Summary of SCIENTIFIC GAMES CORP

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

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to enhance the reader's understanding of our operations and current business environment. This MD&A should be read in conjunction with our unaudited consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q, as well as the "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the fiscal year ended December 31, 2011 and the "Business" section included in our 2011 Annual Report on Form 10-K, for a more complete understanding of our financial condition and results of operations.

This MD&A also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and should be read in conjunction with the disclosures and information contained and referenced under "Forward-Looking Statements" included in this Quarterly Report on Form 10-Q.

As used in this MD&A, the terms "we," "us," "our" and the "Company" mean Scientific Games Corporation together with its consolidated subsidiaries.

Business Overview
General
We are a leading global supplier of products and services to lotteries and a leading provider of technology and content to gaming operators worldwide. We also gain access to technology and pursue global expansion through strategic acquisitions and equity investments. We manage and report our operations in three business segments: Printed Products; Lottery Systems; and Gaming. Corporate expenses are not allocated to our reportable segments. See "Business Segment Results" below and Note 12 to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional business segment information.
The discussion below highlights certain key drivers of our business and certain known trends, demands, commitments, events and uncertainties that have affected our recent, and may affect our future, financial and operating performance. Our revenue is classified as instant ticket revenue, service revenue and sales revenue. Instant ticket revenue includes revenue related to our instant ticket fulfillment and services businesses, including our brand licensing and Properties Plus® businesses. Revenue generated from our sales of lottery systems, terminals, gaming terminals, gaming content and phone cards, which sales are typically non-recurring in nature and not subject to multi-year supply agreements, is categorized as sales revenue. All other revenue generated from Lottery Systems (including revenue from the validation of instant tickets and other systems management contracts) and Gaming is classified as service revenue. We believe we are likely to continue to experience a highly competitive environment for domestic and international customer contracts in connection with bids, re-bids, extensions and renewals, which could lead to the loss of contracts, rate or volume reductions and additional service requirements in contracts that we win or retain. See the table "Business - Contract Procurement" in Item 1 of our 2011 Annual Report on Form 10-K for additional information regarding our customer contracts, including when they may become subject to re-bid, extension, or renewal. Our strategy to mitigate these industry trends includes working with our customers to grow their sales through a variety of methods including launching new products and services, implementing innovative technologies and marketing tools, and expanding retail distribution. We derive approximately 52% of our annual revenue from sales to customers outside of the U.S. and are affected by fluctuations in foreign currency exchange rates, particularly the British Pound Sterling and Euro. The British Pound Sterling and the Euro represented, respectively, approximately $182 million, or 26.4%, and $41 million, or 5.9%, of our consolidated revenue for the nine months ended September 30, 2012. Historically, foreign currency fluctuations have impacted our revenue more than our expenses, as a significant portion of our raw materials, such as paper and ink, are contracted for in U.S. dollars. We also have foreign currency exposure related to our equity investments denominated in British Pounds Sterling and Euros. Our earnings from our Euro-denominated equity investment in Lotterie Nazionali S.r.l ("LNS") were $14.0 million for the nine months ended September 30, 2012. When we refer to the impact of foreign currency exchange rate fluctuations, we are referring to the difference between the current period rates and the prior period rates applied to the current period activity.
We manage our foreign currency exchange risks on a global basis by (1) securing payment from our customers in the functional currency of the selling subsidiary when possible, (2) entering into foreign currency hedging contracts and (3) netting asset and liability exposures denominated in similar foreign currencies to the extent possible. Periodically, we enter into foreign currency exchange or other contracts to hedge the risk associated with certain firm sales commitments, net investments and

