10-K 1 sgms1231201310k.htm 10-K SGMS 12.31.2013 10K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K

 
 
 
ý
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2013
Or
o
 
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: 0-13063
SCIENTIFIC GAMES CORPORATION
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
(State or other jurisdiction of
incorporation or organization)
 
81-0422894
(I.R.S. Employer
Identification No.)
750 Lexington Avenue, 25th Floor
New York, New York 10022
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 754-2233
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
Title of each class
 
Name of each exchange on which registered
Class A Common Stock, $.01 par value
 
Nasdaq Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý   No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý
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 ý    No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

 
 
 
 
 
 
 
Large accelerated filer  o

 
Accelerated filer ý
 
Non-accelerated filer o
 (Do not check if
smaller reporting company)
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý
As of June 30, 2013, the market value of voting and non-voting common equity held by non-affiliates of the registrant was $545,560,256 (1).
Common shares outstanding as of March 10, 2014 were 83,933,250.
         DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement relating to the 2014 annual meeting of stockholders are incorporated by reference in Part III. The proxy statement will be filed with the Securities and Exchange Commission no later than 120 days after the conclusion of the registrant's fiscal year ended December 31, 2013.
________________________________________________________________________________________________________________________________

(1)
For this purpose only, "non-affiliates" excludes directors and executive officers.
         EXHIBIT INDEX APPEARS ON PAGE 149


2


TABLE OF CONTENTS
PART I
 
5
Item 1.
Business
6
Item 1A.
Risk Factors
21
Item 1B.
Unresolved Staff Matters
37
Item 2.
Properties
37
Item 3.
Legal Proceedings
37
Item 4.
Mine Safety Disclosures
41
 
 
 
PART II
 
42
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
42
Item 6.
Selected Financial Data
44
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
47
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
71
Item 8.
Financial Statements and Supplementary Data
72
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
72
Item 9A.
Controls and Procedures
72
Item 9B.
Other Information
74
 
 
 
PART III
 
75
Item 10.
Directors, Executive Officers and Corporate Governance
75
Item 11.
Executive Compensation
75
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
75
Item 13.
Certain Relationships and Related Transactions, and Director Independence
75
Item 14.
Principal Accounting Fees and Services
75
 
 
 
PART IV
 
76
Item 15.
Exhibits, Financial Statement Schedules
76

3


Glossary of Terms
 
 
 
The following terms or acronyms used in this Form 10-K are defined below:
 
 
Term or Acronym
Definition
2016 Notes
7.875% senior subordinated notes due 2016
2018 Notes
8.125% senior subordinated notes due 2018
2019 Notes
9.250% senior subordinated notes due 2019
2020 Notes
6.250% senior subordinated notes due 2020
ADS
Technology and Gaming, Ltd.
ASC
Accounting Standards Codification
ASU
Accounting Standards Update
Barcrest
Barcrest Group Limited
China Loans
RMB denominated loans due 2014
coin-in
the amount wagered
CSG
Beijing CITIC Scientific Games Technology Co., Ltd.
CSL
China Sports Lottery
FASB
Financial Accounting Standards Board
Global Draw
The Global Draw Limited
GLB
Beijing Guard Libang Technology Co., Ltd.
Hellenic Lotteries
Hellenic Lotteries S.A.
ITL
International Terminal Leasing
LAP
local-area progressive
LBO
licensed betting office
LNS
Lotterie Nazionali S.r.l.
net win
coin-in less payouts
Northstar Illinois
Northstar Lottery Group, LLC
Northstar New Jersey
Northstar New Jersey Lottery Group, LLC
Note
refers to a note to our Consolidated Financial Statements in this Annual Report on Form 10-K, unless otherwise noted
Parspro
Parspro.com ehf
participation
with respect to our lottery business, refers to a contract or arrangement in which the Company is paid based on a percentage of retail sales
PMA
private management agreement
Provoloto
SG Provoloto, S. de R.L. de C.V.
R&D
research and development
Racing Business
racing and venue management businesses
RCN
Roberts Communications Network, LLC
RFP
request for proposal
RMB
Chinese Renminbi Yuan
RSU
restricted stock unit
SEC
Securities and Exchange Commission
SG&A
selling, general and administrative
Sportech
Sportech plc
U.S.
United States of America
U.S. GAAP
accounting principles generally accepted in the United States of America
VLT
video lottery terminal
WAP
wide-area progressive
WMS
WMS Industries Inc.

4


PART I
FORWARD-LOOKING STATEMENTS
Throughout this Annual Report on Form 10-K, we make "forward-looking statements" within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements describe future expectations, plans, results or strategies and can often be identified by the use of terminology such as "may," "will," "estimate," "intend," "continue," "believe," "expect," "anticipate," "should," "could," "potential," "opportunity," or similar terminology. The forward-looking statements contained in this Annual Report on Form 10-K are generally located in the material set forth under the headings "Business," "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" but may be found in other locations as well. These statements are based upon management's current expectations, assumptions and estimates and are not guarantees of timing, future results or performance. Actual results may differ materially from those contemplated in these statements due to a variety of risks and uncertainties and other factors, including, among other things:

competition;
U.S. and international economic and industry conditions;
slow growth of new gaming jurisdictions, slow addition of casinos in existing jurisdictions and declines in the replacement cycle of gaming machines;
ownership changes and consolidation in the casino industry;
opposition to the expansion of legalized gaming;
ability to adapt to, and offer products that keep pace with, evolving technology;
ability to develop successful gaming concepts and content;
laws and government regulation, including those relating to gaming licenses and environmental laws;
inability to identify and capitalize on trends and changes in the lottery and gaming industries, including the expansion of interactive gaming;
dependence upon key providers in our social gaming business;
retention and renewal of existing contracts and entry into new or revised contracts;
level of our indebtedness, availability and adequacy of cash flows to satisfy obligations or future needs, and restrictions and covenants in our debt agreements
protection of our intellectual property, ability to license third party intellectual property, and the intellectual property rights of others;
security and integrity of our software and systems and reliance on or failures in our information technology systems;
natural events that disrupt our operations or those of our customers, suppliers or regulators;
inability to benefit from, and risks associated with, strategic equity investments and relationships, including (1) the inability of our joint venture to meet the net income targets or otherwise to realize the anticipated benefits under its PMA with the Illinois Lottery, (2) the inability of our joint venture to meet the net income targets or other requirements under its agreement to provide marketing and sales services to the New Jersey Lottery or otherwise to realize the anticipated benefits under such agreement (including as a result of a protest) and (3) failure to realize the anticipated benefits related to the award to our consortium of an instant lottery game concession in Greece;
failure to achieve the intended benefits of the WMS acquisition, including due to the inability to realize synergies in the anticipated amounts or within the contemplated time-frames or cost expectations, or at all;
inability to complete and integrate future acquisitions;
restructuring costs, revenue recognition standards and impairment charges;
fluctuations in our results due to seasonality and other factors;
dependence on suppliers and manufacturers;
risks relating to foreign operations, including fluctuations in foreign currency exchange rates;
dependence on our employees;
litigation and other liabilities relating to our business, including litigation and liabilities relating to our contracts and licenses, our products and systems, our employees, intellectual property and our strategic relationships;
influence of certain stockholders; and
stock price volatility.

Additional information regarding risks and uncertainties and other factors that could cause actual results to differ materially from those contemplated in forward-looking statements is included from time to time in our filings with the SEC, including under the heading "Risk Factors" in this Annual Report on Form 10-K. Forward-looking statements speak only as of the date they are made and, except for our ongoing obligations under the U.S. federal securities laws, we undertake no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise.

5


You should also note that this Annual Report on Form 10-K may contain references to industry market data and certain industry forecasts. Industry market data and industry forecasts are obtained from publicly available information and industry publications. Industry publications generally state that the information contained therein has been obtained from sources believed to be reliable, but that the accuracy and completeness of that information is not guaranteed. While we believe industry information to be accurate, it is not independently verified by us and we do not make any representation as to the accuracy of that information. In general, we believe there is less publicly available information concerning the international lottery and gaming industries than the lottery and gaming industries in the U.S.
ITEM 1.    BUSINESS
Unless otherwise specified or the context otherwise indicates, all references to the words "Scientific Games," "we," "us," "our," and the "Company" refer to Scientific Games Corporation and its consolidated entities. "SGI" refers to Scientific Games International, Inc., a wholly owned subsidiary of Scientific Games Corporation. "U.S." jurisdictions refer to the 50 states in the U.S. plus the District of Columbia and Puerto Rico and "international" refers to non-U.S. jurisdictions.
Scientific Games Corporation was incorporated in the state of Delaware on July 2, 1984. We are a leading developer of technology-based products and services and associated content for worldwide gaming and lottery markets.  The Company’s portfolio includes: instant and draw-based lottery games; electronic gaming machines and game content; server-based lottery and gaming systems; sports betting technology; loyalty and rewards programs; and social, mobile and interactive content and services.  We also gain access to technologies and pursue global expansion through strategic acquisitions and equity investments. We operate our business in the lottery and gaming industries, and within those industries we report our operations in three business segments—Instant Products, Lottery Systems and Gaming. 
On October 18, 2013, the Company acquired WMS for $1,485.9 million, creating one of the largest diversified global gaming suppliers.
Our mission is to be a global leader in providing technology, gaming content and services to the regulated lottery and gaming industries. We seek to realize this goal in a manner that maximizes value for our stockholders. The key elements of our corporate strategy include: (a) growing our customers’ revenues and capturing new growth opportunities by accelerating development of innovative content and technology; (b) capitalizing upon our increased scope and scale following the WMS acquisition while leveraging the complementary capabilities of each organization; and (c) continuously improving our core competencies.
Lottery Industry
Lotteries are operated by U.S. and international governmental authorities and their licensees in approximately 180 jurisdictions throughout the world. Governments typically authorize lotteries as a means of generating revenues without imposing additional taxes. Net lottery proceeds are generally set aside for public purposes, such as education, aid to the elderly, conservation, transportation and economic development. Many jurisdictions have come to rely on the proceeds from lottery game sales as a significant source of funding for these programs. Although there are many types of lottery games worldwide, the two principal categories of products offered are draw lottery games and instant lottery games. Currently 44 U.S. jurisdictions offer instant game lotteries and 45 jurisdictions offer draw lotteries.
An instant lottery game is typically played by removing a scratch-off coating from a preprinted ticket to determine whether it is a winner. Draw lottery games, such as Powerball® and Mega Millions®, are based on a random selection of a series of numbers, and prizes are generally based on the number of winners who share the prize pool, although set prizes are also offered. Draw lottery games are provided through a lottery system in which lottery terminals in retail outlets are continuously connected to a central computer system for the activation, sale and validation of lottery games and related functions. A lottery system may also be used to validate instant lottery games to confirm that a ticket is a winner and prevent duplicate payments. In some jurisdictions, separate instant game validation systems may be installed.
Lotteries may offer a range of other games. In the U.S., some lotteries offer high frequency games such as keno, which is typically played every four to five minutes in restricted social settings, such as bars, and is usually offered as an extension of the lottery system.
Based on third party data, U.S. instant lottery game retail sales and draw lottery retail sales totaled approximately $37 billion and approximately $26 billion, respectively, during the U.S. lottery industry's 2013 fiscal year (which in most U.S. jurisdictions ended on June 30, 2013). Based on published industry information, we estimate that worldwide instant lottery game retail sales and worldwide draw lottery retail sales totaled approximately $76 billion and approximately $199 billion, respectively, during fiscal year 2012.


6


Segments
Effective in the fourth quarter of 2013, we revised our operating segments to reflect the re-organization of our business following the WMS acquisition and the financial information regularly reviewed by our chief executive officer. Based on that review, we changed the name of our "Printed Products" business segment to "Instant Products" to more clearly describe the instant lottery tickets and related products and services within that segment. We also changed the relevant revenue and cost of revenue descriptions on the consolidated statements of operations and comprehensive income from "instant tickets" to "instant games." These description changes had no impact on the operations of the business or the amounts included in the consolidated statements of operations and comprehensive income for any of the years presented. In addition, as a result of the re-organization, our video systems operating segment now resides in the Gaming business segment rather than the Lottery Systems business segment. This change, which was effective as of December 31, 2013, had no impact on the Company's consolidated financial statements for any periods. Prior period reportable segment information for the years ended December 31, 2012 and 2011 has been adjusted to reflect the change in reportable segment reporting. See Note 2 (Business and Geographic Segments) for additional information regarding our business segments.
The following table summarizes the primary business activities and equity investments included in the Instant Products and Lottery Systems business segments.
Segment
 
Primary Business Activities
 
Strategic Equity Investments
 
 
 
 
 
Instant Products
 
Ÿ    Designing, printing and selling instant lottery games
 
Ÿ LNS—20% equity interest in the operator of the Gratta e Vinci instant ticket lottery in Italy
 
 
Ÿ Providing instant game-related services
 
Ÿ Northstar Illinois—20% equity interest in the private manager of the Illinois Lottery
 
 
Ÿ Sublicensing brands and providing promotional products
 
Ÿ Northstar New Jersey—17.69% equity interest in the operating entity that provides marketing and sales services to the New Jersey Lottery
 
 
Ÿ Supplying player loyalty programs, merchandising services and interactive marketing campaigns
 
Ÿ   Hellenic Lotteries—16.5% equity interest in the operator of the Greek state lotteries
 
 
Ÿ   Printing and selling phone cards
 
Ÿ CSG—49% equity interest in the instant game supplier to the China Sports Lottery
 
 
 
 
 
 
 
 
 
 
Lottery Systems
 
Ÿ Providing lottery systems, including equipment, software, data communication services and support
 
Ÿ GLB—50% equity interest in a provider of lottery systems and services for the China Welfare Lottery
 
 
Ÿ Providing instant game validation systems
 
 
 
 
Ÿ Providing software, hardware and related services for sports wagering and keno systems
 
 
 
 
 
 
 
The types of products and services from which each segment derives its revenues are discussed in Note 1 (Description of the Business and Summary of Significant Accounting Policies). Certain financial information relating to our segments, including revenue, operating income (loss) and total assets for the last three fiscal years and revenue and assets in the U.S. and other geographic areas is included in Note 2 (Business and Geographic Segments). Risks related to our international operations are described under the heading "Risk Factors" in Item 1A of this Annual Report on Form 10-K.
Instant Products
Our Instant Products segment is primarily comprised of our global instant lottery games business. We generate revenue from the manufacturing and sale of instant lottery games, 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 believe these services help lotteries effectively manage and support their operations, achieve higher retail sales and lower operating costs. We also provide licensed games and promotional and interactive marketing service to the lottery industry.

7


In 1974, we introduced the first secure instant lottery game ticket. We believe we are the leading designer, manufacturer and distributor of instant lottery games in the world. We market instant lottery games and related services to U.S. and international lotteries and commercial customers. We supply instant lottery games to 40 of the 44 U.S. jurisdictions that sell instant lottery games and have sold instant lottery games to customers in approximately 50 countries. Our U.S. instant lottery game 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 games on a price-per-unit or participation basis. Certain of our international customers purchase instant lottery games as needed rather than under multi-game supply contracts.
Some of our contracts bundle the design and manufacturing of instant lottery games, instant game management systems and marketing and other services, such as the design and installation of game management software, inventory and distribution, sales, accounting, training and advisory services, market research, and retailer training and recruitment. We are typically paid on a participation basis under these contracts.
We operate five instant lottery game printing facilities across four continents (including the facility owned by CSG) with an aggregate capacity to print in excess of 46 billion 2" by 4" equivalent standard instant lottery tickets annually. Our instant lottery tickets 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 in the industry. Instant lottery tickets generally range in size from 2" by 3" to as large as 8" by 12".
The technology and security capabilities necessary to manufacture and service instant lottery games continue to separate our business from conventional forms of printing. We believe we are generally recognized within the lottery industry as the leader in applying computer-based technologies to the manufacturing and sale of instant lottery games. In order to maintain our position as a leading innovator within the lottery industry, we intend to continue to invest in the development of new technologies for instant lottery games and systems.
We provide lotteries with access to some of the world's most popular entertainment brands on lottery products, which we believe helps increase our customers' instant game sales. Our licensed entertainment brands include Harley-Davidson®, Loteria®, Major League Baseball®, MONOPOLY™, National Basketball Association®, The Price is Right®, Slingo®, and Wheel-of-Fortune®. We also provide branded merchandise, advertising, promotional support, drawing management services and prize fulfillment programs. In addition, we offer lotteries interactive marketing services through our Properties Plus® program which features players clubs, reward programs, second chance promotional websites, interactive games and subscription systems that enable players to purchase lottery games securely over the internet.
We have strategic equity investments in LNS, Northstar Illinois, Northstar New Jersey and Hellenic Lotteries, which entities operate or assist in the operation of lotteries. We are also the primary provider of instant lottery games to LNS and Northstar New Jersey and the exclusive provider of instant lottery games to Northstar Illinois. We will also be the primary instant lottery game provider to Hellenic Lotteries once operations commence, which is expected to occur during the first half of 2014. Additional information regarding these equity investments is included in Note 11 (Equity Investments).
Lottery Systems
We are a leading provider of customized computer software, software support, equipment and data communication services to lotteries. In the U.S., we typically provide equipment, software and maintenance services on a participation basis pursuant to long-term contracts that typically have an initial term of at least five years. Our U.S. contracts typically contain multiple renewal options that generally have been exercised by our customers in the past. Internationally, we typically sell point-of-sale terminals and/or computer software to lotteries and may provide ongoing fee-based systems and software support services.
Our lottery systems use proprietary technology that facilitates high-speed processing of draw lottery game wagers as well as validation of winning draw and instant lottery games. Our lottery systems business includes the supply of proprietary transaction-processing software, draw lottery games, keno, point-of-sale terminals, central site computers and communication platforms as well as ongoing operational support and maintenance services. We have contracts to operate lottery systems for 10 of the 45 U.S. jurisdictions that operate draw lotteries. In addition, we have a contract with the manager of the Indiana lottery to operate the lottery system in the state of Indiana. We believe we are the second largest supplier of lottery systems in the U.S. and a leading supplier in Europe. Internationally, we have lottery systems operating in Canada, China, France, Germany, Hungary, Iceland, Israel, Italy, Latvia, Mexico, Norway, the Philippines, Spain and Switzerland. We are the exclusive provider of instant game validation services to the CSL under an agreement that expires in January 2016. For additional information regarding our agreement with the CSL, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations" in Item 7 of this Annual Report on Form 10-K. We have a strategic equity investment in

8


GLB, a provider of lottery systems and services for the China Welfare Lottery. Additional information regarding our equity investment in GLB is included in Note 11 (Equity Investments).
Contract Procurement
Lotteries in the U.S. typically operate under state-mandated public procurement regulations. See further discussion in "Government Regulation" in this Item 1 of this Annual Report on Form 10-K. Lotteries typically select an instant game or online supplier by issuing a RFP, which outlines the products and services to be delivered and related contractual obligations. An evaluation committee frequently comprised of key lottery staff typically evaluates RFP responses based on various criteria, including the quality of product and/or technical solutions, security plan and features, experience in the industry, quality of personnel and services to be delivered, and price. We believe that our product functionality and game content, the quality of our personnel, our technical expertise and our demonstrated ability to help lotteries increase their revenues may give us an advantage relative to our competitors when responding to lottery RFPs in the U.S. However, many lotteries award contracts to the qualified vendor strictly based on their offering the lowest price, regardless of these other factors. Contract awards by lottery authorities are sometimes challenged by vendors that were not selected, which can result in protracted legal proceedings.
Internationally, lottery authorities do not always utilize a formal bidding process, but rather may engage in bilateral negotiations with one or more potential vendors. Our international lottery service contracts typically include automatic renewal provisions and/or do not have specified expiration dates. These service contracts can generally be terminated at any time upon notification by either the customer or us subject to the applicable notice periods.
The table below lists our more significant lottery contracts representing approximately 43% of our combined Instant Products and Lottery Systems revenue. The U.S. lottery industry's 2013 fiscal year generally ended on June 30, 2013. We are the exclusive provider of systems in all such lottery systems contracts and the primary supplier of instant lottery games where noted below. The commencement date of the contract is the date we began generating revenue under such contract, which for our lottery contracts is typically the start-up date. The table below also includes instant or draw lottery game retail sales, if publicly available, for each jurisdiction.
Lottery/Operator
 
Fiscal 2013
State Instant Game
or Lottery Systems
Retail Sales
(in millions)
 
Type of
Contract
 
Commencement
Date of
Current Contract
 
Expiration Date of
Current Contract
(before any exercise
of remaining
renewal options)
 
Current Renewal
Options
Remaining
Instant Products
 
 
 
 
 
 
 
 
 
 
Florida *
 
$
3,029

 
Participation
 
October 2008
 
September 2018
 
None
Georgia *
 
$
2,631

 
Participation
 
September 2003
 
September 2018
 
None
Northstar Illinois *
 
$
1,768

 
Participation
 
July 2011
 
January 2021
 
None
Pennsylvania *
 
$
2,305

 
Participation
 
August 2007
 
August 2015
 
2 one-year
Camelot Group plc (U.K.) (1)
 
$
2,836

 
Participation
 
November 2013
 
January 2023
 
None
Loto-Québec (Canada) (2)
 
$
417

 
Price-per-unit
 
February 2007
 
January 2014
 
None
Loto-Québec (Canada) (3)
 
$
417

 
Price-per-unit
 
February 2010
 
February 2015
 
2 one-year
La Francaise des Jeux (France) (4)
 
N/A

 
Price-per-unit
 
December 2013
 
December 2016
 
3 one-year
LNS (Italy)
 
$
12,178

 
Price-per-unit
 
October 2010
 
September 2019
 
1 nine-year
Lottery Systems
 
 
 
 
 
 
 
 
 
 
Maryland
 
$
1,270

 
Lottery Systems
 
October 2005
 
June 2016
 
None
Pennsylvania
 
$
1,394

 
Lottery Systems
 
January 2009
 
December 2014
 
4 one-year
Puerto Rico
 
$
397

 
Lottery Systems
 
March 2005
 
June 2016
 
None
China Sports Lottery
 
$
2,659

 
Lottery Systems
 
January 2008
 
January 2016
 
None
___________________________________________________________________________________________________________________________________
* Primary supplier
(1)
Camelot Group plc is the lottery operator of the U.K. National Lottery.
(2)
Following the expiration of our contract in January 2014, we have continued to provide instant lottery games to this customer under the previous contract terms. In November 2013, we were awarded a new price-per-unit contract with Loto-Québec that will represent a significantly smaller portion of such customer’s instant lottery game business than the recently expired contract. We understand that a contract has been awarded to one of our competitors for certain categories of instant games that we provided under the recently expired contract.
(3)
Contract for the supply of a special type of games.
(4)
Non-exclusive contract under which the lottery selects the instant game printer on a game-by-game basis.



