Attached files
| file | filename |
|---|---|
| EX-32 - EXHIBIT 32 - PlayAGS, Inc. | ex32-201733110q.htm |
| EX-31.2 - EXHIBIT 31.2 - PlayAGS, Inc. | ex312-201733110q.htm |
| EX-31.1 - EXHIBIT 31.1 - PlayAGS, Inc. | ex311-201733110q.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, 2017
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 | Emerging growth company x | ||||
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 5, 2017, there were 100 shares of the Registrant’s Class A common stock, $.01 par value per share, and 15,041,361 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)
(unaudited)
March 31, 2017 | December 31, 2016 | ||||||
Assets | |||||||
Current assets | |||||||
Cash and cash equivalents | $ | 7,642 | $ | 17,977 | |||
Restricted cash | 100 | 100 | |||||
Accounts receivable, net of allowance of $1,740 and $1,972, respectively | 23,989 | 24,035 | |||||
Inventories | 11,712 | 10,729 | |||||
Prepaid expenses | 3,676 | 2,609 | |||||
Deposits and other | 3,227 | 3,052 | |||||
Total current assets | 50,346 | 58,502 | |||||
Property and equipment, net | 70,821 | 67,926 | |||||
Goodwill | 252,728 | 251,024 | |||||
Deferred tax asset | 9 | 9 | |||||
Intangible assets | 222,068 | 232,877 | |||||
Other assets | 20,891 | 23,754 | |||||
Total assets | $ | 616,863 | $ | 634,092 | |||
Liabilities and Stockholders’ Equity | |||||||
Current liabilities | |||||||
Accounts payable | $ | 6,242 | $ | 8,790 | |||
Accrued liabilities | 17,576 | 17,702 | |||||
Current maturities of long-term debt | 6,287 | 6,537 | |||||
Total current liabilities | 30,105 | 33,029 | |||||
Long-term debt | 541,550 | 547,238 | |||||
Deferred tax liability - noncurrent | 8,315 | 6,957 | |||||
Other long-term liabilities | 31,976 | 30,440 | |||||
Total liabilities | 611,946 | 617,664 | |||||
Commitments and contingencies (Note 12) | |||||||
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, 2017 and December 31, 2016, and 14,931,529 Class B Shares issued and outstanding at March 31, 2017 and December 31, 2016. | 149 | 149 | |||||
Additional paid-in capital | 177,276 | 177,276 | |||||
Accumulated deficit | (168,837 | ) | (156,451 | ) | |||
Accumulated other comprehensive loss | (3,671 | ) | (4,546 | ) | |||
Total stockholders’ equity | 4,917 | 16,428 | |||||
Total liabilities and stockholders’ equity | $ | 616,863 | $ | 634,092 | |||
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, | |||||||
2017 | 2016 | ||||||
Revenues | |||||||
Gaming operations | $ | 40,433 | $ | 38,638 | |||
Equipment sales | 7,341 | 1,597 | |||||
Total revenues | 47,774 | 40,235 | |||||
Operating expenses | |||||||
Cost of gaming operations1 | 7,471 | 6,273 | |||||
Cost of equipment sales1 | 3,852 | 170 | |||||
Selling, general and administrative | 10,281 | 12,683 | |||||
Research and development | 5,304 | 4,663 | |||||
Write downs and other charges | 232 | 110 | |||||
Depreciation and amortization | 18,451 | 20,542 | |||||
Total operating expenses | 45,591 | 44,441 | |||||
Income (loss) from operations | 2,183 | (4,206 | ) | ||||
Other (income) expense | |||||||
Interest expense | 15,160 | 14,616 | |||||
Interest income | (15 | ) | (23 | ) | |||
Other (income) expense | (2,809 | ) | 4,422 | ||||
Loss before income taxes | (10,153 | ) | (23,221 | ) | |||
Income tax (expense) benefit | (2,233 | ) | 2,155 | ||||
Net loss | (12,386 | ) | (21,066 | ) | |||
Foreign currency translation adjustment | 875 | 81 | |||||
Total comprehensive loss | $ | (11,511 | ) | $ | (20,985 | ) | |
Basic and diluted loss per common share: | |||||||
Basic | $ | (0.83 | ) | $ | (1.41 | ) | |
Diluted | $ | (0.83 | ) | $ | (1.41 | ) | |
Weighted average common shares outstanding: | |||||||
Basic | 14,932 | 14,932 | |||||
Diluted | 14,932 | 14,932 | |||||
(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, | |||||||
2017 | 2016 | ||||||
Cash flows from operating activities | |||||||
Net loss | $ | (12,386 | ) | $ | (21,066 | ) | |
Adjustments to reconcile net loss to net cash provided by operating activities: | |||||||
Depreciation and amortization | 18,451 | 20,542 | |||||
Accretion of contract rights under development agreements and placement fees | 1,149 | 1,170 | |||||
Amortization of deferred loan costs and discount | 939 | 847 | |||||
Payment-in-kind interest capitalized | 112 | — | |||||
Provision for bad debts | 595 | 118 | |||||
Loss on disposition of assets | 577 | 108 | |||||
Impairment of assets | 285 | — | |||||
(Benefit) provision for deferred income tax | 1,350 | (2,074 | ) | ||||
Changes in assets and liabilities that relate to operations: | |||||||
Accounts receivable | 637 | (175 | ) | ||||
Inventories | 2,315 | 145 | |||||
Prepaid expenses | (1,062 | ) | 134 | ||||
Deposits and other | (90 | ) | (257 | ) | |||
Other assets, non-current | (1,089 | ) | 4,301 | ||||
Accounts payable and accrued liabilities | (4,564 | ) | 1,573 | ||||
Net cash provided by operating activities | 7,219 | 5,366 | |||||
Cash flows from investing activities | |||||||
Purchase of intangible assets | (358 | ) | (56 | ) | |||
Software development and other expenditures | (2,210 | ) | (2,151 | ) | |||
Proceeds from disposition of assets | — | 87 | |||||
Purchases of property and equipment | (11,861 | ) | (5,460 | ) | |||
Net cash used in investing activities | (14,429 | ) | (7,580 | ) | |||
Cash flows from financing activities | |||||||
Payment of financed placement fee obligations | (1,320 | ) | (1,525 | ) | |||
Payments on debt | (1,833 | ) | (1,641 | ) | |||
Payment of previous acquisition obligation | — | (1,125 | ) | ||||
Proceeds from employees in advance of common stock issuance | 25 | — | |||||
Net cash used in financing activities | (3,128 | ) | (4,291 | ) | |||
Effect of exchange rates on cash and cash equivalents | 3 | 1 | |||||
Decrease in cash and cash equivalents | (10,335 | ) | (6,504 | ) | |||
