Attached files
| file | filename |
|---|---|
| EX-31.2 - EXHIBIT 31.2 - PlayAGS, Inc. | ex312-201633110q.htm |
| EX-32 - EXHIBIT 32 - PlayAGS, Inc. | ex32-201633110q.htm |
| EX-31.1 - EXHIBIT 31.1 - PlayAGS, Inc. | ex311-201633110q.htm |
| EX-10.1 - EXHIBIT 10.1 - PlayAGS, Inc. | ex101-sleeamendedemplyment.htm |
| EX-10.2 - EXHIBIT 10.2 - PlayAGS, Inc. | ex102-mfranicseparationagr.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
for the quarter ended March 31, 2016
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 000-55119
AP GAMING HOLDCO, INC.
(Exact name of registrant as specified in its charter)
Delaware | 46-3698600 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
5475 S. Decatur Blvd., Ste #100 Las Vegas, NV 89118 |
(Address of principal executive offices) (Zip Code) |
(702) 722-6700 |
(Registrant’s telephone number, including area code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 o No x*
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 the 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 o | Non-accelerated filer x (Do not check if a 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 Exchange Act). Yes o No x
As of May 10, 2016, there were 100 shares of the Registrant’s Class A common stock, $.01 par value per share, and 15,038,027 shares of the Registrant’s Class B common stock, $.01 par value per share, outstanding.
*The Company does not have any public stockholders. Accordingly, it does not maintain an investor relations website where Interactive Data Files would be posted.
TABLE OF CONTENTS
ii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AP GAMING HOLDCO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share and per share data)
March 31, 2016 | December 31, 2015 | ||||||
(unaudited) | |||||||
Assets | |||||||
Current assets | |||||||
Cash and cash equivalents | $ | 29,218 | $ | 35,722 | |||
Restricted cash | 100 | 100 | |||||
Accounts receivable, net of allowance of $198 and $113, respectively | 23,802 | 23,653 | |||||
Inventories | 7,044 | 7,087 | |||||
Prepaid expenses | 4,509 | 4,642 | |||||
Deposits and other | 2,766 | 2,440 | |||||
Total current assets | 67,439 | 73,644 | |||||
Property and equipment, net | 65,494 | 66,699 | |||||
Goodwill | 253,605 | 253,851 | |||||
Deferred tax asset | 37 | 37 | |||||
Intangible assets | 278,079 | 290,356 | |||||
Other assets | 22,213 | 26,560 | |||||
Total assets | $ | 686,867 | $ | 711,147 | |||
Liabilities and Stockholders’ Equity | |||||||
Current liabilities | |||||||
Accounts payable and accrued liabilities | $ | 23,617 | $ | 23,030 | |||
Current maturities of long-term debt | 7,061 | 6,919 | |||||
Total current liabilities | 30,678 | 29,949 | |||||
Long-term debt | 533,247 | 533,290 | |||||
Deferred tax liability - noncurrent | 13,224 | 15,347 | |||||
Other long-term liabilities | 30,166 | 32,024 | |||||
Total liabilities | 607,315 | 610,610 | |||||
Commitments and contingencies (Note 14) | |||||||
Stockholders’ equity | |||||||
Preferred stock at $0.01 par value; 100,000 shares authorized, no shares issued and outstanding | — | — | |||||
Common stock at $0.01 par value; 30,000,100 shares authorized; 100 Class A Shares issued and outstanding at March 31, 2016 and December 31, 2015, and 14,931,529 Class B Shares issued and outstanding at March 31, 2016 and December 31, 2015. | 149 | 149 | |||||
Additional paid-in capital | 177,276 | 177,276 | |||||
Accumulated deficit | (96,143 | ) | (75,077 | ) | |||
Accumulated other comprehensive loss | (1,730 | ) | (1,811 | ) | |||
Total stockholders’ equity | 79,552 | 100,537 | |||||
Total liabilities and stockholders’ equity | $ | 686,867 | $ | 711,147 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
1
AP GAMING HOLDCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(amounts in thousands, except per share data)
(unaudited)
Three months ended March 31, | |||||||
2016 | 2015 | ||||||
Revenues | |||||||
Gaming operations | $ | 38,638 | $ | 18,567 | |||
Equipment sales | 1,597 | 228 | |||||
Total revenues | 40,235 | 18,795 | |||||
Operating expenses | |||||||
Cost of gaming operations1 | 6,273 | 3,194 | |||||
Cost of equipment sales1 | 170 | 85 | |||||
Selling, general and administrative | 12,683 | 6,150 | |||||
Research and development | 4,663 | 1,275 | |||||
Write downs and other charges | 110 | 3,481 | |||||
Depreciation and amortization | 20,542 | 8,346 | |||||
Total operating expenses | 44,441 | 22,531 | |||||
Loss from operations | (4,206 | ) | (3,736 | ) | |||
Other expense (income) | |||||||
Interest expense | 14,616 | 4,272 | |||||
Interest income | (23 | ) | (9 | ) | |||
Other expense | 4,422 | 476 | |||||
Loss before income taxes | (23,221 | ) | (8,475 | ) | |||
Income tax benefit (expense) | 2,155 | (760 | ) | ||||
Net loss | (21,066 | ) | (9,235 | ) | |||
Foreign currency translation adjustment | 81 | 243 | |||||
Total comprehensive loss | $ | (20,985 | ) | $ | (8,992 | ) | |
Basic and diluted loss per common share: | |||||||
Basic | $ | (1.41 | ) | $ | (0.92 | ) | |
Diluted | $ | (1.41 | ) | $ | (0.92 | ) | |
Weighted average common shares outstanding: | |||||||
Basic | 14,932 | 10,000 | |||||
Diluted | 14,932 | 10,000 | |||||
(1) exclusive of depreciation and amortization
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
AP GAMING HOLDCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three months ended March 31, | |||||||
2016 | 2015 | ||||||
Cash flows from operating activities | |||||||
Net loss | $ | (21,066 | ) | $ | (9,235 | ) | |
Adjustments to reconcile net loss to net cash provided by operating activities: | |||||||
Depreciation and amortization | 20,542 | 8,346 | |||||
Accretion of contract rights under development agreements and placement fees | 1,170 | 55 | |||||
Amortization of deferred loan costs and discount | 847 | 322 | |||||
Provision for bad debts | 118 | 12 | |||||
Imputed interest income | — | (8 | ) | ||||
Loss on disposition of assets | 108 | 313 | |||||
(Benefit) provision for deferred income tax | (2,074 | ) | 760 | ||||
Changes in assets and liabilities that relate to operations: | |||||||
Accounts receivable and notes receivable | (175 | ) | 536 | ||||
Inventories | 145 | 211 | |||||
Prepaid expenses | 134 | (467 | ) | ||||
Deposits and other | (257 | ) | (596 | ) | |||
Other assets, non-current | 4,301 | (376 | ) | ||||
Accounts payable and accrued liabilities | 1,573 | 4,375 | |||||
Net cash provided by operating activities | 5,366 | 4,248 | |||||
Cash flows from investing activities | |||||||
Collection of notes receivable | — | 88 | |||||
Purchase of intangible assets | (56 | ) | (333 | ) | |||
Software development and other expenditures | (2,151 | ) | (1,018 | ) | |||
Proceeds from disposition of assets | 87 | 4 | |||||
Purchases of property and equipment | (5,460 | ) | (3,374 | ) | |||
Net cash used in investing activities | (7,580 | ) | (4,633 | ) | |||
Cash flows from financing activities | |||||||
Borrowings under the revolving facility | — | 1,000 | |||||
Payment of placement fee obligations | (1,525 | ) | — | ||||
Payments on debt | (1,641 | ) | (617 | ) | |||
Payment of previous acquisition obligation | (1,125 | ) | — | ||||
Proceeds from employees in advance of common stock issuance | — | 182 | |||||
Net cash (used in) provided by financing activities | (4,291 | ) | 565 | ||||
Effect of exchange rates on cash and cash equivalents | 1 | 451 | |||||
(Decrease) increase in cash and cash equivalents | (6,504 | ) | 631 | ||||
Cash and cash equivalents, beginning of period | 35,722 | 10,680 | |||||
Cash and cash equivalents, end of period | $ | 29,218 | $ | 11,311 | |||
Supplemental cash flow information: | |||||||
Cash paid during the period for interest | $ | 9,774 | $ | 4,263 | |||
Cash paid during the period for taxes | $ | 310 | $ | 198 | |||
Non-cash investing and financing activities: | |||||||
Financed purchase of property and equipment | $ | 865 | $ | — | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
AP Gaming Holdco, Inc. (the “Company,” “AP Gaming,” “we,” “us,” or “our”) is a leading designer and supplier of gaming products and services for the gaming industry. The Company is a leader in the Class II Native American and Mexican gaming jurisdictions and has expanded its product lines to include Class III Native American, commercial and charity jurisdictions. We supply electronic gaming machines (“slot machines”), server-based systems and back-office systems that are used by casinos and various gaming locations. Over the past two years, the Company has significantly broadened and diversified its product portfolio through both organic development and strategic acquisitions. We launched a new table products division in mid-2014 to provide live felt table games to casino operators. Through the acquisition of Cadillac Jack (defined in Note 2) on May 29, 2015, we greatly expanded our games library and slot machine offerings. The Company also acquired online developer Gamingo Limited in June 2015, expanding its offerings to include interactive products such as social casino games, available to play on desktop and mobile devices.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain disclosures required by generally accepted accounting principles (“GAAP”) are omitted or condensed in these condensed consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) that are necessary to present fairly the Company's financial position, results of operations and cash flows for the interim periods have been made. The interim results reflected in these condensed consolidated financial statements are not necessarily indicative of results to be expected for the full fiscal year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Certain amounts in the consolidated financial statements for the previous years have been reclassified to be consistent with the current year presentation. These reclassifications had no effect on the previously reported net loss.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires the Company to make decisions based upon estimates, assumptions, and factors considered relevant to the circumstances. Such decisions include the selection of applicable accounting principles and the use of judgment in their application, the results of which impact reported amounts and disclosures. Changes in future economic conditions or other business circumstances may affect the outcomes of the estimates and assumptions. Accordingly, actual results could differ materially from those anticipated.
