Summary of SCIENTIFIC GAMES CORP

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion addresses the results of operations of Scientific Games Corporation (together with its consolidated subsidiaries, "we," "us," "our" or the "Company" unless otherwise specified or the context otherwise requires), for the three months ended March 31, 2009, compared to the corresponding period in the prior year. This discussion should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the fiscal year ended December 31, 2008 included in our 2008 Annual Report on Form 10-K.

The first and fourth quarters of the calendar year traditionally comprise the weakest season for our Diversified Gaming segment. As a result of inclement weather during the winter months, a number of racetracks do not operate and those that do operate often experience missed racing days. This adversely affects the amounts wagered and our corresponding service revenues. Additionally, the fourth quarter is the weakest quarter for Global Draw Limited ("Global Draw") due to reduced wagering during the holiday season. Wagering and lottery equipment sales and software license revenues usually reflect a limited number of large transactions, which do not recur on an annual basis. Consequently, revenues and operating results of our Lottery Systems Group can vary substantially from period to period as a result of the timing of revenue recognition for major equipment sales and software licensing transactions and any Powerball jackpot activity in the quarter. In addition, Printed Products sales may vary depending on the season and timing of contract awards, changes in customer budgets, changes in the way that we price our contracts, inventory ticket levels, lottery retail sales and general economic conditions.

Background

We operate in three business segments: Printed Products Group, Lottery Systems Group and Diversified Gaming Group. Our revenues consist of two major components: services revenues and sales revenues.

Printed Products Group

We provide instant lottery tickets and related services. Instant ticket and related services include ticket design and manufacturing as well as value-added services, including game design, sales and marketing support, inventory management and warehousing and fulfillment services. Additionally, this division provides lotteries with access to a licensed property portfolio, including Deal or No Deal™, Major League Baseball®, National Basketball Association, Harley-Davidson®, Wheel-of-Fortune®, Monopoly™, Corvette® and World Poker Tour®. This division also includes promotional instant tickets and pull-tab tickets that we sell to both lottery and non-lottery customers.

We are a manufacturer of prepaid phone cards, which entitle cellular phone users to a pre-specified value of airtime. Prepaid phone cards offer consumers a cost-effective way to purchase cellular airtime, without requiring phone companies to extend credit or consumers to commit to contracts. Prepaid phone cards utilize the same secure process that we employ in the production of instant lottery tickets.

In 2007, we entered into an arrangement to sell instant lottery tickets directly to the China Sports Lottery for a temporary period of time between March 2008 and December 2008. During 2008, we recorded approximately $40.2 million in revenues from the China Sports Lottery as a result of this temporary arrangement. Beginning in 2009, the China Sports Lottery began purchasing instant lottery tickets through our joint venture in CSG Lottery Technology (Beijing) Co. Ltd, of which we own 49%.

Lottery Systems Group

Our lottery systems business includes the supply of transaction processing software for the accounting and validation of instant ticket and online lottery games, point-of-sale terminal hardware sales, central site computers and communication hardware sales, and ongoing support and maintenance services for these products. This business also includes software and hardware and support services for sports betting and the operation of credit card processing systems.

Diversified Gaming Group

Our Diversified Gaming Group provides services and systems to private and public operators in the wide area gaming markets and in the pari-mutuel wagering industry. Our product offering includes server-based gaming machines (including our Nevada™ dual screen terminals, which can offer Great Britain regulated Category B2 or B3 content on the same machines), VLTs, monitor games, wagering systems for the pari-mutuel racing industry, sports betting systems and services and Great Britain regulated Category C AWP and SWP terminals. Business units within the Diversified Gaming Group include Global Draw, a leading supplier of gaming terminals, systems and monitor games to licensed bookmakers, primarily in the U.K., Austria and Mexico; Scientific Games Racing LLC, a leading worldwide supplier of computerized systems for pari-mutuel wagering; Games Media Limited ("Games Media"), our AWP and SWP terminal supplier in the U.K. pub market; and our pari-mutuel gaming operations in Connecticut, Maine and the Netherlands.