Cash and cash equivalents, beginning of period | 17,977 | 35,722 | |||||
Cash and cash equivalents, end of period | $ | 7,642 | $ | 29,218 | |||
Supplemental cash flow information: | |||||||
Cash paid during the period for interest | $ | 9,655 | $ | 9,774 | |||
Cash paid during the period for taxes | $ | 273 | $ | 310 | |||
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 three 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 Amaya Americas Corporation (“Cadillac Jack”) on May 29, 2015, we greatly expanded our games library and slot machine offerings. The Company also acquired online developer Gamingo Limited (formerly known as “RocketPlay”, currently known as “AGSi”) in June 2015, further expanding its offerings to include interactive products such as social casino games, available to play on mobile devices.
The Company operates and reports in the following three segments:
A. Electronic Gaming Machines
Our EGM segment offers a selection of video slot titles developed for the global marketplace, as well as EGM cabinets such as ICON, Halo, Colossal Diamonds cabinet (“Big Red”), and Orion. In addition to providing complete EGM units, we offer conversion kits that allow existing game titles to be converted to other game titles offered within that operating platform.
B. Table Products
Our table products include live proprietary table games and side bets, as well as ancillary table products. Products include both internally developed and acquired proprietary table games, side bets, and table technology related to blackjack, poker, baccarat, craps and roulette. We have acquired a number of popular brands, including In-Bet, Buster Blackjack, Double Draw Poker and Criss Cross Poker that are based on traditional well-known public domain games such as blackjack and poker; however, these proprietary games provide intriguing betting options that offer more excitement and greater volatility to the player, ultimately enhancing our casino customers’ profitability. Our Tornado product is unique in that it allows players to control the spin of the roulette ball by pressing a remote ball activation device. We believe this mechanism enhances player interaction without altering traditional roulette rules and procedures; similarly, our Double Ball Roulette game creates a unique game experience by allowing players to use two balls instead of one.
C. Interactive
Our social gaming products are primarily delivered through our mobile apps, Lucky Play Casino and Vegas Fever. The apps contain several game titles available for consumers to play for fun and with coins that they purchase through the app. Some of our most popular social games include content that is also popular in land-based settings such as Colossal Diamonds, So Hot, and Monkey in the Bank.
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 only normal recurring adjustments) that are necessary for a fair statement of 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, 2016.
4
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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.
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, 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.
5
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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.
Property and Equipment
The cost of gaming equipment, consisting of gaming 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.
6
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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 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, 2017, there were no indicators of impairment.
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
7
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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, 2017 and December 31, 2016 was $558.4 million and $557.8 million, respectively.
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 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 will use the modified retrospective application approach and does not expect adoption of the new revenue standards to have a material impact on its consolidated financial statements as the majority of our revenue is recognized under lease accounting guidance.
8
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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. This ASU did not have a material effect on our financial condition, 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.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). ASU 2016-15 intends to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the provisions of ASU 2016-15 to have a material effect on our financial condition, results of operations or cash flows.
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The new guidance clarifies the definition of a business in order to allow for the evaluation of whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact of adopting this guidance.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the new amendments, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. We adopted this guidance prospectively at the beginning of first quarter 2017, which will simplify our future goodwill impairment testing.
We do not expect that any other recently issued accounting guidance will have a significant effect on our financial statements.
NOTE 2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
March 31, 2017 | December 31, 2016 | ||||||
Gaming equipment | $ | 114,108 | $ | 108,635 | |||
Other property and equipment | 15,229 | 13,900 | |||||
Less: Accumulated depreciation | (58,516 | ) | (54,609 | ) | |||
Total property and equipment, net | $ | 70,821 | $ | 67,926 | |||
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 $6.1 million and $7.3 million for the three months ended March 31, 2017 and 2016, respectively.
