10-Q 1 a2018093010q.htm 10-Q3 2018 Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
 
 
FORM 10-Q
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarter ended September 30, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from                          to                          .
Commission file number 001-38357
 
 
 
 
 
PLAYAGS, INC.
(Exact name of registrant as specified in its charter)
Nevada
 
46-3698600
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
5475 S. Decatur Blvd., Ste #100 Las Vegas, NV 89118
(Address of principal executive offices) (Zip Code)
(702) 722-6700 
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x  No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  o
 
Accelerated filer o
 
Non-accelerated filer  x (Do not check if a smaller reporting company)
 
Smaller reporting company  o
 
Emerging growth company  x 
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. Yes  x  No  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No  x
As of November 5, 2018 there were 35,305,479 shares of the Registrant’s common stock, $.01 par value per share, outstanding.



TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

ii

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PLAYAGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share and per share data)
(unaudited)
 
September 30,
2018
 
December 31,
2017
Assets
Current assets
 
 
 
Cash and cash equivalents
$
33,227

 
$
19,242

Restricted cash
78

 
100

Accounts receivable, net of allowance of $1,180 and $1,462, respectively
46,082

 
32,776

Inventories
31,819

 
24,455

Prepaid expenses
4,638

 
2,675

Deposits and other
4,275

 
3,460

Total current assets
120,119

 
82,708

Property and equipment, net
84,323

 
77,982

Goodwill
282,731

 
278,337

Intangible assets
204,801

 
232,287

Deferred tax asset
1,047

 
1,115

Other assets
12,489

 
24,813

Total assets
$
705,510

 
$
697,242

 
 
 
 
Liabilities and Stockholders’ Equity
Current liabilities
 
 
 
Accounts payable
$
12,094

 
$
11,407

Accrued liabilities
22,517

 
24,954

Current maturities of long-term debt
6,223

 
7,359

Total current liabilities
40,834

 
43,720

Long-term debt
492,208

 
644,158

Deferred tax liability - noncurrent
678

 
1,016

Other long-term liabilities
25,789

 
36,283

Total liabilities
559,509

 
725,177

Commitments and contingencies (Note 13)

 

Stockholders’ equity

 
 
Preferred stock at $0.01 par value; 100,000 shares authorized, no shares issued and outstanding
—

 
—

Common stock at $0.01 par value; 450,000,000 shares authorized at September 30, 2018 and 46,629,155 at December 31, 2017; and 35,305,479 and 23,208,706 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively.
353

 
149

Additional paid-in capital
359,819

 
177,276

Accumulated deficit
(212,058
)
 
(201,557
)
Accumulated other comprehensive loss
(2,113
)
 
(3,803
)
Total stockholders’ equity
146,001

 
(27,935
)
Total liabilities and stockholders’ equity
$
705,510

 
$
697,242

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

1

PLAYAGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(amounts in thousands, except per share data)
 (unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues
 
 
 
 
 
 
 
Gaming operations
$
50,701

 
$
42,849

 
$
152,887

 
$
125,040

Equipment sales
24,825

 
13,591

 
60,317

 
29,254

Total revenues
75,526

 
56,440

 
213,204

 
154,294

Operating expenses
 
 
 
 
 
 
 
Cost of gaming operations(1)
10,494

 
7,344

 
29,062

 
21,794

Cost of equipment sales(1)
12,109

 
6,330

 
28,919

 
14,326

Selling, general and administrative
15,284

 
9,742

 
47,411

 
30,368

Research and development
7,894

 
6,467

 
23,374

 
17,912

Write-downs and other charges
667

 
490

 
3,282

 
2,655

Depreciation and amortization
18,968

 
16,931

 
57,784

 
53,598

Total operating expenses
65,416

 
47,304

 
189,832

 
140,653

Income from operations
10,110

 
9,136

 
23,372

 
13,641

Other expense (income)
 
 
 
 
 
 
 
Interest expense
8,956

 
12,666

 
28,253

 
42,380

Interest income
(89
)
 
(25
)
 
(162
)
 
(80
)
Loss on extinguishment and modification of debt
—

 
—

 
4,608

 
8,129

Other expense (income)
434

 
(467
)
 
10,121

 
(4,805
)
Income (loss) before income taxes
809

 
(3,038
)
 
(19,448
)
 
(31,983
)
Income tax benefit (expense)
3,538

 
(1,052
)
 
8,947

 
(4,603
)
Net income (loss)
4,347

 
(4,090
)
 
(10,501
)
 
(36,586
)
Foreign currency translation adjustment
1,636

 
(498
)
 
1,690

 
707

Total comprehensive income (loss)
$
5,983

 
$
(4,588
)
 
$
(8,811
)
 
$
(35,879
)
 
 
 
 
 
 
 
 
Basic and diluted earnings (loss) per common share:
 
 
 
 


 
 
Basic
$
0.12

 
$
(0.18
)
 
$
(0.31
)
 
$
(1.58
)
Diluted
$
0.12

 
$
(0.18
)
 
$
(0.31
)
 
$
(1.58
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
35,305

 
23,208

 
34,097

 
23,208

Diluted
36,313

 
23,208

 
34,097

 
23,208

(1) exclusive of depreciation and amortization

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


2

PLAYAGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(amounts in thousands)
 (unaudited)
 
 
 
Common Stock - Shares
 
Common Stock - Amount
 
Additional Paid-in Capital
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Loss
 
Total Stockholders’ Equity
Balance at December 31, 2016
14,932

 
149

 
177,276

 
(156,451
)
 
(4,546
)
 
16,428

Net loss
—

 
—

 
—

 
(45,106
)
 
—

 
(45,106
)
Foreign currency translation adjustment
—

 
—

 
—

 
—

 
743

 
743

Balance at December 31, 2017
14,932

 
149

 
177,276

 
(201,557
)
 
(3,803
)
 
(27,935
)
Net loss
—

 
—

 
—

 
(10,501
)
 
—

 
(10,501
)
Foreign currency translation adjustment
—

 
—

 
—

 
—

 
1,690

 
1,690

Stock-based compensation expense
—

 
—

 
9,167

 
—

 
—

 
9,167

Stock split (1.5543-for-one) and reclassification
8,277

 
83

 
(83
)
 
—

 
—

 
—

Reclassification of management shares
171

 
2

 
1,319

 
—

 
—

 
1,321

Vesting of restricted stock
69

 
—

 
—

 
—

 
—

 
—

Stock option exercises
70

 
1

 
730

 
—

 
—

 
731

Issuance of common stock
11,787

 
118

 
171,410

 
—

 
—

 
171,528

Balance at September 30, 2018
35,305

 
$
353

 
$
359,819

 
$
(212,058
)
 
$
(2,113
)
 
$
146,001


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


3


PLAYAGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Nine months ended September 30,
 
2018
 
2017
Cash flows from operating activities
 
 
 
Net loss
$
(10,501
)
 
$
(36,586
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
57,784

 
53,598

Accretion of contract rights under development agreements and placement fees
3,412

 
3,459

Amortization of deferred loan costs and discount
1,388

 
2,315

Payment-in-kind interest capitalized
—

 
7,807

Payment-in-kind interest payments
(37,624
)
 
(2,698
)
Write-off of deferred loan cost and discount
3,410

 
3,294

Stock-based compensation expense
9,167

 
—

(Benefit) provision for bad debts
(198
)
 
902

Loss on disposition of assets
1,383

 
2,896

Impairment of assets
1,199

 
333

Fair value adjustment of contingent consideration
700

 
—

(Benefit) provision for deferred income tax
(205
)
 
2,147

Changes in assets and liabilities that relate to operations:
 
 
 
Accounts receivable
(12,277
)
 
(9,649
)
Inventories
(3,173
)
 
(453
)
Prepaid expenses
(1,958
)
 
(1,119
)
Deposits and other
(626
)
 
(276
)
Other assets, non-current
13,574

 
(2,010
)
Accounts payable and accrued liabilities
(12,135
)
 
2,333

Net cash provided by operating activities
13,320

 
26,293

Cash flows from investing activities
 
 
 
Business acquisitions, net of cash acquired
(4,452
)
 
(7,000
)
Purchase of intangible assets
(931
)
 
(565
)
Software development
(8,794
)
 
(6,334
)
Proceeds from disposition of assets
21

 
171

Purchases of property and equipment
(34,457
)
 
(35,961
)
Net cash used in investing activities
(48,613
)
 
(49,689
)
Cash flows from financing activities
 
 
 
Proceeds from issuance of first lien credit facilities
—

 
448,725

Repayment of senior secured credit facilities
(115,000
)
 
(410,655
)
Payments on first lien credit facilities
(3,864
)
 
(1,125
)
Payment of financed placement fee obligations
(2,688
)
 
(2,971
)
Payments on deferred loan costs
—

 
(3,127
)
Repayment of seller notes
—

 
(12,401
)
Payments on equipment long-term note payable and capital leases
(2,108
)
 
(1,832
)
Initial public offering cost
(4,160
)
 
(1,203
)
Proceeds from issuance of common stock
176,341

 
—

Proceeds from employees in advance of common stock issuance
—

 
25

Proceeds from stock option exercise
731

 
—

Net cash provided by financing activities
49,252

 
15,436

Effect of exchange rates on cash and cash equivalents and restricted cash
4

 
8

Increase in cash and cash equivalents and restricted cash
13,963

 
(7,952
)
Cash, cash equivalents and restricted cash, beginning of period
19,342

 
17,977

Cash, cash equivalents and restricted cash, end of period
$
33,305

 
$
10,125


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





4
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


NOTE 1. DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

PlayAGS, Inc. (formerly AP Gaming Holdco, Inc.) (the "Company," "PlayAGS," "we," "us," or "our") is a leading designer and supplier of gaming products and services for the gaming industry. We operate in legalized gaming markets across the globe and provide state-of-the-art, value-add products in three distinct segments: Electronic Gaming Machines (“EGM”), which includes server-based systems and back-office systems that are used by Class II Native American and Mexican gaming jurisdictions and Class III Native American, commercial and charitable jurisdictions; Table Products (“Table Products”), which includes live felt table games, side-bets and progressives as well as our newly introduced card shuffler, “DEX S”; and Interactive Social Casino Games (“Interactive”), which provides social casino games on desktop and mobile devices as well as a platform for content aggregation used by real-money gaming (“RMG”) and sports-betting partners. Each segment's activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of a distinct product line.
    
The Company filed a Registration Statement on Form 10 on December 19, 2013, which went effective under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), on December 19, 2013. On January 30, 2018, we completed the initial public offering of 10,250,000 shares of our common stock, at a public offering price of $16.00 per share (the “IPO”).

Electronic Gaming Machines

Our EGM segment offers a selection of video slot titles developed for the global marketplace, and EGM cabinets which include the Orion Portrait, ICON, Halo, Colossal Diamonds (“Big Red”) and our newly introduced Orion Slant. In addition to providing complete EGM units, we offer conversion kits that allow existing game titles to be converted to other game titles offered within that operating platform.

Table Products

Our table products include live proprietary table products and side-bets, as well as ancillary table products. Products include both internally developed and acquired proprietary table products, side-bets, progressives, and table technology related to blackjack, poker, baccarat, craps and roulette. We have acquired a number of popular brands, including In Bet Gaming (“In Bet”), Buster Blackjack, Double Draw Poker and Criss Cross Poker that are based on traditional well-known public domain games such as blackjack and poker; however, these proprietary games provide intriguing betting options that offer more excitement and greater volatility to the player, ultimately enhancing our casino customers’ profitability. In addition, we recently introduced a single deck card shuffler for poker tables, “DEX S.”

Interactive

Our business-to-consumer (“B2C”) social casino games are primarily delivered through our mobile app, Lucky Play Casino. The app contains several game titles available for consumers to play for fun and with coins that they purchase through the app. Some of our most popular social casino games include content that is also popular in land-based settings such as Golden Wins, Royal Wheels and So Hot. We have recently expanded into the business-to-business (“B2B”) space through our core app, Lucky Play Casino, whereby we white label our social casino game product and enable our land-based casino customers to brand the social casino gaming product with their own casino name. With the recent acquisition of Gameiom Technologies Limited (defined below) as described in Note 2, we now offer a platform for B2B content aggregation used by RMG and sports-betting partners.

Basis of Presentation
    
The accompanying condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain disclosures required by generally accepted accounting principles (“GAAP”) are omitted or condensed in these condensed consolidated financial statements. In the opinion of management, all adjustments (consisting of only normal recurring adjustments) that are necessary for a fair statement of the Company's financial position, results of operations and cash flows for the interim periods have been made. The interim results reflected in these condensed consolidated financial statements are not necessarily indicative of results to be expected for the full fiscal year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2017.

5
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


Principles of Consolidation

The accompanying condensed consolidated financial statements include the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires the Company to make decisions based upon estimates, assumptions, and factors considered relevant to the circumstances. Such decisions include the selection of applicable accounting principles and the use of judgment in their application, the results of which impact reported amounts and disclosures. Changes in future economic conditions or other business circumstances may affect the outcomes of the estimates and assumptions. Accordingly, actual results could differ materially from those anticipated.

Revenue Recognition

Gaming Operations

Gaming operations revenue is earned by providing customers with gaming machines, gaming machine content licenses, back-office equipment and linked progressive systems, which are collectively referred to as gaming equipment, under participation arrangements. The participation arrangements convey the right to use the equipment (i.e. gaming machines and related integral software) for a stated period of time, which typically ranges from one to three years upon which the contract continues on a month-to-month basis thereafter. In some instances, the Company will enter arrangements for longer periods of time; however, many of these arrangements include the ability of the customer to cancel the contract and return the games to the Company, a provision which renders their contracts effectively month-to-month contracts. Primarily due to these factors, our participation arrangements are accounted for as operating leases. In some instances, we will offer a free trial period during which no revenue is recognized. If during or at the conclusion of the trial period the customer chooses to enter into a lease for the gaming equipment, we commence revenue recognition according to the terms of the agreement.

Under participation arrangements, the Company retains ownership of the gaming equipment installed at the customer facilities and receives either revenue based on a percentage of the win per day generated by the gaming equipment or a daily fee. Thus, in our consolidated financial statements the Company records revenue monthly related to these arrangements and the gaming equipment is recorded in property and equipment, net on our balance sheet and depreciated over the expected life of the gaming equipment.

The majority of the Company’s leases require the Company to provide maintenance throughout the entire term of the lease. In some cases, a performance guarantee exists that, if not met, provides the customer with the right to return the gaming machines to the Company. This performance guarantee is considered a cancellation clause, a provision which renders their contracts effectively month-to-month contracts. Accordingly, the Company accounts for these contracts in a similar manner with its other operating leases as described above. Whether contractually required or not, the Company develops and provides new gaming titles throughout the life of the lease. Certain arrangements require a portion of the win per day to be retained by the customer to fund facility-specific marketing, advertising and promotions. These amounts retained by the customer reduce the monthly revenue recognized on each arrangement.

Gaming operations revenue is also earned from the licensing of table product content and is earned and recognized on a fixed monthly rate. Our B2C social casino products earn revenue from the sale of virtual coins or chips, which is recorded when the purchased coins or chips are used by the customer. B2C social casino revenue is presented gross of the platform fees. B2B social casino products earn revenue primarily based on a percentage of the monthly revenue generated by the white label casino apps that we build and operate for our customers. RMG revenue is earned primarily based on a percentage of the revenue produced by the games on our platform as well as monthly platform fees and initial integration fees. RMG revenue is presented net of payments to game and content suppliers.

Equipment Sales
Revenues from contracts with customers are recognized and recorded when the following criteria are met:

6
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


•
We have a contract that has been approved by both the customer and the Company. Our contracts specify the products being sold and payment terms and are recognized when it is probable that we will collect substantially all of the contracted amount; and
•
Delivery has occurred and services have been rendered in accordance with the contract terms.

Equipment sales are generated from the sale of gaming machines and licensing rights to game content software that is installed in the gaming machine, parts, and other ancillary equipment. Also included within the deliverables are delivery, installation and training, all of which occur within a few days of arriving at the customer location. Gaming equipment sales do not include maintenance beyond a standard warranty period. The recognition of revenue from the sale of gaming devices occurs as the customer obtains control of the product and all other revenue recognition criteria have been satisfied. Our contracts include a fixed transaction price. Amounts are due from customers within 30 to 90 days of the invoice date and to a lesser extent we offer extended payment terms of 12 to 24 months with payments due monthly during the extended payment period.

The Company enters into revenue arrangements that may consist of multiple performance obligations, which are typically multiple distinct products that may be shipped to the customer at different times. For example, gaming equipment arrangements may include the sale of gaming machines to be delivered upon the consummation of the contract and additional game content conversion kits that will be delivered at a later date when requested by the customer to replace the game content on the customer’s existing gaming machines. Products are identified as separate performance obligations if they are distinct, meaning that the customer can benefit from the product on its own and is separately identifiable from other promises in the contract.

Revenue is allocated to the separate performance obligations based on relative standalone selling prices determined at contract inception. Standalone selling prices are primarily determined by prices that we charge for the products when they are sold separately. When a product is not sold separately, we determine the standalone selling price with reference to our standard pricing policies and practices.

Cash and Cash Equivalents

Cash and cash equivalents consist primarily of deposits held at major banks and other marketable securities with original maturities of 90 days or less.

Restricted Cash

Restricted cash amounts represent funds held in escrow as collateral for the Company’s surety bonds for various gaming authorities.

Allowance for Doubtful Accounts

Accounts receivable are stated at face value less an allowance for doubtful accounts. The Company maintains an allowance for doubtful accounts related to accounts receivable and notes receivable, which are non-interest bearing, deemed to have a high risk of collectability. The Company reviews the accounts receivable and notes receivable on a monthly basis to determine if any receivables will potentially be uncollectible. The Company analyzes historical collection trends and changes in the customers’ payment patterns, customer concentration, and creditworthiness when evaluating the adequacy of the allowance for doubtful accounts. The Company includes any receivable balances that are determined to be uncollectible in the overall allowance for doubtful accounts. Changes in the assumptions or estimates reflecting the collectability of certain accounts could materially affect the allowance for both accounts and notes receivable.

7
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


Inventories

Inventories consist primarily of parts and supplies that are used to repair and maintain machinery and equipment as well as EGMs in production and finished goods held for sale. Inventories are stated at net realizable value. Cost of inventories is determined using the first-in, first-out (“FIFO”) method for all components of inventory. The Company regularly reviews inventory quantities and updates estimates for the net realizable value of inventories. This process includes examining the carrying values of parts and ancillary equipment in comparison to the current fair market values for such equipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levels of the inventories, the current and projected sales levels for such products, the projected markets for such products and the costs required to sell the products, including refurbishment costs. Changes in the assumptions or estimates could materially affect the inventory carrying value. As of September 30, 2018 and December 31, 2017, the value of raw material inventory was $24.6 million and $19.9 million, respectively. As of September 30, 2018 and December 31, 2017, the value of finished goods inventory was $7.2 million and $4.6 million, respectively. There was no work in process material as of September 30, 2018 and December 31, 2017.

