Note 3 – Merger and Acquisitions

Montana Acquisitions

On January 29, 2016, the Company completed the Initial Montana Acquisition, which involved 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., for total consideration of $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 14, Financial Instruments and Fair Value Measurements, for further discussion regarding the estimated fair value of the contingent consideration. The preliminary allocation of the $20.1 million purchase price to the assets acquired as of January 29, 2016 includes $1.7 million of cash, $2.4 million of property and equipment, $14.2 million of intangible assets and $1.9 million of goodwill. The preliminary amounts assigned to intangible assets include customer relationships of $9.8 million with an economic life of 15 years, non-compete agreements of $3.9 million with an economic life of five years and trade names of $0.5 million with an economic life of four years.

On April 22, 2016, the Company completed the Second Montana Acquisition, which involved 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, for total consideration of $25.7 million. The preliminary allocation of the $25.7 million purchase price to the assets acquired as of April 22, 2016 includes $0.3 million of cash, less than $0.1 million of prepaid gaming license fees, $7.8 million of property and equipment, $11.1 million of intangible assets and $6.3 million of goodwill. The preliminary amounts assigned to intangible assets include customer relationships of $9.1 million with an economic life of 15 years, non-compete agreements of $1.8 million with an economic life of five years and trade names of $0.2 million with an economic life of four years.

The goodwill recognized in the Montana Acquisitions is 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 that have yet to be finalized, and accordingly, the assets acquired are subject to adjustment once such analyses are completed. The Company may record adjustments to the carrying value of assets acquired 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 relevant acquisition.

The Company reports the results of operations from each of the Montana Acquisitions, subsequent to their respective closing dates, within its Distributed Gaming segment. For the year ended December 31, 2016, net revenues from the Montana Acquisitions totaled $47.0 million. For the year ended December 31, 2016, transaction-related costs for the Montana Acquisitions totaled $0.5 million 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.

Merger with Sartini Gaming, Inc.

On July 31, 2015, the Company acquired Sartini Gaming through the consummation of the Merger. At the effective time of the Merger, all issued and outstanding shares of capital stock of Sartini Gaming were canceled and converted into the right to receive shares of the Company’s common stock. At the closing of the Merger, the Company issued 7,772,736 shares of its common stock to The Blake L. Sartini and Delise F. Sartini Family Trust (the “Sartini Trust”), as sole shareholder of Sartini Gaming in accordance with the agreement and plan of merger (the “Merger Agreement”). In addition, at the closing of the Merger, the Company issued 457,172 shares of its common stock to holders of warrants issued by a subsidiary of Sartini Gaming that elected to receive shares of the Company’s common stock in exchange for their warrants. The total number of shares of the Company’s common stock issued in connection with the Merger was subject to adjustment pursuant to the post-closing adjustment provisions of the Merger Agreement. In connection with such post-closing adjustment, the Company issued an additional 223,657 shares of its common stock to the Sartini Trust. As a result, the value of the purchase consideration following such adjustment was $77.4 million. This amount is the product of the 8,453,565 shares of the Company’s common stock issued in the aggregate in connection with the Merger and the closing price of $9.15 per share of the Company's common stock on July 31, 2015. In August 2016, the 777,274 shares previously held in escrow as security in the event of any claims for indemnifiable losses in accordance with the Merger Agreement were released to the Sartini Trust in accordance with the terms of the escrow agreement.

Under the Merger Agreement, the number of shares of the Company’s common stock issued in connection with the Merger reflected the pre-Merger value of Sartini Gaming relative to the pre-Merger value of the Company, which pre-Merger values were calculated in accordance with formulas set forth in the Merger Agreement. To determine the number of shares of the Company’s common stock issued in connection with the Merger, the sum of the number of shares of the Company’s common stock outstanding immediately prior to the Merger and the number of shares issuable upon the exercise of outstanding in-the-money stock options was divided by the percentage of the total pre-Merger value of both companies that represented the Company’s pre-Merger value to determine the total number of fully diluted shares immediately following the Merger. The number of shares of the Company’s common stock issued in connection with the Merger was the difference between the total number of fully diluted shares immediately following the Merger and the total number of fully diluted shares immediately prior to the Merger. No fractional shares of the Company’s common stock were issued in connection with the Merger, and any fractional share was rounded to the nearest whole share.