9


Competition
The instant lottery game business is highly competitive and continues to be subject to intense price-based competition. Our principal instant lottery game competitors in the U.S. are Pollard Banknote Limited and Gtech S.p.A. Except as permitted by the North American Free Trade Agreement with respect to Canada, it is currently illegal to import lottery games into the U.S. from a foreign country. Our business could be adversely affected should additional international competitors in Canada export lottery products to the U.S. or should other international competitors establish instant game printing facilities in the U.S. or Canada to supply the U.S. Internationally, a number of instant lottery game vendors compete with us including the competitors noted above as well as diversified printers in India, China and Latin America. Our principal competitors in the provision of licensed games, promotional entertainment and loyalty or rewards programs to the lottery industry are Alchemy3 LLC, ePrize LLC, Gtech S.p.A., Pollard Banknote Limited and Intralot S.A.
The lottery systems business is also highly competitive and continues to be subject to intense price-based competition. Our principal competitors in this business are Gtech S.p.A., Intralot S.A. and Tattersalls Group. We also compete with various suppliers of lottery system components, such as terminals and computer systems, as well as lottery operators that internally develop their own systems.
As countries liberalize gaming regulations, lotteries may expand their scope by offering sports wagering, gaming machines, internet gaming or other forms of gaming, which may introduce new suppliers that compete with us for lottery customers. In some jurisdictions, the liberalization of gaming regulations has included the privatization or outsourcing of all or a portion of the lottery operations via a competitive bidding process. We believe Camelot Group plc, the Tattersalls Group, Gtech S.p.A. and Intralot, S.A to be among those who may bid on such opportunities.
Lottery Strategy
In our lottery business, we are focused on the following strategies:
Grow Customer SalesA key component of our strategy is to help our customers grow their lottery revenue in a responsible manner, and thereby grow our revenue. We operate a significant portion of our business on a participation basis, where our revenue is based on a percentage of our customers' retail sales. While not directly linked, our revenue from our non-participation basis contracts also depends to some extent on the success of our customers. We employ performance and customer relationship management tools, including our proprietary Marketing Analysis and Planning System, to regularly evaluate performance and identify sales growth opportunities for our customers. 
Enhance ProductsOur lottery game development efforts are focused on delivering new games, features and functionality that maintain advanced security while delivering compelling games to players.  We believe that our database of over 30,000 instant games is the largest in the lottery industry and facilitates the analysis of game attributes and performance that assists us in game development. New lottery game features and functionality are also designed to leverage and promote our library of licensed brands as well as our players clubs, rewards programs and interactive second chance promotional websites.
Develop Sales ChannelsWe seek to develop technologies and processes that drive player traffic while causing minimal disruption to retail outlets, including social retail outlets such as bars and restaurants. Development efforts have recently focused on handheld, gas-pump and other non-traditional validating and vending solutions that may be particularly attractive to large retail chains and convenience outlets (including gasoline station operators) that do not currently sell lottery games.  We have also developed self-service vending machines and other solutions that address retailer-specific conditions, as well as internet subscription services that enable the purchase of lottery games directly from lottery websites.
Manage the Lottery Value ChainWe endeavor to manage as much of our customers’ value chain as possible.  Controlling or influencing the management of games, inventory, logistics, marketing and/or retailer recruitment enables us to leverage our understanding of consumer drivers as well as our extensive experience in the lottery business, to increase retail sales.  Similarly, we pursue lottery out-sourcing and privatization opportunities both domestically and internationally where financially attractive. We recently entered into the Northstar New Jersey joint venture to pursue such opportunities in New Jersey.  
Penetrate New GeographiesWe invest in the pursuit of new international lottery business opportunities, including in jurisdictions serviced by our competitors as well as in jurisdictions without existing lottery operations.  We have recently secured new lottery business in Greece, Panama and the Dominican Republic. Our

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successful long-term partnerships with state-run lottery operators have also resulted in our being asked for guidance on establishing new lotteries and improving underdeveloped lotteries. 
Gaming Industry
The gaming industry is a large and dynamic worldwide marketplace characterized by the rapid development of new technologies, products and game content in both land-based venues and online. Gaming products and services are utilized by a diverse group of customers, including commercial and tribal casinos, riverboat casinos, horse and greyhound racetracks, bars, Jai Alai frontons, truck stops, night clubs, bingo and arcade halls, LBOs and similar venues, as well as interactive customers such as gaming website operators and social gaming players. In addition, U.S. and international lotteries may offer VLTs and other forms of gaming, such as bingo and sports wagering. The rapidly evolving interactive gaming sector includes online real-money gaming and social (non-wagering) gaming and is increasingly focused on products and services that operate on mobile products and platforms.
Our gaming machines are installed in all of the major regulated gaming jurisdictions in the U.S., as well as in approximately 145 international gaming jurisdictions. We believe the installed base of gaming machines in North America is approximately 940,000 units and has been relatively stable over the last few years. Growth of gaming in land-based venues is driven by the expansion of gaming in new and existing jurisdictions, the opening of new casinos, and the expansion of existing casinos. In addition, land-based gaming is significantly impacted by the rate at which casinos replace their gaming machines, which is itself dependent upon a number of factors, including casino customers’ capital budgets. Growth in interactive gaming is driven largely through new channels of distribution, such as the various new types of mobile gaming, and through the expansion of legal online real-money gaming and social gaming websites and portals.  Virtually all sectors of the gaming industry are impacted by changes in economic conditions that impact players’ disposable incomes.
Segment
The following table summarizes the primary business activities and investments included in the Gaming business segment.
Segment
 
Primary Business Activities
 
Strategic Equity Investments
 
 
 
 
 
Gaming
 
Ÿ Selling new and used gaming machines, conversion kits and parts to commercial, tribal and governmental gaming operators
 
Ÿ RCN—29.4% equity interest in a provider of communications services to racing and non-racing customers
 
 
Ÿ Leasing or otherwise providing gaming machines, server-based gaming systems and content to commercial, tribal and governmental gaming operators.
 
Ÿ Sportech—20% equity interest in an operator and supplier of sports pools and tote systems (sold on January 9, 2014)
 
 
Ÿ Providing video lottery central monitoring and control systems and networks for gaming regulators
 
Ÿ ITL—50% equity interest in an entity from which we lease gaming machines and provide them to our customers
 
 
Ÿ Providing interactive services, including social gaming and game content for real-money gaming websites, for both desktop and mobile devices
 
 
 
 
 
 
 
The types of products and services from which the Gaming segment derives its revenues are discussed in Note 1 (Description of the Business and Summary of Significant Accounting Policies). Certain financial information relating to our segments, including segment revenue, operating income (loss) and total assets for the last three fiscal years is included in Note 2 (Business and Geographic Segments). Risks related to our international operations are described under the heading "Risk Factors" in Item 1A of this Annual Report on Form 10-K. Information regarding our equity investments in the Gaming segment is included in Note 11 (Equity Investments).
We generate revenues within our Gaming segment in two principal ways: product sales and services.



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Product sales
Our product sales include the sale of new and used video or mechanical reel gaming machines to casinos, other gaming machine operators and wide-area gaming operators as well as sales of VLTs, conversion kits (including game, hardware or operating system conversions), parts and game content.
Video gaming machines: The majority of our product sales are derived from sales of video gaming machines containing games where casino patrons wager on multiple pay-lines. These gaming machines include our WMS Bluebird®2 , Bluebird xD, Bluebird2e and Blade branded gaming cabinets that combine advanced graphics, digital music and sound effects and secondary bonus games. The primary game feature of our video products is a video screen that simulates traditional mechanical reel spinning action or that provides innovative variations on the movement and play action of the symbols on the video screen, such as our Cascading Reels and Rotating Wild® series.
Mechanical reel gaming machines: Our Bluebird2, Bluebird xD and Bluebird2e and, beginning in March 2014, Blade cabinets include five-reel and three-reel, single-line and multi-line and multi-coin games and feature our Transmissive Reels® technology, which combines traditional mechanical reel spinning technology with video technology in a single gaming machine.
Parts sales, conversion kits, used gaming machines and game content: We sell replacement parts, used gaming machines and hardware, operating system and content conversion kits for our gaming machines.
Services
Our services revenue includes revenue earned from participation games, other services and our interactive business. Participation games are gaming machines provided to customers through service or leasing arrangements in which our revenues are calculated based on: (1) a percentage of net win; (2) fixed daily fees; (3) a percentage of the coin-in; or (4) a combination of a fixed daily fee and a percentage of the coin-in. We categorize our participation gaming machines as (1) WAP and premium participation games and (2) other leased and participation games.
WAP and premium participation games
WAP participation games: WAP participation games are electronically linked gaming machines that are located across multiple casinos within a single gaming jurisdiction, or across Native American gaming jurisdictions. Players across linked gaming machines contribute to and compete for large, system-wide progressive jackpots that are designed to increase gaming machine play for participating casinos by giving the players the opportunity to win a larger jackpot than on a non-WAP gaming machine. We are responsible for funding WAP jackpots. We create WAP games using our proprietary brands and licensed brands such as MONOPOLY™, THE WIZARD OF OZ, SPIDER-MAN, THE LORD OF THE RINGS and WILLY WONKA AND THE CHOCOLATE FACTORY. We operate WAP systems in Arizona, Colorado, Mississippi, Missouri, Nevada and New Jersey, as well as in Native American casinos.
Premium participation games: We offer two types of non-WAP premium participation games: LAP and standalone. LAP games are gaming machines that are located within a single casino and are electronically linked to a progressive jackpot for that specific casino. Our LAP gaming machines feature games using our proprietary brands such as Jackpot Party Progressive®, Life of Luxury® Progressive, Reel ‘em In: Greatest Catch®, Kingdom of the Titans®, and Treasures of the World™, as well as licensed brands such as THE GODFATHER® brand. Our LAP products leverage both exclusive brand names and game play intellectual property, and typically offer players the chance to win multiple progressive jackpots, all of which tend to result in a higher average bet on these games. Net win per gaming machine for LAP games is generally similar to non-linked standalone gaming machines on a casino floor. We also provide certain standalone participation games that are not linked to other gaming machines. Our standalone games feature titles, among others, under the MONOPOLY brand and, in those jurisdictions where we do not operate a WAP system, THE WIZARD OF OZ, THE PRICE IS RIGHT®, CHEERS™, THE GAME OF LIFE™ and KISS® brands. Our standalone participation gaming machines generally feature larger, more elaborate top-boxes and provide game play experiences not possible on a single screen game or on gaming machines that we sell.
Other leased and participation games
We provide wide-area gaming operators, such as LBOs, bingo halls and arcades, a comprehensive package of server-based products and services under long term contracts that typically include gaming machines, remote management of game content and management information, central computer systems, secure data

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communication and field support services. We are typically paid a fee based on net win generated by these gaming machines (subject to certain adjustments as may be specified in a particular contract, including adjustments for taxes and other fees). Our business in this category consists of substantially all of the Company's gaming business prior to the WMS acquisition, which was primarily based in the U.K.
Certain customers lease our multi-game and single-game VLTs, which include video gaming machines, mechanical reel gaming machines and video poker games. Our VLTs may be operated as standalone units or may interface with central monitoring systems operated by government agencies. Our VLTs are typically located in places where casino-style gaming is not the only attraction, such as racetracks, bars and restaurants.
Other services
Customer-owned daily fee games: This category consists of gaming machines for which the customer purchases the base gaming machine and leases the top-box and game theme from us at a lower fixed daily lease payment than if they were to lease the entire gaming machine. Customer-owned daily fee games typically feature a second LCD screen in the top-box that provides additional bonus experiences for the player.
Class II and centrally determined systems: We offer video and mechanical-reel gaming machines and VLTs for Class II and certain VLT markets where the game outcome is determined by a central server system which we provide. These Class II systems primarily operate in Native American casinos in Washington, Florida and Oklahoma. We receive either a fixed daily fee or a percentage of the net win generated by the gaming machines or VLTs connected to the central determination system.
Licensing: We derive revenue from licensing our games and intellectual property to third parties. Methods for determining our license or royalty revenue vary, but are generally based on a fixed amount for each licensed game purchased, placed or shipped in a period, a fixed daily royalty amount for each game or a percentage of the revenue generated by the placement of the games.
Interactive
Our services revenue includes revenue from the provision of interactive gaming products and services for both real-money gaming and social gaming, available via desktop and mobile devices. We earn revenue in two primary ways:
Social Gaming: We host Jackpot® Party Social Casino (“JPSC”) on Facebook®, the Apple® platform, the Android® platform and the Kindle® platform. We earn revenue from the sale of virtual coins, which players can use to play (i.e., spin) our WMS® branded slot games. 
Real-Money Gaming (“RMG”): We serve real-money gaming website operators, primarily in Europe, by offering our games on a revenue share basis. We host our game content on our centrally-located servers (often referred to as remote game servers) that are integrated into the operators’ websites. We typically earn a percentage of the operator’s net gaming revenue generated by the games we host.
Contract Procurement
Our gaming business product sales revenue is generated on an order-by-order basis. Certain of our gaming machines are sold with extended financing payment terms that are typically for a one-year period and, in some cases, up to three years. Except for contracts with our LBO customers, our VLT central monitoring and control systems contracts, and our other leased and participation products, our gaming services revenue contracts can be terminated at any time upon notification by either the customer or us subject to the applicable notice periods. Our interactive social revenue is typically generated from a high volume of one-time transactions, whereas our RMG revenue is generated under agreements with operators that typically have a duration of approximately three years.
Four large bookmakers operate approximately 86% of the LBOs in the U.K. In June 2013, Betfred Group Ltd. (“Betfred”) awarded an exclusive supply contract to one of our competitors that took effect following the expiration of our secondary supply contract with Betfred in December 2013. For the year ended December 31, 2013, our contracts with three of the large U.K. bookmakers represented a significant portion of the gaming service revenue from the Company's server-based gaming business. Our current contract with Ladbrokes plc commenced on October 22, 2013 and is set to expire on March 31, 2019. Our current contract with Gala Coral Group Ltd. commenced on January 1, 2010 and is set to expire on December 31, 2017. The revenue from our VLT central monitoring business is derived from six U.S. and three international customers and no individual contract represents a significant portion of our gaming service revenues.


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Competition
The gaming machine and interactive gaming sectors are highly competitive and are characterized by the continuous introduction of new games, gaming machines and related technologies. We estimate that about 25 companies in the world manufacture gaming machines and VLTs for legalized gaming markets. In the categories of video and mechanical reel gaming machines, we compete primarily with International Game Technology ("IGT"), as well as Ainsworth Game Technology, Aristocrat Leisure Ltd, Aruze Gaming America, Inc., Atronic Casino Technology, a subsidiary of Gtech S.p.A., Bally Technologies, Inc., Franco Gaming Ltd., Inspired Gaming Group Limited, Konami Digital Entertainment, Inc., Multimedia Games, Inc. and the Novomatic Group of Companies. In the VLT category, we compete primarily with Bally, IGT, and Gtech Holdings Corporation and SPIELO International, both subsidiaries of Gtech S.p.A. Our principal direct competitor in our U.K. LBO business is Inspired Gaming Group Limited.
Our interactive gaming products and services primarily consist of social gaming and RMG.  In our social gaming business, our primary competitors are DoubleDown Interactive, a subsidiary of IGT, Caesars Entertainment Corporation, Big Fish Games Inc., Blue Shell Games LLC., High 5 Games and Zynga Inc.  In our RMG business, our primary competitors are Playtech Limited, Net Entertainment, Microgaming Software Systems Ltd., IGT, NYX Gaming Group, High 5 Games and SPIELO International.
Gaming Strategy
In our gaming business, we are focused on the following strategies:
Develop innovative contentWe place great emphasis on producing high performing game content and have content development capabilities across 11 studios located on 4 continents. Substantial emphasis is placed on our Player Driven InnovationTM process which incorporates player feedback and market research into our content development process. We develop, acquire and license intellectual property and advanced technologies that we believe contribute to our development of innovative and appealing games.
Develop new gaming products—We seek to expand our gaming business through the development of new product offerings. In 2013, we developed a mechanical 3-reel spinning Blade cabinet that is expected to launch in March 2014 and our new Clarity gaming machine for our U.K. gaming business, which was launched in February 2014 in the Ladbrokes estate. We also look to diversify our portfolio of gaming products by expanding into adjacent product areas. For example, we have developed a kiosk that provides a secure and reliable cash management system for gaming payment transactions and reporting.
Expand into new geographies and segments while further penetrating existing marketsWe currently serve a variety of operators, including major corporate casinos, Native American casinos, independent gaming and casino operators, and government-owned gaming operators, in substantially all legal gaming markets globally. We are focused on increasing our share with these operators. We are also focused on growing our customer base in new regions and further penetrating existing markets. We recently took over direct sales of our products in Australia and Peru, where we previously worked through distributors, as we believe our direct efforts can expand our share in each of these geographies.
Develop advanced gaming machine platformsOur gaming software platforms are regularly updated to keep pace with the increasing complexity of game play requirements, regulatory requirements and expected future game theme software releases. Our new Blade and Gamefield xD® electronic gaming machines, released in the March 2013 quarter, contain the latest version of our operating system software, the CPU-NXT3 platform. We believe that this advanced platform allows us to develop our most advanced game content.
Expand our regulatory, administrative and CRM systems businessWe are a leading provider of “Command, Monitor & Control Systems” (CMCS) to regulators of wide area gaming environments. We are seeking to leverage these core products and capabilities to provide a wider range of systems solutions to government and commercial operators around the world.
Grow our interactive businessWe supply our content to third party interactive gaming customers and utilize it in our social gaming business. Our interactive gaming customers utilize our content as part of their real-money online gaming offerings. We see additional real-money online gaming opportunities across Europe and North America. In our social gaming business, we utilize our content by marketing it directly to consumers and on a B2B basis for casino customers. Recently, we expanded our JPSC offering with the addition of Goldfish® social casino, a social gaming site now available on Facebook and expected on mobile devices in the second quarter of 2014. We are focused on growing the business by expanding our product offerings, integrating with additional interactive gaming customers in existing and new jurisdictions, and further developing our mobile capabilities.

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Research and Product Development
We believe our ability to attract new lottery and gaming customers and retain existing customers depends in part on our ability to continually develop new innovative games, hardware and functionality to enhance player entertainment. We are also focused on expanding utilization of the internet and other interactive technologies to grow playership. Our gaming machines are usually designed and programmed by our internal engineering staff and game development studios with the input and cooperation of our customers. We believe that many of our innovations have become industry standards.
Our Chicago R&D facility is a state-of-the-art technology campus and houses a large portion of our R&D team. We also have game development studios in Las Vegas, Sydney, Manchester and Pune, with additional R&D staff in other locations, including Atlanta, Reno and Vienna. Each of our game development studios works concurrently on multiple games and is staffed with producers, software developers, graphic artists, mathematicians, composers and game designers. During the years ended December 31, 2013, 2012 and 2011, we incurred R&D expense of $26.0 million, $6.6 million and $6.1 million, respectively.
Intellectual Property
Many of our products utilize intellectual property rights, including trademarks, copyrights and patents.  We consider a number of our U.S. and international patents to be, in the aggregate, material to our business. The terms of our patents vary based on the date and jurisdiction of filing. The term of U.S. patents generally expires 20 years from the date of filing. The actual protection afforded by a patent depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the applicable country. Certain technology which is material to our lottery, gaming and interactive systems, gaming machines and processes is the subject of patents issued and patent applications currently pending in the U.S. and certain other countries. Our lottery business utilizes our patented and patent-pending technology in the production, secure printing, validation and distribution of instant lottery games. Our gaming and interactive businesses utilize our patented and patent-pending technology in games and associated platforms and systems. In addition, we patent and license game content as part of our licensed properties and gaming businesses. Our patents have various expiration dates through about 2033.
We market many of our products under trademarks and copyrights that provide product recognition and promote our portfolio of product offerings. We generally register our copyrights. In addition, we generally seek to register our trademarks for the names or symbols under which we market and license our significant products and game concepts.  Protection for trademarks exist in many countries, including the U.S., for as long as the trademark is registered and/or used.  Registrations are generally issued for fixed, but renewable terms, although trademark rights may exist whether or not a mark is registered.
We believe that our use of licensed brand names and related intellectual property contributes to the appeal and success of our products, and that our future ability to license, acquire or develop new brand names is important to our continued success. Therefore, we continue to invest in the recognition of our brands and brands that we license. Certain of our games are based on popular brands licensed from third parties, such as Hasbro International, Inc., Fremantle Media North America, CBS Studios Inc., Turner Entertainment Co., Warner Bros. Consumer Products Inc., Harley-Davidson, Major League Baseball and National Basketball Association. Brand license terms typically obligate us to make minimum guaranteed royalty payments over the duration of the license period and to make advance payments against those commitments. Licensors also typically have the right to inspect and approve the use of licensed property.
The following three licensed technologies from two separate parties are utilized in substantially all of our gaming machine products:
Several of our competitors have pooled their intellectual property patents relating to cashless gaming capabilities, specifically "ticket-in ticket-out" technology, which enables casino patrons to cash out from a gaming machine and receive a printed ticket instead of coins. We have a non-exclusive, royalty-bearing license for certain patents related to this technology with IGT through the expiration date of the relevant patents. Royalties related to product sales are passed through to our customers.
The original operating system for our Bluebird gaming machines, the CPU-NXT platform, was developed in 2003 by Sierra Design Group Inc., which is now owned by Bally Technologies, Inc. We have a perpetual license to use this technology with no continuing royalty obligation for this license. Our CPU-NXT2 and CPU-NXT3 operating systems were developed internally and are based on the CPU-NXT platform.
In February 2008, we entered into a ten-year non-exclusive, royalty-bearing patent cross-license agreement with IGT. This agreement provides for a cross-license of intellectual property evidenced by certain patents owned by each of us relating to computing and networked gaming infrastructures.
From time to time we become aware of potential infringement of our intellectual property by competitors and other

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third parties and consider what action, if any, to take in that regard, including litigation where appropriate. We are also subject to threatened or actual intellectual property-related claims by third parties from time to time. See "Legal Proceedings" in Item 3 of this Annual Report on Form 10-K.
Production Processes, Sources and Availability of Components
Our dedicated computer-controlled printing process is specifically designed to produce secure instant lottery games for government-sanctioned lotteries. Our facilities support high-speed variable image printing, packaging and distribution of instant lottery games and capability to track instant scratch games from the point of production through delivery to retailers. Instant lottery games are delivered finished and ready for distribution by the lottery authority (or by us under certain contracts). An instant lottery game that has been removed at any point in the distribution chain in an unauthorized manner can be flagged and invalidated in the event that it is used to claim winnings. Paper and ink are the principal raw materials consumed in our instant lottery manufacturing operations.
Production of our lottery terminals (and related component products) primarily involves the assembly of electronic and mechanical components into more complex systems and products. Third-party vendors generally manufacture and assemble our lottery terminals. We normally have sufficient lead time between reaching an agreement and the commencement of operations so that we are able to provide our lottery customers with a fully functioning system that is customized to meet their requirements. The lead time for obtaining most of the electronic components that we use is approximately 90 days. We believe that this is consistent with our competitors' lead times and is also consistent with the needs of our customers. We place advance orders for those components that have long lead times in anticipation of firm purchase orders from our customers, provided that the investment in inventory and the risk of the customer order not materializing are deemed acceptable.
We currently produce substantially all of our gaming machines at our facility in Waukegan, Illinois. We also have finishing lines in our Las Vegas and Barcelona offices, as well as in Sydney, Midrand, South Africa and Buenos Aires. These finishing lines allow for the completion and testing of our gaming machine assemblies from our facility in Waukegan. We also refurbish used gaming machines at our Las Vegas facility. Manufacturing commitments are generally based on expected quarterly sales orders from customers. Due to uneven order flow from customers, component parts common to all gaming machines are purchased and assembled into partial products that are inventoried to be able to quickly fill final customer orders. Our manufacturing processes generally consist of assembling component parts and sub-assemblies into a complete gaming machine.
The raw materials used in manufacturing our lottery terminals, and gaming machines include various metals, plastics, wood, glass and numerous component parts, including electronic subassemblies, computer boards and LCD screens. We believe that our sources of supply of component parts and raw materials are generally adequate.
Seasonality
Our results of operations can fluctuate due to seasonal trends and other factors. Sales of our gaming machines to casinos are generally strongest in the spring and slowest in the summer, while service revenue from our participation gaming machines is generally strongest in the spring and summer. In general, land-based gaming machine play levels are highest in the spring and summer months and lower in the fall and winter months. See the risk factor captioned "-Our results of operations fluctuate due to seasonality and other factors and therefore, our periodic operating results are not guarantees of future performance." under the heading "Risk Factors" in Item 1A of this Annual Report on Form 10-K for additional information.
Employees
As of December 31, 2013, we employed approximately 5,200 persons worldwide, with 3,300 employed domestically and 1,900 employed internationally.
Government Regulation
General
Lotteries and other forms of gaming are generally subject to extensive and evolving regulation that customarily includes some form of licensing or regulatory screening of operators, suppliers, manufacturers and distributors and their applicable parents, affiliates and subsidiaries, as well as their major shareholders, officers, directors and key employees. In addition, certain of our gaming products and technologies must be certified or approved in certain jurisdictions where we operate. Regulators review many facets of an applicant or holder of a license, including its financial stability, integrity and business experience. Any failure to receive a license or the loss of a license that we currently hold could have a material adverse effect on us or on our results of operations or financial condition.