Property and Equipment

The cost of gaming equipment, consisting of fixed-base player terminals, file servers and other support equipment as well as other property and equipment, is depreciated over their estimated useful lives, using the straight-line method for financial reporting. The Company capitalizes costs incurred for the refurbishment of used gaming equipment that is typically incurred to refurbish a machine in order to return it to its customer location. The refurbishments extend the useful life of the gaming equipment beyond the original useful life. Repairs and maintenance costs are expensed as incurred. The Company routinely evaluates the estimated lives used to depreciate assets. The estimated useful lives are as follows:
Gaming equipment
2 to 6 years
Other property and equipment
3 to 6 years
 

The Company reviews its property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The Company groups long-lived assets for impairment analysis at the lowest level for which identifiable cash flows can be measured independently of the cash flows of other assets and liabilities. This is typically at the individual gaming machine level or at the cabinet product line level. Impairment testing is performed and losses are estimated when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets’ carrying amount.

When the estimated undiscounted cash flows are not sufficient to recover the asset’s carrying amount, an impairment loss is measured to the extent the fair value of the asset is less than its carrying amount.

The Company measures recoverability of assets to be held and used by comparing the carrying amount of an asset to future cash flows expected to be generated by the asset. The Company’s policy is to impair, when necessary, excess or obsolete gaming machines on hand that it does not expect to be used. Impairment is based upon several factors, including estimated forecast of gaming machine demand for placement into casinos. While the Company believes that the estimates and assumptions used in evaluating the carrying amount of these assets are reasonable, different assumptions could affect either the carrying amount or the estimated useful lives of the assets, which could have a significant impact on the results of operations and financial condition.

Intangible Assets

The Company reviews its identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment losses are recognized for identifiable intangibles, other than goodwill, when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets’ carrying amount.

When the estimated undiscounted cash flows are not sufficient to recover the intangible asset’s carrying amount, an impairment loss is measured to the extent the fair value of the asset is less than its carrying amount.

Certain trade names have an indefinite useful life and the Company tests these trade names for possible impairment at least annually, on October 1, or whenever events or changes in circumstances indicate that the carrying value may be impaired. We

8
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

perform a qualitative assessment to determine if it is more likely than not that the fair value of the asset is less than its carrying amount. If we believe, as a result of our qualitative assessment, that it is more likely than not that the fair value of the asset is less than its carrying amount, the quantitative impairment test is required.

Costs of Capitalized Computer Software

Internally developed gaming software represents the Company’s internal costs to develop gaming titles to utilize on the Company’s gaming machines. Internally developed gaming software is stated at cost and amortized over the estimated useful lives of the software, using the straight-line method. Software development costs are capitalized once technological feasibility has been established and are amortized when the software is placed into service. The computer software we develop reaches technological feasibility when a working model of the computer software is available. Any subsequent software maintenance costs, such as bug fixes and subsequent testing, are expensed as incurred. Discontinued software development costs are expensed when the determination to discontinue is made. Software development costs are amortized over the expected life of the title or group of titles, if applicable, to amortization expense.

On a quarterly basis, or more frequently if circumstances warrant, the Company compares the net book value of its internally developed computer software to the net realizable value on a title or group of title basis. The net realizable value is determined based upon certain assumptions, including the expected future revenues and net cash flows of the gaming titles or group of gaming titles utilizing that software, if applicable.

Goodwill

The excess of the purchase price of an acquired business over the estimated fair value of the assets acquired and the liabilities assumed is recorded as goodwill. The Company tests for possible impairment of goodwill at least annually, on October 1, or when circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The Company has the option to begin with a qualitative assessment, commonly referred to as “Step 0”, to determine whether it is more likely than not that the reporting unit’s fair value of goodwill is less than its carrying value. This qualitative assessment may include, but is not limited to, reviewing factors such as the general economic environment, industry and market conditions, changes in key assumptions used since the most recently performed valuation and overall financial performance of the reporting units. If the Company determines that it is more likely than not that a reporting unit’s fair value is less than its carrying value, the Company performs a quantitative goodwill impairment analysis, and depending upon the results of that measurement, the recorded goodwill may be written down and charged to income from operations when the carrying amount of the reporting unit exceeds the fair value of the reporting unit. As of September 30, 2018, there were no indicators of goodwill impairment.

Acquisition Accounting

The Company applies the provisions of ASC 805, “Business Combinations” (ASC 805), in accounting for business acquisitions. It requires us to recognize separately from goodwill the fair value of assets acquired and liabilities assumed on the acquisition date. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. Significant estimates and assumptions are required to value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable. These estimates are inherently uncertain and subject to refinement and typically include the calculation of an appropriate discount rate and projection of the cash flows associated with each acquired asset. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the consolidated statements of operations.

Fair Value of Financial Instruments

The Company applies the provisions of ASC 820, “Fair Value Measurements” (ASC 820) to its financial assets and liabilities. Fair value is defined as a market-based measurement intended to estimate the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs when measuring fair value. These inputs are categorized as follows:


9
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

•
Level 1 - quoted prices in an active market for identical assets or liabilities;
•
Level 2 - quoted prices in an active market for similar assets or liabilities, inputs other than quoted prices that are observable for similar assets or liabilities, inputs derived principally from or corroborated by observable market data by correlation or other means; and
•
Level 3 - valuation methodology with unobservable inputs that are significant to the fair value measurement.

The carrying values of the Company’s cash and cash equivalents, restricted cash, receivables and accounts payable approximate fair value because of the short term maturities of these instruments. The fair value of our long-term debt is based on the quoted market prices for similar issues (Level 2 inputs). The estimated fair value of our total debt balance as of September 30, 2018 and December 31, 2017 was $513.0 million and $675.7 million, respectively.

Accounting for Income Taxes

We conduct business globally and are subject to income taxes in U.S. federal, state, local, and foreign jurisdictions. Determination of the appropriate amount and classification of income taxes depends on several factors, including estimates of the timing and probability of realization of deferred income taxes, reserves for uncertain income tax positions and income tax payment timing

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Taxes on income of our foreign subsidiaries are provided at the tax rates applicable to the tax jurisdictions in which they are located. Future tax benefits are recognized to the extent that realization of those benefits is considered more likely than not and a valuation allowance is established for deferred tax assets which do not meet this threshold.

The recoverability of certain deferred tax assets is based in part on estimates of future income and the timing of temporary differences, and the failure to fully realize such deferred tax assets could result in a higher tax provision in future periods.

We apply the accounting guidance to our uncertain tax positions and under the guidance, we may recognize a tax benefit from an uncertain position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the issue. The amount recognized in the financial statements is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement.

We are required to make significant judgments when evaluating our uncertain tax positions and the related tax benefits. We believe our assumptions are reasonable; however, there is no guarantee that the final outcome of the related matters will not differ from the amounts reflected in our income tax provisions and accruals. We adjust our liability for uncertain tax positions based on changes in facts and circumstances such as the closing of a tax audit or changes in estimates. We adjusted our liability in the quarter ended September 30, 2018, which is described in Note 12.

On December 22, 2017, President Trump signed H.R. 1, originally known as the “Tax Cuts and Jobs Act” (the “Tax Act”) into law, which significantly reformed the Internal Revenue Code of 1986, as amended. The new legislation, among other things, changed the U.S. federal tax rates (including permanently reducing the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate), allowed the expensing of capital expenditures, and put into effect the migration from a “worldwide” system of taxation to a territorial system. The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. The Company has recognized the provisional tax impacts related to deemed repatriated earnings and the revaluation of deferred tax assets and liabilities and included these amounts in its consolidated financial statements for the period ended December 31, 2017. The ultimate impact of the Tax Act on our consolidated financial statements may differ from these provisional amounts, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the Tax Act. For the nine months ended September 30, 2018, there was no change to the provisional Transaction Tax recorded in the prior period. The Company expects to complete its analysis within one year from the Tax Act’s enactment in accordance with SAB 118.


10
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Under U.S. GAAP, the Company must make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to Global Intangible Low-Taxed Income ("GILTI") as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method). The Company has elected the period cost method and has considered the estimated 2018 GILTI impact in its 2018 tax expense which we currently deem to be immaterial on the consolidated financial statements.

Contingencies

The Company assesses its exposures to loss contingencies including claims and legal proceedings and accrues a liability if a potential loss is considered probable and the amount can be estimated. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, if the actual loss from a contingency differs from management’s estimate, there could be a material impact on the results of operations or financial position. Operating expenses, including legal fees, associated with contingencies are expensed when incurred.

Foreign Currency Translation

The financial statements of the Company’s foreign subsidiaries are translated into U.S. dollars at the period end rate of exchange for asset and liability accounts and the weighted average rate of exchange for income statement accounts. The effects of these translations are recorded as a component of other accumulated comprehensive loss in stockholders’ equity.

Recently Issued Accounting Pronouncements

Adopted in the Current Year

In May 2014, the FASB issued an accounting standards update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which clarifies the principles for recognizing revenue from contracts with customers. The amendment outlines a single comprehensive model for entities to depict the transfer of goods or services to customers in amounts that reflect the payment to which a company expects to be entitled in exchange for those goods or services. The amendment also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. The ASU may be adopted using either a full retrospective transition method or a modified retrospective transition method and was adopted by the Company on January 1, 2018. The Company used the modified retrospective application approach and the adoption of the new revenue standards did not have a material impact on its consolidated financial statements as the majority of our revenue is recognized under lease accounting guidance. Related disclosures of the Company’s revenue recognition policy have been updated above under Revenue Recognition to reflect the adoption of the new standards.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). ASU 2016-15 intends to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company adopted this ASU in the current year and it did not have a material effect on our financial condition, results of operations or cash flows.

The FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash in 2016. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We adopted the guidance retrospectively at the beginning of the first quarter of 2018. The adoption of this guidance resulted in immaterial increases to the cash, cash equivalents and restricted cash beginning-of-period and end-of period line items in the statement of cash flows to include the balance of restricted cash.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The new guidance clarifies the definition of a business in order to allow for the evaluation of whether transactions should

11
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

be accounted for as acquisitions or disposals of assets or businesses. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We adopted this ASU in the current year and it will be effective for acquisitions that are consummated in the current and future periods.

To be Adopted in Future Periods

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 intends to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The adoption of this guidance is expected to result in a significant portion of our operating leases, where we are the lessee, to be recognized on our consolidated balance sheets. The FASB also issued ASU 2018-11, Leases (Topic 842) Targeted Improvements in July 2018. These ASUs allow lessees and lessors to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach or at the adoption date with recognition of a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years with earlier adoption permitted. The Company is currently evaluating the provisions of the amendment and the impact on its future consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement—Reporting Comprehensive (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. ASU 2018-02 requires the remeasurement of deferred tax assets and liabilities as a result of a change in tax laws or rates to be presented in net income from continuing operations. Adjusting temporary differences originally recorded to Accumulated Other Comprehensive Income (“AOCI”) through continuing operations may result in disproportionate tax effects ultimately being lodged in AOCI. The new guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact of adopting this guidance.

We do not expect that any other recently issued accounting guidance will have a significant effect on our financial statements.

NOTE 2. ACQUISITIONS

AGS iGaming

During the quarter ended June 30, 2018, the Company acquired all of the equity of Gameiom Technologies Limited (formerly known as “Gameiom”, currently known as “AGS iGaming”). AGS iGaming is a licensed gaming aggregator and content provider for real-money gaming (“RMG”) and sports betting partners. The acquisition was accounted for as an acquisition of a business and the assets acquired and liabilities assumed were measured based on our preliminary estimates of their fair values at the acquisition date. The estimated fair values of assets acquired and liabilities assumed and resulting goodwill are subject to adjustment as we finalize our fair value analysis. The significant items for which a final fair value has not been determined as of the filing of this report include the fair value of intangible assets. We expect to complete our fair value determinations no later than one year from the acquisition date.

We attribute the goodwill acquired to our ability to utilize AGS iGaming’s existing RMG platform to distribute our existing EGM game content into many markets, diversification of our Interactive segment’s product portfolio that now includes a real-money gaming solution and other strategic benefits. Total consideration of $5.0 million included cash paid of $4.5 million and $0.5 million of deferred consideration that is payable within 18 months of the acquisition date. The consideration was preliminarily allocated primarily to goodwill that is not tax deductible for $3.4 million and intangible assets of $2.4 million, which will be amortized over a weighted average period of approximately 6.8 years.

The intangible assets consist primarily of customer relationships and a technology platform. The customer relationships were valued using the excess earnings method (level 3 fair value measurement), which is a risk-adjusted discounted cash flow approach that determines the value of an intangible asset as the present value of the cash flows attributable to such asset after excluding the proportion of the cash flows that are attributable to other assets. The contribution to the cash flows that are made by other assets - such as working capital, workforce and other intangible assets - was estimated through contributory asset capital charges. The value of the customer relationships is the present value of the attributed post-tax cash flows, net of the post-tax return on fair value attributed to the other assets. The technology platform was valued using the royalty savings method (level 3 fair value measurement), which is a risk-adjusted discounted cash flow approach. The royalty savings method values an intangible asset by estimating the royalties saved through ownership of the asset. The royalty savings method requires identifying the future revenue that would be impacted by the technology platform (or royalty-free rights to the assets), multiplying it by a royalty rate deemed

12
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

to be avoided through ownership of the asset and discounting the projected royalty savings amounts back to the acquisition date.  The royalty rate used in such valuation was based on a consideration of market rates for similar categories of assets.

Rocket Gaming Systems

On December 6, 2017, the Company acquired an installed base of approximately 1,500 Class II EGMs across the United States that were operated by Rocket Gaming Systems (“Rocket”) for total consideration of $56.9 million that was paid at the acquisition date. This asset acquisition was accounted for as an acquisition of a business. The acquisition expanded the Company’s Class II footprint in primary markets such as California, Oklahoma, Montana, Washington and Texas and is expected to provide incremental revenue as the Company upgrades the EGMs with its game content and platforms over the next several years. In addition, the acquisition expanded the Company’s product library and included a wide-area progressive and standalone video and spinning-reel games and platforms, including Gold Series®, a suite of games that feature a $1 million+ progressive prize that is the longest-standing million dollar wide-area progressive on tribal casino floors.

We have recorded the Rocket assets acquired and liabilities assumed based on our estimates of their fair values at the acquisition date. The determination of the fair values of the assets acquired and liabilities assumed (and the related determination of estimated lives of depreciable and amortizable tangible and identifiable intangible assets) requires significant judgment and estimates. The estimates and assumptions used include the projected timing and amount of future cash flows and discount rates that reflect risk inherent in the future cash flows. The estimated fair values of the Rocket assets acquired and liabilities assumed and resulting goodwill are subject to adjustment as we finalize our fair value analysis. The significant items for which a final fair value has not been determined as of the filing of this report on Form 10-Q include the fair value of property and equipment and intangible assets. We expect to complete our fair value determinations no later than one year from acquisition date. We do not currently expect our fair value determinations to change; however, there may be differences compared to those amounts reflected in our consolidated financial statements as we finalize our fair value analysis and such changes could be material.

The preliminary allocation of the purchase price to the estimated fair values of the assets acquired and the liabilities assumed was as follows (in thousands):    
Inventories
$
354

Property and Equipment
3,307

Goodwill
23,417

Intangible assets
30,090

      Total Assets
57,168

Other long-term liabilities
(318
)
Total purchase price
$
56,850


Based on our preliminary estimates, the total consideration exceeded the aggregate estimated fair value of the acquired assets and assumed liabilities at the acquisition date and has been recorded as goodwill. We attribute this goodwill to our opportunities for synergies through our ability to leverage our existing service network to service the acquired assets, the opportunity to derive incremental revenue through upgrading the EGMs with the Company’s existing game content and platforms and other strategic benefits. The goodwill associated with the acquisition is deductible for income tax purposes.

Our preliminary estimates of the fair values of identifiable intangible assets include $21.9 million customer relationships, $7.2 million gaming software and technology platforms, and $0.9 million trade names. The intangible assets have a weighted average useful life of 6.4 years.

The fair value of property and equipment assets as well as the fair value of gaming content software was primarily determined using cost approaches in which we determined an estimated reproduction or replacement cost, as applicable.

The estimated fair value of customer relationships was determined using the excess earnings method, which is a risk-adjusted discounted cash flow approach that determines the value of an intangible asset as the present value of the cash flows attributable to such asset after excluding the proportion of the cash flows that are attributable to other assets. The contribution to the cash flows that are made by other assets - such as fixed assets, working capital, workforce and other intangible assets - was estimated through contributory asset capital charges. The value of the acquired customer relationship asset is the present value of the attributed post-tax cash flows, net of the post-tax return on fair value attributed to the other assets.


13
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The estimated fair values of acquired trade names and gaming technology platforms were primarily determined using the royalty savings method, which is a risk-adjusted discounted cash flow approach. The royalty savings method values an intangible asset by estimating the royalties saved through ownership of the asset. The royalty savings method requires identifying the future revenue that would be impacted by the trade name or intellectual property (or royalty-free rights to the assets), multiplying it by a royalty rate deemed to be avoided through ownership of the asset and discounting the projected royalty savings amounts back to the acquisition date.  The royalty rate used in such valuation was based on a consideration of market rates for similar categories of assets.

The revenue and net loss of Rocket from the acquisition date through December 31, 2017, are presented below and are included in our consolidated statements of operations and comprehensive loss. These amounts are not necessarily indicative of the results of operations that Rocket would have realized if it had continued to operate as a stand-alone company during the period presented, primarily due to the inclusion of amortization on purchased intangible assets and short term transition services expenses that the Company incurred in December 2017.
 
From December 6, 2017 through December 31, 2017
Revenue
$
1,139

Net income
$
203


It is not practicable to provide pro forma statements of operations giving effect to the Rocket acquisition as if it had been completed at an earlier date. This is due to the lack of historical financial information sufficient to produce such pro forma statements given that the Company purchased specific assets from the sellers that were not segregated in the seller’s financial records and for which separate carve-out financial statements were not produced.

In Bet Gaming

During the quarter ended September 30, 2017, the Company acquired certain intangible assets related to the purchase of table games and table game related intellectual property from In Bet. The acquisition was accounted for as an acquisition of a business and the assets acquired and liabilities assumed were measured based on our final estimates of their fair values at the acquisition date. We attribute the goodwill acquired to our ability to commercialize the products over our distribution and sales network, opportunities for synergies, and other strategic benefits. Total consideration of $9.6 million included an estimated $2.6 million of contingent consideration that is payable upon the achievement of certain targets and periodically based on a percentage of product revenue earned on the purchased table games. 

The consideration was allocated primarily to tax deductible goodwill for $3.2 million and intangible assets of $5.5 million, which will be amortized over a weighted average period of approximately 9 years.   

The contingent consideration was valued using scenario-based methods (the Company used level 3 of observable inputs in this valuation) that account for the expected timing of payments to be made and discounted using an estimated borrowing rate.  The borrowing rate utilized for this purpose was developed with reference to the Company’s existing borrowing rates, adjusted for the facts and circumstances related to the contingent consideration.

The intangible assets consist of a primary asset that includes the intellectual property acquired, which asset represents the majority of the intangible asset value.  This intellectual property was valued using the excess earnings method (the Company used level 3 of observable inputs in this valuation), which is a risk-adjusted discounted cash flow approach that determines the value of an intangible asset as the present value of the cash flows attributable to such asset after excluding the proportion of the cash flows that are attributable to other assets. The contribution to the cash flows that are made by other assets - such as working capital, workforce and other intangible assets - was estimated through contributory asset capital charges. The value of the acquired intellectual property is the present value of the attributed post-tax cash flows, net of the post-tax return on fair value attributed to the other assets.