The Merger Agreement specified the procedure for determining the pre-Merger values of Sartini Gaming and the Company. The final pre-Merger values of the Company and Sartini Gaming were determined and approved during the fourth quarter of 2015, pursuant to the post-closing adjustment provisions of the Merger Agreement.

The total number of shares of the Company’s common stock issued in connection with the Merger was as follows:

Pre-Merger

Value of Lakes

Lakes %

Pre-Merger

Value of Sartini

Gaming

Sartini

Gaming %

Total Post-Closing

Shares⁽¹⁾

Total Shares Issued

in Connection

with Merger⁽²⁾

134,615,083

62.6%

80,523,753

37.4%

22,592,260

8,453,565

(1)

Calculated as the sum of the number of shares of the Company’s common stock outstanding immediately after the Merger (on a fully diluted basis, including shares issuable upon the exercise of outstanding in-the-money stock options) and the number of shares of the Company’s common stock issued pursuant to the post-closing adjustment provisions of the Merger Agreement.

(2)	Includes 457,172 shares of the Company’s common stock that were issued to certain former holders of warrants issued by a subsidiary of Sartini Gaming upon the closing of the Merger.

Merger Accounting

The Merger has been accounted for under the purchase method of accounting in accordance with Accounting Standards Codification Topic 805, Business Combinations. Under the purchase method, the total purchase price, or consideration transferred, was measured at the Merger closing date. The purchase price of the acquisition was allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The excess of the purchase price over the estimated fair values was recorded as goodwill. The goodwill recognized in the Merger was primarily attributable to potential expansion and future development of, and anticipated synergies from, the tavern brands and the acquired distributed gaming and casino businesses, while enhancing the Company’s existing brand and casino portfolio. None of the goodwill recognized is expected to be deductible for income tax purposes. The Company allocated the goodwill to each reporting unit at the conclusion of the measurement period.

Measurement Period Adjustments

The final pre-Merger values of the Company and Sartini Gaming were determined and approved during the fourth quarter of 2015, pursuant to the post-closing adjustment provisions of the Merger Agreement. As a result of this post-closing adjustment calculation, the number of shares issued in connection with the Merger was increased by an additional 223,657 shares, and the 388,637 shares of the Company's common stock held in escrow as security for the post-closing adjustment were released to the Sartini Trust. The effect of the issuance of these additional shares on the purchase price consideration calculation was an increase of $2.1 million to $77.4 million. This amount is the product of the 8,453,565 total shares of the Company’s common stock issued in connection with the Merger on July 31, 2015 and issued pursuant to the post-closing “true-up” adjustment and the $9.15 per share closing price of the Company's common stock on July 31, 2015. The Company accounted for the issuance of the additional 223,657 shares, and the adjustment of the purchase price consideration, during the fourth quarter of 2015 when the additional shares were issued.

The measurement period for the Merger ended on July 31, 2016. In addition to the issuance of the additional shares pursuant to the post-closing adjustment calculation mentioned above, during the measurement period, the Company:

•

recorded a deferred tax liability totaling $14.7 million due to the assumption of a net deferred tax liability generated from intangible assets acquired in the Merger, with a corresponding increase to goodwill by the same amount;

•

recorded an adjustment to increase goodwill by $1.6 million, decreasing accounts receivable by the same amount, due to the determination that receivables acquired as part of the Merger were deemed to be uncollectible as of the Merger date;

•

further analyzed the trade names acquired as part of the Merger, which were originally given 10 year useful lives, and concluded that the trade names are indefinite-lived. An adjustment to reverse $0.2 million of amortization for the trade names in the third quarter of 2015 was recorded during the fourth quarter of 2015;

