systems operations. Prior to joining
the Company, Mr. Rosner was the Managing Director for CWS.
DONALD N. MACLEAN joined the Company in 1997 as Director of Human
Resources. Mr. MacLean manages the personnel function for all of the Company's
locations. Prior to joining the Company, Mr. MacLean held the position of Vice
President of Human Resources for Burnham Service Corporation from 1989 to 1997.
In addition, Mr. MacLean was the Corporate Director of Human Resources for
Interlake Corporation and Division Director of Human Resources for Mueller
Corporation.
KENNETH W. TAYLOR joined the Company in 1987 and was promoted to
Corporate Controller in 1990. Mr. Taylor has management responsibility for
accounting and financial information as well as responsibility for customer
pricing compliance. Prior to joining the Company, Mr. Taylor held auditor
positions with Bally Manufacturing Corporation, Duchossois Industries and Amsted
Industries, Inc.
WILLIAM R. MURPHY joined the Company in 1984 and was promoted to Senior
Director - MIS Support in 1998. Mr. Murphy has overall management responsibility
for software support for all U.S. system implementations, company-wide
communication networks, domestic PC workstations and system hardware. Mr. Murphy
is also responsible for POS terminal hotline support as well as operational
support for CSP system locations. Mr. Murphy was involved in the initial
development of the Company's original on-line software system and has been
heavily involved in all of the Company's domestic systems installations. Prior
to joining the Company, Mr. Murphy held positions as a systems
engineer/programmer for Consultec, Inc., Data Crown, Inc. and Electronic Data
Systems.
LYNN A. BECKER joined the Company in 1986 and was promoted to Senior
Director, Business Information Systems in 1998. Mr. Becker has overall
management responsibility for all game development efforts, including
programming for instant game development, game auditing and validation. Mr.
Becker is also responsible for the Company's internal computer systems and
applications.
JOHN J. WALSH joined the Company in 1986 and was promoted to
Vice-President of Operations in 1998. Mr. Walsh has overall management
responsibility for coordinating lottery operations support for both the Instant
Ticket and Related Services and Systems segments. Prior to joining the Company,
Mr. Walsh held positions with Control Data Corporation and Ticketron's sports
and entertainment division.
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
quarterly and annual consolidated results for 1999, 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 regulatory authority, the
lottery statutes generally dictate certain broad parameters of lottery
operation, including the percentage of lottery revenues which must be paid out
in prizes. Lottery authorities typically exercise significant control as to the
selection of vendors (such as the Company) and award of lottery contracts,
including ticket prices, types of games played and marketing strategy, all of
which can affect the Company's operating results.
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<PAGE> 10
Prior to and after granting a lottery contract, governmental
authorities generally conduct an investigation of the Company and its employees
and such authorities may require removal of an 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 from time to time retains governmental affairs
representatives in 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 in its relations with lottery authorities.
Scientific Games also makes campaign contributions to various state political
parties and state 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 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.
MARKETS
The Company's operations are international in scope. With 37 states and
the District of Columbia currently operating lotteries in the United States, 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. The Company has a high percentage of the U.S. instant
ticket market but has a minimal U.S. systems presence. As a result, management
believes the U.S. systems market to be a source of potential revenue growth for
the Company. Contrasted with the domestic market, the international market is
far from mature, with various countries viewing lotteries as a potential source
of revenue for a variety of governmental programs. For a discussion of the
Company's net revenues, operating income and identifiable assets attributable to
U.S. production operations, see Note 11 of the Notes to Consolidated Financial
Statements set forth elsewhere in this report, which is incorporated herein by
reference thereto. For a discussion of revenues from lottery agencies and other
customers domiciled in foreign countries, also see Note 11 which is incorporated
herein by reference.
In 1998, no customer accounted for more than 10% of the revenues of the
Company. During 1998, the Company had nine U.S. contracts that were subject to
extensions or scheduled to expire. Of such contracts, six contained extension
options. With respect to the foregoing contracts, the Company received six
contract extensions, negotiated one additional extension, was the successful
bidder on one new contract and was the unsuccessful bidder on one contract. The
Company was the unsuccessful bidder on the California State Lottery contract.
However, the Company did receive a back-up supply contract extension through
June 1999. With regard to contracts previously held by its competitors, the
Company was the successful bidder in 1998 for the Connecticut Lottery
Corporation.
The Company has thirteen U.S. contracts which are subject to extensions
or scheduled to expire in 1999. Of these thirteen contracts, 8 have extensions
available. Management believes new contracts for those jurisdictions without
extensions will be awarded through a competitive procurement process in which
the Company will participate. The Company estimates, based in part upon industry
and lottery furnished information, that 1998 U.S. instant ticket retail sales by
lotteries ("1998 Lottery Sales") were in excess of $14 billion. In comparison,
1998 international instant ticket retail sales are estimated to be $14 billion.
Based in part on such information, management estimates the Company's U.S.
customers with contracts subject to extensions or scheduled to expire in 1999
represent, in the aggregate, retail sales of approximately 40.7% of 1998 Lottery
Sales. In contrast, management believes that lottery contracts with eight states
currently serviced by its competitors are subject to extensions or are scheduled
to expire in 1999 which the Company estimates had aggregate retail sales equal
to approximately 32.0% of 1998 Lottery Sales. The Company expects that new
contracts for such states not exercising extensions will be awarded through the
competitive procurement process in which the Company expects to participate.
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<PAGE> 11
U.S. instant ticket lottery contracts typically have an initial term of
from one to five years and usually provide the customer with options to extend
the contract one or more times under the same or mutually agreeable terms and
conditions for additional periods generally ranging from one to five years. The
average term of a U.S. on-line contract is five to ten years, with additional
extension options, which limits the number of contracts available for bidding in
any given year. The Company's customers have exercised extension options in the
Company's U.S. instant lottery contracts a majority of the time.
The table included herein lists the United States lottery contracts for
which the Company had executed agreements as of March 22, 1999 and certain
information with respect thereto. The Company is the primary instant ticket
supplier unless otherwise noted. The table also includes 1998 instant ticket
retail sales for each state or district.
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<PAGE> 12
SCIENTIFIC GAMES
UNITED STATES LOTTERY CONTRACTS
<TABLE>
<CAPTION>
1998
INSTANT TICKET COMMENCEMENT EXPIRATION CURRENT RENEWAL
RETAIL SALES DATE OF CURRENT DATE OF CURRENT OPTIONS
STATE/DISTRICT (IN MILLIONS) CONTRACT CONTRACT REMAINING TYPE OF CONTRACT
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Arizona 108.4 January 1998 January 2001 2 one-year ITRS
California 685.3 January 1996 June 1999 none ITRS
Colorado 225.2 May 1995 June 2000 none ITRS
Connecticut 429.4 August 1998 August 2000 2 one-year ITRS
Delaware 18.1 July 1995 July 2000 none ITRS
District of Columbia 23.4 May 1996 May 1999 3 one-year ITRS
Florida 663.9 April 1997 September 2002 none ITRS
Georgia 609.8 May 1993 April 2003 none ITRS
Illinois 618.3 July 1996 July 1999 3 one-year ITRS
Indiana 351.5 December 1997 December 1999 2 one-year ITRS
Iowa 90.6 January 1995 December 1999 none ITRS
Kentucky 261.9 October 1997 October 1999 3 one-year ITRS
Maine 105.5 July 1990 June 2000 none ITRS and Systems
Massachusetts 2,085.0 October 1993 June 1999 none ITRS
Minnesota 260.1 January 1995 January 2000 1 one-year ITRS
Missouri 257.3 June 1997 June 1999 none ITRS and Systems
Nebraska 39.8 July 1993 June 2001 none ITRS and Systems
New Jersey 518.6 November 1996 October 1999 2 one-year ITRS
New Mexico 48.6 March 1997 March 1999 4 one-year ITRS
New York 1.009.9 April 1996 July 1999 1 one-year ITRS and Systems
Oregon 121.9 June 1998 June 1999 none ITRS*
Pennsylvania 469.2 April 1997 April 2002 5 one-year ITRS
South Dakota 14.5 June 1995 June 1999 1 one-year ITRS
Texas 1,615.6 March 1999 March 2002 none ITRS**
Virginia 302.3 January 1997 July 2002 1 three or five year Systems
Washington 230.3 May 1995 May 2000 none ITRS
W. Virginia 80.2 December 1996 June 2000 1 one-year ITRS and Systems
Wisconsin 246.6 October 1996 October 1999 none ITRS*
- ---------------------------------------------------------------------------------------------------------------------------------
* secondary printer
** See Recent Developments of Management's Discussion and Analysis of Financial Condition and Results of Operations set forth
in Part IV, Item 14, Exhibit 13.1 of the Company's Annual Report on Form 10-K.
ITRS = Instant Ticket and Related Services
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company's re-entry into the on-line lottery business in 1998 has
and will allow the Company to compete for a share of both the U.S. and
international sales in the future. The Company expects to bid on these U.S.
contracts, while pursuing international on-line opportunities during 1999.
The Company currently provides instant ticket validation systems to the
five states shown in the chart. In addition, the Company currently has eleven
SGI-NET systems installations in Europe and expects to add France, Western
Canada and Golden Casket Lottery Corporation in Australia. As a result of
winning the contract to provide on-line lottery services to the Western Canada
Lottery Corp., we believe we are now better positioned to compete for additional
on-line contracts, not only in the remainder of Canada, but also in the rest of
North America. In addition, the sale of SciScan terminals to Greece and France
better positions the Company to market its SciScan Technology in Europe.
Management believes that its technical and marketing expertise, its reputation
as a quality instant ticket provider, its financial stability and its quality
on-line products will allow it to compete in the U.S. on-line market.
Sales outside the United States may consist of sales of goods and
services exported to customers located overseas, sales of goods and services to
customers in countries in which the Company's foreign subsidiaries have
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<PAGE> 13
manufacturing facilities or sales of goods and services by the Company's foreign
subsidiaries located outside the country of production. Although the Company
does business worldwide, a majority of the Company's current foreign operations
are conducted in Europe, and a majority of U.S. export sales are made to
customers located in Europe.
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 than domestic
U.S. customers. The volume and timing of the international contracts fluctuate
from country to country and it is difficult to predict the volume or timing of
sales to these customers from period to period.
INDUSTRY SEGMENT INFORMATION AND CLASSES OF SIMILAR SERVICES
Information with respect to the Company's industry segments,
geographical operations and classes of similar services is set forth in Note 11
to the Consolidated Financial Statements of the Company, which appears on pages
28 through 39 of the Company's 1998 Annual Report to Shareholders, which Note 11
is incorporated herein by reference.
LOTTERY CONTRACTS: PROCUREMENT PROCESS AND REQUIREMENTS
Lotteries in the United States typically select an instant ticket or
on-line 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. We believe that the quality of
our personnel, our technical expertise and our manufacturing efficiency give us
many advantages relative to the competition when responding to state lottery
RFPs. However, many lotteries still award the contract to the qualified vendor
with the lowest price, regardless of factors other than price. Contract awards
by lottery authorities in the United States are sometimes challenged by
unsuccessful competitors which can result in protracted legal proceedings.
Domestic lottery contracts, including ours, typically contain
provisions for payment of liquidated damages for late delivery of tickets,
delivery of defective tickets or system non-operability, which in the aggregate
could result in several million dollars or more per day in penalties to the
Company. Although the payment 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 typically paid liquidated damages in a
material amount under instant ticket lottery contracts, although we have on
occasion negotiated customer allowances which have not had a material effect on
our business.
Lottery contracts to which the Company is party frequently contain
exacting implementation schedules and performance requirements. Failure to meet
these schedules and requirements may 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 various insurance companies. As of December 31, 1998, $77 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 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 of the surety.
Our contracts 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 our current contracts will be extended
or that we 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 we derived thereunder, the
termination, expiration or failure to renew one or more lottery
contracts could have a material adverse effect on the our results of operation,
business or prospects.
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<PAGE> 14
COMPETITION
The instant and on-line lottery businesses are highly competitive, and
the Company's business faces competition from a number of domestic and foreign
instant ticket manufacturers, on-line lottery system providers and other
competitors.
Scientific Games currently has two primary instant lottery ticket
competitors in the U.S.: Pollard Banknote Limited ("Pollard") and BABN
Technologies ("BABN," a subsidiary of Group Francois-Charles Oberthur of
France). In addition, Creative Games International, Inc. ("Creative Games") is
also a competitor in the U.S. The Company estimates that the retail sales value
of its U.S. customer base was in excess of 70% of total U.S. instant ticket
retail sales in 1998 - approximately twice as large 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 in Canada or Mexico export their lottery products to the U.S. or
should other foreign competitors establish printing facilities in the U.S.,
Canada or Mexico to supply the U.S. market.
Internationally, there are many lottery instant ticket vendors which
provide competition to the Company, including, among others, BABN, Pollard,
Creative Games, GPS Honsel and various other vendors.
GTECH Holdings Corporation ("GTECH") is our major competitor in the
on-line market with about 70% of the U.S. market. Other on-line competitors in
the U.S. are Automated Wagering Inc. ("AWI") a subsidiary of Powerhouse
Technologies, and Autotote Corporation. GTECH is also our major competitor in
the international on-line market with the balance of the market being served by
Scientific Games, AWI, EssNet AB and a few other companies.
Both in the U.S. market and internationally, factors which influence
the award of lottery contracts in addition to price, 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 offered and the satisfaction of various other requirements
and qualifications imposed by specific jurisdictions.
We believe our position as a leading worldwide producer of instant
lottery tickets and our reputation as a developer of state-of-the-art technology
and marketing concepts, as well as experience in the industry, enhance
significantly our 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. Our business could be adversely
affected should our competitors' research and development activities result in
reduced technological differentiation between our products and their products.
Similarly, in the event technological developments materially reduce the capital
investment required to finance secure lottery ticket printing and systems
operations, the Company's business could be adversely affected by increased
competition. We do not anticipate any material reduction in the level of capital
financing required for entry into the lottery product business in the
foreseeable future.
The Company believes it has no current competitor in the U.S. market
which produces instant lottery tickets, provides on-line systems and offers a
full range of services to state lotteries. Competitors have typically either
manufactured only instant tickets or provided only certain 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 jointly be considered a competitor or potential competitor. 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: AWI and GTECH.
In 1997, we discontinued our charity pull-tab ticket business, which
was produced and distributed by our subsidiary GameTec Inc. ("GameTec"). In
connection with the disposition, we sold substantially all of the assets of
GameTec to International Gamco, Inc. ("Gamco"). We entered into a three-year
extendible marketing agreement
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<PAGE> 15
with Gamco to provide marketing and related services to state lotteries for
pull-tab tickets. Currently, the Company has 3 contracts with state lotteries
for pull-tab tickets. We believe it is desirable to offer pull-tab tickets to
lottery customers to maintain a full range of products and services and we
continue to provide pull-tab tickets to our lottery customers through the
marketing agreement. Our sales of pull-tab tickets to lottery customers are
included in our Instant Ticket and Related Services segment and accounted for
less than 10% of our consolidated gross revenues in 1998.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
Our operating results may vary significantly from period to period.
Revenues and capital expenditures may be difficult to forecast because our sales
cycle may 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.
Our 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 Tickets and Related Services. Significant new
customer contracts may require the expenditure of additional resources and the
creation of additional infrastructures before revenues are realized. In
addition, operating results may be affected if we need to utilize overtime labor
or by our ability to smoothly integrate new and/or upgraded production equipment
with our existing production operations. Revenues from the sale of Instant
Tickets and Related Services and Systems may be recognized based upon ticket
shipments, a percentage of the lottery's sales to the public, a contracted
price, a license agreement, an equipment lease agreement or any combination of
the foregoing.
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 may make it difficult to forecast
revenues and expenditures related to our operations over extended periods and
may result in fluctuations in our quarterly financial results. Accordingly,
quarter to quarter fluctuations in revenues may be expected.
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
(See "Executive Officers"). 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 our actual results and
could cause our actual consolidated results for the first quarter of 1999, 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 our
products, and the resulting effects on margins, our actions in connection with
continued competition in many product areas, including, but not limited to,
price competition and fluctuating demand for certain lottery ticket 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 SGI-NET, SciScan 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
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<PAGE> 16
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 inability of the Company's vendors and customers as well as the
Company itself to adequately prepare for and respond to potential business
interruptions caused by the Year 2000 problem;
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;
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 our Company or in compensation and
benefit levels; activities of third parties with which we have an agreement or
understanding, including any issues affecting any investment or joint venture in
which we have an interest; the amount, type and cost of the financing available
to or utilized by us; and
The ability to integrate acquisitions into our 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 timeframes or at all.
For a more detailed discussion of certain of these risks see Item 3
"Legal Proceedings" and Item 7 "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
ITEM 2. PROPERTIES
The Company currently has four instant ticket manufacturing sites: a
71,000 square foot leased facility in Gilroy, California (the "California
Facility"); a 185,000 square foot owned headquarters and manufacturing facility
in Alpharetta, Georgia (the "Georgia Facility"); a 112,000 square foot leased
facility in Leeds, United Kingdom (the "Leeds Facility"); and a 30,000 square
foot leased facility in Bradford, United Kingdom (the "Bradford Facility").
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<PAGE> 17
We also have a 8,000 square foot leased facility in Vienna, Austria
(the "Austria Facility"), which is dedicated to software development activities
for our on-line business. We currently are subleasing space from FDJ in Paris,
France for our French software development activities until an appropriate
office building is located and tenant improvements are installed for the
Company's French operations. The South Africa sales branch leases approximately
1,900 square feet in Woodmead, South Africa. Sales support, research, product
development, U.S. software development and graphics are located in the Company's
corporate headquarters at the Georgia Facility where the Company also has a
10,000 square foot leased facility for software development in addition to its
manufacturing facility. Our employees also may be located at facilities owned or
leased by lotteries. In addition, we lease facilities in several states in order
to provide additional services to our Instant Ticket and Related Services
customers.
The four manufacturing facilities have a combined maximum production
capacity of approximately 14 billion "standard sized" (2 by 4 inch) tickets per
year. However, at maximum production capacity, the Company incurs substantial
overtime expense and can encounter reduced efficiencies. The California Facility
consists of office and production space equipped with a modern gravure press
with multiple ink-jet imagers. The California Facility lease expires April 30,
2005. Currently. In addition, the Company separately leases in California an
approximately 14,000 square foot ink production facility under a lease expiring
April 30, 1999. The Company is currently negotiating the terms of a new lease
for the same 14,000 square foot facility. The Leeds Facility consists of office
and production space equipped with five sheet-fed offset presses. The
administrative and game development departments for both the Leeds and Bradford
Facilities are in this location. The Leeds Facility lease expires October 31,
2001. The Bradford Facility includes office and production space and is equipped
with three separate printing processes: offset, inkjet and rotary screen. The
Bradford Facility lease expires June 30, 2016. The Austria Facility consists of
office and software development space equipped with state-of-the-art software
development tools. The Austria Facility lease expires on December 31, 2007.
Scientific Games' headquarters and printing facility in Georgia began
operation in February 1992. The Georgia Facility operates two presses, including
a modern 15 station gravure press. The Georgia Facility's gravure press is
equipped with a state-of-the-art register control system, designed to reduce
overall waste while achieving high quality. The press has four reversible
stations providing color flexibility including potential four-color back
printing in selected situations and is designed to accommodate alternative
printing technology on a station-by-station basis. The press is designed to dry
both water-based and solvent-based inks at full press speed. Currently, the use
of water-based inks is increasing as the printing industry moves to reduce its
output of volatile organic compounds (VOC's) created as the result of drying
solvent based inks.
In 1994-95, after an analysis of projected future manufacturing
requirements, the Company installed new imagers, data stations and related
equipment incorporating significantly advanced technology for its existing
presses in its California and Georgia facilities at a total cost of
approximately $5 million. Such imagers materially increased the efficiency and
flexibility (and thus capacity) of the Company's existing presses.
In 1995, we also installed an additional custom-designed printing
press, including new imagers, data stations and related equipment, in its
Georgia Facility. The total cost of the equipment and building expansion was
approximately $15.5 million. This is designed to employ both offset and
flexographic printing technologies and allows us to more economically produce
smaller print runs than the existing two gravure presses, by, among other
things, reducing press set-up costs as compared to the existing gravure presses
in Georgia and California. The savings in operation of the third press are
attributable to, among other factors, the flexographic and offset technologies
which use photopolymer and aluminum plates rather than the engraved chrome
plated cylinders used in the gravure process.
In 1998, we installed our own film development equipment in our Georgia
Facility. The new film development equipment allows us to internalize our
pre-press functions and reduce our manufacturing costs.
The Company has presses at the Leeds and Bradford Facilities located in
the United Kingdom. The Leeds Facility has five sheet-fed offset presses as well
as imaging and silk screen equipment. The Bradford Facility utilizes three
separate printing processes, which are an offset, inkjet and rotary screen. In
1997, after an analysis of projected future manufacturing requirements, we began
installation of new imagers, data stations and related equipment incorporating
significantly advanced technology for our existing presses at the Bradford
Facility at a total
17
<PAGE> 18
retail cost of approximately $3.0 million. Such imagers became fully operational
in March 1998 and materially increased the efficiency and flexibility (and thus
capacity) of our existing presses at the Bradford Facility.
ITEM 3. LEGAL PROCEEDINGS
The Company's SGI subsidiary owns a minority interest in Wintech de
Colombia, S.A. ("Wintech"), which has operated the Colombian national lottery
under contract with Empresa Colombiana de Recursos para la Salud, S.A.
("Ecosalud"), an agency of the Colombian government. The contract projected that
certain levels of lottery ticket sales would be attained, and provided a penalty
against Wintech, SGI and the other shareholders of Wintech of up to $5,000,000
if such levels were not achieved. In addition, with respect to a further
guarantee of performance under the contract with Ecosalud, SGI delivered to
Ecosalud a $4,000,000 bond issued by a Colombian surety, Seguros del Estado
("Seguros"). Wintech started the instant lottery in Colombia but, due to
difficulties beyond its control, the projected sales level was not met for the
year ending 1993. On July 1, 1993, Ecosalud adopted resolutions declaring, among
other things, that the contract was in default and asserted various claims for
compensation and penalties against Wintech, SGI and shareholders of Wintech. As
the Company has previously disclosed, litigation is pending in Colombia
concerning various claims among Ecosalud, Wintech and the Company relating to
the termination of the contracts with Ecosalud (the "Colombian Litigation").
Ecosalud's claims in the Colombian Litigation are for, among other things,
realization on the full amount of the penalty plus interest and costs of the
bond.
SGI has consulted with Colombian counsel and has been advised that SGI
has various legal defenses to Ecosalud's claims. SGI also has certain cross
indemnities and undertakings from the two other private shareholders of Wintech
for their respective shares of any liability to Ecosalud. That obligation is
secured in part by a $1,500,000 confirmed letter of credit in favor of SGI. The
Colombian surety which issued a $4,000,000 bond to Ecosalud under the contract
has reportedly paid $2,400,000 to Ecosalud under the bond, and made demand upon
SGI for that amount under the indemnity agreement entered into by the surety and
SGI. SGI declined to make or authorize any such payment and notified the surety
that any payment in response to Ecosalud's demand on the bond is at the surety's
risk. No assurance can be given that the other shareholders of Wintech will, or
have sufficient assets to, honor their indemnity undertakings to SGI when the
claims by Ecosalud against SGI and Wintech are resolved, in the event such
claims result in any liability.
In June 1996, Ecosalud filed a complaint against the Company in the
United States District Court for the Northern District of Georgia, Atlanta
Division (the "Georgia Litigation"). Total damages claimed in the original
Complaint were "not less than $84,423,267." The complaint also sought reasonable
attorneys' fees and costs allegedly pursuant to the contract. In response to the
complaint, SGI filed a motion to dismiss the action on multiple grounds,
including the mandatory arbitration clause contained within the contract.
Ecosalud then filed an amended complaint in which it withdrew its claim for in
excess of $84,000,000 and, instead, seeks $5,000,000 under an "Executive Title,"
a purported joint and several guarantee by the Company, Wintech and other
shareholders in Wintech that projected levels of lottery ticket sales would be
attained. In addition, Ecosalud also sought attorneys' fees and interest on the
claim. SGI filed a motion to dismiss the amended complaint on the grounds, inter
alia, that litigation involving the same subject matter was pending in Colombia,
the dispute is subject to an arbitration clause and forum non conveniens. On
March 19, 1997, judgment was entered on behalf of the Company. The Court
dismissed the action on the grounds that it was governed by the arbitration and
forum selecting clauses in the contract which require that all disputes be
settled either by arbitration in Colombia or in the administrative courts of
Colombia. The Court also dismissed the action on the grounds of lis alibi
pendens. On April 16, 1997, the Plaintiff filed a notice of appeal. The United
States Court of Appeals for the Eleventh Circuit heard oral argument on the
appeal of the dismissal of the complaint of Ecosalud on January 16, 1998 and
thereafter affirmed the holding of the
18
<PAGE> 19
trial Court. Ecosalud did not seek reconsideration by the Eleventh Circuit;
accordingly, the Georgia Litigation has been concluded.
On April 2, 1998, Seguros brought suit against the Company in the
United States District Court for the Northern District of Georgia, Atlanta
Division. The plaintiff seeks $2,400,000 for sums paid by Seguros to Esosalud
under the surety bond on November 1, 1994, plus interest at the Colombian bank
rate of interest. The Company has filed a motion to dismiss based on the
Colombian statute of limitations of two years and, alternatively, seeking that
the case be dismissed on other grounds. Seguros filed a motion for summary
judgment with the Court on May 6, 1998 seeking summary judgment on its claim in
the amount of $2,400,000, plus $3,246,916 in accrued interest, plus interest,
thereafter.
SGI intends to vigorously defend the Colombian Litigation and the
recently filed Seguros litigation and has been advised by counsel that the
Company has numerous defenses on the merits, as well as procedural defenses to
the litigation. Although it is not possible to determine the outcome of the
litigation in Colombia, or the other related surety and indemnity claims,
management believes based upon, among other things, the advice of counsel that
SGI has various defenses (which it has asserted in response to such proceedings
and claims), that adequate provision has been made for such claims and the
disposition thereof should not have a material adverse effect on the Company's
consolidated financial condition or consolidated results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders at any time
during the fourth quarter of the year ended December 31, 1998.
19
<PAGE> 20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In July 1997, the Company adopted a shareholders rights plan which
provided for the issuance to each holder of the Company's Common Stock, certain
rights (the "Rights") to purchase shares of the Company's redeemable Series A
Participating Cumulative Preferred Stock pursuant to the terms of a Rights
Agreement. Such rights are exercisable after distribution by holders other than
"Acquiring Persons" as defined in the Rights Agreement in the event of certain
ownership changes and in connection with certain business combinations. The
Rights may have certain anti-takeover effects. The Rights may cause substantial
dilution to a person that attempts to acquire the Company without a condition to
such an offer being that a substantial number of the Rights be acquired or that
the Rights be redeemed or declared invalid. The Rights should not interfere with
any merger or other business combination approved by the Board of Directors
(under some circumstances, with the concurrence of the Continuing Directors)
since the Rights may be redeemed by the Company. A copy of the Rights Agreement
and a more expansive summary of the provisions thereof is set forth in the
Company's Form 8-A/A with respect thereto, filed with the Commission on August
6, 1997.
The information presented under the caption "Corporate Information" on
page 41 of the Company's 1998 Annual Report to Shareholders is incorporated
herein by reference.
ITEM 6 SELECTED FINANCIAL DATA
The information presented under the caption "Five-Year Selected
Financial Data" on page 14 of the Company's 1998 Annual Report to Shareholders
is incorporated herein by reference.
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information presented under the caption "Management's Discussion
and Analysis of Financial Condition and Results of Operations" on pages 15
through 23 of the Company's 1998 Annual Report to Shareholders is incorporated
herein by reference.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information set forth under the heading "Inflation, Changing
Prices, Foreign Currency Fluctuations and Market Risk" appearing on pages 21
through 22 of our 1998 Annual Report to Shareholders is incorporated herein by
reference.
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information presented under the caption's "Consolidated Statements
of Income", "Consolidated Balance Sheets", "Consolidated Statements of Cash
Flows", "Consolidated Statements of Shareholders' Equity", and "Notes to
Consolidated Financial Statements", on pages 24 - 40 of the Company's 1998
Annual Report to Shareholders is incorporated herein by reference.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable
20
<PAGE> 21
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information required by Item 10 is incorporated by reference from
the information in Registrant's proxy statement (filed or to be filed pursuant
to Regulation 14A) for its Annual Meeting of Stockholders to be held May 21,
1999, except as to biographical information on Executive Officers which is
contained in Item 1 of this Annual Report on Form 10-K.
ITEM 11 EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from
the information in Registrant's proxy statement (filed or to be filed pursuant
to Regulation 14A) for its Annual Meeting of Stockholders to be held May 21,
1999.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference from
the information in Registrant's proxy statement (filed or to be filed pursuant
to Regulation 14A) for its Annual Meeting of Stockholders to be held May 21,
1999.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from
the information in Registrant's proxy statement (filed or to be filed pursuant
to Regulation 14A) for its Annual Meeting of Stockholders to be held May 21,
1999.
21
<PAGE> 22
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Consolidated Financial Statements
The following financial statements and notes thereto of Scientific
Games Holdings Corp. are incorporated in Item 8 by reference from the Company's
1998 Annual Report to Shareholders:
<TABLE>
<CAPTION>
Page in Annual
Report to Shareholders
----------------------
<S> <C>
Consolidated Statements of Income, Years ended December 31, 1998, 1997 and 1996 24
Consolidated Balance Sheets-- December 31, 1998 and 1997 25
Consolidated Statements of Cash Flows -- Years ended December 31, 1998, 1997 and 1996 26
Consolidated Statements of Shareholders' Equity, Years ended December 31, 1998, 1997 and 1996 27
Notes to Consolidated Financial Statements-- December 31, 1998 28-39
Report of Independent Auditors 40
</TABLE>
(a)(2) Financial Statement Schedules
Schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
(a)(3) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1998.
(a)(4) Listing of Exhibits
The exhibits listed below are filed with or incorporated by reference
into this annual report on Form 10-K.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
<S> <C>
3.1 -- Second Amended and Restated Certificate of Incorporation of Scientific Games
Holdings Corp. with Certificate of Designation (12)
3.2 -- Second Amended and Restated By-Laws of Scientific Games Holdings Corp. (4)
10.2 -- Agreement by and between the Massachusetts State Lottery Commission and
Scientific Games, Inc. dated December 18, 1987 and extensions thereto (1)
10.6 -- Employment Agreement ("Old Malloy Employment Agreement") dated as of October 1,
1991 between Scientific Games Operating Corp. (now known as Scientific Games
Inc.) and William G. Malloy (1)
10.7 -- Employment Agreement ("Behm Employment Agreement") dated as of October 1, 1991
between Scientific Games Operating Corp. (now known as Scientific Games Inc.)
and William F. Behm (1)
10.8 -- Employment Agreement ("Little Employment Agreement") dated as of October 1,
1991 between Scientific Games Operating Corp. (now known as Scientific Games
Inc.) and Thomas F. Little (1)
10.10 -- Form of Promissory Note evidencing loans to Management Stockholders (1)
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C>
10.16 -- Second Amendment to Asset Purchase Agreement dated as of October 1, 1991
between Bally Manufacturing Corporation and Scientific Games Operating Corp.