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certain assets and liabilities denominated in foreign currencies. During 2012, we entered into foreign currency forward contracts to hedge a portion of the net investment in one of our subsidiaries that is denominated in Euros. These foreign currency forward contracts are described in Note 6 to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
Printed Products
Our Printed Products segment is primarily comprised of our global instant ticket lottery business. We generate revenue from the manufacture and sale of instant tickets, as well as the provision of value-added services such as game design, sales and marketing support, specialty games and promotions, inventory management and warehousing and fulfillment services. We also provide lotteries with cooperative service programs ("CSPs") to help them efficiently and effectively manage and support their operations to achieve higher retail sales and lower operating costs. Moreover, we provide licensed games, promotional entertainment and internet-based services to the lottery industry. Our U.S. instant ticket contracts typically have an initial term of three to five years and frequently include multiple renewal options for additional periods ranging from one to five years, which our customers have generally exercised in the past. We typically sell our instant lottery tickets for a price per thousand units ("PPK") or for a fee equal to a percentage of the retail sales of the instant lottery tickets ("POS"). Under our CSP contracts we are typically paid on a POS basis. Some of our international customers purchase instant lottery tickets periodically rather than through multi-year supply contracts. Retail sales of instant tickets can be a key performance indicator of our instant ticket revenue, although there may not always be a direct correlation between retail sales and our instant ticket revenue due to the type of contract (e.g., PPK versus POS or CSP contracts), the impact of changes in our customer contracts, the performance of our licensed properties business or other factors. Based on third-party data, our customers' total instant ticket lottery retail sales in the U.S. increased 8.9% and 10.3% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. Most of our U.S. customers reported year-over-year growth in retail sales of instant tickets, which we believe was driven by a variety of factors, including lottery private management, product innovation, better instant ticket product management, prize payout increases and sales of higher price-point tickets. Our licensed game contracts are generally game-specific and therefore short-term and non-recurring. Our instant ticket revenue may be negatively impacted to the extent we are unable to continue to win licensed game-specific or multi-state game contracts. There has been increased interest within the lottery industry in player loyalty programs, which we believe may result in growth opportunities for our Properties Plus® loyalty program, which features players clubs, reward programs, second chance promotional websites and interactive games. Recently, we signed an agreement with the North Carolina lottery for a new Properties Plus program and the Iowa Lottery extended the term of its existing Properties Plus loyalty program. The Tennessee lottery added our Points for Prizes® store to its player loyalty program in February 2012. The Missouri lottery awarded us a Properties Plus contract that commenced in August 2012 and the Kentucky lottery awarded us a Properties Plus contract that is expected to commence in late 2012 or early 2013.
We are the primary supplier of instant lottery tickets for LNS, which was awarded the concession to be the exclusive operator of the Italian Gratta e Vinci instant ticket lottery beginning on October 1, 2010. LNS succeeded Consorzio Lotterie Nazionali, a consortium comprised of essentially the same group that owns LNS, which held the prior concession. Over the life of the new concession, we expect that we will supply no less than 80% of LNS' instant ticket production requirements. Retail sales for LNS for the three and nine months ended September 30, 2012 declined by approximately 6.3% and 6.0%, respectively, compared to the prior-year periods, which we believe was due in part to a decline in consumer spending related to difficult economic conditions and tax increases. We also faced challenging year-over-year retail sales comparisons for the nine months ended September 30, 2012 in light of the strong retail sales performance of the Italian instant ticket lottery during the prior-year period. We have seen some recent evidence of stabilization in the instant ticket business in Italy based on a number of weeks of improved performance in both September and October 2012.
Under a private management agreement with a department of the State of Illinois ("PMA"), Northstar Lottery Group, LLC ("Northstar"), in which we have a 20% equity investment, commenced operations as the private manager of the Illinois lottery on July 1, 2011. Under our CSP agreement with Northstar, we are responsible for the design, development, manufacturing, warehousing and distribution of instant lottery tickets and are compensated based on a percentage of retail sales. Illinois lottery instant ticket sales increased approximately 20% in the three months ended September 30, 2012. Our POS-based instant ticket revenue for the three and nine months ended September 30, 2012 reflected the commencement of our CSP agreement with Northstar on July 1, 2011.

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Northstar is entitled to reimbursement on a monthly basis for most of its operating expenses under the PMA, although certain expenses of Northstar associated with managing the lottery are not reimbursable. Northstar is also entitled to receive annual incentive compensation payments from the State to the extent it is successful in increasing the lottery's net income above specified target levels, subject to a cap of 5% of the applicable year's net income. Northstar will be responsible for payments to the State to the extent such targets are not achieved, subject to a similar cap. The lottery net income levels set forth in Northstar's successful bid for the PMA were $851 million, $950 million, $980 million, $986 million and $1 billion for the five fiscal years ending June 30, 2012, 2013, 2014, 2015 and 2016, respectively, representing a compound annual growth rate in lottery net income of approximately 44%, including an approximate 27% increase in lottery net income in the first year.