9
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
NOTE 3. GOODWILL AND INTANGIBLES
There were no accumulated impairments of goodwill as of March 31, 2017. Changes in the carrying amount of goodwill are as follows (in thousands):
Gross Carrying Amount | |||||||||||||||
EGM | Table Products | Interactive | Total | ||||||||||||
Balance at December 31, 2016 | $ | 242,796 | $ | 3,400 | $ | 4,828 | $ | 251,024 | |||||||
Foreign currency adjustments | 1,704 | — | — | 1,704 | |||||||||||
Balance at March 31, 2017 | $ | 244,500 | $ | 3,400 | $ | 4,828 | $ | 252,728 | |||||||
Intangible assets consist of the following (in thousands):
March 31, 2017 | December 31, 2016 | ||||||||||||||||||||||||
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 | 3 - 5 | 13,600 | (5,407 | ) | 8,193 | 13,600 | (4,671 | ) | 8,929 | ||||||||||||||||
Customer relationships | 5 - 12 | 166,119 | (54,588 | ) | 111,531 | 165,078 | (49,528 | ) | 115,550 | ||||||||||||||||
Contract rights under development and placement fees | 1 - 7 | 16,496 | (6,384 | ) | 10,112 | 16,488 | (5,235 | ) | 11,253 | ||||||||||||||||
Gaming software and technology platforms | 2 - 7 | 124,997 | (54,956 | ) | 70,041 | 123,596 | (49,014 | ) | 74,582 | ||||||||||||||||
Intellectual property | 3 - 10 | 12,780 | (2,715 | ) | 10,065 | 12,780 | (2,343 | ) | 10,437 | ||||||||||||||||
$ | 346,118 | $ | (124,050 | ) | $ | 222,068 | $ | 343,668 | $ | (110,791 | ) | $ | 232,877 | ||||||||||||
Intangible assets are amortized over their respective estimated useful lives ranging from one to twelve years. Amortization expense related to intangible assets was $12.4 million and $13.3 million for the three months ended March 31, 2017 and 2016, 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 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 $1.1 million and $1.2 million for the three months ended March 31, 2017 and 2016, respectively.
10
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
NOTE 4. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
March 31, 2017 | December 31, 2016 | ||||||
Salary and payroll tax accrual | $ | 2,883 | $ | 6,594 | |||
Taxes payable | 2,375 | 2,128 | |||||
Accrued interest | 4,031 | 2 | |||||
Placement fees payable | 4,000 | 4,000 | |||||
Accrued other | 4,287 | 4,978 | |||||
Total accounts payable and accrued liabilities | $ | 17,576 | $ | 17,702 | |||
NOTE 5. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
March 31, 2017 | December 31, 2016 | ||||||
Senior secured credit facilities: | |||||||
Term loans, interest at LIBOR or base rate plus 8.25% (9.38% at March 31, 2017), net of unamortized discount and deferred loan costs of $14.3 million and $15.1 million at March 31, 2017 and December 31, 2016, respectively. | $ | 395,329 | $ | 395,581 | |||
Senior secured PIK notes, net of unamortized discount and deferred loan costs of $3.4 million and $3.5 million at March 31, 2017 and December 31, 2016, respectively. | 133,393 | 133,286 | |||||
Seller notes | 15,096 | 20,116 | |||||
Equipment long-term note payable and capital leases | 4,019 | 4,792 | |||||
Total debt | 547,837 | 553,775 | |||||
Less: Current portion | (6,287 | ) | (6,537 | ) | |||
Long-term debt | $ | 541,550 | $ | 547,238 | |||
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
11
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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, 2017.
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 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, 2017, notes payable related to the AGS Seller Notes totaled $7.1 million, which includes capitalized interest of $1.6 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, 2017, 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. During the quarter ended March 31, 2017, the Amaya Seller Note was reduced by $5.1 million to settle a clause from the Stock Purchase Agreement allowing for a refund if certain deactivated gaming machines in Mexico were not in operation as of a specified date. At March 31, 2017, the Amaya Seller Note totaled $8.0 million, which includes capitalized interest of $1.1 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.
12
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
NOTE 6. 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, 2017, 109,832 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 7. 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, 2017, the Company recognized $0.2 million in write-downs and other charges driven by losses from the disposal of assets of $0.5 million, the impairment to intangible assets of $0.3 million related to game titles, offset by a fair value adjustment to an acquisition contingent receivable of $0.6 million. The contingency was resolved in Q1 2017 as described in Note 5.
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.
NOTE 8. 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 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 6). 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.
13
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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 10).
There were no potentially dilutive securities for the three months ended March 31, 2017.
Excluded from the calculation of diluted EPS for the three months ended March 31, 2017 and 2016, are 50,000 restricted shares and 0.3 million stock options, as such securities were anti-dilutive.
NOTE 9. 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, 2017 and 2016, was $0.3 million and $0.3 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 1,450,000. As of March 31, 2017, approximately 0.4 million shares remain available for issuance.
NOTE 10. 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 6), which is not considered to be probable as of March 31, 2017. 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.
Three Months Ended March 31, 2017 | Three Months Ended March 31, 2016 | ||
Option valuation assumptions: | |||
Expected dividend yield | —% | —% | |
Expected volatility | 63% | 55% | |
Risk-free interest rate | 1.32% | 1.67% | |
Expected term (in years) | 6.5 | 6.3 | |
14
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, 2017, 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, 2016 | 895,100 | $13.35 | |||||||
Granted | 48,750 | $16.39 | |||||||
Canceled | (28,750) | $16.98 | |||||||
Options outstanding as of March 31, 2017 | 915,100 | $13.39 | 8.0 | $ | 2,740,729 | ||||
Exercisable as of March 31, 207 | 169,566 | $13.33 | 7.9 | $ | 551,352 | ||||
Restricted Stock
No restricted stock was granted, canceled or forfeited during the three months ended March 31, 2017. There were no changes to outstanding restricted stock awards during the three months ended March 31, 2017.
NOTE 11. INCOME TAXES
The Company's effective income tax rate for the three months ended March 31, 2017, was an expense of 22.0%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended March 31, 2017, was primarily due to changes in our valuation allowance on deferred tax assets. 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.
NOTE 12. 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.
15
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
NOTE 13. OPERATING SEGMENTS
We report our business segment results by segment in accordance with the “management approach.” The management approach designates the internal reporting used by our chief operating decision maker, who is our Chief Executive Officer, for making decisions and assessing performance of our reportable segments.
See Note 1 for a detailed discussion of our three segments. Each segment’s activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its product lines. We evaluate the performance of our operating segments based on revenues and segment adjusted EBITDA.