(now known as Scientific Games Inc.) (re: earnout) (1)
10.17 -- Stockholders' Agreement dated as of July 1, 1993, as amended (1)
10.18 -- Amended First 1991 Management Stock Option Plan (1)
10.19 -- Amended Second 1991 Management Stock Option Plan (1)
10.20 -- 1993 Management Stock Option Plan (1)
10.21 -- Industrial Real Estate Lease dated December 4, 1984 between Arroyo One as
Landlord and Scientific Games Inc. as Tenant (Gilroy Lease), as amended (1)
10.22 -- Lease dated April 27, 1987 between Kishimura Bros. and Scientific Games of
California, Inc. (Scientific Games of California, Inc. assigned its leasehold
interest to Scientific Games Operating Corp., now known as Scientific Games,
Inc.), as amended (1)
10.23 -- Form of Amendment to Old Malloy Employment Agreement (1)
10.24 -- Form of Amendment to Behm Employment Agreement (1)
10.25 -- Form of Amendment to Little Employment Agreement (1)
10.26 -- Instant Ticket and Associated Products and Services Agreement dated May 4, 1993
by and between Georgia Lottery Corporation and Scientific Games, Inc. (4)
10.31 -- Form of revised Severance Benefits Agreement (4)
10.32 -- Amendment to Amended First 1991 Management Stock Option Plan (4)
10.33 -- Amendment to Amended Second 1991 Management Stock Option Plan (4)
10.34 -- Amendment to 1993 Management Stock Option Plan (4)
10.35 -- First Amended and Restated 1993 Directors' Stock Option Plan (4)
10.37 -- 1994 Management Stock Option Plan (6)
10.38 -- 1995/1996 Management Stock Option Plan (6)
10.39 -- Key Employee Restricted Stock Option Plan (6)
10.40 -- Severance Benefits Agreement dated as of May 5, 1995, between Scientific Games Holdings Corp. and
Cliff O. Bickell (7)
10.42 -- Key Employee Restricted Stock Plan (6)
10.43 -- Form of Key Employee Restricted Stock Plan Restricted Stock Award Agreement (7)
10.45 -- Instant Lottery Tickets Supply Agreement between Thomas De La Rue Limited, Scientific Games Inc. and
Camelot Group plc, dated June 15, 1995. (3)(8)
10.46 -- Credit Agreement for Line of Credit From First Union National Bank of Georgia to Scientific Games
Holdings Corp. and Scientific Games Inc. Dated: December 20, 1996 (9)
10.47 -- Rights Agreement dated as of July 10, 1997 between Scientific Games Holdings Corp. and First Union
National Bank as Rights Agent (11)
10.48 -- Amended Bank Credit Agreement (12)
10.49 -- 1998 Employee Stock Purchase Plan, as amended and restated (12)
10.50 -- Stock Purchase Agreement dated as of April 15, 1997, by and between Scientific Games Holdings Corp.
and Autotote Corporation with Respect to All Outstanding Capital Stock of TeleControl Kommunications
- und Computersysteme Gesellschaft m.b.H. (12)
10.51 -- Form of Amendment to Behm Employment Agreement (12)
10.52 -- Form of Amendment to Little Employment Agreement (12)
10.53 -- Severance Benefits And Employment Agreement dated as of January 1, 1998 between William G. Malloy
and Scientific Games Holdings Corp.
11.0 -- Statement re: computation of per share earnings (loss)
13.1 -- 1998 Annual Report to Shareholders pages 14, 15-39 and 41 only
21.0 -- List of Subsidiaries of Registrant
23.0 -- Consent of Independent Auditors
27.0 -- Financial Data Schedule (for SEC use only)
</TABLE>
- ---------------------
(1) Previously filed with Registration Statement No. 33-65582, filed on
July 2, 1993 or as subsequently amended on July 28, 1993, August 9,
1993 or August 20, 1993.
23
<PAGE> 24
(2) Previously filed with the Company's Quarterly Report on Form 10-Q for
the Quarter Ended September 30, 1993.
(3) Portions of Exhibits 10.28 and 10.43 deemed confidential by the Company
have been omitted, were filed separately with the Commission and
confidential treatment has been granted for portions of these exhibits.
(4) Previously filed with the Company's Registration Statement No.
33-75168, filed on February 11, 1994 or as subsequently amended on
March 4, 1994.
(5) Previously filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1993.
(6) Previously filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1994.
(7) Previously filed with the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1995.
(8) Previously filed with the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1995.
(9) Previously filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1996.
(10) Previously filed with the Company's Current Report on Form 8-K dated
April 15, 1997 and filed with the Commission on June 30, 1997.
(11) Previously filed with the Company's Current Report of Form 8-K 8A/A
dated August 6, 1997 and filed with the Commission on such date.
(12) Previously filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1997.
(b) Reports on Form 8-K: none.
(c) Executive Compensation Plans and Arrangements.
(i) Employment Agreement ("Old Malloy Employment
Agreement") dated as of October 1, 1991 between
Scientific Games Operating Corp. (now known as
Scientific Games Inc.)
and William G. Malloy, Exhibit 10.6 (1)
(ii) Employment Agreement ("Behm Employment Agreement")
dated as of October 1, 1991 between Scientific Games
Operating Corp. (now known as Scientific Games Inc.)
and William F. Behm, Exhibit 10.7 (1)
(iii) Employment Agreement ("Little Employment Agreement")
dated as of October 1, 1991 between Scientific Games
Operating Corp. (now known as Scientific Games Inc.)
and Thomas F. Little, Exhibit 10.8 (1)
(iv) Amended First 1991 Management Stock Option Plan,
Exhibit 10.18 (1)
(v) Amended Second 1991 Management Stock Option Plan,
Exhibit 10.19 (1)
(vi) 1993 Management Stock Option Plan, Exhibit 10.20 (1)
(vii) Form of Amendment to Old Malloy Employment Agreement,
Exhibit 10.23 (1)
(viii) Form of Amendment to Behm Employment Agreement,
Exhibit 10.24 (1)
(ix) Form of Amendment to Little Employment Agreement,
Exhibit 10.25 (1)
(x) Form of revised Severance Benefits Agreement, Exhibit
10.31 (2)
(xi) Amendment to Amended First 1991 Management Stock
Option Plan, Exhibit 10.32 (2)
(xii) Amendment to Amended Second 1991 Management Stock
Option Plan, Exhibit 10.33 (2)
(xiii) Amendment to 1993 Management Stock Option Plan,
Exhibit 10.34 (2)
(xiv) 1994 Management Stock Option Plan, Exhibit 10.37 (3)
(xv) 1995/1996 Management Stock Option Plan, Exhibit 10.38
(3)
(xvi) Severance Benefits Agreement dated as of May 5, 1995,
between Scientific Games Holdings Corp and Cliff O.
Bickell, Exhibit 10.40 (4)
(xvii) Key Employee Restricted Stock Plan, Exhibit 10.42 (3)
(xviii) Form of Key Employee Restricted Stock Plan Restricted
Stock Award Agreement, Exhibit 10.43 (4)
(xix) Form of Amendment to Behm Employment Agreement,
Exhibit 10.51 (5)
24
<PAGE> 25
(xx) Form of Amendment to Little Employment Agreement,
Exhibit 10.52 (5)
(xxi) Severance Benefits and Employment Agreement dated as
of January 1, 1998 between William G. Malloy and
Scientific Games Holdings Corp. Exhibit 10.53.
------------------------------------
(1) Previously filed with Registration Statement No.
33-65582, filed on July 2, 1993 or as subsequently
amended on July 28, 1993, August 9, 1993 or August
20, 1993.
(2) Previously filed with Registration Statement No.
33-75168, filed on February 11, 1994 or as
subsequently amended on March 4, 1994.
(3) Previously filed with the Company's Annual Report on
Form 10-K for the year ended December 31, 1994.
(4) Previously filed with the Company's Annual Report on
Form 10-Q for the quarter ended June 30, 1995.
(5) Previously filed with the Company's Annual Report on
Form 10-K for the year ended December 31, 1997.
25
<PAGE> 26
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 report to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Alpharetta, and State of Georgia on this 31st day of
March, 1999.
Scientific Games Holdings Corp.
By: /s/ William G. Malloy
---------------------------------------
William G. Malloy, Chairman
of the Board, President, and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed by the following persons on behalf of the Registrant, Scientific
Games Holdings Corp. in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ William G. Malloy Chairman of the Board, President, March 31, 1999
- ---------------------------- and Chief Executive Officer
William G. Malloy (Principal Executive Officer)
/s/ Cliff O. Bickell Chief Financial Officer, March 31, 1999
- ---------------------------- Vice President and Treasurer
Cliff O. Bickell (Principal Financial and Accounting
Officer)
/s/ Paul F. Balser Director March 31, 1999
- ----------------------------
Paul F. Balser
/s/ William F. Behm Director March 31, 1999
- ----------------------------
William F. Behm
/s/ Mark E. Jennings Director March 31, 1999
- ----------------------------
Mark E. Jennings
</TABLE>
26
<PAGE> 27
<TABLE>
<S> <C> <C>
/s/ Frank S. Jones Director March 31, 1999
- ----------------------------
Frank S. Jones
/s/ Edith K. Manns Director March 31, 1999
- ----------------------------
Edith K. Manns
/s/ Dennis L. Whipple Director March 31, 1999
- ----------------------------
Dennis L. Whipple
</TABLE>
27
<PAGE> 1
EXHIBIT 10.53
SEVERANCE BENEFITS AND EMPLOYMENT AGREEMENT
This Agreement is made and entered into as of the 1st day of January,
1998, by and between Scientific Games Holdings Corp., a Delaware corporation
(hereinafter called the "Company"), and William G. Malloy (hereinafter called
"Officer").
WITNESSETH:
The Board of Directors of the Company ("Board") recognizes that
Officer's contributions to the past and future growth and success of the Company
have been, and are expected to continue to be, substantial. The Board therefore
desires to assure the Company of Officer's services as an employee of, and for
the benefit of, the Company and its Affiliates in an executive, managerial
capacity now, and in the event that the Company were to be faced with a takeover
possibility.
In order to induce Officer to remain in the employ of the Company, this
agreement (the "Agreement") sets forth employment and severance benefits which
the Company shall pay to Officer in connection with his employment and in the
event of a severance of Officer's employment with the Company including, but not
limited to, in connection with a "Change in Control of the Company" (as defined
in Section 10 below).
NOW THEREFORE FOR AND IN CONSIDERATION of the mutual representations
and promises herein contained, and other good and valuable consideration, the
receipt, sufficiency and adequacy of which are hereby acknowledged, the parties
mutually agree as follows:
1. CERTAIN DEFINITIONS. The following defined terms are in
addition to those set forth elsewhere in this Agreement:
(a) "Change in Control of the Company", for purposes of
this Agreement, shall be deemed to have occurred if (i) the Board or the
stockholders of the Company shall approve (x) any consolidation or merger of the
Company pursuant to which the holders of Voting Securities of the Company
immediately prior to such merger or consolidation do not have more than fifty
percent (50%) of the combined voting power of the Voting Securities of the
Company or such surviving or parent entity immediately after the consolidation
or merger, (y) any sale, lease, exchange or other transfer of all or
substantially all of the assets of the Company (determined on a consolidated
basis) in one transaction or a series of related transactions other than a
transfer to a wholly-owned subsidiary of the Company, (ii) the Board or
stockholders of the Company shall adopt any plan or proposal for the liquidation
or dissolution of the Company; (iii) any "person" or "group" of persons (as such
terms are determined pursuant to Sections 13(d)(3) and 14(d)(2) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") and the rules
and regulations promulgated thereunder), other than the Management Stockholders,
either alone or in conjunction with their Affiliates (as that term is defined in
Rule 405 promulgated under the Exchange Act), becomes the beneficial owner,
directly or indirectly, of voting securities of the Company representing, or
<PAGE> 2
securities convertible into, or exchangeable for, securities representing, more
than fifty percent (50%) of the combined voting power of the Company's then
outstanding Voting Securities; or (iv) any "person" or "group" of persons (as
such terms are determined pursuant to Sections 13(d)(3) and 14(d)(2) of the
Exchange Act and the rules and regulations promulgated thereunder), other than
the Management Stockholders, either alone or in conjunction with their
Affiliates (as that term is defined in Rule 405), acquires the right or power to
nominate and/or control, directly or indirectly, whether through the ownership
of Voting Securities of the Company, by contract or otherwise, a majority of the
members of the Company's Board.
(b) "Date of Termination" shall mean (A) if Officer's
employment is terminated by Officer under circumstances referred to in Section
10(a) hereof, the date on which Officer delivers Notice of Termination to the
Company, (B) if Officer's employment is terminated by the Company for
Disability, thirty (30) days after Notice of Termination is given by the Company
(provided that Officer shall not have returned to the performance of his duties
on a full-time basis during such thirty (30) day period, (C) if Officer's
employment is terminated due to his death, the date of the Officer's death, (D)
if Officer resigns pursuant to Section 11(a), the effective date of the
termination of Officer's employment as specified in the notice (unless Officer's
employment is earlier terminated by the Company), or (E) if Officer's employment
is terminated by the Company for any other reason, the date on which a Notice of
Termination is given.
(c) "Exchange Act" shall mean the Securities Exchange Act
of 1934, as amended.
(d) "Executive Officer" or "Executive Officers" as used
herein shall have the meaning set forth in Section 3b-7 of the Exchange Act.
(e) "Governmental Authority" shall mean any nation,
province, state or political subdivision thereof, and any government or any
Person exercising executive, legislative, regulatory or administrative functions
of or pertaining to government, and any corporation or other entity owned or
controlled, through stock or capital ownership or otherwise, by any of the
foregoing having jurisdiction over the Person and the subject matter.
(f) "Index" shall mean the consumer price index for all
urban consumers, all item as published by the Bureau of Labor Statistics of the
United States Department of Labor.
(g) "Management Directors" shall mean the persons set
forth on Exhibit D hereto under such caption.
(h) "Management Stockholders" shall mean the persons set
forth on Exhibit D hereto under such caption.
(i) "Notice of Termination" shall mean a notice which
shall indicate the specific termination provision in this Agreement relied upon
and shall set forth in reasonable detail the facts
2
<PAGE> 3
and circumstances claimed to provide a basis for termination of Officer's
employment under the provision so indicated. For purposes of this Agreement, no
such purported termination shall be effective without Notice of Termination. If
the date of termination is to be later than the date of deliver of such Notice
of Termination, such date shall be specified in the Notice of Termination. No
Notice of Termination shall be effective prior to the date of its delivery to
Officer.
(j) "Person" shall mean an individual, corporation,
partnership, association, trust, business trust, limited liability company,
joint venture, joint stock company, pool, syndicate, sole proprietorship,
unincorporated organization, Governmental Authority or any other form of entity
or group.
(k) "Senior Executive Officers" shall mean those
"Executive Officers" of the Company identified as Senior Executive Officers on
Exhibit D hereto or, if such persons cease to be Executive Officers of the
Company performing their duties and functions as of the date of this Agreement,
then those persons performing similar duties for the Company at the applicable
time or, in the event of a Change In Control of the Company, immediately prior
to such Change in Control of the Company.
(l) "Voting Securities" shall mean as to any securities of an
entity ordinarily and generally having the right to vote in the election of
directors of such entity and shall not include securities whose voting rights
accrue under special circumstances, unless such circumstances shall have
occurred and be continuing).
2. EMPLOYMENT TERM. The Company employs Officer and Officer
accepts employment with the Company in the position of Chairman of the Board,
President and Chief Executive Officer for the Company (and such of its
Affiliates that the Officer or the Board deems necessary or advisable for
Officer to serve as Chairman of the Board, President, Chief Executive Officer
and/or other executive officer thereof, which initially shall include all
Significant Subsidiaries of the Company) upon the terms and conditions
hereinafter set forth. The term of Officer's employment is subject to
termination by the Company at any time without cause upon sixty (60) days'
written notice, subject to Officer's right to receive the applicable severance
benefits described herein. Except as otherwise provided herein, Officer may
terminate his employment with the Company upon sixty (60) days prior written
notice or such shorter period as the Company may allow. Except as otherwise
specifically provided in this Agreement, no severance benefits shall be due in
the event of Officer's voluntary termination of employment hereunder. The
initial term of this Agreement shall be for five (5) years from, and including,
the date first written above; provided, however, that this Agreement shall
automatically extend for subsequent terms of an additional five (5) years on
each anniversary date of the fifth anniversary of the Agreement unless the
Company or Officer shall give notice to the other party of their decision not to
extend the term of this Agreement by giving at least one hundred eighty (180)
days written notice prior to the end of such initial term or a successive term
in which event this Agreement shall have a remaining term equal to then
remaining initial or current term of the Agreement.
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3. DUTIES AND EXTENT OF SERVICES. Officer will, during the
continuance of his employment hereunder, perform the duties of Chairman of the
Board, President and Chief Executive Officer of the Company and Scientific
Games, Inc. Officer will devote his full working time, attention and abilities
(subject to the Company's policies, as in effect prior to any Change in Control,
and the provisions of this Agreement, in each case, with respect to vacations,
illness, government service, sabbaticals, etc.) to his duties as Chairman of the
Board, President and Chief Executive Officer and will use his best reasonable
efforts to promote the interests and welfare of the Company. For purposes of
this Agreement, the Company and Officer agree that Officer has heretofore
devoted his full working time, attention and abilities to his duties and further
agree that such standard of performance shall be applicable in assessing whether
Officer has devoted his full time, attention and abilities to his duties under
this Agreement. In such capacities, the Officer shall perform such duties and
shall have such responsibilities as are normally associated with such positions
and as otherwise may be assigned to the Officer from time to time by or upon the
authority of the Board. Should any question arise between the Officer and the
Company as to whether such Officer is devoting or has devoted full time,
attention and abilities to his duties, the reasonable, good faith opinion of the
Board (which shall consider Officer's historical work pattern in making its
assessment and the work patterns of chief executive officers of comparable
companies, both within and without the Company's line of business, whose
executives are required, whether by contract or practice, to devote their "full
time, attention and abilities" to their duties) pursuant to the affirmative vote
of a two-thirds the Company's entire Board (excluding Officer) shall be
dispositive of such question. To the extent not inconsistent with his duties
hereunder, Officer may pursue other business or personal activities, provided
(i) all other business activities (including such activities which would
conflict with the Company's business) are disclosed in writing in advance to,
and approved in advance by, the Company's Board (provided, however, that passive
investments in businesses other than business in competition with the business
of the Company need not be approved in advance, so long as Officer's investment
therein is less than five percent (5%) of the voting securities of such entity)
and (ii) such personal activities would not have a material adverse effect on
the Officer's performance of his duties. The Officer shall not pursue any
material outside business activity to which the Company's Board shall have
previously consented, if the entire Board (excluding Officer) by the affirmative
vote of two-thirds of its members expresses objection in writing to such
Officer; provided, however, that if the Board expresses such objection, Officer
shall be afforded a commercially reasonable time to terminate such activities in
a manner reasonably calculated to result in no material financial detriment to
Officer, unless the Company shall agree to indemnify Officer against any
material financial detriment which Officer may suffer from the immediate
termination of such previously permitted outside activities. Officer agrees,
upon receipt of the Notice from the Board of Board's objection to previously
permitted outside activities, to use his best efforts to terminate such
activities as soon as practicable, consistent with the standards set forth in
the immediately preceding sentence. Officer's office and principal place of
employment will be located in metropolitan Atlanta, Georgia. Officer
acknowledges that his duties and services will involve usual and customary
travel required of the Company's employees currently located in Atlanta,
Georgia. Officer shall have direct reporting authority to the Company's Board.
All existing
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obligations of the Company to the Officer with respect to employment prior to
the effective date of this Agreement shall not be affected hereby, except that
this Agreement shall supersede the Severance Benefits Agreement, dated March 4,
1994, between the Company and Officer and the Employment Agreement dated October
1, 1991, as amended August 23, 1993, between Scientific Games Inc. ("SGI") and
Officer.
4. COMPENSATION.
(a) Base Salary.
(i) For all services to be rendered by Officer
in any capacity during the period of his employment under this Agreement,
including, without limitation, services as an executive, officer, director or
member of any committee of the Company and its Affiliates, Officer shall be paid
as compensation a base salary ("Base Salary") at the rate of not less than
$440,000 per annum for each year during which Officer is employed under this
Agreement commencing with the year beginning January 1, 1998 and ending December
31, 1998 ("fiscal 1998"), or at such higher rate as may from time to time be
fixed by the Compensation Committee (the "Committee") of the Board of the
Company, payable in accordance with the customary payroll practices of the
Company, but in no event less frequently than monthly. Under no circumstance
shall any increase in Base Salary (i) limit or reduce any other obligation to
Officer under this Agreement, or (ii) be later reduced or eliminated, once
effective, as to any future periods.
(ii) The Officer's annual Base Salary shall be
increased each year by an amount no less than the greater of (A) the product of
the Officer's annual Base Salary in effect during the immediately preceding year
and a fraction, the numerator of which shall be the excess of the Index for
December of such first mentioned year over the Index for December of the
immediately preceding year and the denominator of which shall be the Index for
December of the immediately preceding year, or (B) the percentage increase in
the annual Base Salaries of the Company's Senior Executive Officers (as defined
in Exhibit D) taken as a group; provided, however, that in the event of the
occurrence of a Change In Control of the Company, the amount of the annual
increase in Officer's Annual Base Salary shall be the greater of: (1) the amount
established by the greater of clauses (A) or (B) above, or (2) five percent (5%)
of the Officer's annual Base Salary for the immediately preceding year.
(b) Incentive Compensation. As additional compensation
for all services rendered by Officer during the period of his employment under
this Agreement, Officer will, after consultation with the Board and Compensation
Committee of the Company ("Committee") be awarded an annual bonus under the
Company's Annual Incentive Compensation Plan and under the Company's
Intermediate Incentive Plan, each as further described on Exhibit A hereto, the
amount of which, in each case, shall be determined annually by the Committee in
accordance with such plans. Nothing under this Agreement shall be construed to
limit the amount Officer may earn as his annual bonus under either plan.
Compensation payable for the annual bonuses shall be payable no
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later than ninety (90) days after the end of the fiscal year for which such
compensation is awarded, unless Officer shall otherwise timely elect to defer
the receipt of some or all of such compensation pursuant to a deferred
compensation plan then in effect in which Officer is entitled to participate.
(c) Reimbursement of Expenses. The Company shall pay, or
reimburse Officer in accordance with the Company's prevailing corporate policy,
for reasonable travel, continuing education, and other expenses incurred by
Officer in performing his duties under this Agreement in accordance with
corporate policy. Notwithstanding the foregoing, reasonable travel expenses
shall include first class (or business class, as applicable), subsonic air
travel when such level of service is reasonably appropriate in light of
Officer's position with the Company and other factors, such as the duration of
the applicable flight, the nature, if any, of other business travelers traveling
with Officer, and the extent to which such level of service will facilitate the
productivity of Officer during or after such travel.
(d) Participation in Benefit Plans. The payments provided
for in other paragraphs of this Section 4 are in addition to any benefits and
perquisites to which Officer may be or may become entitled under any present or
future employment benefit and perquisite plan or program, or executive
contingent compensation plan of the Company for which corporate officers are or
shall become eligible, and Officer shall be eligible to receive during the
period of his employment under this Agreement, benefits and emoluments for which
either corporate officers or Company employees, in general, are eligible under
every plan or program to the extent permissible under the general terms and
provisions thereof. The foregoing notwithstanding, but only so long as no Change
in Control of the Company shall have occurred, the Company may change, or
discontinue any such other benefits; provided, however, that so long as any
benefit is made available to corporate officers or employees generally, such
benefit will be extended to Officer on the same terms such benefit is made
available to other corporate officers or employees, and provided that the
Company shall use commercially reasonable efforts to continue to provide to
Officer such other benefits as are made generally available to the Company's
Senior Executive Officers as of the date of this Agreement. In determining the
commercial reasonableness of such efforts, the Company shall be entitled to
consider the cost of providing such equivalent benefits to its Senior Executive
Officers as a group. In the event of a Change In Control of the Company, the
Company may change or discontinue any other benefits only so long as the total
economic value of the benefits provided to Officer is not diminished. The
Company also may change or discontinue other benefits at any time to adjust for
change in the tax laws, ERISA, or other applicable laws and any regulations
promulgated pursuant thereto.
(e) Insurance. In further consideration of his employment
by the Company, Officer shall be entitled to the following insurance benefits:
(i) Health and accident insurance for Officer, his spouse
and dependents and long-term disability insurance for Officer, all in amounts
and coverage comparable to that presently provided by the Company to its Senior
Executive Officers, which amounts may be changed
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from time to time by the Committee, provided that the Company shall have used
commercially reasonable efforts to continue to provide coverage substantially
similar to the levels of coverage provided to Officer as of the date of this
Agreement. In determining the commercial reasonableness of such efforts, the
Company shall be entitled to consider the cost of providing such equivalent
benefits to its Senior Executive Officers as a group. The foregoing
notwithstanding, but only so long as no Change In Control of the Company shall
have occurred, the Company may change or discontinue any such benefit if Officer
is treated no less favorably than any other Senior Executive Officer under such
new benefits. In the event of a Change In Control of the Company, the Company
may change or discontinue such insurance benefits only so long as the total
economic value of the insurance benefits provided to Officer is not diminished.
The Company also may change or discontinue such insurance benefits at any time
to adjust for change in the tax laws, ERISA, or other applicable laws and
regulations promulgated pursuant thereto. In the event of a Change In Control of
the Company, then in all the foregoing cases, the Company shall provide to
Officer proof that Officer and his dependents are properly covered by all of the
aforesaid types of insurance without any exclusion or exceptions for
pre-existing conditions to the maximum extent permitted by law and applicable
regulations; and
(ii) Term life insurance for Officer in the amount of
$4,000,000, the beneficiary of which will be designated in the sole discretion
of Officer. The foregoing notwithstanding, but only so long as no Change In
Control of the Company shall have occurred, the Company may change or
discontinue any such benefit if Officer is treated no less favorably than any
other Senior Executive Officer under such new benefits. If for any reason during
the term of this Agreement any required policy or coverage is canceled or
coverage denied for any reason, the Company agrees to use commercially
reasonable efforts to provide Officer with replacement insurance in the required
amount so long as said insurance is available at commercially reasonable rates.
The Company shall cause so much of said insurance to be included under an
Employee Group Term Life Insurance Plan which qualifies under IRC ss. 79 so that
the cost of said insurance, to the maximum extent allowable by law, will not be
includable in the gross taxable income of Officer. In the event of a Change In
Control of the Company, the Company may change or discontinue such term
insurance benefits only so long as the total economic value of such term
insurance benefits provided to Officer is not diminished. The Company also may
change or discontinue such term insurance benefits at any time to adjust for
change in the tax laws, ERISA, or other applicable laws and regulations
promulgated pursuant thereto.
(f) Vacation. The Company shall provide Officer five (5)
weeks of annual paid vacation.
(g) Sick Leave. The Company shall provide Officer a
reasonable number of paid sick days as established from time to time by
corporate policy or as approved by the Committee and taken solely in the
discretion of Officer.
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(h) Transportation Allowance. The Company shall furnish a
transportation allowance of $15,988 per year for the benefit of Officer. Such
transportation allowance shall include the cost of providing the motor vehicle,
gas, maintenance and repairs thereon and insurance therefor (which may be the
allocable cost of group insurance for the Company's owned motor vehicles). The
Officer's annual transportation allowance shall be increased each year by an
amount equal to the product of the previous year's Transportation Allowance and
a fraction, the numerator of which shall be the excess of the Index for December
of such first mentioned year over the Index for December of the immediately
preceding year and the denominator of which shall be the Index for December of
the immediately preceding year, of this Agreement. The transportation allowance
shall be utilized by the Company to purchase or lease a motor vehicle suitable
for Officer's position, in each case, with a manufacturer's list price not to
exceed Seventy-Five Thousand Dollars ($75,000). The Company also shall pay on
behalf of Officer or reimburse Officer in the form of an additional
transportation allowance for all parking expenses and for any other motor
vehicle related expenses incurred by Officer for which the Company generally
pays or reimburses pays or reimburses its Senior Executive Officers, as of the
date of this Agreement.
(i) Deferred and Supplemental Compensation Programs. The
Company shall use commercially reasonable efforts to maintain (A) a deferred
compensation plan, and (B) a supplemental executive retirement plan,
substantially in the form of the deferred compensation plan and the supplemental
executive retirement plan, in each case, maintained by the Company as of the
date of this Agreement for the Company's Senior Executive Officers and Officer
shall be entitled to participate in such plans or any successors thereto at a
participation level not less than the maximum level at which Officer is entitled
to participate in such plans as of the date of this Agreement, so long as such
participation shall not have a material adverse effect on the Company or its
ability to maintain such plans for its Senior Executive Officers as a group, and
further provided that if the Company is unable to maintain such plans, it will
use commercially reasonable efforts to provide other benefits with substantially
equivalent economic value to the Officer. In determining the commercial
reasonableness of such efforts, the Company shall be entitled to consider the
cost of providing such equivalent benefits to its Senior Executive Officers as a
group. The foregoing notwithstanding, but only so long as no Change In Control
of the Company shall have occurred, the Company may change or discontinue any
such plans if Officer is treated no less favorably than any other Senior
Executive Officer under such new benefits. In the event of a Change In Control
of the Company, the Company may change or discontinue such plans only so long as
the total economic value of the benefits provided to Officer is not diminished.
The Company also may change or discontinue such plans at any time to adjust for
change in the tax laws, ERISA, or any other applicable laws and regulations
promulgated pursuant thereto.
(j) Stock Options. Officer shall be granted stock options
entitling Officer to purchase 200,000 shares of the Company's Common Stock in
accordance with the terms of Exhibit B and the employee benefit plan or plans
referenced therein.
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(k) Registration Rights Agreement. Officer and the
Company shall, contemporaneously with the execution of this Agreement, enter
into a registration rights agreement substantially in the form attached as
Exhibit C hereto.