Revenue Recognition
Gaming Operations
Gaming operations revenue is earned by providing customers with gaming machines, gaming machine content licenses, back-office equipment and linked progressive systems, which are collectively referred to as gaming equipment, under participation arrangements. The participation arrangements convey the right to use the equipment (i.e. gaming machines and related integral software) for a stated period of time and are accounted for as operating leases. Under these arrangements, the Company retains ownership of the gaming equipment installed at customer facilities and receives either revenue based on a percentage of the win per day generated by the gaming equipment or a daily fee. The majority of the Company’s leases require the Company to provide maintenance throughout the entire term of the lease. In some cases, a performance guarantee exists that, if not met, requires the Company to replace or remove the gaming machines from the customer’s floor. Whether contractually required or not, the Company develops and provides new gaming titles throughout the life of the lease. Certain arrangements require a portion of the facility’s win per day to be set aside to be used to fund facility-specific marketing,
4
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
advertising, promotions and service. These amounts are offset against gaming revenue. Gaming operations revenue is also earned from the licensing of table game content and is earned and recognized on a fixed monthly rate. Our social gaming products earn revenue from the sale of virtual coins or chips, which is recorded when the purchased coins or chips are used by the customer.
Equipment Sales
Revenues from the stand-alone product sales or separate accounting units are recorded when:
• | Pervasive evidence of an arrangement exists; |
• | The sales price is fixed and determinable; |
• | Delivery has occurred and services have been rendered; and |
• | Collectability is reasonably assured. |
Equipment sales are generated from the sale of gaming machines and licensing rights to game content software that is installed in the gaming machine, parts, and other ancillary equipment. Also included within the deliverables are delivery, installation and training, all of which occur within a few days of arriving at the customer location. Gaming equipment sales do not include maintenance beyond a standard warranty period. The recognition of revenue from the sale of gaming devices occurs as title and risk of loss have passed to the customer and all other revenue recognition criteria have been satisfied. As the combination of game content software and the tangible gaming device function together to deliver the product’s essential functionality, revenue from the sale of gaming devices is recognized under general revenue recognition guidance.
Cash and Cash Equivalents
Cash and cash equivalents consist primarily of deposits held at major banks and other marketable securities with original maturities of 90 days or less.
Restricted Cash
Restricted cash amounts represent funds held in escrow as collateral for the Company’s surety bonds for various gaming authorities and funds held to ensure the availability of funds to pay wide-area progressive jackpot awards.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts related to accounts receivable deemed to have a high risk of collectability. The Company reviews the accounts receivable on a monthly basis to determine if any receivables will potentially be uncollectible. The Company analyzes historical collection trends and changes in the customers’ payment patterns, customer concentration, and credit worthiness when evaluating the adequacy of the allowance for doubtful accounts. A large percentage of receivables are with Native American tribes, and the Company has concentrations of credit risk with several tribes. The Company includes any receivable balances that are determined to be uncollectible in the overall allowance for doubtful accounts. Changes in the assumptions or estimates reflecting the collectability of certain accounts could materially affect the allowance for accounts receivable.
Inventories
Inventories consist primarily of parts and supplies that are used to repair and maintain machinery and equipment. Inventories are stated at the lower of cost or market. Cost of inventories is determined using the first-in, first-out (“FIFO”) method for all components of inventory. The Company regularly reviews inventory quantities and updates estimates for the net realizable value of inventories. This process includes examining the carrying values of parts and ancillary equipment in comparison to the current fair market values for such equipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levels of the inventories, the current and projected sales levels for such products, the projected markets for such products and the costs required to sell the products, including refurbishment costs. Changes in the assumptions or estimates could materially affect the inventory carrying value.
5
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Property and Equipment
The cost of gaming equipment, consisting of fixed-base player terminals, file servers and other support equipment as well as other property and equipment, is depreciated over their estimated useful lives, using the straight-line method for financial reporting. Repairs and maintenance costs are expensed as incurred. The Company routinely evaluates the estimated lives used to depreciate assets. The estimated useful lives are as follows:
Gaming equipment | 3 to 6 years |
Other property and equipment | 3 to 6 years |
The Company measures recoverability of assets to be held and used by comparing the carrying amount of an asset to future cash flows expected to be generated by the asset. The Company’s policy is to impair, when necessary, excess or obsolete gaming machines on hand that it does not expect to be used. Impairment is based upon several factors, including estimated forecast of gaming machine demand for placement into casinos. While the Company believes that the estimates and assumptions used in evaluating the carrying amount of these assets are reasonable, different assumptions could affect either the carrying amount or the estimated useful lives of the assets, which could have a significant impact on the results of operations and financial condition.
Intangible Assets
The Company reviews its identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment losses are recognized for identifiable intangibles, other than goodwill, when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets’ carrying amount.
When the estimated undiscounted cash flows are not sufficient to recover the intangible asset’s carrying amount, an impairment loss is measured to the extent the fair value of the asset is less than its carrying amount.
Certain trade names have an indefinite useful life and the Company tests these trade names for possible impairment at least annually, on October 1, or whenever events or changes in circumstances indicate that the carrying value may be impaired. We perform a qualitative assessment to determine if it is more likely than not that the fair value of the asset is less than its carrying amount. If we believe, as a result of our qualitative assessment, that it is more likely than not that the fair value of the asset is less than its carrying amount, the quantitative impairment test is required.
Costs of Computer Software
Internally developed gaming software represents the Company’s internal costs to develop gaming titles to utilize on the Company’s gaming machines. Internally developed gaming software is stated at cost and amortized over the estimated useful lives of the software, using the straight-line method. Software development costs are capitalized once technological feasibility has been established and are amortized when the software is placed into service. The computer software we develop reaches technological feasibility when a working model of the computer software is available. Any subsequent software maintenance costs, such as bug fixes and subsequent testing, are expensed as incurred. Discontinued software development costs are expensed when the determination to discontinue is made. Software development costs are amortized over the expected life of the title or group of titles, if applicable, to amortization expense.
On a quarterly basis, or more frequently if circumstances warrant, the Company compares the net book value of its internally developed computer software to the net realizable value on a title or group of title basis. The net realizable value is determined based upon certain assumptions, including the expected future revenues and net cash flows of the gaming titles or group of gaming titles utilizing that software, if applicable.
Goodwill
The excess of the purchase price of an acquired business over the estimated fair value of the assets acquired and the liabilities assumed is recorded as goodwill. The Company tests for possible impairment of goodwill at least annually, on October 1, or when circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The Company has the option to begin with a qualitative assessment, commonly referred to as “Step 0”, to
6
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
determine whether it is more likely than not that the reporting unit’s fair value of goodwill is less than its carrying value. This qualitative assessment may include, but is not limited to, reviewing factors such as the general economic environment, industry and market conditions, changes in key assumptions used since the most recently performed valuation and overall financial performance of the reporting units. If the Company determines that it is more likely than not that a reporting unit’s fair value is less than its carrying value, the Company performs a quantitative goodwill impairment analysis, and depending upon the results of that measurement, the recorded goodwill may be written down and charged to income from operations when its carrying amount exceeds its estimated fair value. As of March 31, 2016, there were no indicators of impairment.
Deferred Financing Costs
Direct and incremental costs incurred and original issue discounts in connection with the issuance of long-term debt are deferred and amortized using the effective interest method over the life of the related loans. Deferred financing costs incurred in connection with the issuance of the Company's revolving credit facilities of $0.3 million at March 31, 2016 and December 31, 2015 are presented in other assets on the Condensed Consolidated Balance Sheets. All other deferred financing costs are presented as a direct reduction of long-term debt on the Condensed Consolidated Balance Sheets. See the Recently Issued Accounting Pronouncements section below for details on the presentation change of deferred financing costs.