14
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


NOTE 3. PROPERTY AND EQUIPMENT

Property and equipment consist of the following (in thousands):
 
September 30,
2018
 
December 31,
2017
Gaming equipment
$
138,600

 
$
125,064

Other property and equipment
20,899

 
17,229

Less: Accumulated depreciation
(75,176
)
 
(64,311
)
Total property and equipment, net
$
84,323

 
$
77,982


Gaming equipment and other property and equipment are depreciated over the respective useful lives of the assets ranging from two to six years. Depreciation expense was $8.0 million and $7.1 million for the three months ended September 30, 2018 and 2017, respectively. Depreciation expense was $23.7 million and $19.9 million for the nine months ended September 30, 2018 and 2017, respectively.
NOTE 4. GOODWILL AND INTANGIBLES
There were no accumulated impairments of goodwill as of September 30, 2018. Changes in the carrying amount of goodwill are as follows (in thousands):
 
Gross Carrying Amount
 
EGM
 
Table Products
 
Interactive
 
Total
Balance at December 31, 2017
$
266,868

 
$
6,641

 
$
4,828

 
$
278,337

Acquisition - Interactive
—

 
—

 
3,359

 
3,359

Foreign currency adjustments
925

 
—

 
(90
)
 
835

Purchase accounting adjustment
200

 
—

 
—

 
200

Balance at September 30, 2018
$
267,993

 
$
6,641

 
$
8,097

 
$
282,731


Intangible assets consist of the following (in thousands):
 
 
 
September 30, 2018
 
December 31, 2017
 
Useful Life (years)
 
Gross
Value
 
Accumulated
Amortization
 
Net Carrying
Value
 
Gross
Value
 
Accumulated
Amortization
 
Net Carrying
Value
Indefinite lived trade names
Indefinite
 
$
12,126

 
$
—

 
$
12,126

 
$
12,126

 
$
—

 
$
12,126

Trade and brand names
7
 
14,730

 
(9,943
)
 
4,787

 
14,730

 
(7,642
)
 
7,088

Customer relationships
7
 
189,496

 
(87,435
)
 
102,061

 
188,419

 
(69,564
)
 
118,855

Contract rights under development and placement fees
1 - 7
 
17,622

 
(13,227
)
 
4,395

 
16,834

 
(9,860
)
 
6,974

Gaming software and technology platforms
1 - 7
 
148,152

 
(78,507
)
 
69,645

 
141,231

 
(67,189
)
 
74,042

Intellectual property
10 - 12
 
17,205

 
(5,418
)
 
11,787

 
17,180

 
(3,978
)
 
13,202

 
 
 
$
399,331

 
$
(194,530
)
 
$
204,801

 
$
390,520

 
$
(158,233
)
 
$
232,287

 

Intangible assets are amortized over their respective estimated useful lives ranging from one to twelve years. Amortization expense related to intangible assets was $11.0 million and $9.9 million for the three months ended September 30, 2018 and 2017, respectively. Amortization expense related to intangible assets was $34.1 million and $33.7 million for the nine months ended September 30, 2018 and 2017, respectively.




15
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The Company enters into development agreements and placement fee agreements with certain customers to secure floor space under lease agreements for its gaming machines. Amounts paid in connection with the development agreements are repaid to the Company in accordance with the terms of the agreement, whereas placements fees are not reimbursed. For development agreements in the form of a loan, interest income is recognized on the repayment of the notes based on the stated rate or, if not stated explicitly in the development agreement, on an imputed interest rate. If the stated interest rate is deemed to be other than a market rate or zero, a discount is recorded on the note receivable as a result of the difference between the stated and market rate and a corresponding intangible asset is recorded. The intangible asset is recognized in the financial statements as a contract right under development agreement and amortized as a reduction in revenue over the term of the agreement. Placement fees can be in the form of cash paid upfront or free lease periods and are accreted over the life of the contract and the expense is recorded as a reduction of revenue. We recorded a reduction of gaming operations revenue from the accretion of contract rights under development agreements and placement fees of $1.2 million for the three months ended September 30, 2018 and 2017. We recorded a reduction of gaming operations revenue from the accretion of contract rights under development agreements and placement fees of $3.4 million and $3.5 million for the nine months ended September 30, 2018 and 2017.
NOTE 5. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
 
September 30,
2018
 
December 31,
2017
Salary and payroll tax accrual
$
9,962

 
$
9,449

Taxes payable
3,238

 
2,655

License fee obligation
1,000

 
1,000

Placement fees payable
2,438

 
4,000

Accrued other
5,879

 
7,850

Total accrued liabilities
$
22,517

 
$
24,954

 

NOTE 6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
 
September 30,
2018
 
December 31,
2017
First Lien Credit Facilities:
 
 
 
Term loans, interest at LIBOR or base rate plus 4.25% (6.33% at September 30, 2018), net of unamortized discount and deferred loan costs of $11.7 million and $13.4 million at September 30, 2018 and December 31, 2017, respectively.
$
497,071

 
$
499,173

Senior secured PIK notes, net of unamortized discount and deferred loan costs of $3.0 million at December 31, 2017.
—

 
149,588

Equipment long-term note payable and capital leases
1,360

 
2,756

Total debt
498,431

 
651,517

Less: Current portion
(6,223
)
 
(7,359
)
Long-term debt
$
492,208

 
$
644,158


First Lien Credit Facilities

On June 6, 2017 (the “Closing Date”), AP Gaming I, LLC (the “Borrower”), a wholly owned indirect subsidiary of the Company, entered into a first lien credit agreement (“the First Lien Credit Agreement”), providing for $450.0 million in term loans and a $30.0 million revolving credit facility (the “First Lien Credit Facilities”).  The proceeds of the term loans were used primarily to repay the senior secured credit facilities (the “Existing Credit Facilities”), the notes issued by the Company to AGS Holdings, LLC (the “AGS Seller Notes”) and the promissory note issued by the Company to Amaya Inc. (the “Amaya Seller Note”), to pay for the fees and expenses incurred in connection with the foregoing and otherwise for general corporate purposes.

On December 6, 2017, AP Gaming I, LLC (the “Borrower”), a wholly owned indirect subsidiary of the Company, entered into incremental facilities for $65.0 million in term loans. The net proceeds of the incremental term loans were used to finance the acquisition of electronic gaming machines and related assets operated by Rocket as described in Note 2, to pay fees and expenses in connection therewith and for general corporate purposes. 

16
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


On February 7, 2018, the Company entered into an Incremental Assumption and Amendment Agreement (the “Incremental Agreement”), which amended and restated the First Lien Credit Agreement, dated as of June 6, 2017, as amended by the incremental facilities dated as of December 6, 2017, to reduce the applicable margin for the term loans thereunder by 1.25%. The Incremental Agreement also provides that any refinancing of the term loans through the issuance of certain debt or any repricing amendment resulting in a lower yield occurring at any time during the first six months after February 7, 2018 will be accompanied by a 1.00% payment premium or fee.

Prior to entering into the Incremental Agreement, net deferred loan costs and discounts totaling $13.3 million were capitalized and were being amortized over the term of the agreement. In conjunction with the Incremental Agreement approximately $0.4 million of these deferred loan costs and discounts was written off as a portion of the loss on extinguishment and modification of debt and the remainder of these cost will be amortized over the remaining term of the First Lien Credit Facilities. An additional $1.2 million in third party fees was incurred related to the Incremental Agreement. Given the composition of the lender group, certain lenders were accounted for as a debt modification and, as such, $1.2 million of these costs were expensed and included in the loss on extinguishment and modification of debt.

The term loans will mature on February 15, 2024, and the revolving credit facility will mature on June 6, 2022. Starting with the first full quarter after the Closing Date, the term loans require scheduled quarterly payments in amounts equal to 0.25% of the original aggregate principal amount of the term loans, with the balance due at maturity.  Borrowings under the term loans bear interest at a rate equal to, at the Borrower’s option, either LIBOR or the base rate, subject to an interest rate floor plus an applicable margin rate.  Borrowings under the revolving credit facility bear interest at a rate equal to, at the Borrower’s option, either LIBOR or the base rate plus an applicable margin rate.  In addition, on a quarterly basis, the Borrower is required to pay each lender under the revolving credit facility a commitment fee in respect of any unused commitments thereunder at a rate of 0.50% per annum.

The First Lien Credit Facilities are guaranteed by AP Gaming Holdings, LLC, the Borrower’s material, wholly owned domestic subsidiaries (subject to certain exceptions), and are secured by a pledge by AP Gaming Holdings, LLC of the Borrower’s equity interest directly held by AP Gaming Holdings, LLC and a pledge of substantially all of the existing and future property and assets of the Borrower and the subsidiary guarantors, subject to certain exceptions. The First Lien Credit Facilities require that the Borrower maintain a maximum net first lien leverage ratio set at a maximum of 6.0 to 1.0. 

The First Lien Credit Facilities also contain customary affirmative covenants and negative covenants that limit our ability to, among other things: (i) incur additional debt or issue certain preferred shares; (ii) create liens on certain assets; (iii) make certain loans or investments (including acquisitions); (iv) pay dividends on or make distributions in respect of our capital stock or make other restricted payments; (v) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; (vi) sell assets; (vii) enter into certain transactions with our affiliates; (viii) enter into sale-leaseback transactions; (ix) change our lines of business; (x) restrict dividends from our subsidiaries or restrict liens; (xi) change our fiscal year; and (xii) modify the terms of certain debt or organizational agreements. The new senior secured credit facilities also contain customary events of default included in similar financing transactions, including, among others, failure to make payments when due, default under other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments.

On October 5, 2018, the Borrower, entered into an Incremental Assumption and Amendment Agreement No. 2 (the “Incremental Agreement No. 2”) with certain of the Borrower’s subsidiaries, the lenders party thereto from time to time and Jefferies finance LLC, as administrative agent, (the “Administrative Agent”). For more information on the Incremental Agreement, see Note 15 - Subsequent Events.

Amended and Restated Senior Secured PIK Notes

On January 30, 2018, the Company used the net proceeds of the IPO and cash on hand to redeem in full its 11.25% senior secured PIK notes due 2024 (the “PIK Notes”). On the redemption date, the aggregate principal amount of the PIK Notes outstanding was $152.6 million (comprised of the original principal amount of $115 million and the remaining principal amount comprised of capitalized interest) and the amount of accrued and unpaid interest was $1.4 million. In connection with the redemption, the Company repaid all of the outstanding obligations in respect of principal, interest and fees under the PIK Notes and net deferred loan costs and discounts totaling $3.0 million were written off and included in the loss on extinguishment and modification of debt.


17
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Concurrently with the redemption of the PIK notes, the Company terminated its amended and restated note purchase agreement (the “A&R Note Purchase Agreement”), dated May 30, 2017, among the Company, AP Gaming Holdings, LLC, as subsidiary guarantor, Deutsche Bank AG, London Branch, as holder, and Deutsche Bank Trust Company Americas, as collateral agent, which governed the PIK Notes.

Equipment Long Term Note Payable and Capital Leases

The Company has entered into a financing agreement to purchase certain gaming devices, systems and related equipment and has entered into leases for vehicles and equipment that are accounted for as capital leases.

NOTE 7. STOCKHOLDERS’ EQUITY

Common Stock

Prior to the completion of the IPO, the Company’s common stock consisted of two classes: class A voting common stock (“Class A Shares”) and class B non-voting common stock (“Class B Shares”). In connection with the IPO, we (i) reclassified Class B Shares into a new class of voting common stock, which is the class of stock investors received in the IPO, and (ii) canceled the Class A Shares. Concurrent with this reclassification, and immediately prior to the consummation of the IPO, we effected a 1.5543-for-1 stock split of the Company’s new voting common stock such that existing stockholders each received 1.5543 shares of the new voting common stock described above in clause (i) for each share of Class B Shares they held at that time. Accordingly, all share and per share amounts for all periods presented in these financial statements and notes thereto have been adjusted retroactively, where applicable, to reflect the stock split.

On January 30, 2018, the Company completed the IPO, in which it issued and sold 10,250,000 shares of common stock at a public offering price of $16.00 per share. On February 27, 2018 the Company sold an additional 1,537,500 shares of its common stock, pursuant to the underwriters’ exercise in full of the over-allotment option. The aggregate net proceeds received by the Company from the IPO were $171.5 million, after deducting underwriting discounts and commissions and offering expenses directly related to issuance of the equity.
    
Prior to the consummation of the IPO, 170,712 shares of common stock were held by management. Pursuant to the Securityholders Agreement dated April 28, 2014 (the “Securityholders Agreement”), these shares were outstanding, but were not considered issued for accounting purposes as they contained a substantive performance condition, a “Qualified Public Offering”, as defined in the Securityholders Agreement, which had to be probable for the holders of these shares to benefit from their ownership. The IPO satisfied the substantive performance condition and as a result the shares and related proceeds of $1.3 million were reclassified from other long-term liabilities to additional paid-in capital and considered issued for accounting purposes. During the three and nine month period ended September 30, 2018, the Company recognized stock-based compensation expense for stock options and restricted stock awards, which is further described in Note 11.

As further clarification of the foregoing, prior to the IPO, shares were held by management that were subject to repurchase rights as outlined in Section 6 of the Securityholders Agreement, that were contingent on the holder’s termination. The repurchase rights enabled the Company to recover the shares issued to management without transferring any appreciation of the fair value of the stock to the holder upon certain terminations of the holder’s employment prior to a “Qualified Public Offering”, as defined in the Securityholders Agreement. If a holder’s employment was terminated by the Company prior to the consummation of a Qualified Public Offering for “Cause”, as defined in the Securityholders Agreement, or was terminated by such holder without “Good Reason”, as defined in the Securityholders Agreement, then the Company had the right to repurchase all or any portion of the shares held by the holder for the lesser of original cost or fair market value. If a holder’s employment was terminated by the Company prior to the consummation of a Qualified Public Offering other than as described above and in the Securityholders Agreement, then the Company had the right to repurchase all or any portion of the shares held by the holder for fair market value.
    

18

NOTE 8. WRITE-DOWNS AND OTHER CHARGES

The Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) include various non-routine transactions or consulting and transaction-related fees that have been classified as write-downs and other charges. During the three months ended September 30, 2018, the Company recognized $0.7 million in write-downs and other charges driven by losses from the disposal of assets of $0.4 million, impairment of intangible assets related to game titles of $0.2 million (level 3 fair value measurement based on projected cash flows), and a $0.1 million fair value adjustment to contingent consideration (level 3 fair value measurement based on projected cash flows). During the nine months ended September 30, 2018, the Company recognized $3.3 million in write-downs and other charges driven by losses from the disposal of assets of $1.4 million, the impairment to intangible assets of $1.2 million related to game titles and a development agreement (the Company used level 3 of observable inputs in conducting the impairment tests), and a fair value adjustment to contingent consideration of $0.7 million (the Company used level 3 fair value measurements based on projected cash flows).

During the three months ended September 30, 2017, the Company recognized $0.5 million in write-downs and other charges driven by losses from the disposal of assets. During the nine months ended September 30, 2017, the Company recognized $2.7 million in write-downs and other charges, driven by losses from the disposal of assets of $2.9 million and the impairment to intangible assets of $0.3 million related to game titles (the Company used level 3 fair value measurement based on projected cash flows for the specific game titles), offset by a fair value adjustment to an acquisition contingent receivable of $0.6 million (the Company used level 3 fair value measurements based on projected cash flows). The contingency was resolved within the quarter ended March 31, 2017.

NOTE 9. BASIC AND DILUTED INCOME (LOSS) PER SHARE

The Company computes net income (loss) per share in accordance with accounting guidance that requires presentation of both basic and diluted earnings per share (“EPS”) on the face of the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss). Basic EPS is computed by dividing net income (loss) for the period by the weighted average number of shares outstanding during the period. Basic EPS includes common stock weighted for average number of shares issued during the period. Diluted EPS is computed by dividing net income (loss) for the period by the weighted average number of common shares outstanding during the period, increased by potentially dilutive common shares that were outstanding during the period. Diluted EPS excludes all potential dilutive shares if their effect is anti-dilutive. Potentially dilutive common shares include stock options and restricted stock, see Note 11.

The weighted average number of common and common equivalent shares used in the calculation of basic and diluted EPS consisted of the following (in thousands, except per share amounts):
 
 
Three months ended September 30, 2018
Numerator:
 
 
Net income
 
$
4,347

Net income attributable to participating securities
 
(16
)
Net income attributable to common stock
 
$
4,331

 
 
 
Denominator:
 
 
Weighted average of common shares outstanding
 
35,305

Potential dilutive effect of stock options
 
1,008

Weighted average of common and common equivalent shares outstanding
 
36,313

 
 
 
Basic earnings per share
 
$
0.12

Diluted earnings per share
 
$
0.12


There were no potentially dilutive securities for the nine months ended September 30, 2018.

Included within the calculation of diluted EPS for the three months ended September 30, 2018 was 1,007,988 stock options, as such securities were dilutive. Excluded from the calculation of diluted EPS for the nine months ended September 30, 2018 was 70,744 restricted shares and 840,815 stock options, as such securities were anti-dilutive.

19
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


Excluded from the calculation of diluted EPS for the three months ended September 30, 2017 was 77,715 restricted shares and 386,424 stock options, as such securities were anti-dilutive. Excluded from the calculation of diluted EPS for the nine months ended September 30, 2017 was 77,715 restricted shares and 412,058 stock options, as such securities were anti-dilutive.
NOTE 10. BENEFIT PLANS
The Company has established a 401(k) plan (the “401(k) Plan”) for its employees. The 401(k) Plan allows employees to contribute a portion of their earnings, and the Company may match a percentage of the contributions on a discretionary basis. The expense associated with the 401(k) Plan for the three months ended September 30, 2018 and 2017, was $0.3 million and $0.2 million, respectively. The expense associated with the 401(k) Plan for the nine months ended September 30, 2018 and 2017, was $0.9 million and $0.8 million, respectively.
On April 28, 2014, the board of directors of the Company approved the 2014 Long-Term Incentive Plan (“LTIP”). Under the LTIP, the Company is authorized to grant nonqualified stock options, rights to purchase common stock, restricted stock, restricted stock units and other awards settleable in, or based upon, common stock to persons who are directors and employees of and consultants to the Company or any of its subsidiaries on the date of the grant. The LTIP will terminate ten years after approval by the board. Subject to adjustments in connection with certain changes in capitalization, the maximum number of shares of common stock that may be delivered pursuant to awards under the LTIP is 2,253,735. As of September 30, 2018, approximately 423,468 shares remain available for issuance.
On January 16, 2018, our board adopted and our stockholders approved the 2018 Omnibus Incentive Plan (the “Omnibus Incentive Plan”) pursuant to which equity-based and cash incentives may be granted to participating employees, directors and consultants. The Omnibus Incentive Plan provides for an aggregate of 1,607,389 shares of our common stock. As of September 30, 2018, 1,285,597 shares remain available for issuance.
NOTE 11. SHARE-BASED COMPENSATION

Stock Options

The Company has granted stock awards to eligible participants under its incentive plans. The stock awards include options to purchase the Company’s common stock. These stock options include a combination of service and market conditions, as further described below. Prior to the Company’s IPO, these stock options included a performance vesting condition, a Qualified Public Offering (see Note 7), which was not considered to be probable prior to the consummation of the IPO and as a result, no share-based compensation expense for stock options was recognized prior to 2018.