(l) Medical Examinations. The complete cost of an annual
physical examination to be conducted by a physician, that is Board certified to
be selected by Officer and acceptable to the Committee, shall be borne by the
Company if not otherwise paid by insurance furnished by the Company. The
Committee of the Board of the Company shall be furnished the results of said
physical examination: (i) if Officer should request a leave of absence in excess
of the sum of his then accrued annual vacation (including carried over
vacation), plus the number of days of paid sick leave previously established by
corporate policy or the Committee, or (ii) if Officer shall have been absent
from his duties for one hundred eighty (180) consecutive business days in order
to establish when or if Officer may be reasonably expected to return to work and
perform his duties. Officer shall submit to such annual physical exam upon
reasonable notice at any time during any calendar year.
(m) Other Compensation. The Company may provide as
additional compensation to the Officer such awards of Company securities,
including restricted stock grants and stock options, as may be approved in the
sole discretion of the Company's Board, the Committee or pursuant to delegated
authority therefrom, provided, however, that the Company shall provide Officer
with such other benefits as are generally provided to other Senior Executive
Officers of the Company after taking into account the grant of stock options
provided for above, it being the current judgment of the Committee and Officer
that such options currently provide appropriate stock option compensation to
Officer for the period January 1, 1998 through December 31, 2000.
5. LOAN. The Company shall provide Officer with the right to
borrow up to $650,000, which right may be exercised at any time and from time to
time during the life of this Agreement, subject to the limitations set forth
below. Borrowings under such loan shall be secured by a security interest in
property reasonably acceptable to the Company (which acceptable security shall
include, without limitation, shares of Common Stock of the Company). A draw
under such loan may be made by Officer upon reasonable advance notice to the
Company, during the initial or any subsequent term of this Agreement; provided,
however, that no more than one (1) advancement of funds shall be made in any
period of twelve (12) consecutive months. Such loan shall bear interest at a
floating rate equal to the interest rate available to the Company for borrowings
under the bank credit agreement with the lowest interest rate as in effect as of
the most recent date of borrowing (whether total or partial, initial or
subsequent) under this provision or, if no such agreement shall exist, at an
interest rate equal to the rate of interest on any senior indebtedness of the
Company for money borrowed or, if no such indebtedness shall then be
outstanding, then at the "prime rate" as established from time to time by First
Union National Bank of Georgia, N.A. (such interest rates hereinafter,
individually and collectively, the "Reference Rate"). The interest rate on
borrowings under the loan shall be adjusted at such times and under such
conditions as the applicable Reference Rate with installments of interest only
payable annually on December 31 of each year. Upon termination of this
Agreement, no advances shall be permitted under the Section and the then
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existing borrowing thereunder (if any) shall be repayable in equal total
quarterly installments of principal and interest sufficient to fully amortize
the loan over a period of two (2) years. All borrowings under the loan may be
prepaid, without penalty, at any time.
6. INDEMNITY, PROFESSIONAL AND OFFICERS LIABILITY INSURANCE.
(a) The Company agrees to indemnify and save harmless
Officer from all liability and costs incurred (including reasonable attorney's
fees and disbursements) as a consequence of claims by third parties, whether or
not derivatively on behalf of the Company (or, after a Change in Control of the
Company as defined in Section 11(a) hereof, by the Company against the Officer
or by the Officer against the Company), resulting from or growing out of
Officer's past, present or future status as or as a result of his being or
having been a director and/or officer of the Company or any subsidiary or
affiliate thereof to the full extent permitted by law (provided, however, that
the Company shall not obligated to indemnify against any amount paid in
settlement unless the Company has consented to such settlement, which consent
shall not be unreasonably withheld); so long as (i) Officer shall not have been
terminated for Just and Substantial Cause with respect to, or as a result of,
the matter for which indemnification is sought, and (ii) acted in good faith and
in a manner he reasonably believed to be in or not opposed to the best interest
of the Company. The termination of any threatened or actual action, suit or
proceeding by judgment, order, settlement, conviction or upon a plea of nolo
contendere or its equivalent, shall not, of itself, create a presumption that
Officer did not act in good faith and in a manner which he reasonably believed
to be in or not opposed to the best interests of the Company, and, with respect
to any criminal action or proceeding, had reasonable cause to believe that his
conduct was unlawful. The terms, provisions and conditions of the indemnity
provided for hereunder shall be in addition to those presently provided for
under the Articles of Incorporation and Bylaws of the Company. The terms,
provisions and conditions of indemnity under this Agreement shall remain an
independent, contractual obligation of the Company to Officer from and after the
date hereof regardless of how the Company might hereafter amend or change its
Articles of Incorporation or Bylaws to provide for different terms, conditions
and provisions of indemnity for other officers and directors of the Company. In
the event the Company should amend its articles of Incorporation or Bylaws to
provide for different terms, conditions and provisions of indemnity after the
effective date hereof, Officer shall be notified in writing of the change.
Officer shall thereafter have thirty (30) days to elect in writing to accept the
changed conditions of indemnity as a modification to the Company's contractual
obligation hereunder or to continue under the terms of indemnity as provided for
herein. If Officer fails to make such election, such failure shall be deemed to
be an election to continue under the terms of indemnity as provided for herein.
The Company's agreement to provide indemnity hereunder shall survive the
termination of this contract regardless of the cause of termination. The Company
shall advance promptly as incurred reasonable fees and disbursements of counsel
for Officer in defending Officer against any claims for which the Company would
be so required to indemnify Officer provided (i) Officer shall otherwise comply
with such mandatory requirements of Delaware law as may be required for such
indemnification and (ii) Officer shall cause such counsel to cooperate fully
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in good faith with such requests as the Company or its counsel may reasonably
make in order to endeavor to keep such legal fees at a minimum level consistent
with an adequate defense of Officer.
(b) Officers and Directors' Liability Insurance. The
Company agrees to provide, at no expense to the Officer, insurance insuring
Officer in his capacity as an officer and director of the Company in such form
and amount substantially equal to that presently maintained by the Company for
or covering its Senior Executive Officers and directors or in such other form
and amounts as Officer and Company may, from time to time, in good faith agree
are reasonable and appropriate for Senior Executive Officers and directors of
corporations substantially similar in size to the Company.
7. TERMINATION OF EMPLOYMENT BY COMPANY FOR JUST AND
SUBSTANTIAL CAUSE. The Company may terminate Officer's employment at any time
for "Just and Substantial Cause" but only after written Notice of Termination
(as defined in this Agreement) to Officer as approved by the Board (excluding
Officer) as set forth below specifying the cause of such action. Just and
Substantial Cause shall mean: (a) conviction of Officer of a crime constituting
a felony; (b) commission of an act or acts of dishonesty on the part of Officer
when such acts are intended to result, directly or indirectly, in substantial
wrongful gain or substantial wrongful personal enrichment of Officer at the
expense of the Company; or (c) the engaging by Officer in willful misconduct
materially injurious to the Company with respect to which (i) Officer knew or
reasonably should have known that such conduct would result in material
financial injury to the Company, (ii) such conduct actually results in material
financial injury to the Company provided that, in the case of conduct not
expressly contrary to the specific directives or policies of the Company as
established by the Board or any committee thereof, Just and Substantial Cause
shall also require the damage resulting from such conduct shall not have been
cured (if the same is reasonably susceptible to cure) within a reasonable time
following receipt by Officer of written notice thereof from the Company
referring to this Agreement. Notwithstanding the foregoing, Officer shall not be
deemed to have been terminated for Just and Substantial Cause unless and until
there shall have been delivered to Officer a copy of a resolution duly adopted
by the affirmative vote of not less than two-thirds of the entire membership of
the Company's Board (excluding Officer) at a meeting of the Board called, duly
noticed and held for the purpose (after a reasonable notice to Officer and an
opportunity for Officer, together with Officer's counsel, to be heard before the
Board), finding that in the reasonable good faith opinion of the Board, Officer
was guilty of conduct set forth in the second sentence of this Section 7 and
specifying the particulars thereof in detail and that as a result, Officer is
being terminated for Just and Substantial Cause. Any termination by the Company
pursuant to this Section 7 above shall be communicated by written Notice of
Termination. For purposes of any determination by the Board of whether Just and
Substantial Cause exists, if the employment of a Management Director is proposed
to be severed, the vote of that Management Director on whether Just and
Substantial Cause exists shall be ignored and shall not be required for any such
purpose of this Agreement. In the event Officer shall be terminated for Just and
Substantial Cause, Officer shall be entitled to all salary actually earned prior
to termination, vested stock
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options, vested bonuses, vested restricted shares and all deferred compensation.
No severance pay would be owing in the event of termination pursuant to this
Section for Just and Substantial Cause.
8. TERMINATION OF EMPLOYMENT IN THE EVENT OF OFFICER'S ILLNESS OR
DISABILITY. Officer and the Company agree that Officer may not reasonably be
expected to be able to perform his duties and the essential functions of his
office if Officer shall have been absent from his duties with the Company, or
not otherwise be performing the duties of his office due to physical or mental
illness, in each case, on a full-time basis for one hundred eighty (180) days.
Accordingly, if, in the reasonable, good faith opinion of the Board, as a result
of Officer's incapacity due to physical or mental illness, Officer shall have
been absent from his duties with the Company on a full time basis for one
hundred eighty (180) consecutive business days, and within thirty (30) days
after written notice of intent to terminate is given by the Company, Officer
shall not have returned to the full time performance of his duties, Officer's
employment shall be terminated for "Disability", in which event Officer shall be
entitled to receive severance benefits under this Agreement and Officer shall be
compensated pursuant to the provisions of this Section 8 as if Officer's
employment had been terminated under Section 10 of this Agreement without Just
and Substantial Cause. Payments of severance benefits under this Section 8 shall
be reduced by the present value of any disability payments provided Officer as a
result of the coverage maintained pursuant to Section 4(e)(i)(A) or in any other
Company-sponsored disability plan providing benefits to Officer and which are
payable to Officer in the first three (3) years following Officer's Disability.
The present value of such payments shall be determined using the average of the
Index for the most recent available twelve (12) months. Officer's employment
shall not be terminable under this Section if Officer is absent from his duties
upon a bona fide leave of absence granted by the Company other than pursuant to
physical or mental illness. In the event that the Company and Officer are unable
to agree whether Officer has returned or is able or not able to return to the
full time performance of his duties because of sickness or disability said
decision shall be made by three physicians, one of whom is to be selected by
Officer, one of whom is to be selected by the Board, and the third of whom is to
be selected by the previous two. The decision of said three physicians shall be
binding upon the parties and the cost of such examinations shall be borne by the
Company.
9. TERMINATION OF EMPLOYMENT IN THE EVENT OF DEATH DURING
EMPLOYMENT.
(a) Subject to Section 9(b) below, if Officer dies during
the term of this Agreement, the Company shall pay and provide to Officer's
designated beneficiary severance benefits pursuant to this Section 9(a) the same
as if Officer's employment had been terminated under Section 10 of this
Agreement without Just and Substantial Cause; provided that no benefits need be
provided under Section 10(f) with respect to Club membership.
(b) If, at any time, there shall exist any dispute
between any beneficiary of Officer with respect to the payment or exercise of
any benefits hereunder, or if at any time the Company is unable to determine, to
the Company's good faith satisfaction, the proper payment of any portion of
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the benefits or the Company's proper actions with respect to its obligations
hereunder, then the Company may, in its sole discretion, take either or both of
the following actions:
(i) suspend the performance of any of its
obligations (including without limitation any disbursement obligations) under
this Agreement until such dispute or uncertainty shall be resolved to the good
faith satisfaction of the Company; provided, however, that the Company shall
invest all monies payable hereunder in one or more of the following: (A) direct
obligations of the United States of America or obligations the principal of and
the interest on which are unconditionally guaranteed by the United States of
America; (B) certificates of deposit issued by any bank, bank and trust company,
or national banking association, which certificates of deposit are insured by
the Federal Deposit Insurance Corporation or a similar governmental agency; (C)
any money market fund substantially all of which is invested in the foregoing
investment categories; and/or
(ii) petition (by means of an interpleader action
or any other appropriate method) any court of competent jurisdiction in any
venue convenient to the Company, for instructions with respect to such dispute
or uncertainty, and to the extent required by law, pay into such court, for
holding and disposition in accordance with the instructions of such court, all
funds payable by it under this Agreement, after deduction and payment to the
Company of all fees and expenses (including court costs and attorneys' fees)
reasonably payable to, reasonably incurred by, or reasonably expected to be
incurred by, the Company in connection with the performance of its duties and
the exercise of its rights under this Section 9(b).
The Company shall have no liability to Officer's estate, any beneficiary of
Officer or any other Person with respect to any such suspension of performance
or disbursement into court, specifically including any liability or claimed
liability that may arise, or be alleged to have arisen, out of or as a result of
any delay in the disbursement of funds or any delay in or with respect to any
other action required or requested of the Company, so long as the Company shall
have acted in good faith.
10. TERMINATION OF EMPLOYMENT WITHOUT JUST AND SUBSTANTIAL CAUSE;
CONSTRUCTIVE TERMINATION OTHER THAN IN CONNECTION WITH A CHANGE IN CONTROL.
(a) Should the Company (i) change the location of
Officer's office or of the Company's principal executive offices from
metropolitan Atlanta, Georgia to a place other than a location within fifty (50)
miles of the location of the Company's principal executive offices as specified
in Section 14 and otherwise within metropolitan Atlanta, Georgia, or change the
location of Officer's office from the location of the Company's principal
executive office, (ii) fail to appoint or reappoint Officer to the offices and
positions Officer holds by virtue of this Agreement or such other position held
immediately prior to any Notice of Termination (or to higher or equivalent
offices and positions to which Officer agrees in writing, such agreement not to
be unreasonably withheld), (iii) make any reduction in Officer's Base Salary,
(iv) adversely change the methodology
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pursuant to which Officer's bonus is determined or make any other material
adverse change in any of Officer's employee benefits (other than any such
benefit which is immaterial or inconsequential or any change which is required
by law) (A) unless such change in methodology is binding on all participants in
the plan under which Officer's bonus is awarded or does not otherwise
discriminate against the Officer, and (B) in the case of benefits, substantially
equivalent economic benefits cannot be provided to Officer by commercially
reasonable efforts at commercially reasonable cost, (v) make any material change
in Officer's function, duties or responsibilities which would cause Officer's
position with the Company to become of less responsibility, importance or scope,
in any material respect, than the position and attributes thereof immediately
prior to the date of this Agreement, (vi) change the person or persons to whom
Officer reports at the date hereof (i.e., the Board of Directors) to a person or
persons of lesser rank, title or responsibility, (vii) fail to obtain the
express written assumption of this Agreement by any successor of the Company or
any assignee of all or substantially all of its assets at or prior to such
succession or assignment (such succession or assignment not relieving the
Company of any liability hereunder), (viii) breach this Agreement in any
material respect which is not cured within fifteen (15) days after written
notice from Officer to the Company, or (ix) fail to renew this Agreement for not
less than an additional five (5) year term on terms materially no less favorable
to Officer (in the event the Company gives notice pursuant to Section 2 of its
decision not to automatically renew this Agreement, then the failure to renew
shall be deemed to occur at the end of the initial term or, if this Agreement
has been renewed at the end of the then current term), Officer shall be entitled
to (A) resign from the Company's employ and (B) receive severance benefits under
this Agreement as set forth in the remainder of this Section 10 (regardless of
whether Officer resigns) upon the giving of Notice of Termination from Officer
to the Company (unless in any case referred to in the preceding clauses (i)
through (ix), the Company shall at such time have grounds to terminate Officer
for Just and Substantial Cause and shall have delivered to Officer a copy of a
resolution of the Board contemplated by Section 10 hereof except that it does
not specify that Officer is being terminated at that time). The occurrence of
one or more of the events described in clauses (i) through (ix) above are
hereinafter referred to as a "Constructive Termination."
(b) Base Salary and Bonus Based Severance Benefits. The
Company shall pay to Officer (or, in the event of his death, pay his beneficiary
or beneficiaries or his estate, as the case may be), as severance benefits under
this Section:
(i) a lump sum on the thirtieth (30th) day
following the Date of Termination, in an amount equal to the sum of (a)
Officer's full Base Salary through the Date of Termination to the extent such
Base Salary has not previously been paid through such date, at the rate in
effect at the time written notice of termination is given and (b) any bonus or
awards theretofore made to Officer which have not yet been paid to Officer; and
(ii) a lump sum, also on the thirtieth (30th) day
following the Date of Termination, in an amount equal to three (3) times the
average of: the sum of Officer's annual Base Salary plus all bonuses paid to
Officer during the twenty-four (24) month period immediately
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preceding the Date of Termination. For purposes of this Agreement, salary and
bonus are deemed paid when earned and are not affected by the deferral of any
compensation.
(c) Insurance Benefits. The Company, at its expense,
shall maintain in full force and effect, for the continued benefit of Officer,
his spouse and dependents until the earlier of: (i) the third anniversary of
Officer's Date of Termination; (ii) eighteen (18) months after Officer's Date of
Termination if at such time Officer, his spouse or dependents, as applicable, is
uninsurable under the Company's life, accident, medical and dental insurance
plans; or (iii) the date Officer, his spouse and dependents become entitled to
participate in similar plans, programs or arrangements provided by Officer's
subsequent employer: all life, accident, medical and dental insurance benefit
plans and programs or arrangements in which Officer, his spouse and dependents
were entitled to participate immediately prior to the Date of Termination
provided that the continued participation of Officer, his spouse and dependents,
as applicable, is possible under the general terms and provisions of such plans
and programs. In the event that the participation of Officer, his spouse or
dependents in any such plan or program is barred, the Company shall arrange to
provide Officer, his spouse or dependents, as the case may be, to the fullest
extent permitted by law or applicable regulation for a period of not less than
thirty-six (36) months (eighteen (18) months if the reason the participation of
Officer, his spouse or dependents are barred is that Officer, his spouse or
dependents, as applicable, are uninsurable) following Officer's Date of
Termination, with benefits substantially similar to those which Officer, his
spouse and dependents would have been entitled to receive under such plans and
program; provided, however, that, if the reason Officer, his spouse or
dependents are barred is not the fact that one or more of such persons are
uninsurable and such reasons are applicable to the Company's Senior Executive
Officers, as a whole, then, unless a Change In Control of the Company shall have
occurred, the Company need only use commercially reasonable efforts to provide
benefits beyond eighteen (18) months and that, for purposes of determining the
commercial reasonableness of providing substantially similar benefits, costs
which are similar to the cost Officer would incur for such benefits by making a
COBRA election for such period shall be considered reasonable.
(d) Stock Options & Restricted Stock. Simultaneous with
the Date of Termination (other than in the case of Officer's voluntary
resignation, other than under circumstances as contemplated by the definition of
Date of Termination, including, without limitation, Sections 10(a) and 11(a) of
this Agreement, or a termination for Just and Substantial Cause) (i) all stock
options which have theretofore been granted to Officer shall immediately vest
and be exercisable, and (ii) all restrictions on all restricted stock awards
shall terminate and such shares shall immediately vest, in each case, regardless
of any contrary provisions in any employee benefit plan or other agreement under
which such stock options or restricted stock awards were granted. In the event
Officer voluntarily terminates his employment under circumstances in which this
Section 10(d) does not apply, vesting, acceleration and removal of restrictions
shall be governed by the applicable award agreement and plan under which such
securities were awarded.
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(e) Motor Vehicle. As a further benefit, the Company, at
its expense, shall cause to be vested in Officer, free and clear title to the
motor vehicle then being furnished to Officer by the Company at or prior to
Officer's Date of Termination.
(f) Club Membership. As a further benefit, the Company
shall, at its expense, use its best efforts to cause the conversion of the
Company's corporate membership in the Golf Club of Georgia into a comparable
individual membership and the transfer of such membership to Officer, provided
that, in no event, shall the cost to the Company to transfer such membership
exceed $1,000.
(g) Payments In the Event of Constructive Receipt. As a
further benefit, if at any time it is determined that Officer must include a
portion or all of the severance benefits provided pursuant to this Section in
Officer's gross income for federal income tax purposes prior to the time Officer
receives payment of such benefits, then the Company agrees to pay Officer, as
soon as administratively feasible, an amount of cash sufficient to enable
Officer to pay the full federal and state tax liability attributable to the
inclusion of the severance benefits, or a portion thereof, in Officer's gross
income. Any cash so paid to Officer shall directly reduce the amount of future
installments, pro rata, of severance benefits payable to Officer as provided
hereunder.
11. TERMINATION IN THE EVENT OF A CHANGE IN CONTROL.
(a) Except as otherwise expressly provided in Sections
11(c) and 11(d) below, no benefits shall be payable under this section unless
and until (i) there shall have been a "Change in Control of the Company," as
defined in this Section 11, and (ii) Officer is then an employee of the Company
or, if Officer is not then an employee of the Company, Officer's employment was
severed within six (6) months prior to such Change in Control of the Company for
any reason other than for Just and Substantial Cause.
(b) In the event of a Change in Control of the Company,
Officer shall have, in addition to any other rights provided under this
Agreement, the right to terminate his employment under this Agreement by (i)
resignation on not less than sixty (60) days' prior written notice given within
six (6) calendar months after the occurrence of the Change in Control of the
Company. If the Company shall terminate Officer's employment in connection with
a Change in Control of the Company as defined in Section 11(a) above, or if
Officer shall resign from the Company under circumstances referred to in this
Section 11(b), then the Company shall (i) pay and provide to Officer as
severance pay under this Section the compensation and benefits which would be
payable under, and provided pursuant to, Section 9 in the event of the
termination of Officer's employment without Just and Substantial Cause, and (ii)
pay and provide the additional benefits set forth in this Article 11.
(c) Option Exercise Loan. In order to facilitate the
exercise of options and other rights to purchase Company Stock awarded under
employee benefit plans, the Company shall, in the event Officer's employment
with the Company is severed without Just and Substantial Cause within
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one (1) year following a Change in Control, make, if Officer so requests, an
unsecured loan to Officer (without the necessity of Officer demonstrating
financial need or otherwise) in an amount not less than the sum of the aggregate
exercise price of such options plus the amount of state and federal income tax
payable by Officer in respect of such exercise (an "Exercise Loan"). Such
Exercise Loan shall be for a three (3) year term and bear interest at the
generally prevailing prime commercial rate at the time of such loan. If the
Company shall so request, the Exercise Loan shall, if and to the extent legally
permissible, be secured by a pledge of the Common Stock purchased pursuant to
the exercise of the stock options or other rights, plus such number of other
shares of Common Stock owned by Officer, if any, as are necessary to meet any
applicable federal margin rules. In no event will Officer be required to pledge
any other security, including without limitation, the pledge of any options or
rights to purchase Common Stock held by Officer. Officer shall, promptly and, in
no event later than thirty (30) days after the date of sale, use the Net
Proceeds (as defined below) from any sale of Common Stock acquired with the
proceeds of the Exercise Loan to prepay such loan, in whole or in part. For
purposes of this Section, Net Loan Proceeds means the net proceeds from the sale
of such stock after deduction for all applicable transaction costs incurred in
connection with such sale and all applicable taxes on such sale and the proceeds
thereof. In the case of taxes not yet due and payable, the amount of taxes may
be based on Officer's reasonable good faith estimate of such liability.
(d) Excess Parachute Payment. In the event that any
payment or benefit, or any combination of payment or benefits, to Officer
hereunder with respect to a termination in connection with a Change in Control
of the Company is determined to be an "excess parachute payment" pursuant to
Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), then
the Company, at the time such determination becomes final, shall pay to Officer,
as additional severance pay, an amount which would equal, after deducting all
state and federal income taxes incurred by the Officer with respect to receipt
of such payment, would equal to the excise tax, if any, imposed on Officer
pursuant to Section 4999 of the Code.
(e) Certain Legal Fees. In addition to the rights
provided to Officer by Section 12 of this Agreement, the Company shall pay all
costs, legal fees and expenses as and when incurred by Officer in connection
with Officer's interpretation of, or determinations under any actual, threatened
or contemplated litigation or legal or administration or other proceeding
involving the provisions of this Section 11, whether or not initiated by
Officer.
(f) Duty to Provide Services Prior to Change In Control.
In the event any "person" or "group" of persons (as defined in Section 11(a)
above) begins a tender or exchange offer, circulates a proxy to stockholders or
takes other steps to effect a Change in Control of the Company, Officer agrees
that Officer will not voluntarily leave the employ of the Company, and will
render services to the Company commensurate with Officer's position, until such
"person" or "group" has abandoned or terminated efforts to effect a Change in
Control of the Company or until a Change in Control of the Company has occurred.
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12. LEGAL FEES; MITIGATION OF DAMAGES. The Company shall
reimburse, as and when incurred, such costs, legal fees and expenses as may be
reasonably incurred by Officer in contesting or disputing any such termination,
or in seeking to obtain or enforce any right or benefit provided by this
Agreement, and Officer shall have no obligation to reimburse the Company for
such costs if Officer is successful in any material respect in connection with
enforcing any of Officer's rights or the Company's obligations under this
Agreement in such dispute. Officer shall not be required to mitigate the amount
of any payment provided for in this Agreement by seeking other employment or
otherwise, nor shall the amount of any payment provided for in this Agreement be
reduced by any compensation earned by Officer as the result of employment by
another employer after the Date of Termination, or otherwise. The Company and
its subsidiaries shall have no right to set off payments owed to Officer under
this Agreement against amounts claimed to be owed by the Officer to any of such
Persons under this Agreement or otherwise, but shall be entitled (in each case
without duplication) to offset any payments owed against amounts owed to such
Persons which are evidenced by one or more final, non-appealable judgments in
favor of such Persons against Officer.
13. SUCCESSORS; BINDING AGREEMENT.
(a) The Company will require any successor (whether
direct or indirect, by purchaser, merger, consolidation or otherwise) to the
business and/or assets of the Company to expressly assume and agree to perform
this Agreement in the same manner and to the same extent that the Company would
be required to perform it if no such succession had taken place. Failure of the
Company to obtain such agreement shall constitute a material breach of this
Agreement and shall entitle Officer to compensation from the Company in the same
amount and on the same terms as Officer would be entitled hereunder if such
succession had not occurred, except that for purposes of implementing the
foregoing, the date of which any such succession becomes effective shall be
deemed the Date of Termination. In connection with any transaction with, or any
proposed transaction with, any successor to the Company approved or recommended
by Officer and the Board, Officer agrees to consider, but shall not be obligated
to agree to, a waiver, deferral or amendment of any right or benefit conferred
on Officer under this Agreement, if requested in good faith by the Board of the
Company. As used in this Agreement, "Company" shall mean the Company and its
Significant Subsidiaries as hereinbefore defined and any successor to its
consolidated business and/or assets as aforesaid which executes and delivers the
agreement provided for in this Section 13 or which otherwise becomes bound by
all the terms and provisions of this Agreement by operation of law. The
obligations of the Company and its Significant Subsidiaries shall be joint and
several.
(b) This Agreement shall inure to the benefit of and be
enforceable by Officer's personal or legal representatives, executors,
administrators, successors, heirs, distributees, devisees and legatees. If
Officer should die while any amounts are still payable to Officer hereunder, all
such amounts, unless otherwise provided herein, shall be paid in accordance with
the terms of this Agreement to Officer's devisee, legatee, or other designee of,
if there be no such designee, to Officer's estate.
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14. NOTICE. For the purposes of this Agreement, notices,
Notices of Termination, and all other communication provided for in this
Agreement shall be in writing and shall be deemed to have been duly given only
when personally delivered or mailed by United States certified mail, return
receipt requested, postage prepaid, addressed as follows:
If to the Company:
Scientific Games Holdings Corp.
1500 Bluegrass Lakes Parkway
Alpharetta, Georgia 30004
Attention: C. Gray Bethea, Jr.
Vice President and General Counsel
If to Officer:
William G. Malloy
9220 Stonemist Trace
Roswell, Georgia 30076
or, in either case, to such other address as either party may have furnished to
the other in writing in accordance herewith, except that notices of change of
address shall be effective only upon receipt.
15. MISCELLANEOUS. Officer's interest in the severance benefits
hereunder is an unsecured claim against the general assets of the Company. To
the extent that any applicable state or federal law, rule or regulation confers
upon Officer any greater benefit or right than that set forth in this Agreement,
such law, rule or regulation shall control in lieu of the provisions hereof
relating to such benefit or right.
16. ADDITIONAL REPRESENTATIONS AND WARRANTIES. The Company
represents and warrants to Officer that this Agreement is the legal, valid and
binding agreement of the Company, that the Company has full power and authority
to enter into this Agreement without further action, and that the Company is not
now and will not in the future become a party to any contract, agreement or
understanding which would prevent the fulfillment by the Company of its
obligations under this Agreement. To the extent that any applicable state or
federal law, rule or regulation confers upon Officer any greater benefit or
right than that set forth in this Agreement, such law, rule or regulation shall
control in lieu of the provisions hereof relating to such benefit or right. The
Company will, upon Officer's request, whether in connection with a Change of
Control of the Company or otherwise, cause this Agreement to be expressly
confirmed and ratified by its Board. Failure to cause such action to be taken
shall be a material breach and shall entitle Officer to liquidated damages as
provided below; it being agreed by the parties that the actual damages which
might be sustained by Officer by reason of the Company's breach of this Section
are uncertain
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and difficult to ascertain. It is further agreed that in the event of the breach
of any of the representations, warranties or covenants contained in this
Section, that the Officer shall be entitled to an amount equal to all sums which
would be payable under Sections 10 and 11 in the event of a Change in Control of
the Company the same as if (i) Officer's employment had been terminated under
Section 10 of this Agreement, and (ii) a Change In Control had occupied under
Section 11 of this Agreement even though a triggering event may not have
otherwise occurred with respect to such sections. The parties agree that this
sum is reasonable and just compensation for such breach and in the event of a
breach, Company agrees to pay, and Officer agrees to accept such sum, as
liquidated damages, and not as a penalty.
17. VALIDITY. The invalidity or unenforceability of any provision
of this Agreement shall not effect the validity or enforceability of any other
provision of this Agreement, which shall remain in full force and effect. If any
provision of this Agreement is held to be illegal, invalid, or unenforceable
under present or future laws effective, such provision shall be fully severable
and this Agreement shall be construed and enforced as if such illegal, invalid,
or unenforceable provision had never comprised a part hereof; and the remaining
provisions hereof shall remain in full force and effect and shall not be
affected by the illegal, invalid, or unenforceable provision or by its severance
herefrom. Furthermore, in lieu of such illegal, invalid, or unenforceable
provision, there shall be added automatically as a part of this Agreement a
provision as similar in terms to such illegal, invalid or unenforceable
provision as may be possible and still be legal, valid or enforceable. It is
acknowledged that any payment which may be made by the Company to Officer under
this Agreement is in the nature of employment and/or severance and not a penalty
payment. Should the obligation to make any payment hereunder be held to be void
or voidable as a penalty by a final non-appealable court of competent
jurisdiction, this Agreement shall be deemed to provide an obligation on the
part of the Officer to render such consulting services as the Company may
reasonably request during the period of and in exchange for such payments as
would otherwise have been made by the Company as severance benefits and the
parties agree such payments shall constitute reasonable compensation for the
value of Officer's services during such period.
