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AGS PlayAGS

Filed: 5 Nov 20, 4:24pm
 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 


FORM 10-Q

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the quarter ended September 30, 2020

or

 

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)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common stock, $0.01 par value

AGS

New York Stock Exchange

 

As of November 3, 2020, there were 35,765,771 shares of the Registrant’s common stock, $0.01 par value per share, outstanding.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No  ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒  No  ☐

 

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

 

Large accelerated filer  ☐

Accelerated filer ☒

Non-accelerated filer ☐

Smaller reporting company  ☐

Emerging growth company ☒

 

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 ☒  No ☐

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

 

 

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

 

 

 

ITEM 1.

FINANCIAL STATEMENTS

 

 

 

 

 

CONDENSED CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 2020 AND DECEMBER 31, 2019

1

 

 

 

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019

2

 

 

 

 

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019

3

 

 

 

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019

4

 

 

 

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5

 

 

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

23

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

45

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

46

 

 

 

PART II. OTHER INFORMATION

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

47

 

 

 

ITEM 1A.

RISK FACTORS

47

 

 

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

47

 

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

47

 

 

 

ITEM 4.

MINE SAFETY DISCLOSURES

47

 

 

 

ITEM 5.

OTHER INFORMATION

47

 

 

 

ITEM 6.

EXHIBITS

48

 

 

 

 

SIGNATURES

49

 

 

 

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, 2020

  

December 31, 2019

 

Assets

 

Current assets

        
Cash and cash equivalents $113,200  $13,162 
Restricted cash  20   20 
Accounts receivable, net of allowance of $1,961 and $723, respectively  39,673   61,224 
Inventories  30,435   32,875 
Prepaid expenses  4,401   2,983 
Deposits and other  4,371   5,332 

Total current assets

  192,100   115,596 
Property and equipment, net  79,234   103,598 
Goodwill  284,206   287,049 
Intangible assets  196,126   230,451 
Deferred tax asset  4,048   4,965 
Operating lease assets  10,143   11,543 
Other assets  12,101   9,176 

Total assets

 $777,958  $762,378 
         

Liabilities and Stockholders’ Equity

 

Current liabilities

        
Accounts payable $4,682  $15,598 
Accrued liabilities  28,055   34,840 
Current maturities of long-term debt  7,061   6,038 

Total current liabilities

  39,798   56,476 
Long-term debt  632,232   518,689 
Deferred tax liability, non-current  1,139   1,836 
Operating lease liabilities, long-term  9,926   11,284 
Other long-term liabilities  31,048   40,309 

Total liabilities

  714,143   628,594 

Commitments and contingencies (Note 13)

          

Stockholders’ equity

        

Preferred stock at $0.01 par value; 50,000,000 shares authorized, no shares issued and outstanding

  0   0 
Common stock at $0.01 par value; 450,000,000 shares authorized at September 30, 2020 and at December 31, 2019; and 35,697,583 and 35,534,558 shares issued and outstanding at September 30, 2020 and December 31, 2019, respectively.  357   355 
Additional paid-in capital  376,193   371,311 
Accumulated deficit  (304,093)  (235,474)
Accumulated other comprehensive loss  (8,642)  (2,408)
Total stockholders’ equity  63,815   133,784 

Total liabilities and stockholders’ equity

 $777,958  $762,378 

 

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

 

 

 

 

PLAYAGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME

(amounts in thousands, except per share data)

 (unaudited)

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2020

  

2019

  

2020

  

2019

 

Revenues

                

Gaming operations

 $36,299  $52,522  $89,173  $158,976 

Equipment sales

  12,985   26,855   31,212   67,952 

Total revenues

  49,284   79,377   120,385   226,928 

Operating expenses

                

Cost of gaming operations(1)

  8,268   10,170   23,756   30,721 

Cost of equipment sales(1)

  3,981   13,479   13,351   32,906 

Selling, general and administrative

  10,862   16,861   31,111   46,343 

Research and development

  6,180   8,671   19,342   25,175 

Write-downs and other charges

  1,932   807   2,806   6,859 

Depreciation and amortization

  20,463   23,810   66,353   69,002 

Total operating expenses

  51,686   73,798   156,719   211,006 

(Loss) income from operations

  (2,402)  5,579   (36,334)  15,922 

Other expense

                

Interest expense

  11,330   9,320   30,566   27,754 

Interest income

  (671)  (42)  (843)  (112)
Loss on extinguishment and modification of debt  0   0   3,102   0 

Other expense

  (311)  (106)  3,993   5,108 

(Loss) income before income taxes

  (12,750)  (3,593)  (73,152)  (16,828)

Income tax (expense) benefit

  1,672   (1,926)  5,016   3,884 

Net (loss) income

  (11,078)  (5,519)  (68,136)  (12,944)

Less: Net income attributable to non-controlling interests

  0   (17)  0   (231)

Net (loss) income attributable to PlayAGS, Inc.

  (11,078)  (5,536)  (68,136)  (13,175)

Foreign currency translation adjustment

  1,375   (1,273)  (6,234)  (403)

Total comprehensive (loss) income

 $(9,703) $(6,809) $(74,370) $(13,578)
                 

Basic and diluted loss per common share:

                
Basic $(0.31) $(0.16) $(1.91) $(0.37)
Diluted $(0.31) $(0.16) $(1.91) $(0.37)

Weighted average common shares outstanding:

                

Basic

  35,647   35,447   35,598   35,416 

Diluted

  35,647   35,447   35,598   35,416 

 

(1) exclusive of depreciation and amortization

 

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

 

 

 

PLAYAGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(amounts in thousands)

 (unaudited)

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2020

  

2019

  

2020

  

2019

 

Common stock

                

Balance, beginning of period

 $356  $354  $355  $353 
Stock option exercises  0   1   0   1 
Repurchase of common stock  0   (1)  0   (1)
Vesting of restricted stock  1   0   2   1 

Balance of common stock, end of period

  357   354   357   354 

Additional paid-in capital

                
Balance, beginning of period  374,461   365,562   371,311   361,628 
Stock option exercises  0   100   158   684 
Stock-based compensation expense  1,733   1,959   4,726   5,309 
Vesting of restricted stock  (1)  (1)  (2)  (1)

Balance of additional paid-in capital, end of period

  376,193   367,620   376,193   367,620 

Accumulated deficit

                
Balance, beginning of period  (292,892)  (230,042)  (235,474)  (222,403)
Net loss attributable to PlayAGS, Inc.  (11,078)  (5,536)  (68,136)  (13,175)
Repurchase of common stock  0   (1,000)  0   (1,000)
Restricted stock vesting and withholding  (123)  (132)  (483)  (132)

Balance of accumulated deficit, end of period

  (304,093)  (236,710)  (304,093)  (236,710)

Accumulated other comprehensive loss

                
Balance, beginning of period  (10,017)  (2,904)  (2,408)  (3,774)
Foreign currency translation adjustment  1,375   (1,273)  (6,234)  (403)

Balance of accumulated other comprehensive loss, end of period

  (8,642)  (4,177)  (8,642)  (4,177)

Non-controlling interests

                
Balance, beginning of period  0   128   0   0 
Net income  0   17   0   231 
Business acquisitions  0   0   0   71 
Cash distributions to non-controlling interest owners  0   (145)  0   (302)

Balance of non-controlling interests, end of period

  0   0   0   0 

Total stockholders' equity

 $63,815  $127,087  $63,815  $127,087 

 

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

 

 

 

PLAYAGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

  

Nine Months Ended September 30,

 
  

2020

  

2019

 

Cash flows from operating activities

        
Net (loss) income $(68,136) $(12,944)

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

        
Depreciation and amortization  66,353   69,002 
Accretion of contract rights under development agreements and placement fees  5,643   4,550 
Amortization of deferred loan costs and discount  2,538   1,426 
Stock-based compensation expense  4,726   5,309 
Provision (benefit) for bad debts  1,133   183 
Loss on disposition of long-lived assets  2,004   1,015 
Impairment of assets  6   5,343 
Fair value adjustment of contingent consideration  796   501 
Benefit for deferred income tax  (518)  873 
Changes in assets and liabilities that relate to operations:        
Accounts receivable  19,391   (12,136)
Inventories  5,840   961 
Prepaid expenses  (1,463)  (1,098)
Deposits and other  667   (3,081)
Other assets, non-current  1,955   9,024 
Accounts payable and accrued liabilities  (21,216)  (6,447)

Net cash provided by operating activities

  19,719   62,481 

Cash flows from investing activities

        
Customer notes receivable  (4,690)  0 
Proceeds from payments on customer notes receivable  279   0 
Business acquisitions, net of cash acquired  0   (54,935)
Purchase of intangible assets  (1,414)  (4,926)
Software development and other expenditures  (8,004)  (9,957)
Proceeds from disposition of assets  32   161 
Purchases of property and equipment  (12,196)  (38,760)

Net cash used in investing activities

  (25,993)  (108,417)

Cash flows from financing activities

        
Repayment of first lien credit facilities  (4,040)  (4,040)
Repayment of incremental term loans  (238)  0 
Payment of financed placement fee obligations  (4,179)  (6,058)
Proceeds from incremental term loans  92,150   0 
Borrowing on revolver  30,000   0 
Payment of deferred loan costs  (5,744)  0 
Payments of previous acquisition obligation  (292)  (1,227)
Payments on finance leases and other obligations  (1,012)  (1,043)
Repurchase of stock  (483)  (1,133)
Proceeds from stock option exercise  158   685 
Distributions to non-controlling interest owners  0   (302)

Net cash provided by (used in) financing activities

  106,320   (13,118)
Effect of exchange rates on cash and cash equivalents  (8)  3 

Net increase (decrease) in cash and cash equivalents

  100,038   (59,051)
Cash, cash equivalents and restricted cash, beginning of period  13,182   70,804 

Cash, cash equivalents and restricted cash, end of period

 $113,220  $11,753 
         

Supplemental cash flow information:

        

Non-cash investing and financing activities:

        
Intangible assets obtained under financed placement fee arrangements $0  $39,198 
Leased assets obtained in exchange for new finance lease liabilities $426  $882 
Leased assets obtained in exchange for new operating lease liabilities $0  $13,048 

 

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

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

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

 

Description of Business

 

PlayAGS, 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, Mexico and the Philippines 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 Games (“Interactive”), which provides social casino games on desktop and mobile devices (our "Interactive Social" reporting unit) as well as a platform for content aggregation used by real-money gaming (“RMG”) online casino operators (our "RMG Interactive" reporting unit). 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”). On February 27, 2018, we sold an additional 1,537,500 shares of common stock, pursuant to the underwriters’ exercise in full of the over-allotment option.

 

Electronic Gaming Machines

 

Our EGM segment offers a selection of video slot titles developed for the global marketplace, and EGM cabinets which include the AloraOrion Portrait, Orion Curve, Orion Rise, Orion Upright, ICON, Big Red (“Colossal Diamonds”) and our 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 proprietary table products, side-bets, progressives, and table technology related to blackjack, poker, baccarat, craps and roulette. We have a number of popular proprietary 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 offer a single deck card shuffler for poker tables, Dex S and recently introduced our second shuffler, the Pax S single-deck pack shuffler, which we plan to launch in 2020.

 

Interactive

 

We operate a Business-to-Business ("B2B") online gaming platform for content aggregation that we offer to our RMG online casino customers. This platform aggregates content from several game suppliers and offers online casino operators the convenience to reduce the number of integrations that are needed to supply the online casino. We also operate Business-to-Consumer (“B2C”) social casino games that include online versions of our EGM titles and are accessible to players on multiple mobile platforms. Our B2C social casino games are available on our mobile app, Lucky Play Casino. The app contains numerous AGS game titles available for consumers to play for free or with virtual currency they purchase in the app. 