Segment revenues include leasing, licensing, or selling of products within each reportable segment. Segment adjusted EBITDA includes the revenues and operating expenses from each segment adjusted for depreciation, amortization, write downs and other charges, accretion of placement fees, non-cash compensation, as well as other costs such as certain acquisitions and integration related costs including restructuring and severance charges; legal and litigation expenses including settlement payments; new jurisdictions and regulatory licensing costs; non-cash charges on capitalized installation and delivery; contract cancellation fees; and other adjustments primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance and other costs deemed to be non-recurring in nature. Revenues in each segment are attributable to third parties and segment operating expenses are directly associated with the product lines included in each segment such as research and development, product approval costs, product-related litigation expenses, sales commissions and other directly-allocable sales expenses. Cost of gaming operations and cost of equipment sales primarily include the cost of products sold, service, manufacturing overhead, shipping and installation.
Segment adjusted EBITDA excludes other income and expense, income taxes and certain expenses that are managed outside of the operating segments.
16
AP GAMING HOLDCO INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The following provides financial information concerning our reportable segments for the three months ended March 31,:
Three months ended March 31, | |||||||
2017 | 2016 | ||||||
Revenues by segment | |||||||
EGM | $ | 45,012 | $ | 37,851 | |||
Table Products | 632 | 719 | |||||
Interactive | 2,130 | 1,665 | |||||
Total Revenues | $ | 47,774 | $ | 40,235 | |||
Adjusted EBITDA by segment | |||||||
EGM | 25,199 | 23,760 | |||||
Table Products | (177 | ) | (454 | ) | |||
Interactive | (117 | ) | (2,049 | ) | |||
Subtotal | 24,905 | 21,257 | |||||
Write downs and other: | |||||||
Loss on disposal of long lived assets | 577 | 119 | |||||
Impairment of long lived assets | 285 | 2 | |||||
Fair value adjustments to contingent consideration and other items | (630 | ) | — | ||||
Acquisition costs | — | (11 | ) | ||||
Depreciation and amortization | 18,451 | 20,542 | |||||
Accretion of placement fees(1) | 1,149 | 1,170 | |||||
Acquisitions & integration related costs including restructuring & severance | 647 | 1,349 | |||||
Legal & litigation expenses including settlement payments | 399 | 656 | |||||
New jurisdictions and regulatory licensing costs | 235 | 48 | |||||
Non-cash charge on capitalized installation and delivery | 412 | 508 | |||||
Non-cash charges and loss on disposition of assets | 550 | — | |||||
Other adjustments | 647 | 1,080 | |||||
Interest expense | 15,160 | 14,616 | |||||
Interest income | (15 | ) | (23 | ) | |||
Other expense (income) | (2,809 | ) | 4,422 | ||||
Loss before income taxes | $ | (10,153 | ) | $ | (23,221 | ) | |
(1) Non-cash expense related to the accretion of contract rights under development agreements and placement fees.
The Company’s chief operating decision maker does not receive a report with a measure of total assets or capital expenditures for each reportable segment as this information is not available or necessary for the evaluation of segment performance. Therefore, the Company has not provided asset and capital expenditure information by reportable segment.
17
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, 2016 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.
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 designer and supplier of diverse products and services for the gaming industry. Founded in 2005, our roots are in the Class II Native American gaming market, where we are one of the market leaders in electronic gaming machines (“EGMs”), which include slot machines, video bingo machines, and other electronic gaming devices. Our customers predominantly consist of casino operators in Class II and Class III Native American and commercial gaming enterprises. Historically, nearly 90% of our total revenue is recurring which refers to Interactive revenue and revenue generated under contracted lease agreements, from lease agreements whereby we place EGMs, systems, and table game products at a customer’s facility in return for either a share of the revenues that these products generate, or a daily or monthly fee. Over the past three years, we have significantly broadened and diversified our product portfolio through both organic development and strategic acquisitions, and we now offer three distinct categories of products: Electronic Gaming Machines (“EGM”), Table products (“Table Products”), and Interactive Social Casino Games (“Interactive”). Each segment's activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of a distinct product line.
As of March 31, 2017, we had approximately 21,200 EGM units installed under revenue sharing or fee per day agreements. 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 EGMs 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.
The following points should be noted as they relate to each of our segments:
Electronic Gaming Machines
• | Our EGM segment is primarily a lease model, and we expect to continue to realize the majority of our EGM revenues through leases in markets such as the United States, and Mexico, as well as other markets that make strategic sense. |
• | We also expect growth in markets such as Latin America and the United States. In the current year, we have grown our footprint in Latin America and the United States and expect continued growth in these markets. |
18
Table Products
• | The majority of our Table Products segment revenue is derived from royalties and leases primarily in the United States. We are constantly looking to expand our proprietary table product footprint through the acquisition or development of new games. |
• | We also pursue opportunities to place Table Products in new properties and jurisdictions in the United States. In the past few years, several jurisdictions have either opened new casino properties or approved live table games, and we have seen placements of our table products in those new jurisdictions. |
• | We intend to increase our Table Products content through development and acquisition of new proprietary titles. By increasing our footprint with new titles, we hope to increase our market penetration. |
Interactive
• | Currently, our interactive social gaming revenue is generated from a high volume of consumers’ purchases of virtual coins which are used to play the games. |
• | We expect to begin offering business to business (“B2B”) social casino products available to land-based casino customers. |
• | We expect to devote substantial resources to the ongoing maintenance and development of our Interactive gaming segment. |
Key Drivers of Our Business
Our revenues are impacted by the following key factors:
• | the amount of money spent by consumers on our domestic revenue share installed base; |
• | the amount of the daily fee and selling price of our participation electronic gaming machines; |
• | our revenue share percentage with customers; |
• | the capital budgets of our customers; |
• | the level of replacement of existing electronic gaming machines in existing casinos; |
• | expansion of existing casinos; |
• | development of new casinos; |
• | opening of new gaming jurisdictions both in the United States and internationally; |
• | our ability to obtain and maintain gaming licenses in various jurisdictions; |
• | the relative competitiveness and popularity of our electronic gaming machines compared to competitive products offered in the same facilities; and |
• | general macro-economic factors, including levels of and changes to consumer disposable income and personal consumption spending. |
Our expenses are impacted by the following key factors:
• | fluctuations in the cost of labor relating to productivity; |
• | overtime and training; |
• | fluctuations in the price of components for gaming equipment; |
• | fluctuations in energy prices; |
• | changes in the cost of obtaining and maintaining gaming licenses; and |
• | fluctuations in the level of maintenance expense required on gaming equipment. |
Variations in our selling, general and administrative expenses, or SG&A, and research and development, or R&D are primarily due to changes in employment and salaries and related fringe benefits.