18. OFFICER'S OBLIGATIONS UPON TERMINATION OF EMPLOYMENT.
Upon the termination of his employment hereunder for whatever
reason (other than death) Officer shall:
(a) Forthwith tender his resignation from any
directorship or office he may hold in the Company; and
(b) Not at any time represent himself still to be
connected or to have any connection with the Company.
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19. EFFECT OF TERMINATION.
The provisions of this Agreement shall survive the termination
of this Agreement and the termination of Officer's employment with the Company
to the extent required to give full effect to the covenants and agreements
contained herein.
20. CONFIDENTIALITY.
(a) Officer agrees that, both during the term of this
Agreement and after the termination of this Agreement, Officer will hold in a
fiduciary capacity for the benefit of the Company, and shall not directly or
indirectly use or disclose, except as authorized by the Company in connection
with the performance of Officer's duties, any Confidential Information, as
defined hereinafter, that Officer may have or acquire (whether or not developed
or compiled by Officer and whether or not Officer has been authorized to have
access to such Confidential Information) during the term of this Agreement. The
term "Confidential Information" as used in this Agreement shall mean and include
any information, data and know-how relating to the business of the Company that
is disclosed to Officer by the Company or known by him as a result of his
relationship with the Company and not generally within the public domain
(whether constituting a trade secret or not), including without limitation, the
following: financial information, supply and service information, marketing
information, personnel information, customer information and information with
respect to any corporate affairs that the Company agreed to treat as
confidential.
The term "Confidential Information" does not include information that
has become generally available to the public by the act of one who has the right
to disclose such information without violating any right of the Company or the
client to which such information pertains.
(b) The covenant contained in this Section 20 shall
survive the termination of Officer's employment with the Company for any reason
for a period of three (3) years; provided, however, that with respect to those
items of Confidential Information which constitute trade secrets under
applicable law, Officer's obligations of confidentiality and non-disclosure as
set forth in this Section 20 shall continue to survive after said three (3) year
period to the greatest extent permitted by applicable law. These rights of the
Company are in addition to those rights the Company has under the common law or
applicable statutes for the protection of trade secrets.
21. NON-COMPETITION.
(a) So long as Officer is employed by the Company, and
for a period of three (3) years after termination of his employment for any
reason, Officer agrees not to engage in any "Competitive Activity" within the
"Noncompete Territory" (as those terms are defined in subsection (b) below).
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(b) As used herein, the term "Noncompete Territory" shall
mean any geographic area in which the Company has business or operations which
were performed, supervised by or assisted in by the Officer, or in which the
Company has customers or actively sought prospective customers with whom Officer
had Material Contact while employed by the Company. As used herein, the term
"Competitive Activity" shall mean any activity in which the Officer directly or
indirectly owns, manages, operates, controls, is employed by (either as an
Officer or independent contractor) or participates in the ownership, management,
operation or control of, any business (a "Competitor") that is engaged in the
manufacture or distribution of lottery products and services that are comparable
in type to the lottery products and services manufactured, distributed or
provided by the Company.
(c) "Material Contact" shall, for the purposes of
Sections 21(b) and 22(a) of this Agreement, exist between Officer and each
customer or potential customer: (i) with whom Officer dealt; (ii) whose dealings
with the Company were coordinated or supervised by Officer; (iii) about whom
Officer obtained confidential information in the ordinary course of business as
a result of Officer's association with the Company; or (iv) who receives
products or services authorized by the Company, the sale or provision of which
results or resulted in compensation, commissions, or earnings for Officer,
directly or indirectly, within two (2) years prior to the date of termination of
Officer's employment with the Company.
(d) For purposes of this Agreement, the determination of
whether a particular geographic area is within the Noncompete Territory or
whether a particular activity is a Competitive Activity shall be made at the
earlier of the time that enforcement of this covenant is sought, or the date the
Officer ceases, for any reason, to be an Officer of the Company.
(e) The Company and Officer acknowledge and agree, based
upon the current activities of the Company and a good faith projection of its
future activities, that the Noncompete Territory shall be presumed to be the
entire world; provided, however, that in the event this presumption is in
conflict at the time of determination with the definition contained in
subsection (b) above, then the Noncompete Territory shall comprise only that
portion of the world as falls within such definition.
(f) Nothing herein contained, however, shall restrict the
Officer from making any investments in not more than four and nine-tenths
percent (4.9%) of the voting securities in any Person whose stock is listed on a
national securities exchange or actively traded in the over-the-counter market,
so long as such investment does not give the Officer the right to control or
influence the policy decisions of any such business or enterprise which is, or
might be, directly or indirectly in competition with the Business of the
Company.
(g) The provisions of this Section 21 shall survive the
termination of the Officer's employment hereunder, irrespective of the reason
therefor until three (3) years after the date of termination.
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22. NON-SOLICITATION OF EMPLOYEES AND CUSTOMERS.
(a) Officer agrees that he will, for so long as he is
employed hereunder and for a period of three (3) years after termination of his
employment, refrain from (i) recruiting or hiring, or attempting to recruit or
hire, directly or by assisting others, any other employee of the Company who is
employed by the Company or any successor or affiliate of the Company, if the
Company or its successor or affiliate is then engaged in the business of
manufacturing or distributing products or providing services that are the same
as or substantially comparable in type to the products manufactured or
distributed by, or the services provided by, the Company or any of its
Affiliates at such time of termination were being and continue to be provided by
the Company, unless such employee (1) resigns voluntarily (without any
solicitation from Officer or his Affiliates, or (2) is terminated by the Company
or its Affiliates, or (ii) soliciting, enticing or inducing any Person with whom
Officer had Material Contact, that then presently is, or at any time during such
period shall be, a customer or potential customer of the Company, or any of its
Affiliates, to become a customer of any other Person for products or services
the same as, or comparable in type to, those products and services which, at
such time of termination, were being and continue to be provided by the Company
or any of its Affiliates and the Officer shall not approach any such Person for
such purpose or authorize or knowingly approve the taking of such actions by any
other Person, or assist any such Person in taking such action.
(b) The provisions of this Section 22 shall survive the
termination of the Officer's employment hereunder, irrespective of the reason
therefor until three (3) years after the date of termination.
23. TOLLING OF PERIOD OF RESTRAINT.
Officer hereby expressly agrees that any purported violation
of the restraints set forth in Sections 20 through 22 shall automatically toll
and suspend the period of the restraint for the amount of time from the date
Officer or the Corporation commences litigation with respect to the
enforceability of such provisions and/or such purported violation until a final,
non-appealable decision is rendered or the parties otherwise resolve the
purported violation; provided that the applicable period of restraint shall not
be extended unless there shall have been a violation of the restraints set forth
in the applicable section at issue during such period of time.
24. ACKNOWLEDGMENTS.
Officer hereby acknowledges and agrees that the restrictions
contained in Sections 20, 21 and 22 are fair and reasonable and necessary for
the protection of the legitimate business interests of the Company. Officer
acknowledges that in the event Officer's employment with the Company terminates
for any reason, Officer will be able to earn a livelihood without violating the
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restrictions contained in Sections 20, 21 and 22. Officer acknowledges that such
restrictions are a material condition to Officer's employment and continued
employment with the Company.
25. RIGHTS TO MATERIALS.
All records, files, memoranda, reports, price lists, customer
lists, drawings, plans, sketches, documents and the like (together with all
copies thereof) relating to the business of the Company, which Officer shall use
or prepare or come in contact with in the course of, or as a result of, his
employment shall, as between the parties hereto, remain the sole property of the
Company. Upon the termination of his employment or upon the prior demand of the
Company, he shall immediately return all such materials and shall not thereafter
cause removal thereof from the premises of the Company; provided that, for the
avoidance of doubt, upon termination of his employment, Officer shall be
entitled to retain or to have furnished to him, at Company expense the following
documents: originals of Officer's appointment and desk calendars, copies of
travel and entertainment reports and requests for reimbursement and associated
supporting documentation; and further provided that, for the avoidance of doubt,
the Company shall be entitled, at its sole cost and expense, to make copies of
the foregoing original records which officer is entitled to retain, provided
that if Officer's employment is terminated, a request to copy any original
records to which Officer is entitled must be communicated by Notice to Officer
no later than sixty (60) days following the termination of his employment.
26. INVENTIONS.
Officer will promptly disclose to the Company and to no other,
any Invention (as hereinafter defined) which Officer may conceive or make either
alone or in conjunction with others during his employment by the Company or
which Officer may conceive or make within one (1) year after termination of his
employment with the Company for any reason. Moreover, Officer will execute all
papers deemed proper by Company to enable it, at its expense, to prepare and
file any and all original, divisional, continuation, continuation-in-part,
refile, renewal, reissue and other applications for Letters Patent of the United
States and of other countries covering such Inventions, to establish and
maintain the Company's title to and obtain for the Company or its designee
patents on said applications or any other patent owned or claimed by the
Company, all at the option of the Company, and to vest the Officer's entire
right, title and interest in and to said Inventions, patent applications and
patents in the Company or its designee. Officer will also execute all such
proper and necessary papers to perfect or otherwise protect the Company's rights
in such Inventions as may be presented to the Officer at any time during or
after the termination of his employment with the Company. For purposes of this
provision, the term "Invention" shall mean and include any invention or
technical information related to the business of the Company in the nature of a
new design, art, machine, process, formula, procedure, computer program, method
of manufacture, composition matter or any new or useable improvements thereof,
whether or not patentable.
24
<PAGE> 25
27. WORKS MADE FOR HIRE.
All Works (as hereinafter defined) and all copyrights and
other rights, titles and interests whatsoever in and to the Works, belong
solely, irrevocably and exclusively throughout the world to the Company as
"works made for hire." Moreover, if and to the extent any court or agency should
conclude that the Works (or any of them) do not constitute or qualify as a "work
made for hire" the Officer hereby assigns, grants and delivers, solely,
irrevocably, and exclusively throughout the world unto the Company, all
copyrights and other rights, titles and interests whatsoever in and to Works.
Officer shall execute (whether or not any court or agency has concluded that the
Works, or any of them, do not constitute or qualify as "works made for hire")
such further grants and assignments of all rights which the Company from time to
time reasonably may request for the purpose of evidencing, enforcing,
registering or defending its complete, exclusive, perpetual and worldwide
ownership of the Works. Without limiting the preceding provisions of this
Section, Officer acknowledges and agrees that the Company may edit and otherwise
modify, and use, publish and otherwise exploit, the Works (and any of them or
part of them) in any media and in such manner as the Company in its sole
discretion may determine, provided, however, that the Company shall expressly
disclaim Officer's involvement with any edited or modified work unless Officer
shall consent to the use of his name with respect thereto. For purposes of this
provision, the term "Works" shall mean and include all writings, tapes,
recordings, computer programs and other works in any tangible medium of
expression, regardless of the form of the medium, which have been or are
prepared by the Officer, or to which the Officer contributes, in connection with
his employment by the Company, whether created within or without the Company's
facilities and whether created before, during or after normal business hours.
28. INJUNCTIVE RELIEF. Officer understands, acknowledges and
agrees that in the event of a breach or threatened breach of any of the
covenants and promises contained in Sections 20, 21, 22, 26, and 27, the Company
will suffer irreparable injury for which there is no adequate remedy at law and
the Company will therefore be entitled to injunctive relief enjoining said
breach or threatened breach. Officer further acknowledges, however, that the
Company shall have the right to seek a remedy at law as well as or in lieu of
equitable relief in the event of any such breach.
29. ENTIRE AGREEMENT; CHOICE OF LAW. This Agreement sets forth the
entire understanding of the parties and supersedes all prior agreements or
understandings, whether written or oral, with respect to the subject matter
hereof. No agreements or representations, oral or otherwise, express or implied,
with respect to the subject matter hereof have been made by either party which
are not set forth expressly in this Agreement. The validity, interpretation
construction and performance of this Agreement shall be governed by the laws of
the State of Georgia and any applicable federal laws of the United States of
America. No terms, conditions, warranties, other than those contained herein,
and no amendments or modifications hereto shall be binding unless made in
writing and signed by the parties hereto. No provisions of this Agreement may be
modified, waived or discharged unless such waiver, modification or discharge is
agreed to in writing signed by Officer and a Senior Executive Officer of the
Company or such other employee of the Company
25
<PAGE> 26
as may be specifically designated by the Board of the Company, whose authority
is evidenced by a resolution of the Compensation Committee and such other
Committee or the entire Board as necessary to establish the authority of such
Senior Executive Officer or such employee of the Company as may be specifically
designated by the Board of the Company. No waiver by either party hereto at any
time of any breach by the other part hereto of, or compliance with, any
condition or provision of this Agreement to be performed by such other party
shall be deemed a waiver of similar or dissimilar provisions or conditions at
the same or at any prior or subsequent time.
30. BINDING EFFECT. This Agreement shall extend to and be binding
upon and inure to the benefit of the parties hereto, their respective successors
and assigns; provided, however, that neither party shall have the right to
assign this Agreement without the prior written consent of the other party
hereof, which consent shall not unreasonably be refused upon the provision of
assurances of performance reasonably satisfactory to Officer and assumption of
the Agreement in the manner contemplated herein. Officer may not assign, pledge
or otherwise hypothecate Officer's interest in the severance benefits payable
hereunder, and any attempt by Officer to do so will not be recognized by the
Company.
31. TITLES. Titles of the headings herein are used solely for
convenience and shall not be used for interpretation or construing any work,
section clause, paragraph, or provision of this Agreement.
32. COUNTERPARTS. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but which together
shall constitute one and the same instrument.
33. ENFORCEMENT. The provisions of this Agreement may be enforced
by all legal and equitable remedies available to the parties including specific
performance and injunction. Nothing herein shall be construed as prohibiting
either party from pursuing any other remedies available to it, including
recovery of damages.
34. CONSTRUCTION. Each of the parties has agreed to the use of the
particular language of the provisions of this Agreement and all attached
Exhibits, and any questions of doubtful interpretation shall not be resolved
solely by any rule or interpretation against the draftsman but rather in
accordance with the fair meaning thereof. The Company acknowledges it was
represented by independent counsel in connection with the negotiation and
execution of this Agreement.
26
<PAGE> 27
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date and year first written above.
SCIENTIFIC GAMES HOLDINGS CORP.
By:
-------------------------------------------
Cliff O. Bickell
Vice President and Chief Financial Officer
Attest
By:
-------------------------------------------
C. Gray Bethea, Jr.
Its: Vice President and General Counsel
Accepted and Agreed as of the
date first above written:
- -----------------------------------------
(Signature)
WILLIAM G. MALLOY
(Print Name)
27
<PAGE> 28
EXHIBIT A
INCENTIVE COMPENSATION PLANS
ANNUAL INCENTIVE COMPENSATION PLAN
An Annual Incentive Compensation Plan (the "AICP") has been instituted
by the Company which provides an annual cash bonus plan for senior management.
The amount of the annual bonus shall be determined annually by the Compensation
Committee (the "Committee") of the Board of Directors of the Company in relation
to results achieved by participants in the AICP based on the degree of
achievement by the Company of its strategic and financial targets for the
preceding year. The degree to which the targets are achieved will produce a
payout for participants proportionately greater for above target performance and
proportionately smaller for below target performance. Targets may include, but
are not limited to, such items as earnings before interest, taxes, depreciation
and amortization ("EBITDA"), earnings per share ("EPS"), stock price levels,
cash flow and operating income as established by the Committee after
consultation with the Chief Executive Officer or pursuant to authority delegated
by the Committee.
Under the AICP, Officer shall be eligible initially for incentive
compensation of 48% of his Base Salary at December 31 of any year for
performance at target. Bonus payments to Officer under the AICP will be in
accordance with each AICP, as approved by the Committee. Enhancements to amounts
annually payable under the AICP may be made by the Committee, at its discretion,
based on the officer's individual evaluation and performance and any such
enhancement payments (or lack thereof) need not be uniform with respect to
individual performance based payments to other Executive Officers, including,
without limitation, Senior Executive Officers. Under the AICP, Officer will be
eligible for incentive compensation according to the terms of the AICP, as
approved from time to time by the Committee.
The AICP shall be subject to amendment, modification and interpretation
by the Committee provided that any such amendment, modification or
interpretation shall not materially reduce the right of Officer to any payment
or benefit earned thereunder and provided that any amendment, modification or
interpretation of the AICP shall be binding on all participants affected
thereby.
INTERMEDIATE INCENTIVE COMPENSATION PLAN
An Intermediate Incentive Compensation Plan ("IICP") has been
established by the Company. Under the IICP, Officer is eligible for, and annual
cash bonuses are earned based on, the Company's achievement of a specified
financial performance goal based upon the compounded growth in the Company's
earnings per share over rolling three-year periods beginning with the three-
28
<PAGE> 29
year period ending December 31, 1995. If the Company's actual results fall short
of the performance goal specified during any three-year period, no amounts will
be payable under the IICP for such three-year period; however, if the target is
met or exceeded, Officer will be eligible to receive a cash bonus payable over
the following three (3) years. To receive any payment under the IICP, Officer
must be an employee of the Company on the first business day of any year in
which payments become payable. The total amount payable to Officer will vary
within the range established under the IICP, with a minimum amount specified for
meeting the target and a maximum amount specified for exceeding the target by a
specified percentage or more. Under the IICP, Officer will be eligible for
incentive compensation according to the terms of the IICP, as approved from time
to time by the Committee.
The IICP shall be subject to amendment, modification and interpretation
by the Committee provided that any such amendment, modification or
interpretation shall not materially reduce the right of Officer to any payment
or benefit earned thereunder and provided that any amendment, modification or
interpretation of the IICP shall be binding on all participants affected
thereby.
29
<PAGE> 30
EXHIBIT B
SCIENTIFIC GAMES HOLDINGS CORP.
FORM OF STOCK OPTION AWARD AGREEMENT
You have been selected to be a Participant in the Scientific Games
Holdings Corp. 1996 Key Employee Stock Option Plan (the "Plan") as specified
below.
The Plan provides complete details of all of your rights under the Plan
and this Award Agreement, as well as all of the conditions and limitations
affecting such rights. All capitalized terms appearing in this Award Agreement
shall have the meanings ascribed to them in the Plan or that certain Employment
and Severance Benefits Agreement between Participant and the Company dated as of
January 1, 1998 (the "ESBA"), as the context requires. If there is any
inconsistency between the terms of this Award Agreement and the terms of the
Plan, the Plan's terms shall completely supersede and replace the conflicting
terms of this Award Agreement.
1. NUMBER OF SHARES GRANTED UNDER THIS OPTION: 200,000
2. DATE OF GRANT: November 18, 1998
3. EXERCISE PRICE: $
--------------------------------
4. EXERCISE OF OPTIONS: Subject to the terms of the Plan, the
Shares covered by this Option may be purchased according to the following
schedule:
<TABLE>
<CAPTION>
Portion of Option Cumulative Number of
Which Becomes Shares Which May Be
Date Exercisable Purchased
<S> <C> <C>
January 1, 2000 50,000 50,000
January 1, 2001 50,000 100,000
January 1, 2002 50,000 150,000
January 1, 2003 50,000 200,000
</TABLE>
5. EXPIRATION DATE OF OPTION: January 1, 2008 subject to Plan
provisions in the case of death or permanent disability.
1
<PAGE> 31
6. RESTRICTION ON TRANSFERABILITY: A Participant may not sell,
pledge, encumber, transfer or by pursuant to a gift, or bequest or otherwise
transfer or dispose of, and may not permit to be sold, pledged, encumbered or
transferred or disposed of in any manner, all or any portion of, or any direct
interest in, any Shares acquired pursuant to the Plan, except:
(a) that options granted hereunder may be transferred by
the Participant, subject to such rules as the Committee may adopt to preserve
the purposes of the Plan, to one or more of:
(i) the Participant's spouse, children or
grandchildren, parents, grandparents,[siblings, mothers-in-law, fathers-in-law,
sons-in-law, daughters-in-law, brothers-in-law and sisters-in-law (including, in
each case, adopted and step relationships) (collectively, the "Immediate
Family");
(ii) a trust or trusts solely for the benefit of
the Participant and/or his or her Immediate Family; or
(iii) a partnership or limited liability company,
the partners or shareholders of which are limited to the Participant and his or
her Immediate Family members;
(each transferee described in clauses (i), (ii) and (iii) above is hereinafter
referred to as a "Permitted Transferee"); provided that (A) the Participant
gives the Committee advance written notice describing the terms and conditions
of the proposed transfer and the Committee notifies the Participant in writing
that such a transfer would comply with the requirements of the Plan and this
award agreement, (B) such transfer can be effected at no out-of-pocket cost to
the Company, (C) such transfer will not result in a material adverse effect on
the Company or any plan under which such options were granted, and (D) the
Participant shall have appointed, and given written notice to the Company of the
same, not less than three (3) Persons (at least one of whom shall be a law firm,
trust department of a bank, or other institutional fiduciary), each ready,
willing and able at the time of appointment to serve as guardian or similar
advisor if Participant is found to be mentally incompetent or as a
representative of Participant's estate (hereinafter, a "Representative"), in
each case, for the purpose of acting on behalf of Permitted Transferees under
this Agreement, including, without limitation, Section 8 hereof. For purposes of
this Agreement, Participant shall designate from his Representatives (i) a
primary Representative, (ii) a first alternate Representative (who shall serve
as the Representative hereunder if the primary Representative(s) is unwilling or
unable to serve, and (iii) a second alternate Representative(s) (who shall serve
as the Representative hereunder if both the primary Representative and the first
alternate Representative(s) are unwilling or unable to serve. The Participant
may require that one or more of the primary Representative, the first alternate
Representative or the second alternate Representative act in concert to take any
action on behalf of the Permitted Transferees. No transfer of Options awarded by
this Agreement shall be permitted unless or until the Participant shall have
furnished notice to the Company of the identity of Participant's Representatives
and such other information as the Company reasonably may request to confirm that
such Persons are ready, willing and able to act as a Representative hereunder.
The
2
<PAGE> 32
Participant may, from time to time, change the identity and priority of one or
more Persons serving as a Representative of Participant by notice to the
Company, given as provided in that certain Employment and Severance Benefits
Agreement between the Participant and the Company, dated as of January 1, 1998.
The terms of any option transferred in accordance with the immediately
preceding sentence shall apply to the Permitted Transferee, except that (a) a
Permitted Transferee shall not be entitled to transfer any options, other than
by will or the laws of descent and distribution; and (b) Permitted Transferee
shall not be entitled to exercise any transferred options unless there shall be
in effect a registration statement on an appropriate form covering the shares to
be acquired pursuant to the exercise of such option, if the Committee determines
that such a registration statement is necessary or appropriate; and
(b) or otherwise as further permitted by the Plan and, in
each case, in accordance with and subject to the terms of the Plan and this
Award Agreement.
Any transfer by the Participant contrary to the terms of the Plan shall
be void and shall vest no right, title, or interest in the transferee.
7. ACCELERATED EXERCISABILITY: In the event the employment of a
Participant is terminated, either voluntarily or involuntarily, by reason of
death, permanent disability, or Change in Control or Constructive Termination,
except, in each case, with Just and Substantial Cause, all Shares under this
Option shall become immediately exercisable one hundred percent (100%), and
shall remain exercisable for their entire term and any period of restriction
shall immediately terminate. In the event Participant otherwise voluntarily
terminates his employment with the Company, Options shall vest and be
exercisable only as provided for by the ESBA or the Plan.
8. MANNER OF EXERCISE: As further described in the Plan, a
Participant entitled to exercise the Option or any portion thereof may do so by
delivering written notice of exercise in person or addressed and mailed,
certified mail, postage-prepaid, to the Company at its executive office in
Alpharetta, Georgia or such other address as the Company may, from time to time,
specify, except as otherwise limited hereby. Such written notice shall specify
the number of Shares with respect to which the Option is being exercised, the
purchase price of each Share, the aggregate purchase price for all Shares being
purchased under said notice, and the date (which shall not be more than ninety
(90) days after the notice) upon which the Shares shall be purchased. Such
notice shall be signed by such Participant (or other person authorized to
exercise such Options) and shall be accompanied by payment, whether in cash, by
check, by shares of Common Stock (whether issuable in connection with the
exercise of the Option if permitted by the Committee in its sole discretion
following prior written request by the Participant or previously acquired by the
Participant if acquired more than six months prior to the date of exercise of
the Option), or any combination thereof, as elected by the Participant subject
to the limitations stated above, in full for such aggregate purchase price. The
Committee's decision to allow payments to be made in the form of Shares
3
<PAGE> 33
issuable in connection with the exercise of the Option shall be made by giving
written notice to the Participant (or other person exercising the Option).
Notwithstanding anything in this Agreement to the contrary, the Company
shall not be obligated to take any action under this Agreement on behalf of, or
with respect to, any Permitted Transferee unless permitted to do so in writing
(i) by the Participant, if the Participant is still living and has not been
found to be mentally incompetent (and no guardian or similar advisor shall have
been appointed with respect to his affairs) or (ii) if the Participant is
deceased or shall have been found to be mentally incompetent, and a guardian or
similar advisor shall have been appointed with respect to his affairs, from the
representative of Participant's estate or such guardian or advisor, as the case
may be. The above provision only addresses the obligations of the Company with
respect to Permitted Transferees, as to whom the Company shall have no liability
for its acts or failure to act as provided in the foregoing sentence, and does
not address the relative rights and obligations between the original
Participant, on the one hand, and any Permitted Transferees, on the other hand.
9. RESTRICTION ON EXERCISE AND RESALE OF SHARES: Participant
acknowledges that the Shares to be acquired upon exercise of this Option are not
presently registered under the Securities Act of 1933, as amended (the
"Securities Act"). If at any time during which this Option would otherwise be
exercisable according to its terms, there is no effective registration statement
on file with the Securities and Exchange Commission covering the Shares which
would then be acquirable hereunder, the Options to acquire such Shares shall not
be exercised until the Shares are registered pursuant to the Securities Act;
provided, however, the Committee may, by written action, waive such restriction
on exercise and may condition such exercise upon its receipt of such
representations, factual assurances and legal opinions as it shall reasonably
deem necessary to determine and document the availability of an exemption from
the registration requirements of the Securities Act (and such state securities
laws as shall be applicable).
Participant agrees that until and unless registration occurs the
certificates representing any Shares acquired hereunder may be imprinted with a
restrictive legend substantially as follows and that appropriate stop transfer
orders may be issued by the Company to its transfer agent:
"The Shares represented by this certificate have not been
registered under the Securities Act of 1933, as amended, and
may not be transferred or otherwise disposed of in the absence
of such registration or of an opinion in form and from counsel
reasonably satisfactory to the Company to the effect that such
registration is not required."
10. REGISTRATION RIGHTS OF SHARES: Certificates representing
Options and certificates for underlying Shares which are entitled to
Registration Rights under that certain Registration Rights Agreement between the
Company and Participant shall, in each case, also bear a legend referring such
rights, and any person asserting rights thereunder shall be required to
establish, to the
4
<PAGE> 34
Company's reasonable satisfaction, the identity of the Holder's transferor and,
in the case of Shares, that such Shares were issued pursuant to Options granted
under this Agreement.
11. ACKNOWLEDGMENT AND ACCEPTANCE: Please acknowledge your
agreement to participate in this Plan and this Agreement, and to abide by all of
the governing terms and provisions, by signing the following representation:
Agreement to Participate
By signing a copy of this Agreement and returning it to the
Company, I acknowledge that I have read the Plan, and that I
fully understand all of my rights under the Plan, as well as
all of the terms and conditions which may limit any
eligibility to exercise this Option and/or transfer Shares
acquired under this Option.
IN WITNESS WHEREOF, the parties have caused this Agreement to be
executed as of the Date of Grant.
SCIENTIFIC GAMES HOLDINGS CORP.
By:
-------------------------------------------------
Cliff O. Bickell
Vice President and Chief Financial Officer
Attest:
By:
-------------------------------------------------
C. Gray Bethea, Jr.
Its: Vice President and General Counsel
(Participant's Signature)
- --------------------------------
Name:
5
<PAGE> 35
Transfer History
[To be Completed By the Company]
<TABLE>
<CAPTION>
Initial Holder Subsequent Transferee
-------------- ---------------------
<S> <C>
</TABLE>
Transfers of Options may not be unilaterally made by the Holder of the
Options evidenced by this Certificate
No proposed transfer shall be effective unless and until the Company shall issue
a new option certificate in the name of the transferee and shall have completed
this box on the new option certificate and all conditions to any such transfer
shall have been complied with by the proposed transferor and the proposed
transferee.
<PAGE> 36
EXHIBIT C
SCIENTIFIC GAMES HOLDINGS CORP.
REGISTRATION RIGHTS AGREEMENT
This REGISTRATION RIGHTS AGREEMENT (the "Agreement") is made as of
_____________, __ 1998 by and between SCIENTIFIC GAMES HOLDINGS CORP., a
Delaware corporation (the "Company"), and WILLIAM G. MALLOY ("Officer").
RECITALS
WHEREAS, the Company and Officer are parties to that certain Employment
and Severance Benefits Agreement of even date herewith (the "ESB Agreement) and;
WHEREAS, Capitalized terms appearing herein and not otherwise defined
have the meanings such terms are assigned in the ESB Agreement; and
WHEREAS, the Company expects to receive substantial benefits as a
result of the transactions contemplated by the ESB Agreement, and the Company's
agreement to enter into this Agreement is a condition to execution of the ESB
Agreement by Officer;
NOW, THEREFORE, in consideration of the premises and the mutual
obligations and covenants hereinafter set forth, the parties hereto agree as
follows:
1. Certain Definitions. As used in this Agreement, the following
terms shall have the following respective meanings:
"Affiliate" shall mean, with respect to any person or entity, any
person or entity which directly, or indirectly through one or more
intermediaries, controls, is controlled by or is under common control with such
person or entity.
"Commission" shall mean the Securities and Exchange Commission or any
other Federal agency at the time administering the Securities Act.
"Common Stock" shall mean the common stock of the Company, par value
$0.001 per share.
"Company Notice" shall have the meaning assigned to such term in
Section 2.1.
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<PAGE> 37
"ESB Agreement" has the meaning set forth in the Recitals hereto.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended, or any similar Federal rule or statute and the rules and regulations of
the Commission thereunder, all as the same shall be in effect at the time.