For the three months ended September 30, 2018, the Company recognized $0.3 million in stock-based compensation for stock options and $0.2 million for restricted stock awards. For the nine months ended September 30, 2018, the Company recognized $8.4 million in stock-based compensation for stock options and $0.8 million for restricted stock awards, the majority of which was recognized upon the consummation of the IPO. We recognize stock-based compensation on a straight line basis over the vesting period for time based awards and we recognize the expense immediately for awards with market conditions. The amount of unrecognized compensation expense associated with stock options was $2.2 million and with restricted stock was $8.1 million at September 30, 2018, which is expected to be recognized over the a 2.5 and 3.9 yearly weighted average period, respectively.

The Company calculated the grant date fair value of stock options that vest over a service period using the Black Scholes model. For stock options that contain a market condition related to the return on investment that the Company’s stockholders achieve, the options were valued using a lattice-based option valuation model. The assumptions used in these calculations are noted in the following table. Expected volatilities are based on implied volatilities from comparable companies. The expected time to liquidity is based on management’s estimate. The risk-free rate is based on the U.S. Treasury yield curve for a term equivalent to the estimated time to liquidity.
 
Nine months ended September 30,
 
2018
 
2017
Option valuation assumptions:
 
 
 
Expected dividend yield
—%
 
—%
Expected volatility
50%
 
66%
Risk-free interest rate
2.71%
 
1.80%
Expected term (in years)
6.3
 
6.2


20
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Stock option awards represent options to purchase common stock and are granted pursuant to the Company’s incentive plans, and include options that the Company primarily classifies as Tranche A or time based, Tranche B and Tranche C.

Tranche A or time based options are eligible to vest in equal installments of 25% or 20% on each of the first four or five anniversaries of the date of the grant, subject to continued employment with the Company or its subsidiaries. In the event of a termination of employment without cause or as a result of death or disability, any such time based options which would have vested on the next applicable vesting date shall become vested, and the remaining unvested time based options shall be forfeited. In addition, upon a Change in Control (as defined in the incentive plans), subject to continued employment through the date of the Change in Control, all outstanding unvested time based options shall immediately vest. An IPO does not qualify as a Change in Control as it relates to the vesting of stock options.

All other option awards are eligible to vest upon the satisfaction of certain performance conditions (collectively, “Performance Options”). On January 16, 2018, we amended our option agreements to add additional vesting provisions to our Performance Options. Tranche B options are eligible to vest based on (a) achievement of an Investor IRR equal to or in excess of 20%, subject to a minimum cash-on-cash return of 2.5 times the Investor Investment (as such terms are defined in the Company’s 2014 Long-Term Incentive Plan) or (b) on the first day that the volume-weighted average price per share of our common stock for the prior 60 consecutive trading days exceeds $19.11 (provided that such 60-day period shall not commence earlier than the 181st day after the completion of our IPO). Tranche C options are eligible to vest based on (a) achievement of an Investor IRR (as defined in the incentive plans) equal to or in excess of 25%, subject to a minimum cash-on-cash return of 3.0 times the Investor Investment or (b) on the first day that the volume-weighted average price per share of our common stock for the prior 60 consecutive trading days exceeds $22.93 (provided that such 60-day period shall not commence earlier than the 181st day after the completion of our IPO). In the event of a termination of employment without cause or as a result of death or disability, any Performance Options which are outstanding and unvested will remain eligible to vest subject to achievement of such performance targets (without regard to the continued service requirement) until the first anniversary of the date of such termination. As a result of the modification, the Company measured the incremental fair value of Tranche B and Tranche C options, which resulted in $2.9 million of incremental fair value.

As of September 30, 2018, the Company had 667,565 Performance Options outstanding.

A summary of the changes in stock options outstanding during the nine months ended September 30, 2018 is as follows:
 
Number of Options
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contract Term (years)
 
Aggregate Intrinsic Value (in thousands)
Options outstanding as of December 31, 2017
1,644,212

 
$
8.81

 

 


Granted
48,400

 
24.46

 
 
 
 
     Exercised
(70,419
)
 
10.35

 
 
 
 
Canceled or forfeited
(100,565
)
 
10.74

 
 
 
 
Options outstanding as of September 30, 2018
1,521,628

 
$
9.11

 
6.9
 
$
30,976

Exercisable as of September 30, 2018
437,258

 
$
8.53

 
6.5
 
$
9,155


Restricted Stock

A summary of the changes in restricted stock shares outstanding during the nine months ended September 30, 2018 is as follows:
 
Shares Outstanding
 
Grant Date Fair Value (per share)
Outstanding as of December 31, 2017
77,715

 
$
6.43

Granted
273,392

 
31.03

Vested
(68,772
)
 
8.16

Canceled or forfeited
(106
)
 
31.74

Outstanding as of September 30, 2018
282,229

 
$
29.83


21
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


NOTE 12. INCOME TAXES

The Company determines our provision for income taxes for interim periods using an estimate of our annual effective tax rate. This estimate requires us to forecast pre-tax book income and loss. This forecast is subject to adjustment in subsequent quarterly periods as our estimates of pre-tax income and loss for the year fluctuate, including changes in the geographic mix of pre-tax income and loss.

The Company's effective income tax rate for the three months ended September 30, 2018, was a benefit of 437.3%. The difference between the federal statutory rate of 21% and the Company's effective tax rate for the three months ended September 30, 2018, was primarily due to our valuation allowance on deferred tax assets and changes in our annual forecasted pretax book losses, all of which had a significant rate impact due to the nominal pretax book income recognized for the three months ended September 30, 2018. The Company's effective income tax rate for the three months ended September 30, 2017, was an expense of 34.6%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended September 30, 2017, was primarily due to changes in our valuation allowance on deferred tax assets.

The Company's effective income tax rate for the nine months ended September 30, 2018, was a benefit of 46.0%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the nine months ended September 30, 2018, was primarily due to changes in our valuation allowance on deferred tax assets, various permanent items and lapse in the applicable statute of limitations for certain uncertain tax positions. The Company's effective income tax rate for the nine months ended September 30, 2017, was an expense of 14.4%. The difference between the federal statutory rate of 35.0% and the Company's effective tax rate for the nine months ended September 30, 2017, was primarily due to changes in our valuation allowance on deferred tax assets.

The Company entered into an indemnification agreement with the prior owners of Cadillac Jack whereby the prior owners have agreed to indemnify the Company for changes in tax positions by taxing authorities for periods prior to the acquisition. As of September 30, 2018, an indemnification receivable of $9.5 million has been recorded in other assets in the financial statements. This amount includes the indemnification of the original pre-acquisition tax positions along with any related accrued interest and penalties and is offset by a corresponding liability for unrecognized tax benefits in other long-term liabilities. When the related unrecognized tax benefits are favorably resolved, a corresponding charge to relieve the associated indemnification receivable would be recognized in our Consolidated Statements of Operations and Comprehensive Loss. During the nine months ended September 30, 2018, the Company recognized a $9.4 million reduction in the indemnification receivable and related charge in our Consolidated Statements of Operations and Comprehensive Loss.

Under U.S. GAAP, The Company must make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to Global Intangible Low-Taxed Income ("GILTI") as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method).   The Company has elected the period cost method and has considered the estimated 2018 GILTI impact in its 2018 tax expense which we currently deem to be immaterial on the consolidated financial statements.
NOTE 13. COMMITMENTS AND CONTINGENCIES
The Company is subject to federal, state and Native American laws and regulations that affect both its general commercial relationships with its Native American tribal customers, as well as the products and services provided to them. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. If a potential loss from any claim or legal proceeding is considered reasonably possible, the Company discloses an estimate of the possible loss or range of possible loss, or a statement that such an estimate cannot be made. There are no matters that meet the criteria for disclosure outlined above. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to their pending claims and litigation and may revise their estimates. Such revisions in the estimates of the potential liabilities could have a material impact on the results of operations and financial condition.

22
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


NOTE 14. OPERATING SEGMENTS
We report our business segment results by segment in accordance with the “management approach.” The management approach designates the internal reporting used by our chief operating decision maker (“CODM”), who is our chief executive officer (the “CEO”), for making decisions and assessing performance of our reportable segments.
See Note 1 for a detailed discussion of our three segments. Each segment’s activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its product lines. We evaluate the performance of our operating segments based on revenues and segment adjusted EBITDA, which is defined in the paragraph below.
Segment revenues include leasing, licensing, or selling of products within each reportable segment. Segment adjusted EBITDA includes the revenues and operating expenses from each segment adjusted for depreciation, amortization, write-downs and other charges, accretion of placement fees, non-cash stock-based compensation expense, as well as other costs such as certain acquisitions and integration related costs including restructuring and severance charges; legal and litigation expenses including settlement payments; new jurisdictions and regulatory licensing costs; non-cash charges on capitalized installation and delivery; contract cancellation fees; and other adjustments primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance and other costs deemed to be non-recurring in nature. Revenues in each segment are attributable to third parties and segment operating expenses are directly associated with the product lines included in each segment such as research and development, product approval costs, product-related litigation expenses, sales commissions and other directly-allocable sales expenses. Cost of gaming operations and cost of equipment sales primarily include the cost of products sold, service, manufacturing overhead, shipping and installation.
Segment adjusted EBITDA excludes other income and expense, income taxes and certain expenses that are managed outside of the operating segments.

23
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following provides financial information concerning our reportable segments for the three and nine months ended September 30, (amounts in thousands):     
 
Three months ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues by segment
 
 
 
 
 
 
 
EGM
$
71,784

 
$
53,331

 
$
202,361

 
$
145,747

Table Products
2,052

 
1,099

 
5,514

 
$
2,442

Interactive
1,690

 
2,010

 
5,329

 
6,105

Total Revenues
$
75,526

 
$
56,440

 
$
213,204

 
$
154,294

Adjusted EBITDA by segment
 
 
 
 
 
 
 
EGM
34,026

 
29,756

 
105,197

 
81,450

Table Products
428

 
(232
)
 
684

 
(721
)
Interactive
(877
)
 
(123
)
 
(1,223
)
 
(337
)
Subtotal
33,577

 
29,401

 
104,658

 
80,392

Write-downs and other:
 
 
 
 
 
 
 
Loss on disposal of long-lived assets
363

 
490

 
1,383

 
3,000

Impairment of long-lived assets
204

 
—

 
1,199

 
285

Fair value adjustments to contingent consideration and other items
100

 
—

 
700

 
(630
)
Depreciation and amortization
18,968

 
16,931

 
57,784

 
53,598

Accretion of placement fees(1)
1,206

 
1,192

 
3,412

 
3,492

Non-cash stock-based compensation expense
538

 
—

 
9,167

 
—

Acquisitions and integration related costs including restructuring and severance
746

 
71

 
3,156

 
899

Initial public offering costs
859

 
—

 
2,168

 
—

Legal and litigation expenses including settlement payments
(45
)
 
181

 
789

 
766

New jurisdictions and regulatory licensing costs
—

 
567

 
—

 
1,304

Non-cash charge on capitalized installation and delivery
494

 
359

 
1,478

 
1,284

Non-cash charges and loss on disposition of assets
—

 
—

 
—

 
686

Other adjustments
34

 
474

 
50

 
2,067

Interest expense
8,956

 
12,666

 
28,253

 
42,380

Interest income
(89
)
 
(25
)
 
(162
)
 
(80
)
Loss on extinguishment and modification of debt
—

 
—

 
4,608

 
8,129

Other expense (income)
434

 
(467
)
 
10,121

 
(4,805
)
Income (loss) before income taxes
$
809

 
$
(3,038
)
 
$
(19,448
)
 
$
(31,983
)
(1) Non-cash item related to the accretion of contract rights under development agreements and placement fees.

The Company’s CODM does not receive a report with a measure of total assets or capital expenditures for each reportable segment as this information is not used for the evaluation of segment performance. The CODM assesses the performance of each segment based on adjusted EBITDA and not based on assets or capital expenditures due to the fact that two of the Company’s reportable segments, Table Products and Interactive, are not capital intensive. Any capital expenditure information is provided to the CODM on a consolidated basis. Therefore, the Company has not provided asset and capital expenditure information by reportable segment.

24
PLAYAGS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)


NOTE 15. SUBSEQUENT EVENTS
Term Loan Repricing    

On October 5, 2018 (the “Closing Date”), the Borrower entered into the Incremental Agreement No. 2 with certain of the Borrower’s subsidiaries, the lenders party thereto from time to time and the Administrative Agent. The Incremental Agreement amended and restated that certain First Lien Credit Agreement, dated as of June 6, 2017, as amended on December 6, 2017 and as amended and restated on February 7, 2018 (the “Existing Credit Agreement”), among the Borrower the lenders party thereto, the Administrative Agent and other parties named therein (the “Amended and Restated Credit Agreement”), to (a) reduce the applicable interest rate margin for the Term B Loans (as repriced, the “Repriced Term B Loans”) under the Credit Agreement by 0.75% (which shall increase by an additional 0.25% if at any time on or after the Closing Date the Borrower receives a corporate credit rating of at least B1 from Moody’s, regardless of any future rating) and (b) provide for the incurrence by the Borrower of incremental term loans in an aggregate principal amount of $30 million (the “Incremental Term Loans” and together with the Repriced Term B Loans, the “Term B Loans”). In connection with the Incremental Agreement No. 2, the Company incurred third-party and lender of $1.5 million. The net proceeds of the Incremental Term Loans are expected to be used for general corporate purposes and additional capital to accelerate growth.

The Amended and Restated Credit Agreement also provides that any refinancing of the Term B Loans through the issuance of certain debt or any repricing amendment, in either case, that constitutes a “repricing event” applicable to the Term B Loans resulting in a lower yield occurring at any time during the first six months after the Closing Date (i.e. until April 5, 2019) will be accompanied by a 1.00% prepayment premium or fee, as applicable.

The Incremental Term Loans have the same terms as the Borrower’s Repriced Term B Loans. Other than as described above, the Term B Loans continue to have the same terms as provided under the Existing Credit Agreement. Additionally, the parties to the Amended and Restated Credit Agreement continue to have the same obligations set forth in the Existing Credit Agreement. Other than as described above, the provisions of the Term B Loans and the obligations under the Existing Credit Agreement.

25


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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains “forward-looking statements.” Forward-looking statements include any statements that address future results or occurrences. In some cases you can identify forward-looking statements by terminology such as “may,” “might,” “will,” “would,” “should,” “could” or the negatives thereof. Generally, the words “anticipate,” “believe,” “continue,” “expect,” “intend,” “estimate,” “project,” “plan” and similar expressions identify forward-looking statements. In particular, statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance contained elsewhere in this Quarterly Report on Form 10-Q as well as those discussed under “Item 1. Business” and “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year-ended December 31, 2018 are forward-looking statements. These forward-looking statements include statements that are not historical facts, including statements concerning our possible or assumed future actions and business strategies. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks, uncertainties and other factors, many of which are outside of our control, which could cause our actual results, performance or achievements to differ materially from any results, performance or achievements expressed or implied by such forward-looking statements. Given the risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements are made only as of the date of this Quarterly Report. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments unless required by federal securities law. New factors emerge from time to time, and it is not possible for us to predict all such factors.
    
Unless the context indicates otherwise, or unless specifically stated otherwise, references to the “Company”, “PlayAGS”, “AGS”, “we”, “our” and “us” refer to PlayAGS, Inc. and its consolidated subsidiaries.

Overview

We are a leading designer and supplier of EGMs and other products and services for the gaming industry. Founded in 2005, we historically focused on supplying EGMs, including slot machines, video bingo machines, and other electronic gaming devices, to the Native American gaming market, where we maintain approximately 19% market share of all Class II EGMs. Since 2014, we have expanded our product line-up to include: (i) Class III EGMs for commercial and Native American casinos permitted to operate Class III EGMs, (ii) table game products and (iii) interactive products, all of which we believe provide us with growth opportunities as we expand in markets where we currently have limited or no presence. Our expansion into Class III and ancillary product offerings has driven our strong growth and momentum in revenue, EGM adjusted EBITDA and our installed base. For the three and nine months ended September 30, 2018, approximately 67% and 72%, respectively, of our total revenue was generated through recurring contracted lease agreements whereby we place EGMs and table game products at our customers’ gaming facilities under either a revenue sharing agreement (we receive a percentage of the revenues that these products generate) or fee-per-day agreement (we receive a daily or monthly fixed fee per EGM or table game product), or recurring revenue from our Interactive gaming operations. We operate our business in three distinct segments: EGMs, Table Products and Interactive. Each segment's activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of a distinct product line.
    
EGM Segment

EGMs constitute our largest segment, representing 95% of our revenue for the three and nine months ended September 30, 2018. We have a library of over 350 proprietary game titles that we deliver on several state-of-the-art EGM cabinets, including Orion Portrait (our Premium cabinet), ICON (our core cabinet), Orion Slant (our newly introduced slant cabinet), Halo (legacy Class II cabinet) and Big Red/Colossal Diamonds (our specialty large-format cabinet). We also have developed a new Latin-style bingo cabinet called ALORA, which we plan to use in select international markets, including the Philippines and Brazil.

Our cabinets and game titles are among the top performing premium leased games in the industry. We design all of our cabinets with the intention of capturing the attention of players on casino floors while aiming to maximize operator profits. The third quarter 2018 Eilers - Fantini Quarterly Slot Survey stated our premium leased games outperform most of the EGMs manufactured by our competitors, generating win per day that is up to 2.1x times higher than house average.

As of September 30, 2018, our total EGM installed base was 24,184 units (16,068 domestic and 8,116 international). We remain highly focused on continuing to expand our installed base of leased EGMs in markets that we currently serve, as well as

26

new jurisdictions where we do not presently have any EGMs installed. Since our founding, we have made significant progress in expanding the number of markets where we are licensed to sell or lease our EGMs. In 2005, we were licensed in three states (5 total licenses) and currently we are licensed in 36 U.S. states and 6 foreign countries (approximately 260 total licenses). As of September 30, 2018, our EGM footprint of leased and sold games represented only approximately 2% of the total domestic market of approximately 990,000 EGMs installed throughout the United States and Canada. According to Eilers & Krejcik, U.S. casino operators expect to allocate approximately 5.2% of their 2018 EGM purchases to AGS products. We believe we are positioned to gain additional market share over the next several years.

We offer our customers the option of either leasing or purchasing our EGMs and associated gaming systems. Currently, we derive the majority of our gaming revenues from EGMs installed under revenue sharing or fee-per-day lease agreements, also known as “participation” agreements, and we refer to such revenue generation as our “participation model”. As we expand into new gaming markets and roll out our new and proprietary cabinets and titles, we expect the sales of gaming machines and systems will play an increasingly important role in our business and will complement our core participation model.

We have strategically shifted our focus to create new internal content and leverage our Atlas operating platform as a conduit for our current and future products. Currently, our Orion Portrait, ICON, and Orion Slant cabinets run on the Atlas operating platform. We will continue porting our legacy games onto the Atlas platform, enhancing both our Class II and III offerings. We expect internally-generated content to be a larger source of our installed base going forward.