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Results of Operations
Three Months Ended March 31, 2017 compared to the Three Months Ended March 31, 2016
The following tables set forth certain selected condensed consolidated financial data for the three months ended March 31, 2017 and 2016 (in thousands):
Three months ended March 31, | $ | % | ||||||||||||
2017 | 2016 | Change | Change | |||||||||||
Consolidated Statements of Operations: | ||||||||||||||
Revenues | ||||||||||||||
Gaming operations | $ | 40,433 | $ | 38,638 | $ | 1,795 | 4.6 | % | ||||||
Equipment sales | 7,341 | 1,597 | 5,744 | 359.7 | % | |||||||||
Total revenues | 47,774 | 40,235 | 7,539 | 18.7 | % | |||||||||
Operating expenses | ||||||||||||||
Cost of gaming operations | 7,471 | 6,273 | 1,198 | 19.1 | % | |||||||||
Cost of equipment sales | 3,852 | 170 | 3,682 | 2,165.9 | % | |||||||||
Selling, general and administrative | 10,281 | 12,683 | (2,402 | ) | (18.9 | )% | ||||||||
Research and development | 5,304 | 4,663 | 641 | 13.7 | % | |||||||||
Write downs and other charges | 232 | 110 | 122 | 110.9 | % | |||||||||
Depreciation and amortization | 18,451 | 20,542 | (2,091 | ) | (10.2 | )% | ||||||||
Total operating expenses | 45,591 | 44,441 | 1,150 | 2.6 | % | |||||||||
Income (loss) from operations | 2,183 | (4,206 | ) | 6,389 | (151.9 | )% | ||||||||
Other expense (income) | ||||||||||||||
Interest expense | 15,160 | 14,616 | 544 | 3.7 | % | |||||||||
Interest income | (15 | ) | (23 | ) | 8 | (34.8 | )% | |||||||
Other (income) expense | (2,809 | ) | 4,422 | (7,231 | ) | (163.5 | )% | |||||||
Loss before income taxes | (10,153 | ) | (23,221 | ) | 13,068 | (56.3 | )% | |||||||
Income tax (expense) benefit | (2,233 | ) | 2,155 | (4,388 | ) | (203.6 | )% | |||||||
Net loss | $ | (12,386 | ) | $ | (21,066 | ) | $ | 8,680 | (41.2 | )% | ||||
Revenues
Gaming Operations. The increase in gaming operations was primarily due to the increase in EGM installed base of nearly 550 domestic units and 875 international units, increased EGM revenue per day, and a $0.5 million increase in Interactive revenue driven by business to consumer (“B2C”) arrangements when compared to the prior year period. Current period results have been negatively impacted by $0.8 million relating to foreign currency fluctuations compared to the prior year period.
Equipment Sales. The increase in equipment sales is due to the sale of 453 units in the three months ended March 31, 2017, compared to 24 units in the prior year period. The increase in the number of units sold is primarily attributable to the success of our new ICON cabinet and our growth in the Class III market in which many customers prefer to buy rather than lease EGMs.
Operating Expenses
Cost of gaming operations. The increase in costs of gaming operations was the result of increased tribal marketing fees of $0.6 million and costs associated with an increased EGM installed base compared to the prior year period. There was also an increase in Interactive cost of gaming operations that were commensurate with increased revenue. As a percentage of gaming operations revenue, costs of gaming operations was 18.6% for the three months ended March 31, 2017 compared to 16.2% for the prior year period.
Selling, general and administrative. The decrease in selling, general and administrative expenses is primarily due to decreased user acquisition fees of $1.3 million from our Interactive segment, integration related professional fees of $1.0 million, salaries and benefits expense of $0.6 million and tradeshow costs of $0.3 million. The decreases were offset by increased bad debt expense and customer credits of $0.5 million.
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Research and development. The increase in research and development expenses are driven by increased salaries and benefits costs of $1.0 million due to increased headcount, prototype parts and associated labor of $0.5 million, and offset with decreased professional fees of $0.6 million related to software testing and compliance.
Write downs and other charges. During the three months ended March 31, 2017, the Company recognized $0.2 million in write-downs and other charges driven by losses from the disposal of assets of $0.5 million, the impairment to intangible assets of $0.3 million related to game titles, fair value adjustment to an acquisition contingent receivable of $0.6 million. The contingency was resolved in the first quarter of 2017 as described in Item 1. “Financial Statements” Note 5.
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.
Due to the changing nature of our write downs and other charges, we describe the composition of the balances as opposed to providing a year over year comparison.
Depreciation and amortization. The decrease was due to assets acquired in acquisitions that have reached the end of their useful lives. These assets were fully depreciated at the beginning of the current period and therefore had no depreciation for three months ended March 31, 2017.