"Holder" shall mean Officer, so long as such individual holds the
Registrable Stock, and any person holding the Registrable Stock to whom the
rights under this Agreement have been transferred in accordance with Section 9,
so long as such individual holds Registrable Stock.
"Permitted Transferees" shall have the meaning ascribed to such term in
the Option Award Agreement between Officer and the Company dated as of the same
date as this Agreement and awarded pursuant to the Company's 1996 Employee Stock
Option Plan.
"Person" shall mean an individual, partnership, corporation (including
a business trust), limited liability company, joint stock company, trust,
unincorporated association, joint venture or other entity, or a government or
any political subdivision or agency thereof.
"Priority Shares" shall mean other Registrable Securities senior in
priority of registration rights to the Registrable Stock. The Registrable Stock
shall not constitute Priority Shares.
"Recitals" shall mean the recitals to this Agreement which constitute
integral terms hereof and conditions hereto.
"Registrable Securities" shall mean (a) shares of Registerable Stock
and (b) any other shares of the capital stock of the Company having similar
registration rights; provided, however, that such securities shall only be
treated as Registrable Securities if and so long as (i) they have not been
registered or sold to or through a broker or dealer or underwriter in a public
distribution or a public securities transaction, (ii) they have not been sold
pursuant to Rule 144, or (iii) the registration rights with respect to such
shares have not otherwise terminated.
"Registrable Stock" shall mean (a) shares of Common Stock issued to
Officer by the Company or issuable upon the exercise of options to purchase
Common Stock issued to Officer by the Company, (b) any other shares of Common
Stock acquired by Officer while an Affiliate of the Company, (including shares
issuable upon the exercise of options transferred to Permitted Transferees) (c)
any other shares of Common Stock acquired by a Permitted Transferee but only if,
while and so long as, such Person is or may be deemed to be an Affiliate of the
Company, and (d) any shares issued or issuable to Officer or his Permitted
Transferees upon or as a result of any stock split, stock dividend,
recapitalization, conversion or similar event; provided, however, that, in the
case of clauses (a)-(d), such securities shall only be treated as Registrable
Stock if and so long as (i) they have not been registered or sold to or through
a broker or dealer or underwriter in a public distribution or a public
securities transaction, (ii) they have not been sold pursuant to
2
<PAGE> 38
Rule 144, or (iii) the registration rights with respect to such shares have not
otherwise terminated.
The terms "register", "registered" and "registration" shall refer to a
registration effected by preparing and filing a registration statement in
compliance with the Securities Act, and the declaration or ordering of the
effectiveness of such registration statement.
"Registration Expenses" shall mean all expenses, except as otherwise
stated below, incurred in complying with Section 2.1, including, without
limitation, all registration, qualification and filing fees, printing expenses,
escrow fees, fees and disbursements of counsel for the Company, blue sky fees
and expenses, and expense of any special audits incident to or required by any
such registration, compensation of regular employees of the Company and expenses
of all marketing and promotional efforts reasonably requested by the managing
Underwriter relating to all securities being offered in an offering and which
are customarily paid by issuers or sellers of securities and such other fees and
disbursements of Underwriters customarily paid by issuers or sellers of
securities (but not the fees and disbursements of Underwriters' counsel);
provided, however, that each Holder shall bear all fees and expenses of its own
counsel, underwriting discounts and commissions, brokerage fees or commissions
and transfer taxes, in each case, if any, relating to the sale of its
Registrable Stock.
"Registration Rights Period" shall mean, (a) with regard to any
non-Affiliate Holder and the shares of Registrable Stock then held by such
Holder, that period during which the shares of Registrable Stock held by such
Holder constitute Registrable Stock; provided, however, that notwithstanding
anything contained herein to the contrary, the Registration Rights Period for
any non-Affiliate Holder shall end no later than the first date on which the
Registrable Stock held by such Holder may be publicly sold pursuant to Rule 144
and free of any contractual restriction on sale under this Agreement or the ESB
Agreement; and (b) with respect to any Holder who is an Affiliate of the
Company, until the later of (i) ninety (90) days after such Holder ceases to be
an Affiliate of the Company, or (ii) would not be deemed an underwriter under
Section 2(11) of the Securities Act with respect to the sale of the Registrable
Stock.
"Restricted Stock" shall mean the Registerable Stock constituting
restricted securities as defined in Rule 144.
"Rule 144" shall mean Rule 144 promulgated under the Securities Act.
"Securities Act" shall mean the Securities Act of 1933, as amended, or
any similar Federal rule or statute and the rules and regulations of the
Commission thereunder, all as the same shall be in effect at the time.
"Selling Holder" shall mean a Holder who offers or sells Registrable
Stock pursuant to a registration statement in which such Holder participates
pursuant to this Agreement.
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<PAGE> 39
"Underwriter" means a securities dealer who purchases any Registrable
Securities as principal in an underwritten offering and not as part of such
dealer's market-making activities.
"Withdrawal Election" shall have the meaning assigned to such term in
Section 2.2(a)(v).
2. Piggyback/Incidental Registration.
(a) Notice of Registration. If at any time or from time
to time during the Registration Rights Period the Company shall determine to
register any of its equity securities, either for its own account or the account
of stockholders of the Company, other than (a) registration relating solely to
employee benefit plans registered on Form S-8 or any successor form thereto (but
only so long as securities issuable upon the exercise of transferable options
may not be and are not being registered thereunder), (b) a registration relating
solely to a transaction meeting the requirements of Rule 145 under the
Securities Act transaction (a "Rule 145 transaction"), (c) a registration in
which the only equity security being registered is Common Stock issuable upon
conversion of convertible debt securities which are also being registered, or
(d) constituting a registered exchange offer or shelf registration entered into
pursuant to or in connection with an offering pursuant to Rule 144A under the
Securities Act, the Company will give written notice (the "Company Notice"), at
its expense, to all Holders of Registrable Stock of its intention to do so at
least fifteen (15) days prior to the filing of a registration statement with
respect to such registration with the Commission. If any Holder or Holders of
Registrable Stock desires to dispose of all or part of its or their Registrable
Stock, such Holder or Holders may request registration thereof in connection
with Company's registration by delivering to the Company, within ten (10) days
after receipt of the Company's Notice, written notice of such request (the
"Holder's Notice") stating the number of shares of Registrable Stock to be
disposed of and the intended method of disposition of such shares by such Holder
or Holders. The Company shall use its reasonable best efforts to cause all
shares of Registrable Stock specified in the Holder's Notice to be registered
under the Securities Act pursuant to the registration statement referred to in
the Company Notice (and any related qualification under blue sky laws) so as to
permit the sale or other disposition (in accordance with the intended methods
thereof as aforesaid) by such Holder or Holders of the Registrable Stock so
registered, subject, however, to the limitations set forth in Section 2.2; and,
provided, however, that the Company shall not be required to grant any
concession or additional rights or other consideration to any other Person to
secure the right of any Holder of Registrable Stock to participate in such
registration.
(b) Limitations on Piggyback/Incidental Registration.
(i) If the registration of which the Company
gives notice pursuant to Section 2.1 above is for the purpose of permitting the
disposition of securities by the Company or any other Person pursuant to a firm
commitment underwritten offering, the Company shall so advise the Holder as a
part of the Company Notice given pursuant to Section 2.1. In such event,
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<PAGE> 40
the right of the Holder to registration pursuant to Section 2.1 shall be
conditioned upon the Holder's participation in such underwriting (if any), and
the inclusion of Registrable Stock in the offering and/or underwriting shall be
limited to the extent provided herein. Holders of Registrable Stock electing to
register all or part of their shares of Registrable Stock in the registration
shall sell such shares to or through the Underwriter(s) (if any) of the
securities being registered for the account of the Company (or otherwise
selected by the Company, in its sole discretion, to manage such underwriting)
upon terms generally comparable to the terms applicable to the Company (except
that the Company shall bear all Registration Expenses to the extent provided in
Section 4).
If requested in writing to do so in good faith by the managing
Underwriter of an underwritten offering, the Company shall have the right to
limit the aggregate size of the offering or decrease the number of shares to be
included therein by Holders of Registrable Stock to the extent necessary to
reduce the number of securities to be included in the registration to the level
recommended by the managing Underwriter, and only securities which are to be
included in the underwriting may be included in the registration. Each Holder
participating in such offering shall (together with the Company and other
holders of the Registrable Securities distributing their securities through such
underwriting) enter into an underwriting agreement in customary form with the
managing Underwriter selected for such underwriting by the Company.
Notwithstanding any other provision of this Section 2.2, if the
managing Underwriter (or, if there is no managing Underwriter, then the Company)
determines that marketing factors or its contractual obligations with respect to
Priority Shares require a limitation of the number of securities to be
underwritten or offered, then the Company shall so advise all holders of
Registrable Securities requesting to be included in the registration and
underwriting, and the number of shares of Registrable Securities that may be
included in the registration and underwriting shall be allocated among all
holders of Registrable Securities requesting to be included in the registration
and underwriting as follows:
(i) Whenever the number of shares which may be
registered pursuant to Section 2.1 is limited by the provisions of subsection
(a), the Holders of Registrable Stock shall have priority as to sales over the
other holders of the Company's securities without registration rights, and the
Company shall cause such other holders to withdraw from such offering to the
extent necessary to allow all requesting Holders of Registrable Stock, together
with the holders of Registrable Securities that have the right to participate in
the firm commitment underwritten offering pursuant to registration rights
granted by the Company prior to the date of this Agreement, to include all of
the shares so requested to be included within such registration.
(i) Whenever the number of shares which may be
registered pursuant to Section 2.1 is still limited by the provisions of this
Section 2.2, after the withdrawal of the other holders of the Company's
securities, the Company, together with the holders of Priority
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<PAGE> 41
Shares that have the right to participate in the firm commitment underwritten
offering pursuant to registration rights granted by the Company (but only to the
extent required by the terms of any grants of such registration rights), shall
have priority as to participation in such registration over the Holders of
Registrable Stock. In furtherance thereof, each Holder further agrees that it
shall withdraw its Registrable Stock from such registration to the extent
necessary to allow the Company to include (A) all the securities which the
Company desires to sell for its own account and (B) all shares of Registrable
Securities which are required to be included in such registration pursuant to
the exercise of any demand registration rights which entitle the holder thereof
to include Registrable Securities in such registration.
(i) The Holders of Registrable Stock given
rights by Section 2.1, together with the holders of Registrable Securities that
have the right to participate in the firm commitment underwritten offering
pursuant to incidental registration rights granted by the Company prior to the
date of this Agreement, shall, unless such incidental registration rights
provide to the contrary, share in the available amount of securities which may
be included in the registration in proportion, as nearly as practicable, to the
respective amounts of Registrable Securities held by them at the time of filing
the registration statement from and to the extent the Company may reasonably
bind such other holders to do so, except that Registrable Securities (other than
Priority Shares), shall be excluded in proportion, as nearly as practicable, to
the respective amounts of such securities held by the holders thereof at the
time of filing the registration statement before any Priority Shares requested
to be included in the registration and underwriting are excluded.
(i) In making the determinations contemplated by
Section 2.1, a managing Underwriter or the Company may consider whether the
inclusion of any securities will affect the number of securities that can be
sold in an orderly fashion within a price range acceptable to the Company (or,
if the Company is not selling any securities in such registration to the
prospective selling holders) and the Company shall not be required to grant any
concession or additional rights or pay any additional consideration to any
holder of Registrable Securities to secure the right of any Holder of
Registrable Stock to participate in any registration.
(i) If (A) as a result of the proration
provisions of this Section 2.2 (a) any Holder of Registrable Stock is not
entitled to include all such Registrable Stock which such Holder requested to
include in such registration, or (B) the terms of the proposed compensation to
the Underwriters change in a manner materially adverse to the Holder from those
described in the Company Notice, such Holder may by notice in writing elect to
withdraw his request to include any Registrable Stock in such registration (a
"Withdrawal Election"); provided, however, that a Withdrawal Election shall be
irrevocable and a Holder of Registrable Stock who has made a Withdrawal Election
shall no longer have any right to include any Registrable Stock in the
registration as to which such Withdrawal Election was made. The Holder shall
give any Withdrawal Election as promptly as possible and, in no event, later
than five (5) business days of notice of the terms of the proposed underwriting.
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<PAGE> 42
(i) To facilitate the allocation of shares in
accordance with the above provisions, the Company or the Underwriters may round
the number of shares allocated to any holder of Registrable Securities to the
nearest 100 shares.
(i) The Company shall use its reasonable best
efforts to provide that the number of shares of Registrable Securities required
to satisfy any Underwriters' over-allotment option shall be allocated pro rata
among the Company and all holders of securities to be included in the offering
on the basis of the relative number of securities otherwise to be included by
each of them in the registration provided that the Company shall not be required
to grant any concession or additional rights or pay any additional consideration
to any holder of Registrable Securities to secure such allocation.
(ii) Designation of Underwriter. In the case of
any registration which is proposed to be effected as to which Section 2.1 is
applicable, the Company shall have the sole and exclusive right to designate the
Underwriter(s) therefore (if any), and all Holders of Registrable Stock
participating in the registration shall sell their shares of Registrable Stock
only pursuant to such underwriting (if any).
(iii) Right to Terminate Registration. The Company
shall have the right to terminate or withdraw any registration initiated by it
or pursuant to the demand registration rights of any Person, which registration
gives rise to rights of Holders of Registrable Stock under Section 2.1, prior to
the effectiveness of such registration whether or not any Holder of Registrable
Stock has elected to include securities in such registration.
3. Lock-Up Agreement. If requested in writing by the Company or
by the managing Underwriter of any offering effected pursuant to this Agreement
each Holder of Registrable Stock who is an officer or director of the Company,
or an Affiliate thereof, or who owns of record more than one percent (1%) of the
shares of Common Stock then outstanding (including for purpose of such
calculation all shares of Common Stock a Holder of Registrable Stock has the
right to acquire) agrees not to sell, make any short sale of, loan, grant any
option for the purchase of, or otherwise dispose of or transfer its economic
risk with respect to any securities of the Company (other than those included in
the registration) within seven (7) days before or one hundred eighty (180) days
after the effective date of a registration statement filed pursuant to this
Agreement, unless such limitations are waived in writing by the Company and the
managing Underwriter. The Holder agrees that the Company may instruct its
transfer agent to place stop transfer notations in its records to enforce the
provisions of this Section 3.
4. Expenses of Registration. The Company shall bear all
Registration Expenses incurred in connection with all registrations undertaken
pursuant to Section 2, subject to the limitations set forth in the definition of
Registration Expenses. Notwithstanding the foregoing, the Company shall not be
required to pay for any Registration Expenses of any registration
7
<PAGE> 43
proceeding begun under Section 2, the request for which has been subsequently
withdrawn by the Holder other than pursuant to Section 2.2(a)(v) or is otherwise
not successfully completed due to no fault of the Company, unless the withdrawal
is based upon material adverse information concerning the Company, which the
Company had not yet publicly disclosed at the time of such request.
5. Registration Procedures.
(a) Obligations of the Company. In the case of each
registration effected by the Company pursuant to this Agreement, the Company
will keep the Selling Holders advised in writing as to the initiation of such
registration and as to the completion thereof. The Company will:
(i) Prepare and file with the Commission a
registration statement and such amendments and supplements as may be necessary
and use its reasonable best efforts to cause such registration statement to
become and remain effective for at least ninety (90) days or until the
distribution described in the registration statement has been completed,
whichever first occurs;
(ii) Furnish to each Selling Holders and to the
Underwriters of the securities being registered such reasonable number of copies
of the registration statement, preliminary prospectus, final prospectus and such
other documents as such Underwriters may reasonably request in order to
facilitate the public offering of such securities;
(iii) Use its reasonable best efforts to register
or qualify the securities covered by such registration statement under such
other securities or state blue sky laws of such jurisdictions as the
Underwriters or any Selling Holders shall reasonably request, and to do any and
all other acts and things which may be necessary under such securities or blue
sky laws to enable each Selling Holders to consummate the public sale or other
disposition in such jurisdictions of the securities owned by such Selling
Holder; provided that the Company shall not be required in connection therewith
or as an election thereto to qualify to do business or to file a general consent
to service of process in any such jurisdiction or to take any action which could
subject it to tax, including tax on its corporate income or assets, or to the
service of process (other than in connection with such registration) in any
state where it is not subject thereto; and
(iv) Use its reasonable best efforts to cause all
such Registrable Stock registered pursuant hereto to be listed on the principal
securities exchange or automated quotation system on which similar securities
issued by the Company are then listed, if the listing of such securities is then
permitted under the rules of such exchange, or trading market or quotation
system on which such securities issued by the Company are then listed.
(b) Obligations of the Holders.
8
<PAGE> 44
(i) As a condition to including any Registrable
Stock in a registration, the Company may require (i) that each Holder furnish to
the Company such information regarding such Holder and the contemplated
distribution of such Holder's Registrable Stock as is required to be included in
the Registration Statement, and (ii) that such information be furnished to the
Company in writing and signed by such Holder and stated to be specifically for
use in the related registration statement, prospectus, offering circular or
other document incident thereto.
(ii) The Holder shall not (until further notice)
effect sales of Registrable Stock after receipt of written notice from the
Company to suspend sales to permit the Company to correct or update a
registration statement or prospectus, and the Company shall make such amendment
in a reasonably commercial manner; provided, that the Company is able to do so
in compliance with the federal securities laws. The period during which the
registration statement remains effective pursuant to the Agreement shall be
extended for a period of time equal to the period for which the Holders
refrained from selling pursuant to this Section 5.2(b).
6. Indemnification.
(a) The Company will indemnify each Selling Holder and
each person controlling such Selling Holder within the meaning of Section 17 of
the Securities Act, with respect to which registration has been effected
pursuant to this Agreement, against all claims, losses, damages or liabilities
(or actions in respect thereof), to which such Selling Holder or controlling
person may be subject under the Securities Act or under any other statute or at
common law, insofar as such losses, claims, damages or liabilities arise out of
or are based upon (i) any untrue statement (or alleged untrue statement) of any
material fact contained, on the effective date thereof, in the applicable
registration statement under which such Registrable Stock were registered under
the Securities Act, any preliminary prospectus or final prospectus contained
therein, or any summary prospectus issued in connection with any Registrable
Stock being registered or offered for sale, or any amendment or supplement
thereto, or (ii) any omission (or alleged omission) to state therein a material
fact required to be stated therein or necessary to make the statements therein
not misleading provided, however, that the Company shall not be liable to any
Selling Holder or controlling person in any such case to the extent that any
such loss, claim, damage or liability arises out of or is based upon any such
untrue statement or omission made in such Registration Statement, preliminary
prospectus, summary prospectus, prospectus, or amendment or supplement thereto,
or any other document, in reliance upon and in conformity with written
information furnished to the Company by any Selling Holder, underwriter, other
selling agent or controlling person, respectively, specifically for use therein.
The indemnity provided for herein shall remain in full force and effect
regardless of any investigation made by or on behalf of such Selling Holder,
underwriter, other selling agent or controlling person, and shall survive the
transfer of such securities by such Selling Holder.
9
<PAGE> 45
(b) The Company may require, as a specific condition to
including any Registrable Stock of a Holder in any registration statement filed
pursuant to Section 2.1, that such Holder shall enter into and deliver to the
Company an undertaking satisfactory to it from such Holder of such Registrable
Stock, severally and not jointly, to indemnify and hold harmless (in the same
manner and to the same extent as set forth in this Section 6) the Company, each
director of the Company, each officer of the Company who shall sign such
Registration Statement and each other Person, if any, who controls the Company
within the meaning of the Securities Act (except the indemnifying holder, if
such indemnifying holder so controls the Company), and each other Holder or
controlling person participating in the offering with respect to any untrue
statement of material fact or omission of material fact from such Registration
Statement, any preliminary prospectus or final prospectus contained therein, any
summary prospectus issued in connection with any Registrable Stock being
registered or offered for sale, or any amendment or supplement thereto, in each
case if such statement or omission was made in reliance on and in conformity
with written information furnished to the Company by such Holder specifically
for use in preparing any such Registration Statement, preliminary prospectus,
final prospectus, summary prospectus or amendment or supplement thereto. Each
Holder hereunder shall promptly provide such undertaking to indemnify in
accordance with this Section 6.2 upon request. In the event the undertaking to
indemnify under this subsection is given by Holder, it shall remain in full
force and effect regardless of any investigation made by or on behalf of the
indemnified party and shall survive any transfer of the Registrable Stock held
by the indemnifying party.
(c) If the indemnification provided for in Sections 6.1
or 6.2 is unavailable or insufficient to hold harmless an indemnified party
under this Section 6, then each indemnifying party, in lieu of indemnifying such
indemnified party, shall contribute to the amount paid or payable by such
indemnified party as a result of the claims, losses, damages or liabilities (or
actions in respect thereof) referred to in Sections 6.1 or 6.2: (a) in such
proportion as is appropriate to reflect the relative benefits received by each
indemnifying party from the offering of the securities or (b) if the allocation
provided by clause (a) above is not permitted by applicable law, in such
proportion as is appropriate to reflect not only the relative benefits referred
to in clause (a) above but also the relative fault of each indemnifying party in
connection with the statements or omissions that resulted in such claims,
losses, damages or liabilities (or actions in respect thereof) as well as any
other relevant equitable considerations. Relative fault shall be determined by
reference to, among other things, whether the untrue or alleged untrue statement
of a material fact or the omission or alleged omission to state a material fact
relates to information supplied by each indemnifying party or by the indemnified
party and the parties' relative intent, knowledge, access to information and
opportunity to correct or prevent such untrue statement or omission. The parties
agree that it would not be just and equitable if contributions pursuant to this
Section 6.3 were to be determined by pro rata allocation or by any other method
of allocation which does not take into account the equitable considerations
referred to in the first sentence of this Section 6.3. The amount paid by an
indemnified party as a result of the claims, losses, damages or liabilities (or
actions in respect thereof) referred to in the first
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<PAGE> 46
sentence of this subsection (c) shall be deemed to include, subject to the
limitations set forth above, any legal or other expenses reasonably incurred by
such indemnified party in connection with investigating or defending against any
action or claim which is the subject of this Section 6.3. No Person guilty of
fraudulent misrepresentation (within the meaning of Section 11(f) of the
Securities Act) shall be entitled to contribution from any person who was not
guilty of such fraudulent misrepresentation. The Company may require, as a
specific condition to including any Registrable Stock of a Holder in any
registration statement filed pursuant to Section 2 that such Holder shall enter
into and deliver to the Company an undertaking reasonably satisfactory to it
from such Holder of such Registrable Stock, severally and not jointly, to
contribute to the amount paid or payable by an indemnified party hereunder as
and to the extent set forth in this Section 6.3, and each Holder participating
in such offering hereunder shall promptly provide such undertaking upon request.
(d) Each party entitled to indemnification or
contribution under this Section 6 (the "Indemnified Party") shall give notice to
the party required to provide indemnification or contribution (the "Indemnifying
Party") promptly after such Indemnified Party has actual knowledge of any claim
as to which indemnity or contribution may be sought, provided that the failure
of any Indemnified Party to give notice as provided herein shall not relieve the
Indemnifying Party of its obligations under this Agreement unless the failure to
give such notice is materially prejudicial to an Indemnifying Party's ability to
defend such action, and shall permit the Indemnifying Party to assume the
defense of any such claim or any litigation resulting therefrom, provided that
counsel for the Indemnifying Party, who shall conduct the defense of such claim
or litigation, shall be approved by the Indemnified Party (whose approval shall
not unreasonably be withheld), and the Indemnified Party may participate in such
defense at such party's expense, and provided further, that if the defendants in
any such action include both the Indemnified Party and the Indemnifying Party
and the Indemnified Party shall have reasonably concluded that there may be
legal defenses available to it and/or other Indemnified Parties which are
materially different from or additional to those available to the Indemnifying
Party, the Indemnified Party or Parties shall have the right to select separate
counsel to assert such legal defenses (in which case the Indemnifying Party
shall not have the right to direct the defense of such action on behalf of the
Indemnified Party or parties). Upon the permitted assumption by the Indemnifying
Party of the defense of such action, and approval by the Indemnified Party of
counsel, the Indemnifying Party shall not be liable to such Indemnified Party
under this Section 6.4 for any legal or other expenses subsequently incurred by
such Indemnified Party in connection with the defense thereof (other than
reasonable costs of investigation) unless (a) the Indemnified Party shall have
employed separate counsel in connection with the assertion of legal defenses in
accordance with the proviso to the next preceding sentence, (b) the Indemnifying
Party shall not have employed counsel satisfactory to the indemnified party to
represent the Indemnified Party within a reasonable time, or (c) the
Indemnifying Party has authorized the employment of counsel for the Indemnified
Party at the expense of the Indemnifying Party. No Indemnifying Party, in the
defense of any such claim or litigation, shall, except with the consent of each
Indemnified Party (whose consent shall not be unreasonably withheld),consent to
entry
11
<PAGE> 47
of any judgment or enter into any settlement which does not include as an
unconditional term thereof the giving by the claimant or plaintiff to such
Indemnified Party of a release from all liability in respect to such claim or
litigation.
7. Information by Holder. If a Holder has Registrable Stock
included in any registration, such Holder shall furnish to the Company such
information regarding the Holder, the Registrable Stock held by the Holder and
the distribution proposed by the Holder as the Company may reasonably request in
writing and as shall be required in connection with any registration referred to
in this Agreement.
8. Rule 144 Reporting. With a view to making available the
benefits of certain rules and regulations of the Commission which may at any
time permit the sale of the Registrable Stock to the public without
registration, so long as a public market exists for the Common Stock, the
Company agrees to furnish to any holder of Registrable Stock, upon request, a
written statement executed by the Company as to the steps it has taken to comply
with the current public information requirements of Rule 144.
9. Transfer of Registration Rights.
(a) Permitted Transfers. The rights to cause the Company
to register securities granted to any Holder under Section 2.1 may be assigned
to a transferee or assignee reasonably acceptable to the Company in connection
with any transfer or assignment of Registrable Stock by the Holder, provided
that: (a) such transfer is otherwise effective in accordance with applicable
securities laws and the terms of this Agreement, (b) the Company is promptly
given written notice, (c) such transferee agrees to be bound by the provisions
of this Agreement; provided, however, that in each case the proposed transferor
shall furnish such representations and warranties and legal opinion of counsel
acceptable to the Company and its counsel that any such transfer will be exempt
from registration under the federal securities laws and any applicable state
securities or blue sky laws.
(b) Limitation of Rights of Transferee Holders.
Notwithstanding anything in this Agreement to the contrary, if the Initial
Holder transfers or assigns Registrable Stock at any time and for any reason
(unless such Registrable Stock ceases to be Registrable Stock upon or as a
result of such transfer or assignment), the Company shall not be obligated to
take any action under this Agreement on behalf of any Holder unless permitted to
do so by the written consent of (i) the Initial Holder if the Initial Holder is
still living and has not been found to be mentally incompetent (or no guardian
or similar advisor shall have been appointed with respect to his affairs), or
(ii) if the Initial Holder is deceased or shall have been found to be mentally
incompetent or a guardian or similar advisor shall have been appointed with
respect to his affairs, the Holders who hold more than fifty (50%) percent of
the Registrable Stock then held by all such Holders. Any such action shall bind
each and every Holder.
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<PAGE> 48
10. Amendment. Any provision of this Agreement may be amended or
the observance thereof may be waived (either generally or in a particular
instance and either retroactively or prospectively), only with the mutual
written consent of the Company and (i) the Initial Holder if the Initial Holder
is still living and has not been found to be mentally incompetent (or no
guardian or similar advisor shall have been appointed with respect to his
affairs), or (ii) if the Initial Holder is deceased or shall have been found to
be mentally incompetent or a guardian or similar advisor shall have been
appointed with respect to his affairs, the Holders of more than fifty (50%)
percent of the Registrable Stock. Any amendment or waiver effected in accordance
with this Section 11 shall be binding upon each party to this Agreement and each
transferee of securities subject to this Agreement.
11. Governing Law. THIS AGREEMENT SHALL BE GOVERNED IN ALL
RESPECTS BY THE INTERNAL LAWS OF THE STATE OF DELAWARE WITHOUT REGARD TO
CONFLICT OF LAWS PROVISIONS.
12. Entire Agreement. This Agreement constitutes the full and
entire understanding and agreement among the parties regarding the matters set
forth herein. Except as otherwise expressly provided herein, the provisions
hereof shall inure to the benefit of, and be binding upon the successors,
assigns, heirs, executors and administrators of the parties hereto.
13. Notices, etc. All notices, demands or other communications
required or permitted hereunder shall be in writing and shall be mailed by
registered or certified mail, postage prepaid, or otherwise delivered, by hand
or by messenger, addressed:
(a) If to the Holder, to the address shown in the ESB
Agreement or to such other address as such Holder shall have furnished to the
Company.
(b) If to the Company, to:
Scientific Games Holdings Corp.
1500 Bluegrass Lakes Parkway
Alpharetta, Georgia 30004
Attention: C. Gray Bethea, Jr., Esq.
Vice President & General Counsel
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<PAGE> 49
or to such other address as the Company shall have furnished to the Holder, with
a copy to:
Smith, Gambrell & Russell, LLP
Suite 3100, Promenade II
1230 Peachtree Street, N.E.
Atlanta, Georgia 30309-3592
Attn: M. Timothy Elder, Esq.
Each such notice or other communication shall for all purposes of this
Agreement be treated as effective or having been given when delivered if in
writing and delivered personally, or, if sent by mail, postage pre-paid, at the
earlier of its receipt or 72 hours after the same has been deposited in a
regularly maintained receptacle for the deposit of the United States mail,
addressed, pre-paid and mailed as aforesaid. Any party may change by such notice
the address to which notices to it are to be addressed.
14. Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original, but all of which together
shall constitute one instrument.
15. Captions and Section Headlines. Section titles or captions
contained in this Agreement are inserted as a matter of convenience and for
reference purposes only, and in no way define, limit, extend or describe the
scope of this Agreement or the intent of any provision hereof.
16. Singular and Plural, Etc. Whenever the singular number is used
herein and where required by the context, the same shall include the plural, and
the neuter gender shall include the masculine and feminine genders.
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<PAGE> 50
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first above written.
THE COMPANY: SCIENTIFIC GAMES HOLDINGS CORP.
By:
---------------------------------------------
Cliff O. Bickell
Vice President and Chief Financial Officer
Attest:
By:
---------------------------------------------
C. Gray Bethea, Jr.
Its: Vice President and General Counsel
HOLDER:
-------------------------------------------------
WILLIAM G. MALLOY
15
<PAGE> 51
EXHIBIT D
MANAGEMENT DIRECTORS
William G. Malloy
William F. Behm
MANAGEMENT STOCKHOLDERS
William G. Malloy*
William F. Behm*
Thomas F. Little*
Cliff O. Bickell*
C. Gray Bethea, Jr.*
Bruce H. Longhurst
Howard H. Roath
William C. Christie
James H. Edwards, Jr.