We categorize our EGM titles into two main groups: “Core” and “Premium and Specialty”. Our development studios, located in Atlanta, Austin, Las Vegas, and Sydney, are responsible for creating Core video and premium slot content as well as new hardware designs and concepts. Our Core titles have a proven track record of success and are targeted at maintaining and growing our current installed base. Our Premium titles include unique and niche titles that provide a distinctive player experience and are targeted at increasing floor space in both existing and new jurisdictions. Specialty titles describe our jumbo games, such as Colossal Diamonds, and games made specifically for high-limit winnings. In total, our development teams have the capabilities to produce approximately 50 games per year. We believe this strategy of producing diversified content will allow us to maintain and grow our market leadership within our current Class II base, as well as expand into Class III casinos in other key jurisdictions.

Table Products

In addition to our existing portfolio of EGMs, we also offer our customers approximately 30 unique Table Product offerings, including premium live felt table games, side bet offerings, progressives, signage and other ancillary table game equipment. Our table products are designed with the goal of enhancing the table games section of the casino floor (commonly known as “the pit”). Over the past 10 years, there has been a trend of introducing side-bets on blackjack tables to increase the game’s overall hold. Our Table Products segment offers a full suite of side-bets and specialty table games that capitalize on this trend, and we believe that this segment will serve as an important growth engine for our company, including by generating further cross-selling opportunities with our EGM offerings. As of September 30, 2018, we had an installed base of 3,065 table products domestically and internationally and we believe we are presently a leading supplier of table products to the gaming industry based on number of products placed.

Our Table Products segment focuses on high margin recurring revenue generated by leases. Nearly all of the revenue we generate in this segment is recurring. We have acquired several proprietary table games and side-bets and developed others in-house.

As one of the newer areas of our Table Products business, our equipment offerings are ancillary to table games, such as card shufflers and table signage, and provide casino operators a greater variety of choice in the marketplace. This product segment includes our highly-anticipated single-card shuffler, “DEX S”, as well as our Baccarat Signage solution and Roulette Readerboard. We believe this area of the business holds many opportunities for growth, as the technology currently installed in the signage and readerboard areas are in a replacement cycle.

After acquiring intellectual property around progressive bonusing systems, our Table Products segment has heavily expanded on our base systems to now offer a bonusing solution for casino operators. We believe progressive bonusing on table products is a growing trend with substantial growth opportunities. We continue to develop and expand our core system to offer new and exciting bonusing and progressive products for the marketplace.


27

Interactive Social Casino Products

Our business-to-consumer (“B2C”) social casino games include online versions of our popular EGM titles and are accessible to players worldwide on multiple mobile platforms, which we believe establishes brand recognition and cross selling opportunities. Our B2C social casino games operate on a free-to-play model, whereby game players may collect virtual currency or other virtual consumable goods (collectively referred to as “virtual goods” or “virtual currency”) free of charge, through the passage of time or through targeted marketing promotions. Additionally, players have the ability to send free “gifts” of virtual goods to their friends through interactions on certain social platforms. If a game player wishes to obtain virtual goods above and beyond the level of free virtual goods available to that player, the player may purchase additional virtual goods. Once obtained, virtual currency (either free or purchased) cannot be redeemed for cash nor exchanged for anything other than game play. We design our portfolio of B2C social casino games to appeal to the interests of a broad group of people who like to play casino-themed social and mobile games.

We have recently expanded into the business-to-business (“B2B”) space through our core B2C app, Lucky Play Casino, whereby we white label our social casino game product and enable our land-based casino customers to brand the social casino gaming product with their own casino name. The app contains numerous AGS game titles available for consumers to play for fun or with virtual goods they purchase in the app. Some of our most popular social casino games include content that is also popular in land-based settings such as Fire Wolf, Gold Dragon Red Dragon, Legend of the White Buffalo, Royal Reels, Golden Wins, So Hot, Monkey in the Bank, and many more. Our B2C social casino games leverage the global connectivity and distribution of mobile platforms such as the Apple App Store and Google Play Store. With the acquisition of Gameiom Technologies Limited (formerly known as “Gameiom”, currently known as “AGS iGaming”) in the current year, we now offer a B2B platform for content aggregation used by real-money gaming (“RMG”) and sports-betting partners.

Other Information

Customers and marketing. We market our products to casinos and other legal gaming establishments around the world with our domestic and international sales force and several domestic and international distributors and/or representatives. We believe the quality and breadth of our customer base is a strong testament to the effectiveness and quality of our product offerings, technological innovation and customer service. Our customer base includes leading casino operators in leading established gaming markets such as the United States, Canada and Latin America. Our customers include, among others, Caesar’s Entertainment Corp., MGM Resorts International, Poarch Creek Band of Indians, and the Chickasaw Nation.

Our products and the locations in which we may sell them are subject to the licensing and product approval requirements of various national, state, provincial and tribal jurisdictional agencies that regulate gaming around the world, as discussed in “Part I, Item 1. Business” in our Annual Report on Form 10-K for the year-ended December 31, 2017. We lease and sell our products, with an emphasis on leasing versus selling, primarily in the United States. We service the products we lease and offer service packages to customers who purchase products from us.

Product supply. We obtain most of the parts for our products from outside suppliers, including both off-the-shelf items as well as components manufactured to our specifications. We also manufacture parts in-house that are used for product assembly and for servicing existing products. We generally perform warehousing, quality control, final assembly and shipping from our facilities in Atlanta, Las Vegas, Mexico City and Oklahoma City, although small inventories are maintained and repairs are performed by our field service employees. We believe that our sources of supply for components and raw materials are adequate and that alternative sources of materials are available.

Key Drivers of Our Business

Our revenues are impacted by the following key factors:

•the amount of money spent by consumers on our domestic revenue share installed base;
•the amount of the daily fee and selling price of our participation electronic gaming machines;
•our revenue share percentage with customers;
•the capital budgets of our customers;
•the level of replacement of existing electronic gaming machines in existing casinos;
•expansion of existing casinos;
•development of new casinos;
•opening of new gaming jurisdictions both in the United States and internationally;
•our ability to obtain and maintain gaming licenses in various jurisdictions;
•the relative competitiveness and popularity of our electronic gaming machines compared to competitive products offered in the same facilities; and

28

•general macro-economic factors, including levels of and changes to consumer disposable income and personal consumption spending.

Our expenses are impacted by the following key factors:

•fluctuations in the cost of labor relating to productivity, overtime and training;
•fluctuations in the price of components for gaming equipment;
•fluctuations in energy prices;
•changes in the cost of obtaining and maintaining gaming licenses; and
•fluctuations in the level of maintenance expense required on gaming equipment.

Variations in our selling, general and administrative expenses, and research and development expenses are primarily due to changes in employment and salaries and related fringe benefits.

29

Results of Operations
    
Three Months Ended September 30, 2018 compared to the Three Months Ended September 30, 2017

The following table set forth certain selected condensed consolidated financial data for the three months ended September 30, 2018 and 2017 (in thousands): 
 
Three months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Consolidated Statements of Operations:
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
Gaming operations
$
50,701

 
$
42,849

 
$
7,852

 
18.3
 %
Equipment sales
24,825

 
13,591

 
11,234

 
82.7
 %
Total revenues
75,526

 
56,440

 
19,086

 
33.8
 %
Operating expenses
 
 
 
 
 
 
 
Cost of gaming operations
10,494

 
7,344

 
3,150

 
42.9
 %
Cost of equipment sales
12,109

 
6,330

 
5,779

 
91.3
 %
Selling, general and administrative
15,284

 
9,742

 
5,542

 
56.9
 %
Research and development
7,894

 
6,467

 
1,427

 
22.1
 %
Write-downs and other charges
667

 
490

 
177

 
36.1
 %
Depreciation and amortization
18,968

 
16,931

 
2,037

 
12.0
 %
Total operating expenses
65,416

 
47,304

 
18,112

 
38.3
 %
Income from operations
10,110

 
9,136

 
974

 
10.7
 %
Interest expense
8,956

 
12,666

 
(3,710
)
 
(29.3
)%
Interest income
(89
)
 
(25
)
 
(64
)
 
(256.0
)%
Other expense (income)
434

 
(467
)
 
901

 
192.9
 %
Income (loss) before income taxes
809

 
(3,038
)
 
3,847

 
126.6
 %
Income tax benefit (expense)
3,538

 
(1,052
)
 
4,590

 
436.3
 %
Net income (loss)
$
4,347

 
$
(4,090
)
 
$
8,437

 
206.3
 %
Revenues

Gaming Operations. The increase in gaming operations revenue was primarily due to the increase in our EGM installed base of approximately 1,500 domestic units, which is primarily attributable to the purchase of approximately 1,500 EGMs from Rocket in December 2017 as described in Item 1 “Financial Statements” Note 2 to our condensed consolidated financial statements. The increase is also attributable to the continued success of our ICON cabinet and the popularity of our Orion Portrait cabinet and the placement of over 500 domestic Class II units in casino expansions and newly opened casinos offset by the strategic removal of approximately 500 EGMs in the third quarter at one casino as well as the sale of previously leased EGMs. In addition, the increase is attributable to an increase of $1.70, or 6.7% in our domestic EGM revenue per day driven by our new product offerings and through the optimization of our installed base by installing our newer and more competitive game content on our EGMs. In addition, the increase is also attributable to the increase of 645 international EGM units, which is due to our gaining market share in under serviced markets within Mexico. Furthermore, we had a $0.8 million increase in Table Products gaming operations revenue which is attributable to the increase in the Table Products installed base to 3,065 units compared to 2,350 units in the prior year period most notably due to the increased installed base of our side bets and progressive games as well as revenue from the In Bet games in the entire third quarter, as those games were acquired in August in 2017.

Equipment Sales. The increase in equipment sales is due to the sale of 1,332 EGM units in the three months ended September 30, 2018, compared to 842 units in the prior year period. The increase in the number of units sold is primarily attributable to the success of our premium Orion Portrait cabinet and our growth in the Class III market as well as the continued success of our ICON cabinet. The increase was also attributable to a $2,161, or 13.6% increase in the average sales price compared to the prior year period. The increase in the average sales price is due to the higher sales price of our premium Orion Portrait and Orion Slant cabinets compared to other cabinets.


30

Operating Expenses

Cost of gaming operations. The additional costs of gaming operations was the result of our increased service and production costs related to our increased installed base of 24,184 EGM units compared to 22,015 units in the prior year period, as well as table games installed base that increased 30.4% compared to the prior year period. As a percentage of gaming operations revenue, costs of gaming operations increased to 20.7% for the three months ended September 30, 2018 compared to 17.1% for the prior year primarily due to the increase service costs mentioned above, as well as period costs related to manufacturing.

Cost of Equipment Sales. The increase in cost of equipment sales is attributable to 1,332 EGM units sold for the three months ended September 30, 2018 compared to 842 in prior year period. As a percentage of equipment sales revenue, costs of equipment sales was 48.8% for the three months ended September 30, 2018 compared to 46.6% for the prior year period primarily due to changes in the mix of products sold in each period and the costs to manufacture the sold products.

Selling, general and administrative. The $5.5 million increase in selling, general and administrative expenses was primarily due to a $2.5 million increase in salary and benefit costs due to higher headcount, $0.2 million increase due to to stock-based compensation expense, and $2.2 million increase in professional fees driven by costs associated with the acquisition and integration of AGS iGaming and previous offerings.

Research and development. The increase in research and development expenses is primarily due to $0.4 million of increased salary and benefit costs due to higher headcount, a $0.3 million increase of stock-based compensation expense, an increase in software and development expenses of $0.2 million and an increase of $0.2 million in hardware and equipment expenses. As a percentage of total revenue, research and development expense was 10.5% for the period ended September 30, 2018 compared to 11.5% for the prior year period.

Write-downs and other charges. The Condensed Consolidated Statements of Operations and Comprehensive Loss include various non-routine transactions or consulting and transaction-related fees that have been classified as write-downs and other charges. During the three months ended September 30, 2018, we recognized $0.7 million in write-downs and other charges driven by losses from the disposal of assets of $0.4 million, impairment of intangible assets of $0.2 million and a fair value adjustment to contingent consideration of $0.1 million (the Company used level 3 fair value measurements based on projected cash flows). During the three months ended September 30, 2017, the Company recognized $0.5 million in write-downs and other charges driven by losses from the disposal of assets.

Due to the changing nature of our write-downs and other charges, we describe the composition of the balances as opposed to providing a year over year comparison.

Depreciation and amortization. The increase was predominantly due to a $0.9 million increase in depreciation driven by an increased installed base and an increase of amortization expense of $1.1 million due to the purchase of In Bet, AGS iGaming and Rocket Gaming Systems. See Item 1. “Financial Statements” Note 2 for a detailed discussion regarding the acquisitions of In Bet, AGS iGaming and Rocket Gaming Systems.

Other Expense (Income)

Interest expense. The decrease in interest expense is predominantly attributed to the termination of our senior secured credit facilities and seller notes and entering into a first lien credit agreement on June 6, 2017 and the redemption of its 11.25% senior secured PIK notes as well as the further decrease in the interest rate on our first lien credit facilities we obtained on February 7, 2018. See Item 1. “Financial Statements” Note 6 for a detailed discussion regarding long-term debt. These transactions resulted in a lower weighted average interest rate. These decreases were partially offset by an increase in the average principal amounts outstanding under the first lien credit facilities as of September 30, 2018, compared to the amount outstanding at  September 30, 2017.

Other expense (income). The increase is predominantly due to changes from the effect of foreign currency fluctuation on trade payables and receivables denominated in foreign currencies.

31


Income Taxes

The Company's effective income tax rate for the three months ended September 30, 2018, was a benefit of 437.3%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three months ended September 30, 2018, was primarily due to changes in our valuation allowance on deferred tax assets and increases in our estimated annual forecasted losses during the third quarter of 2018 due to changes in our business and various permanent items, all of which impacted the required accounting for income taxes under generally accepted accounting principles for interim reporting periods.

 The Company's effective income tax rate for the three months ended September 30, 2017, was an expense of 34.6%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended September 30, 2017, was primarily due to changes in our valuation allowance on deferred tax assets.

32


Nine Months Ended September 30, 2018 compared to the Nine Months Ended September 30, 2017

The following table set forth certain selected condensed consolidated financial data for the nine months ended September 30, 2018 and 2017 (in thousands): 
 
Nine months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Consolidated Statements of Operations:
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
Gaming operations
$
152,887

 
$
125,040

 
$
27,847

 
22.3
 %
Equipment sales
60,317

 
29,254

 
31,063

 
106.2
 %
Total revenues
213,204

 
154,294

 
58,910

 
38.2
 %
Operating expenses


 


 
 
 
 
Cost of gaming operations
29,062

 
21,794

 
7,268

 
33.3
 %
Cost of equipment sales
28,919

 
14,326

 
14,593

 
101.9
 %
Selling, general and administrative
47,411

 
30,368

 
17,043

 
56.1
 %
Research and development
23,374

 
17,912

 
5,462

 
30.5
 %
Write-downs and other charges
3,282

 
2,655

 
627

 
23.6
 %
Depreciation and amortization
57,784

 
53,598

 
4,186

 
7.8
 %
Total operating expenses
189,832

 
140,653

 
49,179

 
35.0
 %
Income from operations
23,372

 
13,641

 
9,731

 
71.3
 %
Interest expense
28,253

 
42,380

 
(14,127
)
 
(33.3
)%
Interest income
(162
)
 
(80
)
 
(82
)
 
(102.5
)%
Loss on extinguishment and modification of debt
4,608

 
8,129

 
(3,521
)
 
(43.3
)%
Other expense (income)
10,121

 
(4,805
)
 
14,926

 
310.6
 %
Income (loss) before income taxes
(19,448
)
 
(31,983
)
 
12,535

 
39.2
 %
Income tax benefit (expense)
8,947

 
(4,603
)
 
13,550

 
294.4
 %
Net income (loss)
$
(10,501
)
 
$
(36,586
)
 
$
26,085

 
71.3
 %
Revenues

Gaming Operations. The increase in gaming operations revenue was primarily due to the increase in our EGM installed base of approximately 1,500 domestic units, which is primarily attributable to the purchase of approximately 1,500 EGMs from Rocket in December 2017 as described in Item 1. “Financial Statements” Note 2 to our condensed consolidated financial statements. The increase is also attributable to the continued success of our ICON cabinet and the popularity of our Orion Portrait cabinet and the placement of over 500 domestic Class II units in casino expansions and newly opened casinos offset by the strategic removal of approximately 500 EGMs in the third quarter at one casino as well as the sale of previously leased EGMs. Additionally, we had an increase of $1.49, or 5.8% in our domestic EGM revenue per day driven by our new product offerings, recently entered jurisdictions and through the optimization of our installed base by installing our newer and more competitive game content on our EGMs. In addition, the increase is due to the increase of 645 international EGM units, which is attributable to our gaining market share in under serviced markets within Mexico. Furthermore, we had a $2.9 million increase in Table Products gaming operations revenue which is attributable to the increase in the Table Products installed base to 3,065 units compared to 2,350 units in the prior year period most notably due to the increased installed base of our side bets and progressive games as well as revenue from the In Bet games in the entire current year period, as those games were acquired in August in 2017.
    
Equipment Sales. The increase in equipment sales is due to the sale of 3,228 EGM units in the nine months ended September 30, 2018, compared to 1,868 EGM units in the prior year period. The increase in the number of units sold is primarily attributable to the success of our premium Orion Portrait cabinet and our growth in the Class III market as well as the continued success of our ICON and Orion Slant cabinet. The increase was also attributable to a $2,373, or 15.0% increase in the average sales price compared to the prior year period. The increase in the average sales price is due to the higher sales price of our premium Orion Portrait and Orion Slant cabinets compared to other cabinets.


33

Operating Expenses

Cost of gaming operations. The increase in costs of gaming operations was the result of our increased installed base of 24,184 EGM units compared to 22,015 units in the prior year period, as well as increased table games installed base that increased 30.4% compared to the prior year period. As a percentage of gaming operations revenue, costs of gaming operations was 19.0% for the nine months ended September 30, 2018 compared to 17.4% for the prior year primarily due to increased service costs, as well as period costs related to manufacturing.

Cost of Equipment Sales. The increase in cost of equipment sales is attributable to 3,228 EGM units sold for the nine months ended September 30, 2018 compared to 1,868 in the prior year period. As a percentage of equipment sales revenue, costs of equipment sales was 47.9% for the nine months ended September 30, 2018 compared to 49.0% for the prior year period primarily due to changes in the mix of products sold in each period and the costs to manufacture the sold products.

Selling, general and administrative. The increase in selling, general and administrative expenses is primarily due to $6.8 million of stock-based compensation expense (which includes an initial charge of $6.2 million recorded in connection with the IPO), professional fees of $4.8 million related to the acquisition and integration of AGS iGaming, the Company’s IPO and related offerings as well as legal settlements. Additionally, the increase is attributable to an increase in salary and benefit costs of $5.0 million due to higher headcount, increased occupancy and costs related to our increased presence of $1.2 million and increased insurance costs of $0.6 million, and offset by a decrease of $0.9 million of property tax expense and a decrease in marketing expense of $0.3 million.