Acquisition Accounting
The Company applies the provisions of ASC 805, “Business Combinations” (ASC 805), in accounting for business acquisitions. It requires us to recognize separately from goodwill the fair value of assets acquired and liabilities assumed on the acquisition date. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. Significant estimates and assumptions are required to value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable. These estimates are inherently uncertain and subject to refinement and typically include the calculation of an appropriate discount rate and projection of the cash flows associated with each acquired asset. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the consolidated statements of operations.
Fair Value of Financial Instruments
The Company applies the provisions of ASC 820, “Fair Value Measurements” (ASC 820) to its financial assets and liabilities. Fair value is defined as a market-based measurement intended to estimate the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. ASC 820 also established a fair value hierarchy, which requires an entity to maximize the use of observable inputs when measuring fair value. These inputs are categorized as follows:
• | Level 1 - quoted prices in an active market for identical assets or liabilities; |
• | Level 2 - quoted prices in an active market for similar assets or liabilities, inputs other than quoted prices that are observable for similar assets or liabilities, inputs derived principally from or corroborated by observable market data by correlation or other means; and |
• | Level 3 - valuation methodology with unobservable inputs that are significant to the fair value measurement. |
The carrying values of the Company’s cash and cash equivalents, restricted cash, receivables and accounts payable approximate fair value because of the short term maturities of these instruments. The fair value of our long-term debt is based on the quoted market prices for similar issues (Level 2 inputs). The estimated fair value of our long-term debt as of March 31, 2016 was $504.6 million.
Accounting for Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is
7
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
recognized in income in the period that included the enactment date. Future tax benefits are recognized to the extent that realization of those benefits is considered more likely than not, and a valuation allowance is established for deferred tax assets which do not meet this threshold.
Contingencies
The Company assesses its exposures to loss contingencies including claims and legal proceedings and accrues a liability if a potential loss is considered probable and the amount can be estimated. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, if the actual loss from a contingency differs from management’s estimate, there could be a material impact on the results of operations or financial position. Operating expenses, including legal fees, associated with contingencies are expensed when incurred.
Foreign Currency Translation
The financial statements of the Company’s foreign subsidiaries are translated into U.S. dollars at the period end rate of exchange for asset and liability accounts and the weighted average rate of exchange for income statement accounts. The effects of these translations are recorded as a component of other accumulated comprehensive loss in stockholders’ equity.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued an accounting standards update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which clarifies the principles for recognizing revenue from contracts with customers. The amendment outlines a single comprehensive model for entities to depict the transfer of goods or services to customers in amounts that reflect the payment to which a company expects to be entitled in exchange for those goods or services. The amendment also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. The ASU may be adopted using either a full retrospective transition method or a modified retrospective transition method and will be adopted by the Company on January 1, 2018. The Company is currently evaluating the provisions of the amendments and the impact on its future consolidated financial statements.
In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. The amendments clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard on January 1, 2016, did not have a material effect on our financial position, results of operations or cash flows.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern: Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern. The ASU requires management to assess an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, consolidated in the aggregate, indicate that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. Currently, there is no guidance in U.S. GAAP for management's responsibility to perform an evaluation. Under the update, management's evaluation is to be performed when preparing financial statements for each annual and interim reporting period and based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. The Company will adopt this standard effective January 1, 2017, and we do not expect it to have a material effect on our consolidated financial statements.
8
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
In January 2015, the FASB issued ASU No. 2015-01, Income Statement-Extraordinary and Unusual Items: Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. ASU 2015-01 eliminates from GAAP the concept of extraordinary items. The presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained and will be expanded to include items that were previously classified as extraordinary. ASU 2015-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted using either a prospective or retrospective method. The adoption of this standard on January 1, 2016, did not have a material effect on our financial condition, results of operations or cash flows.
In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 intends to simplify the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. In August 2015, the FASB issued ASU 2015-15 which clarifies that the guidance issued in April 2015 does not apply to line-of-credit arrangements. According to ASU 2015-15, line-of-credit arrangements will continue to present debt issuance costs as an asset and subsequently amortize the deferred debt issuance costs ratably over the term of the arrangement. ASU 2015-03 is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Company adopted the guidance on January 1, 2016, with retrospective application in the accompanying Condensed Consolidated Balance Sheet at December 31, 2015. This change in accounting principle resulted in net deferred financing costs of $7.8 million incurred in connection with the issuance of the Company's long-term debt (excluding revolving credit facilities) at December 31, 2015 being reclassified as a direct reduction of the long-term debt balance. The presentation of the net deferred financing costs incurred in connection with the issuance of the Company's revolving credit facilities as of December 31, 2015, are not affected by the adoption of this new accounting guidance and are included in other assets in the accompanying Condensed Consolidated Balance Sheet.
In July 2015, the FASB issued ASU No. 2015-11, Inventory: Simplifying the Measurement of Inventory. ASU 2015-11 changes the criteria for measuring inventory within the scope of the ASU. Inventory will now be measured at the lower of cost and net realizable value, while the concept of market value will be eliminated. The ASU defines net realizable value as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the provisions of ASU 2015-11 to have a material effect on our financial condition, results of operations or cash flows.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. ASU 2015-16 eliminates the requirement to retrospectively apply adjustments made to provisional amounts recognized in a business combination. It requires that an acquirer recognize and disclose adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, which should be calculated as if the accounting had been completed at the acquisition date. ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments in this ASU 2015-16 should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this ASU with earlier application permitted for financial statements that have not been issued. The adoption of this standard on January 1, 2016, did not have a material effect on our financial position, results of operations or cash flows.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 intends to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The adoption of this guidance is expected to result in a significant portion of our operating leases, where we are the lessee, to be recognized on our Consolidated Balance Sheets. The guidance requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years with earlier adoption permitted. The Company is currently evaluating the provisions of the amendment and the impact on its future consolidated financial statements.
9
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
NOTE 2. ACQUISITIONS
Cadillac Jack
On May 29, 2015, the Company acquired 100% of the equity of Amaya Americas Corporation (“Cadillac Jack”), a leading provider of Class II gaming machines for the North American tribal gaming market, with key regions of operation within Alabama, Mexico, and Wisconsin. This acquisition is expected to create growth opportunities in Class II and Class III jurisdictions and expands the Company’s geographic footprint. The combined management teams are complementary and possess years of combined experience that is expected to allow us to effectively grow and improve our business.
We have recorded Cadillac Jack’s assets acquired and liabilities assumed based on our preliminary estimates of their fair values at the acquisition date. The determination of the fair values of the assets acquired and liabilities assumed (and the related determination of estimated lives of depreciable and amortizable tangible and identifiable intangible assets) requires significant judgment and estimates. The estimates and assumptions used include the projected timing and amount of future cash flows and discount rates that reflect risk inherent in the future cash flows. The estimated fair values of Cadillac Jack’s assets acquired and liabilities assumed and resulting goodwill are subject to adjustment as we finalize our fair value analysis. The significant items for which a final fair value has not been determined as of the filing of this report on Form 10-Q include accrued liabilities, deferred income taxes and other long-term liabilities. We expect to complete our fair value determinations no later than the second quarter of 2016. We do not currently expect our fair value determinations to change; however, there may be differences compared to those amounts reflected in our condensed consolidated financial statements at March 31, 2016, as we finalize our fair value analysis and such changes could be material.
Based on our preliminary estimates, the total consideration exceeded the aggregate estimated fair value of the acquired assets and assumed liabilities at the acquisition date and has been recorded as goodwill. We attribute this goodwill to our enhanced financial scale and geographic diversification, opportunities for synergies, assembled workforce and other strategic benefits. None of the goodwill associated with the acquisition is deductible for income tax purposes and, as such, no deferred taxes have been recorded related to goodwill.
The following unaudited pro forma statements of operations give effect to the Cadillac Jack acquisition as if it had been completed on January 1, 2014. The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of what the operating results actually would have been during the periods presented had the acquisition been completed on January 1, 2014. In addition, the unaudited pro forma financial information does not purport to project future operating results. This information is preliminary in nature and subject to change based on final purchase price adjustments. The pro forma statements of operations do not reflect: (1) any anticipated synergies (or costs to achieve synergies) or (2) the impact of non-recurring items directly related to the Cadillac Jack acquisition.
Three months ended March 31, 2015 | |||
Revenue | $ | 38,807 | |
Net loss | $ | 14,216 | |
Gamingo Limited
On June 15, 2015, the Company purchased 100% of the equity of Gamingo Limited (formerly known as “RocketPlay”, currently known as “AGSi”), a leading gaming company developing social casino titles for mobile devices. With primary offices in San Francisco and Tel Aviv, AGSi’s flagship product, Lucky Play Casino, gives players a casino-quality experience with slots, table games, tournaments, and live events.
Intellectual Property Acquisitions
During the quarter ended September 30, 2015, the Company acquired certain intangible assets related to the purchase of table games and table game related intellectual property. Some of the acquisitions were accounted for as an acquisition of a business and the assets acquired and liabilities assumed were measured based on our preliminary estimates of their fair values at the acquisition dates. The estimated fair values of assets acquired and liabilities assumed and resulting goodwill are subject to adjustment as we finalize our fair value analysis.