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While we believe that we are in substantial compliance with all material lottery and gaming laws and regulatory requirements applicable to us, there can be no assurance that our activities or the activities of our customers will not become the subject of any regulatory or law enforcement proceeding or that any such proceeding would not have a material adverse impact on us or our operations or financial condition.
We have developed and implemented a rigorous internal compliance program in an effort to ensure that we comply with legal requirements imposed in connection with our lottery and gaming activities, as well as legal requirements generally applicable to all publicly traded companies. The compliance program is run on a day-to-day basis by our chief compliance officer with legal advice provided by attorneys in our legal and compliance departments as well as outside experts. The compliance program is overseen by the compliance committee of our board of directors, which is comprised entirely of non-employee directors. While we are firmly committed to full compliance with all applicable laws, there can be no assurance that our compliance program will prevent the violation of one or more laws or regulations, or that a violation by us or an employee will not result in the imposition of a monetary fine or suspension or revocation of one or more of our licenses.
In the European Union, various judgments by the Court of Justice of the European Union (CJEU) have addressed the approaches adopted by certain member states to restrict and/or regulate gaming.  Topics addressed in those judgments include: the ability of member states to grant, or to maintain, monopolies for lottery and other gaming activities and the power of a member state to limit access by lottery and/or gaming providers established elsewhere in the European Union. Several cases on these subjects are currently pending in the CJEU.
While we believe that we have developed the proper procedures and policies to comply with the requirements of these evolving laws and legal pronouncements, there can be no assurance that our activities or the activities of our customers will not become the subject of law enforcement proceedings or that any such proceedings would not have a material adverse impact on us or our business plans.
Furthermore, laws and regulations applicable to lotteries and gaming in U.S. and international jurisdictions are subject to change, and the effect of such changes on our ongoing and potential operations cannot be predicted with certainty.
From time to time, we retain government affairs representatives in various U.S. and international jurisdictions to advise elected and appointed officials and the public concerning our views on lottery and gaming-related legislation, as well as to monitor such legislation and to advise us in our relations with lottery and gaming authorities.
Lottery
Forty-five U.S. jurisdictions, all the Canadian provinces, Mexico, China and many other countries outside the U.S., including countries in Europe, currently authorize lotteries. The operations of lotteries in the U.S. and internationally are subject to extensive regulation. Although certain features of a lottery, such as the percentage of gross revenues that must be paid back to players in prize money, are usually set by legislation, lottery regulatory authorities generally exercise significant discretion, including with respect to the determination of the types of games played, the price of each wager, the manner in which the lottery is marketed and the selection of suppliers of equipment, technology and services and retailers of lottery products.
To ensure the integrity of contract awards and lottery operations, most jurisdictions require detailed background disclosure on a continuous basis from, and conduct background investigations of, vendors and their officers, directors, subsidiaries, affiliates and principal stockholders. Background investigations of the vendors' employees who will be directly responsible for the operation of lottery systems are also generally conducted, and most states reserve the right to require the removal of employees who they deem to be unsuitable or whose presence they believe may adversely affect the operational security or integrity of the lottery. Certain jurisdictions also require extensive personal and financial disclosure and background checks from persons and entities beneficially owning a specified percentage (typically five percent or more) of a vendor's securities. The failure of such beneficial owners of our securities to submit to background checks and provide such disclosure could result in the imposition of penalties upon these beneficial owners and could jeopardize the award of a lottery contract to us or provide grounds for termination of an existing lottery contract.
The award of lottery contracts and ongoing operations of lotteries in international jurisdictions are also extensively regulated, although international regulations typically vary from those prevailing in the U.S. Restrictions are frequently imposed on foreign companies seeking to do business in such jurisdictions and, as a consequence, we have in a number of instances allied ourselves with local companies when seeking international lottery contracts.
Gaming
We sell our games and gaming machines in legal gaming jurisdictions worldwide. The manufacture and distribution of gaming machines and related hardware and software is subject to regulation and approval by various city, county, state,

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provincial, federal, tribal and foreign agencies. The primary purposes of these rules are to (1) ensure the responsibility, financial stability and character of the parties involved in these activities through licensing requirements, (2) ensure the integrity and randomness of the machines and (3) prohibit the use of gaming machines at unauthorized locations or for the benefit of undesirable parties.
Typically, gaming regulations in the jurisdictions in which operate are established by statute and are administered by a regulatory agency with broad authority to interpret gaming regulations and to regulate gaming activities. Among other things, gaming authorities in the various jurisdictions in which we are licensed:
adopt additional rules and regulations under the implementing statutes;
investigate violations of gaming regulations;
enforce gaming regulations and impose disciplinary sanctions for violations of such laws, including fines, penalties and revocation of gaming licenses;
review the character and fitness of participants in gaming machine manufacturing and distribution and make determinations regarding their suitability or qualification for licensure;
grant licenses for gaming machine manufacturing and distribution;
review and approve transactions (such as acquisitions, material commercial transactions, securities offerings and debt transactions) engaged in by such participants; and
establish and collect related fees and/or taxes.
We believe we hold all of the licenses and permits necessary to conduct our business. In all, we are authorized to sell or lease our gaming machines in approximately 395 jurisdictions worldwide (including jurisdictions that do not require licensing), including approximately 145 international gaming jurisdictions.
In addition, 16 U.S. states authorize wagering on VLTs at state regulated and licensed facilities. Although some states restrict VLTs to already existing wagering facilities (e.g., racetracks), others permit these machines to be placed at venues such as bars, restaurants, truck stops and other specifically licensed gaming facilities. In addition, all of the Canadian provinces and various other international jurisdictions have authorized VLTs.
Regulatory requirements vary among jurisdictions, but the majority of jurisdictions require licenses, permits or findings of suitability for our company, individual officers, directors, major stockholders and key employees. Our gaming hardware and software also must be approved either by a gaming authority laboratory or a private laboratory authorized by the gaming authority.
Interactive
In the United States, the Unlawful Internet Gambling Enforcement Act of 2006 ("UIGEA") prohibits among other things, the transmission of any wager by means of the internet where such wager is prohibited by any applicable law where initiated, received or otherwise made. UIGEA imposes potentially severe criminal and civil sanctions on the owners and operators of such systems and on financial institutions that process wagering transactions. The law contains a safe harbor for wagers placed within a single state (disregarding intermediate routing of the transmission) where the method of placing the bet and receiving the bet is authorized by that state's law, provided the underlying regulations establish appropriate age and location verification.
Within the past year, state-authorized internet casino gaming has been launched in Delaware and New Jersey and state authorized internet poker has been launched in Nevada. A number of other states are also considering adopting legislation to specifically authorize internet gaming or internet poker. Additionally, one state lottery has recently commenced offering internet instant lottery game sales and other lotteries are considering offering internet instant game sales to in-state lottery customers.
    However, there have been various bills proposed recently in the U.S. to restrict or prohibit internet gaming and lottery sales. Significant resources are being devoted to supporting these efforts. Although these efforts have generally not been successful, there can be no assurance that laws restricting internet gaming or lottery sales will not be passed at either the federal or state level.
To varying degrees, a number of European governments have taken steps to change the regulation of internet wagering through the implementation of new or revised licensing and taxation regimes, some of which include the imposition of sanctions on unlicensed providers.

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Countries outside Europe and the U.S. have also begun evaluating internet gaming regulation and an increase in regulated markets outside of the U.S. and Europe is likely to continue.
We continue to devote significant attention to monitoring these developments. However, we cannot predict the timing, scope or terms of any state, federal or foreign regulations relating to internet gaming and lottery sales.
Additional Information Regarding Government Regulations
As the gaming regulations of many jurisdictions are similar and we operate in a large number of jurisdictions, we are not including descriptions of the specific gaming requirements in the different jurisdictions in which we operate. For additional information, we have filed a summary of the gaming regulations that govern our businesses as an exhibit to this Annual Report on Form 10-K, see Exhibit 99.9 “Gaming Regulations.” In addition, see "Risk Factors" in Item 1A of this Annual Report on Form 10-K for a discussion of risk factors related to gaming and lottery regulations to which we may be subject.
Executive Officers of the Company
Certain information regarding each of our executive officers is set forth below.
Name
 
Age
 
Position
David L. Kennedy
 
67
 
President and Chief Executive Officer
Jeffrey S. Lipkin
 
43
 
Senior Vice President and Chief Financial Officer
James C. Kennedy
 
57
 
Executive Vice President and Group Chief Executive of Lottery
William J. Huntley
 
64
 
Executive Vice President and Group Chief Executive of Gaming
Steve W. Beason
 
52
 
Enterprise Chief Technology Officer
Andrew E. Tomback
 
53
 
Senior Vice President and General Counsel
Larry A. Potts
 
66
 
Vice President, Chief Compliance Officer and Director of Security
Jeffrey B. Johnson
 
49
 
Vice President, Finance, and Chief Accounting Officer
David L. Kennedy was appointed to the position of President and Chief Executive Officer of the Company in November 2013. Mr. Kennedy continues to serve as Vice Chairman of the Board, a position he has held since October 2009. Mr. Kennedy served as an executive of the Company from November 2010 until March 2012, including as Chief Administrative Officer from April 2011 until March 2012. Mr. Kennedy also serves as Vice Chairman of the Board of Revlon, Inc. and is a director of Revlon Consumer Products Corporation. Mr. Kennedy has held senior executive positions with MacAndrews & Forbes Holdings, Inc., Revlon, Inc. and The Coca-Cola Company and affiliates during his 40-year business career.
Jeffrey S. Lipkin serves as Senior Vice President, Chief Financial Officer of the Company, a position he has held since joining the Company in April 2009. Prior to joining the Company, Mr. Lipkin was a Managing Director at Credit Suisse in the Media & Telecom group within the Investment Banking division. Mr. Lipkin joined Credit Suisse in September 2003. Prior to Credit Suisse, Mr. Lipkin spent five years in the Investment Banking division at Merrill Lynch & Co and spent four years in public accounting with Coopers & Lybrand LLP. Mr. Lipkin is a certified public accountant.  
James C. Kennedy has served as Executive Vice President and Group Chief Executive of Lottery since September 2013. Prior to this role, Mr. Kennedy served as President of Printed Products and Chief Marketing Officer. From 2005 to 2011, Mr. Kennedy served as Senior Vice President of SGI, and prior to that, Mr. Kennedy served as Vice President of U.S. Sales for SGI. Prior to joining the Company in 1985, Mr. Kennedy was a Systems Engineer for Computer Task Group.
William J. Huntley has served as Executive Vice President and Group Chief Executive of Gaming since September 2013. Prior to this role, Mr. Huntley served as Executive Vice President and Chief Executive Officer, Systems, from January 2013 to September 2013 and President of Lottery Systems from January 2011 to January 2013. From February 2009 to December 2010, Mr. Huntley served as a consultant to the Company. Prior to that, Mr. Huntley served as President of Scientific Games Racing, LLC from 2006 to 2007, and President of the Systems Division of SGI from 2000 to 2006. Prior to that, Mr. Huntley served in various roles at Scientific Games and Autotote Corporation (which merged into SGI) since 1973.
     Steve W. Beason serves as Enterprise Chief Technology Officer. Mr. Beason served as Chief Technology Officer from August 2005 to January 2011 and President, Lottery Systems Group, from November 2006 to November 2010. Prior to joining the Company, Mr. Beason was Executive Director, Information Technology, of The Hong Kong Jockey Club managing a staff of nearly 400 information technology professionals.

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Andrew E. Tomback joined Scientific Games as the Senior Vice President and General Counsel in December 2013.  Prior to joining the Company, Mr. Tomback was a partner at Zuckerman, Spaeder LLP, where he was a litigator in the firm’s New York office.  Previously, he was a partner for 14 years at Milbank, Tweed, Hadley and McCloy LLP.  Prior to entering private practice, Mr. Tomback was Deputy General Counsel of the Resolution Trust Corporation, Senior Advisor to Treasury Secretary Lloyd Bentsen, and an Assistant U.S. Attorney in the Criminal Division of the U.S. Attorney’s Office for the Southern District of New York.
Larry A. Potts has served as Vice President, Chief Compliance Officer and Director of Security since February 2006. Mr. Potts joined the Company in September 2004 as Vice President, Security and Compliance. Previously, he was the Chief Operating Officer of an international consulting and investigative company in Washington, D.C. Prior to that, he served as a Special Agent of the Federal Bureau of Investigation for over 23 years, where he served in a number of management positions, including Deputy Director.
Jeffrey B. Johnson joined the Company in September 2011 and serves as Vice President of Finance and Chief Accounting Officer. Previously, Mr. Johnson was the Executive Vice President and Chief Financial Officer for Tensar Corporation, a global engineering services and construction products manufacturing company. Prior to that, he served as Vice President, Corporate Controller and Chief Accounting Officer for Tempur-Pedic International Inc., a publicly traded consumer products company. Prior to 1999, Mr. Johnson was a Manager of Audit and Business Advisory Services at Andersen LLP. Mr. Johnson is a certified public accountant and a certified management accountant.
Access to Public Filings
We file annual reports, quarterly reports, current reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934, as amended. Copies of any materials we file with the SEC are also available at the SEC’s Public Reference Room at 100 F Street, N.E. Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov.
We make the following information available free of charge through the Investors link on our website at www.scientificgames.com:
our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after they are filed electronically with the SEC;
Section 16 ownership reports filed by our executive officers, directors and 10% stockholders on Forms 3, 4 and 5 and amendments to those reports as soon as reasonably practicable after they are filed electronically with the SEC; and
our code of business conduct, which applies to all of our officers, directors and employees.

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ITEM 1A.    RISK FACTORS
The risks described below are not the only risks facing us. Please be aware that additional risks and uncertainties not currently known to us or that we currently deem to be immaterial could also materially and adversely affect our business operations. You should also refer to the other information contained in our periodic reports, including the Forward-Looking Statements section, our consolidated financial statements and the related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations for a further discussion of the risks, uncertainties and assumptions relating to our business. Except where the context otherwise indicates, references below to "we," "our," "ours," and "us" includes our subsidiaries, including WMS.
Risks Relating to our Business and Industry
We operate in highly competitive industries and our success depends on our ability to effectively compete with numerous domestic and foreign businesses.
We face significant competition as we seek to offer products and services in our traditional lottery and gaming businesses and in the evolving interactive lottery and interactive gaming industries, not only from our traditional competitors but also from a number of other domestic and foreign providers (or, in some cases, the operators themselves), some of which have substantially greater financial resources and/or experience than we do. In addition, we cannot assure you that our products and services will be successful or that we will be able to attract and retain players as our products and services compete with other offerings, which may impact our profitability.
Lottery
Our lottery business faces competition from a number of domestic and foreign businesses, some of which have substantially greater financial resources than we do, which impacts our ability to win new contracts and renew existing contracts. We continue to operate in a period of intense price-based competition, which has affected and could continue to affect the number and the profitability of the lottery contracts we win.
Contract awards by lottery authorities are sometimes challenged by unsuccessful bidders through costly and protracted legal proceedings that can result in delayed implementation or cancellation of awards. In addition, the U.S. lottery industry has matured such that the number of states conducting lotteries is unlikely to increase materially in the near-term.
We believe our principal competitors in the instant lottery game business have increased their production capacity, which has increased, and is expected to continue to increase, pricing pressures in the instant lottery game business, which may adversely affect our ability to win or renew instant lottery game contracts or may reduce the profitability of instant lottery game contracts that we do win. We also compete in the international instant lottery game business with low-price, low-quality printers in a regulated environment where laws are being reinterpreted so as to create competition from non-traditional lottery vendors and products. Our U.S. instant lottery game business could be adversely affected if additional foreign competitors operating in Canada export their lottery products to the U.S. if other foreign competitors establish printing facilities in the U.S. or Canada to supply the U.S.
We face increased price competition in our lottery systems business from our two principal competitors. Since late 2007, we have lost lottery systems contracts to our competitors following the expiration of those contracts in South Carolina, West Virginia, South Dakota, New Hampshire, Vermont and Colorado, as well as with the Atlantic Lottery Corporation.
As some jurisdictions seek to privatize or outsource lottery operations (including partial privatizations through private management agreements or otherwise), we face competition from both traditional and new competitors with respect to these opportunities. Our lottery systems contract with the Indiana lottery was terminated in 2013 in connection with the award of a private management agreement to one of our competitors. In some cases, we may find it necessary or desirable to enter into strategic relationships with third parties, including competitors, to pursue these opportunities.
Pricing pressures and privatization of some lotteries may also change the manner in which lottery system and instant lottery game contracts are awarded and the profitability of those contracts. Any future success of our lottery business will also depend, in part, on the success of the lottery industry in attracting and retaining players in the face of increased competition for these players' entertainment dollars, as well as our own success in developing innovative products and systems to achieve this goal. Our failure to achieve this goal could reduce our revenue from our lottery operations. Additionally, pressure on state and other government budgets could lead to other forms of gaming being legalized, which could adversely impact our lottery business.

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Gaming
Our gaming business faces significant competition, including from illegal operators. We compete on price, pricing models, financing terms and the content, features, quality and functionality of our gaming products and services. The consolidation of casino operators and reduction in capital expenditures by casino operators resulting from the economic downturn and decreased player activity have significantly increased the level of competition among both casino operators and gaming machine providers. Although the expansion of land-based gaming increases demand for our gaming products, new casinos that open in certain jurisdictions compete with our existing casino customers for players, which may reduce our customers’ income and therefore decrease the capital available to them for purchasing our products. This increased competition for players among casinos has also led casino customers to increasingly focus on price in addition to performance, longevity and player acceptance when selecting gaming machines. Casinos also consider game performance when making their purchasing decisions. Game performance can be impacted by the number and placement of gaming machines on the casino floor. Therefore, we also compete to obtain space and favorable placement on casino gaming floors. Competitors with a larger installed base of gaming machines and more game themes than ours have an advantage in obtaining and retaining the most space and best positions in casinos. However, we also face competition from the increased number of small gaming equipment companies that have emerged in the gaming space in recent years. These small gaming equipment companies may focus their resources on developing a smaller number of high-performing products than we do, may offer more favorable pricing or financing to customers, and may offer customers gaming machines on a trial basis more frequently than we do, any of which could give them a competitive advantage.
Under certain circumstances, we have offered customers free conversion kits (and, in some cases, free gaming machines) in connection with the sale of new gaming machines or the placement of participation gaming machines. There can be no assurance that competitive pressure will not cause us to increase the number of free conversion kits or free gaming machines that we offer to our customers, which would decrease our expected margins.
Our casino gaming business expanded the use of extended payment term financing for gaming machine purchases and we expect to continue providing a higher level of extended payment term financing in this business until the economy improves and demand for such financings abates. We believe that our competitors have also increased the amount of extended payment term financings offered to customers. Our competitors may provide a greater amount of financing or better terms than we do and this may impact demand for our gaming machines.
In addition, some of our competitors have developed and sell or otherwise provide centralized player tracking and accounting systems to casino customers, which allows those customers to accumulate accounting and performance data about the operation of gaming machines. As we do not currently offer these systems, we may be at a competitive disadvantage.
Our interactive social gaming and interactive RMG businesses are also subject to significant competition. The interactive side of our business focuses on the supply of game content to online casino operators, and there are a number of competitors in that industry. Additionally, as we have expanded into interactive social gaming, several of our competitors and other companies have also introduced social gaming offerings and we anticipate that more companies will explore this opportunity in the future. In order to stay competitive in both our interactive social gaming and real money gaming businesses, we will need to continue to create game content that attracts players and invest in new and emerging technologies.
Unfavorable U.S. and international economic conditions may adversely affect our business and financial condition.
Unfavorable economic conditions, including recession, economic slowdown and relatively high rates of unemployment, have had, and may continue to have, a negative effect on our business and results of operations. We cannot fully predict the effects that unfavorable economic conditions and economic uncertainty will have on us as they also impact our customers, suppliers and business partners.
In our lottery business, we believe that the difficult economic conditions have contributed to reductions in spending on marketing by our customers and, in certain instances, less favorable terms under our contracts, as many of our customers face significant budget shortfalls and seek to cut costs.
In our gaming business, especially our participation business, our revenues are driven in large part by players’ disposable incomes and level of gaming activity. Unfavorable economic conditions have reduced the disposable incomes of casino patrons and resulted in fewer patrons visiting casinos and lower amounts spent per casino visit. A further or extended decline in disposable income could result in reduced play levels on our participation gaming machines, causing our cash flows and revenues from these products to decline. Additionally, higher airfares, gasoline prices and other costs may adversely affect the number of players visiting our customers’ casinos. A decline in play levels may also negatively impact the cash flows of our casino customers and their ability to purchase our products and services. Unfavorable economic conditions may result in volatility in the credit and equity markets. The difficulty or inability of our customers to generate or obtain adequate levels of capital to finance their ongoing operations may reduce their ability to purchase our products and services.

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Current unfavorable economic conditions have impacted, and could continue to impact, the ability of our customers to make timely payments to us. In addition, continued unfavorable conditions could cause some of our gaming customers to ultimately declare bankruptcy, which would adversely affect our business. In recent years, our casino gaming business expanded the use of extended payment term financing for gaming machine purchases and we expect to continue providing a higher level of extended payment term financing in this business until demand from our customers for such financings abates. These financing arrangements may increase our collection risk and, if customers are not able to pay us, whether as a result of financial difficulties, bankruptcy or otherwise, we may incur provisions for bad debt related to our inability to collect certain receivables. In addition, both extended payment term financing and operating leases result in a delay in our receipt of cash, which reduces our cash balance, liquidity and financial flexibility to respond to changing economic events.
There are ongoing concerns regarding the debt burden of certain countries, particularly in Europe and South America, and their ability to meet their future financial obligations, which have resulted in downgrades of the debt ratings for these countries. We currently operate in, and our growth strategy may involve pursuing expansion or business opportunities in, certain of these countries, such as Italy and Greece. These sovereign debt concerns, whether real or perceived, could result in a recession, prolonged economic slowdown, or otherwise negatively impact the general health and stability of the economies in these countries or more broadly. In more severe cases, this could result in a limitation on the availability of capital, thereby restricting our liquidity and negatively impacting our operating results.
Our future profits may be negatively impacted by the slow growth of new gaming jurisdictions or slow addition of casinos in existing jurisdiction and by, declines in the replacement cycle of gaming machines.    
Demand for our gaming products is driven by the establishment of new land-based or online gaming jurisdictions, the opening of additional casinos in existing jurisdictions, the expansion of existing casinos and the replacement of existing gaming machines in existing casinos. The opening of new casinos and expansion of existing casinos fluctuates with demand, economic conditions, regulatory approvals and the availability of financing. In addition, the expansion of gaming into new jurisdictions can be a protracted process. In the U.S., governments usually require a public referendum and legislative action before establishing or expanding gaming, whether in a land-based or online capacity. Any of these delays and challenges could delay, restrict or prohibit the expansion of our gaming operations and negatively impact our future profits.
Over the years, due to the economic slowdown, the replacement cycle for gaming machines has grown longer. Low levels of demand for gaming machine replacements could reduce the demand for our products and negatively impact our future profits.
Our future profits may be negatively impacted by ownership changes and consolidation in the casino industry.
As repeat customers represent a substantial part of our revenues in our casino gaming business, our business and profits could be affected if our casino customers are sold to or merge with other entities. Such entities may purchase more products and services of our competitors, reduce spending on our products, or cause downward pricing pressures. Consolidation among casino operators could result in order cancellations, a slowing in the replacement cycle for existing gaming machines, or require our current customers to purchase our competitors’ products, any of which could negatively impact our gaming business.
Gaming opponents persist in their efforts to curtail the expansion of legalized gaming, which, if successful, could limit the growth of our operations.
There is significant debate over, and opposition to, gaming (both land-based and interactive). There can be no assurance that this opposition will not succeed in preventing the legalization of gaming in jurisdictions where it is presently prohibited, prohibiting or limiting the expansion of gaming where it is currently permitted or causing the repeal of legalized gaming in any jurisdiction. Any successful effort to curtail the expansion of, or limit or prohibit, legalized gaming could have an adverse effect on our business, financial condition, results of operations or prospects.
Our success is dependent upon our ability to adapt to and offer products that keep pace with evolving technology related to our businesses.
The success of our products and services is affected by changing technology and evolving industry standards. Our ability to anticipate or respond to such changes and to develop and introduce new and enhanced products and services, including, but not limited to, games, gaming machines and interactive lottery and interactive gaming products and services, on a timely basis or at all is a significant factor affecting our ability to remain competitive, retain existing contracts or business, expand and attract new customers and players. There can be no assurance that we will achieve the necessary technological advances or have the financial resources needed to introduce new products or services on a timely basis or at all or that we will otherwise have the ability to compete effectively in the industries we serve.

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In our gaming business, our success depends upon our ability to adapt our manufacturing capabilities and processes to meet the demands of producing new and innovative products. Because our newer products are generally more technologically sophisticated than those we have produced in the past, we must continually refine our production capabilities to meet the needs of our product innovations. If we cannot efficiently adapt our manufacturing infrastructure to meet the needs of our product innovations, or if we are unable to upgrade our production capacity in a timely manner, our gaming business could be negatively impacted. In addition, the social and mobile gaming landscape is rapidly evolving and is characterized by major fluctuations in the popularity of social and mobile products and platforms. We may be unable to develop products at a rate necessary to respond to these changes, or at all, or that anticipate the interests of social and mobile players.
Our success also depends on creating products and services with strong and sustained player appeal. We are under continuous pressure to anticipate player reactions to, and acceptance of, our new products, avoid jackpot fatigue (declining play levels on smaller jackpots) and continue to provide successful products that generate a high level of play. In some cases, a new game or gaming machine will only be accepted by our casino or interactive customers if we can demonstrate that it is likely to produce more revenue and net win and/or has more player appeal than our existing products and services or our competitors’ products and services.
WAP and premium participation gaming machines are replaced on short notice by casino operators if they do not meet and sustain revenue and profitability expectations. In addition, our gaming machines may be installed in casinos on a trial basis and customers may not ultimately purchase them after expiration of the trial period. Customers may cancel pending orders with us if our products are not performing to expectations at other casinos.
Our network gaming applications interface with operating system software on each gaming machine, which we refer to as a "game platform." The game platform manages the software needed to operate the gaming machine. Our network gaming applications, game platforms and the related computer systems are frequently updated and revised to keep pace with the ever-increasing complexity of modern game play, technology and regulatory requirements. We cannot assure you that we will be able to continue to update or manage these systems, obtain all necessary approvals to continue to operate such systems or that the approval process will not result in costly delays, lost network gaming application revenue or changes to our business plans.
In the past, we have experienced delays in launching new products due to the complex or innovative technologies embedded in our products. Such delays can cause a decrease in our revenue. If new participation game themes are not approved as quickly as anticipated and therefore do not replace older game themes as quickly as anticipated, we may experience a higher level of gaming machine removals due to the performance of such older game themes. Any such increase in removal levels may cause a reduction in our installed base of gaming machines and our revenues and profits.
We have invested, and may continue to invest, significant resources in R&D efforts. We invest in a number of areas, including product development for game and system-based hardware, software and game content. If a new product does not gain market acceptance, our business could be adversely affected. There can be no assurance that our investment in R&D will lead to successful new technologies or products. If a new product is not successful, we may not recover our development, regulatory approval or promotion costs.
Our success depends in part on our ability to develop, enhance and/or introduce successful gaming concepts and game content.
Our businesses develop and source game content both internally and through third-party suppliers. We also seek to secure third-party brands for incorporation into our game content. We believe that creative and appealing game content produces more revenue for our gaming machine customers and provides them with a competitive advantage, which in turn enhances our revenue and our ability to attract new business and to retain existing business. In our lottery business, we believe that innovative gaming concepts and game content, such as multiplier games and game content that incorporates licensed brands, can enhance the revenue of our lottery customers and distinguish us from our competitors. There can be no assurance that we will be able to sustain the success of our existing game content or effectively develop or obtain from third parties game content or licensed brands that will be widely accepted both by our customers and players.
We and our industries are subject to strict government regulations that may limit our existing operations and have an adverse impact on our ability to grow.
In the U.S. and many other countries, the provision of lottery and gaming products and services is subject to extensive and evolving regulation. These regulatory requirements vary from jurisdiction to jurisdiction. Therefore, we are subject to a wide range of complex laws and regulations in the jurisdictions in which we are licensed or operate. Most jurisdictions require that we be licensed, that our key personnel and certain of our security holders be found suitable or be licensed, and that our products be reviewed and approved before placement. Licenses, approvals or findings of suitability may be revoked, suspended or conditioned. If a license, approval or finding of suitability is required by a regulatory authority and we fail to seek or do not receive the necessary approval, license or finding of suitability, or if it is granted and subsequently revoked, then we may be

24


prohibited from providing our products or services for use in the particular jurisdiction. In addition, the loss of a license in one jurisdiction could trigger the loss of a license, or affect our eligibility for a license, in other jurisdictions. We may also become subject to regulation in any new jurisdictions in which we decide to operate in the future, including due to expansion of a customer's operations. Gaming authorities may levy fines against us or seize certain of our assets if we violate gaming regulations. There can be no assurance that we will be able to obtain or maintain the necessary licenses or approvals or that the licensing process will not result in delays or adversely affect our operations. The failure to obtain or retain a required license or approval in any jurisdiction would decrease the geographic areas where we are permitted to operate and generate revenue, may limit our ability to obtain a license in other jurisdictions and may put us at a disadvantage relative to our competitors.
Often, our games, gaming machine hardware and software and our interactive gaming products and services must be approved in the jurisdictions in which they are operated, and we cannot assure you that such products or services will be approved in any jurisdiction. Our networked gaming technology requires regulatory approval in gaming jurisdictions prior to the shipment or implementation of any gaming machines, products or services and, although we have received approvals from the jurisdictions in which we currently operate this technology, we cannot assure you that we will receive the approvals necessary to offer it in additional gaming jurisdictions. Many of our customers are required to be licensed and delays in approvals of our customers’ operations or expansions may adversely affect our operations.
The regulatory review process and licensing requirements also may preclude us from using technologies owned or developed by third parties if those parties are unwilling to subject themselves to regulatory review or do not meet regulatory requirements. Some gaming authorities require gaming manufacturers to obtain approval before engaging in certain transactions, such as acquisitions, mergers, reorganizations, financings, stock offerings and share repurchases. Obtaining such approvals can be costly and time consuming and there can be no assurance that such approvals will be granted or that the approval process will not result in delays or disruptions to our strategic objectives.
The regulatory environment in any particular jurisdiction may change in the future, including changes that limit some or all of our existing operations in that jurisdiction, and any such change could materially and adversely affect our results of operations, business or prospects. Moreover, there can be no assurance that the operation of lotteries, video gaming terminals, internet gaming, the manufacture and distribution of gaming machines, or other forms of lottery or gaming will be approved by additional jurisdictions or that those jurisdictions in which these activities are currently permitted will continue to permit such activities. Laws and regulations relating to interactive lottery and interactive gaming are evolving. For additional discussion regarding risks associated with the evolving interactive regulatory landscape, see the risk factor below captioned "-We may not be able to capitalize on the expansion of internet or other forms of interactive gaming or other trends and changes in the lottery and gaming industries, including due to laws and regulations governing these jurisdictions."
There is ongoing adverse publicity in the U.K. surrounding casino-style games available on fixed odds betting terminals. In particular, there have been discussions regarding restricting the number of fixed odds betting terminals permitted at a specific location or a specific area, reductions in the maximum stakes and payout limits, and restrictions on the speed of play and payment methods, any of which could negatively impact our gaming business in the U.K. We cannot predict the likelihood, timing, scope or terms of any such restrictions. In October 2013, the U.K. Gambling Commission (“UKGC”) published its interpretation of certain of the restrictions set forth in the U.K. Gambling Act of 2005, in particular that the operation of gaming machines in betting shops is only lawful if the premises are used primarily for gambling activities. Among other things, the UKGC interpretation could result in decreased gaming activity if betting shops that do not fulfill the aforementioned criteria cease to operate. Additionally, the U.K. Anti Money Laundering Directive, which is scheduled to be implemented throughout the European Union in 2014, expands the scope of certain anti-money laundering directives to include betting shops and LBOs, which may result in increased compliance costs for our international customers. We cannot predict the extent to which any of the foregoing could affect our customers or our U.K. gaming business.
There can be no assurance that authorities will not seek to restrict our business in their jurisdictions or institute enforcement proceedings against us. In addition, there can be no assurance that any instituted enforcement proceedings will be favorably resolved, or that such proceedings will not have a material adverse impact on our ability to retain and renew existing licenses or to obtain new licenses in other jurisdictions. Our reputation may also be damaged by any legal or regulatory investigation, regardless of whether or not we are ultimately accused of, or found to have committed, any violation.
We and certain of our affiliates, major stockholders (generally persons and entities beneficially owning a specified percentage (typically 5% or more) of our equity securities), directors, officers and key employees are subject to extensive background investigations and suitability standards in our businesses. In some jurisdictions, these investigations may require extensive personal and financial disclosure from major stockholders, directors, officers and key employees. The failure of any such individuals or entities to submit to such background checks and provide the required disclosure could jeopardize the award of a contract or license to us or provide grounds for termination of an existing contract or license. Regulatory authorities generally have broad discretion when granting, renewing or revoking these approvals and licenses. Lottery and gaming authorities may require the removal of any of our directors or employees who are deemed to be unsuitable and these authorities

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are generally empowered to disqualify us from receiving a lottery or gaming contract, offering our gaming or lottery products in that jurisdiction a result of any such investigation. Our failure, or the failure of any of our major stockholders, directors, officers, key employees, products or technology, to obtain or retain a required license or approval in one jurisdiction could negatively impact our ability (or the ability of any of our major stockholders, directors, officers, key employees, products or technology) to obtain or retain required licenses and approvals in other jurisdictions.
In light of these regulations and the potential impact on our business, our restated certificate of incorporation allows for the restriction of stock ownership by persons or entities who fail to comply with informational or other regulatory requirements under applicable gaming laws, who are found unsuitable to hold our stock by gaming authorities or whose stock ownership adversely affects our ability to obtain, maintain, renew or qualify for a license, contract, franchise or other regulatory approval from a gaming authority. The licensing procedures and background investigations of the authorities that regulate our businesses and the restriction in our certificate of incorporation may inhibit potential investors from becoming significant stockholders or inhibit existing stockholders from retaining or increasing their ownership.
Our businesses are subject to a number of federal, state, local and foreign laws and regulations governing data privacy and security, including with respect to the collection, storage, use, transmission and protection of personal information and other consumer data. In particular, the European Union has adopted strict data privacy regulations. The scope of data privacy and security regulations is evolving and we believe that the adoption of increasingly restrictive regulations in this area is likely within the U.S. and other jurisdictions. Compliance with data privacy and security restrictions could increase the cost of our operations and failure to comply with such restrictions could subject us to criminal and civil sanctions as well as other penalties.
We are subject to the provisions of the Foreign Corrupt Practices Act and other anti-corruption laws that generally prohibit U.S. persons and companies and their agents from offering, promising, authorizing or making improper payments to foreign government officials for the purpose of obtaining or retaining business. Certain of these anti-corruption laws also contain provisions that require accurate record keeping and further require companies to devise and maintain an adequate system of internal accounting controls. Although we have policies and controls in place that are designed to ensure compliance with these laws, if those controls are ineffective or an employee or intermediary fails to comply with the applicable regulations, we may be subject to criminal and civil sanctions as well as other penalties. Any such violation could disrupt our business and adversely affect our reputation, business, results of operations or financial condition.
We have developed and implemented an internal compliance program in an effort to ensure that we comply with legal requirements imposed in connection with our gaming and lottery activities, as well as legal requirements generally applicable to all publicly traded corporations. The compliance program is run on a day-to-day basis by our chief compliance officer with legal advice provided by attorneys in our legal and compliance departments and outside experts. The compliance program is overseen by the compliance committee of our board of directors, consisting entirely of non-employee directors. There can be no assurance that such steps will prevent the violation of one or more laws or regulations, or that a violation by us or an employee will not result in the imposition of a monetary fine, suspension or revocation of one or more of our licenses or other penalties. See Exhibit 99.9 “Gaming Regulations” for additional information regarding certain of the regulations that govern our gaming business.
We may not be able to capitalize on the expansion of internet or other forms of interactive gaming or other trends and changes in the lottery and gaming industries, including due to laws and regulations governing these industries.
We participate in the new and evolving interactive lottery and interactive gaming industries through our online, social, casual and mobile products. Part of our strategy is to take advantage of the liberalization of internet and mobile gaming, both within the U.S. and internationally. These industries involve significant risks and uncertainties, including legal, business and financial risks. The success of these industries and of our interactive products and services may be affected by future developments in social networks, including Facebook, mobile platforms, regulatory developments, data privacy laws and other factors that we are unable to predict and are beyond our control. This fast-changing environment can make it difficult to plan strategically and can provide opportunities for competitors to grow revenues at our expense. Consequently, our future operating results relating to our interactive lottery and gaming products and services are difficult to predict and we cannot provide assurance that these products and services will grow at the rates we expect, or be successful in the long term.
In general, our ability to successfully pursue our interactive lottery and gaming strategy depends on the laws and regulations relating to wagering through interactive channels. Until recently, there was uncertainty as to whether the Federal Wire Act of 1961 (the "Wire Act") prohibited states from conducting intrastate lottery transactions via the internet if the transmissions over the internet during the transaction crossed state lines. In late 2011, the Office of Legal Counsel of the U.S. Department of Justice ("DOJ") issued an opinion to the effect that state lottery ticket sales over the internet to in-state adults do not violate the Wire Act. The opinion may provide an impetus for states to authorize forms of interactive lottery or interactive gaming in order to generate additional revenue. However, to the extent states wish to pursue interactive gaming, such states

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may be required or otherwise deem it advisable to enact enabling legislation or new regulations addressing the sale of lottery tickets or the offering of other forms of gaming through interactive channels, such as the actions taken by Delaware, Nevada and New Jersey recently to authorize various forms of internet gaming. Despite the 2011 DOJ opinion, there are still significant forces working to limit or prohibit interactive lottery and gaming in the U.S. The enactment of internet gaming legislation that federalizes significant aspects of the regulation of internet gaming and/or limits the forms of internet wagering that are permissible could have an adverse impact on our ability to pursue our interactive strategy in the U.S. Internationally, laws relating to internet gaming are evolving, particularly in Europe. To varying degrees, a number of European governments have taken steps to change the regulation of internet wagering through the implementation of new or revised licensing and taxation regimes, including the possible imposition of sanctions on unlicensed providers. We cannot predict the timing, scope or terms of any such state, federal or foreign laws and regulations, or the extent to which any such laws and regulations will facilitate or hinder our interactive strategy.
With respect to our social gaming business, although largely unregulated at this time, there are movements in some jurisdictions to review social gaming and possibly implement social gaming regulations. We cannot predict the certainty, timing, scope or terms of any such regulation or the extent to which they may affect our social gaming business.
In jurisdictions that authorize internet gaming, there can be no assurance that we will be successful in offering our technology, content and services to internet gaming operators as we expect to face intense competition from our traditional competitors in the lottery and gaming industries as well as a number of other domestic and foreign providers (or, in some cases, the operators themselves), some of which have substantially greater financial resources and/or experience in this area than we do. In addition, there is a risk that the authorization of the sale of lottery and gaming offerings via interactive channels in a particular jurisdiction could, under certain circumstances, adversely impact our lottery and gaming product sales through traditional channels in such jurisdiction. Any such adverse impact would be magnified to the extent we are not involved in, and generating revenue from, the provision of interactive products or services in such jurisdiction. Know-your-customer (KYC) and geo-location programs and technologies supplied by third parties are an important aspect of certain internet or mobile gaming products and services because they confirm certain information with respect to players and prospective players, such as age, identity and location. Payment processing programs and technologies, typically provided by third parties, are also a necessary feature of interactive wagering products and services. These programs and technologies are costly and may have an adverse impact on our interactive gaming revenue. Additionally, there can be no assurance that products containing these programs and technologies will be available to us on commercially reasonable terms, if at all, or that they will perform accurately or otherwise in accordance with our required specifications.
Our social gaming business is largely dependent upon our relationships with key providers and changes in those relationships could negatively impact our social gaming business.
In our social gaming business, our offerings operate largely through Facebook, Apple’s IOS platform and GooglePlay® for Android devices. Consequently, our expansion and future revenue prospects from our social offerings are dependent on our continued relationships with these providers (and any emerging app store providers). Our interactive social gaming casino business will be adversely impacted if we are unable to continue these relationships in the future or if the terms and conditions offered by these providers are altered to our disadvantage. For instance, if any of these providers were to increase their fees, our revenue and profits would suffer. Likewise, if Facebook, Apple or Google were to alter their operating platforms, we could be adversely impacted as our offerings may not be compatible with the altered platforms or may require significant and costly modifications in order to become compatible.
We are heavily dependent on our ability to maintain and renew our customer contracts, including our long-term lottery contracts, and we could lose substantial revenue and profits if we are unable to renew certain of our contracts on substantially similar terms or at all.
Generally, our lottery customer contracts contain initial multi-year terms, with optional renewal periods held by the customer. Upon the expiration of any such contract, including any extensions thereof, a new contract may be awarded through a competitive bidding process. Since late 2007, we have lost lottery systems contracts in South Carolina, West Virginia, South Dakota, New Hampshire, Vermont, Indiana and Colorado and with the Atlantic Lottery Corporation to our competitors following the expiration or termination of our contracts.
A substantial portion of our gaming revenue is dependent on repeat customers. In specific regions, our business may be concentrated with a small number of customers, such as our U.K. LBO business.
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 bidding processes or otherwise in the future. The termination, expiration or failure to renew one or more of our contracts could cause us to lose substantial revenue and profits, which could have an adverse effect on our ability to win or renew other contracts or pursue growth initiatives. There can be no assurance that new or renewed contracts will contain

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terms that are as favorable as our current terms or will contemplate the same size or scope of products and services as our current contracts and any less favorable contract terms or diminution in size or scope could negatively impact our revenue and profits. For additional information regarding the potential expiration dates of certain of our more significant contracts, see the table in "Business-Contract Procurement" in the lottery section in Item 1 of this Annual Report on Form 10-K.
We are also required by certain of our lottery customers to provide surety or performance bonds in connection with our contracts. As of December 31, 2013, we had $197.5 million of outstanding surety and performance bonds. There can be no assurance that we will continue to be able to obtain surety or performance bonds on commercially reasonable terms or at all. Our inability to provide such bonds would materially and adversely affect our ability to renew existing, or obtain new, lottery contracts.
Our level of indebtedness could adversely affect our operations and financial condition.
As of December 31, 2013, we had total indebtedness of $3,192.6 million, consisting primarily of borrowings under our credit agreement and senior subordinated notes.  Our level of indebtedness may affect our ability to obtain financing or refinance existing indebtedness; require us to dedicate a significant portion of our cash flow from operations to interest and principal payments on our indebtedness, thereby reducing the availability of cash flow to fund working capital, capital expenditures and other general corporate purposes; increase our vulnerability to adverse general economic, industry or competitive developments or conditions; and limit our flexibility in planning for, or reacting to, changes in our businesses and the industries in which we operate or in pursuing our strategic objectives. In addition, we are exposed to the risk of increased interest rates as a significant portion of our borrowings are at variable rates of interest. If interest rates increase, the interest payment obligations under our non-hedged variable rate indebtedness would increase even if the amount borrowed remained the same and our net income and cash flows would be negatively impacted. All of these factors could place us at a competitive disadvantage compared to competitors that may have less debt than we do.
We may not have sufficient cash flows from operating activities, cash on hand and available borrowings under our credit agreement to finance required capital expenditures under new contracts, service our indebtedness and meet our other cash needs. These obligations require a significant amount of cash.
Our lottery systems and land-based gaming machine businesses generally require significant upfront capital expenditures for gaming machine or lottery terminal assembly, software customization and implementation, systems and equipment installation and telecommunications configuration. In connection with a renewal or bid of a lottery systems or gaming machine contract, a customer may seek to obtain new equipment or impose new service requirements, which may require additional capital expenditures in order to retain or win the contract. Historically, we have funded these upfront costs through cash flows generated from operations, available cash on hand and borrowings under our credit agreement or subordinated notes. Our ability to generate revenue and to continue to procure new contracts will depend on, among other things, our then present liquidity levels or our ability to obtain additional financing on commercially reasonable terms.
If we do not have adequate liquidity or are unable to obtain financing for these upfront costs on favorable terms or at all, we may not be able to bid on certain contracts, which could restrict our ability to grow and have a material adverse effect on our results of operations. Moreover, we may not realize the return on investment that we anticipate on new or renewed contracts due to a variety of factors, including lower than anticipated retail sales or amounts wagered, higher than anticipated capital or operating expenses and unanticipated regulatory developments or litigation. We may not have adequate liquidity to pursue other aspects of our strategy, including bringing our products and services to new customers or new or underpenetrated geographies (including through equity investments) or pursuing strategic acquisitions.
Our ability to make payments on and to refinance our indebtedness will depend on our ability to generate cash in the future. This, to some extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our lenders, including the lenders participating in our revolving credit facilities, may become insolvent or tighten their lending standards, which could make it more difficult for us to borrow under our revolving credit facilities or to obtain other financing on favorable terms or at all. Our financial condition and results of operations would be adversely affected if we were unable to draw funds under our revolving credit facilities because of a lender default or to obtain other cost-effective financing. Any default by a lender in its obligation to fund its commitment under our revolving credit facilities (or its participation in letters of credit) could limit our liquidity to the extent of the defaulting lender's commitment.
If we are unable to generate sufficient cash flow from operations in the future to meet our commitments, we will be required to adopt one or more alternatives, such as refinancing or restructuring our indebtedness, selling material assets or operations or seeking to raise additional debt or equity capital. We cannot assure you that any of these actions could be completed on a timely basis or on satisfactory terms or at all, or that these actions would enable us to continue to satisfy our capital requirements. Moreover, our existing debt agreements contain, and our future debt agreements may contain, restrictive

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covenants that may prohibit us from adopting these alternatives. Our failure to comply with these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debt.
Our credit facilities and the indentures governing our senior subordinated notes impose certain restrictions. Failure to comply with any of these restrictions could result in the acceleration of the maturity of our indebtedness. Were this to occur, we would not have sufficient cash to pay our accelerated indebtedness.
The operating and financial restrictions and covenants in our debt agreements, including our credit agreement and the indentures governing our senior subordinated notes, may adversely affect our ability to finance future operations or capital needs or to engage in new business activities. Subject to certain exceptions, our credit facilities and/or indentures restrict our ability to, among other things:
declare dividends or redeem or repurchase capital stock;
prepay, redeem or purchase other debt;
incur liens;
make loans, guarantees, acquisitions and investments;
incur additional indebtedness;
engage in sale and leaseback transactions;
amend or otherwise alter debt and other material agreements;
engage in mergers, acquisitions or asset sales;
engage in transactions with affiliates;
enter into arrangements that would prohibit us from granting liens or restrict our ability to pay dividends, make loans or transfer assets among our subsidiaries; and
alter the business we conduct.
In addition, our credit agreement requires us to maintain a maximum first lien net leverage ratio on a quarterly basis if at any time the aggregate amount of all commitments outstanding under our revolving credit facility (excluding certain types of letters of credit) equals or exceeds 15.0% of all commitments thereunder. As a result of these covenants, we will be limited in the manner in which we can conduct our business, and may be unable to engage in favorable business activities or finance future operations or capital needs. A failure to comply with the restrictions contained in our credit agreement or indentures, or to maintain the financial ratio as may be required by our credit agreement, could lead to an event of default which could result in an acceleration of our indebtedness. There can be no assurance that our future operating results will be sufficient to ensure compliance with the covenants in our credit agreement, indentures or other debt instruments or to remedy any such default. In addition, in the event of acceleration, we may not have, or be able to obtain, sufficient funds to make any accelerated payments.
Our business depends on the protection of our intellectual property and proprietary information and on our ability to license intellectual property from third parties.
We believe that our success depends, in part, on protecting our intellectual property in the U.S. and in foreign countries and our ability to license intellectual property from third parties on commercially reasonable terms. Our intellectual property includes certain patents and trademarks relating to our instant lottery games and wagering systems, gaming machines and interactive gaming products and services, as well as proprietary or confidential information that is not subject to patent or similar protection. Our success may depend, in part, on our ability to obtain trademark protection for the names or symbols under which we market our products and to obtain copyright protection and patent protection of our proprietary technologies, intellectual property and game innovations. There can be no assurance that we will be able to build and maintain consumer value in our trademarks, obtain trademark or patent protection or that any trademark, copyright or issued patent will provide competitive advantages for us.
Our intellectual property protects the integrity of our games, systems, products and services. For example, our intellectual property is designed to ensure the security of the printing of our instant lottery games and provide simple and secure validation of our lottery tickets. Competitors may independently develop similar or superior products, software or systems. In cases where our technology or product is not protected by enforceable intellectual property rights, such independent development may result in a significant diminution in the value of such technology or product.

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We rely on products, technologies, trademarks and other intellectual property that we license from third parties, including licensed properties and game content for our lottery and gaming businesses. In addition, substantially all of our gaming machines and our interactive gaming products and services utilize intellectual property licensed from third parties. The future success of our gaming business may depend, in part, on our ability to obtain, retain and/or expand licenses for popular technologies and games in a competitive market. Certain of the products and technology we rely upon are licensed from our competitors. There can be no assurance that these third-party licenses, or support for such licensed products and technology, will continue to be available to us on commercially reasonable terms, if at all. In the event that we cannot renew and/or expand existing licenses, we may be required to discontinue or limit our use of the products that use the licensed intellectual property or bear the licensed trademarks. Certain of our license agreements grant the licensor rights to audit our use of their intellectual property to confirm that we have made the required royalty payments. Disputes with licensors over royalty payment methodologies and calculations could result in the payment of additional royalties or penalties by us, cancellation or non-renewal of the underlying license, or litigation. We are party to ongoing legal proceedings relating to a claim by IGT that we underpaid royalties under a license agreement. See "Legal Proceedings" in Item 3 of this Annual Report on Form 10-K.
We also rely on trade secrets and proprietary know-how. We enter into confidentiality agreements with our employees and independent contractors regarding our trade secrets and proprietary information, but we cannot assure you that the obligation to maintain the confidentiality of our trade secrets or proprietary information will be honored.
The intellectual property rights of others may prevent us from developing new products or entering new markets or may expose us to liability.
Our success depends in part on our ability to continually adapt our products and systems to incorporate new technologies and to expand into markets that may be created by new technologies. If technologies are protected by the intellectual property rights of others, including our competitors, we may be prevented from introducing products based on these technologies or expanding into markets created by these technologies. If the intellectual property rights of others prevent us from taking advantage of innovative technologies, our financial condition, operating results or prospects may be harmed.
There can be no assurance that our business activities, games, products and systems will not infringe upon the proprietary rights of others, or that other parties will not assert infringement claims (with or without merit) against us. Any such claim and any resulting litigation, should it occur, could subject us to significant liability for damages and could result in invalidation of our proprietary rights or discontinuation of the affected products, distract management, and/or require us to enter into costly and burdensome royalty and licensing agreements. Such royalty and licensing agreements, if required, may not be available on terms acceptable to us, or may not be available at all. In the future, we may also need to file or respond to lawsuits to defend the validity of our intellectual property rights and trade secrets, or to determine the validity and scope of the proprietary rights of others. Such litigation, whether successful or unsuccessful, could result in substantial costs and diversion of our resources.
Our business is dependent on the security and integrity of the systems and products we offer.
We believe that our success depends, in part, on providing secure products and systems to our customers. Attempts to penetrate security measures may come from various combinations of customers, retailers, vendors, employees and others. Our ability to monitor and ensure the quality of our products is periodically reviewed and enhanced. Similarly, we regularly assess the adequacy of our security systems to protect against any material loss to any of our customers and the integrity of our products to end users. Expanded utilization of the internet and other interactive technologies may result in increased security risks for us and our customers. There can be no assurance that our business will not be affected by a security breach or lapse, which could have a material adverse impact on our results of operations, business and/or prospects.
Our success depends on our ability to avoid, detect, replicate and correct software and hardware anomalies and fraudulent manipulation of our gaming machines, lottery systems and interactive gaming products and services. All of our games are designed with security features to prevent fraudulent activity. However, we cannot guarantee that these features will effectively stop all fraudulent activities. If our security features do not prevent fraud, we could adversely be affected.
Our gaming machines have experienced anomalies and fraudulent manipulation in the past. Games and gaming machines may be replaced by casinos and other gaming machine operators if they do not perform according to expectations, or they may be shut down by regulators. The occurrence of anomalies in, or fraudulent manipulation of, our gaming machines and our interactive lottery and gaming products and services may give rise to claims from players and claims for lost revenues and earnings and related litigation by our customers and may subject us to investigation or other action by gaming regulatory authorities, including suspension or revocation of our gaming licenses or other disciplinary action. Additionally, in the event of the occurrence of any such issues with our gaming machines or interactive lottery and gaming products and services, substantial engineering and marketing resources may be diverted from other projects to correct these issues, which may delay other projects and the achievement of our strategic objectives.

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We rely on information technology systems and any failures in our systems could disrupt our business and adversely impact our results.
We rely on information technology systems that are important to the operation of our business, some of which are managed by third parties. These systems are used to process, transmit and store electronic information, to manage and support our business operations and to maintain internal controls over our financial reporting. We could encounter difficulties in developing new systems, maintaining and upgrading current systems and preventing security breaches. Among other things, our systems are susceptible to outages due to fire, floods, power loss, break-ins, cyber-attacks, network penetration, denial of service attacks, and similar events. While we have and will continue to implement network security measures and data protection safeguards, our servers and other computer systems are vulnerable to viruses, malicious software, hacking, break-ins or theft, data privacy or security breaches, third-party security breaches, employee error or malfeasance, and similar events. Failures in our systems or services or unauthorized access to or tampering with our systems and databases, could have a material adverse effect on our business, reputation, financial condition, liquidity or results of operations. Any failures in our computer systems or telecommunications services could affect our ability to operate our linked games or otherwise conduct business.
Portions of our information technology infrastructure also may experience interruptions, delays or cessations of service or produce errors in connection with systems integration or migration work that takes place from time to time. We may not be successful in implementing new systems and transitioning data, which could cause business disruptions and be more expensive, time consuming, disruptive and resource-intensive. Such disruptions could materially and adversely impact our ability to deliver products to customers and interrupt other processes. If our information systems do not allow us to transmit accurate information, even for a short period of time, to key decision makers, the ability to manage our business could be disrupted and the results of operations and financial condition could be materially and adversely affected.  Failure to properly or adequately address these issues could impact our ability to perform necessary business operations, which could materially and adversely affect our reputation, competitive position, business, results of operations and financial condition.
In the fourth quarter of 2013, we initiated a process to upgrade and standardize our Enterprise Resource Planning (ERP) systems on a worldwide basis. There are inherent risks associated with changing these systems, including inaccurate data or reporting. If we cannot maintain and execute adequate internal control over financial reporting or implement required new or improved controls that provide reasonable assurance of the reliability of the financial reporting and preparation of our financial statements for external use, we may suffer harm to our reputation, fail to meet our public reporting requirements on a timely basis or be unable to properly report on our business and the results of our operations. Additionally, the inherent limitations of internal controls over financial reporting may not prevent or detect all misstatements or fraud, regardless of the adequacy of those controls. In addition, the process of upgrading and standardizing our ERP system is complex, time-consuming and expensive. Although we believe we are taking appropriate action to mitigate these risks through, among other things, testing, training and staging implementations, there can be no assurance that we will not experience data loss, disruptions, delays or negative business impacts from the upgrade. Any operational disruptions during the course of this process and any delays or deficiencies in the design and implementation of the new ERP system or in the performance of our legacy systems could materially and adversely affect our ability to operate our businesses. Additionally, while we have spent considerable efforts to plan and budget for the implementation of the new ERP system, changes in scope, timeline or cost could have a material adverse effect on our results of operations.
Our results of operations could be affected by natural events in the locations in which we or our customers, suppliers or regulators operate.
We may be impacted by severe weather and other geological events, including hurricanes, earthquakes, floods, or tsunamis that could disrupt our operations or the operations of our customers, suppliers, data service providers and regulators.  Natural disasters or other disruptions at any of our facilities or our suppliers’ facilities may impair or delay delivery of our products and services. Additionally, disruptions experienced by our regulators due to natural disasters or otherwise could delay our introduction of new products or entry into new jurisdictions where regulatory approval is necessary. While we insure against certain business interruption risks, we cannot provide any assurance that such insurance will compensate us for any losses incurred as a result of natural or other disasters.  Any serious disruption to our operations, our customers’ operations, our suppliers’ operations or our regulators could have a material adverse effect on our revenues or increase our costs and expenses.
We may not succeed in realizing the anticipated benefits of our strategic equity investments and relationships.
Under certain circumstances we pursue growth through strategic equity investments, including joint ventures, as a means to, among other things, gain access to new and tactically important geographies, business opportunities and technical expertise, while simultaneously offering the potential for reducing capital requirements.

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These strategic equity investments currently include investments in LNS, Northstar Illinois, Northstar New Jersey, Hellenic Lotteries, as well as our equity investments in China. We are party to strategic agreements with a subsidiary of Playtech Limited relating to gaming machines that contemplate our use of, and reliance on, the subsidiary's back-end technology platform in certain jurisdictions. For additional information regarding our equity investments, see Note 11 (Equity Investments).
Northstar Illinois is responsible under its PMA for payments to the State of Illinois to the extent certain net income targets are not achieved by the Illinois lottery, subject to a cap of 5% of the applicable year’s net income. Northstar New Jersey is responsible for payments to the State of New Jersey to the extent certain net income targets are not achieved by the New Jersey lottery, subject to a cap of 2% of the applicable year's net income and a $20.0 million shortfall payment credit. Our earnings and cash flows from our equity investments in Northstar Illinois and Northstar New Jersey may be impacted to the extent the relevant lottery achieves, or fails to achieve, the applicable net income targets and will be impacted to the extent Northstar Illinois or Northstar New Jersey incurs non-reimbursable expenses. We may be required to make capital contributions to Northstar Illinois and Northstar New Jersey to fund our pro rata share of any shortfall payments that are payable to the relevant state under our agreements.
Under the Northstar Illinois PMA and the Northstar New Jersey services agreement, the relevant state has certain termination rights, including the right to terminate the agreement for convenience (subject to payment of a termination fee) and the right to terminate the agreement in the event net income shortfalls exceeding 10% of the applicable targets occur for any consecutive two contract year period or for any three contract years in a five contract year period. For additional information regarding our equity investments in Northstar Illinois and Northstar New Jersey, see Note 11 (Equity Investments).
As discussed in Note 11 (Equity Investments), operations under the concession agreement granted to Hellenic Lotteries are expected to commence in the first half of 2014, although there can be no assurance that operations will commence within that time-frame or at all. In the event operations under the new concession do not commence, we may not be able to recover the amounts that we have contributed to the operating company.
We may not realize the anticipated benefits of these strategic equity investments and other strategic relationships that we may enter into, or may not realize them in the time-frame expected. These arrangements pose significant risks that could have a negative effect on our operations, including: the potential diversion of our management's attention from our core business; the potential failure to realize anticipated synergies, economies of scale or other value associated with these arrangements; unanticipated costs and other unanticipated events or circumstances, including losses for which we may be responsible for our pro rata portion; possible adverse effects on our operating results during any integration process; impairment charges if our strategic equity investments or relationships are not as successful as we originally anticipate; and our potential inability to achieve the intended objectives of these arrangements.
Furthermore, our strategic equity investments and other strategic relationships pose risks arising from our reliance on our partners and our lack of sole decision-making authority, which may give rise to disputes between us and our partners. For instance, our investments in LNS, Northstar Illinois and Northstar New Jersey are minority investments in ventures whose largest equity holder is Gtech Corporation and, although certain corporate actions require our prior consent, we do not unilaterally control decisions relating to the governance of these entities. Our partners may have economic or business interests or goals that are inconsistent with our interests and goals, take actions contrary to our objectives or policies, undergo a change of control, experience financial and other difficulties or be unable or unwilling to fulfill their obligations under our arrangements.
With respect to our land-based gaming business, in certain regions, we enter into agreements with local distributors for the distribution of our gaming products to multiple customers. Changes to these distributor relationships, including modification or termination of our agreements or difficulties with any such third party distributor could prevent us from delivering products to our customers on a timely basis, or at all, and could negatively impact our results of operations.
The failure to avoid or mitigate the risks described above or other risks associated with such arrangements could have a material adverse effect on our business, financial condition and results of operations.
Our inability to complete future acquisitions and integrate those businesses successfully could limit our future growth.
From time to time, we pursue strategic acquisitions in support of our strategic goals. In connection with any such acquisitions, we could face significant challenges in managing and integrating our expanded or combined operations, including acquired assets, operations and personnel. There can be no assurance that acquisition opportunities will be available on acceptable terms or at all or that we will be able to obtain necessary financing or regulatory approvals to complete potential acquisitions. Our ability to succeed in implementing our strategy will depend to some degree upon the ability of our management to identify, complete and successfully integrate commercially viable acquisitions. Acquisition transactions may disrupt our ongoing business and distract management from other responsibilities. For additional discussion regarding risks

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relating to the integration of WMS, see the risk factor below captioned "-Our acquisition of WMS may not achieve the intended benefits or may disrupt our current plans and operations."
Our acquisition of WMS may not achieve the intended benefits or may disrupt our current plans and operations.
There can be no assurance that we will be able to successfully integrate the businesses of Scientific Games and WMS or do so within the intended time-frame or otherwise realize the expected benefits of the acquisition. The expected cost synergies associated with the acquisition may not be fully realized in the anticipated amounts or within the contemplated time-frames or cost expectations, which could result in increased costs and have an adverse effect on the combined company's financial results and prospects. Our business may be negatively impacted if we are unable to effectively manage our expanded operations. The integration will require significant time and focus from management and may divert attention from the day-to-day operations of the combined business or delay the achievement of our strategic objectives. We expect to incur incremental costs and capital expenditures related to our contemplated integration activities.
We may incur additional restructuring costs
We have restructured portions of our operations from time to time and it is possible that we may engage in additional restructuring initiatives in the future. Restructuring initiatives are primarily driven by acquisitions or other Company reorganizations in an attempt to maximize the efficiency and profitability of our businesses and can result in employee termination and severance costs, facility closure expenses, and/or property and equipment write down costs. Because we are not able to predict with certainty when we will complete acquisitions or reorganize portions of our business, we cannot predict the extent, timing and magnitude of restructuring charges.
Our products and services may be subject to complex revenue recognition standards, which could materially affect our financial results.
As we introduce new gaming and lottery products and our commercial transactions become increasingly complex, additional analysis and judgment is required to account for them and to recognize revenues in accordance with U.S. GAAP. Transactions we enter into may include multiple-element arrangements and/or software components and applicable accounting principles or regulatory product approval delays could change when we recognize revenue with respect to such transactions and could adversely affect our financial results for any given period. In addition, fluctuations may occur in our revenues and related deferred revenues as a result of multiple-element arrangements that include both systems and software. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—Valuation of long-lived and intangible assets and goodwill" in Item 7 of this Annual Report on Form 10-K and Note 1 (Description of the Business and Summary of Significant Accounting Policies) for additional information.
We may be required to recognize additional impairment charges.
We assess our goodwill and other intangible assets and our long-lived assets as and when required by U.S. GAAP to determine whether they are impaired. For additional information, including a description of impairments recorded during the years ended December 31, 2013, 2012 and 2011, refer to the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—Valuation of long-lived and intangible assets and goodwill" in Item 7 of this Annual Report on Form 10-K, Note 1 (Description of the Business and Summary of Significant Accounting Policies) and Note 8 (Property and Equipment). We cannot predict the occurrence of impairments and there can be no assurance that we will not have to record additional impairment charges in the future.
Our results of operations fluctuate due to seasonality and other factors and therefore, our periodic operating results are not guarantees of future performance.
Our results of operations can fluctuate due to seasonal trends and other factors. Sales of our gaming machines to casinos are generally strongest in the spring and slowest in the summer, while service revenue from our participation gaming machines is generally strongest in the spring and summer. In general, land-based gaming machine play levels are highest in the spring and summer months and lower in the fall and winter months.
                The seasonal trends and other factors that may cause our results to fluctuate include: the geographies where we operate; holiday and vacation seasons; climate; weather; economic and political conditions; timing of the release of new products; significant equipment sales or the introduction of gaming or lottery activities in new jurisdictions or to new customers; the size and duration of draw lottery game jackpots; and other factors.
                In light of the foregoing, results for any quarter are not necessarily indicative of the results that may be achieved in another quarter or for the full fiscal year. There can be no assurance that the seasonal trends and other factors that have impacted our historical results will repeat in future periods as we cannot influence or forecast many of these factors.

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We are dependent on our suppliers and contract manufacturers, and any failure of these parties to meet our performance and quality standards or requirements could cause us to incur additional costs or lose customers.
Our production of instant lottery games, in particular, depends upon a continuous supply of raw materials, supplies, power and natural resources. Our operating results could be adversely affected by an interruption or cessation in the supply of these items or a serious quality assurance lapse, including as a result of the insolvency of any of our key suppliers.
Similarly, the operation of our presses and manufacture and maintenance of our gaming machines and lottery and gaming systems are dependent upon a regular and continuous supply of raw materials and components, many of which are manufactured or produced outside of the U.S. Certain of the components we use are customized for our products. The assembly of certain of our products and other hardware is performed by third parties. Any interruption or cessation in the supply of these items or services or any material quality assurance lapse with respect thereto could materially adversely affect our ability to fulfill customer orders, our financial condition or our results of operations. We may be unable to find adequate replacements for our suppliers within a reasonable time frame, on favorable commercial terms or at all.
In our lottery systems business, we transmit certain wagering data utilizing satellite transponders, generally pursuant to long-term contracts. The technical failure of any of these satellites would require us to obtain other communication services, including other satellite access. In some cases, we employ backup systems to limit our exposure in the event of such a failure. There can be no assurance of access to such other satellites or, if available, the ability to obtain the use of such other satellites on favorable terms or in a timely manner. While satellite failures are infrequent, the operation of satellites is outside of our control.
In addition, in our gaming business, we rely upon a number of significant third-party suppliers and vendors delivering parts, equipment and services on schedule in order for us to meet our contractual commitments. Failure of these third parties to meet their delivery commitments could result in us being in breach of, and subsequently losing, the affected customer contracts, which loss could have a material adverse effect on our results of operations. Certain of our products are reliant on network and/or telecommunications services. For instance, any disruption to our network or telecommunications could impact our linked or networked games, reducing our revenue.
In our interactive business, we often rely on third party data center providers to, among other things, host our remote game servers. Our interactive businesses would be adversely impacted to the extent any such data center provider was unable or unwilling to continue to provide services to us.
We have foreign operations, which subjects us to foreign currency exchange rate fluctuations and other risks.
We are a global business and derive a substantial and growing portion of our revenue and profits from operations outside the United States. In the year ended December 31, 2013, we derived approximately 49% of our revenue from sales to customers outside of the United States. Additionally, the success of our strategic initiatives is dependent upon expansion of our operations outside of the United States.
Our consolidated financial results are affected by foreign currency exchange rate fluctuations. Foreign currency exchange rate exposures arise from current transactions and anticipated transactions denominated in currencies other than U.S. dollars and from the translation of foreign currency denominated balance sheet accounts into U.S. dollar-denominated balance sheet accounts. We are exposed to currency exchange rate fluctuations because portions of our revenue and expenses are denominated in currencies other than the U.S. dollar, particularly the British Pound Sterling and the Euro. In particular, uncertainty regarding economic conditions in Europe and the debt crisis affecting certain countries in the European Union pose risk to the stability of the Euro. Exchange rate fluctuations have in the past adversely affected our operating results and cash flows and may adversely affect our results of operations and cash flows and the value of our assets outside the U.S. in the future. If a foreign currency is devalued in a jurisdiction in which we are paid in such currency, we may require our customers to pay higher amounts for our products, which they may be unable or unwilling to pay.
From time to time, we enter into foreign currency forward or other hedging contracts. We are subject to the risk that a counterparty to one or more of these contracts defaults on its performance under the contracts. During an economic downturn, a counterparty's financial condition may deteriorate rapidly and with little notice and we may be unable to take action to protect our exposure. In the event of a counterparty default, we could incur lose the benefit of our hedging contract, which may harm our business and financial condition. In the event that one or more of our counterparties becomes insolvent or files for bankruptcy, our ability to eventually recover any benefit lost as a result of that counterparty's default may be limited by the liquidity of the counterparty.
Foreign governments can impose restrictions on currency movements that may make it costly or impossible to transfer money to the U.S. Additionally, foreign governments may limit or prevent our ability to import our products and services into foreign jurisdictions. In 2012, governmental authorities in Argentina modified regulations relating to importing products and

34


limiting the exchange of pesos into dollars and the transfer of funds from Argentina. If the Argentine government’s current restrictions on currency transfer remain unchanged, the excess peso balances in our Argentinian bank account may continue to grow, which would increase our exposure to any potential currency devaluation in Argentina. In addition, any devaluation of the currency in Argentina will adversely impact the collectability of our customer receivables in Argentina as we invoice our customers in pesos adjusted to reflect original U.S. dollars sales volumes. Currently, our legal entity in Argentina cannot directly import our gaming machines and, if the regulations remain unchanged or if we are unable to continue to import our products into Argentina, our revenue from customers in Argentina will be negatively impacted.
Our operations in foreign jurisdictions subject us to additional risks customarily associated with such operations, including: the complexity of foreign laws, regulations and markets, the uncertainty of enforcement of remedies in foreign jurisdictions, the impact of foreign labor laws and disputes; the economic, tax and regulatory policies of local governments, and the ability to attract and retain key personnel in foreign jurisdictions. In addition, our international business operations could be interrupted and negatively affected by terrorist activity, political unrest or other economic or political uncertainties. Foreign jurisdictions could impose tariffs, quotas, trade barriers, and other similar restrictions on our international sales. 
As a significant amount of our net profits and cash flows are generated outside the U.S., the repatriation of funds currently held in foreign jurisdictions may result in higher effective tax rates for the Company.  In addition, there have been proposals to change U.S. tax laws that could significantly impact how U.S. multinational corporations, such as us, are taxed on foreign earnings.  Although we cannot predict the certainty, timing, scope or terms of any such laws, if enacted, certain of the proposed changes, such as those seeking to limit the deferral of taxes, could have a material adverse impact on our tax expense and cash flow.
Additionally, foreign taxes paid by our foreign subsidiaries and equity investees on their earnings may not be recovered against our U.S. tax liability. At December 31, 2013, we had a deferred tax asset for our foreign tax credit carry forward of $18.2 million. Although we will continue to explore tax planning strategies to use all of our foreign tax credit carry forward, at December 31, 2013, we established a valuation allowance of $18.2 million against the foreign tax credit deferred tax asset to reduce the asset to the net amount that our management estimates is "more likely than not" to be realized.
In addition, our ability to expand successfully in foreign jurisdictions involves other risks, including difficulties in integrating foreign operations, risks associated with entering jurisdictions in which we may have little experience and the day-to-day management of a growing and increasingly geographically diverse company. Our investment in foreign jurisdictions often entails entering into joint ventures or other business relationships with locally based entities, which can involve additional risks arising from our lack of sole decision-making authority, our reliance on a partner's financial condition, inconsistency between our business interests or goals and those of our partners and disputes between us and our partners.
Through our joint ventures and wholly owned foreign enterprises, we have lottery-related investments and business operations in China. Our business in, and results of operations from, China are subject to a number of risks relating to China, including risks relating to competition, the bidding and contract negotiation processes, our ability to finance or refinance our operations, the complex regulatory environment (including currency and money transfer restrictions), our ability to receive timely product approvals, the political climate, the economy and our joint venture and other business partners in China.
We may not realize the operating efficiencies, competitive advantages or financial results that we anticipate from our investments in foreign jurisdictions and our failure to effectively manage the risks associated with our operations in foreign jurisdictions could have a material adverse effect on our results of operations, business or prospects.
We are dependent on our employees.
We depend on the continued performance of our executive officers and key personnel, including David L. Kennedy, our president and chief executive officer. If we lose the services of any of our executive officers or key personnel and cannot find suitable replacements for such persons in a timely manner, it could have an adverse impact on our business. Our ability to expand is dependent on our ability to recruit and retain talented employees in the U.S. and internationally who are capable of leading our employees to achieve our strategic objectives.
We also rely on our highly skilled, technically trained and creative employees to develop new technologies and create innovative products. A lack of skilled technical workers could delay or negatively impact our business plans, ability to compete and results of operations.
We could incur costs in the event of violations of, or liabilities under, environmental laws.
Our operations and real property are subject to U.S. and foreign environmental laws and regulations, including those relating to air emissions, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated sites. We could incur costs, including cleanup costs, fines or penalties, and third-party claims as a result of violations of, or

35


liabilities under, environmental laws. Some of our operations require environmental permits and controls to prevent or reduce environmental pollution, and these permits are subject to review, renewal and modification by issuing authorities.
Failure to perform under our lottery and gaming contracts may result in litigation, substantial monetary liquidated damages and contract termination.
Our business subjects us to contract penalties and risks of litigation, including potential allegations that we have not fully performed under our contracts or that goods or services we supply are defective in some respect. Litigation is pending in Colombia arising out of the termination of certain Colombian lottery contracts in 1993. An agency of the Colombian government has asserted claims against certain parties, including SGI, which owned a minority interest in Wintech de Colombia S.A., or Wintech (now liquidated), the former operator of the Colombian national lottery. The claims are for, among other things, contract penalties, interest and the amount of a bond issued by a Colombian surety. For additional information regarding this or other litigations, see "Legal Proceedings" in Item 3 of this Annual Report on Form 10-K. There can be no assurance that this litigation will not be finally resolved adversely to us or result in material liability.
In addition, our lottery contracts typically permit a lottery authority to terminate the contract at any time for a material failure to perform, other specified reasons and, in many cases, for no reason at all. Lottery contracts to which we are a party also frequently contain exacting implementation schedules and performance requirements and the failure to meet these schedules and requirements may result in substantial monetary liquidated damages, as well as possible contract termination. We are also required by certain of our lottery customers to provide surety or performance bonds. We have paid or incurred liquidated damages under our lottery contracts and material amounts of liquidated damages could be imposed on us in the future, which could, if imposed, have a material adverse effect on our results of operations, business or prospects.
We may be liable for product defects or other claims relating to our products.
Our products could be defective, fail to perform as designed or otherwise cause harm to our customers, their equipment or their products. If any of our products are defective, we may be required to recall the products and/or repair or replace them, which could result in substantial expenses and affect our profitability. Any problem with the performance of our products, such as an instant lottery game misprint or false jackpot or other prize, could harm our reputation, which could result in a loss of sales to customers and/or potential customers. In addition, if our customers believe that they have suffered harm caused by our products, they could bring claims against us that could result in significant liability. Any claims brought against us by customers may result in diversion of management's time and attention, expenditure of large amounts of cash on legal fees and payment of damages, decreased demand for our products or services, or injury to our reputation. Our insurance may not sufficiently cover a judgment against us or a settlement payment, and is subject to customary deductibles, limits and exclusions. In addition, a judgment against us or a settlement could make it difficult for us to obtain insurance in the coverage amounts necessary to adequately insure our businesses, or at all, and could materially increase our insurance premiums and deductibles.
In October 2012, SNAI filed a lawsuit in Italy against Barcrest and Global Draw relating to the erroneous printing of what appeared to be winning jackpots on certain VLTs operated by SNAI and supplied by Barcrest. For additional information regarding this litigation, see "Legal Proceedings" in Item 3 of this Annual Report on Form 10-K.
Litigation may adversely affect our business and financial condition.
We may become subject to litigation claims in the operation of our business, including, but not limited to, with respect to employee matters, alleged product and system malfunctions, alleged intellectual property infringement and claims relating to our contracts, licenses and strategic investments. We may incur significant expense defending or settling any such litigation. Additionally, adverse judgments that may be decided against us could result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business and our financial condition.
Labor disputes may have an adverse effect on our operations.
Certain of our employees are represented by unions, including a majority of the employees at our printing facilities in Canada, Chile and the United Kingdom. Our gaming manufacturing facility in Illinois is dependent on union employees that are represented by the International Brotherhood of Electrical Workers under a collective bargaining agreement that expires in June 2014. While we believe our relations with our employees are satisfactory, we cannot predict whether we will be successful in negotiating new collective bargaining agreements without any disruptions in our manufacturing. Any disruption in our printing or manufacturing operations could have an adverse effect on our revenues and expenses. There can be no assurance that we will not encounter conflicts or strikes with any labor unions that represent our employees. Any such conflict or strike could adversely impact our business or results of operations or our customers’ operations or could cause us to lose customers.


36


Risks Relating to Our Common Stock
Certain holders of our common stock exert significant influence over the Company and may make decisions that conflict with the interests of other stockholders.
In August 2004, MacAndrews & Forbes Holdings Inc. was issued approximately 25% of our outstanding common stock in connection with its conversion of our then outstanding Series A Convertible Preferred Stock. According to an amendment to Schedule 13D filed with the SEC on September 11, 2012, this holder beneficially owns 32,505,737 shares of our common stock, or approximately 38.7% of our outstanding common stock as of March 10, 2014. Pursuant to a stockholders' agreement with us, which we originally entered into with holders of the Series A Convertible Preferred Stock, such holder is entitled to appoint up to four members of our board of directors and certain actions of the Company require the approval of such holder. As a result, this holder has the ability to exert significant influence over our business and may make decisions with which other stockholders may disagree, including, among other things, delaying, discouraging or preventing a change of control of the Company or a potential merger, consolidation, tender offer, takeover or other business combination.
The price of our common stock has been volatile and may continue to be volatile
Our stock price may fluctuate in response to a number of events and factors, many of which are outside our control, including variations in operating results, actions and pronouncements by various regulatory agencies, litigation, changes in financial estimates and recommendations by securities analysts, rating agency reports, performance of other companies that investors or security analysts deem comparable to us, news reports and announcements relating to our business and those of our competitors, responses to our merger with WMS, general and industry-specific economic conditions, public sales of a substantial number of shares of our common stock, and general market conditions. During the 52-week period ended March 7, 2014, our stock price fluctuated between a high of $19.48 and a low of $7.55. This significant stock price fluctuation may make it more difficult for our stockholders to sell their common stock when they want and at prices they find attractive.
ITEM 1B.    UNRESOLVED STAFF MATTERS
None.
ITEM 2.    PROPERTIES
We occupy approximately 2,113,000 square feet of space in the U.S. and Puerto Rico. Internationally, we occupy approximately 931,000 square feet of space. Set forth below is an overview of the principal owned and leased real estate properties that support our Instant Products, Lottery Systems and Gaming segments.
We own an approximate 355,000 square foot facility in Alpharetta, Georgia for administrative offices, manufacturing and warehousing that supports all of our business segments.
We lease approximately 23,000 square feet of office space in New York, New York for our corporate offices that support all of our business segments.
We own an approximate 483,000 square foot facility in Chicago Illinois for R&D that supports our Gaming segment.
We own an approximate 365,000 square foot facility in Waukegan, Illinois for administrative offices and manufacturing that supports our Gaming segment.
We own an approximate 53,000 square foot facility in Reno, Nevada for R&D and WAP operations that supports our Gaming segment.
We own an approximate 150,000 square foot facility in Leeds, England for administrative offices, manufacturing and warehousing that supports our Instant Products segment.
We own an approximate 119,000 square foot facility in Montreal Canada for administrative offices, manufacturing and warehousing that supports our Instant Products segment.
We own an approximate 47,000 square foot facility in Santiago Chile for manufacturing and distribution that supports our Instant Products segment.
We own an approximate 79,000 square foot facility in Germany for administrative offices, warehousing and distribution that supports our Instant Products segment.

Our Alpharetta, Chicago and Reno facilities are encumbered by mortgages securing indebtedness under our credit agreement. In addition to those listed above, we own or lease a number of additional properties in the U.S. and internationally that support our operations.
ITEM 3.    LEGAL PROCEEDINGS
The Company is involved in various legal proceedings, including those discussed below. We record an accrual for legal contingencies when it is both probable that a liability will be incurred and the amount or range of the loss can be reasonably estimated. We evaluate our accruals for legal contingencies at least quarterly and, as appropriate, establish new accruals or adjust existing accruals to reflect (1) the facts and circumstances known to us at the time, including information

37


regarding negotiations, settlements, rulings and other relevant events and developments, (2) the advice and analyses of counsel and (3) the assumptions and judgment of management. Legal costs associated with our legal proceedings are expensed as incurred. As of December 31, 2013, we had accrued aggregate liabilities of $25.9 million for all of our legal matters that were contingencies as of that date.
Substantially all of our legal contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss involves a series of complex judgments about future events. Consequently, the ultimate outcomes of our legal contingencies could result in losses in excess of amounts we have accrued. Any such losses could have a material adverse impact on our financial statements.
Colombia Litigation
Our subsidiary, SGI, owned a minority interest in Wintech de Colombia S.A., or Wintech (now liquidated), which formerly operated the Colombian national lottery under a contract with Empresa Colombiana de Recursos para la Salud, S.A. (together with its successors, "Ecosalud"), an agency of the Colombian government. The contract provided for a penalty against Wintech, SGI and the other shareholders of Wintech of up to $5.0 million if certain levels of lottery sales were not achieved. In addition, SGI delivered to Ecosalud a $4.0 million surety bond as a further guarantee of performance under the contract. Wintech started the instant lottery in Colombia but, due to difficulties beyond its control, including, among other factors, social and political unrest in Colombia, frequently interrupted telephone service and power outages, and competition from another lottery being operated in a province of Colombia that we believe was in violation of Wintech's exclusive license from Ecosalud, the projected sales level was not met for the year ended June 30, 1993.
In 1993, Ecosalud issued a resolution declaring that the contract was in default. In 1994, Ecosalud issued a liquidation resolution asserting claims for compensation and damages against Wintech, SGI and other shareholders of Wintech for, among other things, realization of the full amount of the penalty, plus interest, and the amount of the bond. SGI filed separate actions opposing each resolution with the Tribunal Contencioso of Cundinamarca in Colombia (the "Tribunal"), which upheld both resolutions. SGI appealed each decision to the Council of State. In May 2012, the Council of State upheld the contract default resolution, which decision was notified to us in August 2012. In October 2013, the Council of State upheld the liquidation resolution, which decision was notified to us in December 2013.
In July 1996, Ecosalud filed a lawsuit against SGI in the U.S. District Court for the Northern District of Georgia asserting many of the same claims asserted in the Colombia proceedings, including breach of contract, and seeking damages. In March 1997, the District Court dismissed Ecosalud’s claims. Ecosalud appealed the decision to the U.S. Court of Appeals for the Eleventh Circuit. The Court of Appeals affirmed the District Court’s decision in 1998.
In June 1999, Ecosalud filed a collection proceeding against SGI to enforce the liquidation resolution and recover the claimed damages. In May 2013, the Tribunal denied SGI's merit defenses to the collection proceeding and issued an order of payment of approximately 90 billion Colombian pesos (approximately $50 million) plus default interest (potentially accrued since 1994). SGI has filed an appeal to the Council of State, which appeal has stayed the payment order.
SGI believes it has various defenses, including on the merits, against Ecosalud's claims. Although we believe these claims will not result in a material adverse effect on our consolidated financial position or results of operations, it is not feasible to predict the final outcome, and there can be no assurance that these claims will not ultimately be resolved adversely to us or result in material liability.
SNAI Litigation
In April 2012, certain VLTs operated by SNAI S.p.a. ("SNAI") in Italy and supplied by Barcrest erroneously printed what appeared to be winning jackpot and other tickets with a face amount in excess of €400.0 million. SNAI has stated, and system data confirms, that no jackpots were actually won on that day. The terminals have been deactivated by the Italian regulatory authority. Following the incident, we understand that the Italian regulatory authority revoked the certification of the version of the gaming system that Barcrest provided to SNAI and fined SNAI €1.5 million, but determined to not revoke SNAI's concession to operate VLTs in Italy.
In October 2012, SNAI filed a lawsuit in the Court of First Instance of Rome in Italy against Barcrest and Global Draw, our subsidiary which acquired Barcrest from IGT-UK Group Limited, a subsidiary of IGT, claiming liability based on breach of contract and tort. The lawsuit seeks to terminate SNAI's agreement with Barcrest and damages arising from the deactivation of the terminals, including among other things, lost profits, expenses and costs, potential awards to players who have sought to enforce what appeared to be winning jackpot and other tickets, compensation sought by managers of the gaming locations where SNAI VLTs supplied by Barcrest were installed, damages to commercial reputation and any future damages arising from SNAI's potential loss of its concession or inability to obtain a new concession. In June 2013, Barcrest and Global Draw filed a counterclaim based on SNAI's alleged breach of contract.

38


In September 2013, Global Draw brought an action against IGT-UK Group Limited and IGT in the High Court of Justice (Commercial Court) in London, England seeking relief under the indemnification and warranty provisions contained in the agreement pursuant to which Barcrest was acquired from IGT-UK Group, including in connection with the April 2012 incident and a number of ancillary matters. In November 2013, IGT-UK Group Limited Barcrest filed a defense in which it denied Global Draw’s claims and counterclaimed based on Global Draw’s alleged breach of contract in connection with one of the ancillary matters.
While we believe we have meritorious defenses in the Italian litigation and potential third party recoveries, the lawsuit is in its early stages and we cannot currently predict the outcome of this matter.
WMS Merger Litigation
Complaints challenging the WMS merger were filed early in 2013 in the Delaware Court of Chancery, the Circuit Court of Cook County, Illinois and the Circuit Court of the Nineteenth Judicial Circuit, Lake County, Illinois. The actions are putative class actions filed on behalf of the WMS stockholders. The complaints generally allege that the WMS directors breached their fiduciary duties in connection with their consideration and approval of the merger and in connection with their public disclosures concerning the merger. The complaints allege that other defendants, including WMS, Scientific Games Corporation and certain affiliates of Scientific Games Corporation, aided and abetted those alleged breaches. The plaintiffs sought equitable relief, including to enjoin the acquisition, to rescind the acquisition if not enjoined, damages, attorneys' fees and other costs.
The Delaware actions have been consolidated under the caption In re WMS Stockholders Litigation (C.A. No. 8279-VCP). The plaintiffs in the consolidated Delaware actions submitted to the Delaware Court of Chancery a letter advising that they had conferred with the plaintiffs in the Illinois actions and agreed to stay the consolidated Delaware action.
The Lake County, Illinois actions have been transferred to Cook County. All of the Illinois actions have been consolidated in Cook County with Gardner v. WMS Industries Inc., et al. (No. 2013 CH 3540).
In April 2013, the plaintiffs in the Gardner action filed a motion for preliminary injunction to enjoin the WMS stockholder vote on the merger. Following that, in April 2013, lead counsel in the Gardner action, on behalf of counsel for plaintiffs in all actions in Delaware and Illinois, agreed to withdraw the motion for preliminary injunction and not to seek to enjoin the WMS stockholder vote in return for WMS's agreement to make certain supplemental disclosures related to the merger. WMS made those supplemental disclosures in a Current Report on Form 8-K filed with the SEC on April 29, 2013.
The plaintiffs in the Illinois action filed a claim for interim attorney fees of $0.9 million. In November 2013, the court granted our motion to stay the plaintiffs' claim for an interim award of attorney fees.
In January 2014, the plaintiffs in the Illinois action filed an amended complaint seeking damages for the alleged breach of fiduciary duties by the individual defendants and the alleged aiding and abetting of those breaches by WMS and Scientific Games Corporation. In February 2014, WMS and Scientific Games Corporation filed motions to dismiss the amended complaint.
The Company believes the claims in the Illinois and Delaware actions are without merit.
Conlee Litigation
In May 2011, a putative class action was filed against WMS and certain of its executive officers in the U.S. District Court for the Northern District of Illinois by Wayne C. Conlee. In October 2011, the lead plaintiff filed an amended complaint in the lawsuit seeking unspecified damages. As amended, the lawsuit alleged that, during the period from September 21, 2010 to August 4, 2011 (the date WMS announced its 2011 fiscal year financial results), WMS made material misstatements and omitted material information related to its 2011 fiscal year guidance in violation of federal securities laws. WMS filed a motion to dismiss the amended complaint in December 2011 and, in July 2012, the Court granted the motion without prejudice.
In September 2012, the plaintiffs filed a further amended complaint, which WMS moved to dismiss in October 2012. In April 2013, the District Court granted WMS's motion to dismiss with prejudice. In May 2013, the plaintiffs filed a notice of appeal with the U.S. Court of Appeals for the Seventh Circuit.  In October 2013, the parties advised the court that they had reached a proposed settlement on a class basis and sought the District Court’s approval of the proposed settlement.  In January 2014, the District Court preliminarily approved the proposed settlement and scheduled a fairness hearing for May 2014 for final approval of the settlement. If approved, the settlement will not have a material impact on our results of operations.



39


IGT License Claims
In early 2012, IGT initiated an audit to determine whether WMS was in compliance with the terms of a license agreement between them. IGT claimed that WMS underpaid license fees by approximately $25 million plus approximately $11 million in interest.  IGT subsequently filed a demand for arbitration with the American Arbitration Association seeking $50.0 million from WMS.  We have denied IGT’s claims in the arbitration and have initiated an action in the U.S. District Court for the District of Nevada seeking a preliminary injunction to enjoin or limit the scope of the arbitration and to restrain IGT from seeking to enforce certain provisions of the arbitration clause in the license agreement, as well as a refund of overpaid royalty payments.  The arbitration has been stayed pending resolution of the District Court case. While we believe we have meritorious defenses with respect to these license claims, the proceedings are in their early stages and we cannot currently predict the outcome of this matter.

40


ITEM 4.    MINE SAFETY DISCLOSURES
Not applicable.

41


PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for Our Common Stock
Our outstanding common stock is listed for trading on the Nasdaq Global Select Market under the symbol "SGMS". The following table sets forth, for the periods indicated, the range of high and low sales prices of our Class A common stock.
        
 
 
Sales Price of
Scientific Games
Common Stock
 
 
High
 
Low
Fiscal Year 2013 (January 1, 2013 - December 31, 2013)
 
 
 
 
First Quarter
 
$
10.88

 
$
8.07

Second Quarter
 
$
11.82

 
$
7.55

Third Quarter
 
$
16.70

 
$
11.33

Fourth Quarter
 
$
19.48

 
$
15.50

Fiscal Year 2012 (January 1, 2012 - December 31, 2012)
 
 
 
 
First Quarter
 
$
13.08

 
$
9.86

Second Quarter
 
$
12.29

 
$
7.95

Third Quarter
 
$
9.01

 
$
5.53

Fourth Quarter
 
$
8.89

 
$
6.64

On March 10, 2014, the last reported sale price for our common stock on the Nasdaq Global Select Market was $14.18 per share. There were 922 holders of record of our common stock as of March 10, 2014.
Dividend Policy
We have never paid any cash dividends on our Class A common stock and do not presently intend to pay cash dividends on our Class A common stock in the foreseeable future. Further, under the terms of certain of our debt agreements, we are limited in our ability to pay cash dividends or make certain other restricted payments (other than stock dividends) on our Class A common stock. For further discussion related to dividend restrictions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity, Capital Resources and Working Capital—Credit Agreement and Other Debt" in Item 7 of this Annual Report on Form 10-K
Stock Repurchase Program
On December 5, 2013, our board of directors approved an extension of our existing stock repurchase program to December 31, 2014. The program, originally announced in May 2010, was due to expire on December 31, 2013. Under the program, we are authorized to repurchase, from time to time through open market purchases or otherwise, shares of our outstanding common stock in an aggregate amount up to $200 million. As of December 31, 2013, we had $104.5 million available for potential repurchases under the program. We repurchased 49,308 shares under the repurchase program for $0.8 million during the fourth quarter of 2013 and repurchased an additional 2.0 million shares for $29.5 million in the first quarter of 2014. We have $75.0 million available for potential repurchases under the program as of the date of this Annual Report on Form 10-K.
Period
 
Total Number
of Shares
Purchased (1)
 
Average
Price Paid
per Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
 
Approximate Dollar Value
of Shares that May Yet Be
Purchased Under the
Plans or Programs
10/1/2013 - 10/31/2013
 
6,376

 
$
17.63

 

 
$105.2 million
11/1/2013 - 11/30/2013
 
12,877

 
$
18.07

 

 
$105.2 million
12/1/2013 - 12/31/2013
 
63,522

 
$
16.09

 
49,308

 
$104.5 million
Total
 
82,775

 
$
16.52

 
49,308

 
$104.5 million
_________________________________________________________________________________________________________________________


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(1)
In addition to shares of Class A common stock repurchased as part of our publicly announced stock repurchase program, this column reflects 33,467 shares acquired from employees to satisfy the withholding taxes associated with the vesting of RSUs during the quarter ended December 31, 2013.

Shares Authorized For Issuance Pursuant to Equity Compensation Plans (in thousands)

There are 13,500 shares of common stock authorized for awards under our 2003 Incentive Compensation Plan (the "2003 Plan") plus available shares from a pre-existing equity compensation plan, which plans were approved by our stockholders. In connection with the WMS acquisition, we assumed the WMS Incentive Plan (renamed the Scientific Games Corporation Amended and Restated Incentive Plan (2013 Restatement)) (the "2013 Plan") and the outstanding awards under such plan without stockholder approval, as permitted by applicable stock exchange rules. At the time of the assumption, there were 5,627 shares available for future issuance under the 2013 Plan, excluding shares available under outstanding awards. We have outstanding stock options granted as part of inducement stock option awards that were not approved by our stockholders, as permitted by applicable stock exchange rules. The table below shows information regarding our equity compensation plans as of December 31, 2013:
Equity Compensation Plans
 
 
Shares available for future issuance under the 2003 Plan(1)
 
1,556

Shares available for future issuance under the 2013 Plan(2)
 
4,959

Unrecognized cost of outstanding awards (in millions)
 
$
44.2

Weighted average future recognition period (years)
 
2.0

(1) Excludes 299 shares available for future issuance under our employee stock purchase plan as of December 31, 2013. Under the share counting rules of the 2003 Plan, awards may be outstanding relating to a greater number of shares than the aggregate remaining available under the plan so long as awards will not result in delivery and vesting of shares in excess of the number then available under the 2003 Plan.  Shares available for future issuance under the 2003 Plan do not include shares expected to be withheld in connection with outstanding awards to satisfy tax withholding obligations, which may be deemed to be available for awards under the 2003 Plan as permitted under the applicable share counting rules of the plan.
(2) Shares available for grants of equity awards to WMS employees as of December 31, 2013 under the 2013 Plan.
Stockholder Return Performance Graph
The following graph compares the cumulative total stockholder return over the five-year period ended December 31, 2013 of our common stock, the Nasdaq Composite Index and an index of peer group companies that operate in industries or lines of business similar to ours.
The peer group index consists of Bally Technologies, Inc. (New York Stock Exchange: BYI), IGT (New York Stock Exchange: IGT), Multimedia Games, Inc. (Nasdaq Global Select Market: MGAM), Aristocrat Leisure Limited (Australian Securities Exchange: ALL), Gtech S.p.A. (Borsa Italiana S.p.A.: GTK), Intralot, S.A (Athens Stock Exchange: INLOT) and Pollard Banknote Limited (Toronto Stock Exchange: PLB.UN-TO).
The companies in each peer group have been weighted based on their relative market capitalization each year. The graph assumes that $100 was invested in our common stock, the Nasdaq Composite Index and the peer group index at the beginning of the five-year period and that all dividends were reinvested. The comparisons are not intended to be indicative of future performance of our common stock.

43


 
 
12/08
 
12/09
 
12/10
 
12/11
 
12/12
 
12/13
Scientific Games Corporation
 
100.00

 
82.95

 
56.78

 
55.30

 
49.43

 
96.52

NASDAQ Composite Index
 
100.00

 
144.88

 
170.58

 
171.30

 
199.99

 
283.39

Prior Peer Group Index
 
100.00

 
159.29

 
136.30

 
129.38

 
146.67

 
230.73

Current Peer Group Index
 
100.00

 
159.29

 
136.30

 
135.17

 
154.06

 
221.01


ITEM 6.    SELECTED FINANCIAL DATA
Selected financial data presented below as of and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 have been derived from our audited consolidated financial statements. The information below reflects the acquisitions and dispositions of certain businesses from 2009 through 2013, including the WMS acquisition in October 2013, the disposition of our pub business in March 2013, the acquisition of substantially all of the assets of Parspro in July 2012, the acquisition of Provoloto in June 2012 and the initiation of our exit of the business in December 2013, the acquisition of ADS in June 2012, the acquisition of Barcrest in September 2011, the disposition of our Racing Business in October 2010, the acquisition of substantially all of GameLogic's assets in August 2010 and the acquisition of certain assets of Sceptre Leisure Solutions Limited in April 2010. This data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of this Annual Report on Form 10-K and our Consolidated Financial Statements and the Notes thereto included in Item 8 of this Annual Report on Form 10-K.










44


FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
(in millions, except per share amounts)
 
 
As of and for the Years Ended December 31,
 
 
2013
 
2012
 
2011
 
2010
 
2009
Total revenue
 
$
1,090.9

 
$
928.6

 
$
865.9

 
$
870.5

 
$
914.8

Operating (loss) income (1)
 
(18.3
)
 
62.9

 
92.2

 
62.9

 
2.6

Total other (expense) income
 
(125.0
)
 
(86.1
)
 
(79.6
)
 
(63.5
)
 
(25.3
)
Net (loss) income from continuing operations before income taxes
 
(143.3
)
 
(23.2
)
 
12.6

 
(0.6
)
 
(22.7
)
Income tax benefit (expense)
 
117.7

 
(20.7
)
 
(18.4
)
 
(143.8
)
 
(13.7
)
Net loss from continuing operations
 
$
(25.6
)
 
$
(43.9
)
 
$
(5.8
)
 
$
(144.4
)
 
$
(36.4
)
 
 
 
 
 
 
 
 
 
 
 
Basic and diluted net loss per share:
 
 
 
 
 
 
 
 
 
 
Basic from continuing operations
 
$
(0.30
)
 
$
(0.49
)
 
$
(0.06
)
 
$
(1.56
)
 
$
(0.39
)
Diluted from continuing operations
 
$
(0.30
)
 
$
(0.49
)
 
$
(0.06
)
 
$
(1.56
)
 
$
(0.39
)
 
 
 
 
 
 
 
 
 
 
 
Weighted average number of shares used in per share calculations:
 
 
 
 
 
 
 
 
 
 
Basic shares
 
85.0

 
90.0

 
92.1

 
92.7

 
92.7

Diluted shares
 
85.0

 
90.0

 
92.1

 
92.7

 
92.7

 
 
 
 
 
 
 
 
 
 
 
Statement of Cash Flows Data
 
 
 
 
 
 
 
 
 
 
Net cash provided by operating activities
 
$
171.2

 
$
156.8

 
$
171.1

 
$
170.5

 
$
220.1

Net cash used in investing activities
 
(1,664.7
)
 
(141.9
)
 
(161.1
)
 
(287.6
)
 
(188.2
)
Net cash provided by (used in) financing activities
 
1,538.7

 
(10.1
)
 
(24.7
)
 
(9.8
)
 
92.1

Effect of exchange rates changes on cash and cash equivalents
 
(0.5
)
 
(0.2
)
 
(5.2
)
 
(9.0
)
 
0.4

Increase (decrease) in cash and cash equivalents
 
$
44.7

 
$
4.6

 
$
(19.9
)
 
$
(135.9
)
 
$
124.4

 
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
4,241.9

 
$
2,186.9

 
$
2,161.9

 
$
2,151.5

 
$
2,291.8

Total long-term debt, including current installments
 
$
3,192.6

 
$
1,468.2

 
$
1,390.7

 
$
1,396.7

 
$
1,367.1

Stockholders' equity
 
$
375.0

 
$
364.8

 
$
443.7

 
$
452.7

 
$
619.8

(1) Operating income (loss) includes:
Stock-based compensation of $22.3 million, $24.2 million, $21.5 million, $22.7 million and $34.5 million in 2013, 2012, 2011, 2010 and 2009, respectively.
The write-down of assets held for sale in 2009 resulting from our strategic decision to sell the Racing Business.
Employee termination and restructuring costs of $22.7 million, $10.6 million, $2.0 million, $0.6 million and $3.9 million in 2013, 2012, 2011, 2010 and 2009, respectively.
Depreciation and amortization expense, which includes accelerated depreciation charges related to equipment or technology, the impact of any impairment charges related to underperforming contracts and also includes accelerated depreciation expense related to restructuring plans. Charges for accelerated depreciation or impairment included in depreciation and amortization expense were $22.3 million, $45.5 million, $6.4 million, $31.3 million and $24.7 million for 2013, 2012, 2011, 2010 and 2009, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations" in Item 7 of this Annual Report on Form 10-K for further discussion regarding these charges.

45


Loss or gain on early extinguishment of debt includes losses or gains that we incur when we refinance our long-term debt obligations and also includes write-offs of the associated deferred financing costs. See Note 15 (Long-Term and Other Debt) for more information regarding our debt instruments.

46



ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following MD&A is intended to enhance the reader's understanding of our operations and current business environment and should be read in conjunction with the description of our business (Item 1 of this Annual Report on Form 10-K) and our Consolidated Financial Statements and Notes (Item 8 of this Annual Report on Form 10-K).
            This MD&A contains forward-looking statements and should be read in conjunction with the disclosures and information contained under "Forward-Looking Statements" and "Risk Factors" at the beginning and in Item 1A, respectively, of this Annual Report on Form 10-K. As used in this MD&A, the terms "we," "us," "our" and the "Company" mean Scientific Games Corporation together with its consolidated subsidiaries.
Our MD&A is organized into the following sections:
BUSINESS OVERVIEW
CONSOLIDATED RESULTS
BUSINESS SEGMENT RESULTS
RECENTLY ISSUED ACCOUNTING GUIDANCE
CRITICAL ACCOUNTING ESTIMATES
LIQUIDITY, CAPITAL SOURCES AND WORKING CAPITAL
BUSINESS OVERVIEW
We are a leading developer of technology-based products and services and associated content for worldwide gaming and lottery markets.  The Company’s portfolio includes instant and draw-based lottery games; electronic gaming machines and game content; server-based lottery and gaming systems; sports betting technology; loyalty and rewards programs; and social, mobile and interactive content and services.  We also gain access to technologies and pursue global expansion through strategic acquisitions and equity investments.
Impact of WMS Acquisition and Other Items
On October 18, 2013, the Company acquired WMS for $1,485.9 million. For additional information regarding the WMS acquisition, please see Note 3 (Acquisitions and Dispositions). In connection with the WMS acquisition, we entered into new senior secured credit facilities in an aggregate principal amount of $2,600.0 million, consisting of a $300.0 million revolving credit facility and a $2,300.0 million term loan facility. The term loan facility was used, in part, to finance the consideration paid in the WMS acquisition, to pay off indebtedness under our and WMS's prior credit agreements and to pay related acquisition expenses and financing fees. For additional information regarding our new credit facilities, see Note 15 (Long-Term and Other Debt).
We believe that the WMS acquisition is transformational for Scientific Games, creating one of the largest diversified global gaming suppliers. In particular, we believe that the WMS acquisition (1) significantly expands our gaming business, (2) diversifies our mix of products, customers and geographies in which we do business and (3) allows the combined company to leverage the unique core competencies of each organization. We also expect the combined company to benefit from economies of scale, which we believe will provide opportunities for synergies and cash flow improvements. 
Our consolidated results of operations for the year ended December 31, 2013 were significantly impacted by the inclusion of the results of operations for WMS for the 74 days following the acquisition date. Results for the years ended December 2012 and 2011 do not include results of operations for WMS. Items related to the WMS acquisition and other items that impacted our results of operations are detailed below:
$144.7 million of our revenue was attributable to WMS;
our consolidated results also reflected:
a $13.0 million increase of cost of product sales due to the write-up of finished goods inventory required under purchase accounting for the WMS acquisition;
$19.8 million of acquisition-related fees and expenses related to the WMS acquisition and $24.5 million for legal contingencies and settlements that impacted SG&A;

47


employee termination and restructuring charges of $22.7 million related to the WMS acquisition and other restructuring activities, including $5.3 million related to WMS integration activities, $2.2 related to the discontinuance of a line of gaming machines following the WMS acquisition, $9.1 million related to management changes and $4.5 million related to the exit from our instant lottery game operations in Mexico;
$18.5 million of accelerated or incremental depreciation expense, including $8.0 million of accelerated depreciation related to obsolete software, $4.9 million of incremental depreciation and amortization from the write-up of tangible and intangible assets under purchase accounting for the WMS acquisition, $3.1 million of accelerated depreciation related to our exit of our instant lottery game operations in Mexico and $2.5 million related to an impairment of a lottery systems contract;
a $19.5 million year-over-year increase in interest expense related to the incremental indebtedness that we incurred under our new credit facilities to finance the WMS acquisition;
a $26.6 million decline in our earnings from equity investments primarily reflecting $23.1 million in charges related to a change in the estimated useful lives of certain gaming machines that impacted results of our ITL equity investment and a write-down of our Guard Libang equity investment partially offset by a one-time $7.9 million early termination fee earned by ITL as part of a five-year contract extension;
a loss on early extinguishment of debt of $5.9 million related to the early termination of our prior credit facilities in connection with the financing of the WMS acquisition; and
an income tax benefit of $131.1 million related to the net deferred tax liabilities acquired in the WMS acquisition.
See Note 3 (Acquisitions and Dispositions), Note 4 (Restructuring Plans), Note 8 (Property and Equipment), Note 9 (Intangible Assets and Goodwill), Note 10 (Software), Note 11 (Equity Investments), Note 15 (Long-Term and Other Debt), Note 21 (Income Tax Expense) and Note 22 (Litigation) for additional information regarding the foregoing items.
Our results of operations for the year ending December 31, 2014 will reflect a full year of the results of operations for WMS. Among other things, these results are anticipated to reflect (1) significant investment in R&D by WMS (as illustrated by the $19.4 million increase in our R&D expense for the year ended December 31, 2013, almost all of which was attributable to the inclusion of WMS in our results since October 18, 2013), (2) higher SG&A, including the significant resources expended in the WMS interactive business for player acquisition, (3) incremental depreciation and amortization resulting from the write-up of tangible and intangible assets required under purchase accounting for the WMS acquisition and (4) higher interest expense related to our new credit facilities (as illustrated by the $19.5 million increase in interest expense for the year ended December 31, 2013).
For 2014, we are focused on successfully integrating WMS and Scientific Games and achieving anticipated cost synergies by implementing our plans to streamline our operations and cost structure. We are also focused on positioning the Company for profitable growth by leveraging our core strengths and capabilities to enhance our portfolio of products and services and to expand market penetration worldwide. We anticipate our future results of operations will benefit from these efforts, although we expect these benefits to be offset to some extent by incremental costs and capital expenditures related to our contemplated integration activities. We also expect to incur additional costs during 2014 to position ourselves to capitalize on longer-term revenue synergy opportunities.
Segments
We report our operations in three business segments: Instant Products, Lottery Systems and Gaming. The Instant Products and Lottery Systems business segments are managed by a single executive and the Gaming business segment is managed by a separate executive, both of whom report to our chief executive officer (who is the "chief operating decision maker" under applicable accounting rules). See "Business Segment Results" below and Note 2 (Business and Geographic Segments) for additional business segment information.
Discontinued Operations
On March 25, 2013, we completed the sale of our installed base of gaming machines in our pub business, as discussed in Note 3 (Acquisitions and Dispositions). The results of our discontinued pub operations for the years ended December 31, 2013, 2012 and 2011 are presented in the Consolidated Statements of Operations and Comprehensive Loss in accordance with ASC 205-20, Presentation of Financial Statements - Discontinued Operations. For the years ended December 31, 2013, 2012 and 2011, we recorded a loss from discontinued operations of $3.0 million, $24.6 million and $8.4 million, respectively, and a net loss from discontinued operations of $4.6 million, $18.7 million and $6.8 million, respectively.

48



Foreign Exchange
Our results are subject to the impact of changes in foreign currency exchange rates, which results in the translation of foreign functional currencies into U.S. dollars and the re-measurement of foreign currency transactions. The impact of foreign currency exchange rate fluctuations represents the difference between current rates and prior period rates applied to current activity. We derived approximately 49% and 53% of our revenue from sales to customers outside of the U.S. in 2013 and 2012, respectively. We have exposure to foreign currency volatility, particularly the British Pound Sterling and the Euro. The British Pound Sterling and the Euro represented, respectively, $228.9 million, or 21%, and $65.5 million, or 6%, of our consolidated revenue for the year ended December 31, 2013. We also have foreign currency exposure related to certain of our equity investments. Our earnings from our Euro-denominated equity investment in LNS were $17.9 million for the year ended December 31, 2013. See further information regarding our foreign exchange exposures in "Quantitative and Qualitative Disclosures About Market Risk" in Item 7A of this Annual Report on Form 10-K.
CONSOLIDATED RESULTS
 (in millions)
 
Years ended December 31,
 
Variance
 
 
2013
 
2012 (2)
 
2011 (2)
 
2013 vs 2012
 
2012 vs 2011
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Instant games
 
$
516.0

 
$
493.6

 
$
493.3

 
$
22.4

 
5
 %
 
$
0.3

 
 %
Services
 
415.0

 
340.3

 
318.9

 
74.7

 
22
 %
 
21.4

 
7
 %
Product sales
 
159.9

 
94.7

 
53.7

 
65.2

 
69
 %
 
41.0

 
76
 %
Total revenue
 
1,090.9

 
928.6

 
865.9

 
162.3

 
17
 %
 
62.7

 
7
 %
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of instant games (1)
 
285.1

 
282.5

 
281.6

 
2.6

 
1
 %
 
0.9

 
 %
Cost of services (1)
 
203.1

 
170.7

 
161.8

 
32.4

 
19
 %
 
8.9

 
6
 %
Costs of product sales (1)
 
103.5

 
65.1

 
38.3

 
38.4

 
59
 %
 
26.8

 
70
 %
Selling, general and administrative
 
266.4

 
179.4

 
172.9

 
87.0

 
48
 %
 
6.5

 
4
 %
Research and development
 
26.0

 
6.6

 
6.1

 
19.4

 
294
 %
 
0.5

 
8
 %
Employee termination and restructuring
 
22.7

 
10.6

 
2.0

 
12.1

 
114
 %
 
8.6

 
430
 %
Depreciation and amortization
 
202.4

 
150.8

 
111.0

 
51.6

 
34
 %
 
39.8

 
36
 %
Operating (loss) income
 
(18.3
)
 
62.9

 
92.2

 
(81.2
)
 
(129
)%
 
(29.3
)
 
(32
)%
Total other (expense) income
 
(125.0
)
 
(86.1
)
 
(79.6
)
 
(38.9
)
 
45
 %
 
(6.5
)
 
8
 %
Net (loss) income from continuing operations before income taxes
 
(143.3
)
 
(23.2
)
 
12.6

 
(120.1
)
 
518
 %
 
(35.8
)
 
(284
)%
Income tax benefit (expense)
 
117.7

 
(20.7
)
 
(18.4
)
 
138.4

 
(669
)%
 
(2.3
)
 
13
 %
Net loss from continuing operations
 
$
(25.6
)
 
$
(43.9
)
 
$
(5.8
)
 
$
18.3

 
(42
)%
 
$
(38.1
)
 
657
 %
________________________________________________________________________________________________________________________________
(1)
Exclusive of depreciation and amortization.
(2)
Prior year consolidated results were recast to exclude discontinued operations.
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Revenue
Consolidated revenue increased in each of our categories of revenues (instant games, services and product sales). The inclusion of revenue from WMS following the acquisition increased consolidated revenue by $144.7 million. Consolidated revenue also reflected unfavorable foreign currency translation of $1.7 million.

Instant games revenue increased by $22.4 million reflecting higher revenue from game licensing and player loyalty programs, higher revenue from our participation contracts in U.S. and international jurisdictions and higher revenue from our international price-per-unit contracts, partially offset by a decrease in revenue from our U.S. price-per-unit contracts.


49


Service revenue, which includes our participation-based and other service revenue from our Lottery Systems and Gaming business segments, increased $74.7 million reflecting the inclusion of $75.9 million of WMS service revenue. Excluding the portion related to WMS, service revenue was essentially flat year-over-year.

Product sales revenue included $68.8 million of post-acquisition WMS product sales revenue, and otherwise decreased by $3.6 million. The decrease resulted from lower U.S. lottery systems hardware sales and lower sales of gaming machines to our bingo and arcade customers in the U.K., partially offset by higher sales of hardware and software to our international lottery systems customers.
Cost of Revenue
Consolidated cost of revenue increased $73.4 million, including $63.8 million from WMS. Cost of instant games increased primarily due to increased revenue. Excluding $19.5 million of cost of revenue incurred by WMS following the acquisition, cost of service revenue increased $12.9 million related to a less profitable mix of service revenue. Excluding cost of product sales related to WMS, cost of product sales decreased $5.9 million primarily due to lower product sales in our U.K. gaming business.
SG&A
SG&A increased $87.0 million, which reflected $47.5 million of SG&A incurred by WMS following the acquisition, $19.8 million of fees and expenses related to the WMS acquisition and $24.5 million related to legal contingencies and settlements. The increase in SG&A was partially offset by a $6.2 million decrease in compensation expense.
R&D
R&D increased $19.4 million primarily related to WMS, which accounted for $19.1 million of the increase.
Employee Termination and Restructuring
Employee termination and restructuring costs included $5.3 million related to WMS integration activities, $9.1 million related to management changes, $4.5 million related to the exit from our instant lottery game operations in Mexico and $2.2 related to the discontinuance of a line of gaming machines following the WMS acquisition. We discuss these charges in more detail in Note 4 (Restructuring Plans).
Depreciation and Amortization
Depreciation and amortization increased $51.6 million, including $40.1 million of depreciation and amortization from WMS, which included $4.9 million of incremental depreciation and amortization resulting from the write-up of tangible and intangible assets under our purchase accounting for the WMS acquisition. In addition, as a result of our restructuring activities, we recorded $4.6 million of accelerated depreciation related to software for a line of gaming machines that we discontinued following the WMS acquisition and $3.1 million of accelerated depreciation related to the exit from our instant lottery game operations in Mexico. We also recorded an additional $3.4 million of accelerated depreciation expense related to other obsolete software in our gaming business and higher depreciation due to the placement of an internally developed software platform into service and the deployment of new lottery terminals in China. These increases were offset by $3.3 million of lower lottery systems impairments as compared to the prior year.
Other Income and Expense
Interest expense increased $19.5 million due to the incremental indebtedness that we incurred under our new credit facilities to finance the WMS acquisition. In addition, we recorded a loss on early extinguishment of debt of $5.9 million related to the write-off of deferred financing costs associated with the early termination of our prior credit facilities in connection with the financing of the WMS acquisition. See further details regarding our indebtedness in Note 15 (Long-term and Other Debt). In 2012, we recorded a loss on early extinguishment of debt of $15.5 million due to the redemption of our 2016 Notes comprised primarily of the redemption premium and the write-off of previously deferred financing costs.

Earnings from equity investments decreased by $26.6 million primarily due to lower earnings from our investment in ITL related to the accelerated depreciation of certain gaming machines, as well as lower earnings from our investments in Northstar Illinois and RCN. We also recorded a $6.4 million impairment charge on our equity investment in Guard Libang. These decreases in earnings from equity investments were partially offset by a one-time $7.9 million early termination fee earned by ITL as part of a five-year contract extension. See further details in Note 11 (Equity Investments).


50


Income Tax Benefit (Expense)
We recorded an income tax benefit of $117.7 million for the year ended December 31, 2013 compared to income tax expense of $20.7 million for the year ended December 31, 2012. The effective income tax rates for the years ended December 31, 2013 and 2012 were 82.1% and (89.2)% respectively. In 2013, the Company recorded an income tax benefit of $131.1 million related to the net deferred tax liabilities acquired in the WMS acquisition. The income tax benefit was partially offset by income tax related to current-year profits of our foreign operations, the tax impact related to amortization of indefinite lived intangibles and our inability to recognize tax benefits associated with current-year losses in the U.S. After considering the net deferred tax liabilities acquired as a result of the WMS acquisition and the current-year U.S. loss, the Company recorded a partial release of the valuation allowance related to its net U.S. deferred tax assets in the amount of $68.9 million.

Our 2013 effective income tax rate on foreign earnings was impacted by the mix of income and the statutory tax rates in our foreign jurisdictions, which ranged from a low of 0% to a high of 35%. The foreign jurisdictions that had the most impact on our foreign income tax benefit (expense) in 2013 include Austria, Bermuda, Canada, Ireland, Mexico and the U.K.

Our income tax benefit (expense) may change from period to period based on, among other factors, the mix of earnings between U.S. and foreign jurisdictions and among foreign jurisdictions, the effect of the valuation allowance related to our U.S. deferred tax assets (or the release thereof), state and local taxes, specific events such as the settlement of income tax audits and changes in tax law, and the effects of our global income tax strategies. Please refer to Note 21 (Income Tax Expense) for additional information regarding our foreign and domestic pre-tax income (loss), our foreign and domestic income tax benefit (expense) and the effect foreign taxes have on our overall effective tax rate.
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Revenue
Consolidated revenue reflected increases in each of our categories of revenue and the acquisition of Barcrest, which increased consolidated revenue by $26.9 million. Consolidated revenue also reflected unfavorable foreign currency translation of $8.9 million.

The increase in instant games revenue reflected higher revenue from our U.S. and international participation contracts and higher revenue from our player loyalty programs. This increase was partially offset by a decrease in game licensing revenue and by lower revenue from our U.S. and international price-per-unit contracts.

The increase in consolidated service revenue reflected higher lottery systems service revenue due in part to larger Powerball and Mega Millions jackpots in 2012 and higher instant game validation revenue, as well as higher gaming service revenue due to the acquisition of Barcrest and an increase in revenue from our U.K. LBO contracts.

The increase in product sales revenue resulted from higher equipment sales to U.S. customers, higher hardware and software sales to our international customers and the acquisition of Barcrest.

Cost of Revenue

Consolidated cost of revenue increased in 2012 versus 2011 reflecting the increase in consolidated revenue for the same period. The increase in consolidated cost of revenue included an increase in cost of services and cost of product sales reflecting the increase in service and product sales revenue, respectively, and an increase due to the impact of foreign currency translation of $5.3 million.
SG&A
The increase in SG&A reflected $5.4 million of incremental expense from our business acquisitions, higher compensation expense of $5.8 million (including a $2.6 million increase in stock-based compensation expense), a $6.2 million increase in accounts receivable reserves related to certain gaming customers and $2.9 million of higher expenses related to the expansion of our U.K. LBO business. This increase was partially offset by a decrease of $7.1 million in our accrual for potential incentive compensation under our performance-based incentive compensation plan relating to our Asia-Pacific business (the "Asia-Pacific Plan"), a decrease of $5.9 million due to the impact of a customer claim recorded during the year ended December 31, 2011 and an insurance settlement recovered in 2012 related to that claim, and lower professional and advisory fees of $3.0 million. The overall increase in SG&A was also partially offset by a $1.0 million decrease due to the impact of foreign currency translation.


51


Employee Termination and Restructuring
Employee termination and restructuring costs of $10.6 million related to our exit from the Barcrest analog AWP business, the reorganization of our pub business in an effort to more effectively capitalize on the Barcrest acquisition and the reorganization of our Australian printing operations.
Depreciation and Amortization
Depreciation and amortization increased principally due to $31.9 million of accelerated depreciation expense in our gaming business, including $12.5 million related to the write-down of gaming machines and software in our pub business and $19.4 million related to a write-down of gaming machines primarily related to customers transitioning to newer generation terminals. Depreciation and amortization also increased due to the $5.8 million impairment of certain long-lived assets related to underperforming Lottery Systems contracts, $4.4 million of accelerated depreciation expense related to the write-down of certain development costs in our licensed properties business and $6.8 million of incremental depreciation expense from the acquisition of Barcrest. In addition, we recorded $3.4 million of accelerated depreciation expense related to the reorganization of our Australian printing operations. The increase was partially offset by a $6.4 million decrease due to accelerated depreciation expense recorded in 2011 related to the replacement of our Gaming business technology platform.
Other Income and Expense
Interest expense decreased primarily due to a decline in borrowing costs related to our variable interest rate debt and the expiration of an interest rate swap in October 2011.
Earnings from equity investments decreased due to lower earnings from most of our equity method investments, partially offset by an increase in earnings from RCN.
Loss on early extinguishment of debt increased due to the redemption of our 2016 Notes resulting in a charge of $15.5 million comprised primarily of the redemption premium and the write-off of previously deferred financing costs.
Other expense increased principally due to an increase in foreign exchange transaction expenses.
Income Tax Expense
Income tax expense was $20.7 million for the year ended December 31, 2012 compared to $18.4 million for the year ended December 31, 2011. The effective income tax rates for the year ended December 31, 2012 and 2011 were (89.2)% and 146.0%, respectively. The effective tax rate for 2012 did not include the benefit of the current year U.S. tax loss as a result of the valuation allowance against our U.S. deferred tax assets. Our effective income tax rate on foreign earnings was impacted by the mix of income and the statutory tax rates in our foreign jurisdictions, which ranged from a low of 0% to 35%. The foreign jurisdictions that had the most impact on our foreign income tax in 2012 include Austria, Canada, Ireland, Mexico and the U.K.
    
Our income tax benefit (expense) may change from period-to-period based on, among other factors, the mix of earnings between U.S. and foreign jurisdictions and among foreign jurisdictions, the effect of the valuation allowance related to our U.S. deferred tax assets, state and local taxes, specific events such as the settlement of income tax audits and changes in tax law, and the effects of the Company’s global income tax strategies. Please refer to Note 21 (Income Tax Expense) for additional information regarding our foreign and domestic pre-tax income (loss), our foreign and domestic income tax provision and the effect foreign taxes have on our overall effective tax rate.
BUSINESS SEGMENTS RESULTS
INSTANT PRODUCTS
Our Instant Products segment is primarily comprised of our global instant lottery games business. We generate revenue from the manufacturing and sale of instant lottery games, 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. In addition, we provide licensed games, promotional entertainment and internet-based marketing services to the lottery industry. These revenues are presented as Instant Games in our results of operations. Revenue generated from the sale of phone cards that we manufacture is presented as product sales in our results of operations. Our equity investments in LNS (Italy), Northstar Illinois, Northstar New Jersey, CSG (China) and Hellenic Lotteries (Greece) are included in the Instant Products segment.
Overview
In addition to maintaining our traditional base of U.S. Instant Products customers, we continue to seek opportunities to expand internationally. In May 2013, we became the exclusive supplier of instant lottery games and services to the National

52


Lottery of Panama under a participation-based contract that commenced in October 2013. In May 2013, we commenced operations under a new contract with Loteria Electronica Internacional Dominicana S.A. (Dominican Republic). We expect our results of operations to benefit from these new contracts.
Following the expiration of our contract with Loto-Québec in January 2014, we have continued to provide instant lottery games to this customer under the previous contract terms. In November 2013, we were awarded a new price-per-unit contract with Loto-Québec that will represent a significantly smaller portion of such customer’s instant lottery game business than the recently expired contract. We understand that a contract has been awarded to one of our competitors for certain categories of instant games that we provided under the recently expired contract.
In December 2013, we initiated a reorganization plan to exit our instant lottery game operations in Mexico. In February 2014, we entered into a three-year agreement to supply instant lottery games to a distributor in Mexico.
As U.S. and international jurisdictions increasingly look toward lottery and gaming as a source of revenue growth, we believe there may be interest in pursuing an outsourcing model whereby the day-to-day management of lotteries is conducted by a third party, similar to the PMA model in Illinois or New Jersey. To the extent any of our lottery customers enter into a PMA, such lottery customer or the private manager may terminate our existing contract(s) as part of the transition to the private management model. To date, we have largely pursued these opportunities by making strategic equity investments in the private manager or outsourced service provider and entering into lottery supply agreements with such private manager or provider. Our investments in, and supply agreements with, LNS, Northstar Illinois, Northstar New Jersey and Hellenic Lotteries, are anticipated to represent a significant portion of our business in our Instant Products segment and our results of operations will fluctuate based on their performance. We earn revenue under the supply agreements, while the results of operations of our equity investments are reflected in earnings (loss) from equity investments. Our cash flows are impacted by earnings that are distributed to us by the equity investees, as well as capital contributions to, and return of capital payments by, the equity investees. A discussion of each of our strategic equity investments is included in Note 11 (Equity Investments).
We understand that the Illinois lottery has asserted that Northstar Illinois is responsible for shortfall payments of approximately $22 million with respect to the fiscal year ended June 30, 2012 and approximately $39 million with respect to the fiscal year ended June 30, 2013. We further understand that Northstar Illinois disagrees with the methodology used by the lottery in calculating the lottery's net income that formed the basis of the lottery's shortfall payment claims and believes that certain other matters that could impact any potential shortfall payments have yet to be resolved, and has initiated the resolution process contemplated by the PMA in an attempt to resolve these matters.
We understand that, during 2013, Northstar Illinois, recorded a liability of approximately $42 million associated with its estimate of the potential aggregate net shortfall payments for the first three fiscal years under its PMA with the State of Illinois. As a result, for the year ended December 31, 2013, earnings from our equity investment in Northstar Illinois were reduced by an amount equal to the amortization of our pro rata portion of this $42 million, which amortization has been allocated over the term of the PMA.  These amounts were not material to our results of operations for the year ended December 31, 2013. In December 2013, we contributed $13.8 million to Northstar Illinois. We may be required to make capital contributions to Northstar Illinois to fund our pro rata share of any shortfall payments that are payable to the State under the PMA.
In June 2013, we contributed $21.5 million to Northstar New Jersey, representing our pro rata portion of the $120.0 million payment made by Northstar New Jersey to the State of New Jersey under its services agreement with the State. We also contributed an additional $7.2 million to Northstar New Jersey in 2013, which represents our pro rata share of the initial working capital requirements of Northstar New Jersey. We may be required to make future capital contributions to Northstar New Jersey to fund our pro rata share of any shortfall payments that are payable to the State under the services agreement. Services under the agreement commenced on October 1, 2013 and are scheduled to end on June 30, 2029.
In July 2013, Hellenic Lotteries, in which we have a 16.5% equity interest, was granted a concession by the Greek government for the exclusive rights to the production, operation and management of instant game and certain traditional lotteries in Greece.  Our pro rata portion of the €190.0 concession payment made by Hellenic Lotteries to the Greek government was €31.4 million.  Operations under the concession agreement are expected to commence during the first half of 2014.  According to third-party data, in 2011, OPAP generated approximately €4.4 billion in total lottery retail sales in Greece, making it the third largest lottery in the world in terms of per capita sales. The instant game lottery in Greece has been inactive since 2003. In addition to our portion of the upfront payment, we contributed an additional €0.3 million to Hellenic Lotteries for working capital requirements, resulting in aggregate contributions of €31.7 million to the operating company for the year ended December 31, 2013.
Retail sales of instant lottery games can be a key performance indicator of our instant game revenue, although there may not always be a direct correlation between retail sales and our instant game revenue due to the type of contract (e.g., participation contracts versus price-per-unit contracts), the impact of changes in our customer contracts, the performance of our game licensing and player loyalty business or other factors.

53


Results of Operations and Key Performance Indicators for Instant Products
(in millions)
 
Years ended December 31,
 
Variance
 
 
2013
 
2012
 
2011
 
2013 vs 2012
 
2012 vs 2011
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Instant games
 
$
516.0

 
$
493.6

 
$
493.3

 
$
22.4

 
5
 %
 
$
0.3

 
 %
Product sales
 
13.5

 
11.6

 
9.6

 
1.9

 
16
 %
 
2.0

 
21
 %
Total revenue
 
529.5

 
505.2

 
502.9

 
24.3

 
5
 %
 
2.3

 
 %
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of instant games (1)
 
285.1

 
282.5

 
281.6

 
2.6

 
1
 %
 
0.9

 
 %
Cost of product sales (1)
 
9.3

 
7.6

 
5.9

 
1.7

 
22
 %
 
1.7

 
29
 %
Research and development
0.9

 
0.4

 
0.5

 
0.5

 
125
 %
 
(0.1
)
 
(20
)%
Selling, general and administrative
 
48.2

 
45.2

 
48.7

 
3.0

 
7
 %
 
(3.5
)
 
(7
)%
Employee termination and restructuring
 
4.7

 
5.9

 

 
(1.2
)
 
(20
)%
 
5.9

 
 %
Depreciation and amortization
 
38.5

 
41.0

 
32.8

 
(2.5
)
 
(6
)%
 
8.2

 
25
 %
Operating income
 
$
142.8

 
$
122.6

 
$
133.4

 
$
20.2

 
16
 %
 
$
(10.8
)
 
(8
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings from equity investments
 
$
19.3

 
$
23.4

 
$
26.6

 
$
(4.1
)
 
(18
)%
 
$
(3.2
)
 
(12
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Key Performance Indicators:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Instant games by revenue type:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Participation contracts
 
$
254.7

 
$
243.9

 
$
214.3

 
$
10.8

 
4
 %
 
$
29.6

 
14
 %
Price-per-unit contracts
 
202.5

 
204.0

 
216.7

 
(1.5
)
 
(1
)%
 
(12.7
)
 
(6
)%
Licensing and player loyalty
 
58.8

 
45.7

 
62.3

 
13.1

 
29
 %
 
(16.6
)
 
(27
)%
Total instant games revenue
 
$
516.0

 
$
493.6

 
$
493.3

 
$
22.4

 
5
 %
 
$
0.3

 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Instant games revenue by geography:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
315.1

 
$
305.5

 
$
306.2

 
$
9.6

 
3
 %
 
$
(0.7
)
 
 %
International
 
200.9

 
188.1

 
187.1

 
12.8

 
7
 %
 
1.0

 
1
 %
Total instant games revenue
 
$
516.0

 
$
493.6

 
$
493.3

 
$
22.4

 
5
 %
 
$
0.3

 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. lottery customers’ retail sales of instant games
 
$
36,747

 
$
35,329

 
$
32,499

 
$
1,418

 
4
 %
 
$
2,830

 
9
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Italy retail sales of instant games (in Euros)
 
9,612

 
9,764

 
10,151

 
(152
)
 
(2
)%
 
(387
)
 
(4
)%
________________________________________________________________________________________________________________________________
(1)
Exclusive of depreciation and amortization.
Based on third-party data, our U.S. customers' total instant lottery game retail sales increased 4% for the year ended December 31, 2013 compared to the prior-year period, driven by several factors, including strong performance in those states where we provide instant game product management services. In addition, Italy retail sales of instant games decreased 2% for the year ended December 31, 2013 compared to the prior-year period. Italy retail sales are generally impacted by the level of marketing spending and timing of the launch of new games.
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Revenue
The increase in our instant games revenue reflected higher revenue of $13.1 million from licensing and player loyalty programs, $10.8 million from our U.S. and international participation contracts driven by an increase in retail sales, and $3.6 million from our international price-per-unit contracts. The increase was partially offset by a decrease in revenue from our U.S. price-per-unit contracts of $5.2 million due to unfavorable contract revisions and the timing of orders. Instant game revenue reflected unfavorable foreign currency translation of $1.7 million.


54


Operating Income
Operating income increased primarily due to a higher and more profitable mix of revenue, a decrease in depreciation and amortization and a decrease in employee termination and restructuring charges. These decreases reflected the impact of the reorganization of our Australian operations in the prior-year period, partially offset by the reorganization of our instant lottery game operations in Mexico in 2013. The increase in operating income was partially offset due to higher SG&A reflecting a full year of the operations of Provoloto, which we acquired in June 2012, and an insurance settlement recovered in 2012 that did not recur in 2013, partially offset by lower compensation expense.
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Revenue
The increase in instant game revenue reflected higher revenue of $30.6 million from our U.S. and international participation contracts driven by an increase in retail sales, including from our agreement with Northstar Illinois, and our acquisition of Provoloto. Our instant game revenue also reflected an increase of $8.1 million from our player loyalty programs. These increases were primarily offset by an $11.8 million decrease in revenue from our U.S. and international price-per-unit contracts, primarily due to lower sales to LNS, the timing of orders and contract revisions and a $24.4 million decrease in revenue from our licensed properties business largely due to a challenging year-over-year comparison in light of the impact of our successful launch of a multi-state licensed game in 2011. Revenue for the year ended December 31, 2012 also reflected unfavorable foreign currency translation of $2.2 million. Products sales revenue primarily consisted of printed phone card sales.
Operating Income
Operating income decreased primarily due to restructuring costs of $5.9 million and higher depreciation expense of $8.2 million comprised of $4.4 million of accelerated depreciation expense related to the write-down of certain development costs in our licensed properties business and $3.4 million of accelerated depreciation expense related to the reorganization of our Australian operations. These decreases in operating income were partially offset by lower SG&A of $3.5 million, which reflected the impact of a customer claim recorded during the year ended December 31, 2011 and an insurance settlement recovered in 2012 related to that claim.
LOTTERY SYSTEMS
Our Lottery Systems business segment provides customized computer software, software support, equipment and data communication services, sports wagering systems and keno to lotteries. In the U.S., we typically provide the necessary equipment, software and maintenance services on a participation basis pursuant to long-term contracts that typically have an initial term of at least five years. Internationally, we typically sell point-of-sale terminals and/or computer software to lottery authorities and may provide ongoing fee-based systems maintenance and software support services. Our equity investment in Guard Libang is included in the Lottery Systems segment.
Overview
We are the exclusive instant lottery game validation network provider to the CSL under an agreement that expires in January 2016. Under the terms of this agreement, the participation rate we receive decreased by 0.1% in January 2014. We have seen a recent decline in our instant lottery game validation revenue and our joint venture's instant lottery game printing revenue as instant lottery game retail sales of the CSL have declined, which we believe is due in part to competition from other lottery products impacting instant lottery game sales. In September 2013, an RFP was issued for the provision of a new instant lottery game sales management system for the CSL following the expiration of our current agreement with the CSL in January 2016. The RFP did not cover the range of value-added services that we currently provide under our current CSL agreement. We determined not to submit a bid for the new systems agreement in light of, among other things, the significantly less favorable compensation structure proposed under the RFP relative to our current agreement. We understand that the new agreement was awarded to a Chinese company. We intend to seek opportunities to continue to provide our value-added services relating to the CSL that were not covered by the RFP (e.g., game design and programming) as well as additional business development opportunities to maintain and potentially grow our revenue and profit relating to our China lottery business following the expiration of the our current CSL agreement. To the extent we are not able to do so, our operating results relating to our China lottery business will be adversely affected.
Our lottery systems contract with the Indiana lottery was terminated in 2013 in connection with the award of a PMA to one of our competitors. We entered into an agreement with the new vendor to provide our existing lottery systems equipment and related services through August 2016, which agreement commenced in April 2013. In February 2013, we executed a five-year extension of our lottery systems contract with the Connecticut lottery. In March 2013, we executed a contract with the Oklahoma Lottery to continue supplying instant lottery games and lottery services for an initial period of one year subject to nine one-year

55


contract extension options held by the lottery. In June 2013, the Colorado lottery awarded a new lottery systems contract to one of our competitors. We have protested the contract award. We will continue to provide lottery systems services to the Colorado lottery under our existing contract through October 2014.
In May 2013, a strategic alliance, comprised of us and 888 Holdings Public Limited Company, as the primary vendor team, was awarded a contract to provide internet gaming systems and services to the Delaware lottery for an initial period of five years, subject to four one-year contract extension options held by the lottery. The contract was executed in September 2013 and operations commenced in November 2013. In addition, Williams Interactive LLC (a wholly owned subsidiary of WMS) was selected to provide interactive game content in connection with the launch of internet gaming products and services in Delaware, subject the negotiation and execution of a contract with the lottery.
In December 2013, we executed a contract with the State of Maine Department of Administrative and Financial Services to continue supplying a complete line of lottery gaming systems for instant and draw lottery games, instant ticket printing, and associated instant ticket services for an initial period of six years subject to additional contract extension options held by the lottery.
We believe that retail sales of draw lottery games is a key performance indicator of our Lottery Systems service revenue, although there may not always be a direct correlation between retail sales and our Lottery Systems revenue due to the terms of our contracts, the impact of changes in our customer contracts or other factors. We believe the level of jackpots of the Powerball and Mega Millions multi-state draw lottery games, and the number of drawings conducted before a jackpot is won, have an impact on U.S. retail sales and, therefore, on our service revenue in any given period. Our Lottery Systems service revenue is also impacted by retail sales of instant lottery games where we provide instant lottery game validation services on a standalone basis or as part of a Lottery Systems contract. Our Lottery Systems product sales revenue primarily relates to sales of equipment that are not subject to long-term contracts.


















56


Results of Operations and Key Performance Indicators for Lottery Systems
(in millions)
 
Years ended December 31,
 
Variance
 
 
2013
 
2012
 
2011
 
2013 vs 2012
 
2012 vs 2011
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Services
 
$
203.2

 
$
201.1

 
$
197.4

 
$
2.1

 
1
 %
 
$
3.7

 
2
 %
Product sales
 
57.7

 
51.9

 
32.9

 
5.8

 
11
 %
 
19.0

 
58
 %
Total revenue
 
260.9

 
253.0

 
230.3

 
7.9

 
3
 %
 
22.7

 
10
 %
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of services (1)
 
113.8

 
109.6

 
105.8

 
4.2

 
4
 %
 
3.8

 
4
 %
Cost of product sales (1)
 
37.8

 
35.4

 
24.0

 
2.4

 
7
 %
 
11.4

 
48
 %
Research and development
4.6

 
4.1

 
3.2

 
0.5

 
12
 %
 
0.9

 
28
 %
Selling, general and administrative
 
22.5

 
20.2

 
18.5

 
2.3

 
11
 %
 
1.7

 
9
 %
Employee termination and restructuring
 
0.4

 

 

 
0.4

 
 %
 

 
 %
Depreciation and amortization
 
56.0

 
51.6

 
44.4

 
4.4

 
9
 %
 
7.2

 
16
 %
Operating income
 
$
25.8

 
$
32.1

 
$
34.4

 
$
(6.3
)
 
(20
)%
 
$
(2.3
)
 
(7
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings in equity investments
 
$
(5.7
)
 
$
1.7

 
$
2.8

 
$
(7.4
)
 
(435
)%
 
$
(1.1
)
 
(39
)%