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Results of Operations

Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008

The following analysis compares the results of operations for the quarter ended March 31, 2009 to the results of operations for the quarter ended March 31, 2008.

Overview

Revenue Analysis

For the quarter ended March 31, 2009, total revenue was $230.7 million compared to $257.0 million for the quarter ended March 31, 2008, a decrease of $26.3 million or 10%. Our service revenue for the quarter ended March 31, 2009 was $210.3 million compared to $234.0 million for the quarter ended March 31, 2008, a decrease of $23.7 million, or 10%. The decrease was primarily attributable to the revised terms of our contracts ($12.8 million), lower retail sales in Florida ($1.2 million), lower revenue from a customer in the U.K. as they migrate to a revenue participation model ($4.6 million), decreased revenues from the loss of the South Carolina online lottery contract ($1.3 million), decreased revenue from our pari-mutuel business due to lower dollars wagered, or handle ($3.0 million), and the negative impact from foreign exchange rates ($11.2 million). The decrease was partially offset by increased revenue from instant ticket validation services in China ($5.2 million) and increased service revenue from Global Draw and Games Media ($5.3 million).

Our sales revenue for the quarter ended March 31, 2009 was $20.4 million compared to $23.1 million for the quarter ended March 31, 2008, a decrease of $2.7 million or 12%. The decrease was primarily due to lower phone card sales in the quarter ($2.4 million), decreased sales in Germany due to the closing of the Honsel facility in the first quarter of 2008 ($1.4 million), decreased hardware and software sales in Germany and Norway, decreased sales from Games Media reflecting the expected decline in sales of analog AWP terminals ($3.7 million) as a result of the roll-out of digital AWP terminals, which are being deployed under revenue participation agreements, and the negative impact from foreign exchange rates ($3.5 million). The decrease was partially offset by the sale of Wave™ terminals in Italy ($10.5 million).

Expense Analysis

Cost of services of $125.8 million for the quarter ended March 31, 2009 was $4.6 million or 4% lower than for the quarter ended March 31, 2008. The decrease was primarily due to lower service revenue as discussed above and decreased costs from the Mexico contract ($2.0 million), partially offset by increased costs associated with the new Connecticut online lottery contract ($1.0 million), increased costs related to China ($1.0 million) and costs associated with increased service revenue from Global Draw and Games Media.

Cost of sales of $15.4 million for the quarter ended March 31, 2009 was $1.4 million or 8% lower than for the quarter ended March 31, 2008 primarily due to lower costs in our phone card business as a result of lower sales in the quarter, the decline of sales in Germany, costs associated with decreased hardware and software sales in Germany and reduced sales from Games Media, partially offset by costs associated with the sale of Wave™ terminals in Italy and a sale of pari-mutuel wagering systems in Europe.

Selling, general and administrative expense of $41.5 million for the quarter ended March 31, 2009 was $5.5 million or 12% lower than for the quarter ended March 31, 2008. The decrease was primarily due to reduced incentive compensation costs.

Employee termination costs of $3.9 million for the quarter ended March 31, 2009 were a result of our cost reduction initiatives. Employee termination costs of $2.8 million for the quarter ended March 31, 2008 were a result of the restructuring of our phone card business in the U.K.

Depreciation and amortization expense of $31.1 million for the quarter ended March 31, 2009 decreased $3.4 million or 10% from the quarter ended March 31, 2008 primarily due to decreased amortization on our licensed property contracts, decreased depreciation and amortization on our new Pennsylvania online lottery contract and decreased amortization and depreciation from the Mexico contract, partially offset by increased depreciation from Global Draw and our domestic pari-mutuel business.