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared 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 for the year ended December 31, 2019.

 

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. For the nine months ended September 30, 2020, the impact of the decline in business activity brought about by the coronavirus pandemic (“COVID-19”) continues to evolve. As a result, many of our estimates and assumptions required increased judgment and carry a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, our estimates may change materially in future periods.

 

Revenue Recognition

 

Leasing of equipment in both our EGM and Table Products segments is accounted for under lease accounting guidance in ASC 842, "Leases" (ASC 842) and is recorded in gaming operations revenue. Our remaining revenue streams are accounted for under ASC 606 "Revenue from contracts with customers" (ASC 606) including equipment sales in our EGM and, to a lesser extent, in our Table Products segments. Revenue earned in our Interactive segment is recorded in gaming operations revenue.

 

The following table disaggregates our revenues by type within each of our segments (amounts in thousands):

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2020

  

2019

  

2020

  

2019

 
                 

EGM

                

Gaming operations

 $32,188  $48,854  $78,608  $148,515 

Equipment sales

  12,893   26,445   30,785   67,417 

Total

 $45,081  $75,299  $109,393  $215,932 
                 

Table Products

                

Gaming operations

 $2,170  $2,451  $4,991  $6,902 

Equipment sales

  92   410   427   535 

Total

 $2,262  $2,861  $5,418  $7,437 
                 

Interactive (gaming operations)

                

Social gaming revenue

 $829  $712  $2,746  $2,606 

Real-money gaming revenue

  1,112   505   2,828   953 

Total

 $1,941  $1,217  $5,574  $3,559 

 

Gaming Operations

 

Gaming operations revenue is earned by providing customers with gaming machines, gaming machine content licenses, table products, 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. The Company will also enter into lease contracts with a revenue sharing arrangement whereby the lease payments due from the customer are variable. Our participation arrangements are accounted for as operating leases primarily due to these factors. 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.

 

6

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

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 fixed 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.

 

Gaming operations revenue is also earned from the licensing of table product content and is earned and recognized primarily 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:

 

 

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

 

Control has been transferred and services have been rendered in accordance with the contract terms.

 

Equipment sales are generated from the sale of gaming machines, table products and licensing rights to the integral game content software that is installed in the related equipment, 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. 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, sales arrangements may include the sale of gaming machines and table products 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, which occurs if 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. We elected to exclude from the measurement of the transaction price, sales taxes and all other items of a similar nature, and also elected to account for shipping and handling activities as a fulfillment of our promise to transfer the goods. Accordingly, shipping and handling costs are included in cost of sales.

 

Revenue allocated to any undelivered performance obligations is recorded as a contract liability. The balance of our contract liabilities was not material as of September 30, 2020 and December 31, 2019.

 

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 adjusted for current economic conditions, customer concentration, and credit worthiness when evaluating the adequacy of the allowance for doubtful accounts. A large percentage of receivables are with Native American tribes and the Company has concentrations of credit risk with several tribes. The Company includes any receivable balances that are determined to be uncollectible in the overall allowance for doubtful accounts. Changes in the assumptions or estimates reflecting the collectability of certain accounts could materially affect the allowance for both accounts and notes receivable.

 

7

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

Allowance for Expected Credit Losses 

 

Management estimates the allowance for expected credit losses balance using relevant available information from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in the current environmental economic conditions and reasonable and supportable forecast. The allowance for expected credit losses on financial instruments is measured on a collective (pool) basis when similar risk characteristics exist. The financial instruments that do not share risk characteristics, such as receivables related to development agreements, are evaluated on an individual basis. Expected credit losses are estimated over the contractual term of the related financial instruments, adjusted for expected prepayments when appropriate, based on a historical model that includes periodic write-offs, recoveries, and adjustments to the reserve. Historically, the identified portfolio segments have shared low collectability risk with immaterial write-off amounts. The Company made an accounting policy election not to present the accrued interest receivable balance on a separate statement of financial position line item. Accrued interest receivable is reported within the respective receivables line items on the consolidated balance sheet. 

 

The following table excludes receivables related to operating leases and presents all other receivables' gross amortized cost, allowance for credit losses and amortized cost, net of allowance for credit losses by portfolio segment as of September 30, 2020 and December 31, 2019 (in thousands):

 

                          
   

September 30, 2020

  

December 31, 2019

 
 

Classification

 

Gross amortized cost

  

Allowance for credit losses

  

Amortized cost, net of allowance for credit losses

  

Gross amortized cost

  

Allowance for credit losses

  

Amortized cost, net of allowance for credit losses

 
                          

Trade receivables:

Accounts Receivable

 $9,986  $0  $9,986  $22,741  $0  $22,741 
                          

Receivables with extended payment terms:

                        

Originated in 2020

Accounts Receivable

  7,843   0  $7,843   N/A   N/A   N/A 

Originated in 2019

Accounts Receivable

  1,504   0   1,504   5,461   0   5,461 

Total receivables with extended payment term

 $9,347  $0  $9,347  $5,461  $0  $5,461 
                          
Sales-type leases receivables:                         

Originated in 2019

Accounts Receivable

  1,714   (86) $1,628  $2,206  $(111) $2,095 

Originated in 2017

Accounts Receivable

  9   0   9   52   (3)  49 

Total Sales-type leases receivables

 $1,723  $(86) $1,637  $2,258  $(114) $2,144 
                          

Development Agreements:

                         

Originated in 2020

Deposits and other

  2,510   0  $2,510   N/A   N/A   N/A 

Originated in 2019

Deposits and other

  4,633   0   4,633   2,359   0   2,359 

Total Development Agreements

 $7,143  $0  $7,143  $2,359  $0  $2,359 

 

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, 2020 and December 31, 2019, the value of raw material inventory was $24.3 million and $29.1 million, respectively. As of September 30, 2020 and December 31, 2019, the value of finished goods inventory was $6.1 million and $3.8 million, respectively. There was no work in process material as of September 30, 2020 and December 31, 2019.

 

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 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 (in years)

  2 to 6 

Other property and equipment (in years)

  3 to 6 

 

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.

 

8

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

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 determined for identifiable intangible assets, other than goodwill and indefinite-lived intangible assets, 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 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 titles 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. 

 

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.

 

9

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

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:

 

 

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 following table presents the estimated fair value of our long-term debt as of September 30, 2020 and December 31, 2019 (in thousands):

 

  

September 30, 2020

  

December 31, 2019

 
  

Carrying Amount

  

Fair Value

  

Carrying Amount

  

Fair Value

 

Long-term Debt

 $654,267  $593,144  $533,727  $534,578 

 

 

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

 

In March 2020, in response to the COVID-19 outbreak, President Donald Trump signed H.R. 748, the “Coronavirus Aid, Relief, and Economic Security ACT (the “CARES Act”).  We do not expect the CARES Act, to have a material impact on our condensed consolidated financial statements.

 

10

 

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 other comprehensive loss in stockholders’ equity.

 

Liquidity and Financing and COVID-19

 

Due to the business disruption caused by the rapid nationwide spread of the novel coronavirus and the actions by state and tribal governments and businesses to contain the virus, almost all of the Company’s customers closed their operations during the month of March and April 2020 and their respective markets have been significantly and adversely impacted. Beginning in May 2020 and continuing through September, casinos began to reopen at limited capacity and nearly all of our customers' casino properties in the United States and Canada were partially open as of September 30, 2020 under limited operations. As of September 30, 2020 in Mexico, approximately half of our customers' casinos were partially open under capacity limitations. As a result of the temporary closures of our casino customers, there has been a decrease in the amount of money spent by consumers on our revenue shared installed base and the amount of daily fees of our participation EGMs and a slow down to the expansion of existing casinos or development of new casinos. Specifically, gaming operations revenue and equipment sales have decreased compared to the prior year period as a result of the temporary closures of our casino customers. Similarly, our EGM and Table Products segment operating results have been disrupted because each segment’s activities including design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its products lines have been temporarily halted or significantly reduced. In addition, each segment’s revenue from leasing, licensing and selling products has been adversely impacted due to the temporary closures of our casino customers. As a result, the Company took several actions to adapt to the severity of the crisis. Among other things, the Company implemented short-term furloughs with retained benefits, company-wide salary reductions, and reduced its workforce by over 10%. Our non-employee directors have also agreed to reduce their fees by 50%. Some of the Company's customers have reopened at limited capacity, some have reopened and then been required to close again due to local conditions and regulations relating to the spread of the coronavirus, and there are also customers who still remain closed. Depending on the length of casino closures and if they are required to close again, the Company will consider additional reductions to payroll and related expenses through additional employee furloughs in order to conserve liquidity.

 

As of September 30, 2020, the Company had $113.2 million in cash and cash equivalents. Under the First Lien Credit Agreement (defined below in Note 6), the Company was required to comply with certain financial covenants at the end of each calendar quarter, including to maintain a maximum net first lien leverage ratio of 6.0 to 1.0. On May 1, 2020, the Company entered into an Incremental Assumption and Amendment Agreement No. 4 ("Amendment No.4") which amended its First Lien Credit Agreement to, among other things, (i) provide for a suspension of the testing of the financial covenant for the fiscal quarters ending June 30, 2020, September 30, 2020 and December 31, 2020 and (ii) during the period beginning on May 1, 2020, and ending on the date on which the Company delivers a compliance certificate with respect to the fiscal quarter ending December 31, 2021 (unless earlier terminated by the Company), make certain modifications to the negative covenants set forth in the First Lien Credit Agreement and, solely for purposes of determining compliance with the financial covenant during the first three quarters of 2021 once testing resumes, the calculation of EBITDA. As a result of Amendment No. 4, and based on the Company's projected operating results for the next twelve months, the Company expects that it will be in compliance with its covenants under the First Lien Credit Agreement for at least the next twelve months. Pursuant to the terms of Amendment No. 4, the Company incurred incremental term loans in an aggregate principal amount of $95.0 million, of which the Company received $83.3 million in net proceeds (after original issue discount and related fees, which is described in Note 6). The incremental term loans incurred pursuant to Amendment No. 4 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 of 13.0% for LIBOR loans and 12.0% for base rate loans. Any voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 during the first two years after May 1, 2020 will be subject to a customary “make-whole” premium. On or after May 1, 2022 and prior to November 1, 2022, a voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 will be accompanied by a 1.00% payment premium. Other than described above, the incremental term loans have the same terms applicable to the outstanding term loans under the First Lien Credit Agreement. As a result of the additional financing, along with cash and cash equivalents on hand as of September 30, 2020, Management believes that the Company has sufficient liquidity to fund its operating requirements and meet its obligations as they become due for at least the next twelve months.

 

Recently Issued Accounting Pronouncements

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), which provides updated guidance on how an entity should measure credit losses on financial instruments. The new guidance replaced the current incurred loss measurement methodology with a lifetime expected loss measurement methodology. Subsequently, in November 2018 the FASB issued ASU No. 2018-19, which clarified that receivables arising from operating leases are not within the scope of Subtopic 326-20, but should rather be accounted for in accordance with ASC 842. In May 2019, the FASB issued ASU No. 2019-05 providing targeted transition relief to all reporting entities within the scope of Topic 326. The new standard and related amendments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. This guidance is expected to be applied using a modified retrospective approach for the cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective and using a prospective approach for debt securities for which any other-than-temporary impairment had been recognized before the effective date. The Company adopted ASC 326 using the modified retrospective approach for all applicable financial assets measured at amortized cost. The Company elected the practical expedient to exclude accrued interest from tabular disclosure and not to estimate an allowance for credit losses on accrued interest. Results for reporting beginning after January 1, 2020 are presented under ASC 326 while prior amounts continue to be reported in accordance with previously applicable GAAP. The standard did not materially impact our consolidated net earnings and had no impact on cash flows.

 

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force) which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted the standard prospectively to all implementation costs incurred after January 1, 2020. The standard did not materially impact our consolidated net earnings and had no impact on cash flows. 

 

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

 

11

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 2. ACQUISITIONS

 

In Bet Gaming II

 

During the quarter ended September 30, 2019, the Company acquired certain intangible assets related to table game intellectual property from In Bet Gaming, Inc ("In Bet II"). The acquisition was accounted for as an acquisition of a business and the assets acquired were measured based on our estimates of their fair values at the acquisition date. We attribute the goodwill recognized to our ability to commercialize the products over our distribution and sales network, opportunities for synergies, and other strategic benefits. The consideration of $4.0 million was allocated primarily to tax deductible goodwill for $1.2 million and intangible assets of $2.8 million, which will be amortized over a weighted average period of approximately 9.3 years.

  

 

 

 

 

 

 

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, 2020

  

December 31, 2019

 
Gaming equipment $172,545  $175,837 
Other property and equipment  23,500   23,210 
Less: Accumulated depreciation  (116,811)  (95,449)

Property and equipment, net

 $79,234  $103,598 

 

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 $9.6 million and $11.6 million for the three months ended September 30, 2020 and 2019, respectively. Depreciation expense was $30.3 million and $33.7 million for the nine months ended September 30, 2020 and 2019, respectively.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 4. GOODWILL AND INTANGIBLES

 

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

 

  

Gross Carrying Amount

 
  

EGM

  

Table Products

  

Interactive(1)

  

Total

 

December 31, 2019

 $279,228  $7,821  $0  $287,049 
Foreign currency adjustments  (2,843)  0   0   (2,843)

Balance at September 30, 2020

 $276,385  $7,821  $0  $284,206 

 

(1) Accumulated goodwill impairment charges for the Interactive segment as of September 30, 2020 were $8.4 million.

 

During the first quarter of 2020, our EGM and Table Products reporting units' operating results were significantly lower than expectations, driven by the rapid nationwide spread of the novel coronavirus and the actions taken by state and tribal governments and businesses, including the closure of casinos, in an attempt to contain the virus. Many of our customers temporarily closed their operations and the markets that we serve were significantly and adversely impacted, which was considered to be a triggering event. These closures resulted in a reduction of gaming operations revenues particularly related to our leased EGMs and Table Products as we ceased to bill our customers from the date that they closed. The closures also impacted equipment sales revenue due to a decline in our customer demand to purchase our EGMs and other products during the closures.  Accordingly, we performed a quantitative assessment, or “Step 1” analysis, as of March 31, 2020 to analyze whether this triggering event resulted in an impairment of associated goodwill in these two reporting units.  There is no balance of goodwill in the Company’s other reporting unit.

 

Based on our quantitative analysis, the fair value was 34% greater than the carrying value for the EGM reporting unit and 21% greater for the Table Products reporting unit. As of October 1, 2019 (the date of the Company’s annual impairment assessment), the fair values of the EGM reporting unit and the Table Products reporting unit were 50% and 111% greater than their respective carrying values. We estimated the fair value of both reporting units using the discounted cash flow method. The most significant factor in the assessment was the projected cash flows adjusted for the estimated adverse impact of COVID-19 on the Company’s operations.  Our projected cash flows for the current year are dependent on our assumptions for when our casino customers will reopen. The current year projected cash flows and those for future years are also impacted by our estimate of when the operations of our casino customers will return to pre-COVID-19 levels. Given the ongoing impacts of COVID-19 across our business, the long-range cash flow projections that we use to assess the fair value of our businesses and assets for purposes of impairment testing are subject to greater uncertainty than normal. Other factors included in the discounted cash flow calculation were the discount rate of 10% for EGM and 14% for Table Products and the long-term growth rate of 3% for both reporting units. As of October 1, 2019, the discount rates utilized in the discounted cash flow projections were 10% and 14% for the EGM and Table Products reporting units, respectively. During the second and third quarters of 2020, based on the performance of our re-opened customers and our related revenue share including our projections for future periods, we concluded that there are no triggering events that would more likely than not reduce the fair value of a reporting unit below their carrying value as of September 30, 2020. We will continue to monitor the ongoing impact of COVID-19 on our operations. If our projections do not align with our actual results in future quarters, we will update the projected cash flows, which may result in an impairment of goodwill.

 

Intangible assets consist of the following (in thousands):

 

     

September 30, 2020

  

December 31, 2019

 
  

Useful Life

  

Gross

  

Accumulated

  

Net Carrying

  

Gross

  

Accumulated

  

Net Carrying

 
  

(years)

  

Value

  

Amortization

  

Value

  

Value

  

Amortization

  

Value

 

Indefinite lived trade names

 

Indefinite

  $12,126  $-  $12,126  $12,126  $-  $12,126 

Trade and brand names

 5 - 7   14,870   (14,212)  658   14,870   (13,209)  1,661 

Customer relationships

 5 - 12   217,131   (136,189)  80,942   219,788   (120,384)  99,404 

Contract rights under development and placement fees

 1 - 7   47,012   (13,810)  33,202   48,180   (8,888)  39,292 

Gaming software and technology platforms

 1 - 7   169,347   (110,520)  58,827   162,391   (96,193)  66,198 

Intellectual property

 10 - 12   19,345   (8,974)  10,371   19,345   (7,575)  11,770 
     $479,831  $(283,705) $196,126  $476,700  $(246,249) $230,451 

 

 

Intangible assets are amortized over their respective estimated useful lives ranging from one to twelve years. Amortization expense related to intangible assets was $10.9 million and $12.1 million for the three months ended September 30, 2020 and 2019, respectively. Amortization expense related to intangible assets was $36.1 million and $35.3 million for the  nine months ended September 30, 2020 and 2019, respectively.

 

14

 

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. There were 0 impairments recorded for the period ended September 30, 2020. For the period ended September 30, 2019, we recorded a full impairment of RMG customer relationships, gaming licenses, and game content, which had a carrying value of $0.6 million. We also reduced the value of the RMG technology platform by $0.7 million to its fair value of $0.4 million as of September 30, 2019.

 

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 $1.9 million and $1.7 million for the three months ended September 30, 2020 and 2019, respectively. We recorded a reduction of gaming operations revenue from the accretion of contract rights under development agreements and placement fees of $5.6 million and $4.6 million for the nine months ended September 30, 2020 and 2019, respectively.

 

 

NOTE 5. ACCRUED LIABILITIES

 

Accrued liabilities consist of the following (in thousands):

 

  

September 30, 2020

  

December 31, 2019

 
Salary and payroll tax accrual $5,149  $8,691 
Taxes payable  3,818   4,151 
Current portion of operating lease liability  1,964   2,175 
License fee obligation  1,000   1,000 
Placement fees payable  7,892   8,346 
Accrued other  8,232   10,477 

Total accrued liabilities

 $28,055  $34,840 

 

15

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 6. LONG-TERM DEBT

 

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

 

  

September 30, 2020

  

December 31, 2019

 

First Lien Credit Facilities:

        
Term loans, interest at LIBOR or base rate plus 3.5% (4.5% at September 30, 2020), net of unamortized discount and deferred loan costs of $7.0 million and $9.0 million at September 30, 2020 and December 31, 2019, respectively. $520,996  $522,990 
Incremental term loans, interest at LIBOR or base rate plus 13.0% (14.0% at September 30, 2020), net of unamortized discount and deferred loan costs of $8.0 million at September 30, 2020. $86,742  $0 
Revolving credit facility, interest at LIBOR or base rate plus 3.5% (3.8% at September 30, 2020)  30,000   0 
Finance leases  1,555   1,737 

Total debt

  639,293   524,727 
Less: Current portion  (7,061)  (6,038)

Long-term debt

 $632,232  $518,689 

 

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 proceeds of the term loans were used primarily to repay the Company's then existing term loans, other indebtedness, to pay for the fees and expenses incurred in connection with the foregoing and otherwise for general corporate purposes. The full amount of the revolving credit facility was drawn on March 19, 2020 as a precautionary measure in order to increase the Company’s cash position and facilitate financial flexibility in light of the uncertainty in the global markets resulting from the COVID-19 outbreak. The full amount of the revolving credit facility was repaid in October 2020 and remains available for the Company to draw upon in the future. The term loans will mature on February 15, 2024, and the revolving credit facility will mature on June 6, 2022. 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 and revolving credit facility 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. 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.

 

On December 6, 2017, the Borrower entered into incremental facilities for $65.0 million in term loans (the “December Incremental Term Loans”).  The net proceeds of the December Incremental Term Loans were used to finance the acquisition of electronic gaming machines and related assets operated by Rocket Gaming Systems (“Rocket”) and to pay fees and expenses in connection therewith and for general corporate purposes. 

 

An additional $1.0 million in loan costs were incurred related to the issuance of the December Incremental Term Loans. Given the composition of the lender group, the transaction was accounted for as a debt modification and, as such, $0.9 million in third-party costs were expensed and included in the loss on extinguishment and modification of debt. The remaining amount was capitalized and will be amortized over the term of the agreement.

 

On February 8, 2018, the Borrower completed the repricing of its existing $513.0 million term loans under its First Lien Credit Agreement (the “Term Loans”). The Term Loans were repriced from 550 basis points to 425 basis points over LIBOR. The LIBOR floor remained at 100 basis points.

 

On February 8, 2018, in connection with the repricing of the Term Loans, third-party costs of $1.2 million were expensed and included in the loss and modification of debt. Existing debt issuance costs of $0.4 million were written-off and also included in the loss on extinguishment and modification of debt.

 

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 the administrative agent. The Incremental Agreement No. 2 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 8, 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 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 $30.0 million (the “Incremental Term Loans” and together with the Repriced Term B Loans, the “Term B Loans”).

 

On October 5, 2018, in connection with the repricing of the Term Loans, third-party costs of $1.5 million were expensed and included in the loss on extinguishment and modification of debt.

 

On August 30, 2019, the Borrower entered into Amendment No. 3 (the "Repricing Amendment") to the credit agreement. The Repricing Amendment reduced the interest rate margin on the revolving credit facility to the same interest rate margin as the term loans issued under the credit agreement.

 

On May 1, 2020 the Borrower entered into an Incremental Assumption and Amendment Agreement No. 4 (“Amendment No. 4”) with certain of the Borrower’s subsidiaries, the lenders party thereto and the administrative agent, which amended the First Lien Credit Agreement to provide for covenant relief (as described in Note 1) as well as an aggregate principal amount of $95.0 million in incremental term loans, of which the net proceeds received by the Company were $83.3 million after original issue discount and related fees. The incremental term loans incurred pursuant to Amendment No. 4 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 of 13% for LIBOR loans and 12% for base rate loans. Any voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 during the first two years after May 1, 2020 will subject to a customary ”make-whole” premium. On or after May 1, 2022 and prior to November 1, 2022, a voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 will be accompanied by a 1.00% payment premium. Other than described above, the incremental term loans have the same terms applicable to the outstanding term loans under the First Lien Credit Agreement.

 

An additional $11.7 million in loan costs including original issue discount, lender fees, and third-party costs were incurred related to Amendment No. 4. Given the composition of the lender group, the transaction was accounted for as a debt modification for existing lenders and, as such, $3.1 million in third-party costs were expensed and included in the loss on extinguishment and modification of debt. The remaining $8.6 million was capitalized and will be amortized over the term of the agreement.

 

As of September 30, 2020, we were in compliance with the required covenants of our debt instruments.  See Note 1 “Liquidity and Financing and COVID-19” for a description of a change to our financial covenants for future periods.

 

Finance Leases

 

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

 

16

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 7. 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, 2020, we have 35,697,583 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 through August 11, 2021.

 

 

NOTE 8. WRITE-DOWNS AND OTHER CHARGES

 

The Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income 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, 2020, the Company recognized $1.9 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.

 

During the nine months ended September 30, 2020, the Company recognized $2.8 million in write-downs and other charges driven by the write-off of placement fee intangible assets associated with the sale of previously leased EGMs to distributors in the period of $1.9 million, fair value adjustments to contingent consideration of $0.8 million (the Company used level 3 fair value inputs based on projected cash flows), and $0.1 million in other write-downs.

 

During the three months ended September 30, 2019, the Company recognized $0.8 million in write-downs and other charges driven by losses from the disposal of assets of $0.6 million, impairment to intangible assets of $0.1 million related to game titles (the Company used level 3 fair value measurements based on projected cash flows) 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 nine months ended  September 30, 2019, the Company recognized $6.9 million in write-downs and other charges driven by the impairment of goodwill in our RMG Interactive reporting unit of $3.5 million as well as related impairments of intangible assets in the RMG Interactive reporting unit of $1.3 million. We also recorded losses from the disposal of assets of $1.0 million, an impairment to intangible assets of $0.5 million related to game titles (the Company used level 3 fair value measurements based on projected cash flows) and a fair value adjustment to contingent consideration of $0.5 million (the Company used level 3 fair value measurements based on projected cash flows).

 

 

17

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

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

 

The Company computes net (loss) income 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 (Loss) Income. Basic EPS is computed by dividing net (loss) income 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 (loss) income 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).

 

There were 0 potentially dilutive securities for the three and nine months ended September 30, 2020.

 

Excluded from the calculation of diluted EPS for the three months ended September 30, 2020 were 955,792 restricted shares, as such securities were anti-dilutive. Excluded from the calculation of diluted EPS for the nine months ended September 30, 2020 were 857,453 restricted shares and 43,454 stock options, as such securities were anti-dilutive.

 

Excluded from the calculation of diluted EPS for the three months ended September 30, 2019 was 651,611 restricted shares and 505,309 stock options, as such securities were anti-dilutive. Excluded from the calculation of diluted EPS for the nine months ended September 30, 2019 was 594,265 restricted shares and 733,605 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. In April 2020, the Company temporarily suspended 401(k) matching contributions and there were 0 contribution expenses associated with the 401(k) Plan for the three months ended September 30, 2020. The expense associated with the 401(k) Plan for the three months ended September 2019, was $0.3 million. The expense associated with the 401(k) Plan for the nine months ended September 30, 2020 and 2019, was $0.4 million and $1.0 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 after giving effect to the 1.5543 - for - 1 stock split consummated on January 30, 2018 in connection with our initial public offering.  As of September 30, 2020, 423,268 shares remain available for issuance; however, the Company will not issue additional awards under this plan.

 

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, as amended, provides for an aggregate of 4,607,389 shares of our common stock and 2,186,046 shares remain available for issuance.

 

18

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 11. 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. 

 

For the three months ended September 30, 2020, the Company recognized $0.1 million in stock-based compensation for stock options and $1.6 million for restricted stock or restricted stock unit awards. For the nine months ended September 30, 2020, the Company recognized $0.3 million in stock-based compensation for stock options and $4.4 million for restricted stock or restricted stock unit awards. For the three months ended September 30, 2019, the Company recognized $0.2 million in stock-based compensation for stock options and $1.8 million for restricted stock or restricted stock unit awards. For the nine months ended September 30, 2019, the Company recognized $0.7 million in stock-based compensation for stock options and $4.6 million for restricted stock and restricted stock unit awards. 

 

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, 2020, $0.4 million of unrecognized compensation expense was associated with stock options, $12.0 million was associated with restricted stock or restricted stock units and $2.1 million with phantom stock units. The unrecognized compensation expense associated with stock options, restricted and phantom stock units is expected to be recognized over a 1.4, 2.3 and 2.5 year weighted average period, respectively.

 

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 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. There were 0 options granted during the three and nine months ended September 30, 2020.

 

Stock Options 

 

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 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 556,763 Performance Options exercisable and outstanding.

 

19

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

A summary of the changes in stock options outstanding during the nine months ended September 30, 2020 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, 2019

  1,382,986  $9.10   5.45  $4,793 

Granted

  0   0   -   0 

Exercised

  (15,544) $10.15         

Canceled or forfeited

  (74,607) $7.28         

Options outstanding as of September 30, 2020

  1,292,835  $9.19   4.69  $0 

Options exercisable as of September 30, 2020

  1,223,019  $8.84   4.57  $0 

 

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 60 consecutive trading days exceeds certain stock prices, subject to continued employment with the Company or its subsidiaries.

 

A summary of the changes in restricted stock outstanding during the nine months ended September 30, 2020 is as follows:

 

  

Shares Outstanding

  Grant Date Fair Value (per share) 

Restricted Stock Outstanding as of December 31, 2019

  712,496  $23.66 
Granted  1,342,322  $3.98 
Vested  (217,668) $18.62 
Canceled or forfeited  (34,225) $23.84 
Restricted stock outstanding as of September 30, 2020  1,802,925  $9.61 

 

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. The first vesting tranche of the phantom stock award must be settled in cash and the second, third and fourth vesting tranches may 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 rewards is included in “Accrued Liabilities” within the unaudited Condensed Consolidated Balance Sheets. All other stock-based awards are classified as equity.

 

A summary of the changes in phantom stock outstanding during the nine months ended September 30, 2020 is as follows:

 

  

Shares Outstanding

  Grant Date Fair Value (per share) 

Phantom Stock Outstanding as of December 31, 2019

  0  $0 

Granted

  616,224  $3.94 

Vested

  0  $0 

Canceled or forfeited

  0  $0 

Phantom stock outstanding as of September 30, 2020

  616,224  $3.94 

 

 

20

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 12. INCOME TAXES

 

The Company's effective income tax rate for the three months ended September 30, 2020, was a benefit of 13.1%. The difference between the federal statutory rate of 21.0% and the Company’s effective tax rate for the three months ended September 30, 2019, was primarily due to changes in our valuation allowance on deferred tax assets and lapse in the applicable statute of limitations for certain uncertain tax positions. The Company's effective income tax rate for the three months ended September 30, 2019, was an expense of 53.6%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three months ended September 30, 2019, was primarily due to changes in our valuation allowance on deferred tax assets and changes in the estimated forecast of pre-tax book income and loss for each respective jurisdiction.

 

The Company's effective income tax rate for the nine months ended September 30, 2020, was a benefit of 6.9%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the nine months ended September 30, 2020, 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, 2019, was a benefit of 23.1%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the nine months ended September 30, 2019, was primarily due to changes in our valuation allowance on deferred tax assets, various permanent items, lapse in the applicable statute of limitations for certain uncertain tax positions and impairment of goodwill.

 

The Company entered into an indemnification agreement with the prior owners of Cadillac Jack (acquired in May of 2015) 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, 2020, an indemnification receivable of $0.7 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) Income.

 

During the three months ended September 30, 2020, there was 0 change in the indemnification receivable. During the nine months ended September 30, 2020, the Company recognized a $3.2 million reduction in the indemnification receivable and related charges in our Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income primarily due to lapse in the applicable statute of limitations on indemnified tax positions. During the three and nine months ended September 30, 2019, the Company recognized a $0.1 million increase and a $5.4 million reduction in the indemnification receivable and related charge in our Consolidated Statements of Operations and Comprehensive (Loss) Income due to accrued interest and lapse in the applicable statute of limitations on indemnified tax positions.

 

 

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 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, 2020, a putative class action lawsuit was filed in the United States District Court for the District of Nevada, Case No. 20-cv-1209, by Manjan Chowdhury against 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 complaint alleges that the defendants made false and misleading statements concerning the Company’s forward-looking financial outlook and accounting for goodwill and intangible assets in its RMG Interactive reporting unit, resulting in injury to the purported class members as a result of the decline in the value of the Company’s common stock following its release of its second quarter 2019 results on August 7, 2019. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The defendants believe the claims are without merit, and intend to defend vigorously against them, but there can be no assurances as to the outcome.

 

On July 31, 2020, a second plaintiff, Andrew Miller, filed a putative class action lawsuit in the same court that alleges essentially the same claims on behalf of the same putative class against the same defendants as in the earlier-filed Chowdhury action. U.S. District Court for the District of Nevada, Case No. 20-cv-1428. As in Chowdhury, the complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.  The defendants believe these claims too are without merit, and intend to defend vigorously against them, but there can be no assurances as to the outcome.

 

On August 4, 2020, a third plaintiff, Oklahoma Police Pension and Retirement System (“OPPRS”), filed a putative class action lawsuit in the same court asserting similar claims to those alleged in Chowdhury and Miller, based on substantially the same conduct. U.S. District Court for the District of Nevada, Case No. 20-cv-1443. Specifically, OPPRS claims 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 Securities Exchange Act of 1934 by allegedly making false and misleading statements concerning, among other things, 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 members as a result of the decline in the value of the Company’s common stock following its release of its second quarter 2019 results on August 7, 2019.  OPPRS brings these Exchange Act claims on behalf of a slightly larger putative class than in Chowdhury and Miller, and includes all persons who purchased or otherwise acquired Company securities between May 3, 2018 and August 7, 2019. In addition, based on substantially similar alleged false or misleading statements, OPPRS asserts 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 are brought against the same defendants identified above, plus certain of the Company’s directors and the underwriters.  The defendants believe the claims are without merit, and intend to defend vigorously against them, but there can be no assurances as to the outcome.

 

These three related putative class actions pending in the United States District Court for the District of Nevada will be consolidated in the next few months.

 

21

 

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; initial public offering and secondary offerings costs; 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.

 

The following provides financial information concerning our reportable segments for the three and nine months ended September 30, 2020 and 2019 (amounts in thousands):   

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 
  

2020

  

2019

  

2020

  

2019

 

Revenues by segment

                

EGM

 $45,081  $75,299  $109,393  $215,932 

Table Products

  2,262   2,861   5,418   7,437 

Interactive

  1,941   1,217   5,574   3,559 

Total Revenues

  49,284   79,377  $120,385  $226,928 

Adjusted EBITDA by segment

                

EGM

  25,000   35,825   46,181   108,088 

Table Products

  1,272   1,409   2,044   2,694 

Interactive

  750   (447)  2,145   (1,985)

Subtotal

  27,022   36,787   50,370��  108,797 

Write-downs and other:

                

Loss on disposal of long-lived assets

  1,930   570   2,004   1,015 

Impairment of long-lived assets

  0   136   6   5,343 

Fair value adjustments to contingent consideration and other items

  2   101   796   501 

Depreciation and amortization

  20,463   23,810   66,353   69,002 

Accretion of placement fees(1)

  1,910   1,747   5,643   4,550 

Non-cash stock-based compensation expense

  1,733   1,959   4,726   5,309 

Acquisitions and integration-related costs including restructuring and severance

  79   481   311   2,944 

Initial public offering costs and secondary offering

  0   (11)  0   414 
Legal and litigation expenses including settlement payments  389   1,745   389   1,748 

Non-cash charge on capitalized installation and delivery

  505   679   1,824   1,991 

Other adjustments

  2,413   (9)  4,652   58 

Interest expense

  11,330   9,320   30,566   27,754 

Interest (income)

  (671)  (42)  (843)  (112)
Loss on extinguishment and modification of debt  0   0   3,102   0 

Other expense

  (311)  (106)  3,993   5,108 

(Loss) income before income taxes

 $(12,750) $(3,593) $(73,152) $(16,828)

 

(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.

 

22

 
 

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, 2019 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. 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. 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. 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. For the period ended September 30, 2020, approximately 74% 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.

 

    

EGM Segment

 

EGMs constitute our largest segment, representing 91% of our revenue for three months ended September 30, 2020. We have a library of proprietary game titles that we deliver on several state-of-the-art EGM cabinets. These include our premium lease only cabinets the Orion Starwall, Orion Rise and Big Red. Also, our core cabinets that are available for sale and lease include the Orion Portrait, Orion Curve, Orion Slant, Orion Upright and ICON.

 

We design all of our cabinets with the intention of capturing the attention of players on casino floors while aiming to maximize operator profits. We offer our customers the option of either leasing or purchasing our EGMs and associated gaming systems. Currently, we derive a substantial portion all of our 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”. 

 

 

Table Products

 

In addition to our existing portfolio of EGMs, we also offer our customers more than 40 unique table product offerings, including live felt table games, side bet offerings, progressives, card shufflers, signage, and other ancillary table game equipment. Our table products are designed to enhance 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 the Company, including by generating further cross-selling opportunities with our EGM offerings. As of September 30, 2020, we had an installed base of 4,012 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.

 

Interactive

 

We operate a Business-to-Business ("B2B") online gaming platform for content aggregation that we offer to our real-money gaming (“RMG”) online casino customers. Our B2B platform, the AxSys Games Marketplace, aggregates content from several game suppliers and offers online casino operators the convenience to reduce the number of integrations that are needed to supply the online casino. By integrating with us, online casino operators have access to a significant amount of content from numerous game suppliers. We operate the AxSys Games Marketplace in regulated, legal online gaming jurisdictions such as the UK, parts of Europe, New Jersey, and Pennsylvania.
 
We also operate Business-to-Consumer (“B2C”) social casino games that include online versions of our popular EGM titles and are accessible to players worldwide on multiple mobile platforms, which we believe establishes brand recognition. 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 or the player may purchase additional virtual goods. Our B2C social casino games are available on our mobile app, Lucky Play Casino. The app contains numerous AGS game titles available for consumers to play for free or with virtual currency they purchase in the app.

 

 

 

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 or closure of new gaming jurisdictions both in the United States and internationally;

 

our ability to obtain and maintain gaming licenses in various jurisdictions;

 

the relative competitiveness and popularity of our electronic gaming machines compared to competitive products offered in the same facilities; and

 

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

 

The factors above have been significantly affected by COVID-19 and the related closure of nearly all of our casino customer locations. Due to the business disruption caused by the rapid nationwide spread of the novel coronavirus and the actions by state and tribal governments and businesses to contain the virus, almost all of the Company’s customers closed their operations during the month of March and April 2020 and their respective markets have been significantly and adversely impacted. Beginning in May 2020 and continuing through September, casinos began to reopen at limited capacity and nearly all of our customers' casino properties in the United States and Canada were partially open as of September 30, 2020 under limited operations. As of September 30, 2020, in Mexico, approximately half of our customers' casinos were partially open under capacity limitations. As a result of the temporary closures of our casino customers, there has been a decrease in the amount of money spent by consumers on our revenue shared installed base and the amount of daily fees of our participation EGMs and a slow down to the expansion of existing casinos or development of new casinos. Specifically, gaming operations revenue and equipment sales have decreased compared to the prior year period as a result of the temporary closures of our casino customers. Similarly, our EGM and Table Products segment operating results have been disrupted because each segment’s activities including design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its products lines have been temporarily halted or significantly reduced. In addition, each segment’s revenue from leasing, licensing and selling products has been adversely impacted due to the temporary closures of our casino customers. As a result, the Company took several actions to adapt to the severity of the crisis. Among other things, the Company implemented short-term furloughs with retained benefits, company-wide salary reductions, and reduced its workforce by over 10%. Our non-employee directors have also agreed to reduce their fees by 50%. Some of the Company's customers have reopened at limited capacity, some have reopened and then been required to close again due to local conditions and regulations relating to the spread of the coronavirus, and there are also customers who still remain closed. Depending on the length of casino closures and if they are required to close again, the Company will consider additional reductions to payroll and related expenses through additional employee furloughs in order to conserve liquidity.

 

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;

 

fluctuations in the level of maintenance expense required on gaming equipment; and 

 

tariff increases.

 

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.

 

Acquisitions and Divestitures


We have made several strategic acquisitions over the past two years. 


In Bet Gaming II.
During the quarter ended September 30, 2019, we acquired certain intangible assets related to table game intellectual property from In Bet Gaming, Inc (“In Bet II”). The acquisition was accounted for as an acquisition of a business and the assets acquired were measured based on our estimates of their fair values at the acquisition date. We attribute the goodwill recognized to our ability to commercialize the products over our distribution and sales network, opportunities for synergies, and other strategic benefits. The consideration of $4.0 million was allocated primarily to tax deductible goodwill for $1.2 million and intangible assets of $2.8 million.
 
Integrity.
During the quarter ended March 31, 2019, we acquired all of the equity of Integrity Gaming Corp. (“Integrity”), a regional slot route operator with over 2,500 gaming machines in operation across over 33 casinos in Oklahoma and Texas. The acquisition was accounted for as an acquisition of a business and the assets acquired and liabilities assumed were measured based on our estimates of their fair values at the acquisition date. We attribute the goodwill recognized to our ability to utilize Integrity’s installed base to maximize revenue of the combined product portfolio and the synergies we can obtain through the reduction in our combined service and overhead costs. The total consideration for this acquisition was $52.6 million. The consideration was allocated primarily to non-tax deductible goodwill for $11.4 million, property and equipment of $12.7 million and intangible assets of $30.6 million.

 

 

 

Results of Operations

    

Three Months Ended September 30, 2020 compared to the Three Months Ended September 30, 2019

 

The following tables set forth certain selected condensed consolidated financial data for the three months ended September 30, 2020 and 2019 (in thousands): 

 

  Three Months Ended September 30,  $  

%

 
  

2020

  

2019

  

Change

  

Change

 

Consolidated Statements of Operations:

                

Revenues

                

Gaming operations

 $36,299  $52,522  $(16,223)  (30.9)%

Equipment sales

  12,985   26,855   (13,870)  (51.6)%

Total revenues

  49,284   79,377   (30,093)  (37.9)%

Operating expenses

                

Cost of gaming operations

  8,268   10,170   (1,902)  (18.7)%

Cost of equipment sales

  3,981   13,479   (9,498)  (70.5)%

Selling, general and administrative

  10,862   16,861   (5,999)  (35.6)%

Research and development

  6,180   8,671   (2,491)  (28.7)%

Write-downs and other charges

  1,932   807   1,125   139.4%

Depreciation and amortization

  20,463   23,810   (3,347)  (14.1)%

Total operating expenses

  51,686   73,798   (22,112)  (30.0)%

(Loss) income from operations

  (2,402)  5,579   (7,981)  (143.1)%

Other expense (income)

                

Interest expense

  11,330   9,320   2,010   21.6%

Interest income

  (671)  (42)  (629)  1497.6%
Loss on extinguishment and modification of debt  -   -   -   - 

Other expense

  (311)  (106)  (205)  193.4%

(Loss) income before income taxes

  (12,750)  (3,593)  (9,157)  254.9%

Income tax (expense) benefit

  1,672   (1,926)  3,598   (186.8)%
Net (loss) income  (11,078)  (5,519)  (5,559)  100.7%
Less: Net income attributable to non-controlling interests  -   (17)  17   (100.0)%
Net (loss) income attributable to PlayAGS, Inc. $(11,078) $(5,536) $(5,542)  100.1%

 

Revenues 

 

Gaming Operations.

 

Gaming operations revenue decreased $16.2 million primarily due to a decrease in our EGM and Table Products segments. EGM RPD decreased by 26.3% compared to the prior year and tables average lease price decreased by 27.2% due to the temporary casino closures that began in March 2020 caused by COVID-19. Nearly all of the Company's customers were closed during April 2020 and a limited number began to reopen at reduced capacity starting in late-May through September 2020. As of September 30, 2020, nearly all of our customers' casino properties in the United States and Canada were open under limited operations. On September 30, 2020 in Mexico, approximately half of our customers' casinos were open under capacity limitations. Additional decreases in gaming operations revenue are due to a decrease in our domestic EGM installed base year over year due to sales of 1,367, lower yielding units to distributors during the last twelve months (891 in prior periods and 476 in the third quarter of 2020). During the third quarter, several of our customers reconfigured their slot floors in response to COVID and, as a result, removed nearly 350 EGMs from our domestic installed base. Our international EGM installed base also decreased year over year due primarily to the permanent closure of certain casinos in Mexico and the sale of previously leased EGMs during the last twelve months. The decrease in our EGM and Table Products segments was partially offset by an increase of $0.7 million in our Interactive segment primarily related to an increase in our RMG revenues.

    

Equipment Sales.

 

The decrease in equipment sales was primarily due to a decrease of 1,004 EGMs sold year over year. We sold 387 EGM units during the three months ended September 30, 2020, compared to 1,391 EGM units in the prior year period. EGM equipment sales revenue also includes revenue from the sale of 476 previously leased, lower yielding units to a distributor in the current year period, which units are not included in our sold unit count or domestic average sales price.

 

Operating Expenses

 

Cost of gaming operations. The decrease in costs of gaming operations was the result of a $2.2 million decrease in direct expenses that are related to the volume of revenue primarily due to decreased activity as a result of the temporary casino closures and limited capacity of re-opened casinos caused by COVID-19. The decrease was also attributable to a decrease in field service-related expenses year over year by $0.9 million. These decreases were partially offset by $0.8 million increases in inventory valuation related charges. As a percentage of gaming operations revenue, costs of gaming operations was 22.8% for the three months ended September 30, 2020 compared to 19.4% for the prior year period.

 

 

Cost of Equipment Sales. - The decrease in cost of equipment sales is attributable to the 387 EGM units sold during the three months ended September 30, 2020 compared to 1,391 units sold in prior year period. As a percentage of equipment sales revenue, costs of equipment sales was 30.7% for the three months ended September 30, 2020 compared to 50.2% for the prior year period and the difference is primarily due to the 476 units sold to a distributor in the current year at a higher margin than the Company's historical average margin.

 

Selling, general and administrative. - The decrease in selling, general and administrative expenses is primarily due to a decrease of $2.7 million in salary and benefits, and a $0.8 million decrease in sales and marketing expense, resulting from Management's actions taken to decrease spending amid the COVID-19 crisis including employee furloughs, reduction in work force and salary reductions. The prior year expense included a $1.6 million loss reserve recorded in the third quarter that is described in Item 1 “Financial Statements” Note 13 to our condensed consolidated financial statements. These decreases were offset by $1.2 million in bad debt expense recorded in the current year related to accounts receivable from our customers in Mexico.

 

Research and development. - The decrease in research and development expenses is primarily due to a decrease of $1.9 million in salary and benefits and a $0.3 million decrease in delayed development fees resulting from Management's actions taken to decrease spending amid the COVID-19 crisis including employee furloughs, reduction in work force and salary reduction. 

 

Write-downs and other charges. - During the three months ended September 30, 2020, the Company recognized $1.9 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.

 

During the three months ended September 30, 2019, the Company recognized $0.8 million in write-downs and other charges driven by losses from the disposal of assets of $0.6 million, impairment to intangible assets of $0.1 million related to game titles and a fair value adjustment to contingent consideration of $0.1 million.

 

Depreciation and amortization. - The decrease was predominantly due to several assets purchased in Cadillac Jack acquisition that reached the end of their five-year useful lives during the current year.

 

Other Expense, net

 

Interest expense. The increase in interest expense is predominantly attributed to an increase of $95.0 million in the principal amounts outstanding under the incremental first lien credit facilities, an increase of $30.0 million in debt outstanding on our revolving credit facility and additional interest from financed placement fees. See Item 1. “Financial Statements” Note 6 for a detailed discussion regarding long-term debt. These increases in debt principal are offset by a decrease in variable interest rate applicable to the loans under the first lien credit facilities year over year.

 

Other expense.  The change in other expense 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 three months ended September 30, 2020, was a benefit of 13.1%. The difference between the federal statutory rate of 21.0% and the Company’s effective tax rate for the three months ended September 30, 2020, was primarily due to changes in our valuation allowance on deferred tax assets and lapse in the applicable statute of limitations for certain uncertain tax positions. The Company's effective income tax rate for the three months ended September 30, 2019, was an expense of 53.6%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three months ended September 30, 2019, was primarily due to changes in our valuation allowance on deferred tax assets and changes in the estimated forecast of pre-tax book income and loss for each respective jurisdiction.

 

 

 

 

Nine Months Ended September 30, 2020 compared to the Nine Months Ended September 30, 2019

 

The following tables set forth certain selected condensed consolidated financial data for the nine months ended September 30, 2020 and 2019 (in thousands): 

 

  

Nine Months Ended September 30,

  $  

%

 
  

2020

  

2019

  

Change

  

Change

 

Consolidated Statements of Operations:

                

Revenues

                

Gaming operations

 $89,173  $158,976  $(69,803)  (43.9)%

Equipment sales

  31,212   67,952   (36,740)  (54.1)%

Total revenues

  120,385   226,928   (106,543)  (47.0)%

Operating expenses

                

Cost of gaming operations

  23,756   30,721   (6,965)  (22.7)%

Cost of equipment sales

  13,351   32,906   (19,555)  (59.4)%

Selling, general and administrative

  31,111   46,343   (15,232)  (32.9)%

Research and development

  19,342   25,175   (5,833)  (23.2)%

Write-downs and other charges

  2,806   6,859   (4,053)  (59.1)%

Depreciation and amortization

  66,353   69,002   (2,649)  (3.8)%

Total operating expenses

  156,719   211,006   (54,287)  (25.7)%

Income from operations

  (36,334)  15,922   (52,256)  (328.2)%

Other expense (income)

                

Interest expense

  30,566   27,754   2,812   10.1%

Interest income

  (843)  (112)  (731)  652.7%
Loss on extinguishment and modification of debt  3,102   -   3,102   100.0%

Other expense

  3,993   5,108   (1,115)  (21.8)%

Loss before income taxes

  (73,152)  (16,828)  (56,324)  334.7%

Income tax benefit

  5,016   3,884   1,132   29.1%

Net (loss) income

  (68,136)  (12,944)  (55,192)  426.4%

Less: Net income attributable to non-controlling interests

  -   (231)  231   (100.0)%

Net loss attributable to PlayAGS, Inc.

 $(68,136) $(13,175) $(54,961)  417.2%

 

Revenues 

 

Gaming Operations. Gaming operations revenue decreased $69.8 million primarily due to a decrease in our EGM segment. EGM RPD decreased by 42.2% compared to the prior year primarily due to the temporary casino closures that began in March 2020 caused by COVID-19. Nearly all of the Company's customers were closed during April 2020 and a limited number began to reopen at reduced capacity in late-May through September 2020. As of September 30, 2020, nearly all of our customers' casino properties in the United States and Canada were open under limited operations. On September 30, 2020 in Mexico, approximately half of our customers' casinos were open under capacity limitations. Additional decreases in gaming operations revenue are due to a decrease in our domestic EGM installed base year over year due to sales of 1,367 previously leased, lower yielding units to distributors during the last twelve months (327 units were sold in Q4 2019 and 1,040 units were sold in the current year period). During the third quarter, several of our customers reconfigured their slot floors in response to COVID and, as a result, removed nearly 350 EGMs from our domestic installed base. Our international EGM installed base also decreased year over year due primarily to the permanent closure of certain casinos in Mexico and the sale of previously leased EGMs during the last twelve months. The decrease in our EGM segment was partially offset by an increase of $2.0 million in our Interactive segment primarily related to an increase in our RMG revenues.

 

Equipment Sales. The decrease in equipment sales revenue is due to the sale of 1,060 EGM units in the nine months ended September 30, 2020, compared to 3,596 EGM units in the prior year period, as well as due to a 2.1% decrease in the domestic average sales price compared to the prior year period. EGM equipment sales revenue also includes revenue from the sale of 1,040 previously leased, lower yielding units to a distributor in the current year period, which units are not included in our sold unit count or domestic average sales price.

 

Operating Expenses

 

Cost of gaming operations.  The decrease in costs of gaming operations was the result of a $7.1 million decrease in direct expenses that are related to the volume of revenue primarily due to decreased activity as a result of the temporary casino closures that began in March 2020 caused by COVID-19. The decrease was also attributable to a decrease in field service-related expenses compared to the prior year period by $2.5 million. These decreases were partially offset by $1.7 million in unapplied labor and overhead primarily from idle facilities that were not utilized due to COVID-19 and by $1.0 million in inventory valuation related charges in the current year period. As a percentage of gaming operations revenue, costs of gaming operations was 26.6% for the nine months ended September 30, 2020 compared to 19.3% for the prior year period.

 

 

Cost of Equipment Sales. The decrease in cost of equipment sales is attributable to the sale of 1,060 EGM units sold for the nine months ended September 30, 2020 compared to 3,596 units sold in prior year period. As a percentage of equipment sales revenue, costs of equipment sales was 42.8% for the nine months ended September 30, 2020 compared to 48.4% for the prior year period and the difference is primarily due to the 1,040 units sold to a distributor in the current year at a higher margin than the Company's historical average margin.

 

Selling, general and administrative. The decrease in selling, general and administrative expenses is primarily due to a decrease of $6.7 million in salary and benefits, a decrease of $3.9 million in professional fees, $1.9 million decrease in sales and marketing expense, and a $1.3 million decrease in travel and entertainment expense, all resulting from Management's actions taken to decrease spending amid the COVID-19 crisis including employee furloughs, reduction in work force and salary reduction. The prior year expense included a $1.6 million loss reserve recorded in the third quarter that is described in Item 1 “Financial Statements” Note 13 to our condensed consolidated financial statements. The decreases was also offset by $1.4 million in bad debt expense recorded in the current year related to accounts receivable from our customers in Mexico.

 

Research and development. The decrease in research and development expenses is primarily due to a $4.7 million decrease in salary and benefits, a $0.9 million decrease in delayed development fees, and a $0.4 million decrease in travel and entertainment expense, all resulted from Management's actions taken to decrease spending amid the COVID-19 crisis including employee furloughs, reduction in work force and salary reduction. 

 

Write-downs and other charges. During the nine months ended September 30, 2020, the Company recognized $2.8 million in write-downs and other charges driven by the write-off of placement fee intangible assets associated with the sale of previously leased EGMs to distributors in the period of $1.9 million, fair value adjustments to contingent consideration of $0.8 million, and $0.1 million in other write-downs.

 

During the nine months ended September 30, 2019, the Company recognized $6.9 million in write-downs and other charges driven by the impairment of goodwill in our RMG Interactive reporting unit of $3.5 million as well as related impairments of intangible assets in the RMG Interactive reporting unit of $1.3 million. We also recorded losses from the disposal of assets of $1.0 million, a fair value adjustment to contingent consideration of $0.5 million and the impairment to intangible assets of $0.5 million related to game titles.

 

Depreciation and amortization. The decrease was predominantly due to decrease in depreciation and amortization of assets purchased in the Cadillac Jack acquisition that reached the end of their five-year useful lives during the current year.

 

Other Expense, net 

 

Interest expense. The increase in interest expense is predominantly attributed to an increase of $95.0 million in the principal amounts outstanding under the incremental first lien credit facilities, an increase of $30.0 million in debt outstanding on our revolving credit facility and additional interest from financed placement fees. See Item 1. “Financial Statements” Note 6 for a detailed discussion regarding long-term debt. These increases in debt principal were offset by a decrease in variable interest rate applicable to the loans under the first lien credit facilities year over year.

 

Other expense (income). - The decrease is predominantly attributed to the write-off of indemnification receivables of $5.4 million in the prior year period compared to $3.5 million in the current year as the related liability for uncertain tax positions was also written-off due to the 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, 2020, was a benefit of 6.9%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the nine months ended September 30, 2020, was primarily due to changes in our valuation allowance on deferred tax assets 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, 2019, was a benefit of 23.1%. The difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the nine months ended September 30, 2019, 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.

 

 

 

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 sold unit 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. 

 

Adjusted Expenses

 

We have provided (i) adjusted cost of gaming operations, (ii) adjusted selling, general and administrative costs and (iii) adjusted research and development cost (collectively, the “Adjusted Expenses”) 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 each of the Adjusted Expenses is appropriate to provide additional information to investors about certain non-cash items that vary greatly and are difficult to predict. These Adjusted Expenses take into account non-cash stock compensation expense, acquisitions and integration-related costs including restructuring and severance, initial and secondary public offering costs, legal and litigation expenses including settlement payments, new jurisdictions and regulatory licensing costs, non-cash charges on capitalized installation and delivery, non-cash charges and loss on disposition of assets and other adjustments. Further, we believe each of the Adjusted Expenses provides a meaningful measure of our expenses 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.

 

Each of the Adjusted Expenses is not a presentation made in accordance with GAAP. Our use of the term Adjusted Expenses may vary from others in our industry. Each of the Adjusted Expenses should not be considered as an alternative to our operating expenses under GAAP. Each of the Adjusted Expenses 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 Adjusted Expenses 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 cost of gaming operations, cost of equipment sales, selling, general and administrative costs and research and development costs and use each of the Adjusted Expenses only supplementally.

 

The tables below present each of the Adjusted Expenses and include a reconciliation to the nearest GAAP measure.

 

 

 

Electronic Gaming Machines

 

Three Months Ended September 30, 2020 compared to the Three Months Ended September 30, 2019

 

  Three Months Ended September 30,  $  

%

 

(amounts in thousands, except unit data)

 

2020

  

2019

  

Change

  

Change

 

EGM segment revenues:

                

Gaming operations

 $32,188  $48,854  $(16,666)  (34.1)%

Equipment sales

 $12,893   26,445   (13,552)  (51.2)%

Total EGM revenues

  45,081   75,299   (30,218)  (40.1)%
                 

EGM segment expenses and adjusted expenses:

                

Cost of gaming operations(1)

  7,562   9,590   (2,028)  (21.1)%
Less: Adjustments(2)  1,634   621   1,013   163.1%

Adjusted cost of gaming operations

  5,928   8,969   (3,041)  (33.9)%
                 

Cost of equipment sales

  3,960   13,279   (9,319)  (70.2)%
                 

Selling, general and administrative

  10,098   13,725   (3,627)  (26.4)%
Less: Adjustments(3)  2,652   1,646   1,006   61.1%

Adjusted cost of selling, general and administrative

  7,446   12,079   (4,633)  (38.4)%
                 

Research and development

  5,240   7,564   (2,324)  (30.7)%
Less: Adjustments(4)  583   670   (87)  (13.0)%

Adjusted cost of research and development

  4,657   6,894   (2,237)  (32.4)%
                 

Accretion of placement fees

  1,910   1,747   163   9.3%
                 

EGM adjusted EBITDA

 $25,000  $35,825  $(10,825)  (30.2)%
                 

EGM unit information:

                
VLT  512   517   (5)  (1.0)%
Class II  11,887   12,355   (468)  (3.8)%
Class III  4,426   5,852   (1,426)  (24.4)%

Domestic installed base, end of period

  16,825   18,724   (1,899)  (10.1)%
International installed base, end of period  8,030   8,668   (638)  (7.4)%

Total installed base, end of period

  24,855   27,392   (2,537)  (9.3)%
                 
Installed base - Oklahoma  9,063   10,503   (1,440)  (13.7)%
Installed base - non-Oklahoma  7,762   8,221   (459)  (5.6)%
Domestic installed base, end of period  16,825   18,724   (1,899)  (10.1)%
                 
Domestic revenue per day $20.81  $25.08  $(4.27)  (17.0)%
International revenue per day $0.78  $7.99  $(7.21)  (90.2)%
Total revenue per day $14.50  $19.68  $(5.18)  (26.3)%
                 
Domestic EGM units Sold  387   1,350   (963)  (71.3)%
Total EGM units Sold  387   1,391   (1,004)  (72.2)%
Domestic average sales price $18,190  $18,476  $(286)  (1.5)%

 

(1) Exclusive of depreciation and amortization.

(2) Adjustments to cost of gaming operation include non-cash stock compensation expense, acquisitions and integration-related costs including restructuring and severance, non-cash charges on capitalized installation and delivery and other adjustments.

(3) Adjustments to selling, general and administrative expense include non-cash stock compensation expense, acquisitions and integration-related costs including restructuring and severance, initial public offering, legal and litigation-related costs including settlements payments, and other adjustments.

(4) Adjustments to research and development costs include non-cash stock compensation expense and acquisitions and integration-related costs including restructuring and severance.

 

 

Gaming Operations Revenue 

 

Gaming operations revenue decreased primarily due to a decrease in revenue per day ("RPD") of 26.3% compared to the prior year due to the temporary casino closures that began in March 2020 caused by the COVID-19 outbreak. Nearly all of the Company's customers were closed during April 2020 and a limited number began to reopen at reduced capacity in late-May through September 2020. As of September 30, 2020, nearly all of our customers' casino properties in the United States and Canada were open under limited operations. On September 30, 2020 in Mexico, approximately half of our customers' casinos were open under capacity limitations. Additional decreases in gaming operations revenue are due to a decrease in our domestic EGM installed base year over year due to sales of 1,367 previously leased, lower yielding units to distributors during the last twelve months (891 in prior periods and 476 in the current period). During the third quarter, several of our customers reconfigured their slot floors in response to COVID and, as a result, removed nearly 350 EGMs from our domestic installed base. Our international EGM installed base also decreased year over year due primarily to the permanent closure of certain casinos in Mexico and the sale of previously leased EGMs during the last twelve months.

 

Equipment Sales 

 

The decrease in equipment sales was primarily due to a decrease of 1,004 EGMs sold compared year over year. We sold 387 EGM units during the three months ended September 30, 2020, compared to 1,391 EGM units in the prior year period. To a lesser extent the decrease in equipment sales revenue was also due to a 1.5% decrease in the domestic average sales price compared to the prior year period driven by differences in product mix. EGM equipment sales revenue also includes revenue from the sale of 476 previously leased, lower yielding units to a distributor in the current year period, which units are not included in our sold unit count or domestic average sales price. 

 

EGM Adjusted EBITDA 

 

EGM adjusted EBITDA includes 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 decrease in EGM adjusted EBITDA is attributable to the decrease in revenue described above offset by the related decrease in cost of gaming operations and cost of equipment sales and a decrease in operating expenses as a result of Management's actions taken to decrease spending in response to the COVID-19 crisis. EGM adjusted EBITDA margin was 55.5% for the three months ended September 30, 2020 compared to 47.6% for the three months ended September 30, 2019, reflecting a greater mix of higher-margin lease revenues, the sale of previously leased, lower-yielding Oklahoma units to distributors with modest offsetting costs, and management's actions to reduce operating expenses and other costs in response to the COVID-19 crisis.

 

 

 

Electronic Gaming Machines

 

Nine Months Ended September 30, 2020 compared to the Nine Months Ended September 30, 2019

 

  

Nine Months Ended September 30,

  

$

  

%

 

(amounts in thousands except unit data)

 

2020

  

2019

  

Change

  

Change

 

EGM segment revenues:

                

Gaming operations

 $78,608  $148,515  $(69,907)  (47.1)%

Equipment sales

  30,785   67,417   (36,632)  (54.3)%

Total EGM revenues

 $109,393  $215,932  $(106,539)  (49.3)%
                 

EGM segment expenses and adjusted expenses:

                

Cost of gaming operations(1)

  21,726   28,425   (6,699)  (23.6)%

Less: Adjustments(2)

  4,362   1,793   2,569   143.3%

Adjusted cost of gaming operations

  17,364   26,632   (9,268)  (34.8)%
                 

Cost of equipment sales

  13,248   32,653   (19,405)  (59.4)%
                 

Selling, general and administrative

  28,695   40,018   (11,323)  (28.3)%

Less: Adjustments(3)

  4,772   6,103   (1,331)  (21.8)%

Adjusted cost of selling, general and administrative

  23,923   33,915   (9,992)  (29.5)%
                 

Research and development

  16,314   21,042   (4,728)  (22.5)%

Less: Adjustments(4)

  1,994   1,848   146   7.9%

Adjusted cost of research and development

  14,320   19,194   (4,874)  (25.4)%
                 

Accretion of placement fees

  5,643   4,550   1,093   24.0%
                 

EGM adjusted EBITDA

 $46,181  $108,088  $(61,907)  (57.3)%
                 

EGM unit information:

                

VLT

  512   517   (5)  (1.0)%

Class II

  11,887   12,355   (468)  (3.8)%

Class III

  4,426   5,852   (1,426)  (24.4)%

Domestic installed base, end of period

  16,825   18,724   (1,899)  (10.1)%

International installed base, end of period

  8,030   8,668   (638)  (7.4)%

Total installed base, end of period

  24,855   27,392   (2,537)  (9.3)%
                 
Installed base - Oklahoma  9,063   10,503   (1,440)  (13.7)%
Installed base - non-Oklahoma  7,762   8,221   (459)  (5.6)%
Domestic installed base, end of period  16,825   18,724   (1,899)  (10.1)%
                 

Domestic revenue per day

 $15.95  $25.88  $(9.93)  (38.4)%

International revenue per day

 $2.60  $8.30  $(5.70)  (68.7)%

Total revenue per day

 $11.73  $20.30  $(8.57)  (42.2)%
                 

Domestic EGM units sold

  960   3,427   (2,467)  (72.0)%

Total EGM units sold

  1,060   3,596   (2,536)  (70.5)%

Domestic average sales price

 $18,078  $18,463  $(385)  (2.1)%

 

(1) Exclusive of depreciation and amortization.

(2) Adjustments to cost of gaming operation include non-cash stock compensation expense, acquisitions and integration-related costs including restructuring and severance, non-cash charges on capitalized installation and delivery and other adjustments.

(3) Adjustments to selling, general and administrative expense include non-cash stock compensation expense, acquisitions and integration-related costs including restructuring and severance, initial public offering, legal and litigation-related costs including settlements payments, and other adjustments.

(4) Adjustments to research and development costs include non-cash stock compensation expense and acquisitions and integration-related costs including restructuring and severance.

 

 

Gaming Operations Revenue

 

Gaming operations revenue decreased $69.9 million primarily due to a decrease in RPD of 42.2% compared to the prior year primarily due to the temporary casino closures that began in March 2020 caused by COVID-19. Nearly all of the Company's customers were closed during April 2020 and a limited number began to reopen at reduced capacity in late-May through September 2020. As of September 30, 2020, nearly all of our customers' casino properties in the United States and Canada were open under limited operations. On September 30, 2020 in Mexico, approximately half of our customers' casinos were also open under capacity limitations.  Additional decreases in gaming operations revenue are due to a decrease in our domestic EGM installed base year over year due to sales of 1,367 previously leased, lower yielding units to distributors during the last twelve months (327 were sold in Q4 2019 and 1,040 in the current year period). During the third quarter, several of our customers reconfigured their slot floors in response to COVID and, as a result, removed nearly 350 EGMs from our domestic installed base. Our international EGM installed base also decreased year over year due primarily to the permanent closure of certain casinos in Mexico and the sale of previously leased EGMs during the last twelve months. 

 

Equipment Sales

 

The decrease in equipment sales revenue is due to the sale of 1,060 EGM units in the nine months ended September 30, 2020, compared to 3,596 EGM units in the prior year period, as well as due to a 2.1% decrease in the domestic average sales price compared to the prior year period. EGM equipment sales revenue also includes revenue from the sale of 1,040 previously leased, lower yielding units to a distributor in the current year period, which units are not included in our sold unit count or domestic average sales price.

 

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 decrease in EGM adjusted EBITDA is attributable to the decrease in revenue described above offset by the related decrease in cost of gaming operations and cost of equipment sales and a decrease in operating expenses as a result of Management's actions taken to decrease spending in response to the COVID-19 crisis. EGM adjusted EBITDA margin was 42.2% for the nine months ended September 30, 2020 compared to 50.1% for the nine months ended September 30, 2019.

 

 

 

Table Products

 

Three Months Ended September 30, 2020 compared to Three Months Ended September 30, 2019

 

  Three Months Ended September 30,  $  

%

 

(amounts in thousands, except unit data)

 

2020

  

2019

  

Change

  

Change

 

Table Products segment revenues:

                

Gaming operations

 $2,170  $2,451  $(281)  (11.5)%

Equipment sales

  92   410   (318)  (77.6)%

Total Table Products revenues

  2,262   2,861   (599)  (20.9)%
                 

Table Products segment expenses and adjusted expenses:

                
Cost of gaming operations(1)  288   241   47   19.5%
Less: Adjustments(2)  124   149   (25)  (16.8)%
Adjusted cost of gaming operations  164   92   72   78.3%
                 
Cost of equipment sales  21   200   (179)  (89.5)%
                 
Selling, general and administrative  404   708   (304)  (42.9)%
Less: Adjustments(3)  53   41   12   29.3%
Adjusted cost of selling, general and administrative  351   667   (316)  (47.4)%
                 
Research and development  474   525   (51)  (9.7)%
Less: Adjustments(4)  20   32   (12)  (37.5)%
Adjusted cost of research and development  454   493   (39)  (7.9)%
                 
Table Products adjusted EBITDA $1,272  $1,409  $(137)  (9.7)%
                 

Table Products unit information:

                
Table products installed base, end of period  4,012   3,601   411   11.4%
Average monthly lease price $169  $232  $(63)  (27.2)%

 

(1) Exclusive of depreciation and amortization.