10
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
March 31, 2016 | December 31, 2015 | ||||||
Gaming equipment | $ | 94,545 | $ | 89,361 | |||
Other property and equipment | 15,166 | 14,976 | |||||
Less: Accumulated depreciation | (44,217 | ) | (37,638 | ) | |||
Total property and equipment, net | $ | 65,494 | $ | 66,699 | |||
Gaming equipment and other property and equipment are depreciated over the respective useful lives of the assets ranging from three to six years. Depreciation expense was $7.3 million and $3.9 million for the three months ended March 31, 2016 and 2015, respectively.
NOTE 4. GOODWILL AND INTANGIBLES
There were no accumulated impairments of goodwill as of March 31, 2016. Changes in the carrying amount of goodwill are as follows (in thousands):
Gross Carrying Amount | |||
Balance at December 31, 2015 | $ | 253,851 | |
Foreign currency adjustments | (246 | ) | |
Balance at March 31, 2016 | $ | 253,605 | |
Intangible assets consist of the following (in thousands):
March 31, 2016 | December 31, 2015 | ||||||||||||||||||||||||
Useful Life (years) | Gross Value | Accumulated Amortization | Net Carrying Value | Gross Value | Accumulated Amortization | Net Carrying Value | |||||||||||||||||||
Indefinite lived trade names | Indefinite | $ | 12,126 | $ | — | $ | 12,126 | $ | 12,126 | $ | — | $ | 12,126 | ||||||||||||
Trade and brand names | 7 | 13,600 | (2,709 | ) | 10,891 | 13,600 | (1,721 | ) | 11,879 | ||||||||||||||||
Customer relationships | 7 | 170,892 | (32,117 | ) | 138,775 | 170,927 | (26,676 | ) | 144,251 | ||||||||||||||||
Contract rights under development and placement fees | 1 - 7 | 16,367 | (1,718 | ) | 14,649 | 16,311 | (548 | ) | 15,763 | ||||||||||||||||
Gaming software and technology platforms | 1 - 5 | 119,052 | (30,012 | ) | 89,040 | 116,930 | (23,735 | ) | 93,195 | ||||||||||||||||
Intellectual property | 10 | 14,030 | (1,432 | ) | 12,598 | 14,030 | (888 | ) | 13,142 | ||||||||||||||||
$ | 346,067 | $ | (67,988 | ) | $ | 278,079 | $ | 343,924 | $ | (53,568 | ) | $ | 290,356 | ||||||||||||
Intangible assets are amortized over their respective estimated useful lives ranging from one to ten years. Amortization expense related to intangible assets was $13.3 million and $4.5 million for the three months ended March 31, 2016 and 2015, respectively.
The Company enters into development agreements and placement fee agreements with certain customers to secure floor space under lease agreements for its gaming machines. Amounts paid in connection with the development agreements are repaid to the Company in accordance with the terms of the agreement, whereas placements fees are not reimbursed. For development agreements in the form of a loan, interest income is recognized on the repayment of the notes based on the stated rate or, if not stated explicitly in the development agreement, on an imputed interest rate. If the stated interest rate is deemed to be other than a market rate or zero, a discount is recorded on the note receivable as a result of the difference between the stated and market rate and a corresponding intangible asset is recorded. The intangible asset is recognized in the financial statements
11
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
as a contract right under development agreement and amortized as a reduction in revenue over the term of the agreement. Placement fees can be in the form of cash paid upfront or free lease periods and are accreted over the life of the contract and the expense is recorded as a reduction of revenue. We recorded a reduction of gaming operations revenue from the accretion of contract rights under development agreements and placement fees of $1.2 million and $0.1 million for the three months ended March 31, 2016 and 2015, respectively.
NOTE 5. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following (in thousands):
March 31, 2016 | December 31, 2015 | ||||||
Trade accounts payable | $ | 4,155 | $ | 4,776 | |||
Salary and payroll tax accrual | 3,347 | 5,851 | |||||
Taxes payable | 1,926 | 2,440 | |||||
Accrued interest | 3,752 | 8 | |||||
C2 Gaming contingent consideration | — | 1,125 | |||||
Placement fees payable | 4,525 | 4,525 | |||||
Accrued other | 5,912 | 4,305 | |||||
Total accounts payable and accrued liabilities | $ | 23,617 | $ | 23,030 | |||
NOTE 6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
March 31, 2016 | December 31, 2015 | ||||||
Senior secured credit facilities: | |||||||
Term loans, interest at LIBOR or base rate plus 8.25% (9.25% at March 31, 2016), net of unamortized discount and deferred loan costs of $17.4 million and $18.2 million at March 31, 2016 and December 31, 2015, respectively. | $ | 396,403 | $ | 396,717 | |||
Senior secured PIK notes, net of unamortized discount and deferred loan costs of $3.8 million and $3.9 million at March 31, 2016 and December 31, 2015, respectively. | 118,839 | 118,764 | |||||
Seller notes | 18,902 | 18,902 | |||||
Equipment long-term note payable and capital leases | 6,164 | 5,826 | |||||
Total debt(1) | 540,308 | 540,209 | |||||
Less: Current portion | (7,061 | ) | (6,919 | ) | |||
Long-term debt | $ | 533,247 | $ | 533,290 | |||
(1) Pursuant to the adoption of ASU 2015-03, debt issuance costs of $7.8 million were deducted from the carrying amount of related debt as of December 31, 2015.
Senior Secured Credit Facilities
On December 20, 2013, the Company entered into our senior secured credit facilities, which consisted of $155.0 million in term loans and a $25.0 million revolving credit facility. On May 29, 2015, the Company entered into incremental facilities for $265.0 million in term loans and on June 1, 2015, the Company entered into an incremental agreement for an additional $15.0 million of incremental revolving commitments. The proceeds of the incremental term loans were used primarily to pay the consideration for the Cadillac Jack acquisition.
The term loans will mature on December 20, 2020, and the revolving credit facility will mature on December 20, 2018. The term loans require scheduled quarterly payments in amounts equal to 0.25% of the original aggregate principal amount of the term loans, with the balance due at maturity. Borrowings under the term loans bear interest at a rate equal to, at the Company’s option, either LIBOR or the base rate, subject to an interest rate floor plus an applicable margin rate. Borrowings under the revolving credit facility bear interest at a rate equal to, at the Company’s option, either LIBOR or the base rate plus an applicable margin rate. In addition, on a quarterly basis, the Company is required to pay each lender under the revolving credit facility a commitment fee in respect of any unused commitments thereunder at a rate of 0.50% per annum.
12
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The senior secured credit facilities are guaranteed by AP Gaming Holdings, LLC, the AP Gaming I, LLC’s (the “Borrower”) material, wholly owned domestic subsidiaries (subject to certain exceptions), and are secured by a pledge by AP Gaming Holdings, LLC of the Borrower’s equity interest directly held by AP Gaming Holdings, LLC and a pledge of substantially all of the existing and future property and assets of the Borrower and the subsidiary guarantors, subject to certain exceptions. The senior secured credit facilities require that the Borrower maintain a maximum net first lien leverage ratio set at a maximum of 5.5 to 1 beginning with the first quarter ending June 30, 2014. The senior secured credit facilities contain limitations on additional indebtedness, guarantees, incurrence of liens, investments and distributions, as defined. The senior secured credit facilities also contain customary events of default included in similar financing transactions, including, among others, failure to make payments when due, default under other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments. The Company was in compliance with the covenants of the senior secured credit facilities at March 31, 2016.
Senior secured PIK notes
On May 29, 2015, the Company entered into a note purchase agreement with AP Gaming Holdings, LLC, as subsidiary guarantor (the “Subsidiary Guarantor”), Deutsche Bank AG, London Branch, as purchaser (the “Purchaser”), and Deutsche Bank Trust Company Americas, as collateral agent. Pursuant to the agreement, the Company issued $115.0 million of its 11.25% senior secured PIK notes due 2021 (the “Notes”) at an issue price of 97% of the principal amount thereof to the Purchaser in a private placement exempt from registration under the Securities Act of 1933, as amended. The Notes are secured by the Company’s equity in its subsidiary AP Gaming, Inc., subject to certain limitations including those imposed by gaming laws, and are unconditionally guaranteed by the Subsidiary Guarantor.
Interest on the Notes will accrue at a rate of 11.25% per annum. The Company may elect to pay interest due on the Notes in cash, by increasing the principal of the outstanding Notes or by issuing new Notes (“PIK interest”) for the entire amount of the interest payment or by paying interest partially in cash and partially in PIK interest. Interest on the Notes will accrue from the the date of issuance and will be payable on the dates described in more detail in the agreement. The Notes will mature on May 28, 2021. The net proceeds of the Notes were used primarily to finance the acquisition of Cadillac Jack.