Interest expense of $18.8 million for the quarter ended March 31, 2009 increased $1.7 million or 10% from the quarter ended March 31, 2008, primarily attributable to increased borrowings due to the refinancing that occurred in June 2008, partially offset by a decline in interest rates.

Equity in earnings of joint ventures primarily reflects our share of the earnings from the Italian joint venture Consorzio Lotterie Nazionali ("CLN") in connection with the operation of the Italian Gratta e Vinci instant lottery, our share of the equity of Roberts

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Communications Network, LLC ("RCN") and our interest in Guard Libang. For the quarter ended March 31, 2009, our share of CLN's income totaled $14.1 million compared to $15.1 million in the quarter ended March 31, 2008. The decrease in income for the quarter ended March 31, 2009 reflects the negative impact of foreign exchange rates. For the quarters ended March 31, 2009 and 2008, our share of the earnings of RCN was $1.0 million and $1.0 million, respectively. For the quarters ended March 31, 2009 and 2008, our share of the earnings of Guard Libang was $0.8 million and $0.9 million respectively.

Income tax expense was $38.6 million for the quarter ended March 31, 2009 compared to $8.5 million for the quarter ended March 31, 2008. The effective income tax rates for the quarters ended March 31, 2009 and 2008 were 287.3% and 33.8% respectively. The increase in the effective tax rate was primarily the result of recording a valuation allowance against our deferred tax asset for our foreign tax credit carry forward of approximately $33.8 million.

Segment Overview

Printed Products

For the quarter ended March 31, 2009, total revenue for Printed Products was $114.7 million compared to $135.9 million for the quarter ended March 31, 2008, a decrease of $21.2 million or 16%. For the quarter ended March 31, 2009, service revenue for Printed Products was $110.1 million compared to $127.2 million in the corresponding period in the prior year, a decrease of $17.1 million or 13%. The decrease was primarily attributable to the impact of the revised terms of the Florida cooperative services contract, which began impacting revenue during the fourth quarter of 2008 ($6.3 million), lower retail sales in Florida ($1.2 million), lower revenue from a customer in the U.K. as they migrate to a revenue participation model ($4.6 million) and a negative impact from foreign exchange rates ($5.1 million).

Printed Products sales revenue for the quarter ended March 31, 2009 was $4.6 million compared to $8.7 million for the quarter ended March 31, 2008, a decrease of $4.1 million or 47%. The decrease was primarily the result of lower phone card sales revenue in the quarter ($2.4 million) and decreased sales in Germany due to the closing of the Honsel facility in the first quarter of 2008 ($1.4 million).

Cost of services of $67.1 million for the quarter ended March 31, 2009 was $3.7 million or 5% lower than for the quarter ended March 31, 2008. The decrease was primarily due to lower service revenue as discussed above, partially offset by higher costs from our licensed games business ($2.2 million).

Cost of sales of $2.6 million for the quarter ended March 31, 2009 was $3.6 million or 58% lower than for the quarter ended March 31, 2008 primarily due to lower costs in our phone card business as a result of lower sales in the quarter and the decline of sales in Germany.

Selling, general and administrative expense of $11.5 million for the quarter ended March 31, 2009 was $3.5 million or 23% lower than for the quarter ended March 31, 2008. The decrease was primarily due to reduced incentive compensation costs and a favorable impact from foreign exchange rates.

Employee termination costs of $2.0 million for the quarter ended March 31, 2009 were a result of our cost reduction initiatives. Employee termination costs of $2.8 million for the quarter ended March 31, 2008 were a result of our restructuring of the phone card manufacturing in the U.K.

Depreciation and amortization expense of $7.7 million for the quarter ended March 31, 2009 decreased $2.3 million or 23% compared to the quarter ended March 31, 2008, primarily due to decreased amortization on our licensed property contracts and reduced depreciation and amortization from our domestic and international contracts.