•

determined that the preliminary estimated useful lives of certain tangible acquired assets were not consistent with the useful lives used by other market participants. The useful lives determined during the measurement period were updated to reflect the Company’s determination and are reflected in the property and equipment by category table below;

•

identified an acquired prepaid asset (recorded in other current assets previously) that was reclassified to a gaming license that represents the Company’s ability and right to operate in its current capacity in Montana. Management has valued the gaming license using estimates for explicit and implicit costs to obtain the gaming license and has determined the license has an indefinite life;

•

recorded an adjustment to increase goodwill by less than $0.1 million, increasing accrued taxes by the same amount, due to a tax liability resulting from a prior year assumed as part of the Merger;

•

recorded an adjustment to increase goodwill by $0.3 million, decreasing player relationships at the Company’s Gold Town Casino by the same amount, due to an increase in the discount rate used in the valuation upon further review. This adjustment triggered a reversal of $0.1 million of the previously recorded deferred tax liability, with a corresponding decrease to goodwill by the same amount; and

•

identified $0.9 million worth of equipment that was disposed of prior to the Merger but recorded in the opening balance. As such, the Company recorded an increase to goodwill for the amount of equipment written off.

Allocation

The final allocation of the $77.4 million purchase price to the assets acquired and liabilities assumed as of July 31, 2015 was as follows (in thousands):

	Amount
Cash	$	25,539
Other current assets		14,830
Property and equipment		83,173
Intangible assets		80,460
Goodwill		97,462
Current liabilities		(13,245	)
Warrant liability		(3,435	)
Debt		(190,587	)
Deferred tax liability		(14,576	)
Other long-term liabilities		(2,217	)
Total purchase price	$	77,404

The amounts assigned to property and equipment by category are summarized in the table below (in thousands):

	Remaining Useful Life (Years)	Amount Assigned
Land	Not applicable	$	12,470
Land improvements	5-14		4,030
Building and improvements	19-25		21,310
Leasehold improvements	1-28		20,793
Furniture, fixtures and equipment	1-11		21,935
Construction in process	Not applicable		2,635
Total property and equipment		$	83,173

The amounts assigned to intangible assets by category as of July 31, 2015 are summarized in the table below (in thousands):

	Remaining Useful Life (Years)	Amount Assigned
Trade names	Indefinite	$	12,200
Player relationships	8-14		7,300
Customer relationships	13-16		59,200
Gaming licenses	Indefinite		960
Other intangible assets	2-10		800
Total intangible assets		$	80,460

The trade names acquired encompass the various trade names utilized by the three casinos located in Pahrump, Nevada: Pahrump Nugget Hotel, Gold Town Casino and Lakeside Casino & RV Park. Additionally, the acquired branded taverns utilize various trade names to market and create brand identity for their services and for marketing purposes, including: PT’s Pub, PT’s Gold, Sierra Gold and Sean Patrick’s. The trade names for the Pahrump casinos and taverns have indefinite lives.

Player relationships acquired include relationships with players frequenting the Company’s branded taverns and Nevada casinos. These player relationships comprise Golden Rewards members for the taverns and Gold Mine Rewards members for the Nevada casinos, and such relationships are expected to lead to recurring revenue streams, as well as new revenue opportunities arising from the reputations of the taverns and Nevada casinos.

Customer relationships relate to relationships with the Company’s third party distributed gaming customers that have been developed over many years and are expected to lead to recurring revenue streams, as well as new revenue opportunities arising from the Company’s reputation. The economic life of the customer relationships was determined to be 13 to 16 years, depending on the customer, and was based on the estimated present value of cash flows attributable to the asset.

The Nevada casinos maintain gaming licenses that allow them to operate in their current capacity. The Nevada gaming licenses have an indefinite life.

Other intangible assets acquired include internally developed software and non-compete agreements. The software is utilized for accounting and marketing purposes and is integrated into the Company’s gaming devices in its distributed gaming operations. The economic life of this software was determined to be 10 years based on the expected future utilization of the software in its current form. In conjunction with the Merger Agreement, key employees executed non-competition agreements. The economic life of these non-compete agreements was determined to be two years based on the contractual term of the agreements.