These net income target levels are subject to upward or downward adjustment under certain circumstances in accordance with the terms of the PMA. Northstar may seek downward adjustments to the net income targets in the event certain actions of the State (or the federal government) have a material adverse effect on the lottery's net income and Northstar's ability to receive incentive compensation payments. On November 6, 2012, an arbitrator determined that Northstar is entitled to a $28.4 million downward adjustment to the net income target for the lottery's 2012 fiscal year and a $2.9 million downward adjustment to the net income target for the lottery's 2013 fiscal year. It is unclear at this time if these adjusted net income targets are final, and binding or subject to further review or adjustment. As of the date of this Quarterly Report on Form 10-Q, Northstar is unable to estimate, and therefore has not recorded, any amounts in respect of annual incentive compensation or net income shortfall payments for the three or nine months ended September 30, 2012.

As U.S. and international jurisdictions increasingly look towards lottery and gaming as a source to grow revenue, we believe there will be continued interest in pursuing an outsourcing model whereby the day-to-day management of lotteries are conducted by a third party, similar to the PMA model in Illinois. To the extent any of our lottery customers enter into a private management agreement, whether with us or another party, such lottery customers may choose to terminate their existing contract(s) with us as part of the transition to the private management model. The Indiana lottery recently awarded a private management agreement to another party and we subsequently filed a protest against the award. We cannot currently predict the outcome of the protest, or the impact of the award, on our existing Indiana instant ticket or lottery systems contracts. We recently agreed to assist the Commonwealth of Pennsylvania in its potential procurement of a private management agreement for the Pennsylvania lottery. Should the Commonwealth execute a private management agreement, we will continue in our current role as the exclusive provider of instant tickets and lottery systems and services in Pennsylvania through August 2017 and December 2018, respectively. In light of our role in the process, we will not be bidding for the private management agreement in Pennsylvania.
Following a strategic review of our global Printed Products business, we commenced a reorganization plan on April 18, 2012 to cease all printing and finishing activities at our Australia facility during the second half of 2012 and begin printing instant tickets for customers in this region at our other manufacturing plants. During the third quarter of 2012, we migrated printing for our customers in this region to our other manufacturing facilities. We recorded approximately $0.3 million and $4.8 million of employee termination and other restructuring costs associated with the reorganization for the three and nine months ended September 30, 2012, respectively. In addition, we recorded approximately $1.9 million and $3.4 million of accelerated depreciation expense related to this reorganization during the three and nine months ended September 30, 2012, respectively. We currently do not expect to incur additional material costs or accelerated depreciation related to this reorganization during the remainder of 2012.

On June 8, 2012, we acquired the equity interests of SG Provoloto, S. de R.L. de C.V. ("Provoloto") for approximately $9.7 million, subject to certain adjustments, including an estimated earn-out payable to the sellers of approximately $2.0 million contingent on the future performance of the acquired business. Provoloto develops and distributes instant lottery tickets and manages instant ticket lotteries for Mexican charities. We expect this acquisition to strengthen our presence in Latin America and create a platform for further expansion in the region. The operating results of Provoloto have been included in our Printed Products segment and have been consolidated in our results of operations since the date of acquisition. The acquisition is not expected to have a material impact on our results of operations for the remainder of 2012.

Lottery Systems

We are a leading provider of customized computer software, software support, and equipment and data communication services to lotteries. In the U.S., we typically provide the necessary equipment, software and maintenance services pursuant to long-term contracts that typically have an initial term of at least five years under which we are generally paid a fee equal to a percentage of the lottery's total retail sales. Our U.S. contracts typically contain multiple renewal options, which our customers have generally exercised in the past. Internationally, we typically sell point-of-sale terminals and/or computer software to lottery authorities and may provide ongoing fee-based systems and software support services.