Research and development. The increase in research and development expenses is primarily due to $2.2 million of salary and benefit costs due to higher headcount, $2.3 million of stock-based compensation expense (which includes an initial charge of $1.6 million recorded in connection with the IPO), a $0.3 million increase related to internal software testing and external product approval costs and an increase in professional fees of $0.6 million. As a percentage of total revenue, research and development expense was 11.0% for the period ended September 30, 2018 compared to 11.6% for the prior year period.

Write-downs and other charges. The Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) include various non-routine transactions or consulting and transaction-related fees that have been classified as write downs and other charges. During the nine months ended September 30, 2018, the Company recognized $3.3 million in write-downs and other charges driven by losses from the disposal of assets of $1.4 million, the impairment to intangible assets related to game titles and assets associated with terminated development agreements of $1.2 million (the Company used level 3 of observable inputs in conducting the impairment tests), and a fair value adjustment to contingent consideration of $0.7 million (the Company used level 3 fair value measurements based on projected cash flows).

During the nine months ended September 30, 2017, the Company recognized $2.7 million in write-downs and other charges, driven by losses from the disposal of assets of $2.9 million, the full impairment of certain intangible assets of $0.3 million (the Company used level 3 fair value measurement based on projected cash flows for the specific game titles), offset by a fair value adjustment to an acquisition contingent receivable of $0.6 million (the Company used level 3 fair value measurements based on projected cash flows). The contingency was resolved in the quarter ended March 31, 2017 (the Company used level 3 of observable inputs in conducting the impairment tests).

Due to the changing nature of our write-downs and other charges, we describe the composition of the balances as opposed to providing a year over year comparison.

Depreciation and amortization. The increase was predominantly due to a $3.8 million increase in depreciation driven by an increased installed base, and an increase of amortization expense of $0.4 million due to the purchase of In Bet, AGS iGaming and Rocket Gaming Systems. See Item 1. “Financial Statements” Note 2 for a detailed discussion regarding the acquisitions of In Bet, AGS iGaming and Rocket Gaming Systems.

Other Expense (Income)

Interest expense. The decrease in interest expense is predominantly attributed to the termination of our senior secured credit facilities and seller notes and entering into a first lien credit agreement on June 6, 2017 and the redemption of its 11.25% senior secured PIK notes as well as the further decrease in the interest rate on our first lien credit facilities we obtained on February 7, 2018. See Item 1. “Financial Statements” Note 6 for a detailed discussion regarding long-term debt.  These transactions resulted in a lower weighted average interest rate. These decreases were partially offset by an increase in the average principal amounts outstanding under the first lien credit facilities as of September 30, 2018, compared to the amount outstanding at September 30, 2017.

34


Other income. The increase is predominantly attributed to the write-off in the current year of indemnification receivables of $9.4 million as the related liability for uncertain tax positions was also written off due to the applicable lapse in the statute of limitations. See Item 1. “Financial Statements” Note 12 for a detailed description of the indemnification receivable. The remaining change was due to the effect of foreign currency fluctuation on trade payables and receivables denominated in foreign currencies.

Income Taxes

The Company's effective income tax rate for the nine months ended September 30, 2018, was a benefit of 46.0%. The difference between the federal statutory rate of 21% and the Company's effective tax rate for the nine months ended September 30, 2018, was primarily due to changes in our valuation allowance on deferred tax assets, various permanent items and lapse in applicable statute of limitations for certain uncertain tax positions. The Company's effective income tax rate for the nine months ended September 30, 2017, was an expense of 14.4%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the nine months ended September 30, 2017 was primarily due to changes in our valuation allowance on deferred tax assets.

Segment Operating Results

We report our business segment results by segment in accordance with the “management approach.” The management approach designates the internal reporting used by our chief operating decision maker, who is our Chief Executive Officer, for making decisions and assessing performance of our reportable segments.

See Item 1. “Financial Statements” Note 1 for a detailed discussion of our three segments. Each segment’s activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its product lines. We evaluate the performance of our operating segments based on revenues and segment adjusted EBITDA.

Segment revenues include leasing, licensing or selling of products within each reportable segment. We measure segment performance in terms of revenue, segment-specific adjusted EBITDA and unit placements. We believe that unit placements are an important gauge of segment performance for EGM’s and Table Products because it measures historical market placements of leased and sold units and provides insight into potential markets for next-generation products and service. We do not present a cumulative installed base as previously sold units may no longer be in use by our customers or may have been replaced by other models or products. For our Interactive segment, we view the number of unique players and revenues provided by players on a daily or monthly basis.

35

Electronic Gaming Machines

Three Months Ended September 30, 2018 compared to Three Months Ended September 30, 2017
 
Three months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
EGM Segment Revenue:
 
 
 
 
 
 
 
Gaming operations
$
47,109

 
$
39,767

 
$
7,342

 
18.5
%
Equipment sales
24,675

 
13,564

 
11,111

 
81.9
%
Total EGM revenues
$
71,784

 
$
53,331

 
$
18,453

 
34.6
%
 
 
 
 
 
 
 
 
EGM adjusted EBITDA
$
34,026

 
$
29,756

 
$
4,270

 
14.4
%
 
 
 
 
 
 
 
 
EGM unit information:
 
 
 
 
 
 
 
Domestic installed base, end of period
16,068

 
14,544

 
1,524

 
10.5
%
International base, end of period
8,116

 
7,471

 
645

 
8.6
%
Total installed base, end of period
24,184

 
22,015

 
2,169

 
9.9
%
 
 
 
 
 
 
 
 
Domestic revenue per day
$
27.14

 
$
25.44

 
$
1.70

 
6.7
%
International revenue per day
$
8.52

 
$
8.33

 
$
0.19

 
2.3
%
Total revenue per day
$
20.95

 
$
19.65

 
$
1.30

 
6.6
%
 
 
 
 
 
 
 
 
Domestic EGM units sold
1,332

 
842

 
490

 
58.2
%
International EGM units sold
—

 
—

 
—

 
—
%
Total EGM units sold
1,332

 
842

 
490

 
58.2
%
 
 
 
 
 
 
 
 
Total average sales price
$
18,051

 
$
15,890

 
$
2,161

 
13.6
%

Gaming Operations Revenue

The increase in gaming operations revenue was primarily due to the increase in our EGM installed base of approximately 1,500 domestic units, which is primarily attributable to the purchase of approximately 1,500 EGMs from Rocket in December 2017 as described in as described in Item 1. “Financial Statements” Note 2 to our condensed consolidated financial statements. The increase is also attributable to the continued success of our ICON cabinet and the popularity of our Orion Portrait cabinet and the placement of over 500 domestic Class II units in casino expansions and newly opened casinos offset by the removal of approximately 500 EGMs in the third quarter at one casino as well as the sale of previously leased EGMs. In addition, the increase is also attributable to an increase of $1.70, or 6.7% in our domestic EGM revenue per day driven by our new product offerings and through the optimization of our installed base by installing our newer and more competitive game content on our EGMs. In addition, the increase is also attributed to the increase of 645 international EGM units, which is attributable to our gaining market share in under serviced markets within Mexico.

Equipment Sales

The increase in equipment sales revenue is due to the sale of 1,332 units in the quarter ended September 30, 2018, compared to 842 units in the prior year period. The increase in the number of units sold is primarily attributable to the success of our premium Orion Portrait cabinet and our growth in the Class III market as well as the continued success of our ICON cabinet. The increase was also attributable to a $2,161, or 13.6% increase in the average sales price compared to the prior year period. The increase in the average sales price is due the higher sales price of our premium Orion Portrait cabinet compared to other cabinets.

EGM Adjusted EBITDA

EGM adjusted EBITDA includes the revenues and operating expenses from the EGM segment adjusted for depreciation, amortization, write-downs and other charges, accretion of placement fees, as well as other costs. See Item 1. “Financial Statements”

36

Note 14 for further explanation of adjustments. The increase in EGM adjusted EBITDA is attributable to the increases in revenue described above, and offset by increased adjusted selling, general and administrative expenses of $4.0 million, and increased research and development expenses of $1.3 million, both driven by the increase in salaries and benefit costs due to increased headcount and other operating expenses.The increase in revenue was further offset by increased adjusted cost of gaming operations and equipment sales of $8.9 million due to higher sales volume. EGM adjusted EBITDA margin was 47.4% and 55.8% for the three months ended September 30, 2018 and 2017, respectively. The decrease in adjusted EBITDA margin is attributable to the increased proportion of equipment sales as part of total revenues, increased service costs and period costs related to manufacturing and increased operating costs.

Nine Months Ended September 30, 2018 compared to Nine Months Ended September 30, 2017
 
Nine months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
EGM Segment Revenue:
 
 
 
 
 
 
 
Gaming operations
$
142,301

 
$
116,587

 
$
25,714

 
22.1
 %
Equipment sales
60,060

 
29,160

 
$
30,900

 
106.0
 %
Total EGM revenues
$
202,361

 
$
145,747

 
$
56,614

 
38.8
 %
 
 
 
 
 
 
 
 
EGM adjusted EBITDA
$
105,197

 
$
81,450

 
$
23,747

 
29.2
 %
 
 
 
 
 
 
 
 
EGM unit information:


 


 
 
 
 
Domestic installed base, end of period
16,068

 
14,544

 
1,524

 
10.5
 %
International base, end of period
8,116

 
7,471

 
645

 
8.6
 %
Total installed base, end of period
24,184

 
22,015

 
2,169

 
9.9
 %
 
 
 
 
 
 
 
 
Domestic revenue per day
$
27.22

 
$
25.73

 
$
1.49

 
5.8
 %
International revenue per day
$
8.53

 
$
8.37

 
$
0.16

 
1.9
 %
Total revenue per day
$
21.22

 
$
19.86

 
$
1.36

 
6.8
 %
 
 
 
 
 
 
 
 
Domestic EGM units sold
3,182

 
1,690

 
1,492

 
88.3
 %
International EGM units sold
46

 
178

 
(132
)
 
(74.2
)%
Total EGM units sold
3,228

 
1,868

 
1,360

 
72.8
 %
 
 
 
 
 
 
 
 
Average sales price
$
18,208

 
$
15,835

 
$
2,373

 
15.0
 %

Gaming Operations Revenue

The increase in gaming operations revenue was primarily due to the increase in our EGM installed base of approximately 1,500 domestic units, which is primarily attributable to the purchase of approximately 1,500 EGMs from Rocket in December 2017 as described in as described in Item 1. “Financial Statements” Note 2 to our condensed consolidated financial statements. The increase is also attributable to the continued success of our ICON cabinet and the popularity of our Orion Portrait cabinet and the placement of over 500 domestic units in casino expansions and newly opened casinos offset by the removal of approximately 500 EGMs in the third quarter at one casino as well as the sale of previously leased EGMs. We also had an increase of $1.49, or 5.8% in our domestic EGM revenue per day driven by our new product offerings, recently entered jurisdictions and through the optimization of our installed base by installing our newer and more competitive game content on our EGMs. In addition, the increase is also attributed to the increase of 645 international EGM units, which is attributable our gaining market share in under serviced markets within Mexico.
 
Equipment Sales
        
The increase in equipment sales revenue is due to the sale of 3,228 units in the nine months ended September 30, 2018, compared to 1,868 units in the prior year period. The increase in the number of units sold is primarily attributable to the success of our premium Orion Portrait cabinet and our growth in the Class III market as well as the continued success of our ICON cabinet.

37

The increase was also attributable to an approximate $2,373, or 15.0%, increase in the average sales price compared to the prior year period. The increase in the average sales price is due the higher sales price of our premium Orion Portrait cabinet compared to other cabinets.

EGM Adjusted EBITDA

EGM adjusted EBITDA includes the revenues and operating expenses from the EGM segment adjusted for depreciation, amortization, write-downs and other charges, accretion of placement fees, as well as other costs. See Item 1. “Financial Statements” Note 14 for further explanation of adjustments. The increase in EGM adjusted EBITDA is attributable to the increases in revenue described above offset by increased adjusted cost of gaming operations and equipment sales of $21.9 million due to higher sales volume and increased adjusted operating expenses of $10.7 million due to increased headcount and other operating expenses. EGM adjusted EBITDA margin was 52.0% and 55.9% for the nine months ended September 30, 2018 and 2017, respectively. The decrease in adjusted EBITDA margin is attributable to the increased proportion of equipment sales as part of total revenue, increased service costs and period costs related to manufacturing and increased operating costs.

Table Products

Three Months Ended September 30, 2018 compared to Three Months Ended September 30, 2017
 
Three months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Table Products Segment Revenue:
 
 
 
 
 
 
 
Gaming operations
$
1,902

 
$
1,072

 
$
830

 
77.4
%
Equipment sales
150

 
27

 
123

 
455.6
%
Total Table Products revenues
$
2,052

 
$
1,099

 
$
953

 
86.7
%
 
 
 
 
 
 
 
 
Table Products adjusted EBITDA
$
428

 
$
(232
)
 
$
660

 
284.5
%
 
 
 
 
 
 
 
 
Table Products unit information:
 
 
 
 
 
 
 
Table products installed base, end of period
3,065

 
2,350

 
715

 
30.4
%
Average monthly lease price
$
214

 
$
151

 
$
63

 
41.7
%

Gaming Operations Revenue

The increase in Table Products gaming operations revenue is attributable to the increase in the Table Products installed base to 3,065 units compared to 2,350 units in the prior year period. The recently acquired 493 installed table games from the In Bet acquisition and the continued success of side bets, most notably Buster Blackjack and our progressive Bonus Spin, are the primary driver of the increase in the Table Products revenue and installed base compared to the prior year period. See Item 1. “Financial Statements” Note 2 for a description of the In Bet acquisition. The increase is also attributable to the higher average monthly lease price of $214, up $63 compared to the prior year period.

Equipment Sales

The increase in equipment sales is primarily due to the sales of our new products, roulette and baccarat signs, in the current year.    

Tables Products Adjusted EBITDA

Table Products adjusted EBITDA includes the revenues and operating expenses from the Table Products segment adjusted for depreciation, amortization, write-downs and other charges, as well as other costs. See Item 1. “Financial Statements” Note 14 for further explanation of adjustments. The increase in Table Products adjusted EBITDA is attributable to the increases in revenue described above, and offset by higher adjusted research and development expenses of $0.2 million related to the development of our new card shuffler, the “DEX S”.


38

Nine Months Ended September 30, 2018 compared to Nine Months Ended September 30, 2017
 
Nine months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Table Products Segment Revenue:
 
 
 
 
 
 
 
Gaming operations
$
5,257

 
$
2,348

 
$
2,909

 
123.9
%
Equipment sales
257

 
94

 
163

 
173.4
%
Total Table Products revenues
$
5,514

 
$
2,442

 
$
3,072

 
125.8
%
 
 
 
 
 
 
 
 
Table Products adjusted EBITDA
$
684

 
$
(721
)
 
$
1,405

 
194.9
%
 
 
 
 
 
 
 
 
Table Products unit information:
 
 
 
 
 
 
 
Table products installed base, end of period
3,065

 
2,350

 
715

 
30.4
%
Average monthly lease price
$
215

 
$
111

 
$
104

 
93.7
%

Gaming Operations Revenue

The increase in Table Products gaming operations revenue is attributable to the increase in the Table Products installed base to 3,065 units compared to 2,350 units in the prior year period. The recently acquired 493 installed table games from the In Bet acquisition and the continued success of side bets, most notably Buster Blackjack and our progressive Bonus Spin, are the primary driver of the increase in the Table Products revenue and installed base compared to the prior year period. See Item 1. “Financial Statements” Note 2 for a description of the In Bet acquisition. The increase is also attributable to the higher average monthly lease price of $215, up $104 compared to the prior year period.

Equipment Sales

The increase in equipment sales is primarily due to the sales of our new products, roulette and baccarat signs, in the current year.    

Tables Products Adjusted EBITDA

Table Products adjusted EBITDA includes the revenues and operating expenses from the Table Products segment adjusted for depreciation, amortization, write-downs and other charges, as well as other costs. See Item 1. “Financial Statements” Note 14 for further explanation of adjustments. The increase in Table Products adjusted EBITDA is attributable to the increases in revenue described above, and offset by higher adjusted research and development expenses of $0.7 million related to the development of our new card shuffler, the “DEX S”, a $0.7 million increase in adjusted cost of gaming operations related to In Bet progressive fees and a $0.2 million increase in adjusted selling, general and administrative expenses.


39

Interactive

Three Months Ended September 30, 2018 compared to Three Months Ended September 30, 2017
 
Three months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Interactive Segment Revenue:
 
 
 
 
 
 
 
Gaming operations
$
1,690

 
$
2,010

 
$
(320
)
 
(15.9
)%
Total Interactive revenues
$
1,690

 
$
2,010

 
$
(320
)
 
(15.9
)%
 
 
 
 
 
 
 
 
Interactive adjusted EBITDA
$
(877
)
 
$
(123
)
 
$
(754
)
 
(613.0
)%
 
 
 
 
 
 
 
 
Interactive unit information:
 
 
 
 
 
 
 
Average MAU(1)
148,668

 
194,239

 
(45,571
)
 
(23.5
)%
Average DAU(2)
33,948

 
36,906

 
(2,958
)
 
(8.0
)%
ARPDAU(3)
$
0.43

 
$
0.59

 
$
(0.16
)
 
(27.1
)%
(1) MAU = Monthly Active Users and is a count of unique visitors to our sites during a month
(2) DAU = Daily Active Users, a count of unique visitors to our sites during a day
(3) ARPDAU = Average daily revenue per DAU is calculated by dividing revenue for a period by the DAU for the period by the number of days for the period

Gaming Operations Revenue

Because of our optimization strategy, interactive gaming operations revenue decreased compared to the prior year period due to the decrease in Business-to-Consumer (“B2C”) revenue. This decrease was offset by an increase of $0.2 million in real money gaming revenue in the current period from our recent acquisition of AGS iGaming.

Interactive Adjusted EBITDA

Interactive adjusted EBITDA includes the revenues and operating expenses from the Interactive segment adjusted for depreciation, amortization, write-downs and other charges, as well as other costs. See Item 1. “Financial Statements” Note 14 for further explanation of adjustments. The decrease in interactive adjusted EBITDA is attributable to decreased revenues, as described above as well as additional operating costs incurred by AGS iGaming that were not present in the prior period offset by decreased user acquisition costs of $0.4 million.

Nine Months Ended September 30, 2018 compared to Nine Months Ended September 30, 2017
 
Nine months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Interactive Segment Revenue:
 
 
 
 
 
 
 
Gaming operations
$
5,329

 
6,105

 
$
(776
)
 
(12.7
)%
Total Interactive revenues
$
5,329

 
$
6,105

 
$
(776
)
 
(12.7
)%
 
 
 
 
 
 
 
 
Interactive adjusted EBITDA
$
(1,223
)
 
$
(337
)
 
$
(886
)
 
(262.9
)%
 
 
 
 
 
 
 
 
Interactive unit information:
 
 
 
 
 
 
 
Average MAU(1)
183,593

 
190,237

 
(6,644
)
 
(3.5
)%
Average DAU(2)
37,088

 
37,544

 
(456
)
 
(1.2
)%
ARPDAU(3)
$
0.46

 
$
0.58

 
$
(0.12
)
 
(20.7
)%
(1) MAU = Monthly Active Users and is a count of unique visitors to our sites during a month
(2) DAU = Daily Active Users, a count of unique visitors to our sites during a day
(3) ARPDAU = Average daily revenue per DAU is calculated by dividing revenue for a period by the DAU for the period by the number of days for the period


40

Gaming Operations Revenue

Because of our optimization strategy, interactive gaming operations revenue decreased slightly compared to the prior year period due to the decrease in Business-to-Consumer (“B2C”) revenue. These decreases were offset by an increase in Business-to-Business (“B2B”) revenue of $0.3 million as well as an increase of $0.3 million in real money gaming revenue in the current period from our recent acquisition of AGS iGaming.

Interactive Adjusted EBITDA

Interactive adjusted EBITDA includes the revenues and operating expenses from the Interactive segment adjusted for depreciation, amortization, write-downs and other charges, as well as other costs. See Item 1. “Financial Statements” Note 14 for further explanation of adjustments. The decrease in interactive adjusted EBITDA is attributable to decreased revenues, as described above as well as additional operating costs incurred by AGS iGaming that were not present in the prior period offset by a decrease in user acquisition fees of $1.0 million.

41

Total Adjusted EBITDA

The following tables provide reconciliations of segment financial information to our consolidated statement of operations and to total adjusted EBITDA. We have included revenues, operating expenses and other adjustments by segment which we believe are important to understanding the operating results of our segment:
 
Three months ended September 30, 2018
 
EGM
 
Table Products
 
Interactive
 
Total
Revenues
 
 
 
 
 
 
 
Gaming operations
$
47,109

 
$
1,902

 
$
1,690

 
$
50,701

Equipment sales
24,675

 
150

 
—

 
24,825

Total revenues
71,784

 
2,052

 
1,690

 
75,526

Cost of gaming operations(1)
9,548

 
382

 
564

 
10,494

Cost of equipment sales(1)
12,096

 
13

 
—

 
12,109

Selling, general and administrative
12,917

 
554

 
1,813

 
15,284

Research and development
6,298

 
694

 
902

 
7,894

Write-downs and other charges
667

 
—

 
—

 
667

Depreciation and amortization
17,966

 
701

 
301

 
18,968

Total operating expenses
59,492

 
2,344

 
3,580

 
65,416

 
 
 
 
 
 
 
 
Write-downs and other
 
 
 
 
 
 
 
Loss on disposal of long lived assets
363

 
—

 
—

 
363

Impairment of long lived assets
204

 
—

 
—

 
204

Fair value adjustments to contingent consideration and other items
100

 
—

 
—

 
100

Depreciation and amortization
17,966

 
701

 
301

 
18,968

Accretion of placement fees(2)
1,206

 
—

 
—

 
1,206

Non-cash stock-based compensation expense(3)
502

 
19

 
17

 
538

Acquisitions and integration related costs including restructuring and severance(4)
51

 
—

 
695

 
746

Initial public offering(5)
859

 
—

 
—

 
859

Legal and litigation expenses including settlement payments(6)
(45
)
 
—

 
—

 
(45
)
New jurisdictions and regulatory licensing costs(7)
—

 
—

 
—

 
—

Non-cash charge on capitalized installation and delivery(8)
494

 
—

 
—

 
494

Non-cash charges and loss on disposition of assets(9)
—

 
—

 
—

 
—

Other adjustments(10)
34

 
—

 
—

 
34

Adjusted EBITDA
$
34,026

 
$
428

 
$
(877
)
 
$
33,577


(1) Exclusive of depreciation and amortization.
(2) Non-cash item related to the accretion of contract rights under development agreements and placement fees.
(3) Non-cash stock-based compensation includes non-cash compensation expense related to grants of options, restricted stock, and other equity awards.
(4) Acquisitions and integration related costs primarily relate to costs incurred after the purchase of businesses, such as the purchase of AGS iGaming, to integrate operations and obtain costs synergies. Restructuring and severance costs primarily relate to costs incurred through the restructuring of the Company’s operations from time to time and other employee severance costs recognized in the periods presented.
(5) Costs incurred related to initial public offering, net of costs capitalized to equity and the filing of the related offerings.
(6) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. These costs
related to litigation and matters that were not significant individually.
(7) New jurisdictions and regulatory licensing costs primarily relate to the costs the Company incurred to obtain licenses and develop products for new jurisdictions.
(8) Non-cash charge on capitalized installation and delivery primarily include the costs to acquire contracts that are expensed over the estimated life of each contract.
(9) Non-cash charges and loss on disposition of assets are primarily composed of non-cash inventory obsolescence charges.
(10) Other adjustments are primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance, contract cancellation fees, and other costs deemed to be non-recurring in nature.


42





 
Three months ended September 30, 2017
 
EGM
 
Table Products
 
Interactive
 
Total
Revenues
 
 
 
 
 
 
 
Gaming operations
$
39,767

 
$
1,072

 
$
2,010

 
$
42,849

Equipment sales
13,564

 
27

 
—

 
13,591

Total revenues
53,331

 
1,099

 
2,010

 
56,440

Cost of gaming operations(1)
6,352

 
405

 
587

 
7,344

Cost of equipment sales(1)
6,329

 
1

 
—

 
6,330

Selling, general and administrative
8,011

 
586

 
1,145

 
9,742

Research and development
5,537

 
524

 
406

 
6,467

Write-downs and other charges
490

 
—

 
—

 
490

Depreciation and amortization
16,181

 
185

 
565

 
16,931

Total operating expenses
42,900

 
1,701

 
2,703

 
47,304

 
 
 
 
 
 
 
 
Write-downs and other
 
 
 
 
 
 
 
Loss on disposal of long lived assets
490

 
—

 
—

 
490

Impairment of long lived assets
—

 
—

 
—

 
—

Fair value adjustments to contingent consideration and other items
—

 
—

 
—

 
—

Depreciation and amortization
16,181

 
185

 
565

 
16,931

Accretion of placement fees(2)
1,192

 
—

 
—

 
1,192

Non-cash stock-based compensation expense(3)
—

 
—

 
—

 
—

Acquisitions and integration related costs including restructuring and severance(4)
65

 
5

 
1

 
71

Initial public offering(5)
—

 
—

 
—

 
—

Legal and litigation expenses including settlement payments(6)
181

 
—

 
—

 
181

New jurisdictions and regulatory licensing costs(7)
556

 
11

 
—

 
567

Non-cash charge on capitalized installation and delivery(8)
359

 
—

 
—

 
359

Non-cash charges and loss on disposition of assets(9)
—

 
—

 
—

 
—

Other adjustments(10)
301

 
169

 
4

 
474

Adjusted EBITDA
$
29,756

 
$
(232
)
 
$
(123
)
 
$
29,401


(1) Exclusive of depreciation and amortization.
(2) Non-cash item related to the accretion of contract rights under development agreements and placement fees.
(3) Non-cash stock-based compensation includes non-cash compensation expense related to grants of options, restricted stock, and other equity awards.
(4) Acquisitions and integration related costs primarily relate to costs incurred after the purchase of businesses, such as the purchase of AGS iGaming, to integrate operations and obtain costs synergies. Restructuring and severance costs primarily relate to costs incurred through the restructuring of the Company’s operations from time to time and other employee severance costs recognized in the periods presented.
(5) Costs incurred related to initial public offering, net of costs capitalized to equity and the filing of the related offerings.
(6) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. These costs
related to litigation and matters that were not significant individually.
(7) New jurisdictions and regulatory licensing costs primarily relate to the costs the Company incurred to obtain licenses and develop products for new jurisdictions.
(8) Non-cash charge on capitalized installation and delivery primarily include the costs to acquire contracts that are expensed over the estimated life of each contract.
(9) Non-cash charges and loss on disposition of assets are primarily composed of non-cash inventory obsolescence charges.
(10) Other adjustments are primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance, contract cancellation fees, and other costs deemed to be non-recurring in nature.



43

 
Nine months ended September 30, 2018
 
EGM
 
Table Products
 
Interactive
 
Total
Revenues
 
 
 
 
 
 
 
Gaming operations
$
142,301

 
$
5,257

 
$
5,329

 
$
152,887

Equipment sales
60,060

 
257

 
—

 
60,317

Total revenues
202,361

 
5,514

 
5,329

 
213,204

Cost of gaming operations(1)
26,085

 
1,427

 
1,550

 
29,062

Cost of equipment sales(1)
28,884

 
35

 
—

 
28,919

Selling, general and administrative
41,694

 
1,861

 
3,856

 
47,411

Research and development
19,057

 
2,353

 
1,964

 
23,374

Write-downs and other charges
3,282

 
—

 
—

 
3,282

Depreciation and amortization
55,083

 
1,989

 
712

 
57,784

Total operating expenses
174,085

 
7,665

 
8,082

 
189,832

 
 
 
 
 
 
 
 
Write-downs and other
 
 
 
 
 
 
 
Loss on disposal of long lived assets
1,383

 
—

 
—

 
1,383

Impairment of long lived assets
1,199

 
—

 
—

 
1,199

Fair value adjustments to contingent consideration and other items
700

 
—

 
—

 
700

Depreciation and amortization
55,083

 
1,989

 
712

 
57,784

Accretion of placement fees(2)
3,412

 
—

 
—

 
3,412

Non-cash stock-based compensation expense(3)
8,200

 
844

 
123

 
9,167

Acquisitions and integration related costs including restructuring and severance(4)
2,461

 
—

 
695

 
3,156

Initial public offering(5)
2,166

 
2

 
—

 
2,168

Legal and litigation expenses including settlement payments(6)
789

 
—

 
—

 
789

New jurisdictions and regulatory licensing costs(7)
—

 
—

 
—

 
—

Non-cash charge on capitalized installation and delivery(8)
1,478

 
—

 
—

 
1,478

Non-cash charges and loss on disposition of assets(9)
—

 
—

 
—

 
—

Other adjustments(10)
50

 
—

 
—

 
50

Adjusted EBITDA
$
105,197

 
$
684

 
$
(1,223
)
 
$
104,658


(1) Exclusive of depreciation and amortization.
(2) Non-cash item related to the accretion of contract rights under development agreements and placement fees.
(3) Non-cash stock-based compensation includes non-cash compensation expense related to grants of options, restricted stock, and other equity awards.
(4) Acquisitions and integration related costs primarily relate to costs incurred after the purchase of businesses, such as the purchase of AGS iGaming, to integrate operations and obtain costs synergies. Restructuring and severance costs primarily relate to costs incurred through the restructuring of the Company’s operations from time to time and other employee severance costs recognized in the periods presented.
(5) Costs incurred related to initial public offering, net of costs capitalized to equity and the filing of the related offerings.
(6) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. These costs
related to litigation and matters that were not significant individually.
(7) New jurisdictions and regulatory licensing costs primarily relate to the costs the Company incurred to obtain licenses and develop products for new jurisdictions.
(8) Non-cash charge on capitalized installation and delivery primarily include the costs to acquire contracts that are expensed over the estimated life of each contract.
(9) Non-cash charges and loss on disposition of assets are primarily composed of non-cash inventory obsolescence charges.
(10) Other adjustments are primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance, contract cancellation fees, and other costs deemed to be non-recurring in nature.



44

 
Nine months ended September 30, 2017
 
EGM
 
Table Products
 
Interactive
 
Total
Revenues
 
 
 
 
 
 
 
Gaming operations
$
116,587

 
$
2,348

 
$
6,105

 
$
125,040

Equipment sales
29,160

 
94

 
—

 
29,254

Total revenues
145,747

 
2,442

 
6,105

 
154,294

Cost of gaming operations(1)
19,188

 
798

 
1,808

 
21,794

Cost of equipment sales(1)
14,318

 
8

 
—

 
14,326

Selling, general and administrative
25,490

 
1,424

 
3,454

 
30,368

Research and development
15,652

 
1,277

 
983

 
17,912

Write-downs and other charges
2,655

 
—

 
—

 
2,655

Depreciation and amortization
51,603

 
1,012

 
983

 
53,598

Total operating expenses
128,906

 
4,519

 
7,228

 
140,653

 
 
 
 
 
 
 
 
Write-downs and other
 
 
 
 
 
 
 
Loss on disposal of long lived assets
3,000

 
—

 
—

 
3,000

Impairment of long lived assets
285

 
—

 
—

 
285

Fair value adjustments to contingent consideration and other items
(630
)
 
—

 
—

 
(630
)
Depreciation and amortization
51,603

 
1,012

 
983

 
53,598

Accretion of placement fees(2)
3,492

 
—

 
—

 
3,492

Non-cash stock-based compensation expense(3)
—

 
—

 
—

 
—

Acquisitions and integration related costs including restructuring and severance(4)
952

 
164

 
(217
)
 
899

Initial public offering(5)
—

 
—

 
—

 
—

Legal and litigation expenses including settlement payments(6)
766

 
—

 
—

 
766

New jurisdictions and regulatory licensing costs(7)
1,293

 
11

 
—

 
1,304

Non-cash charge on capitalized installation and delivery(8)
1,284

 
—

 
—

 
1,284

Non-cash charges and loss on disposition of assets(9)
686

 
—

 
—

 
686

Other adjustments(10)
1,878

 
169

 
20

 
2,067

Adjusted EBITDA
$
81,450

 
$
(721
)
 
$
(337
)
 
$
80,392


(1) Exclusive of depreciation and amortization.
(2) Non-cash item related to the accretion of contract rights under development agreements and placement fees.
(3) Non-cash stock-based compensation includes non-cash compensation expense related to grants of options, restricted stock, and other equity awards.
(4) Acquisitions and integration related costs primarily relate to costs incurred after the purchase of businesses, such as the purchase of AGS iGaming, to integrate operations and obtain costs synergies. Restructuring and severance costs primarily relate to costs incurred through the restructuring of the Company’s operations from time to time and other employee severance costs recognized in the periods presented.
(5) Costs incurred related to initial public offering, net of costs capitalized to equity and the filing of the related offerings.
(6) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. These costs
related to litigation and matters that were not significant individually.
(7) New jurisdictions and regulatory licensing costs primarily relate to the costs the Company incurred to obtain licenses and develop products for new jurisdictions.
(8) Non-cash charge on capitalized installation and delivery primarily include the costs to acquire contracts that are expensed over the estimated life of each contract.
(9) Non-cash charges and loss on disposition of assets are primarily composed of non-cash inventory obsolescence charges.
(10) Other adjustments are primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance, contract cancellation fees, and other costs deemed to be non-recurring in nature.

We have provided total adjusted EBITDA in this Form 10-Q because we believe such measure provides investors with additional information to measure our performance.    

We believe that the presentation of total adjusted EBITDA is appropriate to provide additional information to investors about certain material non-cash items that we do not expect to continue at the same level in the future, as well as other items we do not

45

consider indicative of our ongoing operating performance. Further, we believe total adjusted EBITDA provides a meaningful measure of operating profitability because we use it for evaluating our business performance, making budgeting decisions, and comparing our performance against that of other peer companies using similar measures. It also provides management and investors with additional information to estimate our value.

Total adjusted EBITDA is not a presentation made in accordance with GAAP. Our use of the term total adjusted EBITDA may vary from others in our industry. Total adjusted EBITDA should not be considered as an alternative to operating income or net income. Total adjusted EBITDA has important limitations as an analytical tool, and you should not consider it in isolation or as a substitute for the analysis of our results as reported under GAAP.

Our definition of total adjusted EBITDA allows us to add back certain non-cash charges that are deducted in calculating net income and to deduct certain gains that are included in calculating net income. However, these expenses and gains vary greatly, and are difficult to predict. They can represent the effect of long-term strategies as opposed to short-term results. In addition, in the case of charges or expenses, these items can represent the reduction of cash that could be used for other corporate purposes.

Due to these limitations, we rely primarily on our GAAP results, such as net income (loss), income (loss) from operations, EGM Adjusted EBITDA, Table Products Adjusted EBITDA or Interactive Adjusted EBITDA and use Total adjusted EBITDA only supplementally.

The following tables reconcile net income (loss) to total adjusted EBITDA:

Three Months Ended September 30, 2018 compared to the Three Months Ended September 30, 2017
 
Three months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Net income (loss)
$
4,347

 
$
(4,090
)
 
$
8,437

 
206.3
 %
Income tax (benefit) expense
(3,538
)
 
1,052

 
(4,590
)
 
(436.3
)%
Depreciation and amortization
18,968

 
16,931

 
2,037

 
12.0
 %
Other expense (income)
434

 
(467
)
 
901

 
192.9
 %
Interest income
(89
)
 
(25
)
 
(64
)
 
(256.0
)%
Interest expense
8,956

 
12,666

 
(3,710
)
 
(29.3
)%
Write downs and other(1)
667

 
490

 
177

 
36.1
 %
Loss on extinguishment and modification of debt(2)
—

 
—

 
—

 
—
 %
Other adjustments(3)
893

 
474

 
419

 
88.4
 %
Other non-cash charges(4)
1,700

 
1,551

 
149

 
9.6
 %
New jurisdictions and regulatory licensing costs(5)
—

 
567

 
(567
)
 
(100.0
)%
Legal and litigation expenses including settlement payments(6)
(45
)
 
181

 
(226
)
 
(124.9
)%
Acquisitions and integration related costs including restructuring and severance(7)
746

 
71

 
675

 
950.7
 %
Non-cash stock based compensation(8)
538

 
—

 
538

 
100.0
 %
Total Adjusted EBITDA
$
33,577

 
$
29,401

 
$
4,176

 
14.2
 %

(1) Write-downs and other include items related to loss on disposal or impairment of long-lived assets, fair value adjustments to contingent consideration and acquisition costs
(2) Loss on extinguishment and modification of debt primarily relates to the refinancing of long-term debt, in which deferred loan costs and discounts related to old senior secured credit facilities were written off
(3) Other adjustments are primarily composed of professional fees incurred for projects, corporate and public filing compliance, contract cancellation fees and other transaction costs deemed to be non-operating in nature
(4) Other non-cash charges are costs related to non-cash charges and losses on the disposition of assets, non-cash charges on capitalized installation and delivery, which primarily includes the costs to acquire contracts that are expensed over the estimated life of each contract and non-cash charges related to accretion of contract rights under development agreements
(5) New jurisdiction and regulatory license costs relates primarily to one-time non-operating costs incurred to obtain new licenses and develop products for new jurisdictions
(6) Legal and litigation expenses include payments to law firms and settlements for matters that are outside the normal course of business
(7) Acquisition and integration costs include restructuring and severance and are related to costs incurred after the purchase of businesses, such as the acquisitions of Rocket and AGS iGaming, to integrate operations

46

(8) Non-cash stock-based compensation includes non-cash compensation expense related to grants of options, restricted stock, and other equity awards


Nine Months Ended September 30, 2018 compared to the Nine Months Ended September 30, 2017
 
Nine months ended September 30,
 
$
 
%
 
2018
 
2017
 
Change
 
Change
Net loss
$
(10,501
)
 
$
(36,586
)
 
$
26,085

 
71.3
 %
Income tax (benefit) expense
(8,947
)
 
4,603

 
(13,550
)
 
(294.4
)%
Depreciation and amortization
57,784

 
53,598

 
4,186

 
7.8
 %
Other expense (income)
10,121

 
(4,805
)
 
14,926

 
310.6
 %
Interest income
(162
)
 
(80
)
 
(82
)
 
(102.5
)%
Interest expense
28,253

 
42,380

 
(14,127
)
 
(33.3
)%
Write downs and other(1)
3,282

 
2,655

 
627

 
23.6
 %
Loss on extinguishment and modification of debt(2)
4,608

 
8,129

 
(3,521
)
 
(43.3
)%
Other adjustments(3)
2,218

 
2,067

 
151

 
7.3
 %
Other non-cash charges(4)
4,890

 
5,462

 
(572
)
 
(10.5
)%
New jurisdictions and regulatory licensing costs(5)
—

 
1,304

 
(1,304
)
 
(100.0
)%
Legal and litigation expenses including settlement payments(6)
789

 
766

 
23

 
3.0
 %
Acquisitions and integration related costs including restructuring and severance(7)
3,156

 
899

 
2,257

 
251.1
 %
Non-cash stock based compensation(8)
9,167

 
—

 
9,167

 
100.0
 %
Total Adjusted EBITDA
$
104,658

 
$
80,392

 
$
24,266

 
30.2
 %

(1) Write-downs and other include items related to loss on disposal or impairment of long-lived assets, fair value adjustments to contingent consideration and acquisition costs
(2) Loss on extinguishment and modification of debt primarily relates to the refinancing of long-term debt, in which deferred loan costs and discounts related to old senior secured credit facilities were written off
(3) Other adjustments are primarily composed of professional fees incurred for projects, corporate and public filing compliance, contract cancellation fees and other transaction costs deemed to be non-operating in nature
(4) Other non-cash charges are costs related to non-cash charges and losses on the disposition of assets, non-cash charges on capitalized installation and delivery, which primarily includes the costs to acquire contracts that are expensed over the estimated life of each contract and non-cash charges related to accretion of contract rights under development agreements
(5) New jurisdiction and regulatory license costs relates primarily to one-time non-operating costs incurred to obtain new licenses and develop products for new jurisdictions
(6) Legal and litigation expenses include payments to law firms and settlements for matters that are outside the normal course of business
(7) Acquisition and integration costs include restructuring and severance and are related to costs incurred after the purchase of businesses, such as the acquisitions of Rocket and AGS iGaming, to integrate operations
(8) Non-cash stock-based compensation includes non-cash compensation expense related to grants of options, restricted stock, and other equity awards


LIQUIDITY AND CAPITAL RESOURCES

We expect that primary ongoing liquidity requirements for the year ending December 31, 2018 will be for operating capital expenditures, working capital, debt servicing, game development and other customer acquisition activities. We expect to finance these liquidity requirements through a combination of cash on hand and cash flows from operating activities.