Lottery Systems

For the quarter ended March 31, 2009, total revenue for Lottery Systems was $65.9 million compared to $62.4 million for the quarter ended March 31, 2008, an increase of $3.5 million or 6%. Lottery Systems service revenue for the quarter ended March 31, 2009 was $52.1 million compared to $54.6 million for the quarter ended March 31, 2008, a decrease of $2.5 million or 5%. The decrease was primarily due to the revised terms of the Pennsylvania online lottery contract, which began lottery impacting revenue in the first quarter of 2009 ($6.5 million), and decreased revenues from the loss of the South Carolina online contract ($1.3 million), offset by revenue from instant ticket validation services in China ($5.2 million).

Lottery Systems sales revenue for the quarter ended March 31, 2009 was $13.9 million compared to $7.8 million for the quarter ended March 31, 2008, an increase of $6.1 million or 78%. The increase was primarily due to the sale of Wave™ terminals in Italy ($10.5 million), partially offset by decreased hardware and software sales in Germany and Norway and a negative impact from foreign exchange rates ($1.8 million).

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Cost of services of $28.9 million for the quarter ended March 31, 2009 was $0.3 million or 1% higher than for the quarter ended March 31, 2008. The increase was primarily due to increased costs associated with the new Connecticut online lottery contract ($1.0 million) and increased costs related to China ($1.0 million), partially offset by decreased costs from the Mexico contract ($2.0 million).

Cost of sales of $11.8 million for the quarter ended March 31, 2009 was $5.9 million higher than for the quarter ended March 31, 2008, primarily due to costs associated with the sale of Wave™ terminals in Italy, partially offset by costs associated with decreased hardware and software sales in Germany.

Selling, general and administrative expense of $7.5 million for the quarter ended March 31, 2009 was $1.8 million or 19% lower than for the quarter ended March 31, 2008. The decrease was primarily attributable to reduced incentive compensation costs and savings realized from our Profitability Improvement Program.

Depreciation and amortization expense of $10.7 million for the quarter ended March 31, 2009 decreased $4.3 million or 29% compared to the quarter ended March 31, 2008, primarily due to decreased depreciation and amortization on our new Pennsylvania online lottery contract and decreased depreciation and amortization on the Mexico contract.

Diversified Gaming

For the quarter ended March 31, 2009, total revenue for Diversified Gaming was $50.1 million compared to $58.7 million for the quarter ended March 31, 2008, a decrease of $8.6 million or 15%. Diversified Gaming service revenue for the three months ended March 31, 2009 was $48.2 million compared to $52.1 million for the quarter ended March 31, 2008, a decrease of $3.9 million or 7%. The decrease in service revenue was primarily due to decreased revenue from our pari-mutuel business due to lower handle ($3.0 million) and a negative impact from foreign exchange rates ($6.1 million), partially offset by increased service revenue from Global Draw and Games Media ($5.3 million).

The Diversified Gaming sales revenue for the quarter ended March 31, 2009 was $1.9 million compared to $6.6 million for the quarter ended March 31, 2008, a decrease of $4.7 million or 71%. The decrease was primarily due to decreased sales from Games Media reflecting the expected decline in sales of analog AWP terminals ($3.7 million) as a result of the roll-out of digital AWP terminals, which are being deployed under revenue participation agreements and the negative impact from foreign exchange rates ($1.7 million), partially offset by increased sales pari-mutuel wagering systems in Europe ($0.7 million).

Cost of services of $29.8 million for the quarter ended March 31, 2009 was $1.1 million or 4% lower than for the quarter ended March 31, 2008. The decrease was primarily due to lower costs associated with decreased revenue from our domestic pari-mutuel business, partially offset by costs associated with increased service revenue from Global Draw and Games Media.

Cost of sales of $1.0 million for the quarter ended March 31, 2009 was $3.7 million or 79% lower than for the quarter ended March 31, 2008, primarily due to reduced sales from Games Media.