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Based on third-party data, our Lottery Systems customers' total draw game retail sales in the U.S. increased 8.5% and 9.5% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. Reflecting in part this improvement in retail sales, our Lottery Systems service revenue in the U.S. increased 8.9% and 9.5% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. The level of jackpots of the Powerball® and Mega Millions® multi-state draw lottery games impact our service revenues. In 2011, U.S. lottery directors authorized certain changes to the Powerball game, including an increase in the ticket price to $2, which went into effect on January 15, 2012. The industry experienced the third largest Powerball jackpot in history ($336 million) and the largest Mega Millions jackpot in history ($656 million) during the nine months ended September 30, 2012. Our Lottery Systems service revenue is also impacted by retail sales of instant tickets where we provide instant ticket validation services as part of a lottery systems contract. Our Lottery Systems sales revenue is non-recurring in nature.
In June 2012, we executed a four-year extension of our contract to provide instant tickets and lottery systems and services to Loteria Electronica in Puerto Rico. In June 2012, we executed a one-year extension of our lottery systems contract with the Maine lottery.
We are the exclusive instant ticket validation network provider to the China Sports Lottery ("CSL"). The POS rate we receive under our China instant ticket validation contract decreased by 0.1% in January 2012 and is scheduled to decrease by an additional 0.1% in January 2014, in accordance with the contract. Instant ticket retail sales of the CSL decreased approximately 17.6% and 8.3% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011.

Based on third-party data, the lottery industry in China appears strong with total lottery sales growth of 6.6% and 20.0% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. However, instant ticket sales declined by 17.6% and 8.3% for the three and nine months ended September 30, 2012, respectively, compared to the prior year periods, due to a number of factors, including competition from other lottery games. In addition, we believe the decline in instant ticket sales during 2012 reflected in part the product mix introduced in the first half of the year, which varied from our original plans due to delays in product approvals, along with slower than anticipated expansion of the retailer network. We have developed a series of remedial actions that we believe should slow down and ultimately reverse the recent trends; however, we believe it will take some time for these actions to take effect so that we may better capitalize on the long-term opportunity in China. To the extent we are not able to successfully implement these remedial actions and offset our CSL contract rate reductions by retail sales growth, our revenue and profitability may be adversely affected.

On April 7, 2012, we signed a five-year agreement in China to provide sales and distribution management services to the Hubei Sports Lottery. The agreement is similar to the CSP contracts we have with many of our North American and European customers. We expect that these services will assist the Hubei Sports Lottery in achieving higher retail sales and lower operating costs.

We entered into a contract, effective in December 2011, to design, implement and administer our sixth generation AEGIS-Video™ Central Management and Control System (CMCS) for the Illinois Gaming Board. Under the terms of the contract, we will provide real-time communication and control between every licensed video gaming terminal in the State of Illinois, as well as day-to-day management of the operation of the CMCS and service throughout the State. The contract was awarded through a competitive procurement process, has an initial term of six years and may be extended by mutual agreement for up to four additional years. Operations under the contract commenced on October 9, 2012. We currently expect that our results of operations will be impacted by this contract to a limited extent during the remainder of 2012 and to a more significant extent in 2013 as the deployment ramps up in Illinois.
During the three months ended September 30, 2012, we began selling our new ULTRATM multi-game video gaming terminal. We expect this new product to provide us with access to North American gaming machine sector and to complement our central monitoring and control systems business.

On July 19, 2012, we acquired substantially all of the assets of Parspro.com ehf ("Parspro") for approximately $11.8 million, subject to certain adjustments. Parspro is a provider of sports betting systems and related products via point of sale terminals, the internet and mobile devices. The acquired assets include technology that we expect to integrate into our Lottery Systems business and our interactive games platform as part of an expanded service offering to lottery customers. The operating results of Parspro have been included in our Lottery Systems segment and have been consolidated in our results of operations since the date of acquisition. The acquisition is not expected to have a material impact on our results of operations for the remainder of 2012.