The Notes contain limitations on additional indebtedness, guarantees, incurrence of liens, investments and distributions, as defined. The Notes also contains customary events of default included in similar transactions, including, among others, failure to make payments when due, acceleration of other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments.
Seller notes
On December 20, 2013, the Company issued two promissory notes (the “AGS Seller Notes”) to AGS Holdings, LLC, in the amounts of $2.2 million and $3.3 million, to satisfy the conditions set forth in the Acquisition Agreement. At March 31, 2016, notes payable related to the AGS Seller Notes totaled $6.5 million, which includes capitalized interest of $1.0 million . The Seller Notes accrue interest on the unpaid principal balance at 8.5% per annum and shall be payable semi-annually in arrears on June 30 and December 31, commencing on June 30, 2014. Any interest accrued and payable on any interest payment date will be paid by capitalizing such interest and adding it to (and thereby increasing) the outstanding principal amount of this AGS Seller Notes. All principal and interest under the AGS Seller Notes is due and payable on June 18, 2021, the maturity date. The Company may prepay from time to time all or any portion of the outstanding principal balance due under the AGS Seller Notes.
On May 29, 2015, the Company issued a promissory note to Amaya Inc. (the “Amaya Seller Note”) with an initial principal amount of $12.0 million to satisfy the conditions set forth in the Cadillac Jack Stock Purchase Agreement (the “Stock Purchase Agreement”). The Amaya Seller Note accrues interest on the unpaid principal amount at 5.0% per annum and is payable semi-annually on June 30 and December 31 (and on May 29, 2023, the maturity date of the note), commencing on June 30, 2015. All interest accrued and payable on any interest payment date will be paid by capitalizing such interest and adding it to (and thereby increasing) the outstanding principal amount of the Amaya Seller Note. All principal under the note is due and payable on May 29, 2023. The Amaya Seller Note is required to be prepaid under certain circumstances described in more detail in the note agreement. As of March 31, 2016, there was no requirement to prepay the Amaya Seller Note. The Company may prepay from time to time all or any portion of the outstanding principal balance due under the Amaya Seller Note. The
13
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Amaya Seller Note includes certain covenants and events of default that are customary for instruments of this type. At March 31, 2016, the Amaya Seller Note totaled $12.4 million, which includes capitalized interest of $0.4 million.
Equipment Long Term Note Payable and Capital Leases
The Company has entered into a financing agreement to purchase certain gaming devices, systems and related equipment and has entered into leases for servers and equipment that are accounted for as capital leases.
NOTE 7. STOCKHOLDERS’ EQUITY
Common Stock
The Company’s common stock consists of two classes: class A voting common stock (“Class A Shares”) and class B non-voting common stock (“Class B Shares”). The holders of the Class A Shares are entitled to one vote per share on all matters to be voted on by the stockholders of the Company. The holders of the Class A Shares have no economic rights or privileges, including rights in liquidation, and have no right to receive dividends or any other distributions. The holders of the Class B Shares have no right to vote on any matter to be voted on by the stockholders of the Company. Each holder of Class B Shares is entitled to share equally, share for share, dividends declared, as well as any distributions to the stockholders, and in the event of the Company’s liquidation, dissolution or winding up, is entitled to share ratably in any remaining assets after payment of or provision for liabilities and the liquidation on preferred stock, if any.
As of March 31, 2016, 107,498 Class B Shares issued to “Management Holders,” as defined in the Securityholders Agreement dated April 28, 2014 (the “Securityholders Agreement”) were outstanding. The Class B Shares issued to Management Holders are not considered issued for accounting purposes as they contain a substantive performance condition that must be met for the Management Holder to benefit from the ownership of the shares. As a result, shares issued to Management Holders are not considered issued for accounting purposes until such time that the performance condition is met.
Class B Shares that are held by a Management Holder are subject to repurchase rights (the “Repurchase Rights”), as outlined in Section 6 of the Securityholders Agreement, that are contingent on the Management Holder’s termination. The Repurchase Rights enable the Company to recover the Class B Shares issued to Management Holders without transferring any appreciation of the fair value of the stock to the Management Holder upon certain terminations of the Management Holder’s employment prior to a “Qualified Public Offering”, as defined in the Securityholders Agreement. If a Management Holder’s employment is terminated by the Company prior to the consummation of a Qualified Public Offering for “Cause”, as defined in the Securityholders Agreement, or is terminated by such Management Holder without “Good Reason”, as defined in the Securityholders Agreement, then the Company shall have the right to repurchase all or any portion of the Class B Shares held by such Management Holder for the lesser of original cost and fair market value. If a Management Holder’s employment is terminated by the Company prior to the consummation of a Qualified Public Offering other than as described above and in the Securityholders Agreement, then the Company shall have the right to repurchase all or any portion of the Class B Shares held by such Management Holder for fair market value.
NOTE 8. WRITE DOWNS AND OTHER CHARGES
The Condensed Consolidated Statements of Operations and Comprehensive Loss include various non-routine transactions or consulting and transaction-related fees that have been classified as write downs and other charges. During the three months ended March 31, 2016, the Company recognized $0.1 million in write-downs and other charges driven by losses from the disposal of assets.
During the three months ended March 31, 2015, the Company recognized $3.5 million in write-downs and other charges primarily related to acquisition charges of $3.2 million. The Company also recognized losses from the disposal of assets of $0.3 million.
NOTE 9. BASIC AND DILUTED INCOME (LOSS) PER SHARE
The Company computes net income (loss) per share in accordance with accounting guidance that requires presentation of both basic and diluted earnings per share (“EPS”) on the face of the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss). Basic EPS is computed by dividing net income (loss) for the period by the weighted average
14
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
number of shares outstanding during the period. Basic EPS excludes Class B Shares issued to Management Holders until the performance condition or termination event is considered probable (see Note 7). Until such time, the Class B Shares issued to Management Holders will be included in the calculation of diluted EPS using the treasury stock method and are treated as stock options. Diluted EPS is computed by dividing net income (loss) for the period by the weighted average number of common shares outstanding during the period, increased by potentially dilutive common shares that were outstanding during the period. Diluted EPS excludes all potential dilutive shares if their effect is anti-dilutive. Potentially dilutive common shares include stock options and restricted stock (see Note 11).
There were no potentially dilutive securities for the three months ended March 31, 2016.
Excluded from the calculation of diluted EPS for the three months ended March 31, 2016, are 50,000 restricted shares and 0.3 million stock options, as such securities were anti-dilutive.
NOTE 10. BENEFIT PLANS
The Company has established a 401(k) defined contribution plan (the “401(k) Plan”) for its employees. The 401(k) Plan allows employees to contribute up to 15% of their pretax earnings, and the Company may match a percentage of the contributions on a discretionary basis. The expense associated with the 401(k) Plan for the three months ended March 31, 2016 and 2015, was $0.3 million and $0.1 million, respectively.
On April 28, 2014, the Board of Directors of the Company approved the 2014 Long-Term Incentive Plan (“LTIP”). Under the LTIP, the Company is authorized to grant nonqualified stock options, rights to purchase Class B Shares, restricted stock, restricted stock units and other awards settleable in, or based upon, Class B Shares to persons who are directors and employees of and consultants to the Company or any of its subsidiaries on the date of the grant. The LTIP will terminate ten years after approval by the Board. Subject to adjustments in connection with certain changes in capitalization, the maximum number of Class B Shares that may be delivered pursuant to awards under the LTIP is 1,250,000.
NOTE 11. SHARE-BASED COMPENSATION
Stock Options
The Company has granted stock awards to eligible participants under the LTIP. The stock awards include options to purchase the Company’s Class B Shares. These stock options include a combination of service and market conditions, as further described below. In addition, these stock options include a performance vesting condition, a Qualified Public Offering (see Note 7), which is not considered to be probable as of March 31, 2016. As a result, no share-based compensation expense for stock options has been recognized and none will be recognized for these stock awards until the performance condition is considered to be probable. When the performance condition is considered probable, the stock awards will vest in accordance with the underlying service and market conditions.
The Company calculated the grant date fair value of stock options that vest over a service period using the Black Scholes model. For stock options that contain a market condition related to the return on investment that the Company’s stockholders achieve, the options were valued using a lattice-based option valuation model. The assumptions used in these calculations are noted in the following table. Expected volatilities are based on implied volatilities from comparable companies. The expected time to liquidity is based on management’s estimate. The risk-free rate is based on the U.S. Treasury yield curve for a term equivalent to the estimated time to liquidity. The expected dividend yield is 0% for all stock awards.
Three Months Ended March 31, 2016 | Three Months Ended March 31, 2015 | ||
Option valuation assumptions: | |||
Expected dividend yield | —% | —% | |
Expected volatility | 55% | 53% | |
Risk-free interest rate | 1.67% | 1.44% | |
Expected term (in years) | 6.3 | 6.7 | |
15
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
A summary of the changes in stock options outstanding during the three months ended March 31, 2016, is as follows:
Number of Options | Weighted Average Exercise Price | Weighted Average Remaining Contract Term (years) | Aggregate Intrinsic Value | ||||||
Options outstanding as of December 31, 2015 | 765,375 | $12.46 | |||||||
Granted | 227,600 | $16.98 | |||||||
Canceled | (95,000) | $15.70 | |||||||
Options outstanding as of March 31, 2016 | 897,975 | $13.26 | 8.6 | $ | 3,339,193 | ||||
Restricted Stock
No restricted stock was granted, canceled or forfeited during the three months ended March 31, 2016.