Donald N. MacLean
Kenneth W. Taylor
John T. Walsh
or such other persons as may be designated from time to time, in writing, by the
Company or Officer, in each case, with the consent of the non-designating party.
*denotes Senior Executive Officer of the Company
1
<PAGE> 1
SCIENTIFIC GAMES HOLDINGS CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
GENERAL
The Company's revenues are generated primarily from sales of products
and services to governmentally operated or sanctioned lotteries worldwide and,
to a lesser extent, non-lottery related entities both in the United States and
world-wide. These sales are categorized into two main segments, (1) Instant
Ticket and Related Services and (2) Systems.
In the Instant Ticket and Related Services segment, the Company
primarily supplies game design, sales and marketing support, instant ticket
manufacturing and delivery, inventory management and distribution, and retailer
telemarketing and field services. In addition, this segment includes promotional
instant tickets and pull-tab tickets which are sold to both lottery and
non-lottery customers and prepaid phone cards which are sold to
telecommunications companies.
In the Systems segment, the Company primarily supplies transaction
processing software that accommodates instant ticket accounting and validation
and online lottery games, point-of-sale terminal hardware which connects to
these systems, central site computers and communication hardware which run these
systems, and ongoing support and maintenance services for these products. This
segment also includes software, hardware and support for sports betting and
credit card processing systems for non-lottery customers. In addition, the
Company refers to cooperative services agreements in various sections of this
report. Cooperative services is a branded marketing name given to the
combination of any of the products and services offered by both the Instant
Ticket and Related Services segment and the Systems segment under one customer
contract.
Instant Ticket and Related Services revenues are generally based on a
price per 1,000 tickets delivered or based upon a percentage of the lottery's
sales to the public over a contract period. System revenues may be based on a
fixed price for the product or service or based upon a percentage of the
lottery's sales to the public over a contract period.
<PAGE> 2
The Company's operating results may vary significantly from period to
period. Revenues and capital expenditures may be difficult to forecast because
the Company's sales cycle may vary and depend upon factors such as the size and
timing of awarded contracts, changes in customer budgets, ticket inventory
position, lottery retail sales and general economic conditions. Contracts with
governmental entities operating newly authorized instant lotteries tend to
generate higher levels of sales in the initial months. All of the Company's
domestic lottery contracts currently are with jurisdictions whose lotteries have
been in operation at least one year. Operating results may be affected by the
working capital requirements associated with preparing facilities and equipment,
establishing a distribution system and printing tickets for recently awarded
contracts, and by the amount of time elapsing before the receipt and/or
recognition of revenues from the sale of lottery tickets. Operating results may
also be affected by the utilization of overtime labor and the Company's ability
to smoothly integrate new and/or upgraded production equipment with its existing
production operations. Lottery revenues and particular product sales to
lotteries may vary in a quarter causing fluctuations in the Company's revenue
from quarter to quarter. Additionally, circumstances encountered in
international markets, including the substantial amount of time involved in
bidding on an international contract, the evaluation of such bid and the
resultant contract award or rejection may vary significantly from that
originally anticipated when the bid is prepared. All of these factors may make
it difficult to forecast revenues and expenditures related to the Company's
operations over extended periods and may result in fluctuations in the Company's
quarterly financial results.
The Company's U.S. lottery contracts typically have an initial term of
from one to five years and usually provide the customer with options to extend
the contract one or more times under the same, or mutually agreeable, terms and
conditions for additional periods generally ranging from one to five years. The
Company's customers have exercised extension options in the Company's U.S.
instant lottery contracts a majority of the time. 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. Upon the expiration of a contract
(including any extensions which may have been exercised), lottery authorities
often award new contracts through a competitive procurement process. During any
quarter, some lottery contract is typically expiring and/or reaching an
<PAGE> 3
optional extension date. Instant ticket contracts may be to supply tickets on
either a primary or back-up basis. A primary supplier has a contract to supply a
majority of the lottery's ticket needs and a back-up supplier has a contract to
supply some of the lottery's ticket needs.
Sales outside the United States may consist of sales of goods and
services exported from the United States to customers located overseas, sales of
goods and services to customers in countries in which the Company's foreign
subsidiaries have operating facilities, or sales of goods and services by the
Company's foreign subsidiaries to customers located outside the country of
production. Although the Company does business worldwide, a majority of the
Company's current foreign operations are conducted in, and U.S. export sales are
made to, customers located in Europe. For segment and geographic information on
the Company, see Note 11 of the Notes to Consolidated Financial Statements set
forth elsewhere in this report.
During 1998, in the Instant Ticket and Related Services segment, the
Company had nine U.S. contracts subject to extensions or scheduled to expire. Of
such contracts six contained extension options. With respect to the foregoing
contracts, the Company received six contract extensions, negotiated one
additional extension, was the successful bidder on one new contract and was the
unsuccessful bidder on one contract.
The Company estimates, based in part upon industry and lottery
furnished information, that the Company's U.S. customers with contracts
scheduled to expire in 1998 (regardless of whether renewal options were
available under such contracts) represented, in the aggregate, retail sales
equal to approximately 26.5% of total 1998 U.S. instant ticket retail sales by
government lotteries ("1998 Lottery Sales"). Industry sources estimate that 1998
Lottery Sales were approximately $14.1 billion. In comparison, 5 U.S. contracts
held by the Company's competitors were subject to extensions or scheduled to
expire in 1998. The Company estimates that its competitors' domestic customers
with contracts scheduled to expire in 1998 represented aggregate retail sales
equal to approximately 21% of 1998 Lottery Sales. Of the contracts formerly held
by the Company's competitors, the Company was the successful bidder on one
contract and the Company estimates that this contract accounted for
approximately 3.0% of 1998 Lottery Sales. For a listing of the Company's U.S.
contracts and the scheduled expiration dates, also see Item I Business -
"Markets" in its Annual Report on Form 10-K.
<PAGE> 4
During 1998, the Colorado Lottery awarded the Company a contract
extension to produce instant tickets through June 2000. The D.C. Lottery and
Charitable Games Control Board, the Washington State Lottery, the Wisconsin
Lottery, the Minnesota State Lottery, the South Dakota Lottery and the Iowa
Lottery each exercised a one-year extension with the Company to produce instant
tickets. The Massachusetts State Lottery Commission extended its instant ticket
contract through June 1999. With regard to contracts held by the Company, it was
not the successful bidder on the primary contract for the California State
Lottery, which represented approximately 5% of 1998 Lottery Sales. However, the
Company did receive a back-up supply contract extension through June 1999.
With regard to contracts previously held by its competitors, the
Connecticut Lottery Corporation awarded its instant ticket contract to the
Company. The Connecticut contract runs through August 2000, with two 1-year
extensions available. In addition, the Company obtained a back-up supply
contract with the Oregon Lottery through June 1999.
Internationally, the Company received a five-year contract from Instant
Lottery, S.A., the operator of the national lottery in Greece, to supply instant
tickets. The Company was also awarded contracts with varying terms for instant
tickets in the Philippines, Venezuela and Mexico. In addition, the Company was
awarded several other international instant ticket orders for various other
countries, and the Company produced an increased volume of telephone cards for
various international telecommunications companies, as compared to the volume of
such cards produced in the prior year.
In the Systems segment during 1998, the Company did not receive any
significant new U.S. contracts, but pursuant to a contract extension received in
1997 the Company installed 1,500 SciScan Technology(R) instant ticket validation
terminals in Nebraska. Internationally, the Western Canada Lottery Corporation
("WCLC") awarded its contract to provide a new on-line ticket game management
control system and related support services contracts to the Company. A
competitor of the Company had provided WCLC's current system. The Company's
SGI-NET system will replace the WCLC's existing central system and support the
lottery's on-line games. This on-line award was the Company's first on-line
lottery contract in North America since the Company recently reentered the
on-line systems segment of the lottery industry after exiting this business line
in 1991.
<PAGE> 5
The WCLC contract provides for on-going hardware and systems maintenance
following the warranty period of the contract. The Company was also awarded a
contract by Praxa Limited to provide system software and hardware to the Golden
Casket Lottery Corporation Limited ("GCLC"), the state operated lottery in
Queensland, Australia. The contract includes the installation of approximately
1,350 SciScan Technology instant ticket validation terminals, as well as SGI-NET
software to interface with GCLC's existing lottery system technology. The
contract includes an option for the lottery to purchase 650 additional SciScan
terminals. Instant Lottery, S.A., the operator of the national lottery in
Greece, awarded a contract to provide an initial order of 400 SciScan Technology
instant ticket validation terminals. The contract includes an option for the
lottery to purchase an additional 1,600 SciScan terminals.
The Company's joint venture agreement with La Francaise des Jeux
("FDJ"), the operator of the French National Lottery, was entered into by the
parties following approval by the French Minister of Finance. In addition,
definitive agreements for the supply by the Company to FDJ of lottery products
and services were executed. The joint venture is developing a new generation of
on-line terminal incorporating the Company's SciScan Technology. The joint
venture assumed FDJ's terminal hardware and software maintenance contracts with
six German State Lottery customers, as well as lottery terminal software
maintenance for FDJ. The agreements between the Company and FDJ provide for the
initial supply of 15,000 SciScan terminals, the installation of an SGI-NET
instant ticket validation system, a central site computer system and on going
maintenance of the system.
As previously disclosed in the Company's periodic reports, the
Company's business is highly competitive and is in a period of intense
price-based competition, particularly from other instant tickets suppliers. Many
of the lottery contracts awarded or re-awarded to the Company in 1998 (and the
orders thereunder) have certain lower equivalent prices than charged in the
previous contracts. To the extent such contracts contain lower equivalent
prices, the Company's profit margins are adversely affected. The impact of lower
equivalent prices in certain contracts, however, may be offset, in part, by
other factors, including higher order levels from new and existing customers,
increased production efficiencies and other savings associated with economies of
scale. While the timing and extent, both of lower equivalent price contracts and
offsetting factors, cannot be
<PAGE> 6
predicted with certainty, the Company expects significant competition on the
basis of price to continue in 1999.
While the Company has frequently been awarded new contracts when its
prior U.S. contracts and extensions have expired, there may be no assurance that
any of the Company's contracts will be extended or that it will be awarded new
contracts as a result of future competitive procurement processes, nor may 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.
During 1999, the Company will have thirteen Instant Ticket and Related
Services contracts in the U.S. which are subject to extensions or scheduled to
expire. The Company estimates that these thirteen U.S. contracts had aggregate
retail sales equal to approximately 40.7% of 1998 Lottery Sales. The Company
estimates that there are eight U.S. contracts of competitors subject to
extensions or scheduled to expire in 1999 which had aggregate retail sales equal
to approximately 32% of 1998 Lottery Sales. The Company has no U.S. Systems
contracts subject to extensions or scheduled to expire in 1999.
RECENT DEVELOPMENTS
On March 4,1999, Scientific Games and the Texas Lottery Commission
entered into a contract for the provision of instant tickets and related
services by Scientific Games to the Texas Lottery Commission. This contract was
previously held by a competitor and represented approximately 12.8% of 1998
Lottery Sales. On March 7, 1999, BABN Technologies Corporation, a non-winning
bidder in the procurement, protested the award of the contract to Scientific
Games and protested the award of the back-up contract to Pollard Banknote
Limited. On March 30, 1999, Scientific Games was notified by the Executive
Director of the Texas Lottery Commission that the protest filed by BABN was
granted in part and denied in part. The Executive Director declared the
contracts with Scientific Games as primary vendor and Pollard Banknote Limited
as back-up vendor to be void, subject to re-submission by all bidders of ticket
pricing in accordance with the pricing format and matrix determined by the
Executive Director. Scientific Games is reviewing the legal adequacy of the
Executive Director's determination and currently intends to contest any actions
which purport to declare its contract to be void.
In addition, as of March 17, 1999, the Company has received extensions
from six of the thirteen U.S. contracts which were subject to extensions or
scheduled to expire in 1999. The Company estimates that these six contracts
represented approximately 9.9% of 1998 Lottery Sales.
<PAGE> 7
RESULTS OF OPERATIONS
The following table illustrates certain components of the consolidated
results of operations expressed as a percentage of revenues for the periods
indicated.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenues 100.0% 100.0% 100.0%
Gross Margin 35.2 36.8 38.3
Selling, general and
Administrative 12.4 13.0 11.9
Depreciation and
Amortization 7.6 6.7 6.2
One-time write-offs 0.0 6.8 0.0
Interest Income 0.2 0.2 0.6
Gain (loss) on foreign currency (0.0) 0.3 0.5
Interest expense 0.6 0.5 0.1
Income before income taxes 14.8 10.3 21.2
Income tax expense 5.7 5.8 8.4
Net Income 9.1% 4.5% 12.8%
</TABLE>
<PAGE> 8
Year ended December 31, 1998 compared to year ended December 31, 1997.
Revenues for the year ended December 31, 1998 increased $16.3 million
or 8.3% over the revenues for the year ended December 31, 1997. The increase was
primarily due to additional Systems revenues of approximately $20.1 million.
Contributing to this increase was a full year of operations for the Company's
Scientific Games Kommunikations - und Computersysteme GmbH subsidiary ("SG
Austria") which was acquired in April 1997 and sales to new international
customers, including FDJ, operator of the French National Lottery and Praxa
Limited, prime contractor to the Golden Casket Lottery Corporation in Australia.
The increase in revenues was partially offset by a decline of $4.0 million in
Instant Ticket and Related Services revenues which was primarily attributable to
lower international sales volumes and continued lower equivalent sales prices as
a result of competitive pricing pressures as discussed above and in the
Company's prior periodic reports. Instant Ticket and Related Services revenues
accounted for approximately 78.9% of the Company's gross revenues in 1998 versus
87.4% in 1997. Total international revenues based on the customers' country of
domicile accounted for approximately 35.4% of the Company's gross revenues in
1998 versus 33.5% for 1997.
Gross margins decreased to 35.2% for the year ended December 31, 1998
from 36.8% for the year ended December 31, 1997. The margin decline was mainly
attributable to Instant Ticket and Related Services contracts awarded or
re-awarded having lower equivalent sales prices than charged in previous
contracts and lower international sales volumes, partially offset by continued
efficiency improvements in domestic instant ticket manufacturing. Also partially
offsetting the decline was the full year ownership of SG Austria and the new
Systems sales discussed previously.
Selling, general and administrative ("SG&A") expenses increased
$865,000 for the year ended December 31, 1998 over the same period of 1997. SG&A
expenses decreased as a percentage of revenues to 12.4% from 13.0%. The dollar
increase was primarily attributable to a full year ownership of SG Austria,
additional expenses related to the joint venture with FDJ, an increase in
international sales efforts, including the expanded activities of a sales branch
in South Africa, and sales efforts related to The Daily Race Game(TM) joint
venture with Telecom Productions Inc., which was introduced in 1998. This
increase was partially offset by lower domestic SG&A expenses.
<PAGE> 9
Depreciation and amortization expenses increased for the year ended
December 31, 1998 by $3.1 million over the comparable period of 1997. The
increase was due primarily to the full year ownership of SG Austria and
additional SciScan terminals placed in service during the second half of 1997
and the beginning of 1998.
During 1997, the Company recognized a one-time write-off of $10.1
million for in-process technology acquired in connection with the April 15, 1997
acquisition of SG Austria. In addition, in July 1997 the Company discontinued
its charity pull-tab ticket business line which was produced and distributed by
its then named subsidiary GameTec Inc. ("GameTec"). In October 1997, the Company
sold substantially all of the assets of GameTec to International Gamco, Inc.
("Gamco"). The Company also entered into a three year extendible marketing
agreement with Gamco in 1997 to provide marketing and related services to state
lotteries for pull-tab tickets printed by Gamco. The Company continues to
provide pull-tab tickets to its lottery customers through such marketing
agreement. A one-time write-off of $3.4 million (pre-tax) was recognized in the
year ended December 31, 1997 for losses from the disposition of the assets of
its pull-tab ticket business line. The Company did not have similar write-offs
in 1998.
Operating income for the year ended December 31, 1998 increased $11.9
million or 58.6% from the year ended December 31, 1997. The increase was
primarily attributable to the pull-tab business and in-process technology
one-time write-offs in 1997 as discussed previously and additional Systems sales
during 1998. Partially offsetting the operating income increase was a decline in
operating income in the Instant Ticket and Related Services segment due mainly
to pricing pressures discussed previously.
Interest income for the year ended December 31, 1998 increased by
approximately $130,000 from the comparable year ended December 31, 1997. The
increase was mainly due to the interest related to an employee benefit plan,
which was offset by a comparable charge to compensation expense.
The Company experienced a net loss of $65,000 on foreign currency in
the year ended December 31, 1998 compared to a gain of approximately $507,000 in
the year ended December 31, 1997. The losses primarily resulted from
fluctuations in exchange rates on non-U.S. dollar holdings. The 1997 gains were
primarily attributable to gains on the hedging of the purchase price of SG
Austria as
<PAGE> 10
well as net gains on non-U.S. dollar transactions in the normal course of
business.
Interest expense for the year ended December 31, 1998 increased
approximately $442,000 from the year ended December 31, 1997. The increase in
interest expense resulted from higher average borrowings under the Company's
credit facility for year ended December 31, 1998.
The effective tax rate for the year ended December 31, 1998 was 38.6%
as compared to 55.9% for the year ended December 31, 1997. The higher than
normal effective tax rate for 1997 was primarily a result of a non-tax
deductible one-time write-off of $10.1 million for in-process technology.
Net income was $19.4 million for the year ended December 31, 1998
compared to $9.0 million for the year ended December 31, 1997. The increase in
net income of $10.4 million was primarily due to the one-time write-offs in 1997
for the pull-tab business and in-process technology. Comparative net income
excluding these one-time write-off's decreased $1.7 million in 1998.
Earnings per common share (diluted) for the year ended December 31,
1998 were $1.58 per share compared to $0.72 for the comparable period in 1997.
The increase in earnings per share was primarily due to the one-time write-offs
in 1997 as discussed above. Earnings per common share (diluted) for the year
ended December 31, 1997, excluding the one-time write-offs, would have been
$1.70. The decrease in earnings per share, excluding the write-offs, was
partially offset by a reduction in the weighted average number of common
equivalent shares outstanding resulting from the lower average stock price in
1998 and the related effects on dilutive stock options. The weighted average
number of diluted shares outstanding decreased from 12.4 million in 1997 to 12.3
million in 1998.
Year ended December 31, 1997 compared to year ended December 31, 1996.
Revenues for the year ended December 31, 1997 increased $50.8 million
or 34.7% over the revenues for the year ended December 31, 1996. The increase
was primarily due to additional Instant Ticket and Related Services revenues
resulting from an additional $17.3 million generated as a result of the
acquisition of the Company's Scientific Games International Limited ("SGIL")
subsidiary which was acquired on October 1, 1996. In addition, sales to new
domestic and international customers increased, as well as sales to
<PAGE> 11
existing customers. Also contributing to the increase in revenues was an
additional $15.2 million in Systems sales generated as a result of the
acquisition of SG Austria which was acquired in April 1997. As discussed more
fully above, lotteries may have periods of increasing and decreasing retail
sales which, in turn, can have an impact on the operating results of the
Company. Instant Ticket and Related Services revenues accounted for
approximately 87.4% of the Company's gross revenues in 1997 versus 95.4% in
1996. Total international revenues based on the customers' country of domicile
accounted for approximately 33.5% of the Company's gross revenues in 1997 versus
19.5% for 1996.
Gross margins decreased to 36.8% for the year ended December 31, 1997
from 38.3% for the year ended December 31, 1996. The margin decline was
attributable to Instant Ticket and Related Services contracts awarded or
re-awarded having lower equivalent sales prices than charged in previous
contracts, higher production costs due to a change in the mix of materials used
and more frequent production runs with fewer tickets per run. The lower
equivalent sales prices are a result of competitive pricing pressures in the
industry. Also contributing to the decrease in gross margins in 1997 was the
inclusion of SGIL's traditional lower margins for a full twelve months versus
only three months in 1996. The higher costs incurred by SGIL related to a higher
percent of contracted work (i.e., work subcontracted to SGIL by the parties to
the actual lottery contract) and lower production volumes in 1997. These costs
were partially offset in 1997 by a number of factors including continued
efficiency improvements resulting from the 1994 and 1995 capital investment
program and the movement of a higher portion of production to lower cost
production facilities. The acquisition of SG Austria and its on-line business
also partially offset the decline in gross margins.
SG&A expenses increased $8.2 million for the year ended December 31,
1997 over the same period of 1996. SG&A expenses also increased as a percentage
of revenues to 13.0% from 11.9%. Approximately 71% of the increase was
attributable to the additional SG&A costs as a result of the acquisitions of
SGIL and SG Austria. Other factors resulting in the higher expenses included
increases in international marketing and sales expenses, including the
establishment of a sales branch in South Africa, higher trade show, travel, and
telephone expenses as well as an increase in overall compensation costs. For the
fourth quarter of 1997, SG&A expenses were $7.5 million or approximately 14.9%
of sales for such quarter.
<PAGE> 12
SG&A expenses are subject to change both as a percentage of sales and dollar
volume dependent upon the amount of revenues for the applicable period.
Depreciation and amortization expenses increased for the year ended
December 31, 1997 by $4.1 million over the comparable period of 1996. The
increase was attributable to the additional depreciation expense of SGIL and SG
Austria's fixed assets, the amortization of the goodwill related to acquisition
of SGIL and SG Austria, the acquisition of certain customers of ILS, a
Netherlands company and subsidiary of De La Rue PLC of the United Kingdom in
1996, and the representation agreement with De La Rue also entered into in 1996.
The Company recognized a one-time write-off of $10.1 million for
in-process technology acquired in connection with the April 15, 1997 acquisition
of SG Austria. This write-off is consistent with accounting practices related to
other technology-based acquisitions.
In July 1997, the Company discontinued its charity pull-tab ticket
business line which was produced and distributed by its subsidiary GameTec. The
Company continued to produce pull-tab tickets for its state lottery customers
until such time as alternate production facilities could be arranged for these
customers. In October 1997, the Company sold substantially all of the assets of
GameTec to Gamco. The Company also entered into a three year extendible
marketing agreement with Gamco to provide marketing and related services to
state lotteries for pull-tab tickets printed by Gamco. The Company continues to
provide pull-tab tickets to its lottery customers through such marketing
agreement. A one-time write-off of $3.4 million (pre-tax) was recognized in the
year ended December 31, 1997 for losses from disposition of the assets of its
pull-tab ticket business line.
Operating income for the year ended December 31, 1997 decreased $9.2
million or 31.0% form the year ended December 31, 1996. The decrease was
primarily attributable to the pull-tab business and in-process technology
one-time write-offs. Partially offsetting the decrease was the addition of SG
Austria to the Company's System segment.
Interest income for the year ended December 31, 1997 decreased by
approximately $563,000 from the year ended December 31, 1996. The decrease was
due to the lower average cash balances during 1997, resulting from the use of
<PAGE> 13
cash to fund the purchase of SGIL and SG Austria, purchase additional fixed
assets and repurchase 302,000 shares of the Company's common stock during the
twelve-month period ended December 31, 1997.
Gains on foreign currency in 1996 were primarily attributable to
hedging of the SGIL purchase price. Gains on foreign currency decreased by
approximately $241,000 in 1997, and the 1997 gains were primarily attributable
to gains on the hedging of the purchase price of SG Austria as well as net gains
on non U.S. dollar transactions in the normal course of business.
Interest expense for the year ended December 31, 1997 increased
approximately $758,000 from the year ended December 31, 1996. The increase in
interest expense was due to additional borrowings under the Company's credit
facility to fund the purchase of SGIL and SG Austria, purchase additional fixed
assets and repurchase shares of the Company's common stock during the year ended
December 31, 1997.
The effective tax rate for the year ended December 31, 1997 was 55.9%
as compared to 39.7% for the year ended December 31, 1996. The increase in the
effective tax rate is primarily a result of the $10.1 million write-off of
in-process technology, which was partially offset by tax credits.
Net income was $9.0 million for the year ended December 31, 1997 and
$18.7 million for the year ended December 31, 1996. The decrease in net income
of $9.7 million was due primarily to the pull-tab business and in-process
technology one-time write-offs of approximately $3.4 million and $10.1 million,
respectively in 1997.
Earnings per common share (diluted) for the year ended December 31,
1997 were $0.72 cents per share compared to $1.41 for the comparable period in
1996. The 48.9% decrease in earnings per share was primarily due to the one-time
write-offs discussed above and was partially offset by a reduction in the
weighted average number of common equivalent shares outstanding resulting from
the Company's repurchase of shares of its Common Stock during 1997 and the full
benefit of the shares repurchased in 1996. The weighted average number of shares
outstanding decreased from 13.3 million in 1996 to 12.4 million in 1997.
Earnings per
<PAGE> 14
common share for the year ended December 31, 1997, excluding the one-time
write-offs, would have been $1.70.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are from accumulated cash and
cash equivalents, cash provided by operations and borrowings under the Bank
Credit Agreement (as hereafter defined). The primary uses of cash are for
working capital, capital expenditures, and general corporate purposes which may
include acquisitions and investments in joint ventures.
During the year ended December 31, 1998, the Company made an investment
in a foreign joint venture and a foreign sales project, repurchased common stock
and purchased additional property and equipment. In addition, the Company used a
portion of its cash and cash equivalents to make an earnout payment of $4.5
million to Hilton Hotels Corporation ("Hilton")(successor by merger to Bally
Entertainment Corporation) on October 26, 1998. This earnout payment arose in
connection with the October 1, 1991 acquisition of the assets of the Company
from Hilton, in which the Company agreed to make an earnout payment of up to $5
million on April 30, 1997 if total cumulative earnings before interest, income
taxes, depreciation and amortization ("EBITDA") of the Company from October 1,
1991 exceeded $95.4 million. At December 31, 1996, cumulative EBITDA from
October 1, 1991 exceeded $95.4 million without any adjustments for competing
claims, offsets and other adjustments. The Company reached an agreement with
Hilton to reduce the earnout payment to $4.5 million as a result of these
adjustments for competing claims and offsets. The maximum amount payable to
Hilton had been accrued as goodwill in a prior year and the adjusted goodwill
will be amortized over 34.5 years.
The Company's cash and cash equivalents balance increased by
approximately $6.5 million during 1998 increasing from $2.8 million to $9.3
million, while debt decreased from approximately $30.6 million to $12.5 million.
The Company decreased its net borrowings under its credit facility "Bank Credit
Agreement" by $18.1 million. The borrowings in 1997 were originally used to
partially fund the purchase of SG Austria, purchase additional property and
equipment and to fund working capital requirements. Increases in total
shareholders' equity resulted from option exercises in the period and current
year earnings which were partially offset as a result of repurchases under the
Company's stock repurchase program.
<PAGE> 15
In 1998, the Company generated $45.5 million in cash from operating
activities, as compared to $21.5 million in 1997. The primary contributions to
cash from operating activities in 1998 were net income, depreciation and
amortization and an increase in accounts payable.
Cash used in investing activities decreased from $45.6 million in 1997
to $14.6 million in 1998. Cash was used to acquire businesses for $6.5 million
including the $4.5 million payment to Hilton discussed previously and purchase
additional property and equipment in the amount of approximately $8.4 million.
Financing activities utilized cash of approximately $24.1 million in
1998 as compared to providing approximately $20.9 million 1997. The primary
reasons for the decrease were lower average outstanding borrowings under the
Company's Bank Credit Agreement due to net payments thereunder of $18.3 million
and the repurchase of 559,000 shares of common stock for the aggregate cost of
approximately $10.5 million versus the repurchase of 302,000 shares of common
stock for an aggregate cost of approximately $5.8 million in the prior year. The
Company currently has authorization from its Board of Directors to purchase,
from time to time, depending on market conditions, up to 1,941,000 additional
shares of common stock.
As of December 31, 1998, the Company has outstanding borrowings of
approximately $12.5 million under its $80 million revolving Bank Credit
Agreement. The Bank Credit Agreement offers borrowing rate options under prime
rate, London Interbank Offered Rate ("LIBOR")or Interbank Offered Rate ("IBOR"),
plus or minus an applicable margin depending on the type of borrowing and the
Company's debt to total capitalization ratio as defined in such agreement. The
Bank Credit Agreement contains covenants that, among other things, govern a
defined debt to total capitalization ratio, a certain fixed charge ratio, the
imposition of liens on assets, and asset sales.
The Company's Bank Credit Agreement expires in December 1999. The
Company is in the process of arranging for a new credit facility and does not
anticipate any difficulties in securing a facility which will meet its
anticipated requirements. The Company anticipates that the new credit facility
will have similar borrowing covenants and conditions as its existing Bank Credit
Agreement but that it may receive higher interest spreads on its LIBOR and IBOR
borrowings under a new facility due to a change in the
<PAGE> 16
current banking market. The Company does not expect these changes to have a
material adverse effect on the operating results of the Company.
The current Bank Credit Agreement offers the Company the ability to
borrow in U.S. dollars, German Deutsche marks, French francs, English pound
sterling and Euro currency. As of December 31, 1998, all outstanding borrowings
against the revolving credit facility were in German Deutsche marks. The Company
has interest swap agreements that effectively fix the interest rate on Deutsche
Mark equivalent of $8,996,000 of borrowings under the revolving credit agreement
until December 1999. This amount may be borrowed at a fixed rate of 4.065% plus
a credit spread. The credit spread, ranging in 1/8% increments from 0.375% to
0.625%, is set depending on Company's leverage ratio at the time of each
three-month loan renewal. At December 31, 1998 and 1997, the interest rate on
its Deutsche Mark borrowings was 4.4%. These swap agreements involve the
receipt of amounts when the floating rates exceed the fixed rates and the
payment of amounts when the fixed rates exceed the floating rates in such
agreements over the life of the agreements. The differential to be paid or
received is accrued as interest rates change and is recognized as an adjustment
to the floating rate interest expense related to the debt. The related amount
payable to or receivable from counterparties is included in accrued liabilities
or other assets. If, in the future, the interest swap agreements were
terminated, any resulting gain or loss would be deferred and amortized to
interest expense over the remaining life of the interest swap agreement. The
fair value of the swap agreement, which is not recognized in the financial
statements, were estimated not to be significant at December 31, 1998. The fair
value of the Company's bank debt approximates it carrying value.