Gaming

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We are a leading provider of server-based gaming terminals and systems and other products and services to operators in the wide area gaming industry. Our Gaming segment supplies server-based gaming terminals, systems and game content primarily to bookmakers that operate licensed betting offices ("LBOs") in the U.K. and increasingly to gaming operators outside the U.K. through our subsidiary, The Global Draw Limited ("Global Draw"). The LBO sector of the U.K. gaming industry is highly competitive and concentrated among a few operators. The Gaming segment also includes Barcrest Group Limited ("Barcrest") and Games Media Limited ("Games Media"), leading suppliers of gaming terminals, systems and game content to pubs, bingo halls and arcades in the U.K. and continental Europe. We provide many of our Gaming customers with a turnkey offering, which typically includes gaming terminals, remote management of game content and management information, central computer systems, secure data communication and field support services. We develop our own game content and also supplement our offerings with content from third parties.

In our U.K. gaming terminal business, our compensation is typically based on gross win (i.e., amount bet less player winnings) generated by our gaming terminals (subject to certain adjustments as may be specified in a particular contract including adjustments for taxes and other fees). Our Gaming service revenue is therefore impacted by the size of our installed gaming terminal base and the gross win generated by our terminals.
Our gross win per terminal per day increased approximately 5.9% and 6.6% for the three and nine months ended September 30, 2012, respectively, compared to the same period in 2011. As of June 30, 2011, we completed the installation of gaming terminals for the entire Ladbrokes LBO estate in accordance with the contract awarded to us in 2010. In January 2012, William Hill PLC, a U.K. bookmaker, awarded a contract for the exclusive supply of gaming terminals to the bookmaker's entire LBO estate to one of our competitors. This contract took effect following the expiration of our gaming terminal supply contract. The loss of this contract impacted our results of operations in 2012. On October 5, 2012, we extended an agreement to continue as the sole provider of gaming terminals for The Gala Coral Group ("Coral"), a major U.K. bookmaker.
On September 23, 2011, we completed the acquisition of Barcrest, a leading supplier of games, gaming content, gaming platforms and systems to gaming operators and venues in the U.K. and in continental Europe. Barcrest has been integrated with our existing gaming business. The comparability of our 2012 results of operations with our 2011 results of operations is impacted by the Barcrest acquisition.
In January 2012, following a comprehensive strategic review, we announced our exit from the Barcrest analog amusement with prize ("AWP") terminal business in order to focus our game design and other resources solely on our digital server-based supply model. We also reorganized Games Media to more effectively capitalize on the Barcrest acquisition. We recorded approximately $1.5 million and $6.0 million of employee termination and restructuring costs associated with the reorganization for the three and nine months ended September 30, 2012, respectively. We currently do not expect to incur additional material employee termination or other restructuring costs or accelerated depreciation related to this reorganization during the remainder of 2012.
On June 7, 2012, we acquired ADS/Technology and Gaming, Ltd. ("ADS") for £3.5 million, subject to certain adjustments. ADS provides maintenance and other services for LBOs in the U.K. We have integrated the acquisition into our existing Gaming business. We expect that the acquisition will allow us to expand our service offering. The operating results of ADS have been included in our Gaming segment and have been consolidated in our results of operations since the date of acquisition. The acquisition is not expected to have a material impact on our results of operations for the remainder of 2012.
In late 2010, the U.K. government announced its intention to change the taxation of gaming machines by replacing the currently applicable amusement machine license duty and the value-added tax with a new machine games duty, or MGD, based on the gross win generated by a gaming machine. In a budget statement issued in March 2012, the U.K. government announced a standard MGD rate of 20% on gross win, effective February 1, 2013. These tax changes may negatively impact our gaming machine customers' businesses and, therefore, could impact our business in 2013.
On April 16, 2012, certain video lottery terminals operated by SNAI S.p.a. ("SNAI") in Italy and supplied by Barcrest erroneously printed what appeared to be winning jackpot and other tickets. SNAI has stated, and system data confirms, that no jackpots were actually won on that day. The terminals were deactivated pending a review by the Italian regulatory authority of the cause of the incident. We understand that the Italian regulatory authority has decided to revoke the certification of the version of the gaming system that Barcrest provided to SNAI, and has initiated proceedings, but not yet rendered a decision, to revoke the concession SNAI relies upon to operate video lottery terminals in Italy. We also understand that there is a right to appeal the Italian regulatory authority's decision. In October 2012, SNAI filed a lawsuit in Italy against Barcrest and Global Draw, our subsidiary which acquired . . .