Part of our overall strategy includes consideration of expansion opportunities, underserved markets and acquisition and other strategic opportunities that may arise periodically. We may require additional funds in order to execute on such strategic growth, and may incur additional debt or issue additional equity to finance any such transactions. We cannot assure you that we will be able to obtain such debt or issue any such additional equity on acceptable terms or at all.

As of September 30, 2018, we had $33.2 million in cash and cash equivalents and $30.0 million available under our revolving credit facility. Based on our current business plan, we believe that our existing cash balances, cash generated from operations and availability under the revolving credit facility will be sufficient to meet our anticipated cash needs for at least the next twelve months. As of September 30, 2018, we were in compliance with the required covenants of our debt instruments, including the maximum net first lien leverage ratio, which was 3.5 to 1.0. However, our future cash requirements could be higher than we

47

currently expect as a result of various factors. Our ability to meet our liquidity needs could be adversely affected if we suffer adverse results of operations, or if we violate the covenants and restrictions to which we are subject under our debt instruments. Additionally, our ability to generate sufficient cash from our operating activities is subject to general economic, political, regulatory, financial, competitive and other factors beyond our control. Our business may not generate sufficient cash flow from operations, and future borrowings may not be available to us under our existing credit facility in an amount sufficient to enable us to pay our service or repay our indebtedness or to fund our other liquidity needs, and we may be required to seek additional financing through credit facilities with other lenders or institutions or seek additional capital through private placements or public offerings of equity or debt securities.

Indebtedness

First Lien Credit Facilities

On June 6, 2017 (the “Closing Date”), AP Gaming I, LLC (the “Borrower”), a wholly owned indirect subsidiary of the Company, entered into a first lien credit agreement (“the First Lien Credit Agreement”), providing for $450.0 million in term loans and a $30.0 million revolving credit facility (the “First Lien Credit Facilities”).  The proceeds of the term loans were used primarily to repay the senior secured credit facilities (the “Existing Credit Facilities”), the notes issued by the Company to AGS Holdings, LLC (the “AGS Seller Notes”) and the promissory note issued by the Company to Amaya Inc. (the “Amaya Seller Note”), to pay for the fees and expenses incurred in connection with the foregoing and otherwise for general corporate purposes.

On December 6, 2017, AP Gaming I, LLC (the “Borrower”), a wholly owned indirect subsidiary of the Company, entered into incremental facilities for $65.0 million in term loans.  The net proceeds of the incremental term loans were used to finance the acquisition of electronic gaming machines and related assets operated by Rocket as described in Note 2, to pay fees and expenses in connection therewith and for general corporate purposes. 

On February 7, 2018, the Company entered into an Incremental Assumption and Amendment Agreement (the “Incremental Agreement”), which amended and restated the First Lien Credit Agreement, dated as of June 6, 2017, as amended by the incremental facilities dated as of December 6, 2017, to reduce the applicable margin for the term loans thereunder by 1.25%. The Incremental Agreement also provides that any refinancing of the term loans through the issuance of certain debt or any repricing amendment resulting in a lower yield occurring at any time during the first six months after February 7, 2018 will be accompanied by a 1.00% payment premium or fee.

Prior to entering into the Incremental Agreement, net deferred loan costs and discounts totaling $13.3 million were capitalized and were being amortized over the term of the agreement. In conjunction with the Incremental Agreement approximately $0.4 million of these deferred loan costs and discounts was written off as a portion of the loss on extinguishment and modification of debt and the remainder of these cost will be amortized over the remaining term of the First Lien Credit Facilities. An additional $1.2 million in third party fees was incurred related to the Incremental Agreement. Given the composition of the lender group, certain lenders were accounted for as a debt modification and, as such, $1.2 million of these costs were expensed and included in the loss on extinguishment and modification of debt.

The term loans will mature on February 15, 2024, and the revolving credit facility will mature on June 6, 2022. Starting with the first full quarter after the Closing Date, the term loans require scheduled quarterly payments in amounts equal to 0.25% of the original aggregate principal amount of the term loans, with the balance due at maturity.  Borrowings under the term loans bear interest at a rate equal to, at the Borrower’s option, either LIBOR or the base rate, subject to an interest rate floor plus an applicable margin rate.  Borrowings under the revolving credit facility bear interest at a rate equal to, at the Borrower’s option, either LIBOR or the base rate plus an applicable margin rate.  In addition, on a quarterly basis, the Borrower is required to pay each lender under the revolving credit facility a commitment fee in respect of any unused commitments thereunder at a rate of 0.50% per annum.

The First Lien Credit Facilities are guaranteed by AP Gaming Holdings, LLC, the Borrower’s material, wholly owned domestic subsidiaries (subject to certain exceptions), and are secured by a pledge by AP Gaming Holdings, LLC of the Borrower’s equity interest directly held by AP Gaming Holdings, LLC and a pledge of substantially all of the existing and future property and assets of the Borrower and the subsidiary guarantors, subject to certain exceptions.  The First Lien Credit Facilities require that the Borrower maintain a maximum net first lien leverage ratio set at a maximum of 6.0 to 1.0. 

The First Lien Credit Facilities also contain customary affirmative covenants and negative covenants that limit our ability to, among other things: (i) incur additional debt or issue certain preferred shares; (ii) create liens on certain assets; (iii) make certain loans or investments (including acquisitions); (iv) pay dividends on or make distributions in respect of our capital stock or make other restricted payments; (v) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; (vi) sell assets; (vii) enter into certain transactions with our affiliates; (viii) enter into sale-leaseback transactions; (ix) change our lines of business;

48

(x) restrict dividends from our subsidiaries or restrict liens; (xi) change our fiscal year; and (xii) modify the terms of certain debt or organizational agreements. The new senior secured credit facilities also contain customary events of default included in similar financing transactions, including, among others, failure to make payments when due, default under other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments.

On October 5, 2018, the Borrower entered into an Incremental Assumption and Amendment Agreement No. 2 (the “Incremental Agreement No. 2”) with certain of the Borrower’s subsidiaries, the lenders party thereto from time to time and Jefferies finance LLC, as administrative agent, (the “Administrative Agent”). See Item 1. “Financial Statements” Note 15.


Amended and Restated Senior Secured PIK Notes

On January 30, 2018, the Company used the net proceeds of the IPO and cash on hand to redeem in full its 11.25% senior secured PIK notes due 2024 (the “PIK Notes”). On the redemption date, the aggregate principal amount of the PIK Notes outstanding was $152.6 million (comprised of the original principal amount of $115 million and the remaining principal amount comprised of capitalized interest) and the amount of accrued and unpaid interest was $1.4 million. In connection with the redemption, the Company repaid all of the outstanding obligations in respect of principal, interest and fees under the PIK Notes and net deferred loan costs and discounts totaling $3.0 million were written off and included in the loss on extinguishment and modification of debt.

Concurrently with the redemption of the PIK notes, the Company terminated its amended and restated note purchase agreement (the “A&R Note Purchase Agreement”), dated May 30, 2017, among the Company, AP Gaming Holdings, LLC, as subsidiary guarantor, Deutsche Bank AG, London Branch, as holder, and Deutsche Bank Trust Company Americas, as collateral agent, which governed the PIK Notes.

Equipment Long Term Note Payable and Capital Leases

The Company has entered into a financing agreement to purchase certain gaming devices, systems and related equipment and has entered into leases for servers and equipment that are accounted for as capital leases.

The following table summarizes our historical cash flows (in thousands):
 
Nine months ended September 30,
 
2018
 
2017
Cash Flow Information:
 
 
 
Net cash provided by (used in) operating activities
$
13,320

 
$
26,293

Net cash used in investing activities
(48,613
)
 
(49,689
)
Net cash provided by financing activities
49,252

 
15,436

Effect of exchange rates on cash and cash equivalents and restricted cash
4

 
8

Net increase in cash and cash equivalents and restricted cash
$
13,963

 
$
(7,952
)

Operating activities

Net cash provided by operating activities for the nine months ended September 30, 2018, was $13.3 million compared to $26.3 million provided in the prior year period, representing a decrease of $13.0 million. This decrease is primarily due to payment of $37.6 million related to unpaid interest from the redemption of the senior secured PIK notes. Secondarily, the decrease is due to changes in net working capital, which were driven by several factors. Increased sales volume contributed to a $2.6 million change in accounts receivable. Additionally, we had a $14.5 million decrease in accounts payable and accrued liabilities, a $2.7 million change in inventory and to a lesser extent, a $0.8 million change in prepaid expenses. A change in other non-current assets of $15.6 million was primarily related to tax related accruals and offset by a comparable amount in the change in accounts payable and accrued liabilities.

Investing activities

Net cash used in investing activities for the nine months ended September 30, 2018, was $48.6 million compared to $49.7 million in the prior year period, representing a decrease of $1.1 million. The decrease was primarily due to the decrease in business acquisitions, net of cash acquired of $2.5 million as described in Item 1. “Financial Statements” Note 2. The decrease was also

49

attributable to an decrease in purchases of property and equipment of $1.5 million offset by a $2.8 million increase in software development and other expenditures.

Financing activities

Net cash provided by financing activities for the nine months ended September 30, 2018, was $49.3 million compared to cash provided of $15.4 million for the nine months ended September 30, 2017, representing an increase of $33.8 million. The increase was primarily due to the initial public offering net proceeds, after deducting underwriting discounts and commissions of $176.3 million, and offset by $4.2 million initial public offering costs. Additionally, the difference is due to the repayment the principal amount of our 11.25% senior secured PIK notes of $115 million.

Off-Balance Sheet Arrangements

We do not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies

A description of our critical accounting policies can be found in “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2017. There were no material changes to those policies during the nine months ended September 30, 2018.

Recently Issued Accounting Standards

See related disclosure at Item 1. —“Notes to Condensed Consolidated Financial Statements”, Note 1 “Description of the Business and Summary of Significant Accounting Policies.”

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rates. Our primary exposure to market risk is interest rate risk associated with our long-term debt, which accrues interest at variable rates. Certain of our debt instruments accrue interest at LIBOR or the base rate, at our election, subject to an interest rate floor plus an applicable margin rate. In the normal course of business, we are exposed to fluctuations in interest rates as we seek debt and equity capital to sustain our operations. All of our interest rate sensitive financial instruments are held for purposes other than trading purposes. As of September 30, 2018, less than 1% of our debt were fixed-rate instruments. Assuming a constant outstanding balance for our variable-rate long term debt, a hypothetical 1% decrease in interest rates would decrease interest expense $5.1 million given our LIBOR floor on related debt, while a hypothetical 1% increase in interest rates would increase interest expense approximately $5.1 million. 

Foreign currency risk. We are exposed to foreign currency exchange rate risk that is inherent to our foreign operations. We currently transact business in Mexico using the local currency. Our settlement of inter-company trade balances requires the exchange of currencies, which results in the recognition of foreign currency fluctuations. We expect that certain operations will continue to be denominated in foreign currencies. As such, we expect our cash flows and earnings to continue to be exposed to the risks that may arise from fluctuations in foreign currency exchange rates.

ITEM 4. CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Exchange Act) as of September 30, 2018. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure information is recorded, processed, summarized and reported within the periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error and mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of controls.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions or because the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

Changes in Internal Controls

No change in our internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f) occurred as of the end of the fiscal quarter covered by this report, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II
ITEM 1. LEGAL PROCEEDINGS.

We are party to various claims and legal actions that arise in the ordinary course of business. We do not believe the outcome of such disputes or legal actions will have a material adverse effect on our financial condition, results of operations, liquidity or capital resources.

ITEM 1A. RISK FACTORS.

"Item 1A.-Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2017, includes a discussion of our risk factors. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

Appointment of Geoff Freeman as a Member of the Board of Directors

PlayAGS, Inc. (the “Company”) has appointed Geoff Freeman, 43, as a member of the Company’s Board of Directors (the “Board”), Nominating and Governance Committee, Compensation Committee and Audit Committee, effective November 7, 2018. Mr. Freeman is currently the CEO of the Grocery Manufacturers Association. Prior to serving in his current role, Mr. Freeman served as CEO of the American Gaming Association from May 2013 through July 2018, as the COO of The U.S. Travel Association from May 2006 to May 2013, and as a director to The U.S. Travel Association from January 2014 through July 2018. Mr. Freeman holds a Bachelor of Arts, Political Science and Public Policy from the University of California, Berkley.
In connection with Mr. Freeman’s appointment to the Board, the size of the Board will be increased to seven members, and the size of the Audit Committee shall increase to three members, which shall be Mr. Freeman, Ms. Yvette Landau and Mr. Adam Chibib. Additionally, in connection with Mr. Freeman’s appointment to each of the Nominating and Governance Committee and the Compensation Committee, the size of each such committee shall be decreased to three members and certain current members shall be removed therefrom. As a result, the members of the Nominating and Governance Committee shall be Mr. Freeman, Mr. Daniel Cohen and Ms. Landau, while the members of the Compensation Committee shall be Mr. Freeman, Mr. Chibib and Mr. David Sambur.
Employment Agreement with Sigmund Lee
Effective November 5, 2018, AGS, LLC (“AGS”) a subsidiary of PlayAGS, Inc., entered into an employment agreement with Sigmund Lee to continue to serve as Chief Technology Officer of AGS (the “Employment Agreement”). Mr Lee, has served as the Chief Technology Officer for AGS since July 01, 2015.

Pursuant to the Employment Agreement, Mr. Lee’s annual base salary shall be $600,000. Mr. Lee’s base salary may from time to time be increased by AGS, but may be decreased only in connection, and to the same extent, with a Company-wide decrease for all senior leadership positions. Mr. Lee shall also be eligible to receive an annual performance-based bonus, with an annual target bonus opportunity no less than 75% of his base salary if 100% of target is achieved. Mr. Lee will be eligible for this performance-based bonus if he is actively employed by AGS on the time of the bonus payment.


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In exchange for his commitment to remain employed with the Company until September 1, 2021, Mr. Lee will also be eligible to participate in the Annual Incentive Program (“AIP”) which entitles him to three annual AIP bonus payments, each in the gross amount of $450,000, less all required withholding and deductions. If prior to September 1, 2021, Mr. Lee either resigns his employment without “good reason” (as defined in the Employment Agreement) or is terminated for “cause” (as defined in the Employment Agreement), then the net after-tax amount of any AIP bonus payment paid to him in the current fiscal year shall be subject to immediate repayment to AGS. Additionally, AGS has agreed to pay Mr. Lee a one-time sign-on bonus in the gross amount of $500,000, less all required withholding and deductions.  If prior to September 1, 2021, Mr. Lee voluntarily resigns his employment without good reason, then the net after-tax amount of the sign-on bonus is subject to immediate repayment to AGS.

The agreement with AGS is “at-will,” meaning that either Mr. Lee or AGS may terminate the employment relationship at any time and for any reason, either with or without cause. If during the term of the Employment Agreement, AGS terminates Mr. Lee’s employment for any reason, either with or without cause, or due to death or “disability” (as defined in the Employment Agreement), Mr. Lee will only be entitled to receive the unpaid portion of his base salary accrued to the termination date. If during the term of the Employment Agreement, AGS terminates Mr. Lee’s employment without cause, subject to receiving a signed release of claims from Mr. Lee, Mr. Lee will receive severance pay equal to 18 months base salary (paid over an 18-month period) (or, if a change of control (as defined in the Employment Agreement) occurs and such termination occurs on or within 24 months of such change of control, 24 months base salary (paid over a 24-month period)). Mr. Lee shall be entitled to any severance pay if his employment is either terminated by AGS with cause, or by him with or without good reason.

Pursuant to his Employment Agreement, Mr. Lee will also be subject to perpetual confidentiality, intellectual property and non-disparagement, as well as certain non-solicitation restrictions for 18 months following the date of his employment, and certain non-competition restrictions for either (a) twenty-four (24) months post-termination of employment if his employment is terminated prior to September 21, 2021, or (b) six months if his employment is terminated after September 21, 2021.

The description of the terms of the Employment Agreement in this Item 5.02 is qualified in its entirety by reference to the Employment Agreement, which will be filed as an exhibit to PlayAGS, Inc.’s Form 10-K report for the fiscal year ending December 31, 2018.



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ITEM 6. EXHIBITS.
(a). Exhibits.
 
 
 
Exhibit Number
 
Exhibit Description
10.1
 
 
 
 
10.2
 
 
 
 
10.3
 
 
 
 
10.4
 
 
 
 
10.5
 
 
 
 
31.1
 
 
 
 
31.2
 
 
 
 
32
 
 
 
 
101.IN
 
XBRL Instance Document
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
AP GAMING HOLDCO, INC.
 
 
 
 
 
 
Date:
November 8, 2018
 
By:
 
/s/ KIMO AKIONA
 
 
 
Name:
 
Kimo Akiona
 
 
 
Title:
 
Chief Financial Officer, Chief Accounting Officer and Treasurer
(Principal Financial and Accounting Officer)


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