Selling, general and administrative expense of $5.2 million for the quarter ended March 31, 2009 was $1.6 million or 24% lower than for the quarter ended March 31, 2008. The decrease was primarily due to the absence of Global Draw earn-out bonus which was accrued in part in the first quarter of 2008.

Employee termination costs of $0.4 million for the quarter ended March 31, 2009 were a result of our cost reduction initiatives.

Depreciation and amortization expense of $12.6 million for the quarter ended March 31, 2009 increased $3.3 million or 35% from the quarter ended March 31, 2008, primarily due to increased depreciation from Global Draw and our domestic pari-mutuel business.

Critical Accounting Policies

There have been no material changes to our critical accounting policies from those discussed under the caption "Critical Accounting Policies" in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2008 Annual Report on Form 10-K.

Liquidity, Capital Resources and Working Capital

On March 27, 2009, we and our 100%-owned subsidiary, SGI, entered into an amendment (the "Amendment") to the credit agreement, dated as of June 9, 2008 (the "Credit Agreement"), among SGI, as borrower, the Company, as guarantor, the several lenders from time to time parties thereto and JPMorgan Chase Bank, N.A. ("JPMorgan"), as administrative agent

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The purpose of the Amendment is to provide the Company with additional operating and financing flexibility.

Under the Amendment, (i) up to approximately $18.8 million in certain charges incurred and reserves created in the fourth quarter of 2008, (ii) up to $15.0 million of certain charges that may be incurred during the 12-month period commencing on March 1, 2009, including charges in connection with cost-reduction initiatives, and (iii) certain costs and fees incurred in connection with the Amendment, will be added back to "Consolidated EBITDA" for purposes of calculating the "Consolidated Leverage Ratio" and the "Consolidated Senior Debt Ratio" (as such terms are defined under the Credit Agreement).

In addition, for purposes of determining the Consolidated Leverage Ratio and the Consolidated Senior Debt Ratio as of any date prior to the earliest date on which any of the holders of convertible debentures may require the Company to repurchase their convertible debentures (currently June 1, 2010) (the "Convertible Debentures Repurchase Date") neither (i) the earn-out payable with respect to the Company's acquisition of Global Draw nor (ii) the principal amount of any unsecured promissory notes that may be issued in order to defer payment of up to the equivalent of $60.0 million of such earn-out (provided that, among other terms of such promissory notes, no principal payment thereon is required prior to September 30, 2010), will be included as "Indebtedness" in the calculation of "Consolidated Total Debt" (as such terms are defined in the Credit Agreement).

If any promissory notes are issued to defer payment of the Global Draw earn-out, then the revolving credit facility and the term loan facility under the Credit Agreement will mature (if earlier than the date that would otherwise apply under the terms of the Credit Agreement) on the date that is three months prior to the earliest date that any principal payment is required in respect of such promissory notes unless on such date no such promissory notes remain outstanding or the sum of the aggregate available revolving commitments under the Credit Agreement plus unrestricted cash and cash equivalents of SGI and the guarantors under the Credit Agreement is not less than $50.0 million in excess of the amount required to repay in full such outstanding promissory notes.

Under the Amendment, for purposes of determining the Consolidated Leverage Ratio as of any date of determination prior to the earlier of the Convertible Debentures Repurchase Date and the date the convertible debentures are redeemed in full, unrestricted cash and cash equivalents of SGI and the guarantors up to the "Debenture Reserve Amount" at such determination date will be netted against the then outstanding principal amount of the convertible debentures (and Consolidated Total Debt will be thereby reduced to the extent of such netting). The "Debenture Reserve Amount" is an amount equal to the net cash proceeds received by SGI or the guarantors after the date of the Amendment and prior to the Convertible Debentures Repurchase Date from (i) the issuance by the Company of shares of its capital stock (other than disqualified stock), or the issuance of "Permitted Additional Senior Indebtedness" or "Permitted Additional Subordinated Debt," or Indebtedness under the "Incremental Facilities" (as such terms are defined in the Credit Agreement), and (ii) any "Asset Sales" (as defined in the Credit Agreement) (up to an aggregate of $125.0 million of net cash proceeds) with respect to which a reinvestment notice is timely given (provided that the Debenture Reserve Amount will (A) not exceed the outstanding principal amount of the convertible debentures, (B) be reduced to zero on the Convertible Debentures Repurchase Date and (C) to the extent the Debenture Reserve Amount is increased as a result of Assets Sales, will be decreased if and to the extent that term loans under the Credit Agreement are prepaid in lieu of reinvesting the net cash proceeds therefrom pursuant to a reinvestment notice).