NOTE 12. RESTRUCTURING
We recorded no employee termination and restructuring costs during the three months ended March 31, 2016. Employee termination and restructuring costs are classified in selling, general and administrative as well as research and development expense and have been recorded for the following restructuring plans.
Cadillac Jack Integration Plan
In June 2015, we took actions to reduce the staff in all of our locations and to streamline our operations and cost structure. The Company has also entered into retention agreements with certain employees that will be paid upon the completion of their service period.
The following table summarizes the change in our restructuring accruals for the three months ended March 31, 2016 (in thousands), which is included in accounts payable and accrued liabilities in the Condensed Consolidated Balance Sheets:
December 31, 2015 | Charge to expense | Cash paid | March 31, 2016 | ||||||||||||
Accrued severance | $ | 37 | $ | — | $ | 37 | $ | — | |||||||
Total | $ | 37 | $ | — | $ | 37 | $ | — | |||||||
NOTE 13. INCOME TAXES
The Company's effective income tax rate for the three months ended March 31, 2016, was a benefit of 9.3%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended March 31, 2016, was primarily due to changes in our valuation allowance on deferred tax assets, net. The Company's effective income tax rate for the three months ended March 31, 2015, was an expense of 9.0%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended March 31, 2015, was primarily due to valuation allowance considerations and amortization of indefinite life intangibles.
NOTE 14. COMMITMENTS AND CONTINGENCIES
The Company is subject to federal, state and Native American laws and regulations that affect both its general commercial relationships with its Native American tribal customers, as well as the products and services provided to them. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. If a potential loss from any claim or legal proceeding is considered reasonably possible, the Company discloses an estimate of the possible loss or range of possible loss, or a statement that such an estimate cannot be made. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to their pending claims and litigation and may revise their estimates. Such revisions in the estimates of the potential liabilities could have a material impact on the results of operations and financial condition.
16
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains “forward-looking statements.” Forward-looking statements include any statements that address future results or occurrences. In some cases you can identify forward-looking statements by terminology such as “may,” “might,” “will,” “would,” “should,” “could” or the negatives thereof. Generally, the words “anticipate,” “believe,” “continue,” “expect,” “intend,” “estimate,” “project,” “plan” and similar expressions identify forward-looking statements. In particular, statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance contained elsewhere in this Quarterly Report on Form 10-Q as well as those discussed under “Item 1. Business” and “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year-ended December 31, 2015 are forward-looking statements. These forward-looking statements include statements that are not historical facts, including statements concerning our possible or assumed future actions and business strategies. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks, uncertainties and other factors, many of which are outside of our control, which could cause our actual results, performance or achievements to differ materially from any results, performance or achievements expressed or implied by such forward-looking statements. Given the risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements are made only as of the date of this Quarterly Report. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments unless required by federal securities law. New factors emerge from time to time, and it is not possible for us to predict all such factors.
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Unless the context indicates otherwise, or unless specifically stated otherwise, references to the “Company”, “AP Gaming”, “we,” “our” and “us” refer to AP Gaming Holdco, Inc. and its consolidated subsidiaries.
Overview
We are a leading designer and supplier of gaming products and services for the gaming industry. The Company is a leader in the Class II Native American and Mexican gaming jurisdictions and has expanded its product lines to include Class III Native American, commercial and charity jurisdictions. We supply electronic gaming machines (“slot machines”), server-based systems and back-office systems that are used by casinos and various gaming locations. Over the past 24 months, the Company has significantly broadened and diversified its product portfolio through both organic development and strategic acquisitions. We launched a new table products division in mid-2014 to provide live felt table games to casino operators. Through the acquisition of Cadillac Jack (defined below) on May 29, 2015, we greatly expanded our games library and slot machine offerings. The Company also acquired online developer Gamingo Limited in June 2015, expanding its offerings to include interactive products such as social casino games, available to play on desktop and mobile devices.
As of March 31, 2016, we had approximately 19,775 slot machine units installed under revenue sharing or fee per day agreements, approximately 10,500 of which are attributable to the inclusion of Cadillac Jack. The majority of our systems are used by Native American gaming operators in both Class II and Class III jurisdictions as well as commercial casinos in Mexico. We currently derive a substantial portion of our gaming revenues from lease agreements whereby we place slot machines and systems at a customer’s facility in return for either a share of the revenues that these machines and systems generate or a daily fee, which we collectively refer to as “participation agreements” and as our “participation model.”
Impact of Acquisitions
On May 29, 2015, we acquired 100% of the equity of Amaya Americas Corporation (“Cadillac Jack”), a leading provider of Class II gaming machines for the North American tribal gaming market, with key regions of operation including Alabama, Mexico, and Wisconsin. Our consolidated results of operations include the impact of this acquisition and the related transaction costs, as well as the results of operations of Cadillac Jack, from the date of acquisition through March 31, 2016.
On June 15, 2015, the Company purchased 100% of Gamingo Limited (“AGSi”), a leading gaming company developing social casino titles for mobile devices. With primary offices in San Francisco and Tel Aviv, AGSi’s flagship product, Lucky Play Casino, gives players a casino-quality experience with slots, table games, tournaments, and live events. The results of operations from AGSi have been included in our consolidated results from the date of acquisition through March 31, 2016.
Business Strategy
We have invested and expect to continue to invest in new business strategies and services, and innovative products and technologies. We intend to pursue the following strategic initiatives as part of our overall business strategy:
1. | Expand and Diversify Our Library of Content |
We plan to continue to expand and diversify our library of proprietary content across all platforms - slots, tables and social casino. We will continue our focused efforts to develop games, both internally and through partnerships with third parties, tailored to our current and target markets. As of March 31, 2016, our Company had over 250 active slot machine titles and approximately 20 table game titles in our content library and we expect our current pool of development talent to create more than 40 titles on an annual basis.
2. | Optimize Mix of Game Titles |
We plan to improve yield by managing game title mix across our domestic installed base of participation slot machines. We believe that more effective management of the title mix represents an opportunity to generate incremental earnings growth without requiring growth in our installed base of participation gaming machines. In addition, we expect improved game performance will likely drive incremental slot machine placements within our customers’ facilities.
3. | Expand Our Footprint Through Strategic Acquisitions |
We are actively seeking acquisition opportunities that will: 1) have a positive effect on long-term earnings growth, 2) generate strong recurring revenue, 3) provide for expansion into new gaming jurisdictions, 4)
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bolster our library of proprietary content, and 5) diversify our existing product mix. Our acquisitions of Cadillac Jack and AGSi in 2015 are great examples of this strategy.
4. | Focus on Development of Unique Niche Products |
With over 1,000 casino facilities throughout the United States as of March 31, 2016, and the slot machine replacement cycle at a cyclical low, we believe the market potential for unique new games and concepts is favorable. We will target the introduction of a small number of niche gaming products to a large number of casinos.
5. | Build Momentum in Class III Markets and Pursue Class II Market Leadership |
With the inclusion of Cadillac Jack units, we have a foothold of approximately 3,400 Class III placements in total, which represents approximately 1% of the total U.S. Class III market. We believe significant growth potential exists for our Company to further penetrate this market. Utilizing new, recently-issued gaming licenses, we expect to begin placing and selling Class III products in five new jurisdictions (Nevada, Mississippi, Louisiana, New Jersey and Connecticut) in 2016. We also anticipate growing our presence in Class III markets where we currently operate, such as Oklahoma, Florida and California, by placing additional content from our expanding library of games in these states. In addition, we believe that our existing core Class II product offering is among the strongest in the industry today. We expect to continue gaining market share in existing Class II jurisdictions and are focused on penetrating newly licensed jurisdictions.
6. | Focus on Innovation and New Product Verticals For the Next Generation of Casino Players |
In the third quarter of 2014, we began developing table games products through the acquisitions of War Blackjack and other related intellectual property. The extension of our business into table games, as well as our entry into the social casino space through our acquisition of AGSi, demonstrates our commitment to evolving our business to adapt to the preferences of the next-generation gambler. As of March 31, 2016, the Company had approximately 920 table game units under lease arrangements. We plan to continue expanding our table games offerings through acquisitions and internal development. We have already introduced our proven land-based casino content into online and mobile formats for social gaming. Our popular land-based slot machine games - such as So Hot, Colossal Diamonds, and Monkey in the Bank, to name a few - have been among the strongest performers in our social casino game catalog.