The Company believes that the availability of funds under its Bank
Credit Agreement, cash flows from operations and the ability to obtain
alternative sources of financing should permit the Company to fund its
operations, working capital requirements and obligations, as well as other
potential investment or business opportunities. The Company believes that in the
event it has additional capital requirements for new business opportunities that
it has the ability to obtain additional capital from the capital markets. For a
discussion of a dispute under a foreign contract of an affiliated company in
Colombia, see Note 10 of the Notes to Consolidated Financial Statements set
forth elsewhere in this report and Part I, Item 3 of the Company's Annual
Report on Form 10-K, "Legal Proceedings."
<PAGE> 17
INFLATION, CHANGING PRICES, FOREIGN CURRENCY FLUCTUATIONS AND MARKET RISK
Management believes that inflation has not had an abnormal or unanticipated
effect on Scientific Games' operations. Inflationary pressures would be
significant to the Company's business if raw materials used for instant lottery
ticket production are significantly affected. Available supply from the paper
industry tends to fluctuate, and prices may be affected by supply.
In 1998, inflation was not a significant factor in the Company's
results of operations, and the Company was not impacted by significant pricing
changes, except for personnel related expenditures. The Company is not in a
position to forecast the prices or supply of its substrate or other raw
materials in 1999 but does not anticipate any substantial changes which will
materially affect operating results.
In certain limited cases, the Company's contracts with its customers
contain provisions to adjust for inflation on an annual basis, but there is no
assurance that this adjustment would cover raw material price increases.
Although the Company has long-term and generally satisfactory relationships with
most of its suppliers, the Company believes alternative sources to meet its raw
material needs are available.
The Company manages its foreign currency exchange risks on a global
basis by one or more of the following: (i) by securing payment from its
customers in U.S. dollars, when possible (ii) by utilizing borrowings
denominated in foreign currency, and (iii) by entering into foreign currency
exchange contracts. In addition, a significant portion of the cost attributable
to the Company's foreign operations is incurred in the local currencies.
Management believes that a ten percent adverse change in currency exchange rates
would not have a significant effect on the net earnings of the Company.
The Company 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. The Company's Bank Credit Agreement also
allows it to borrow in certain European currencies. The Company does not engage
in currency speculation. Assets and liabilities of foreign
<PAGE> 18
operations are translated from the local currency into U.S. dollars at the
approximate rate of currency exchange at the end of the fiscal period.
Translation gains and losses of foreign operations that use local currencies as
the functional currency are accumulated and reported as a separate component of
shareholders' equity. Revenues and expenses are translated at average monthly
exchange rates for the month. Transaction gains and losses arising from exchange
rate fluctuations on transactions denominated in a currency other than the local
functional currency are included in the results of operations.
To the extent the Company does not hedge its foreign currency exchange
risk, such transactions may have the effect of reducing or increasing the amount
of revenue recorded in dollars or which is actually repatriated to the United
States. Conversely, by entering into hedging contracts, the Company may, in
exchange for minimizing the risk of potential losses associated with foreign
currency transactions, also thereby necessarily minimize the potential for
additional gain associated with foreign currency translation. While the Company
has always been able to enter into foreign currency exchange hedging
transactions when it has sought such arrangements, no assurances can be given
that its ability to enter into such transactions will not adversely be affected
in the future by one or more of the following: (i) doing business in a country
with limitations on the expatriation of earnings or other governmental
regulations, (ii) doing business in a country for which there is only limited
international interest in the provision of hedging arrangements by financial
institutions, and (iii) the inability to procure hedging agreements as the
result of some financial crisis associated with that country, or which has
otherwise affected the interest of financial institutions in entering into
hedging transactions in general.
IMPACT OF YEAR 2000
Background
Currently, there is significant uncertainty within the software
industry and among software users regarding the impact of installed software
that has been programmed to accept only two digit entries in the date code field
and to use such two digit entries in the software's calculation and report
generation features. Such computer software concerns are collectively referred
to as Y2K issues. Current versions of the Company's products have been and
continue to be assessed to determine the impact of becoming both Y2K
<PAGE> 19
"ready" and Y2K "compliant". "Readiness" contemplates the ability to perform
material functions with no material deterioration in functionality or
timeliness. "Compliant" contemplates full functionality with respect to all
identified Y2K issues. The Company currently has modified or replaced a portion
of its affected systems and believes it will be able to modify or replace any
remaining affected systems in time to minimize or eliminate any detrimental
effects in its installed customer base.
Scientific Games Y2K program
The Company's ticket production operations, ticket validation systems,
on-line lottery terminals and other business support systems utilize internal
and external computer systems and equipment that may be affected by the Y2K
issues. Accordingly, achieving Y2K readiness is a priority of the Company.
Scientific Games has implemented a Y2K program for its internal systems and
equipment which has four phases: (1) identification; (2) assessment (including
prioritization); (3) remediation (including modification, upgrading and
replacement); and (4) testing. The Company believes that 90% of its internal
systems and equipment are in phase four (testing) of the Company's Y2K program.
The remaining systems and equipment are currently being modified, upgraded or
replaced in phase three of the Company's Y2K program. The Company is also
reviewing the Y2K readiness of third parties who provide goods or services which
are essential to the Company's operations. In addition, the Company is revising
its existing business interruption contingency plans to address issues specific
to the Y2K problems. The Company's senior management and the Board of Directors
receive periodic updates on the status of the Company's Y2K program.
Business Systems
The Company's business systems and equipment include computer hardware,
software and related equipment which are utilized in connection with ticket
production, ticket validation, on-line lottery services, and inventory
management; including ticket inventory management and control; finance systems,
such as revenue management, revenue accounting and payroll; and other functions,
such as internal voice and data communications, facility management and
security.
In the Instant Ticket and Related Services segment, the Company has analyzed its
instant ticket manufacturing presses and imaging systems and believes that no
date
<PAGE> 20
sensitive information is required for them to function. Internally, hardware and
software used for accounting purposes was purchased as a Y2K compliant product.
The Company has also upgraded or replaced hardware and software for general
corporate use including its payroll systems in order to be Y2K compliant.
In the Company's Systems segment, the operating system that supports the
Company's SGI-NET central system application software has always allowed a
four-digit year format, which is not expected to be affected by the transition
to the Y2K. Both the operating system and the terminal application software
resident in the Company's SciScan terminals have been prepared using a
four-digit year format and the Company believes it to be Y2K compliant. The
Company believes that its operating system for its mainframe computer system
which operates the Instant Lottery Management and Validation System is Y2K
compliant.
Interfaces with Third Parties
The Company continues to review and communicate with third parties
which provide goods or services which are essential to the Company's operations
in order to: (1) determine the extent to which the Company is vulnerable to any
failure by such material third parties to remediate their respective Y2K
problems; and (2) resolve such problems to the extent practicable. These
entities include the suppliers of commodities used in the production process,
the suppliers of utilities and communication services and the providers of
payroll and banking services including the Company's principal lender. To date,
the Company has not received a material notice that its vendors will not be Year
2000 compliant. As previously discussed, the Company's application software
purchased from a third party and used in its instant ticket manufacturing
process has been throughly tested by both internal and external parties and no
significant Year 2000 problems have been found to date.
Estimated Y2K Costs
The Company expects to continue to allocate the necessary staff and/or
monetary resources to address the Y2K issue and currently does not expect that
Y2K issues will pose significant operational problems for the Company's computer
systems or that the Company will incur significant operating expenses or be
required to invest heavily in new computer systems that were not already
budgeted or in updates to its existing computer systems to avoid any Y2K
<PAGE> 21
problems. The total compliance costs are estimated to be $2.1 million. Since
1997, the Company estimates the total Y2K compliance costs (including software,
systems and equipment) already incurred to be approximately $1.2 million.
Contingency Planning
The Company continues to revise its existing business interruption
contingency plans to address internal and external issues specific to the Y2K
problem, to the extent practicable. These plans, which are intended to enable
the Company to continue to operate to the extent that it can do so safely and
economically, include ordering a sufficient supply of raw materials necessary to
manufacture instant lottery tickets for a period of at least ten days subsequent
to December 31, 1999, performing certain processes manually, repairing or
obtaining replacement systems, changing suppliers, increasing security at
warehouses which hold ticket inventories and reducing or suspending operations.
The Company believes, however, that, due to the widespread nature of potential
Y2K issues, the contingency planning process is an ongoing one which will
require further modifications as the Company obtains additional information
regarding (1) the Company's internal systems and equipment during the
remediation and testing phases of its Y2K program; and (2) the status of third
party Y2K readiness.
Possible Consequences of Y2K Problems
The Company believes that completed and planned modifications and
conversions of its internal systems and equipment will allow it to be Y2K ready
in a timely manner. However, the Company's investigation still is ongoing, and
no assurances can be given that the Company's current assessments will continue
to be correct or that the Company will not be exposed to any potential claims
resulting from system problems associated with Y2K issues. Similarly, there can
be no assurance that the Company's internal systems or equipment or those of
third parties on which Scientific Games relies will be Y2K ready or compliant in
a timely manner or that the Company's or third parties' contingency plans will
mitigate the effects of any non-readiness or non-compliance. The failure of the
systems or equipment of Scientific Games or third parties (which Scientific
Games believes is the most reasonably likely worst case scenario) could result
in the reduction or suspension of the Company's operations and could have a
material adverse effect on the Company's business or consolidated financial
statements.
<PAGE> 22
Consolidated Financial Statements
Scientific Games Holdings Corp.
Years ended December 31, 1998, 1997, and 1996
with Report of Independent Auditors
<PAGE> 23
Scientific Games Holdings Corp.
Consolidated Financial Statements
Years ended December 31, 1998, 1997, and 1996
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors......................................................................1
Financial Statements
Consolidated Balance Sheets.........................................................................2
Consolidated Statements of Income...................................................................4
Consolidated Statements of Cash Flows...............................................................5
Consolidated Statements of Shareholders' Equity.....................................................7
Notes to Consolidated Financial Statements..........................................................8
</TABLE>
<PAGE> 24
FIVE-YEAR SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------
(In thousands, except share numbers) 1998 1997(1) 1996(2) 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues $213,800 $197,456 $146,620 $149,240 $119,756
-------- -------- -------- -------- --------
Net income 19,409 8,972 18,726 22,428 16,080
-------- -------- -------- -------- --------
Earnings per common share (diluted) 1.58 .72 1.41 1.64 1.21
======== ======== ======== ======== ========
BALANCE SHEET DATA
Total assets 179,633 164,410 127,529 110,186 81,169
-------- -------- -------- -------- --------
Bank debt,
including lease obligations 12,482 32,716 4,429 376 1,620
-------- -------- -------- -------- --------
Shareholders' equity 111,906(5) 98,127(3) 93,789(4) 94,580 67,233
======== ======== ======== ======== ========
</TABLE>
- ---------------
(1) Includes the operations of SGIL for the full year and SG Austria since the
acquisition in April 1997.
(2) Includes the operations of SGIL since the acquisition in October 1996.
(3) Reflects the purchase of $5.8 million of Company Stock.
(4) Reflects the purchase of $24.6 million of Company Stock.
(5) Reflects the purchase of $10.5 million of Company Stock.
14
<PAGE> 25
Report of Independent Auditors
Board of Directors
Scientific Games Holdings Corp.
We have audited the consolidated balance sheets of Scientific Games Holdings
Corp. (the "Company") as of December 31, 1998 and 1997, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Scientific Games
Holdings Corp. at December 31, 1998 and 1997, and the results of its operations
and cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 3, 1999
<PAGE> 26
Scientific Games Holdings Corp.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
-----------------------------
(In thousands, except share
numbers and par value)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 9,270 $ 2,843
Trade receivables 39,445 34,448
Inventories 15,090 11,602
Prepaid expenses and other current assets 2,111 1,853
Deferred income tax benefits 1,032 1,681
-----------------------------
Total current assets 66,948 52,427
Property and equipment, at cost:
Land 2,521 2,521
Buildings 11,664 11,662
Production and other equipment 101,098 90,996
Construction-in-progress 2,047 4,035
-----------------------------
117,330 109,214
Less accumulated depreciation and amortization (57,386) (45,464)
-----------------------------
59,944 63,750
Goodwill and other intangibles 35,282 34,448
Other assets 17,459 13,785
-----------------------------
$ 179,633 $ 164,410
=============================
</TABLE>
2
<PAGE> 27
Scientific Games Holdings Corp.
Consolidated Balance Sheets (continued)
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
-----------------------------
(In thousands, except share
numbers and par value)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 16,270 $ 6,505
Accrued liabilities 17,822 19,681
Bank debt 12,482 -
Income taxes payable 3,932 4,272
-----------------------------
Total current liabilities 50,506 30,458
Bank debt - 30,624
Other long-term liabilities 8,221 2,092
Deferred income taxes payable 6,694 3,109
Minority interest in consolidated subsidiaries 2,306 -
Commitments and contingencies
Shareholders' equity:
Preferred stock -- 3,000,000 shares authorized, no shares
issued and outstanding - -
Common stock -- par value $.001 per share:
25,750,000 shares authorized; 11,875,737 shares and 11,875,514 shares
issued and outstanding at December 31, 1998 and 1997, respectively
12 12
Additional paid-in capital 65,551 57,949
Accumulated earnings 46,201 39,856
Accumulated other comprehensive income 142 381
-----------------------------
111,906 98,198
Less notes receivable from officers for the sale of stock - (71)
-----------------------------
Total shareholders' equity 111,906 98,127
-----------------------------
$ 179,633 $ 164,410
=============================
</TABLE>
See accompanying notes.
3
<PAGE> 28
Scientific Games Holdings Corp.
Consolidated Statements of Income
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
----------------------------------------------
(In thousands, except per share data)
<S> <C> <C> <C>
Revenues $ 213,800 $197,456 $146,620
Cost of revenues 138,630 124,718 90,442
----------------------------------------------
75,170 72,738 56,178
Selling, general and administrative expenses
26,518 25,653 17,494
Depreciation and amortization 16,330 13,229 9,133
Pull-tab business write-off - 3,376 -
In-process technology write-off - 10,102 -
Interest income 484 354 917
Other income 147 - -
Gain/(loss) on foreign currency (65) 507 748
Interest expense 1,353 911 153
Minority interest in subsidiaries' loss 85 - -
----------------------------------------------
Income before income taxes 31,620 20,328 31,063
Income tax expense 12,211 11,356 12,337
==============================================
Net income $ 19,409 $ 8,972 $ 18,726
==============================================
Basic net income per common share $ 1.60 $ 0.75 $ 1.48
==============================================
Diluted net income per common share $ 1.58 $ 0.72 $ 1.41
==============================================
Average common shares outstanding - basic
12,108 12,020 12,682
Dilutive effect of stock options and
non-vested restricted stock awards 190 407 584
==============================================
Average common shares outstanding - diluted
12,298 12,427 13,266
==============================================
</TABLE>
See accompanying notes.
4
<PAGE> 29
Scientific Games Holdings Corp.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
----------------------------------------------
(In thousands)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 19,409 $ 8,972 $ 18,726
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation 12,012 10,361 8,424
Amortization 4,318 2,868 709
In-process technology write-off - 10,102 -
Pull-tab business write-off - 3,376 -
Gain on disposal of property and
equipment (5) - (15)
Deferred income taxes 4,407 (1,513) (36)
Stock compensation expense 563 1,313 1,764
Minority interest (85) - -
Changes in operating assets and liabilities:
Accounts receivable (4,416) 536 (1,526)
Inventories (3,470) 1,376 (3,174)
Prepaid expenses and other assets (2,109) (10,156) (4,176)
Accounts payable 9,751 (4,256) 1,399
Accrued liabilities 2,990 2,718 1,293
Deferred revenue - (5,653) -
Income taxes payable 2,158 1,421 3,126
----------------------------------------------
Net cash provided by operating activities 45,523 21,465 26,514
INVESTING ACTIVITIES
Proceeds from sale of assets 188 800 173
Payments for property and equipment (8,359) (22,280) (3,910)
Acquisitions of businesses, net of cash
acquired (6,469) (24,091) (23,482)
----------------------------------------------
Net cash used in investing activities (14,640) (45,571) (27,219)
</TABLE>
5
<PAGE> 30
Scientific Games Holdings Corp.
Consolidated Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
----------------------------------------------
(In thousands)
<S> <C> <C> <C>
FINANCING ACTIVITIES
Payments on notes receivable from officers
71 - 28
Borrowings under bank debt 3,000 36,060 8,984
Payments on bank debt and other
long-term debt (21,142) (9,420) (5,000)
Repurchase of common stock (10,461) (5,787) (24,559)
Proceeds from the exercise of common stock
options 4,427 57 1,070
----------------------------------------------
Net cash (used in) provided by financing
activities (24,105) 20,910 (19,477)
Effect of exchange rate changes on cash (351) (213) 21
----------------------------------------------
Increase (decrease) in cash and cash
equivalents 6,427 (3,409) (20,161)
Cash and cash equivalents at beginning of
year 2,843 6,252 26,413
----------------------------------------------
Cash and cash equivalents at end of year $ 9,270 $ 2,843 $ 6,252
==============================================
</TABLE>
See accompanying notes.
6
<PAGE> 31
Scientific Games Holdings Corp.
Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
ADDITIONAL
COMMON STOCK PAID- NOTES RECEIVABLE OTHER
---------------------- IN ACCUMULATED FROM THE COMPREHENSIVE
(In thousands) SHARES AMOUNT CAPITAL EARNINGS SALE OF STOCK INCOME TOTAL
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 13,064 $ 13 $52,163 $ 42,503 $(99) $ - $ 94,580
Foreign currency translation
adjustment - - - - - 691 691
Net income - - - 18,726 - - 18,726
---------
Comprehensive income - - - - - - 19,417
---------
Exercise of stock options,
including tax benefit 298 - 2,559 - - - 2,559
Compensation expense in
connection with stock
option plans - - 1,764 - - - 1,764
Repurchase and retirement
of common stock (1,204) (1) - (24,558) - - (24,559)
Repayment of notes
receivable - - - - 28 - 28
--------------------------------------------- -----------------------------------------------
Balance at December 31, 1996 12,158 12 56,486 36,671 (71) 691 93,789
Foreign currency translation
adjustment - - - - - (310) (310)
Net income - - - 8,972 - - 8,972
---------
Comprehensive income - - - - - - 8,662
---------
Exercise of stock options,
including tax benefit 20 - 150 - - - 150
Compensation expense in
connection with stock
option plans - - 1,313 - - - 1,313
Repurchase and retirement
of common stock (302) - - (5,787) - - (5,787)
-----------------------------------------------------------------------------------------------
Balance at December 31, 1997 11,876 12 57,949 39,856 (71) 381 98,127
Foreign currency translation
adjustment - - - - - 16 16
Additional minimum
pension liability - - - - - (255) (255)
Net income - - - 19,409 - - 19,409
---------
Comprehensive income - - - - - - 19,170
---------
Exercise of stock options,
including tax benefit 659 1 7,039 - - - 7,040
Compensation expense in
connection with stock
option plans - - 563 - - - 563
Repurchase and retirement
of common stock (659) (1) - (13,064) - - (13,065)
Repayment of notes receivable - - - - 71 - 71
-----------------------------------------------------------------------------------------------
Balance at December 31, 1998 11,876 $ 12 $65,551 $ 46,201 $ - $ 142 $ 111,906
===============================================================================================
</TABLE>
See accompanying notes.
7
<PAGE> 32
Scientific Games Holding Corp.
Notes to Consolidated Financial Statements
December 31, 1998
1. CORPORATE ORGANIZATION AND BASIS OF PRESENTATION
Scientific Games Holdings Corp. ("Company") provides a full range of lottery
game consulting and production services, including the manufacturing,
warehousing and distribution of instant lottery tickets and related
instant-ticket services such as game design, sales and marketing support,
retailer telemarketing and field services. The Company also provides lottery
systems and systems-related services, including transaction processing software
that accommodates instant ticket game accounting and validation and on-line
games, point-of-sale terminal hardware which connect to these systems,
central-site computer and communications hardware which runs these systems and
ongoing maintenance for each of these items. These products and services
(Instant Ticket and Related Services and Systems) are provided primarily to
domestic and international governmentally sanctioned lotteries. The Company
enters into short-term and long-term contracts with these lotteries to obtain
rights to provide lottery products and services. Products and services are
provided through the Company's wholly owned subsidiaries and its joint ventures,
Alpharetta, Georgia-based Scientific Games Inc. ("SGI"), United Kingdom-based
Scientific Games International Limited ("SGIL") Austria-based Scientific Games
Kommunikations - und Computersysteme GmbH ("SG Austria") and France-based
SciGames France SAS ("SG France"). See Note 3.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
The following summarizes the Company's principal accounting policies.
Consolidated financial statements presented herein include the accounts and
operations of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
8
<PAGE> 33
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUES AND COST OF REVENUES
Revenues from the sales of the Company's products and services are recognized
based upon instant ticket and related services and/or systems shipment or
delivery, a percentage of the lottery's instant ticket or on-line sales to the
public over a contracted period, as support and maintenance services are
provided under related agreements, or the percentage of completion method for
development projects, or any combination of the foregoing. All costs related to
the design, planning and production of instant tickets are capitalized as
inventories and recognized as cost of revenues when the tickets are shipped or
when sold to the public. Costs related to the planning and development of the
systems and systems-related services may be recorded based upon the percentage
of completion method or if revenue is recognized based on lottery sales to the
public, then the costs may be recognized over the period of the contract. Costs
related to the provision of support and maintenance services are recorded in
costs of revenues, and revenues are recognized when the service is provided.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist principally of cash and institutional money
market funds on deposit with banks. The Company considers all highly liquid
investments with a maturity of three months or less when purchased to be cash
equivalents.
ACCOUNTS RECEIVABLE
The Company generally does not require collateral or other security for its
receivables. For certain foreign receivables, the Company requires letters of
credit backing such amounts. Credit losses have been within management's
expectations.
INVENTORIES
Inventories consist principally of instant lottery tickets, materials related to
their production, and certain electronic components related to Systems
terminals. Inventories are valued at the lower of cost (first-in, first-out
method) or market. Inventories consist of the following:
9
<PAGE> 34
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------
(In thousands)
<S> <C> <C>
Finished goods $ 7,939 $ 5,841
Work-in-process 1,087 1,827
Raw materials 6,064 3,934
------------------------
$15,090 $11,602
========================
</TABLE>
PROPERTY AND EQUIPMENT
Leasehold improvements are amortized on the straight-line method over the lives
of the respective leases or, where applicable, the related lottery game
contracts. Amortization associated with capitalized leases is included in
depreciation expense. Production and other equipment and office furniture and
equipment are depreciated on the straight-line method, generally over 3 to 14
years. Buildings are depreciated on the straight-line method over 31 years.
ACCRUED LIABILITIES
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------
(In thousands)
<S> <C> <C>
Potential legal claims and other assessments $ 917 $ 1,107
Reserves for defective ticket adjustments 650 900
Accrued compensation 2,920 3,201
Amounts due to other entities 3,283 8,328
Pension and deferred compensation plans 6,633 1,770
Other 3,419 4,375
------------------------
$17,822 $19,681
========================
</TABLE>
10
<PAGE> 35
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL
Goodwill represents the excess purchase price paid over the net assets acquired
in connection with business combinations accounted for under the purchase
method. Goodwill is being amortized on the straight-line method. Goodwill
related to SGIL and SG Austria is being amortized over periods of 30 years and
15 years, respectively. Accumulated amortization of goodwill totaled
approximately $3,497,000 and $1,629,000 at December 31, 1998 and 1997,
respectively.
In the event facts and circumstances indicate that goodwill or other long-lived
assets may be impaired, an evaluation of recoverability would then be performed.
If an evaluation is required, the estimated future undiscounted cash flows
associated with the asset would be compared to the asset's carrying amount to
determine if a write-down to market value or discounted cash flow value is
required.
OTHER ASSETS
Other assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------
(In thousands)
<S> <C> <C>
Cash surrender value of life insurance $ 3,836 $ 2,318
Lottery contract costs 5,509 7,169
Intangible pension asset 3,138 -
Other 4,976 4,298
------------------------
$17,459 $13,785
========================
</TABLE>
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of foreign operations are translated from the local
currency into U.S. dollars at the rate of currency exchange at the end of the
fiscal period. Translation gains and losses of foreign operations that use local
currencies as the functional currency are accumulated and reported as other
comprehensive income in shareholders' equity. Revenues and expenses are
translated at average monthly exchange rates. Transaction gains and losses
arising from exchange rate fluctuations on transactions denominated in a
currency other than the local functional currency are included in the results of
operations.
11
<PAGE> 36
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount reflected in the consolidated balance sheets for cash, cash
equivalents, accounts receivable, accounts payable and bank debt approximate
their respective fair values.
COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Financial Accounting Standards Board
("FASB") Statement 130, Reporting Comprehensive Income. Statement 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Company's net income or shareholders' equity. Statement 130 requires that
foreign currency translation and minimum pension liability adjustments, which
prior to adoption were reported separately in shareholders' equity, to be
included in other comprehensive income. Except for the 1998 amount related to
the minimum pension liability adjustment, the entire amount of the Company's
accumulated other comprehensive relates solely to foreign currency translation.
Prior year financial statements have been reclassified to conform to the
requirements of Statement 130.
SEGMENT INFORMATION
On December 31, 1998, the Company adopted FASB Statement 131, Disclosures About
Segments of an Enterprise and Related Information. The new rules establish
revised standards for public companies relating to the reporting of financial
and descriptive information about their operating segments in financial
statements. The adoption of Statement 131 did not effect the Company's primary
financial statements, but did require the disclosure of segment information
contained elsewhere herein. See Note 11.
PENSION DISCLOSURES
In 1998, the Company adopted FASB Statement 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits. Statement 132 revises employers'
disclosures about pension and other postretirement benefit plans. It does not
change the measurement or recognition of those plans. It standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis. The Company has made the required disclosures in
12
<PAGE> 37
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the 1998 financial statements related to an SGIL-sponsored defined benefit plan
and a domestically sponsored supplemental executive retirement plan. See Note 9.
ACCOUNTING STANDARDS NOT YET ADOPTED
In April 1998, the American Institute of Certified Public Accountants ("AICPA")
issued Statement of Position ("SOP") 98-5, Reporting the Costs of Start-up
Activities. The SOP is effective beginning on January 1, 1999, and requires that
start-up costs capitalized prior to January 1, 1999, be written off and any
future start-up costs to be expensed as incurred. The Statement will have no
material impact on the Company.
In June 1998, the FASB issued Statement 133, Accounting for Derivative
Instruments and Hedging Activities. Statement 133 provides a comprehensive
standard for the recognition and measurement of derivatives and hedging
activities. Statement 133 requires all derivatives to be recorded on the balance
sheet at fair value and establishes "special accounting" for the different types
of hedges. Though the accounting treatment and criteria for each type of hedge
are unique, they all result in recognizing offsetting changes in value or cash
flows of both the hedge and the hedged item in earnings in the same period.
Changes in fair value of derivatives that do not meet the hedge criteria are
included in earnings in the period of the change. The Company does not believe
that the adoption of Statement 133 in 2000 will have a significant impact on its
consolidated financial statements.
3. ACQUISITIONS AND DISPOSITIONS
In October 1996, the Company acquired Opax International Limited, a United
Kingdom corporation, which was renamed Scientific Games International Limited
("SGIL"). SGIL is a producer of instant lottery and promotional game tickets
with an international customer base and two printing facilities in the United
Kingdom. In October 1996, the Company also purchased certain sales contracts of
ILS Systems bv, and a sales representation agreement with De La Rue plc. The
Company paid $22.8 million for SGIL and $2.5 million for the sales contracts and
sales representation agreement. Goodwill, representing the excess of the
purchase price over the net assets acquired, totaled approximately $15.3
million.
13
<PAGE> 38
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
3. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
On April 15, 1997, the Company completed its stock acquisition of TeleControl
Kommunikations - und Computersysteme Gesellschaft m.b.h., an Austrian
corporation which was renamed Scientific Games Kommunikations - und
Computersysteme GmbH. ("SG Austria"), an on-line lottery and transaction systems
company located in Vienna, Austria, from Autotote Corporation. The purchase
price was $26.9 million net of $2.8 million of SG Austria's acquired cash. The
purchase was accounted for under the purchase method of accounting. The purchase
price was allocated to approximately $5.1 million of net assets and to a
one-time write-off of $10.1 million in connection with in-process research and
development costs based on an appraisal, with the remainder allocated to
goodwill to be amortized over 15 years.
The accompanying financial statements include the results of operations of SGIL
and SG Austria from the dates of such acquisitions. The following table
summarizes the Company's estimated pro forma unaudited results of operations as
if the purchase of SG Austria and SGIL occurred on January 1, 1997 and January
1, 1996 respectively:
The pro forma results presented above include adjustments to reflect interest
expense on
<TABLE>
<CAPTION>
Year ended December 31 1997 1996
- ---------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C>
Revenues $200,225 $193,930
Net income 18,841 7,565
Earnings per common share-basic 1.57 .60
Earnings per common share-diluted 1.51 .57
</TABLE>
borrowings for the acquisitions, amortization of assets acquired including
intangibles, certain management expenses related to the Company's combined
operations, the $10.1 million in-process research and development costs
write-off reflected in the 1996 amounts, lease expense for a building owned by
the former owner of SGIL which was not purchased as part of the acquisition, and
the income tax effect of such pro forma adjustments and income taxes on
earnings.
These pro forma unaudited results of operations do not purport to represent what
the Company's actual results of operations would have been if the SG Austria and
SGIL acquisitions had occurred on January 1, 1997 and 1996, respectively, and
should not serve as a forecast of the Company's operating results for any future
periods. The pro forma
14
<PAGE> 39
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
3. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
adjustments are based solely upon certain assumptions that management believes
are reasonable under the circumstances at this time. However, the full impact of
potential cost savings has not been reflected in the pro forma results presented
above, although there can be no assurances such cost savings will be achieved.
In the fourth quarter of 1998, the Company formed a joint venture with La
Francaise des Jeux, the operator of the French National Lottery. The joint
venture corporation, SciGames France SAS ("SG France"), was formed to provide
systems maintenance services for the lottery terminal software and hardware of
six German provincial lotteries, terminal maintenance for the French National
Lottery and to develop a lottery terminal to be used by La Francaise de Jeux in
France and by the Company throughout the world. The Company's initial cash
contribution to SG France was approximately $1.9 million which resulted in a 55%
ownership interest. The Company also advanced to SG France approximately $1.4
million as a loan to acquire inventory to be used in the venture. Goodwill and
other intangibles totaling approximately $2,523,000 have been recognized in the
consolidated financial statements in connection with the joint venture.
In 1997, the Company discontinued its charity pull-tab ticket business line
which was produced and distributed by its then named subsidiary GameTec, Inc.