Estimated future amortization expense related to the finite-lived intangible assets acquired in the Merger is as follows (in thousands):

		2017				2018				2019				2020				2021				Thereafter
Estimated amortization expense		$	4,965			$	4,877			$	4,877			$	4,877			$	4,877			$	35,705

See Note 14, Financial Instruments and Fair Value Measurements, for further discussion regarding the valuation of the tangible and intangible assets acquired through the Merger.

Credit Agreement

In connection with the Merger, the Company entered into a Credit Agreement with Capital One, National Association (as administrative agent) and the lenders named therein (the “Credit Agreement”) to refinance the outstanding senior secured indebtedness of Sartini Gaming and the Company’s financing facility with Centennial Bank. See Note 7, Debt, for a discussion of the Credit Agreement and associated refinancing.

Selected Financial Information Related to the Acquiree

The consolidated financial position of Sartini Gaming is included in the Company’s consolidated balance sheet as of December 31, 2016 and December 31, 2015. Sartini Gaming’s consolidated results of operations and cash flows are included in our consolidated financial statements for the year ended December 31, 2016 and for the period from August 1, 2015 through December 31, 2015. During the year ended December 31, 2016, the Company recorded $293.1 million in net revenues and $26.1 million in net income from the operations of Sartini Gaming’s distributed gaming and casino businesses. From August 1, 2015 through December 31, 2015, the Company recorded $117.6 million in net revenues and $10.4 million in net income from the operations of Sartini Gaming’s distributed gaming and casino businesses. Total assets related to Sartini Gaming’s distributed gaming and casino businesses were approximately $244.3 million and $72.6 million, respectively, as of December 31, 2016, compared to approximately $221.6 million and $76.7 million, respectively, as of December 31, 2015. The assets acquired consisted primarily of property and equipment and intangible assets, including goodwill.

Unaudited Pro Forma Combined Financial Information

The following unaudited pro forma combined financial information for the years ended December 31, 2015 and December 28, 2014 are presented as if the Merger had occurred at the beginning of each period presented:

	Twelve Months Ended
	December 31, 2015		December 28, 2014
	(In thousands, except per share data)
Pro forma combined net revenues	$	345,437	$	335,631
Pro forma combined net income (loss)		27,645		(38,426	)

Pro forma combined net income (loss) per share:
Basic	$	1.27	$	(1.76	)
Diluted	$	1.25	$	(1.76	)

Weighted average common shares outstanding:
Basic		21,848		21,833
Diluted		22,073		21,833

This unaudited pro forma combined financial information has been prepared for illustrative purposes only and is not necessarily indicative of or intended to represent the results that would have been achieved had the Merger been consummated as of the dates indicated or that may be achieved in the future. The unaudited pro forma combined financial information does not reflect any operating efficiencies and associated cost savings that may be achieved as a result of the Merger.

The following adjustments have been made to the pro forma combined net income (loss) and pro forma combined net income (loss) per share in the table above:

•

includes additional depreciation expense of property, plant and equipment, and additional amortization expense of intangible assets acquired in the Merger based on their estimated fair values and estimated useful lives;

•

reflects the impact of issuance of 8,453,565 shares of the Company’s common stock in connection with the Merger based on the final pre-Merger values;

•

reflects $11.5 million and $0.5 million of transaction-related costs associated with the Merger for the years ended December 31, 2015 and December 28, 2014, respectively;

•

reflects the elimination of the warrants issued by a subsidiary of Sartini Gaming, which were purchased for $3.4 million in cash and for 457,172 shares of the Company’s common stock (equivalent to $4.2 million based on the Merger per share price); and

•

reflects the elimination of approximately $10.0 million of tax benefit during the year ended December 31, 2015, related to the assumption of a net deferred tax liability generated from the intangible assets acquired in the Merger.