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Results of Operations
Three Months Ended March 31, 2016 compared to the Three Months Ended March 31, 2015
The following tables set forth certain selected condensed consolidated financial data for the three months ended March 31, 2016 and 2015 (in thousands):
Three months ended March 31, | $ | % | ||||||||||||
2016 | 2015 | Change | Change | |||||||||||
Consolidated Statements of Operations: | ||||||||||||||
Revenues | ||||||||||||||
Gaming operations | $ | 38,638 | $ | 18,567 | $ | 20,071 | 108.1 | % | ||||||
Equipment sales | 1,597 | 228 | 1,369 | 600.4 | % | |||||||||
Total revenues | 40,235 | 18,795 | 21,440 | 114.1 | % | |||||||||
Operating expenses | ||||||||||||||
Cost of gaming operations | 6,273 | 3,194 | 3,079 | 96.4 | % | |||||||||
Cost of equipment sales | 170 | 85 | 85 | 100.0 | % | |||||||||
Selling, general and administrative | 12,683 | 6,150 | 6,533 | 106.2 | % | |||||||||
Research and development | 4,663 | 1,275 | 3,388 | 265.7 | % | |||||||||
Write downs and other charges | 110 | 3,481 | (3,371 | ) | (96.8 | )% | ||||||||
Depreciation and amortization | 20,542 | 8,346 | 12,196 | 146.1 | % | |||||||||
Total operating expenses | 44,441 | 22,531 | 21,910 | 97.2 | % | |||||||||
Loss from operations | (4,206 | ) | (3,736 | ) | (470 | ) | 12.6 | % | ||||||
Other expense (income) | ||||||||||||||
Interest expense | 14,616 | 4,272 | 10,344 | 242.1 | % | |||||||||
Interest income | (23 | ) | (9 | ) | (14 | ) | 155.6 | % | ||||||
Other expense (income) | 4,422 | 476 | 3,946 | 829.0 | % | |||||||||
Loss before income taxes | (23,221 | ) | (8,475 | ) | (14,746 | ) | 174.0 | % | ||||||
Income tax benefit (expense) | 2,155 | (760 | ) | 2,915 | (383.6 | )% | ||||||||
Net loss | $ | (21,066 | ) | $ | (9,235 | ) | $ | (11,831 | ) | 128.1 | % | |||
Key Performance Indicators: | ||||||||||||||
Slot install base | 19,787 | 8,626 | 11,161 | 129.4 | % | |||||||||
Slot revenue per day | $ | 20.50 | $ | 23.49 | $ | (2.99 | ) | (12.7 | )% | |||||
Slot units sold | 24 | 14 | 10 | 71.4 | % | |||||||||
Total Revenues
The increase in total revenues is attributable to the inclusion of Cadillac Jack and AGSi for the three months ended March 31, 2016, compared to the prior year period. The inclusion of Cadillac Jack, increased our slot install base by approximately 10,500 units. The remaining increase in revenues was driven by improved game performance and an increase in the install base of our Big Red slot machine that runs on our Colossal platform, which has historically been our best performing game. Slot revenue per day decreased in total, which is primarily attributable to the inclusion of Cadillac Jack’s Mexico install base, which generates lower revenues per day than the Company’s historical install base has returned.
Operating Expenses
Cost of gaming operations. The increase is attributable to the inclusion of Cadillac Jack and AGSi for the three months ended March 31, 2016, compared to the prior year period. As a percentage of gaming operations revenue, costs of gaming operations was 16.2% for the three months ended March 31, 2016 compared to 17.0% for the prior year period.
Selling, general and administrative. The increase is primarily due to the inclusion of Cadillac Jack and AGSi for the three months ended March 31, 2016, compared to the prior year period. The increase is also attributable to increased professional fees of $1.6 million related to legal and accounting fees and integration expenses.
Research and development. The increase in research and development costs is primarily due to the inclusion of Cadillac Jack and AGSi compared to the prior year period.
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Write downs and other charges. During the three months ended March 31, 2016, the Company recognized $0.1 million in write-downs and other charges driven by losses from the disposal of assets.
During the three months ended March 31, 2015, the Company recognized $3.5 million in write-downs and other charges primarily related to acquisition charges of $3.2 million. The Company also recognized losses from the disposal of assets of $0.3 million.
Depreciation and amortization. The increase in depreciation and amortization is primarily due to the inclusion of assets acquired from Cadillac Jack and AGSi, for the three months ended March 31, 2016, compared to the prior year period.
Other Expense (Income), net
Interest expense. The increase is primarily attributed to the increase in the principal amounts outstanding under the senior secured credit facilities and senior secured PIK notes for the three months ended March 31, 2016, compared to the prior year period. The proceeds of the incremental term loans and PIK notes were used primarily to pay the consideration for the Cadillac Jack acquisition.
Other expense. The increase in other income was primarily due to the inclusion of Cadillac Jack and AGSi, for the three months ended March 31, 2016, compared to the prior year period. The amount in the current quarter relates primarily to the change in the balance of the tax indemnification receivable recorded in connection with the acquisition of Cadillac Jack. To a lesser extent, the balance also includes the effect of foreign currency fluctuation on trade payables and receivables denominated in foreign currencies.
Income Taxes
The Company's effective income tax rate for the three months ended March 31, 2016, was a benefit of 9.3%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended March 31, 2015, was primarily due changes in our valuation allowance on deferred tax assets. The Company's effective income tax rate for the three months ended March 31, 2015 was an expense of 9.0%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended March 31, 2015 was primarily due to valuation allowance considerations and amortization of indefinite lived intangible assets.
LIQUIDITY AND CAPITAL RESOURCES
We expect that primary ongoing liquidity requirements for the year ended December 31, 2016, will be for capital expenditures of between $20 million and $30 million, working capital, debt servicing, game development and other customer acquisition activities. We expect to finance these liquidity requirements through a combination of cash on hand and cash flows from operating activities.
Part of our overall strategy includes consideration of expansion opportunities, underserved markets and acquisition and other strategic opportunities that may arise periodically. We may require additional funds in order to execute on such strategic growth, and may incur additional debt or issue additional equity to finance any such transactions. We cannot assure you that we will be able to obtain such debt or issue any such additional equity on acceptable terms or at all.
As of March 31, 2016, we had $29.2 million in cash and cash equivalents and $40.0 million available under our revolving credit facility. Based on our current business plan, we believe that our existing cash balances, cash generated from operations and availability under the revolving credit facility will be sufficient to meet our anticipated cash needs for at least the next twelve months. As of March 31, 2016, we are in compliance with the the required covenants of our debt instruments, including the maximum net first lien leverage ratio. However, our future cash requirements could be higher than we currently expect as a result of various factors. Our ability to meet our liquidity needs could be adversely affected if we suffer adverse results of operations, or if we violate the covenants and restrictions to which we are subject under our debt instruments. Additionally, our ability to generate sufficient cash from our operating activities is subject to general economic, political, regulatory, financial, competitive and other factors beyond our control. Our business may not generate sufficient cash flow from operations, and future borrowings may not be available to us under our existing credit facility in an amount sufficient to enable us to pay our service or repay our indebtedness or to fund our other liquidity needs, and we may be required to seek additional financing through credit facilities with other lenders or institutions or seek additional capital through private placements or public offerings of equity or debt securities.
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Indebtedness
Senior Secured Credit Facilities
On December 20, 2013, the Company entered into our senior secured credit facilities, which consisted of $155.0 million in term loans and a $25.0 million revolving credit facility. On May 29, 2015, the Company entered into incremental facilities for $265.0 million in term loans and on June 1, 2015, the Company entered into an incremental agreement for an additional $15.0 million of incremental revolving commitments. The proceeds of the incremental term loans were used primarily to pay the consideration for the Cadillac Jack acquisition.
The term loans will mature on December 20, 2020, and the revolving credit facility will mature on December 20, 2018. The term loans require scheduled quarterly payments in amounts equal to 0.25% of the original aggregate principal amount of the term loans, with the balance due at maturity. Borrowings under the term loans bear interest at a rate equal to, at the Company’s option, either LIBOR or the base rate, subject to an interest rate floor plus an applicable margin rate. Borrowings under the revolving credit facility bear interest at a rate equal to, at the Company’s option, either LIBOR or the base rate plus an applicable margin rate. In addition, on a quarterly basis, the Company is required to pay each lender under the revolving credit facility a commitment fee in respect of any unused commitments thereunder at a rate of 0.50% per annum.
The senior secured credit facilities are guaranteed by AP Gaming Holdings, LLC, the AP Gaming I, LLC’s (the “Borrower”) material, wholly owned domestic subsidiaries (subject to certain exceptions), and are secured by a pledge by AP Gaming Holdings, LLC of the Borrower’s equity interest directly held by AP Gaming Holdings, LLC and a pledge of substantially all of the existing and future property and assets of the Borrower and the subsidiary guarantors, subject to certain exceptions. The senior secured credit facilities require that the Borrower maintain a maximum net first lien leverage ratio set at a maximum of 5.5 to 1 beginning with the first quarter ending June 30, 2014. The senior secured credit facilities contain limitations on additional indebtedness, guarantees, incurrence of liens, investments and distributions, as defined. The senior secured credit facilities also contain customary events of default included in similar financing transactions, including, among others, failure to make payments when due, default under other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments. The Company was in compliance with the covenants of the senior secured credit facilities at March 31, 2016.