("GameTec"). A write-off of $3.4 million (pre-tax) was recognized for the
disposition of the assets of this business line in 1997. In connection with the
disposition, the Company sold substantially all of the assets of GameTec. The
Company entered into a three-year extendible marketing agreement with the buyer
to provide marketing and related services to state lotteries for pull-tab
tickets. The Company will continue to provide pull-tab tickets to its lottery
customers through the marketing agreement.
4. BANK CREDIT AGREEMENT
On December 20, 1996, the Company entered into a three-year, $80 million credit
facility with three banks (the "Bank Credit Agreement"). The Bank Credit
Agreement, as amended in 1998, contains provisions for foreign currency loans
whereby, at the request of the Company, amounts up to a maximum of $30 million
may be borrowed and repaid in either U.S. dollars, British pounds sterling,
French francs, German Deutsche marks or Euro currency. LIBOR, IBOR and the Base
Rate (the higher of the prime rate, or the federal funds rate plus .5%), plus
the applicable margin as defined in the Bank Credit Agreement, are the
interest-rate options available to the Company under the Bank Credit Agreement.
These interest rates options are applicable and available in varying
circumstances based upon, among other things, the amount and nature of the
borrowings and the Company's leverage ratio at the time such amounts are
borrowed. The weighted-
15
<PAGE> 40
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
4. BANK CREDIT AGREEMENT (CONTINUED)
average interest rates on the outstanding borrowings under the Bank Credit
Agreement, including foreign currency debt, during 1998 and 1997 were 5.0% and
4.7%, respectively. A per annum fee of .125% is payable on the average, daily
unused portion of the commitment.
The Bank Credit Agreement contains covenants that restrict the Company's ability
to incur additional debt or create liens on any of its property, except as
permitted, and require the Company to maintain a leverage ratio, as defined, of
or below 50% and a fixed charge coverage ratio of at least three to one.
The Company has interest-rate swap agreements that effectively fix the interest
rate on Deutsche mark equivalent of $8,996,000 of borrowings under the revolving
Bank Credit Agreement until October 2000. This amount may be borrowed at a fixed
rate of 4.065%, plus a credit spread. The credit spread, ranging in 1/8%
increments from 0.375% to 0.625%, is set depending on the Company's leverage
ratio at the time of each three-month loan renewal. At December 31, 1998 and
1997, the effective interest rate on the Deutsche mark borrowings was 4.4%.
These swap agreements involve the receipt of amounts when the floating rates
exceed the fixed rates and the payment of amounts when the fixed rates exceed
the floating rates in such agreements over the life of the agreements. The
differential to be paid or received is accrued as interest rates change and is
recognized as an adjustment to the floating rate interest expense related to the
debt. The related amount payable to or receivable from counterparties is
included in accrued liabilities or other assets. If, in the future, the
interest-rate swap agreement were terminated, any resulting gain or loss would
be deferred and amortized to interest expense over the remaining life of the
underlying debt. In the event of early extinguishment of a designated debt
obligation, any realized or unrealized gain or loss from the swap would be
recognized in income coincident with the extinguishment. The fair values of the
swap agreement, which are not recognized in the financial statements, were
estimated not to be significant at December 31, 1998. The fair value of the
Company's bank debt approximates its carrying value.
For the years ended December 31, 1998, total interest paid was $1,239,000. For
the year ended December 31, 1997, interest paid and incurred totaled $955,000,
of which $44,000 was capitalized and $153,000 was paid and incurred in 1996.
These amounts include interest on bank debt, interest on capital leases and
commitment fees.
16
<PAGE> 41
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
4. BANK CREDIT AGREEMENT (CONTINUED)
The outstanding balance under the Bank Credit Agreement is due on December 20,
1999. As of December 31, 1998, the Company had not entered into a new agreement
to secure additional borrowings under a new credit facility. The Company has
begun discussions with several banks and expects to enter into a new credit
facility agreement before the current Bank Credit Agreement expires.
5. SHAREHOLDERS' EQUITY
In July 1997, the Company adopted a shareholders' rights plan, which provided
for the issuance to each holder of the Company's common stock, certain rights
(the "Rights") to purchase shares of the Company's redeemable Series A
Participating Cumulative Preferred Stock pursuant to the terms of a Rights
Agreement. Such Rights are exercisable after distribution by the holders
thereof, other than "Acquiring Persons" as defined in the Rights Agreement, in
the event of certain ownership changes and in connection with certain business
combinations. The Rights have certain anti-takeover effects. The Rights may
cause substantial dilution to a person that attempts to acquire the Company
without a condition to such an offer being that a substantial number of the
Rights to be acquired or that the Rights be redeemed or declared invalid. The
Rights should not interfere with any merger or other business combination
approved by the Board of Directors (under some circumstances with the
concurrence of the continuing directors, as defined) since the rights may be
redeemed by the Company.
6. STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and related Interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
Accounting for Stock-Based Compensation, requires use of option valuation models
that were not developed for use in valuing employee stock options.
The Company has stock option plans that provide for the granting of
non-qualified options to purchase the Company's common stock to selected key
employees, officers and directors. Such options generally have ratable, annual
vesting periods ranging from 3 to 7 years from the date of the grant, and
maximum terms ranging from 7 to 10 years from the date of the grant.
17
<PAGE> 42
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
6. STOCK OPTIONS (CONTINUED)
A summary of the Company's stock option activity, and related information for
the years ended December 31, 1998, 1997 and 1996 follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------------------------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
(000'S) PRICE (000'S) PRICE (000'S) PRICE
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding - beginning
of year 1,376 $12.46 1,271 $11.41 1,459 $ 8.31
Granted 345 19.76 125 20.60 115 26.00
Exercised (659) 7.56 (18) 3.17 (298) 3.63
Forfeited (43) 20.68 (2) 3.06 (5) 3.27
--------- --------- ----------
Outstanding - end of year 1,019 $17.72 1,376 $12.46 1,271 $11.41
========= ========= ==========
Exercisable - end of year 558 $15.06 885 $ 9.59 592 $ 6.90
========= ========= ==========
</TABLE>
Exercise prices for options outstanding as of December 31, 1998, ranged from
$1.46 to $38. The weighted-average remaining contractual life of those options
is 8 years. The Company charged approximately $563,000, $1,313,000, and
$1,764,000 to operations in 1998, 1997 and 1996, respectively, representing the
amortization of the difference in the option price and the fair market value of
the option shares at the date of grant. At December 31, 1998, the Company has
reserved approximately 534,000 shares of Common Stock for possible future
issuance in connection with its stock option plans.
Pro forma information regarding net income and earnings per share is required by
Statement 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted subsequent to
December 31, 1994, under the fair value method of that Statement. The fair value
of these options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions for 1998, 1997 and
1996, respectively: risk-free interest rates of 5.2%, 6.7% and 6.6%, a dividend
yield of 0.0%; volatility factors of the expected market price of the Company's
common stock of .41, .46 and .41; and a weighted-average expected life of the
option of 8.0, 8.7 and 8.0 years. The weighted-average fair value of options
granted during 1998, 1997 and 1996 were $10.94, $13.16 and $18.77, respectively.
18
<PAGE> 43
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
6. STOCK OPTIONS (CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for earnings per share
information):
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------------------------------
<S> <C> <C> <C>
Pro forma net income $ 18,352 $ 7,689 $ 17,803
=================================================
Pro forma earnings per share-diluted $ 1.51 $ .62 $ 1.34
=================================================
</TABLE>
Because Statement 123 is applicable to options granted subsequent to December
31, 1994, its pro forma effect will not be fully reflected until future years.
19
<PAGE> 44
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
7. INCOME TAXES
Income tax expense is composed of the following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
--------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 5,939 $ 10,457 $ 9,919
State 796 2,600 2,308
Foreign 1,069 842 132
Deferred:
Federal 2,765 (1,433) 6
State 629 (213) 1
Foreign 1,013 (897) (29)
--------------------------------------------
Income tax expense $12,211 $ 11,356 $ 12,337
============================================
</TABLE>
The difference between the provision for income taxes and amounts computed by
applying federal statutory rates to income before income taxes is summarized as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
----------------------------------------------
<S> <C> <C> <C>
Federal income tax expense at statutory rates $ 11,067 $ 7,115 $ 10,872
State income taxes net of federal income tax
effect 1,082 1,551 1,499
Non-deductible expenses 1,139 450 278
In-process technology write-off - 3,535 -
Tax credits (305) (582) (186)
Interest on tax-exempt securities - - (301)
Other (772) (713) 175
----------------------------------------------
Income tax provision $ 12,211 $ 11,356 $ 12,337
==============================================
</TABLE>
The pre-tax income (loss) attributable to the Company's foreign operations was
approximately $7,659,000, ($8,462,000) and $45,000 for the years ended December
31, 1998, 1997 and 1996 respectively.
20
<PAGE> 45
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
7. INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of December 31, 1998 and
1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
----------------------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation $3,896 $4,789
Other - net 3,204 1,465
----------------------
Total deferred tax liabilities 7,100 6,254
Deferred tax assets:
Accruals and reserves 537 2,737
Stock compensation 902 2,089
----------------------
Total deferred tax assets 1,438 4,826
----------------------
Net deferred tax liabilities $5,662 $1,428
======================
</TABLE>
The Company made federal and state income tax payments of approximately
$7,564,000, $11,731,000, and $9,948,000, in the years ended December 31, 1998,
1997 and 1996, respectively. The Company made $580,000 and $750,000 in foreign
income tax payments in the years ended December 31, 1998 and 1997, respectively.
8. LEASES
The Company leases certain office and warehouse facilities under operating
leases. Lease expense for operating leases totaled approximately $2,804,000,
$2,337,000 and $1,838,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
21
<PAGE> 46
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
8. LEASES (CONTINUED)
Future minimum lease obligations at December 31, 1998, are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
OPERATING
LEASES
----------
<S> <C>
1999 $ 3,330
2000 2,743
2001 2,260
2002 2,241
2003 1,898
Thereafter 5,333
----------
Total lease obligations $ 17,805
==========
</TABLE>
9. BENEFIT PLANS
The Company sponsors the following benefit plans for its employees and
directors:
The Company sponsors the Scientific Games Inc., Savings and Investment Plan, a
savings plan which covers all eligible SGI employees who elect to participate.
Employees are eligible for participation on the enrollment date following six
months of service. In 1998, the Company contributed an amount equal to 33% of
the portion of the employee's elective deferral contributions which do not
exceed 6% of the employee's total pay for each payroll period in which an
elective deferral is made, subject to the limitations of the Internal Revenue
Code. Beginning in 1999, the Company will contribute an amount equal to 50% of
the portion of the employee's elective deferral contributions which do not
exceed 6% of the employee's total pay for each payroll period in which an
elective deferral is made. The Company's matching portion of employees'
contributions is made with the Company's common stock, which is purchased on the
open market. Matching contributions of the Company are 100% vested upon receipt.
Approximately $360,000, $331,000 and $314,000 was expensed by the Company
related to this plan during 1998, 1997 and 1996, respectively.
On October 1, 1996, the Company established the Scientific Games Inc.,
Management Deferred Compensation Plan (MDCP) to provide deferred compensation
for a select group of management or highly compensated employees. Generally,
participants in the MDCP may elect to defer up to 50% of their salary and up to
100% of their annual cash incentive bonus. Assets of the MDCP may be held by a
rabbi trust but are accounted for
22
<PAGE> 47
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
9. BENEFIT PLANS (CONTINUED)
as assets of the Company; therefore all earnings and expenses are recorded in
the Company's financial statements. The net amount of the MDCP's earnings and
losses is recorded as additional liability to the participants and is an expense
of the Company. Assets and liabilities of the MDCP totaled approximately
$1,100,000 and $1,241,000, respectively, at December 31, 1998. Compensation
expense associated with the MDCP was approximately $546,000, $649,000 and
$46,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Effective July 11, 1996, the Company established Scientific Games Holdings Corp.
Directors Deferred Compensation Plan (DDCP) to provide each member of the Board
of Directors who is not an employee of the Company (a "Director") an
opportunity, on an annual basis, to defer all or any portion of his or her
director's fees. Similar to the MDCP discussed above, assets of the DDCP may be
held by a rabbi trust but are accounted for as assets of the Company; therefore
all earnings and expenses are recorded in the Company's financial statements.
Assets and liabilities of the DDCP totaled approximately $227,000 and $255,000,
respectively, at December 31, 1998.
Compensation expense associated with the DDCP was approximately $133,000,
$71,000 and $51,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
The Company also sponsors the following defined benefit plans for certain
employees:
Certain employees of SGIL are participants in a defined-benefit pension plan
administered by SGIL ("SGIL Plan"). The benefits are based on an average of the
employee's compensation over two years preceding retirement or leave of service.
The Company also sponsors the Scientific Games Inc., Supplemental Executive
Retirement Plan ("SERP") covering certain executives as determined by the
Compensation Committee of the Board. All current participants are 100% vested in
their benefits. Generally, participants will receive benefits for 15 years in an
amount equal to 53% of his or her compensation in the final three calendar years
of employment. Such amounts may be reduced based upon length of service and
vesting schedules for participants entering the SERP after January 1, 1996.
The following tables summarize the SGIL Plan and the SERP. Amounts related to
the SGIL Plan for 1996, and for the SERP for 1997 and 1996 have not been
presented as such amounts were not significant.
23
<PAGE> 48
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
9. BENEFIT PLANS (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
SGIL SERP
1998 1997 1998
----------------------------------------
CHANGES IN BENEFIT OBLIGATION (In Thousands)
<S> <C> <C> <C>
Net benefit obligation at beginning
of year $ 9,634 $8,089 $ 5,252
Service cost 963 775 134
Interest cost 631 770 394
Actuarial (gain) loss 732 - (151)
Gross benefits paid - - (122)
----------------------------------------
Net benefit obligation at end of year $11,960 $9,634 $ 5,506
========================================
CHANGES IN PLAN ASSETS
Fair value of plan assets at beginning
of year $ 9,883 $9,059 $ -
Actual return on plan assets 780 49 -
Employer contributions 963 775 -
Plan participants' contribution 151 - -
Gross benefits paid - - -
----------------------------------------
Fair value of plan assets at end of year $11,777 $9,883 $ -
========================================
</TABLE>
The following table sets forth the funded status of the plans and the amount
recognized in the balance sheets:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
SGIL SERP
1998 1997 1998
---------------------------------------
(In Thousands)
<S> <C> <C> <C>
Funded status at end of year $(183) $ 249 $(5,506)
Unrecognized net actuarial gain (loss) (100) (396) 623
Unrecognized prior service cost - -
3,139
Additional minimum liability - - (3,394)
Intangible asset - -
3,139
Accumulated other comprehensive income - - 255
---------------------------------------
Net amount recognized at end of year $(283) $(147) $(1,744)
=======================================
</TABLE>
24
<PAGE> 49
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
9. BENEFIT PLANS (CONTINUED)
Net pension cost included the following components:
<TABLE>
<CAPTION>
Year ended December 31
SGIL SERP
1998 1997 1998
------------------------------------
(In Thousands)
<S> <C> <C> <C>
Service cost $ 963 $ 775 $134
Interest cost 631 770 394
Expected return on plan assets (780) (819) -
Amortization of unrecognized
transition obligation (16) - -
Amortization of prior service cost - - 358
Amortization of actuarial loss - - 29
------------------------------------
Net periodic pension cost $ 798 $ 726 $915
====================================
</TABLE>
Assumptions used in the accounting for the defined benefit plans are as follows:
<TABLE>
<CAPTION>
Year ended December 31
SGIL SERP
1998 1997 1998
<S> <C> <C> <C>
Weighted-average discount rate 5.5% 6.5% 7.5%
Rate of increase in future compensation
levels 4.0% 4.5% 5.0%
Expected long-term rate of return on assets 7.5% 7.5% -
</TABLE>
The SERP is not a qualified plan and has no plan assets. At December 31, 1998,
and in accordance with the minimum liability provisions of Financial Accounting
Standard Board Statement 87, the Company recognized an additional minimum
liability of approximately $3,394,000, including an intangible pension asset of
$3,139,000 and a reduction to other comprehensive income of $255,000 in
connection with the SERP. The additional minimum liability had no effect on the
Company's results of operations.
To provide a funding source for the payment of benefits under the SERP, the
Company owns whole-life insurance contracts on the participants. The cash value
of these policies was approximately $2,509,000 at December 31, 1998. The Company
made cash payments associated with the policies of approximately $787,000
annually during 1998, 1997 and 1996. These policies have been placed in a rabbi
trust, which will hold the policies and death benefits as they are received.
25
<PAGE> 50
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
10. CONTINGENCIES
The Company's SGI subsidiary owns a minority interest in Wintech de Colombia,
S.A. ("Wintech"), which has operated the Colombian national lottery under
contract with Empresa Colombiana de Recursos para la Salud, S.A. ("Ecosalud"),
an agency of the Colombian government. The contract projected that certain
levels of lottery ticket sales would be attained, and provided a penalty against
Wintech, SGI and the other shareholders of Wintech of up to $5,000,000 if such
levels were not achieved. In addition,with respect to a further guarantee of
performance under the contract with Ecosalud, SGI delivered to Ecosalud a
$4,000,000 bond issued by a Colombian surety, Seguros del Estado ("Seguros").
Wintech started the instant lottery in Colombia but, due to difficulties beyond
its control, the projected sales level was not met for the year ending 1993. On
July 1, 1993, Ecosalud adopted resolutions declaring, among other things, that
the contract was in default and asserted various claims for compensation and
penalties against Wintech, SGI and shareholders of Wintech. As the Company has
previously disclosed, litigation is pending in Colombia concerning various
claims among Ecosalud, Wintech and the Company relating to the termination of
the contracts with Ecosalud (the "Colombian Litigation"). Ecosalud's claims in
the Colombian Litigation are for, among other things, realization on the full
amount of the penalty plus interest and costs of the bond.
SGI has consulted with Colombian counsel and has been advised that SGI has
various legal defenses to Ecosalud's claims. SGI also has certain cross
indemnities and undertakings from the two other private shareholders of Wintech
for their respective shares of any liability to Ecosalud. That obligation is
secured in part by a $1,500,000 confirmed letter of credit in favor of SGI. The
Colombian surety which issued a $4,000,000 bond to Ecosalud under the contract
has reportedly paid $2,400,000 to Ecosalud under the bond, and made demand upon
SGI for that amount under the indemnity agreement entered into by the surety and
SGI. SGI declined to make or authorize any such payment and notified the surety
that any payment in response to Ecosalud's demand on the bond is at the surety's
risk. No assurance can be given that the other shareholders of Wintech will, or
have sufficient assets to, honor their indemnity undertakings to SGI when the
claims by Ecosalud against SGI and Wintech are resolved, in the event such
claims result in any liability.
In June 1996, Ecosalud filed a complaint against the Company in the United
States District Court for the Northern District of Georgia, Atlanta Division
(the "Georgia Litigation"). Total damages claimed in the original Complaint were
"not less than $84,423,267." The complaint also sought reasonable attorneys'
fees and costs allegedly pursuant to the contract. In response to the complaint,
SGI filed a motion to dismiss the
26
<PAGE> 51
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
10. CONTINGENCIES (CONTINUED)
action on multiple grounds, including the mandatory arbitration clause contained
within the contract. Ecosalud then filed an amended complaint in which it
withdrew its claim for in excess of $84,000,000 and, instead, seeks $5,000,000
under an "Executive Title," a purported joint and several guarantee by the
Company, Wintech and other shareholders in Wintech that projected levels of
lottery ticket sales would be attained. In addition, Ecosalud also sought
attorneys' fees and interest on the claim. SGI filed a motion to dismiss the
amended complaint on the grounds, inter alia, that litigation involving the same
subject matter was pending in Colombia, the dispute is subject to an arbitration
clause and forum non conveniens. On March 19, 1997, judgment was entered on
behalf of the Company. The Court dismissed the action on the grounds that it was
governed by the arbitration and forum selecting clauses in the contract which
require that all disputes be settled either by arbitration in Colombia or in the
administrative courts of Colombia. The Court also dismissed the action on the
grounds of lis alibi pendens. On April 16, 1997, the Plaintiff filed a notice of
appeal. The United States Court of Appeals for the Eleventh Circuit heard oral
argument on the appeal of the dismissal of the complaint of Ecosalud on January
16, 1998 and thereafter affirmed the holding of the trial Court. Ecosalud did
not seek reconsideration by the Eleventh Circuit; accordingly, the Georgia
Litigation has been concluded.
On April 2, 1998, Seguros brought suit against the Company in the United States
District Court for the Northern District of Georgia, Atlanta Division. The
plaintiff seeks $2,400,000 for sums paid by Seguros to Esosalud under the surety
bond on November 1, 1994, plus interest at the Colombian bank rate of interest.
The Company has filed a motion to dismiss based on the Colombian statute of
limitations of two years and, alternatively, seeking that the case be dismissed
on other grounds. Seguros filed a motion for summary judgment with the Court on
May 6, 1998 seeking summary judgment on its claim in the amount of $2,400,000,
plus $3,246,916 in accrued interest, plus interest, thereafter.
SGI intends to vigorously defend the Colombian Litigation and the recently filed
Seguros litigation and has been advised by counsel that the Company has numerous
defenses on the merits, as well as procedural defenses to the litigation.
Although it is not possible to determine the outcome of the litigation in
Colombia, or the other related surety and indemnity claims, management believes
based upon, among other things, the advice of counsel that SGI has various
defenses (which it has asserted in response to such proceedings and claims),
that adequate provision has been made for such claims and the disposition
thereof should not have a material adverse effect on the Company's consolidated
financial condition or consolidated results of operations.
27
<PAGE> 52
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
11. SEGMENT INFORMATION
The Company's primary customers are government sanctioned lotteries worldwide.
The Company's two reportable segments are organized based on the products and
services it supplies to lotteries, Instant Tickets and Related Services and
Systems.
In the Instant Ticket and Related Services segment, the Company primarily
supplies game design, sales and marketing support, instant ticket manufacturing
and delivery, inventory management and distribution, and retailer telemarketing
and field service. In addition, this segment includes the supply of promotional
instant tickets and pull-tab tickets, which are sold to both lottery and
non-lottery customers as well as prepaid phone cards which are sold to
telecommunications companies. These products represent a small amount of the
segment's activity.
In the Systems segment, the Company primarily supplies transaction processing
software that accommodates instant ticket accounting and validation and online
games, point-of-sale terminal hardware which connects to these systems, central
site computer and communication hardware which run these systems, and ongoing
support and maintenance services for these products. On-line lottery games
include lotto, daily pick, keno and other games. The Systems segment also
includes software and hardware for sports betting systems and credit card
processing systems for non-lottery customers.
The Company refers to Cooperative Services in various sections of this annual
report. Cooperative Services is a branded marketing name given to the
combination of any of the products offered by the two segments under one
customer contract. The Company believes the Cooperative Services name assists it
in promoting greater awareness of its capabilities, but does not treat it as a
separate segment. The intersegment sales relate to Systems activity included in
Instant Ticket and Related Services customer contracts. The amount of
intersegment sales was calculated based on the market value of the System
product or service provided as if sold separately. Corporate relates to
miscellaneous revenues, general and administrative expenses and certain assets
which are not allocated to the segments.
28
<PAGE> 53
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
11. SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
OPERATING SEGMENT INFORMATION YEAR ENDED DECEMBER 31
1998 1997 1996
-------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Revenue from external customers:
Instant Tickets and Related Services $ 176,676 $ 178,923 $ 145,136
Intersegment revenue (8,098) (6,353) (5,252)
Systems 36,810 18,470 1,480
Intersegment revenue 8,098 6,353 5,252
Corporate 314 63 4
-------------------------------------------------
Total revenue from external customers $ 213,800 $ 197,456 $ 146,620
=================================================
Depreciation and amortization:
Instant Tickets and Related Services $ 8,887 $ 8,868 $ 6,234
Systems 6,091 3,406 1,712
Corporate 1,352 955 1,187
-------------------------------------------------
Total depreciation and amortization $ 16,330 $ 13,229 $ 9,133
=================================================
Operating income
Instant Tickets and Related Services $ 34,343 $ 37,707 $ 36,206
Pull-tab business write-off - (3,376) -
Systems 7,577 5,553 2,140
In-process technology write-off - (10,102) -
Corporate (9,598) (9,404) (8,795)
-------------------------------------------------
Total operating income $ 32,322 $ 20,378 $ 29,551
Interest expense (1,353) (911) (153)
Other 651 861 1,665
-------------------------------------------------
Income before income taxes $ 31,620 $ 20,328 $ 31,063
=================================================
Assets:
Instant Tickets and Related Services $ 138,028 $ 136,470 $ 110,473
Systems 26,564 19,485 5,351
Corporate 15,351 8,455 11,705
-------------------------------------------------
Total assets $ 179,633 $ 164,410 $ 127,529
=================================================
</TABLE>
29
<PAGE> 54
11. SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
GEOGRAPHIC INFORMATION YEAR ENDED DECEMBER 31
1998 1997 1996
(000'S) (000'S) (000'S)
--------------------------------------------
<S> <C> <C> <C>
Net revenues (a):
United States $169,360 $158,911 $140,519
Europe 44,440 38,545 6,101
--------------------------------------------
Total net revenues $213,800 $197,456 $146,620
============================================
Net revenues (b):
United States $138,199 $131,335 $118,019
Europe 68,250 58,089 25,005
Other 7,351 8,032 3,596
--------------------------------------------
Total net revenues $213,800 $197,456 $146,620
============================================
Net property and equipment:
United States $ 52,931 $ 57,399 $ 45,887
Europe 7,013 6,351 6,124
--------------------------------------------
Total net property and equipment $ 59,944 $ 63,750 $ 52,011
============================================
</TABLE>
(a) Based on subsidiaries' countries of domicile
(b) Based on customers' countries of domicile
During the years ended December 31, 1998 and 1997, no single customer accounted
for over 10% of the Company's total revenues. During the year ended December 31,
1996, one customer comprised approximately 13% of the Company's total revenues.
30
<PAGE> 55
Scientific Games Holdings Corp.
Notes to Consolidated Financial Statements (continued)
12. QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
IN THOUSANDS, FIRST SECOND THIRD FOURTH
EXCEPT PER SHARE DATA QUARTER QUARTER QUARTER QUARTER
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998
Revenues $48,419 $ 51,567 $53,928 $59,886
Gross profit 16,862 18,832 20,116 19,360
Income before taxes 6,229 8,103 9,093 8,195
Net income 3,777 4,853 5,282 5,497
------------------------------------------------------------
Net income per share - basic $ .32 $ .39 $ .43 $ .46
============================================================
Net income per share - diluted $ .31 $ .39 $ .43 $ .46
============================================================
1997
Revenues $45,612 $ 50,511 $50,669 $50,664
Gross profit 16,963 19,528 17,643 18,604
Income (loss) before taxes 9,237 (4,333) 7,923 7,501
Net income (loss) 5,487 (6,653) 5,030 5,108
------------------------------------------------------------
Net income (loss) per share - basic $ .45 $ (.55) $ .42 $ .43
============================================================
Net income (loss) per share - diluted $ .44 $ (.55) $ .41 $ .42
============================================================
</TABLE>
As discussed in Note 3, on April 15, 1997, the Company acquired SG Austria. The
results of operations of SG Austria are included in the quarters from the date
of the acquisition.
<PAGE> 1
EXHIBIT 21.0
Scientific Games Holdings Corp.
Subsidiaries
<TABLE>
<CAPTION>
State/jurisdiction
of incorporation/ Other names under which
Name organization business is conducted
- -------------------- ------------------- -----------------------------------
<S> <C> <C>
Scientific Games Inc. Delaware
Scientific Games (Greece), Inc. Delaware
Scientific Games Acquisition Corp. Delaware Formerly GameTec Inc.
Scientific Games Foreign Sales Corporation Barbados
Scientific Games International Limited United Kingdone
Line of business: instant ticket manufacturer
Number of subsidiaries within US = 0
Number of subsidiaries outside US = 4
Scientific Games Kommunikations -- und Austria
Computersysteme A.G.
Line of business: on-line lottery systems
Number of subsidiaries within US = 0
Number of subsidiaries outside US = 0
Scientific Games Finance Corporation Delaware
Scientific Games Royalty Corporation Delaware
Scientific Games France Inc. Delaware
</TABLE>
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Scientific Games Holdings Corp. of our report dated February 3, 1999,
included in the 1998 Annual Report to Shareholders of Scientific Games Holdings
Corp.
We also consent to the incorporation by reference in the Registration Statements
of Scientific Games Holdings Corp. listed below of our report dated February 3,
1999, with respect to the consolidated financial statements of Scientific Games
Holdings Corp. incorporated by reference in the Annual Report (Form 10-K) for
the year ended December 31, 1998.
- -- Registration Statement No. 33-78322 on Form S-8 dated April 29, 1994
and related Prospectus.
- -- Registration Statement No. 33-78324 on Form S-8 dated April 29, 1994
and related Prospectus.
- -- Registration Statement No. 33-78326 on Form S-8 dated April 29, 1994
and related Prospectus.
- -- Registration Statement No. 33-78328 on Form S-8 dated April 29, 1994
and related Prospectus.
- -- Registration Statement No. 33-78330 on Form S-8 dated April 29, 1994
and related Prospectus.
- -- Registration Statement No. 33-90948 on Form S-8 dated April 5, 1995
and related Prospectus.
- -- Registration Statement No. 33-90950 on Form S-8 dated April 4, 1995 and
related Prospectus.
- -- Registration Statement No. 333-3034 on Form S-8 dated April 1, 1996 and
related Prospectus.
- -- Registration Statement No. 33-05847 on Form S-8 dated June 12, 1996 and
related Prospectus.
- -- Registration Statement No. 333-30637 on Form S-8 dated July 2, 1997 and
related Prospectus.
- -- Registration Statement No. 333-42833 on Form S-8 dated December 22,
1997 and related Prospectus.
/s/ Ernst & Young LLP
Atlanta, Georgia
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 9,270
<SECURITIES> 0
<RECEIVABLES> 39,445
<ALLOWANCES> (550)
<INVENTORY> 15,090
<CURRENT-ASSETS> 66,948
<PP&E> 117,330
<DEPRECIATION> 57,386
<TOTAL-ASSETS> 179,633
<CURRENT-LIABILITIES> 50,506
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 111,906
<TOTAL-LIABILITY-AND-EQUITY> 179,633
<SALES> 213,800
<TOTAL-REVENUES> 213,800
<CGS> 138,630
<TOTAL-COSTS> 138,630
<OTHER-EXPENSES> 26,518
<LOSS-PROVISION> 128
<INTEREST-EXPENSE> 1,353
<INCOME-PRETAX> 31,620
<INCOME-TAX> 12,211
<INCOME-CONTINUING> 19,409
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,409
<EPS-PRIMARY> 1.60
<EPS-DILUTED> 1.58
</TABLE>