Other Expense (Income), net
Interest expense. The increase is primarily attributed to the increase in the principal amounts outstanding under the senior secured PIK notes for the three months ended March 31, 2017, compared to the amounts outstanding during the prior year period.
Other expense. The amount in the current quarter relates primarily to 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, 2017, was an expense of 22.0%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended March 31, 2017, was primarily due to changes in our valuation allowance on deferred tax assets. 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.
Segment Operating Results
We report our business segment results by segment in accordance with the “management approach.” The management approach designates the internal reporting used by our chief operating decision maker, who is our Chief Executive Officer, for making decisions and assessing performance of our reportable segments.
See Item 1. “Financial Statements” Note 1 for a detailed discussion of our three segments. Each segment’s activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its product lines. We evaluate the performance of our operating segments based on revenues and segment adjusted EBITDA.
Segment revenues include leasing, licensing or selling of products within each reportable segment. We measure segment performance in terms of revenue, segment-specific adjusted EBITDA and unit placements. We believe that unit placements are an important gauge of segment performance for EGM’s and Table Products because it measures historical market placements of leased and sold units and provides insight into potential markets for next-generation products and service. We do not present a cumulative installed base as previously sold units may no longer be in use by our customers or may have been replaced by other models or products. For our Interactive segment, we view the number of unique players and revenues provided by players on a daily or monthly basis.
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The following tables provide reconciliations of segment financial information to our consolidated statement of operations. We have included revenues, operating expenses and other adjustments by segment which we believe are important to understanding the operating results of our segment:
Three months ended March 31, 2017 | |||||||||||||||
EGM | Table Products | Interactive | Total | ||||||||||||
Revenues | |||||||||||||||
Gaming operations | $ | 37,678 | $ | 625 | $ | 2,130 | $ | 40,433 | |||||||
Equipment sales | 7,334 | 7 | — | 7,341 | |||||||||||
Total revenues | 45,012 | 632 | 2,130 | 47,774 | |||||||||||
Cost of gaming operations(1) | 6,659 | 175 | 637 | 7,471 | |||||||||||
Cost of equipment sales(1) | 3,852 | — | — | 3,852 | |||||||||||
Selling, general and administrative | 8,693 | 384 | 1,204 | 10,281 | |||||||||||
Research and development | 4,792 | 324 | 188 | 5,304 | |||||||||||
Write downs and other charges | 232 | — | — | 232 | |||||||||||
Depreciation and amortization | 17,836 | 406 | 209 | 18,451 | |||||||||||
Total operating expenses | 42,064 | 1,289 | 2,238 | 45,591 | |||||||||||
Write downs and other | |||||||||||||||
Loss on disposal of long lived assets | 577 | — | — | ||||||||||||
Impairment of long lived assets | 285 | — | — | ||||||||||||
Fair value adjustments to contingent consideration and other items | (630 | ) | — | — | |||||||||||
Acquisition costs | — | — | — | ||||||||||||
Depreciation and amortization | 17,836 | 406 | 209 | ||||||||||||
Accretion of placement fees(2) | 1,149 | — | — | ||||||||||||
Acquisitions & integration related costs including restructuring & severance(3) | 791 | 74 | (218 | ) | |||||||||||
Legal & litigation expenses including settlement payments(4) | 399 | — | — | ||||||||||||
New jurisdictions and regulatory licensing costs(5) | 235 | — | — | ||||||||||||
Non-cash charge on capitalized installation and delivery(6) | 412 | — | — | ||||||||||||
Non-cash charges and loss on disposition of assets(7) | 550 | — | — | ||||||||||||
Other adjustments(8) | 647 | — | — | ||||||||||||
Adjusted EBITDA | $ | 25,199 | $ | (177 | ) | $ | (117 | ) | |||||||
(1) Exclusive of depreciation and amortization.
(2) Non-cash expense related to the accretion of contract rights under development agreements and placement fees.
(3) Acquisitions & integration related costs primarily relate to costs incurred after the purchase of businesses, such as the purchase of Cadillac Jack and AGSi, to integrate operations and obtain costs synergies. Restructuring and severance costs primarily relate to costs incurred through the restructuring of the Company’s operations from time to time and other employee severance costs recognized in the periods presented.
(4) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. These costs
related to litigation and matters that were not significant individually.
(5) New jurisdictions and regulatory licensing costs primarily relate to the costs the Company incurred to obtain licenses and develop products for new jurisdictions.
(6) Non-cash charge on capitalized installation and delivery primarily include the costs to acquire contracts that are expensed over the estimated life of each contract.
(7) Non-cash charges and loss on disposition of assets are primarily composed of the net book value of electronic gaming machines sold into secondary markets. These gaming machines were previously leased to customers and sold at substantially lower average selling prices. Additional non-cash inventory obsolescence charges are also included.
(8) Other adjustments are primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance, contract cancellation fees, and other costs deemed to be non-recurring in nature.
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Three months ended March 31, 2016 | |||||||||||||||
EGM | Table Products | Interactive | Total | ||||||||||||
Revenues | |||||||||||||||
Gaming operations | $ | 36,279 | $ | 694 | $ | 1,665 | $ | 38,638 | |||||||
Equipment sales | 1,572 | 25 | — | 1,597 | |||||||||||
Total revenues | 37,851 | 719 | 1,665 | 40,235 | |||||||||||
Cost of gaming operations(1) | 5,513 | 262 | 498 | 6,273 | |||||||||||
Cost of equipment sales(1) | 170 | — | — | 170 | |||||||||||
Selling, general and administrative | 8,978 | 1,044 | 2,661 | 12,683 | |||||||||||
Research and development | 3,731 | 377 | 555 | 4,663 | |||||||||||
Write downs and other charges | 119 | — | (9 | ) | 110 | ||||||||||
Depreciation and amortization | 19,515 | 569 | 458 | 20,542 | |||||||||||
Total operating expenses | 38,026 | 2,252 | 4,163 | 44,441 | |||||||||||
Write downs and other | |||||||||||||||
Loss on disposal of long lived assets | 119 | — | — | ||||||||||||
Impairment of long lived assets | 2 | — | — | ||||||||||||
Fair value adjustments to contingent consideration and other items | — | — | — | ||||||||||||
Acquisition costs | (2 | ) | — | (9 | ) | ||||||||||
Depreciation and amortization | 19,515 | 569 | 458 | ||||||||||||
Accretion of placement fees(2) | 1,170 | — | — | ||||||||||||
Acquisitions & integration related costs including restructuring & severance(3) | 1,349 | — | — | ||||||||||||
Legal & litigation expenses including settlement payments(4) | 146 | 510 | — | ||||||||||||
New jurisdictions and regulatory licensing costs(5) | 48 | — | — | ||||||||||||
Non-cash charge on capitalized installation and delivery(6) | 508 | — | — | ||||||||||||
Non-cash charges and loss on disposition of assets(7) | — | — | — | ||||||||||||
Other adjustments(8) | 1,080 | — | — | ||||||||||||
Adjusted EBITDA | $ | 23,760 | $ | (454 | ) | $ | (2,049 | ) | |||||||
(1) Exclusive of depreciation and amortization.
(2) Non-cash expense related to the accretion of contract rights under development agreements and placement fees.
(3) Acquisitions & integration related costs primarily relate to costs incurred after the purchase of businesses, such as the purchase of Cadillac Jack and AGSi, to integrate operations and obtain costs synergies. Restructuring and severance costs primarily relate to costs incurred through the restructuring of the Company’s operations from time to time and other employee severance costs recognized in the periods presented.
(4) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. These costs
related to litigation and matters that were not significant individually.
(5) New jurisdictions and regulatory licensing costs primarily relate to the costs the Company incurred to obtain licenses and develop products for new jurisdictions.
(6) Non-cash charge on capitalized installation and delivery primarily include the costs to acquire contracts that are expensed over the estimated life of each contract.
(7) Non-cash charges and loss on disposition of assets are primarily composed of the net book value of electronic gaming machines sold into secondary markets. These gaming machines were previously leased to customers and sold at substantially lower average selling prices. Additional non-cash inventory obsolescence charges are also included.
(8) Other adjustments are primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance, contract cancellation fees, and other costs deemed to be non-recurring in nature.
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Electronic Gaming Machines
Three Months Ended March 31, 2017 compared to Three Months Ended March 31, 2016
Three months ended | $ | % | ||||||||||||
2017 | 2016 | Change | Change | |||||||||||
EGM Segment Revenue: | ||||||||||||||
Gaming operations | $ | 37,678 | $ | 36,279 | $ | 1,399 | 3.9 | % | ||||||
Equipment sales | 7,334 | 1,572 | 5,762 | 366.5 | % | |||||||||
Total EGM revenues | $ | 45,012 | $ | 37,851 | $ | 7,161 | 18.9 | % | ||||||
EGM adjusted EBITDA | $ | 25,199 | $ | 23,760 | $ | 1,439 | 6.1 | % | ||||||
EGM unit information: | ||||||||||||||
EGM installed base, end of period | 21,204 | 19,747 | 1,457 | 7.4 | % | |||||||||
EGM revenue per day | $ | 19.93 | $ | 19.02 | $ | 0.91 | 4.8 | % | ||||||
EGM units sold | 453 | 24 | 429 | 1,787.5 | % | |||||||||
Average sales price | $ | 15,695 | $ | 16,868 | $ | (1,173 | ) | (7.0 | )% | |||||
Gaming Operations Revenue
The increase in gaming operations was primarily due to the increase in EGM installed base of nearly 550 domestic units and 875 international units, which is primarily attributable to our new ICON cabinets as well as competitive game content. Additionally, we had a 4.8%, or $0.91, increase in EGM revenue per day through the optimization of our installed base by installing our newer and competitive game content on our EGMs. Current period results have been negatively impacted by $0.8 million relating to foreign currency fluctuations compared to the prior year period.
Equipment Sales
The increase in equipment sales is due to the sale of 453 units in the three months ended March 31, 2017, compared to 24 units in the prior year period. The increase in the number of units sold is primarily attributable to the success of our new ICON cabinet and our growth in the Class III market in which many customers prefer to buy rather than lease EGMs.
EGM Adjusted EBITDA
EGM adjusted EBITDA includes the revenues and operating expenses from the EGM segment adjusted for depreciation, amortization, write downs and other charges, accretion of placement fees, non-cash compensation, as well as other costs. See Item 1. “Financial Statements” Note 13 for further explanation of adjustments. The increase in EGM adjusted EBITDA is attributable to the increases in revenue described above offset by increased adjusted cost of equipment sales of $4.4 million due to higher sales volume and increased adjusted research and development costs of $1.0 million due to increased headcount, prototype parts and associated labor.
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Table Products
Three Months Ended March 31, 2017 compared to Three Months Ended March 31, 2016
Three Months Ended March 31, | $ | % | ||||||||||||
2017 | 2016 | Change | Change | |||||||||||
Table Products Segment Revenue: | ||||||||||||||
Gaming operations | $ | 625 | $ | 694 | $ | (69 | ) | (9.9 | )% | |||||
Equipment sales | 7 | 25 | (18 | ) | (72.0 | )% | ||||||||
Total Table Products revenues | $ | 632 | $ | 719 | $ | (87 | ) | (12.1 | )% | |||||
Table Products adjusted EBITDA | $ | (177 | ) | $ | (454 | ) | $ | 277 | 61.0 | % | ||||
Table Products unit information: | ||||||||||||||
Table products installed base, end of period | 1,691 | 923 | 768 | 83.2 | % | |||||||||
Average monthly lease price | $ | 125 | $ | 259 | $ | (134 | ) | (51.7 | )% | |||||
Gaming Operations Revenue
The decrease in tables gaming operations revenue is attributable to the lower average monthly lease price offset by an increased installed base.
Tables Products Adjusted EBITDA
Table Products adjusted EBITDA includes the revenues and operating expenses from the Table Products segment adjusted for depreciation, amortization, write downs and other charges, as well as other costs. See Item 1. “Financial Statements” Note 13 for further explanation of adjustments. The increase in Table Products adjusted EBITDA is attributable to a decrease in adjusted operating expenses. The Table Products segment began its operations in mid-2014 and it has continued to grow through the addition of headcount and purchases of intellectual property from third parties.
Interactive
Three Months Ended March 31, 2017 compared to Three Months Ended March 31, 2016
Three months ended March 31, | $ | % | ||||||||||||
2017 | 2016 | Change | Change | |||||||||||
Interactive Segment Revenue: | ||||||||||||||
Gaming operations | $ | 2,130 | $ | 1,665 | $ | 465 | 27.9 | % | ||||||
Total Interactive revenues | $ | 2,130 | $ | 1,665 | $ | 465 | 27.9 | % | ||||||
Interactive adjusted EBITDA | $ | (117 | ) | $ | (2,049 | ) | $ | 1,932 | 94.3 | % | ||||
Interactive unit information: | ||||||||||||||
Average MAU(1) | 190,545 | 247,672 | 79,406 | 32.1 | % | |||||||||
Average DAU(2) | 38,310 | 43,145 | 16,141 | 37.4 | % | |||||||||
ARPDAU(3) | $ | 0.59 | $ | 0.50 | $ | 0.11 | 22.0 | % | ||||||
(1) MAU = Monthly Active Users and is a count of unique visitors to our sites during a month
(2) DAU = Daily Active Users, a count of unique visitors to our sites during a day
(3) ARPDAU = Average daily revenue per DAU is calculated by dividing revenue for a period by the DAU for the period by the number of days for the period
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Gaming Operations Revenue
The increase in interactive gaming operations revenue is attributable to increases in Business-to-Consumer (“B2C”) revenue driven by an increase in ARPDAU.
Interactive Adjusted EBITDA
Interactive adjusted EBITDA includes the revenues and operating expenses from the Interactive segment adjusted for depreciation, amortization, write downs and other charges, as well as other costs. See Item 1. “Financial Statements” Note 13 for further explanation of adjustments. The increase in interactive adjusted EBITDA is attributable to a decrease in adjusted operating expenses primarily driven by decreased marketing and user acquisition costs. These decreases in adjusted operating expenses were complimented by the increase in gaming operations revenues discussed above.
LIQUIDITY AND CAPITAL RESOURCES
We expect that primary ongoing liquidity requirements for the year ending December 31, 2017 will be for operating capital expenditures, 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, 2017, we had $7.6 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, 2017, we were in compliance with 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.
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
26
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, 2017.
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 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, 2017, notes payable related to the AGS Seller Notes totaled $7.1 million, which includes capitalized interest of $1.6 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, 2017, 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. During the quarter ended March 31, 2017, the Amaya Seller Note was reduced by $5.1 million to settle a clause from the Stock Purchase Agreement allowing for a refund if certain deactivated gaming machines in Mexico were not in operation as of a specified date. At March 31, 2017, the Amaya Seller Note totaled $8.0 million, which includes capitalized interest of $1.1 million.
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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, | |||||||
2017 | 2016 | ||||||
Cash Flow Information: | |||||||
Net cash provided by operating activities | $ | 7,219 | $ | 5,366 | |||
Net cash used in investing activities | (14,429 | ) | (7,580 | ) | |||
Net cash used in financing activities | (3,128 | ) | (4,291 | ) | |||
Effect of exchange rates on cash and cash equivalents | 3 | 1 | |||||
Net decrease in cash and cash equivalents | $ | (10,335 | ) | $ | (6,504 | ) | |
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, 2017, net cash provided by operating activities was $7.2 million compared to $5.4 million for the three months ended March 31, 2016, representing an increase of $1.9 million. The increase is primarily due to an increase as a result of changes in net working capital partially offset by a 9.6 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, 2017, was $14.4 million compared to $7.6 million for the three months ended March 31, 2016, representing an increase of $6.8 million. The increase was primarily due to an increase in the purchase of property and equipment of $6.4 million and software development and other expenditures of $0.1 million.
Financing activities
Net cash used in the current period was $3.1 million compared to $4.3 million for the three months ended March 31, 2017. The decrease was primarily due to decreased payments of previous acquisition obligations of $1.1 million.
Off-Balance Sheet Arrangements
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, 2016. There were no material changes to those policies during the three months ended March 31, 2017.
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.”
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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, 2017, approximately 28% of our debt were fixed-rate instruments. Assuming a constant outstanding balance for our variable-rate long term debt, a hypothetical 1% decrease in interest rates would not have a material impact on interest expense because of our LIBOR floor on related debt, while a hypothetical 1% increase in interest rates would increase interest expense approximately $4.1 million.
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, 2017. 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.
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 as of the end of the fiscal quarter covered by this report, 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, 2016, 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 | |
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 10, 2017 | By: | /s/ KIMO AKIONA | ||
Name: | Kimo Akiona | ||||
Title: | Treasurer (Principal Financial and Accounting Officer) | ||||
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