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 consolidated 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. Our income tax provision may be impacted to the extent that the final outcome of these tax positions is different than the amounts recorded.

On August 16, 2022, the Inflation Reduction Act ("IRA") was signed into law. The IRA, among other things, implements a 15% minimum tax on financial statement income of certain large corporations, a 1% excise tax on stock repurchases and extends, enhances, and creates several tax incentives to promote clean energy. While we continue to evaluate the IRA, at present, we do not believe it will have a material effect on our consolidated financial statements.

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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 income (loss) in stockholders’ equity.

Research and Development

Research and development costs related primarily to software product development costs and is expensed as incurred until technological feasibility has been established. Employee related costs associated with product development are included in research and development.

Recently Issued Accounting Pronouncements

In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326). ASU No. 2022-02 eliminates the accounting guidance for troubled debt restructurings by creditors in ASC 310-40 and requires disclosure of current-period gross write-offs by year of origination for financing receivables and net investments in leases. ASU No. 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years with earlier adoption permitted. We are currently evaluating the provisions ofadopted the amendment and doin this current quarter, which did not anticipatehave a significant effect on our consolidated financial statements.

We have not adopted any other new accounting pronouncements in the current yearperiod and there has not been any other recently issued accounting guidance that will have a significant effect on our consolidated financial statements. 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 2. PROPERTY AND EQUIPMENT

Property and equipment consist of the following (in thousands):

Gaming equipment and other property and equipment are depreciated over the respective useful lives of the assets ranging from one to sixfive years. Depreciation expense was $10.2$10.6 million and $9.5$9.7 million for the three months ended September 30, 2022March 31, 2023 and 20212022, respectively. Depreciation expense was $29.5 million and $28.5 million for the nine months ended September 30, 2022 and 2021, respectively. 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 3. GOODWILL AND INTANGIBLES

Changes in the carrying amount of goodwill are as follows (in thousands):

⁽¹⁾ Accumulated goodwill impairment charges for the Interactive segment as of September 30, 2022March 31, 2023 were $8.4 million.

Intangible assets consist of the following (in thousands):

Intangible assets are amortized over their respective estimated useful lives ranging from one to twelve years. Amortization expense related to intangible assets was $8.8$8.5 million and $9.0$9.1 million for the three months ended September 30, 2022March 31, 2023 and 2021, respectively. Amortization expense related to intangible assets was $27.5 million and $27.0 million for the nine months ended September 30, 2022and 2021, respectively. 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Management reviews intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We recorded no impairments for the nine months ended September 30, 2022. We recorded impairments related to internally developed gaming titles of $0.7 million for the nine months ended September 30, 2021, as it was determined by management that the gaming titles would no longer be used. 

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. Amounts paid against the placement fee agreements with payment terms greater than ninety days are disclosed in the Financingfinancing section of the Condensed Consolidated Statementcondensed consolidated statement of Cash Flows.cash flows. Amounts paid for the placement fee agreements with the agreement terms less than ninety days, are disclosed in the Investing section of the Condensed Consolidated Statementcondensed consolidated statement of Cash Flows.cash flows. 

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 consolidated 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 $1.5 million and $1.6 million for the three months ended September 30, 2022March 31, 2023 and 20212022,. We recorded a reduction of gaming operations revenue from the accretion of contract rights under development agreements and placement fees of $4.8 million and $4.9 million for the nine months ended September 30, 2022 and 2021, respectively. 

NOTE 4. ACCRUED LIABILITIES

Accrued liabilities consist of the following (in thousands):

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 5. LONG-TERM DEBT

Long-term debt consists of the following (in thousands):

First Lien Credit Facilities

On February 15, 2022, AP Gaming I, LLC (the “Borrower”), a Delaware limited liability company and wholly owned indirect subsidiary of PlayAGS, Inc. (the “Company”) and AP Gaming Holdings, LLC, a Delaware limited liability company and wholly owned indirect subsidiary of the Company (“Holdings”) entered into the Amended Credit Agreement with certain of the Borrower’s subsidiaries, the lenders party thereto and Jefferies Finance LLC, as administrative agent (the "Amended Credit Agreement"). The Amended Credit Agreement amends and restates the existing credit agreement, among the Borrower, Holdings, the lenders party thereto from time to time, the Administrative Agent and the other parties named therein.

The Borrower is a direct subsidiary of AP Gaming Holdings, LLC, which is a direct subsidiary of AP Gaming, Inc., which is a direct subsidiary of PlayAGS, Inc.  These entities between the Borrower and PlayAGS, Inc. are holding companies with no other operations, cash flows, material assets or liabilities other than the equity interests in the Borrower.

The Amended Credit Agreement provides (i) a senior secured first lien term loan in an aggregate principal amount of $575.0 million (the “New Term Loan Facility”), the proceeds of which, together with cash on hand of the Borrower and its subsidiaries, were used by the Borrower on the Closing Date to repay all amounts outstanding under the existing term loan facilities set forth in the Existing Credit Agreement and to pay related fees and expenses, and (ii) a $40.0 million senior secured first lien revolving facility, with a $7.5 million letter of credit subfacility and a $5.0 million swingline subfacility (the “New Revolving Credit Facility”).

Borrowings under the Amended Credit Agreement bear interest at a per annum rate equal to, at the Borrower’s election, either (a) an adjusted term Secured Overnight Financing Rate ("SOFR") for the interest period in effect, subject to a floor of (i) in the case of term loan borrowings, 0.75% and (ii) in the case of revolver borrowings, 0.00% or (b) a base rate determined by the highest of (i) the prime rate in effect, (ii) the federal funds effective rate plus 0.50% and (iii) an adjusted term SOFR with an interest period of one month plus 1.00%, in each case plus an applicable margin of 4.00% for adjusted term SOFR loans and 3.00% for base rate loans.
 
The New Term Loan Facility will mature on February 15, 2029 and, commencing with the quarter ending June 30, 2022, will amortize in quarterly installments equal to 0.25% of the original aggregate principal amount of the term loans, with the balance due at maturity. The commitments under the New Revolving Credit Facility will terminate on February 15, 2027.
 
The Borrower may voluntarily repay outstanding loans under the Amended Credit Agreement at any time, without prepayment premium or penalty, except in connection with a repricing event in respect of the New Term Loan Facility, subject to customary breakage costs with respect to adjusted term SOFR loans. Any refinancing through the issuance of certain debt or any repricing amendment, in either case, that constitutes a repricing event applicable to the New Term Loan Facility resulting in a lower yield occurring at any time on or prior to August 15, 2022 will be accompanied by a 1.00% prepayment premium or fee, as applicable.
 
The Amended Credit Agreement includes customary mandatory prepayment events, affirmative covenants, negative covenants and events of default. In addition, the New Revolving Credit Facility requires the Borrower to comply on a quarterly basis, commencing on June 30, 2022, with a maximum net first lien senior secured leverage ratio of 6.70 to 1.00 if the aggregate amount of funded loans and issued letters of credit (excluding up to $5.0 million of undrawn letters of credit under the New Revolving Credit Facility and letters of credit that are cash collateralized) under the New Revolving Credit Facility on such date exceeds 35% of the then-outstanding commitments under the New Revolving Credit Facility.

An additional $17.6 million in loan costs including original issue discount, lender fees, third-party costs, and make-whole premium were incurred related to the Amended Credit Agreement. Given the composition of the lender group, the transaction was accounted for as a debt modification for existing lenders. As a result of the amendment, approximately $8.5 million in costs were expensed and included in the loss on extinguishment and modification of debt, and the remaining costs were capitalized and will be amortized over the term of the agreement.

As of September 30, 2022March 31, 2023, there were no required financial covenants for our debt instruments.

Finance Leases

The Company has entered into leases for vehicles and equipment that are accounted for as finance leases.

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 6. STOCKHOLDERS’ EQUITY

Our amended and restated articles of incorporation provide that our authorized capital stock will consist of 450,000,000 shares of common stock, par value $0.01 per share, and 50,000,000 shares of preferred stock, par value $0.01 per share. As of September 30, 2022March 31, 2023, we have 37,704,80637,904,589 shares of common stock and zero shares of preferred stock outstanding.

Common Stock

Voting Rights

The holders of our common stock are entitled to one vote per share on all matters submitted for action by the stockholders, and do not have cumulative voting rights with respect to the election of our directors. 

Dividend and Distribution Rights

All shares of our common stock are entitled to share equally in any dividends and distributions our board of directors may declare from legally available sources, subject to the terms of any outstanding preferred stock.

Share repurchase program

During 2019, the board of directors approved a share repurchase program that will permit the Company to repurchase up to $50.0 million of the Company’s shares of common stock. The board approved extending this share buyback program to August 11, 2023. As of September 30, 2022March 31, 2023, $47.0 million of the $50.0 million authorized by the board of directors is still available for repurchasing of the Company's shares of common stock.

NOTE 7. WRITE-DOWNS AND OTHER CHARGES

The Condensed Consolidated Statementscondensed consolidated statements of Operationsoperations and Comprehensive Income (Loss)comprehensive loss include various transactions, such as loss on disposal or impairment of long-lived assets and fair value adjustments to contingent consideration that have been classified as write-downs and other charges.

During the three months-ended September 30, 2022, the Company identified an error related to the fair value of adjustments to contingent consideration and recorded an adjustment of $1.5 million, of which approximately $1.2 million relates to  periods prior to January 1, 2022. The Company evaluated the impact of the error and concluded that prior periods were not materially misstated and the adjustment did not have a material impact to the current year financial statements. The adjustment was recorded in other long-term liabilities and had no effect on the Condensed Consolidated Statements of Cash Flows.

During the three months ended September 30, 2022March 31, 2023, the Company recognized $1.4$0.2 million in write-downs and other charges primarily related to the impairment ofa intangible assets (the Company used level 3 fair value adjustment to contingent consideration.inputs based on projected cash flows) and the disposal of long-lived assets. During the three months ended September 30, 2021March 31, 2022, the Company recognized $0.2$0.1 million in write-downs and other charges primarily related to the disposal of long-lived assets.

During the nine months ended September 30, 2022, the Company recognized $1.8 million in write-downs and other charges primarily related to a fair value adjustment to contingent consideration. During the nine months ended September 30, 2021, the Company recognized $1.0 million in write-downs and other charges primarily related to the write-off of placement fee intangible assets associated with the sale of previously leased EGMs to distributors in the period.

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 8. BASIC AND DILUTED INCOME (LOSS) PER SHARELOSS

The Company computes net income (loss)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 Statementcondensed consolidated statement of Operationsoperations and Comprehensive Income (Loss).comprehensive loss. Basic EPS is computed by dividing net income (loss)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)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 10. "Stock-Based Compensation").

There were 2,183,245 participating securities included in the calculation of EPS for the three months ended September 30, 2022. There were no potentially dilutive securities included in the calculation of EPS for the ninethree months ended  September 30, 2022 and the threeMarch 31, 2023 and nine months ended September 30, 20212022 because the Company reported a net loss in each period.

Excluded from the calculation of diluted EPS for the three months ended September 30, 2022March 31, 2023 were 1,796,0531,221,370 restricted shares, subject to performance vesting conditions that have not been met yet, met, and 1,162,088 underwater stock options. Excluded from the calculation of diluted EPS for the ninethree months ended September 30, 2022March 31, 2023 were 2,252,4393,269,247 restricted shares and 25,596 stock options, as such securities were anti-dilutive.

Excluded from the calculation of diluted EPS for the three months ended September 30, 2021March 31, 2022 were 1,648,6092,325,198 restricted shares and 349,262248,639 stock options, as such securities were anti-dilutive. Excluded from the calculation of diluted EPS for nine months ended September 30, 2021 were 1,714,827 restricted shares and 276,451 stock options, as such securities were anti-dilutive. 

NOTE 9. 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 both the three months ended September 30, 2022March 31, 2023 and 20212022 was $0.4 million. The expense associated with the 401(k) Plan for the nine months ended September 30, 2022 and 2021 was $1.5$0.7 million and $1.2$0.6 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 shares of common stock, restricted stock, restricted stock units and other awards to be settled in, or based upon, shares of 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, 2022March 31, 2023, 423,268 shares remain available for issuance; however, these will not be issued and awards granted by the Company in the future are expected to be from the Omnibus Incentive Plan only.

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. On May 8, 2020, the board of directors of the Company approved an amendment to the 2018Omnibus Incentive Plan to increase the number of shares of Common Stock authorized for issuance thereunder from 1,607,389 shares to 4,607,389 shares, an increase of 3,000,000 shares (the “2020 Plan Amendment”), which was approved by the stockholders on July 1, 2020 at the 2020 Annual Meeting of Stockholders.

On April 28, 2022, the board of directors of the Company approved an amendment to the 2018Omnibus Incentive Plan, as amended by the 2020 Plan Amendment, to increase the number of shares of Common Stock authorized for issuance thereunder from 4,607,389 shares to 9,607,389 shares, an increase of 5,000,000 shares (the “2022 Plan Amendment”), which was approved by the stockholders on July 1, 2022 at the 2022 Annual Meeting of Stockholders. As a result of the 2022 Plan Amendment, awards that were previously accounted for as liability awards were reclassified to equity as they are expected to be settled with equity. Prior to the 2022 Plan Amendment, there were insufficient shares available to settle the liability awards with equity. As of March 31, 2023, we had 5,070,407 shares available for issuance under the Omnibus Incentive Plan. 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 10. STOCK-BASED COMPENSATION

The Company has granted equity or equity-based awards to eligible participants under its incentive plans. The awards include options to purchase the Company’s common stock, restricted stock or restricted stock units and phantom stock units. These awards include a combination of service and market conditions, as further described below.

We recognize stock-based compensation on a straight-line basis over the vesting period for time-based awards and we recognize the expense for awards with market conditions over the service period derived from the related valuation. As of September 30, 2022March 31, 2023, there was no unrecognized compensation expense associated with stock options, $2.4$5.0 million was associated with restricted stock and restricted stock units, and $3.2$9.2 million with phantom stock units. The unrecognized compensation expense associated with restricted and phantom stock units is expected to be recognized over a 1.42.2 and 2.02.1 year weighted average period, respectively.

During the quarter ended March 31, 2023, the Company amended certain performance-based restricted stock units granted to the CEO and CFO on April 30, 2021. The amendment provides eligibility for vesting based on both service and performance conditions. The incremental fair value attributable to the modified awards was $3.9 million, of which 50% will be recognized over the four year service period and 50% over the performance vesting tranche, not to exceed one year.

Stock Options

The Company calculates the grant date fair value of stock options that vest over a service period using the Black Scholes model. For stock options and other stock awards that contain a market condition related to the return on investment that the Company’s stockholders achieve or obtaining a certain stock price, the awards are valued using a lattice-based valuation model. The assumptions used in these calculations are the expected dividend yield, expected volatility, risk-free interest rate and expected term (in years). Expected volatilities are based on implied volatilities from comparable companies. The risk-free rate is based on the U.S. Treasury yield curve for a term equivalent to the estimated time to liquidity. There were no options granted during the three and ninemonths ended September 30, 2022March 31, 2023.

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 20% or 25% on each of the first five or four 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, comprised of Tranche B and Tranche C, are eligible to vest upon the satisfaction of certain performance conditions (collectively, “Performance Options”). These performance conditions included the achievement of investor returns or common stock trading prices. These performance conditions were achieved in October of 2018 for all Performance Options that have been granted and there are currently 493,104 Performance Options exercisable and outstanding.

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

A summary of the changes in stock options outstanding during the ninethree months ended September 30, 2022March 31, 2023, is as follows:

Restricted Stock and Restricted Stock Units

Restricted stock awards and restricted stock units are typically eligible to vest in equal installments of 25% on each of the first four 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 upon or within 12 months following a change in control or as a result of death or disability, any such unvested time-based awards shall become vested.

Certain restricted stock units are eligible to vest upon the satisfaction of certain performance conditions. Vesting occurs on the first day that the average price per share of our common stock for the prior 60a specified number of consecutive trading days exceeds certain stock prices, subject to continued employment with the Company or its subsidiaries. The performance-based restricted stock units will be forfeited if the performance target is not achieved within four years of the grant date. 

A summary of the changes in restricted stock and restricted stock units outstanding during the ninethree months ended September 30, 2022March 31, 2023, is as follows:

Phantom Stock Units

Phantom stock awards are typically eligible to vest in equal installments of 25% on each of the first four 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 upon or within 12 months following a change in control or as a result of death or disability, any such unvested awards shall become vested. Vesting tranches of the phantom stock awards can be settled in cash or stock at the Company’s discretion. The phantom stock awards that the Company intends to settle in cash are accounted for as liability awards and are re-measured at fair value each reporting period until they become vested with compensation expense being recognized over the requisite service period. The liability associated with such awards is included in “Accrued Liabilities”“accrued liabilities” within the unaudited Condensed Consolidated Balance Sheets.condensed consolidated balance sheets. All other stock-based awards are classified as equity. 

Certain phantom stock units are eligible to vest upon the satisfaction of certain performance conditions. Vesting occurs on the first day that the average price per share of our common stock for the prior 60a specified number of consecutive trading days exceeds certain stock prices and only if the performance date occurs prior to the fourth anniversary of the date of the grant; provided. However, if the performance date occurs prior to the first anniversary of the date of grant, vesting will occur on the first anniversary of the date of grant, subject to continued employment with the Company or its subsidiaries.

A summary of the changes in phantom stock outstanding during the ninethree months ended September 30, 2022March 31, 2023 is as follows:

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 11. INCOME TAXES

The Company's effective income tax rate for the three months ended September 30, 2022March 31, 2023, was a benefit of 134.0%78.1%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three months ended September 30, 2022March 31, 2023, is primarily due to changes in our valuation allowance on deferred tax assets and the expiration of the applicable statute of limitations for certain uncertain tax positions. The Company's effective income tax rate for the three months ended September 30, 2021March 31, 2022, was a benefitan expense of 59.8%3.9%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three months ended September 30, 2021March 31, 2022 was primarily due to changes in our valuation allowance on deferred tax assets and the expiration of the applicable statute of limitations for certain uncertain tax positions.

The Company's effective income tax rate for the nine months ended September 30, 2022, was a benefit of 10.9%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three months ended September 30, 2022, is primarily due to changes in our valuation allowance on deferred tax assets and the expiration of the applicable statute of limitations for certain uncertain tax positions. The Company's effective income tax rate for the nine months ended September 30, 2021, was a benefit of 13.6%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three months ended September 30, 2021 was primarily due to changes in our valuation allowance on deferred tax assets and the expiration of the applicable statute of limitations for certain uncertain tax positions.

As of  September 30, 2022, the statute of limitations has expired for all uncertain tax positions covered by the indemnification agreement with the prior owners of Cadillac Jack (acquired in May of 2015), accordingly, no indemnification receivable is recorded in other assets in the financial statements and no change was recognized in the indemnification receivable during the three and nine months ended  September 30, 2022. During the three and nine months ended September 30, 2021, the Company recognized a $0.8 million reduction in the indemnification receivable and related benefits in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) related to the expiration of the applicable statute of limitations on indemnified tax positions.assets. 

NOTE 12. COMMITMENTS AND CONTINGENCIES

The Company is subject to federal, state and Native American laws and regulations that affect both its general commercial relationships with its customers, as well as the products and services provided to them. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. If a potential loss from any claim or legal proceeding is considered reasonably possible, the Company discloses an estimate of the possible loss or range of possible loss, or a statement that such an estimate cannot be made. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to their pending claims and litigation and may revise their estimates. Such revisions in the estimates of the potential liabilities could have a material impact on the results of operations and financial condition.

During the three months ended September 30, 2019, the Company recorded a $1.6 million loss reserve, for which insurance coverage has been triggered. In accordance with GAAP, the offsetting insurance recovery will be recognized when it is realized or realizable in a future period.

On June 25, and July 31, 2020 putative class action lawsuits were filed in the United States District Court for the District of Nevada (the "Court"), by two separate plaintiffs against PlayAGS, Inc. (the "Company") and certain of its officers, individually and on behalf of all persons who purchased or otherwise acquired Company securities between August 2, 2018 and August 7, 2019.  The complaints alleged that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) by making false and misleading statements concerning the Company’s forward-looking financial outlook and accounting for goodwill and intangible assets in its iGaming reporting unit, resulting in injury to the purported class members when the value of the Company’s common stock declined following its release of its Second Quarter 2019 results on August 7, 2019. 

On August 4, 2020, a third plaintiff (“OPPRS”) filed a putative class action lawsuit in the same court asserting similar claims to those alleged in the first two class action complaints, based on substantially the same conduct, on behalf of a slightly larger class (stretching back to May 3, 2018). Specifically, OPPRS claimed that the Company, certain of its officers, and certain entities that allegedly beneficially held over 50% of the Company’s common stock at the beginning of the class period, violated Sections 10(b) and 20(a) of the Exchange Act by allegedly making false and misleading statements concerning the Company’s forward-looking financial outlook and accounting for goodwill and intangible assets in its iGaming reporting unit, and the adequacy of its internal controls over financial reporting, resulting in injury to the purported class when the Company’s common stock price declined following the release of its Second Quarter 2019 results.  In addition, based on substantially similar alleged false or misleading statements, OPPRS asserted claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933, on behalf of all persons who purchased Company common stock pursuant and/or traceable to the Company’s August 2018 and March 2019 secondary public offerings. These secondary-offering claims were brought against the same defendants identified above, plus certain of the Company’s directors and the underwriters. 

On October 28, 2020, the Court consolidated these three related putative class actions into In re PlayAGS, Inc. Securities Litigation and appointed OPPRS as lead plaintiff.  On January 11, 2021, the lead plaintiff filed an Amended Complaint in the consolidated action against the same set of defendants, again asserting claims (i) under Sections 10(b) and 20(a) of the Exchange Act, with an even larger putative class period ( May 3, 2018 through March 4, 2020), and (ii) under Sections 11, 12(a)(2) and 15 of the Securities Act on behalf of the same putative class as in OPPRS’s previous complaint. The Amended Complaint alleges that statements the defendants made about, among other things, the Company’s growth, financial performance, and forward-looking financial outlook were materially false or misleading because the Company omitted to state that, according to plaintiffs, its market strength was declining, its growth strategies were unsustainable, and it was experiencing challenges in the Oklahoma market. Plaintiffs claim that the purported class was injured when the common stock price declined after the alleged “truth” was revealed following release of the Company’s financial reports on August 7, 2019, November 7, 2019, and March 4, 2020. Plaintiffs also assert that the Company violated Regulation S-K Items 303 and 105 by failing to disclose these same alleged negative trends and significant risks in the registration materials for the Company’s secondary offerings. Unlike the previous complaints, the Amended Complaint does not allege false or misleading statements concerning the Company’s accounting for the iGaming reporting unit or the adequacy of the Company’s internal controls over financial reporting.

On February 23, 2021, the Court granted the lead plaintiff’s unopposed motion to file a Second Amended Complaint. The Second Amended Complaint was filed on March 25, 2021 and asserts substantially the same claims as the Amended Complaint but extends the beginning of the putative class period back to January 26, 2018.  TheOn May 24, 2021, the defendants filed motions to dismiss the second amended complaint, and on May 24, 2021;December 2, 2022, the court granted in part and denied in part those motions. It dismissed each of the five claims in the second amended complaint—including all claims under the Securities Act—but the court carved out from the dismissal a “scheme liability” claim under Section 10(b), brought only against the Company, David Lopez, and Kimo Akiona, which the court felt was insufficiently briefed. The lead plaintiff was granted leave to file a further amended complaint but chose not to, and instead seeks to move forward on the sole remaining scheme liability claim.

On January 17, 2023, the Company, Mr. Lopez, and Mr. Akiona filed its opposition papersan answer to the remaining claim, along with a motion to temporarily stay discovery and a motion for judgment on the pleadings, arguing that the legal findings contained in the court’s JulyDecember 2, 2022 decision require dismissal of the scheme liability claim as well and termination of the action. Those motions were fully briefed as of March 22, 2023. On March 23, 2021,2023, andthe Court decided the motion to temporarily stay discovery in favor of the defendants, filed their repliesholding that all discovery is stayed pending resolution of the motion for judgment on September 13, 2021.  The motions to dismiss are now fully briefed and await the Court's decision; no oral argument has yet been scheduled.pleadings. The defendants believe all claims in the claimsaction are without merit, and intend to defend vigorously against them, but there can be no assurances as to the outcome.

On March 18, 2022, a shareholder derivative lawsuit was filed in the United States District Court for the District of Nevada by putative stockholder Manjan Chowdhury, allegedly on behalf of the Company, that piggy-backs on the consolidated securities class action referenced above and currently pending before the same Court.  The derivative complaint names David Lopez, Kimo Akiona, and members of the Board as defendants, and generally alleges that they breached their fiduciary duties by causing or failing to prevent the same allegedly false and misleading statements asserted in the securities class action. The derivative complaint also alleges claims for contribution against Mr. Lopez and Mr. Akiona under Sections 10(b) and 21D of the Exchange Act.  On June 9, 2022, the court stayed the derivative action, pursuant to a stipulation between the parties, pending resolution of the motion to dismiss the consolidated securities class action. On January 27, 2023, at the request of the parties, the court ordered that the derivative action remain stayed pending resolution of the motion for judgment on the pleadings in the securities class action. The Company and the individual defendants believe the claims in the shareholder derivative action are without merit and intend to defend vigorously against them, but there can be no assurances as to the outcome.

At this time, we are unable to estimate the probability or the amount of liability, if any, related to thisthe securities class action or the shareholder derivative matter.

In January 2021, we obtained the results of an audit conducted by the Alabama Department of Revenue (“ADOR”), in which the ADOR assessed $3.3 million including interest in unpaid state and local rental taxes on participation revenues and licensing fees that we received from the leasing of EGMs to a Native American tribe in the state of Alabama in the period from May 2016 through August 2019. ADOR claims that such revenues constitute a lease rental payment and are deemed taxable in nature even in situations involving Native American tribe lessees.

We believe that we were not required to collect and remit Alabama state lease/rental tax on our leases of EGMs in the state as those leases are on federally designated Indian reservation land and because federal Indian trading laws and Indian gaming laws, as well as the U.S. Constitution, preempt application of the rental tax to these transactions with the Native American tribe. We have disputed ADOR’s audit findings in accordance with applicable state and local tax procedures and ADOR rules. Our dispute is currently in the discovery phase at the Alabama Tax Tribunal, which is the independent tax court for the state of Alabama. We expect a hearing for this dispute at the Alabama Tax Tribunal will be scheduled in 2023.

We have not accrued the $3.3 million assessed by ADOR, as we do not believe that it is probable that a liability has occurred. However, if we do not prevail in the dispute with ADOR, we may be required to accrue this amount as well as applicable interest. It is also possible that ADOR may similarly audit the participation revenues and licensing fees that we received from the leasing of EGMs to a Native American tribe in the state of Alabama subsequent to August 2019. While we cannot reasonably calculate the amount that ADOR would assess for the revenues from such subsequent periods due to the types of revenues and rates that apply, based solely on the amount assessed for the period from May 2016 through August 2019, we estimate that ADOR’s assessment for taxable lease rental payments for subsequent periods through September 30, 2022March 31, 2023 would not exceed $2.0$2.3 million, excluding interest. There is no assurance that ADOR will assess our revenues from subsequent periods or that such assessment will not materially differ from our estimate.

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PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

NOTE 13. OPERATING SEGMENTS

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

See Note 1. "Description of the Business and Summary of Significant Accounting Policies" 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:

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.

The following provides financial information concerning our reportable segments for the three and ninemonths ended September 30, 2022March 31, 2023 and 20212022 (amounts in thousands):