Senior secured PIK notes
On May 29, 2015, the Company entered into a note purchase agreement with AP Gaming Holdings, LLC, as subsidiary guarantor (the “Subsidiary Guarantor”), Deutsche Bank AG, London Branch, as purchaser (the “Purchaser”), and Deutsche Bank Trust Company Americas, as collateral agent. Pursuant to the agreement, the Company issued $115.0 million of its 11.25% senior secured PIK notes due 2021 (the “Notes”) at an issue price of 97% of the principal amount thereof to the Purchaser in a private placement exempt from registration under the Securities Act of 1933, as amended. The Notes are secured by the Company’s equity in its subsidiary AP Gaming, Inc., subject to certain limitations including those imposed by gaming laws, and are unconditionally guaranteed by the Subsidiary Guarantor.
Interest on the Notes will accrue at a rate of 11.25% per annum. The Company may elect to pay interest due on the Notes in cash, by increasing the principal of the outstanding Notes or by issuing new Notes (“PIK interest”) for the entire amount of the interest payment or by paying interest partially in cash and partially in PIK interest. Interest on the Notes will accrue from the the date of issuance and will be payable on the dates described in more detail in the agreement. The Notes will mature on May 28, 2021. The net proceeds of the Notes were used primarily to finance the acquisition of Cadillac Jack.
The Notes contain limitations on additional indebtedness, guarantees, incurrence of liens, investments and distributions, as defined. The Notes also contains customary events of default included in similar transactions, including, among others, failure to make payments when due, acceleration of other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments.
Seller notes
On December 20, 2013, the Company issued two promissory notes (the “AGS Seller Notes”) to AGS Holdings, LLC, in the amounts of $2.2 million and $3.3 million, to satisfy the conditions set forth in the Acquisition Agreement. At March 31, 2016, notes payable related to the AGS Seller Notes totaled $6.5 million, which includes capitalized interest of $1.0 million . The Seller Notes accrue interest on the unpaid principal balance at 8.5% per annum and shall be payable semi-annually in arrears on June 30 and December 31, commencing on June 30, 2014. Any interest accrued and payable on any interest payment date will be paid by capitalizing such interest and adding it to (and thereby increasing) the outstanding principal amount of this
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AGS Seller Notes. All principal and interest under the AGS Seller Notes is due and payable on June 18, 2021, the maturity date. The Company may prepay from time to time all or any portion of the outstanding principal balance due under the AGS Seller Notes.
On May 29, 2015, the Company issued a promissory note to Amaya Inc. (the “Amaya Seller Note”) with an initial principal amount of $12.0 million to satisfy the conditions set forth in the Cadillac Jack Stock Purchase Agreement (the “Stock Purchase Agreement”). The Amaya Seller Note accrues interest on the unpaid principal amount at 5.0% per annum and is payable semi-annually on June 30 and December 31 (and on May 29, 2023, the maturity date of the note), commencing on June 30, 2015. All interest accrued and payable on any interest payment date will be paid by capitalizing such interest and adding it to (and thereby increasing) the outstanding principal amount of the Amaya Seller Note. All principal under the note is due and payable on May 29, 2023. The Amaya Seller Note is required to be prepaid under certain circumstances described in more detail in the note agreement. As of March 31, 2016, there was no requirement to prepay the Amaya Seller Note. The Company may prepay from time to time all or any portion of the outstanding principal balance due under the Amaya Seller Note. The Amaya Seller Note includes certain covenants and events of default that are customary for instruments of this type. At March 31, 2016, the Amaya Seller Note totaled $12.4 million, which includes capitalized interest of $0.4 million.
Equipment Long Term Note Payable and Capital Leases
The Company has entered into a financing agreement to purchase certain gaming devices, systems and related equipment and has entered into leases for servers and equipment that are accounted for as capital leases.
The following table summarizes our historical cash flows (in thousands):
Three months ended March 31, | |||||||
2016 | 2015 | ||||||
Cash Flow Information: | |||||||
Net cash provided by operating activities | $ | 5,366 | $ | 4,248 | |||
Net cash used in investing activities | (7,580 | ) | (4,633 | ) | |||
Net cash (used in) provided by financing activities | (4,291 | ) | 565 | ||||
Effect of exchange rates on cash and cash equivalents | 1 | 451 | |||||
Net increase in cash and cash equivalents | $ | (6,504 | ) | $ | 631 | ||
Operating activities
The Company has historically produced a loss from operations, which is primarily due to the capital nature of the business and the resulting depreciation and amortization expense. For the three months ended March 31, 2016, net cash provided by operating activities was $5.4 million compared to net $4.2 million for the three months ended March 31, 2015, representing an increase of $1.1 million. The increase is primarily due to an increase as a result of changes in net working capital partially offset by a $0.9 million decrease in income from operating activities excluding non-cash expenses.
Investing activities
Net cash used in investing activities for the three months ended March 31, 2016, was $7.6 million compared to $4.6 million for the three months ended March 31, 2015, representing an increase of $2.9 million. The increase was primarily due to increased purchases of property and equipment of $2.1 million and software development expenditures of $1.1 million offset by a decrease in the purchase of intangible assets of $0.3 million.
Financing activities
Net cash used in the current period was $4.3 million compared to cash provided by financing activities of $0.6 million for the same period in 2015. The increase was primarily due to payments on debt of $1.6 million, payments of placement fees of $1.5 million, payments for previous acquisition obligations of $1.1 million offset by decreased borrowings of our revolving credit facility of $1.0 million.
Off-Balance Sheet Arrangements
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We do not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
A description of our critical accounting policies can be found in “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2015. There were no material changes to those policies during the three months ended March 31, 2016.
Recently Issued Accounting Standards
See related disclosure at Item 1—“Notes to Condensed Consolidated Financial Statements”, Note 1 “Description of the Business and Summary of Significant Accounting Policies.”
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rates. Our primary exposure to market risk is interest rate risk associated with our long-term debt, which accrues interest at variable rates. Certain of our debt instruments accrue interest at LIBOR or the base rate, at our election, subject to an interest rate floor plus an applicable margin rate. In the normal course of business, we are exposed to fluctuations in interest rates as we seek debt and equity capital to sustain our operations. All of our interest rate sensitive financial instruments are held for purposes other than trading purposes. As of March 31, 2016, approximately 25% of our debt were fixed-rate instruments. As of March 31, 2016, the three month LIBOR rate was lower than 1%, with our term loans having a LIBOR floor of 1%, our variable debt is essentially at a fixed rate until the LIBOR rate exceeds 1%.
Foreign currency risk. We are exposed to foreign currency exchange rate risk that is inherent to our foreign operations. We currently transact business in Mexico using the local currency. Our settlement of inter-company trade balances requires the exchange of currencies, which results in the recognition of foreign currency fluctuations. We expect that certain operations will continue to be denominated in foreign currencies. As such, we expect our cash flows and earnings to continue to be exposed to the risks that may arise from fluctuations in foreign currency exchange rates.
ITEM 4. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Exchange Act) as of March 31, 2016. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure information is recorded, processed, summarized and reported within the periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error and mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of controls.
The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions or because the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
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Changes in Internal Controls
No change in our internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f) occurred during the three months ended March 31, 2016, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
ITEM 1. LEGAL PROCEEDINGS.
We are party to various claims and legal actions that arise in the ordinary course of business. We do not believe the outcome of such disputes or legal actions will have a material adverse effect on our financial condition, results of operations, liquidity or capital resources.
ITEM 1A. RISK FACTORS.
"Item 1A.-Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2015, includes a discussion of our risk factors. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.
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ITEM 6. EXHIBITS.
(a). Exhibits.
Incorporated by Reference | |||||||
Exhibit Number | Exhibit Description | Filed Herewith | Form | Period Ending | Exhibit | Filing Date | |
10.1 | First Amendment to the July 1, 2015 Employment Agreement, dated as of January 14, 2016, by and between AGS, LLC and Sigmund Lee. | X | — | — | — | — | |
10.2 | Separation Agreement and Release of All Claims, dated as of January 22, 2016 by and between between AGS, LLC and Mauro Franic. | X | |||||
31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | — | — | — | — | |
31.2 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | — | — | — | — | |
32 | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | X | — | — | — | — | |
101.IN | XBRL Instance Document | X | — | — | — | — | |
101.SCH | XBRL Taxonomy Extension Schema Document | X | — | — | — | — | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | X | — | — | — | — | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | X | — | — | — | — | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | X | — | — | — | — | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | X | — | — | — | — | |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AP GAMING HOLDCO, INC. | |||||
Date: | May 16, 2016 | By: | /s/ KIMO AKIONA | ||
Name: | Kimo Akiona | ||||
Title: | Treasurer (Principal Financial and Accounting Officer) | ||||
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