The Amendment will increase each of the interest rates set forth in the pricing grid in the Credit Agreement by 0.25% such that, depending upon the Consolidated Leverage Ratio, the interest rate will vary from 2.00% to 3.00% above LIBOR for eurocurrency loans, and 1.00% to 2.00% above the higher of (i) the prime rate or
(ii) the Federal Funds Effective Rate plus 0.50% for base rate loans. Notwithstanding the foregoing, from the Effective Date until the date the compliance certificate for the third fiscal quarter of 2009 is delivered pursuant to the Credit Agreement, the applicable margin for eurocurrency loans will be deemed to be 3.00% and the applicable margin for base rate loans will be deemed to be 2.00%.

In connection with the Amendment, SGI agreed to pay an aggregate of approximately $2.8 million in fees to consenting lenders and the administrative agent.

Our Credit Agreement is secured by a first priority, perfected lien on
(1) substantially all the property and assets (real and personal, tangible and intangible) of the Company and its direct and indirect 100%-owned domestic subsidiaries and (2) 100% of our interest in the capital stock (or other equity interests) of all of our direct and indirect 100%-owned domestic subsidiaries and 65% of our interest in the capital stock (or other equity interests) of the first-tier foreign subsidiaries of SGI and the guarantors.

We were in compliance with our covenants as of March 31, 2009.

As of March 31, 2009, we had approximately $196.9 million available for additional borrowing or letter of credit issuance under our revolving credit facility. There were no borrowings and $53.1 million in outstanding letters of credit under our revolving credit facility as of March 31, 2009. Our ability to borrow under the Credit Agreement will depend on us remaining in compliance with the limitations imposed by our lenders, including the maintenance of our financial ratios or covenants.

The Company may, from time to time, seek to retire or purchase its outstanding debt in open market purchases, in privately negotiated transactions, or otherwise. Any such retirement or purchase of debt may be funded by cash flows from operations, borrowings or other sources and will depend upon prevailing market conditions, liquidity requirements, contractual restrictions and other factors, and the amounts involved may be material. During the three months ended March 31, 2009, we repurchased approximately $47.0 million in aggregate principal amount of our convertible debentures for approximately $42.3 million in cash under our previously announced convertible debentures program. Between April 1, 2009 and May 11, 2009, we have repurchased approximately $10.00 million in aggregate principal amount of the Convertible Debentures for approximately $9.2 million in cash under our previously announced convertible debentures program.

On May 7, 2009, the Company entered into an agreement with the principal selling shareholder and key management of Global Draw related to the earn-out and contingent bonuses that were payable to them in connection with the Company's 2006 acquisition. Based on the performance of the business, the total amount payable was determined to be approximately £60.6 million, or $89.7 million, of which approximately £30.5 million, or $45.2 million, was paid on May 7, 2009. Approximately £28.1 million, or $41.6 million, of the total amount payable was deferred under the terms of two-year, unsecured promissory notes issued by certain of the Company's foreign subsidiaries (and guaranteed by the Company and certain of its U.S. subsidiaries). The earn-out balance of approximately £2.0 million, or $2.9 million, is scheduled to be paid by September 30, 2009.

In May 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") No. Accounting Principles Board ("APB") 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion . . .