UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended March 31, 2017

OR

 

For the transition period from _____ to _____

 

Commission File Number: 000-24993

 

GOLDEN ENTERTAINMENT, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Registrant’s telephone number, including area code: (702) 893-7777

 

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   ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of May 8, 2017, the registrant had 22,251,472 shares of common stock, $0.01 par value per share, outstanding.

 

 

 

 

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GOLDEN ENTERTAINMENT, INC.

FORM 10-Q

INDEX

 

 

 

 

 

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Part I. Financial Information

ITEM 1.  FINANCIAL STATEMENTS 

GOLDEN ENTERTAINMENT, INC.

Consolidated Balance Sheets

(In thousands)

(Unaudited)

 

 

The accompanying condensed notes are an integral part of these consolidated financial statements.

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GOLDEN ENTERTAINMENT, INC.

Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

 

 

The accompanying condensed notes are an integral part of these consolidated financial statements.

 

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GOLDEN ENTERTAINMENT, INC.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

The accompanying condensed notes are an integral part of these consolidated financial statements.

 

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GOLDEN ENTERTAINMENT, INC. 

Condensed Notes to Consolidated Financial Statements (Unaudited)

 

Note 1 – Nature of Business and Basis of Presentation

Overview

Golden Entertainment, Inc. and its wholly owned subsidiaries (collectively, the “Company”) is a diversified group of gaming companies that focus on distributed gaming (including tavern gaming) and casino and resort operations. The Company’s common stock is traded on the NASDAQ Global Market, and the Company’s ticker symbol is “GDEN.”

The Company conducts its business through two reportable operating segments: Distributed Gaming and Casinos. The Company’s Distributed Gaming segment involves the installation, maintenance and operation of gaming and amusement devices in certain strategic, high-traffic, non-casino locations (such as grocery stores, convenience stores, restaurants, bars, taverns, saloons and liquor stores) in Nevada and Montana, and the operation of traditional, branded taverns targeting local patrons, primarily in the greater Las Vegas, Nevada metropolitan area. The Company’s Casinos segment consists of the Rocky Gap Casino Resort in Flintstone, Maryland (“Rocky Gap”) and three casinos in Pahrump, Nevada: Pahrump Nugget Hotel Casino (“Pahrump Nugget”), Gold Town Casino and Lakeside Casino & RV Park.

Basis of Presentation

The unaudited consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial information. Accordingly, certain information normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) has been condensed and/or omitted. For further information, please refer to the audited consolidated financial statements of the Company for the year ended December 31, 2016 and the notes thereto included in the Company’s Annual Report on Form 10-K previously filed with the SEC. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s results for the periods presented. Results for interim periods should not be considered indicative of the results to be expected for the full year.

The accompanying unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. Certain minor reclassifications have been made to the prior year period amounts to conform to the current presentation.

Net Income Per Share

For all periods, basic net income per share is calculated by dividing net income by the weighted-average common shares outstanding. Diluted net income per share in profitable periods reflects the effect of all potentially dilutive common shares outstanding by dividing net income by the weighted-average of all common and potentially dilutive shares outstanding. In the event of a net loss, diluted shares are not considered because of the anti-diluted effect.

New Accounting Pronouncements 

Changes to GAAP are established by the Financial Accounting Standards Board (“FASB”), in the form of Accounting Standards Updates (“ASUs”) to the FASB's Accounting Standards Codification. The Company considers the applicability and impact of all ASUs. While management continues to assess the possible impact on the Company's consolidated financial statements of the future adoption of new accounting standards that are not yet effective, management currently believes that the following new standards may have a material impact on the Company's financial statements and disclosures:

In February 2016, the FASB issued ASU 2016-02, Leases, which replaces the existing guidance. ASU 2016-02 requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability. ASU 2016-02 is effective for annual periods beginning after December 15, 2018 and interim periods therein, with early application permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

In May 2014, the FASB issued a comprehensive new revenue recognition model, ASU 2014-09, Revenue from Contracts with Customers which created a new Topic 606 (“ASC 606”). The new guidance is intended to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP applicable to revenue transactions. Existing industry guidance will be eliminated, including revenue recognition guidance specific to the gaming industry. The FASB has recently issued several

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amendments to the standard, including clarification on accounting for and identifying performance obligations. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. The guidance should be applied using the full retrospective method or retrospectively with the cumulative effect initially applying the guidance recognized at the date of initial application. The Company anticipates adopting this standard effective January 1, 2018. The Company is currently in the process of its analysis and anticipate this standard will have a material effect on its consolidated financial statements. As described below, the Company expects the most significant effect will be related to the accounting for customer loyalty programs and casino promotional allowances. However, the quantitative effects of these changes have not yet been determined and are still being analyzed. The Company is currently assessing the full effect the adoption of this standard will have on its financial statements.

The customer loyalty programs affect revenues from our four core business operations: gaming, food and beverage, rooms and other operations. Currently, the Company estimates the cost of fulfilling the redemption of player rewards, after consideration of breakage, based upon the cost of historical redemptions. Upon adoption of the new guidance, player rewards will no longer be recorded at cost, and a deferred revenue model will be used to account for the classification and timing of revenue recognized as well as the classification of related expenses when player rewards are redeemed.

Additionally, the Company expects to see a significant decrease in food and beverage and room revenues because the practice of including the retail value of goods and services provided to customers without charge in gross revenue with a corresponding offset in promotional allowances to arrive at net revenue will be discontinued.

No other recently issued accounting standards that are not yet effective have been identified that management believes are likely to have a material impact on the Company's financial statements.

 

Note 2 – Acquisitions

On January 29, 2016, the Company completed the acquisition of approximately 1,100 gaming devices, as well as certain other non-gaming assets and the right to operate within certain locations, from C. Lohman Games, Inc., Rocky Mountain Gaming, Inc. and Brandy’s Shoreliner Restaurant, Inc. (the “Initial Montana Acquisition”). The total consideration for the transaction was $20.1 million, including the issuance of $0.5 million of the Company’s common stock (comprising 50,252 shares at fair value at issuance of $9.95 per share). In connection with the Initial Montana Acquisition, the Company is required to pay the sellers contingent consideration of up to a total of $2.0 million in cash paid in four quarterly payments beginning in September 2017, subject to certain potential adjustments. See Note 9, Financial Instruments and Fair Value Measurements, for further discussion regarding the estimated fair value of the contingent consideration.

On April 22, 2016, the Company completed the acquisition of approximately 1,800 gaming devices, as well as amusement devices and certain other non-gaming assets and the right to operate within certain locations, from Amusement Services, LLC (the “Second Montana Acquisition”, and, together with the Initial Montana Acquisitions, the “Montana Acquisitions”). The total consideration for the transaction was $25.7 million.

 

Acquisition Method of Accounting

The Company followed the acquisition method of accounting for the Montana Acquisitions per ASC 805 guidance. In accordance with ASC 805, the Company allocated the purchase price for each Montana Acquisition to the tangible and intangible assets acquired and liabilities assumed based on their fair values, which were determined primarily by management with assistance from third-party appraisals. The excess of the purchase prices over those fair values was recorded as goodwill.

The allocation of the $20.1 million purchase price of the Initial Montana Acquisition was finalized in the first quarter of 2017, and as of the date of the acquisition, was comprised of the following:

 

 

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The intangible assets acquired in the Initial Montana Acquisition and the related weighted average useful lives of definite-lived intangible assets were as follows:

 

 

The preliminary allocation of the $25.7 million purchase price of the Second Montana Acquisition as of the date of acquisition was comprised of the following:

 

 

The preliminary valuation of intangible assets acquired in the Second Montana Acquisition and the related weighted average useful lives of definite –lived intangible assets were as follows:

 

 

The goodwill recognized in the Montana Acquisitions was primarily attributable to potential expansion and future development of, and anticipated synergies from, the acquired businesses and is expected to be deductible for income tax purposes. The Company's estimation of the fair value of the assets acquired in the Montana Acquisitions as of the respective dates of the acquisitions was determined based on certain valuations and analyses. For the Second Montana Acquisition, those valuations and analyses have yet to be finalized, and accordingly, the assets acquired in that transaction are subject to adjustment once such analyses are completed. The Company may record adjustments to the carrying value of assets acquired in the Second Montana Acquisition with a corresponding offset to goodwill during the applicable measurement period, which can be up to one year from the date of the consummation of the acquisition.

The Company reports the results of operations from each of the Montana Acquisitions, subsequent to their respective closing date, within its Distributed Gaming segment. For the three months ended March 31, 2017 and 2016, net revenues from the Montana Acquisitions totaled $15.2 million and $4.0 million, respectively. For the three months ended March 31, 2017 and 2016, transaction-related costs for the Montana Acquisitions totaled $0.1 million and $0.2 million, respectively, and were included in preopening expenses. The Company may incur additional transaction-related costs related to the Montana Acquisitions in future periods. Pro forma information is not being presented as there is no practicable method to calculate pro forma earnings given that the Montana Acquisitions were asset purchases that represented only a component of the businesses of the sellers. As a result, historical financial information obtained would have required significant estimates.

 

 

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Note 3 – Property and Equipment, Net

The following table summarizes the components of property and equipment, net:

 

 

Depreciation expense for the three months ended March 31, 2017 and 2016, was $4.6 million and $4.3 million, respectively.

 

 

Note 4 – Goodwill and Intangible Assets, Net

Goodwill consisted of the following:

 

 

Goodwill was acquired in connection with the 2015 acquisition of Sartini Gaming, Inc. through a merger transaction (the “Merger”), as well as the Montana Acquisitions. The Company may continue to record adjustments to the carrying value of assets acquired with a corresponding offset to goodwill during the measurement period related to the Second Montana Acquisition, which can be up to one year from the date of the consummation of the acquisition. See Note 2, Acquisitions, for a description of the intangible assets acquired through the Montana Acquisitions.

 

Intangible assets, net, consisted of the following:

 

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Total amortization expense related to intangible assets was $2.0 million and $1.4 million for the three months ended March 31, 2017 and 2016, respectively. As of March 31, 2017, estimated future amortization expense was as follows: 

 

 

 

Note 5 – Long-Term Debt

Long-term debt, net was comprised of the following: 

 

 

Credit Agreement

 

As of March 31, 2017, the facilities under the Company’s Credit Agreement with Capital One, National Association (as administrative agent) and the lenders named therein (the “Credit Agreement”) consisted of $160.0 million in senior secured term loans (“Term Loans”) and a $50.0 million Revolving Credit Facility. The facilities mature on July 31, 2020. Borrowings under the Credit Agreement bear interest, at the Company’s option, at either (1) the highest of the federal funds rate plus 0.50%, the Eurodollar rate for a one-month interest period plus 1.00%, or the administrative agent’s prime rate as announced from time to time, or (2) the Eurodollar rate for the applicable interest period, plus in each case, an applicable margin based on the Company’s leverage ratio. For the three months ended March 31, 2017, the weighted-average effective interest rate on the Company’s outstanding borrowings under the Credit Agreement was approximately 3.3%.

The Company was in compliance with its financial covenants under the Credit Agreement as of March 31, 2017.

 

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Note 6 – Promotional Allowances

The retail value of food and beverages, rooms and other services furnished to customers without charge, including coupons for discounts when redeemed, is included in gross revenues and then deducted as promotional allowances. The estimated retail value of the promotional allowances was as follows:

 

 

The estimated cost of providing these promotional allowances, which is primarily included in gaming expenses, was as follows:

 

 

 

Note 7 – Stock Incentive Plans and Share-Based Compensation

Overview

On August 27, 2015, the Board of Directors of the Company approved the Golden Entertainment, Inc. 2015 Incentive Award Plan (the “2015 Plan”), which was approved by the Company’s shareholders at the Company’s 2016 annual meeting. The 2015 Plan authorizes the issuance of stock options, restricted stock, restricted stock units (“RSUs”), dividend equivalents, stock payment awards, stock appreciation rights, performance bonus awards and other incentive awards. The 2015 Plan authorizes the grant of awards to employees, non-employee directors and consultants of the Company and its subsidiaries. Options generally have a ten-year term. Except as provided in any employment agreement between the Company and the employee, if an employee is terminated (voluntarily or involuntarily), any unvested options as of the date of termination will be forfeited.

The maximum number of shares of the Company’s common stock for which grants may be made under the 2015 Plan is 2.25 million shares, plus an annual increase on each January 1 during the ten-year term of the 2015 Plan equal to the lesser of 1.8 million shares, 4% of the total shares of the Company’s common stock outstanding (on an as-converted basis) and such smaller amount as may be determined by the Board in its sole discretion. In addition, the maximum aggregate number of shares of common stock that may be subject to awards granted to any one participant during a calendar year is 2.0 million shares. The annual increase on January 1, 2017 was 889,259 shares.

The 2015 Plan provides that no stock option or stock appreciation right (even if vested) may be exercised prior to the earlier of August 1, 2018 or immediately prior to the consummation of a change in control of the Company that would result in an “ownership change” as defined in Section 382 of the Internal Revenue Code of 1986, as amended. There were 3,539,358 stock options outstanding under the 2015 Plan as of March 31, 2017, of which 720,021 had vested. As of March 31, 2017, a total of 333,314 shares of the Company’s common stock remained available for grants of awards under the 2015 Plan.

In June 2007, the Company’s shareholders approved the 2007 Lakes Stock Option and Compensation Plan (the “2007 Plan”), which is authorized to grant a total of 1.25 million shares of the Company’s common stock. Vested options are exercisable for ten years from the date of grant; however, if the employee is terminated (voluntarily or involuntarily), any unvested options as of the date of termination will be forfeited. There were 673,675 stock options outstanding under the 2007 Plan as of March 31, 2017, 391,040 of which had vested. As of March 31, 2017, no shares of the Company’s common stock remained available for grants of awards under the 2007 Plan.

Stock Options

The Company uses the Black-Scholes option pricing model to estimate the fair value and compensation cost associated with employee incentive stock options, which requires considerable judgment, including estimating stock price volatility, expected option life and

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forfeiture rates. The Company develops estimates based on historical data and market information, which can change significantly over time. There were 847,000 stock options granted in the three months ended March 31, 2017, and 160,000 stock options granted in the three months ended March 31, 2016, with weighted-average grant date fair values of $5.89 and $3.94 per share, respectively.

Share-based compensation expense related to stock options was $1.0 million and $0.4 million for the three months ended March 31, 2017 and 2016, respectively.

The following table summarizes the Company’s stock option activity during the three months ended March 31, 2017 and 2016: 

 

 

As of March 31, 2017, the outstanding stock options had a weighted-average remaining contractual life of 8.1 years, weighted-average exercise price of $9.90 per share and an aggregate intrinsic value of $14.2 million. As of March 31, 2017, the outstanding exercisable stock options had a weighted-average remaining contractual life of 1.6 years, weighted-average exercise price of $4.34 per share and an aggregate intrinsic value of $3.5 million.

There were 19,989 and 159,626 options exercised during the three months ended March 31, 2017 and 2016, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2017 and 2016 was $0.1 million and $0.7 million, respectively. The Company’s unrecognized share-based compensation expense related to stock options was approximately $14.5 million as of March 31, 2017, which is expected to be recognized over a weighted-average period of 3.3 years.

The Company issues new shares of common stock upon the exercise of stock options.

Restricted Stock Units

There were 141,296 RSUs outstanding under the 2015 Plan as of March 31, 2017, none of which had vested. Share-based compensation expense related to RSUs was $0.4 million for the three months ended March 31, 2017. There was no RSU activity during the three months ended March 31, 2016.

 

 

Note 8 – Income Taxes

The Company’s effective tax rate was -46.4% and 2.5% for the three months ended March 31, 2017 and 2016, respectively.

Income tax benefit was $1.7 million for the three months ended March 31, 2017, which was attributed primarily to a partial release of valuation allowance. Income tax expense was less than $0.1 million for the three months ended March 31, 2016, which was attributed primarily to tax amortization of indefinite-lived intangibles.

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In connection with the Merger, on July 31, 2015, the Company entered into a NOL Preservation Agreement with The Blake L. Sartini and Delise F. Sartini Family Trust (the “Sartini Trust”), Lyle A. Berman (a director and shareholder of the Company), as well as certain other shareholders of the Company affiliated with Mr. Berman or that are trusts for which Neil Sell, a director of the Company, serves as trustee. The NOL Preservation Agreement is intended to help minimize the risk of an “ownership change,” within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended, that would limit the Company’s ability to utilize its federal net operating loss carryforwards to offset future taxable income.

Deferred tax assets are evaluated by considering historical levels of income, estimates of future taxable income and the impact of tax planning strategies. The Company's financial results include the reversal of a portion of the valuation allowance recorded against the deferred tax assets of the Company. This reversal resulted in the recognition of a $1.7 million income tax benefit for the three months ended March 31, 2017. The Company has performed a continuing evaluation of its deferred tax asset valuation allowance on a quarterly basis. The Company concluded that, effective December 31, 2016, it is more likely than not that the Company will generate sufficient taxable income within the applicable net operating loss carry-forward periods to realize a portion of its deferred tax assets. This conclusion, and the resulting partial reversal of the deferred tax asset valuation allowance, is based upon consideration of several factors, including the Company's completion of six consecutive quarters of profitability, its demonstrated ability in such quarters to meet or exceed budgets, and its forecast of future profitability.

The Company's income taxes receivable was $0.2 million as of March 31, 2017, and $2.3 million as of December 31, 2016. The decrease in income taxes receivable was primarily due to the collection of a $2.2 million tax refund which was released in connection with the settlement of an IRS audit related to 2012 taxable losses carried back to a prior year.

 

 

Note 9 – Financial Instruments and Fair Value Measurements

Overview

The authoritative accounting guidance for fair value measurements specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These inputs create the following fair value hierarchy:

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Thus, assets and liabilities categorized as Level 3 may be measured at fair value using inputs that are observable (Levels 1 and 2) and unobservable (Level 3). Management's assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of assets and liabilities and their placement within the fair value hierarchy levels.

Balances Measured at Fair Value

For the Company’s cash and cash equivalents, accounts receivable and payable, short-term borrowings and accrued and other current liabilities, the carrying amounts approximate fair value because of the short duration of these financial instruments. As of March 31, 2017 and December 31, 2016, the fair value of the Company’s long-term debt approximated the carrying value based upon the Company’s expected borrowing rate for debt with similar remaining maturities and comparable risk.

In connection with the Montana Acquisitions, the Company preliminarily recognized the acquired assets at fair value. For the Initial Montana Acquisition, these amounts were finalized as of March 31, 2017. All amounts are recognized as Level 3 measurements due to the subjective nature of the unobservable inputs used to determine the fair values. Additionally, in connection with the Initial Montana Acquisition, the Company is required to pay the sellers contingent consideration of up to a total of $2.0 million in cash paid in four quarterly payments beginning in September 2017, subject to certain potential adjustments based upon the availability of certain gaming machines and, if applicable, the performance of replacement games. The fair value of the Company’s contingent consideration recorded in connection with the Initial Montana Acquisition was estimated to be $2.0 million as of March 31, 2017 and is recorded in “Other accrued expenses” and “Other long-term obligations” on the Company’s consolidated balance sheet. Changes to the estimated fair value of the contingent consideration will be recognized in earnings of the Company. See Note 2, Acquisitions, for a discussion of the Montana Acquisitions.

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Balances Measured at Fair Value on a Non-recurring Basis

The identified intangible assets acquired in connection with the Second Montana Acquisition and the Initial Montana Acquisition have been valued (on a preliminary basis for the Second Montana Acquisition) using unobservable (Level 3) inputs at a fair value of $11.4 million (on a preliminary basis) and $14.4 million, respectively (see Note 2, Acquisitions).

The Company owns various parcels of developed and undeveloped land relating to its casinos in Pahrump, Nevada. The Company performs an impairment analysis on the land it owns at least quarterly and determined that no impairment had occurred as of March 31, 2017 and December 31, 2016.

 

 

Note 10 – Commitments and Contingencies

 

There have been no material changes to the Company’s commitments described under Note 15, Commitments and Contingencies, in the consolidated financial statements set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

Rent Expense and Future Minimum Lease Payments

The Company leases its branded tavern locations, office headquarters building, equipment and vehicles under noncancelable operating leases that are not subject to contingent rents. The original terms of the current branded tavern location leases range from one to 14 years with various renewal options from one to 15 years. The Company has operating leases with related parties for certain of its tavern locations and its office headquarters building. See Note 12, Related Party Transactions, for more detail. Gaming device placement contracts in the form of space lease agreements are also accounted for as operating leases. Under space lease agreements, the Company pays fixed monthly rental fees for the right to install, maintain and operate its gaming devices at business locations, which are recorded in gaming expenses.

Operating lease rental expense, which is calculated on a straight-line basis, net of surcharge revenue, associated with all operating leases was as follows:

 

 

As of March 31, 2017, future minimum operating lease payments, excluding contingent rents, were as follows:

 

 

The current and long-term obligations under capital leases are included in “Current portion of long-term debt, net” and “Long-term debt, net,” respectively. The majority of the capital leases relate to vehicles with minimum lease payment terms of three to four years. During the first quarter of 2017, the Company entered into a capital lease agreement with a related party for one of its tavern locations. See Note 12, Related Party Transactions, for more detail.

 

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As of March 31, 2017, future minimum capital lease payments, excluding contingent rents, were as follows:

 

Participation and Revenue Share Agreements

The Company also enters into gaming device placement contracts in the form of participation and revenue share agreements. Under revenue share agreements, the Company pays the business location a percentage of the gaming revenue generated from the Company’s gaming devices placed at the location, rather than a fixed monthly rental fee. Under participation agreements, the business location holds the applicable gaming license and retains a percentage of the gaming revenue that it generates from the Company’s gaming devices. During the three months ended March 31, 2017, the total contingent payments recognized by the Company (recorded in gaming expenses) under revenue share and participation agreements were $34.8 million, including $0.3 million under revenue share and participation agreements with related parties, as described in Note 12, Related Party Transactions. During the three months ended March 31, 2016, the total contingent payments recognized by the Company (recorded in gaming expenses) under revenue share and participation agreements were $28.2 million, including $0.5 million under revenue share and participation agreements with related parties.

The Company also enters into amusement device and ATM placement contracts in the form of revenue share agreements. Under these revenue share agreements, the Company pays the business location a percentage of the non-gaming revenue generated from the Company’s amusement devices and ATMs placed at the location. During the three months ended March 31, 2017 and 2016, the total contingent payments recognized by the Company (recorded in other operating expenses) for amusement devices and ATMs under such agreements were $0.4 million and $0.1 million, respectively.

 

Employment Agreements

The Company has entered into at-will employment agreements with each of the Company’s executive officers. Under each employment agreement, in addition to the executive’s annual base salary, the executive is entitled to participate in the Company’s incentive compensation programs applicable to executive officers of the Company. The executives are also eligible to participate in all health benefits, insurance programs, pension and retirement plans and other employee benefit and compensation arrangements. Each executive is also provided with other benefits as set forth in his employment agreement. In the event of a termination without “cause” or a “constructive termination” of the Company’s executive officers (as defined in their respective employment agreements), the Company could be liable for estimated severance payments of up to $8.9 million for Mr. Sartini, $3.3 million for Stephen A. Arcana, $3.9 million for Charles H. Protell, $2.2 million for Sean T. Higgins, $1.4 million for Blake L. Sartini II, and $0.5 million for Gary A. Vecchiarelli (assuming each officer’s respective annual salary and health benefit costs as of March 31, 2017 are the amounts in effect at the time of termination and excluding potential expense related to acceleration of stock options).

Miscellaneous Legal Matters

From time to time, the Company is involved in a variety of lawsuits, claims, investigations and other legal proceedings arising in the ordinary course of business. Although lawsuits, claims, investigations and other legal proceedings are inherently uncertain and their results cannot be predicted with certainty, the Company believes that the resolution of its currently pending matters will not have a material adverse effect on its business, financial condition, results of operations or liquidity. In addition, it is possible that an unfavorable resolution of one or more such proceedings could in the future materially and adversely affect the Company’s business, financial condition, results of operations or liquidity in a particular period.

 

In February and April 2017, several former employees filed two separate purported class action lawsuits against the Company in the District Court of Clark County, Nevada, and on behalf of similarly situated individuals employed by the Company in the State of Nevada. The lawsuits allege the Company violated certain Nevada labor laws including payment of an hourly wage below the statutory minimum wage without providing a qualified health insurance plan and an associated failure to pay proper overtime

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compensation. The complaints seek, on behalf of the plaintiffs and members of the putative class, an unspecified amount of damages (including punitive damages), injunctive and equitable relief, and an award of attorneys’ fees, interest and costs. These cases are at an early stage in the proceedings, and the Company is therefore unable to make a reasonable estimate of the probable loss or range of losses, if any, that might arise from these matters. Therefore, the Company has not recorded any amount for the claims as of the date of this filing. While legal proceedings are inherently unpredictable and no assurance can be given as to the ultimate outcome of these matters, based on management’s current understanding of the relevant facts and circumstances, the Company believes that these proceedings should not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

Note 11 – Segment Information

The Company conducts its business through two reportable operating segments: Distributed Gaming and Casinos.

The Company’s Distributed Gaming segment involves the installation, maintenance and operation of gaming and amusement devices in certain strategic, high-traffic, non-casino locations (such as grocery stores, convenience stores, restaurants, bars, taverns, saloons and liquor stores) in Nevada and Montana, and the operation of traditional, branded taverns targeting local patrons, primarily in the greater Las Vegas, Nevada metropolitan area. The Company’s Casinos segment includes results of operations and assets related to Rocky Gap in Flintstone, Maryland and its three casino properties in Pahrump, Nevada. The Corporate and Other segment includes the Company’s cash and cash equivalents and corporate overhead. Costs recorded in the Corporate and Other segment have not been allocated to the Company’s reportable operating segments because these costs are not easily allocable and to do so would not be practical.

 

 

 

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Note 12 – Related Party Transactions

As of March 31, 2017, the Company leased its office headquarters building and one tavern location from a company 33% beneficially owned by Blake L. Sartini, 5% owned by a trust for the benefit of Mr. Sartini’s immediate family members (including Blake L. Sartini, II) for which Mr. Sartini serves as trustee, and 3% beneficially owned by Stephen A. Arcana, and leased three tavern locations, one of which the Company accounts for as a capital lease, from companies controlled by Mr. Sartini through a trust for the benefit of Mr. Sartini’s immediate family members (including Blake L. Sartini, II) for which Mr. Sartini serves as trustee. The lease for the Company’s office headquarters building expires on July 31, 2025. The rent expense for the office headquarters building during each of the three months ended March 31, 2017 and 2016 was $0.3 million and there was no amount owed by the Company with respect to such lease as of March 31, 2017. The leases for the tavern locations have remaining terms of up to 15 years. The rent expense for the tavern locations during the three months ended March 31, 2017 and 2016 was $0.3 million and $0.4 million, respectively, and no amounts were owed by the Company with respect to such leases as of March 31, 2017. Additionally, a portion of the office headquarters building was sublet to a company owned or controlled by Mr. Sartini through February 28, 2017. Rental income for the sublet portion of the office headquarters building during each of the three months ended March 31, 2017 and 2016 was less than $0.1 million. Mr. Sartini serves as the Chairman of the Board, President and Chief Executive Officer of the Company and is co-trustee of the Sartini Trust, which is a significant shareholder of the Company. Mr. Arcana serves as the Executive Vice President and Chief Operating Officer of the Company. As of March 31, 2017, all of these related party lease agreements were in place prior to the consummation of the Merger, other than two lease agreements entered into in 2016.

In April 2016, the Audit Committee of the Board of Directors approved the Company’s entering into an aircraft timesharing agreement between the Company and Sartini Enterprises, Inc., a company controlled by Mr. Sartini. Pursuant to the agreement, the Company will reimburse Sartini Enterprises, Inc. for direct costs and expenses incurred by Company employees traveling on Company business on the private aircraft owned by Sartini Enterprises Inc. During the three months ended March 31, 2017, the Company paid less than $0.1 million, and as of March 31, 2017 the Company owed less than $0.1 million, under the aircraft timesharing agreement.

Mr. Sartini’s son, Blake L. Sartini, II (“Mr. Sartini II”), serves as Senior Vice President of Distributed Gaming of the Company. Mr. Sartini II has an employment agreement that was approved by both the Audit Committee and Compensation Committee of the Board of Directors, which was amended and restated in March 2017. The amended and restated employment agreement provides for an annual base salary of $375,000, of which approximately $79,000 was earned during the three months ended March 31, 2017. Additionally, Mr. Sartini II is eligible for a target annual bonus equal to 50% of his base salary. Mr. Sartini II also participates in the Company's equity award and benefit programs. In 2017, Mr. Sartini II received a grant of 75,000 options to purchase the Company’s

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common stock with an exercise price of $13.50 per share, which stock options will vest over a four-year period (but pursuant to the 2015 Plan such stock options may not be exercised prior to August 1, 2018 except in limited circumstances).

One of the distributed gaming locations at which the Company’s gaming devices are located is owned in part by Sean T. Higgins, who serves as the Company’s Chief Legal Officer and Executive Vice President of Development, Compliance and Government Affairs. This arrangement was in place prior to Mr. Higgins joining the Company on March 28, 2016. Net revenues and gaming expenses recorded by the Company from the use of the Company’s gaming devices at this location were each $0.3 million during the three months ended March 31, 2017, and an immaterial amount during the three months ended March 31, 2016, as such period predominantly related to the period prior to the commencement of Mr. Higgins’ employment with the Company. No amounts were owed to the Company and no amounts were due and payable by the Company related to this arrangement as of March 31, 2017.

Three of the distributed gaming locations at which the Company’s gaming devices are located are owned in part by the spouse of Matthew W. Flandermeyer, the former Executive Vice President and Chief Financial Officer of the Company. Net revenues and gaming expenses recorded by the Company from the use of the Company’s gaming devices at these three locations were $0.5 million and $0.4 million, respectively, during the three months ended March 31, 2016. Mr. Flandermeyer ceased to be an employee of the Company and a related party in November 2016. The gaming expenses recorded by the Company represent amounts retained by the counterparty (with respect to the two locations that are subject to participation agreements) or paid to the counterparty (with respect to the location that is subject to a revenue share agreement) from the operation of the gaming devices. All of the agreements were in place prior to the consummation of the Merger.

One distributed gaming location at which the Company’s gaming devices are located was owned in part by Terrence L. Wright, who serves on the Board of Directors of the Company, who divested his interest in such distributed gaming location in March 2016. Net revenues and gaming expenses recorded by the Company from the use of the Company’s gaming devices at this location during the period in which the agreement was with a related party were $0.1 million during the three months ended March 31, 2016. This agreement was in place prior to the consummation of the Merger. 

In connection with the Merger, Lyle A. Berman, who serves on the Board of the Directors of the Company, entered into a three-year consulting agreement with the Company that pays his wholly owned consulting firm $200,000 annually, plus reimbursements for certain health insurance, administrative assistant and office costs. Expenses recorded by the Company for the agreement with Mr. Berman were $0.1 million for each of the three months ended March 31, 2017 and 2016, and no amounts were due and payable by the Company at March 31, 2017.

Additionally, in connection with the Merger, Timothy J. Cope, who serves on the Board of Directors of the Company entered into a short-term consulting agreement for the period from July 31, 2015 to April 1, 2016 under which Mr. Cope was paid a total of $140,000, plus reimbursement of certain health insurance costs.  Expenses recorded by the Company for the agreement with Mr. Cope were $0.1 million for the three months ended March 31, 2016.

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As used in this Quarterly Report on Form 10-Q, unless the context suggests otherwise, the terms “Golden,” “we,” “our” and “us” refer to Golden Entertainment, Inc. and its subsidiaries.

The following information should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission (“SEC”).

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 and the Securities Exchange Act of 1934, or the Exchange Act. Forward-looking statements can generally be identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “intend,” “plan,” “project,” “seek,” “should,” “think,” “will,” “would” and similar expressions. In addition, forward-looking statements include statements regarding our strategies, objectives, business opportunities and plans for future expansion, developments or acquisitions, anticipated future growth and trends in our business or key markets, projections of future financial condition, operating results, income, capital expenditures, costs or other financial items, anticipated regulatory and legislative changes, our ability to utilize our net operating loss carryforwards (“NOLs”) to offset future taxable income, as well as other statements that are not statements of historical fact. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. These forward-looking statements are subject to assumptions, risks and uncertainties that may change at any time, and readers are therefore cautioned that actual results could differ materially from those expressed in any forward-looking statements. Factors that could cause actual results to differ include: our ability to realize the anticipated cost savings, synergies and other benefits of the 2015 acquisition of Sartini Gaming, Inc. through a merger transaction (the “Merger”), and the acquisitions of distributed gaming assets in Montana, and integration risks relating to such transactions, changes in national, regional and local economic and market conditions, legislative and regulatory matters (including the cost of compliance or failure to comply with applicable laws and regulations), increases in gaming taxes and fees in the jurisdictions in which we operate, litigation, increased competition, our ability to renew our distributed gaming contracts, reliance on key personnel (including our Chief Executive Officer, Chief Operating Officer, Chief Strategy Officer and Chief Financial Officer), the level of our indebtedness and our ability to comply with covenants in our debt instruments, terrorist incidents, natural disasters, severe weather conditions (including weather or road conditions that limit access to our properties), the effects of environmental and structural building conditions, the effects of disruptions to our information technology and other systems and infrastructure, the occurrence of an “ownership change” as defined in Section 382 of the Internal Revenue Code (the “Code”), factors affecting the gaming, entertainment and hospitality industries generally, and other factors identified under the heading “Risk Factors” in our Annual Report on Form 10-K and in Part II, Item 1A of this report, elsewhere in this Quarterly Report on Form 10-Q and in our other filings with the SEC. Readers are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the filing date of this report. We undertake no obligation to revise or update any forward-looking statements for any reason.

Overview

We are a diversified group of gaming companies that focus on distributed gaming (including tavern gaming) and casino and resort operations.

We conduct our business through two reportable operating segments: Distributed Gaming and Casinos.

Distributed Gaming

Our Distributed Gaming segment involves the installation, maintenance and operation of gaming and amusement devices in certain strategic, high-traffic, non-casino locations (such as grocery stores, convenience stores, restaurants, bars, taverns, saloons and liquor stores) in Nevada and Montana, and the operation of traditional, branded taverns targeting local patrons, primarily in the greater Las Vegas, Nevada metropolitan area. As of March 31, 2017, our distributed gaming operations comprised over 10,300 gaming devices in approximately 960 locations.

Nevada law limits distributed gaming operations (commonly known as “restricted gaming” operations) to certain types of non-casino locations, including grocery stores, drug stores, convenience stores, restaurants, bars, taverns, saloons and liquor stores, where gaming is incidental to the primary business being conducted at the location and games are limited to 15 or fewer gaming devices and no other

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forms of gaming activity. The gaming area in these business locations is typically small, and in many instances, segregated from the primary business area, including the use of alcoves in grocery stores and drug stores and installation of gaming devices into the physical bar (more commonly known as “bar top” gaming devices) in bars, taverns and saloons. Such segregation provides greater oversight and supervision of the gaming devices. Under Montana law, distributed gaming operations are limited to business locations licensed to sell alcoholic beverages for on-premises consumption only, with such locations restricted to offering a maximum of 20 gaming devices.

Gaming and amusement devices are placed in locations where we believe they will receive maximum customer traffic, generally near a store’s entrance. In Nevada, we generally enter into three types of gaming device placement contracts as part of our distributed gaming business: space lease, revenue share and participation agreements. Under space lease agreements, we pay a fixed monthly rental fee for the right to install, maintain and operate our gaming devices at a business location. Under revenue share agreements, we pay the business location a percentage of the gaming revenue generated from our gaming devices placed at the location, rather than a fixed monthly rental fee. With regard to both space lease and revenue share agreements, we hold the applicable gaming license to conduct gaming at the location (although revenue share locations are required to obtain separate regulatory approval to receive a percentage of the gaming revenue). Under participation agreements, the business location holds the applicable gaming license and retains a percentage of the gaming revenue that it generates from our gaming devices. In Montana, our gaming and amusement device placement contracts are all revenue share agreements.

Our branded taverns offer a casually upscale environment catering to local patrons offering superior food, beer and other alcoholic beverages, and typically include 15 onsite gaming devices. As of March 31, 2017, we operated 54 taverns, which offered a total of approximately 860 onsite gaming devices. Most of our taverns are located in the greater Las Vegas, Nevada metropolitan area and cater to locals seeking to avoid the congestion of the Las Vegas Strip. Our tavern brands include PT’s Pub, PT’s Gold, PT’s Place, PT’s Brewing Company, Sierra Gold, SG Bar and Sean Patrick’s. Our taverns also serve as an incubator for new games and technology that can then be rolled out to our third party distributed gaming customers within the segment and to our Casinos segment. We also opened our first brewery in Las Vegas, PT’s Brewing Company, during the first quarter of 2016 to produce craft beer for our taverns and casinos, as well as other establishments licensed to sell liquor for on-premises consumption.

Casinos

We own and operate the Rocky Gap Casino Resort in Flintstone, Maryland (“Rocky Gap”) and three casinos in Pahrump, Nevada: Pahrump Nugget Hotel Casino (“Pahrump Nugget”), Gold Town Casino and Lakeside Casino & RV Park. Pahrump is located approximately 60 miles from Las Vegas and is a gateway to Death Valley National Park. All of our casinos emphasize gaming device play.

Rocky Gap is situated on approximately 270 acres in the Rocky Gap State Park, which are leased from the Maryland Department of Natural Resources under a 40-year operating ground lease expiring in 2052 (plus a 20-year option renewal). As of March 31, 2017, Rocky Gap offered 662 gaming devices, 18 table games, two casino bars, three restaurants, a spa and the only Jack Nicklaus signature golf course in Maryland. Rocky Gap is a AAA Four Diamond Award® winning resort with approximately 200 hotel rooms, as well as an event and conference center.

As of March 31, 2017, our Pahrump Nugget casino offered 449 gaming devices, as well as 11 table games (which include three live poker tables), a race and sports book, a 208-seat bingo facility and a bowling center. Pahrump Nugget is our largest property in the Nevada market with approximately 70 hotel rooms. As of March 31, 2017, our Gold Town Casino offered 237 gaming devices and a 125-seat bingo facility, and our Lakeside Casino & RV Park offered 189 gaming devices and a recreational vehicle park surrounding a lake with approximately 160 RV hook-up sites.

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Results of Operations

The following discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q for the three months ended March 31, 2017 and 2016.

 

 

Three Months Ended March 31, 2017 Compared to Three Months Ended March 31, 2016 

Net Revenues

The increase in net revenues compared to the prior year period was primarily due to a $13.0 million and $2.3 million increase in our gaming and food and beverage revenues, respectively.

The increase in net revenues related to our Distributing Gaming segment compared to the prior year period was primarily due to an increase of $11.2 million in gaming revenues (reflecting the opening of five new taverns in the Las Vegas Valley after the first quarter of 2016), as well as inclusion in the current year period of net revenues relating to our acquisition of gaming devices, certain other non-gaming assets and the right to operate within certain locations from a distributed gaming operator in Montana (the “Initial Montana Acquisition”) on January 29, 2016, and our additional acquisition of gaming devices, amusement devices, certain other non-gaming assets and the right to operate within certain locations from a second distributed gaming operator in Montana (the “Second Montana Acquisition”, and, together with the Initial Montana Acquisitions, the “Montana Acquisitions”) on April 22, 2016.

The increase in net revenues related to our Casinos Segment compared to the prior year period was primarily due to an increase of $1.5 million in gaming revenues at our Rocky Gap casino, reflecting an increase in parking capacity to accommodate peak days, increased patron volume and revised marketing efforts to cater to our gaming customers. The year-over-year gaming revenue increases were partially offset by a decrease in food and beverage revenues.

Operating Expenses

The increase in operating expenses compared to the prior year period resulted primarily from the inclusion in the current year period of $12.8 million in operating expenses relating to the businesses acquired in the Montana Acquisitions in 2016. Operating expenses comprise gaming, food and beverage, rooms and other operating expenses.

Selling, General and Administrative Expenses

The increase in selling, general and administrative (“SG&A”) expenses compared to the prior year period resulted primarily from increases of $2.1 million in salaries and bonus expenses (including share-based compensation expense) and $0.6 million in building

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and rent expense, which were partially offset by decreases of $0.3 million in professional fees and $0.2 million in marketing and advertising expenses. Share-based compensation expense increased during the current year quarter due primarily to $0.4 million of expense related to a restricted stock unit award granted in November of 2016 and $0.2 million of additional expense related to the approximately 0.8 million stock options granted in the third quarter of 2016.

Within our Distributed Gaming segment, SG&A expenses were $6.1 million for the three months ended March 31, 2017, compared to $5.7 million for the prior year period.

Within our Casinos segment, SG&A expenses were $5.1 million for the three months ended March 31, 2017, compared to $5.7 million for the prior year period. The $0.6 million change was primarily due to decreases in utility, business tax and insurance expenses. SG&A expenses relating to our Rocky Gap casino were $3.3 million for the three months ended March 31, 2017 compared to $3.5 million for the prior year period. The decrease in SG&A expenses at Rocky Gap was primarily the result of cost reduction efforts in payroll, professional fees and other related costs.

Preopening Expenses

Preopening expenses consist of labor, food, utilities, training, rent and organizational costs incurred. Non-capital costs associated with the opening of tavern and casino locations are also expensed as preopening expenses as incurred. During the three months ended March 31, 2017, preopening expenses were $0.3 million, which related primarily to the opening of new taverns in Las Vegas, Nevada. During the three months ended March 31, 2016, preopening expenses were $0.6 million, which related primarily to costs incurred in connection with the Initial Montana Acquisition and the opening of new tavern locations in Las Vegas, Nevada.

Depreciation and Amortization

The $0.8 million increase in depreciation and amortization expenses compared to the prior year period was primarily due to the depreciation of the assets and the amortization of the intangibles acquired in the Montana Acquisitions.

Non-Operating Expense, Net

Non-operating expense, net was $1.7 million for the three months ended March 31, 2017 compared to $1.4 million for the prior year period. The increase in non-operating expense, net was due primarily to a year-over-year increase in interest expense related to higher outstanding borrowings under our senior secured credit agreement with Capital One, National Association (as administrative agent) and the lenders named therein (the “Credit Agreement”).

Income Taxes

Income tax benefit was $1.7 million for the three months ended March 31, 2017, which resulted primarily from the partial release of deferred tax asset valuation allowances. Income tax expense was less than $0.1 million for the three months ended March 31, 2016, which was attributed primarily to tax amortization of indefinite-lived intangibles. Our effective tax rate was -46.4% for the three months ended March 31, 2017, which differed from the federal tax rate of 35% due primarily to the partial release of the valuation allowance against our deferred tax assets. Our effective tax rate for the three months ended March 31, 2016 was 2.5%, which differed from the federal tax rate of 35% due primarily to changes in the valuation allowance for deferred tax assets.

Non-GAAP Measures

To supplement our consolidated financial statements presented in accordance with United States generally accepted accounting principles (“GAAP”), we use Adjusted EBITDA, a measure we believe is appropriate to provide meaningful comparison with, and to enhance an overall understanding of, our past financial performance and prospects for the future. We believe Adjusted EBITDA provides useful information to both management and investors by excluding specific expenses and gains that we believe are not indicative of our core operating results. Further, Adjusted EBITDA is a measure of operating performance used by management, as well as industry analysts, to evaluate operations and operating performance and is widely used in the gaming industry. The presentation of this additional information is not meant to be considered in isolation or as a substitute for measures of financial performance prepared in accordance with GAAP. In addition, other companies in our industry may calculate Adjusted EBITDA differently than we do. A reconciliation of net income to Adjusted EBITDA is provided in the table below.

We define “Adjusted EBITDA” as earnings before interest and other non-operating income (expense), income taxes, depreciation and amortization, preopening expenses, merger expenses, share-based compensation expenses, executive severance and sign-on bonuses, impairments and other gains and losses.

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The following table presents a reconciliation of Adjusted EBITDA to net income:

 

Liquidity and Capital Resources

As of March 31, 2017, we had $45.2 million in cash and cash equivalents and no short-term investments. We currently believe that our cash and cash equivalents, cash flows from operations and borrowing availability under the revolving credit facility under our Credit Agreement (the “Revolving Credit Facility”) will be sufficient to meet our working capital requirements during the next 12 months.

Our operating results and performance depend significantly on national, regional and local economic conditions and their effect on consumer spending. Declines in consumer spending would cause revenues generated in both our Distributed Gaming and Casinos segments to be adversely affected. In addition, we perform on-going refurbishment and maintenance at our properties, of which certain maintenance costs are capitalized if such improvement or refurbishment extends the life of the related asset, while other maintenance costs that do not so qualify are expensed as incurred. The commitment of capital and the related timing thereof are contingent upon, among other things, negotiation of final agreements and receipt of approvals from the appropriate regulatory bodies.

To further enhance our liquidity position or to finance acquisitions or other business investment initiatives, we may obtain additional financing, which could consist of debt, convertible debt or equity financing from public and/or private credit and capital markets. Any additional financing that is needed may not be available to us or, if available, may not be on terms favorable to us. In June 2016, we filed a universal shelf registration statement with the SEC for the future sale of up to $150.0 million of common stock, preferred stock, debt securities, warrants and units. The securities may be offered from time to time, separately or together, directly by us or through underwriters, dealers or agents at amounts, prices, interest rates and other terms to be determined at the time of the applicable offering.

Cash Flows

Net cash provided by operating activities was relatively unchanged year-over-year, at $10.7 million for the three months ended March 31, 2017, compared to $10.8 million for the prior year period.

Net cash used in investing activities was $5.8 million for the three months ended March 31, 2017, compared to $26.6 million for the prior year period. The decrease in net cash used in investing activities as compared to the prior year period was primarily due to the consummation of the Initial Montana Acquisition during the prior year period.

Net cash used in financing activities was $6.7 million for the three months ended March 31, 2017, primarily related to repayments under the Credit Agreement. Net cash provided by financing activities was $13.1 million for the three months ended March 31, 2016, primarily related to proceeds from borrowings, net of repayments, under the Credit Agreement.

Credit Agreement

As of March 31, 2017, the facilities under the Credit Agreement consisted of $160.0 million in senior secured term loans (“Term Loans”) and a $50.0 million Revolving Credit Facility (together with the Term Loans, the “Facilities”). As of March 31, 2017, we had $147.0 million in principal amount of outstanding Term Loan borrowings and $27.0 million in principal amount of outstanding borrowings under the Revolving Credit Facility. The facilities mature on July 31, 2020.

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Borrowings under the Credit Agreement bear interest, at our option, at either (1) the highest of the federal funds rate plus 0.50%, the Eurodollar rate for a one-month interest period plus 1.00%, or the administrative agent’s prime rate as announced from time to time, or (2) the Eurodollar rate for the applicable interest period, plus, in each case, an applicable margin based on our leverage ratio. For the three months ended March 31, 2017, the weighted average effective interest rate on our outstanding borrowings under the Credit Agreement was approximately 3.3%.

Outstanding borrowings under the Term Loans at March 31, 2017 will be repaid in seven quarterly payments of $3.0 million each (commencing March 31, 2017), followed by four quarterly payments of $4.0 million each (commencing December 31, 2018), followed by three quarterly payments of $6.0 million each (commencing December 31, 2019), followed by a final installment of $95.0 million at maturity on July 31, 2020. The commitment fee for the Revolving Credit Facility is payable quarterly at a rate of between 0.25% and 0.30%, depending on our leverage ratio, and is accrued based on the average daily amount of the available revolving commitment.

The Credit Agreement is guaranteed by all of our present and future direct and indirect wholly owned subsidiaries (other than certain insignificant or unrestricted subsidiaries), and is secured by substantially all of our and the subsidiary guarantors’ present and future personal and real property (subject to receipt of certain approvals).

Under the Credit Agreement, we and our subsidiaries are subject to certain limitations, including limitations on our ability to: incur additional debt, grant liens, sell assets, make certain investments, pay dividends and make certain other restricted payments. In addition, we will be required to pay down the Facilities under certain circumstances if we or any of our subsidiaries sell assets or property, issue debt or receive certain extraordinary receipts. The Credit Agreement contains financial covenants regarding a maximum leverage ratio and a minimum fixed charge coverage ratio. The Credit Agreement also prohibits the occurrence of a change of control, which includes the acquisition of beneficial ownership of 30% or more of our equity securities (other than by certain permitted holders, which include, among others, Blake L. Sartini, Lyle A. Berman and certain affiliated entities) and a change in a majority of the members of our Board of Directors that is not approved by the Board. If we default under the Credit Agreement due to a covenant breach or otherwise, the lenders may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell our assets to satisfy the obligations thereunder. We were in compliance with our financial covenants under the Credit Agreement as of March 31, 2017.

Other Items Affecting Liquidity

The outcome of the following matters may also affect our liquidity.

Commitments, Capital Spending and Development

We perform on-going refurbishment and maintenance at our facilities, of which certain maintenance costs are capitalized if such improvement or refurbishment extends the life of the related asset, while other maintenance cost that do not so qualify are expensed as incurred. The commitment of capital and the related timing thereof are contingent upon, among other things, negotiation of final agreements and receipt of approvals from the appropriate regulatory bodies. We intend to fund capital expenditures through our Revolving Credit Facility and operating cash flows.

See Note 10, Commitments and Contingencies, in the accompanying consolidated financial statement for additional information regarding commitments and contingencies that may also affect our liquidity.

 

Other Opportunities

We may investigate and pursue expansion opportunities in our existing or new markets. Such expansions will be influenced and determined by a number of factors, which may include licensing availability and approval, suitable investment opportunities and availability of acceptable financing. Investigation and pursuit of such opportunities may require us to make substantial investments or incur substantial costs, which we may fund through cash flows from operations or borrowing availability under our Revolving Credit Facility. To the extent such sources of funds are not sufficient, we may also seek to raise such additional funds through public or private equity or debt financings or from other sources. No assurance can be given that additional financing will be available or that, if available, such financing will be obtainable on terms favorable to us. Moreover, we can provide no assurances that the investigation or pursuit of an opportunity will result in a completed transaction.

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Critical Accounting Policies and Estimates

Management's discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the balance sheet date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to the application of the acquisition method of accounting, long-lived assets, goodwill and indefinite-lived intangible assets, revenue recognition and promotional allowances, income taxes and share-based compensation expenses. We base our estimates and judgments on historical experience and on various other factors that are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.

There have been no material changes to our critical accounting policies described under 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, previously filed with the SEC.

Commitments and Contractual Obligations

No significant changes occurred in the first three months of 2017 to the contractual commitments discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Commitments and Contractual Obligations” in our Annual Report on Form 10-K for the year ended December 31, 2016.

Seasonality

We believe that our Distributed Gaming and Casinos segments are affected by seasonal factors, including holidays, weather and travel conditions. Rocky Gap typically experiences higher revenues during summer months and may be significantly adversely impacted by inclement weather during winter months. Our casinos and distributed gaming business in Nevada have historically experienced lower revenues during the summer as a result of fewer tourists due to higher temperatures, as well as increased vacation activity by local residents. Our Nevada and Montana distributed gaming operations typically experience higher revenues during the fall which corresponds with several professional sports seasons. Additionally, our Montana distributed gaming operations typically see higher revenues during winter months due to the inclement weather during winter months limiting outdoor activities. While other factors like unemployment levels, market competition and the diversification of our business may either offset or magnify seasonal effects, some seasonality is likely to continue, which could result in significant fluctuation in our quarterly operating results.

 

Recently Issued Accounting Pronouncements

See Note 1, Nature of Business and Basis of Presentation, in the accompanying consolidated financial statements for information regarding recently issued accounting pronouncements.

Regulation and Taxes

The distributed gaming and casino industries are subject to extensive regulation by state gaming authorities. Changes in applicable laws or regulations could have a material adverse effect on us.

The gaming industry represents a significant source of tax revenues to regulators. From time to time, various federal and state legislators and officials have proposed changes in tax law, or in the administration of such law, affecting the gaming industry. It is not possible to determine the likelihood of possible changes in tax law or in the administration of such law. Such changes, if adopted, could have a material adverse effect on our future financial position, results of operations, cash flows and prospects.

Off Balance Sheet Arrangements

We have no off balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. 

 

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary exposure to market risk is interest rate risk associated with our variable rate long-term debt. As of March 31, 2017, approximately 96% of our indebtedness for borrowed money accrued interest at a variable rate, which primarily comprised our indebtedness under the Credit Agreement.

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At March 31, 2017, we had $174.0 million in principal amount of outstanding borrowings under the Credit Agreement. Our primary interest rate under the Credit Agreement is the Eurodollar rate plus an applicable margin that is based on our total leverage ratio. For the three months ended March 31, 2017, the weighted average effective interest rate on our outstanding borrowings under the Credit Agreement was 3.3%. Assuming the outstanding balance remained constant over a year, a 50 basis point increase in the interest rate would increase interest incurred, prior to effects of capitalized interest, by $0.9 million over a twelve-month period.

As of March 31, 2017, our investment portfolio included $45.2 million in cash and cash equivalents. As of March 31, 2017, we did not hold any short-term investments.

 

ITEM 4.  CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified and pursuant to the requirements of the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), we carried out an evaluation, with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of March 31, 2017, the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the material weakness in our internal control over financial reporting which existed as of December 31, 2016, as described below, existed as of March 31, 2017. As a result of this material weakness, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of March 31, 2017.

On April 22, 2016, the Second Montana Acquisition was completed. Management has begun the evaluation of the internal control structures of the distributed gaming businesses acquired in the Second Montana Acquisition. However, SEC guidance permits management to omit an assessment of an acquired business’ internal control over financial reporting from management’s assessments of internal control over financial reporting and disclosure controls and procedures for a period not to exceed one year from the date of the acquisition. Accordingly, we excluded the distributed gaming businesses acquired in the Second Montana Acquisition from our evaluation of our disclosure controls and procedures as of March 31, 2017. We have reported the operating results of such acquired distributed gaming businesses in our consolidated statements of operations and cash flows from the acquisition date through March 31, 2017. As of March 31, 2017, total assets related to the businesses acquired in the Second Montana Acquisition represented approximately 6.1% of our total assets, which consisted primarily of intangible assets, including goodwill, recorded on a preliminary basis as the measurement period for the business combination remained open as of March 31, 2017. Net revenues from the Second Montana Acquisition comprised approximately 7.8% of our consolidated net revenues for the three months ended March 31, 2017.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness that management previously identified in connection with its evaluation of our internal control over financial reporting, as of December 31, 2016 was as follows:

In light of the material weakness described above, and based on the criteria set forth in Internal Control — Integrated Framework (2013) issued by the COSO, our management concluded that our internal control over financial reporting was not effective as of December 31, 2016.

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We are in the process of actively addressing and remediating the material weaknesses in internal control over financial reporting described above. During the three months ended March 31, 2017, the Audit Committee directed management to develop and present to the Committee a plan and timetable for the implementation of remediation measures to correct this material weakness. Management has delivered the remediation plan and timetable to the Audit Committee. Under management’s remediation plan, the remediation measures will include, among other things:

During the quarter ended March 31, 2017, except as described above, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. As described above, we completed the Second Montana Acquisition on April 22, 2016. Acquisition-related integration activities may lead us to modify certain internal controls in future periods.

 

 

Part II. Other Information

ITEM 1.  LEGAL PROCEEDINGS

From time to time, we are involved in a variety of lawsuits, claims, investigations and other legal proceedings arising in the ordinary course of business, including proceedings concerning labor and employment matters, personal injury claims, breach of contract claims, commercial disputes, business practices, intellectual property, tax and other matters. Although lawsuits, claims, investigations and other legal proceedings are inherently uncertain and their results cannot be predicted with certainty, we believe that the resolution of our currently pending matters will not have a material adverse effect on our business, financial condition, results of operations or liquidity. Regardless of the outcome, legal proceedings can have an adverse impact on us because of defense costs, diversion of management resources and other factors. In addition, it is possible that an unfavorable resolution of one or more such proceedings could in the future materially and adversely affect our business, financial condition, results of operations or liquidity in a particular period.

 

In February and April 2017, several former employees filed two separate purported class action lawsuits against us in the District Court of Clark County, Nevada, and on behalf of similarly situated individuals employed by us in the State of Nevada. The lawsuits allege we violated certain Nevada labor laws including payment of an hourly wage below the statutory minimum wage without providing a qualified health insurance plan and an associated failure to pay proper overtime compensation. The complaints seek, on behalf of the plaintiffs and members of the putative class, an unspecified amount of damages (including punitive damages), injunctive and equitable relief, and an award of attorneys’ fees, interest and costs. These cases are at an early stage in the proceedings, and we are therefore unable to make a reasonable estimate of the probable loss or range of losses, if any, that might arise from these matters. Therefore, we have not recorded any amount for the claims as of the date of this filing. While legal proceedings are inherently unpredictable and no assurance can be given as to the ultimate outcome of these matters, based on management’s current understanding of the relevant facts and circumstances, we believe that these proceedings should not have a material adverse effect on our financial position, results of operations or cash flows.

ITEM 1A.  RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016, which factors could materially affect our business, financial condition, liquidity or future results. There have been no material changes to the risk factors described in the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2016. The risks described in our Annual Report on Form 10-K are not the only risks facing our company. 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, liquidity, future results or prospects.

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ITEM 6.  EXHIBITS

 

 

 

 

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SIGNATURES 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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