(2) Adjustments to cost of gaming operation include non-cash charges on capitalized installation and delivery.

(3) Adjustments to selling, general and administrative expense include non-cash stock compensation expense and acquisitions and integration-related costs including restructuring and severance.

(4) Adjustments to research and development costs include non-cash stock compensation expense and acquisitions and integration-related costs including restructuring and severance.

 

Gaming Operations Revenue 

 

The decrease in Table Products gaming operations revenue is attributable to the decrease in average monthly lease price as we suspended billing our customers when they closed due to COVID-19 in the current year period. Nearly all of the Company's customers were closed during April 2020 and a limited number began to reopen at reduced capacity in late-May through September 2020. The success of our progressives such as Super 4, Blackjack Match, Royal 9 as well as the success of the Dex S, are the primary drivers of the increase in the Table Products installed base compared to the prior year period. 

 

Equipment Sales 

 

The decrease in equipment sales is primarily due to lower sales in the current period due to the closure due to COVID-19 in the current year period.

 

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 decrease in Table Products adjusted EBITDA is attributable to the decreases in gaming operations revenue and by decreased revenue from equipment sales described above, offset by the related decrease in operating expenses resulted from Management's actions taken to decrease spending in response to the COVID-19 crisis.

 

 

Table Products

 

Nine Months Ended September 30, 2020 compared to the Nine Months Ended September 30, 2019

 

  

Nine Months Ended September 30,

  

$

  

%

 

(amounts in thousands, except unit data)

 

2020

  

2019

  

Change

  

Change

 

Table Products segment revenues:

                

Gaming operations

 $4,991  $6,902  $(1,911)  (27.7)%

Equipment sales

  427   535   (108)  (20.2)%

Total Table Products revenues

  5,418   7,437   (2,019)  (27.1)%
                 

Table Products segment expenses and adjusted expenses:

                

Cost of gaming operations(1)

  776   1,191   (415)  (34.8)%
Less: Adjustments(2)  441   356   85   23.9%

Adjusted cost of gaming operations

  335   835   (500)  (59.9)%
                 

Cost of equipment sales

  103   253   (150)  (59.3)%
                 

Selling, general and administrative

  1,270   1,784   (514)  (28.8)%

Less: Adjustments(3)

  127   106   21   19.8%

Adjusted cost of selling, general and administrative

  1,143   1,678   (535)  (31.9)%
                 

Research and development

  1,849   2,070   (221)  (10.7)%

Less: Adjustments(4)

  56   93   (37)  (39.8)%

Adjusted cost of research and development

  1,793   1,977   (184)  (9.3)%
                 

Table Products adjusted EBITDA

 $2,044  $2,694  $(650)  (24.1)%
                 

Table Products unit information:

                

Table products installed base, end of period

  4,012   3,601   411   11.4%

Average monthly lease price

 $136  $226  $(90)  (39.8)%

 

(1) Exclusive of depreciation and amortization.

(2) Adjustments to cost of gaming operation include non-cash charges on capitalized installation and delivery.

(3) Adjustments to selling, general and administrative expense include non-cash stock compensation expense and acquisitions and integration-related costs including restructuring and severance.

(4) Adjustments to research and development costs include non-cash stock compensation expense and acquisitions and integration-related costs including restructuring and severance.

 

Gaming Operations Revenue 

 

The decrease in Table Products gaming operations revenue is attributable to the decrease in average monthly lease price as we suspended billing our customers when they closed due to COVID-19 in the current year period. Nearly all of the Company's customers were closed during April 2020 and a limited number began to reopen at reduced capacity in late-May through September 2020. The success of our progressives such as Super 4, Black Jack Match, Royal 9 as well as the success of the Dex S, are the primary drivers of the increase in the Table Products installed base compared to the prior year period.

 

Equipment Sales 

 

The decrease in equipment sales is primarily due to lower sales in the current period due to the closure due to COVID-19 in the current year period.

 

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 decrease in Table Products adjusted EBITDA is attributable to the decreases in gaming operations revenue and by decreased revenue from equipment sales described above, offset by the related decrease in cost of gaming operations, cost of equipment sales as well as decrease in operating expenses resulted from Management's actions taken to decrease spending in response to the COVID-19 crisis.

 

 

 

Interactive

 

Three Months Ended September 30, 2020 compared to Three Months Ended September 30, 2019

 

  Three Months Ended September 30,  $  

%

 
(amounts in thousands) 2020  2019  Change  Change 

Interactive segment revenue:

                

Social gaming revenue

 $829  $712  $117   16.4%
Real-money gaming revenue  1,112   505   607   120.2%

Total Interactive revenue

  1,941   1,217   724   59.5%
                 

Interactive segment expenses and adjusted expenses:

                
Cost of gaming operations(1)  418   339   79   23.3%
                 
Selling, general and administrative  360   2,428   (2,068)  (85.2)%
Less: Adjustments(2)  41   1,649   (1,608)  (97.5)%
Adjusted cost of selling, general and administrative  319   779   (460)  (59.1)%
                 
Research and development  466   582   (116)  (19.9)%
Less: Adjustments(3)  12   36   (24)  (66.7)%
Adjusted cost of research and development  454   546   (92)  (16.8)%
                 
Interactive adjusted EBITDA $750  $(447) $1,197   (267.8)%

 

(1) Exclusive of depreciation and amortization.

(2) Adjustments to selling, general and administrative expense include non-cash stock compensation expense and other adjustments.

(3) Adjustments to research and development costs include non-cash stock compensation expense and other adjustments. 

 

Gaming Operations Revenue 

 

The increase in gaming operations revenue is attributable to an increase of $0.6 million in RMG revenue in the current period primarily due to an increase in the number of customers and games year over year as well as the addition of our land-based content on the AxSys Games Marketplace platform. We have also entered the state of New Jersey and the state of Pennsylvania markets with our land-based content. Social gaming revenue also increased $0.1 million as a result of increased activity on our B2C social casino app, Lucky Play Casino.

 

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 increase in Interactive adjusted EBITDA is primarily attributable to an increase in revenues as described above and a decrease in operating costs including salary and benefit related expenses and professional fees.

 

 

Interactive

 

Nine Months Ended September 30, 2020 compared to the Nine Months Ended September 30, 2019

 

  

Nine Months Ended September 30,

  $  

%

 

(amounts in thousands)

 

2020

  

2019

  

Change

  

Change

 

Interactive segment revenue:

                

Social gaming revenue

 $2,746  $2,606  $140   5.4%
Real-money gaming revenue  2,828   953   1,875   196.7%

Total Interactive revenue

 $5,574  $3,559  $2,015   56.6%
                 

Interactive segment expenses and adjusted expenses:

                

Cost of gaming operations(1)

  1,254   1,105   149   13.5%
                 

Selling, general and administrative

  1,146   4,541   (3,395)  (74.8)%

Less: Adjustments(2)

  116   2,045   (1,929)  (94.3)%

Adjusted cost of selling, general and administrative

  1,030   2,496   (1,466)  (58.7)%
                 

Research and development

  1,179   2,063   (884)  (42.9)%

Less: Adjustments(3)

  34   120   (86)  (71.7)%

Adjusted cost of research and development

  1,145   1,943   (798)  (41.1)%
                 

Interactive adjusted EBITDA

 $2,145  $(1,985) $4,130   (208.1)%

 

(1) Exclusive of depreciation and amortization.

(2) Adjustments to selling, general and administrative expense include non-cash stock compensation expense and other adjustments.

(3) Adjustments to research and development costs include non-cash stock compensation expense and other adjustments. 

 

Gaming Operations Revenue 

 

The increase in gaming operations revenue is primarily attributable to a $1.9 million increase in RMG revenue in the current period primarily due to an increase in the number of customers and games year over year as well as the addition of our land-based content on the AxSys Games Marketplace. We have also entered the state of New Jersey and the state of Pennsylvania markets with our land-based content. 

 

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 increase in Interactive adjusted EBITDA is primarily attributable to an increase in revenues as described above and a decrease in operating costs including salary and benefit related expenses and professional fees.

 

 

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 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 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 (loss) income, income 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 loss attributable to PlayAGS, Inc. to total adjusted EBITDA (amounts in thousands):

 

Three Months Ended September 30, 2020 compared to the Three Months Ended September 30, 2019

 

  

Three Months Ended September 30,

  $  

%

 
  

2020

  

2019

  

Change

  

Change

 
Net (loss) income attributable to PlayAGS, Inc. $(11,078) $(5,536) $(5,542)  100.1%

Income tax (benefit) expense

  (1,672)  1,926   (3,598)  (186.8)%

Depreciation and amortization

  20,463   23,810   (3,347)  (14.1)%

Other expense

  (311)  (106)  (205)  193.4%

Interest income

  (671)  (42)  (629)  1497.6%

Interest expense

  11,330   9,320   2,010   21.6%
Loss on extinguishment and modification of debt  -   -   -   - 

Write-downs and other(1)

  1,932   807   1,125   139.4%
Other adjustments(2)  2,413   (3)  2,416   (80533.3)%

Other non-cash charges(3)

  2,415   2,426   (11)  (0.5)%
Legal and litigation expenses including settlement payments(4)  389   1,745   (1,356)  (77.7)%

Acquisitions and integration-related costs including restructuring and severance(5)

  79   481   (402)  (83.6)%

Non-cash stock-based compensation

  1,733   1,959   (226)  (11.5)%

Total Adjusted EBITDA

 $27,022  $36,787  $(9,765)  (26.5)%

 

(1) Write-downs and other include items related to loss on disposal, impairment of long-lived assets and fair value adjustments to contingent consideration.

(2) 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 as well as costs incurred related to initial public offering, net of costs capitalized to equity and the cost of related secondary offerings.

(3) 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.

(4) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. 

(5) Acquisitions and integration-related costs primarily relate to costs incurred after the purchase of businesses 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.

 

 

Nine Months Ended September 30, 2020 compared to the Nine Months Ended September 30, 2019

 

  

Nine Months Ended September 30,

  

$

  

%

 
  

2020

  

2019

  

Change

  

Change

 

Net (loss) income attributable to PlayAGS, Inc.

 $(68,136) $(13,175) $(54,961)  417.2%

Income tax (benefit) expense

  (5,016)  (3,884)  (1,132)  29.1%

Depreciation and amortization

  66,353   69,002   (2,649)  (3.8)%

Other expense

  3,993   5,108   (1,115)  (21.8)%

Interest income

  (843)  (112)  (731)  652.7%

Interest expense

  30,566   27,754   2,812   10.1%
Loss on extinguishment and modification of debt  3,102   -   3,102   100.0%

Write-downs and other(1)

  2,806   6,859   (4,053)  (59.1)%

Other adjustments(2)

  10,295   703   9,592   1364.4%

Other non-cash charges(3)

  1,824   6,541   (4,717)  (72.1)%

Legal and litigation expenses including settlement payments(4)

  389   1,748   (1,359)  (77.7)%

Acquisitions and integration-related costs including restructuring and severance(5)

  311   2,944   (2,633)  (89.4)%

Non-cash stock-based compensation

  4,726   5,309   (583)  (11.0)%

Total Adjusted EBITDA

 $50,370  $108,797  $(58,427)  (53.7)%

 

(1) Write-downs and other include items related to loss on disposal, impairment of long-lived assets and fair value adjustments to contingent consideration.

(2) 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 as well as costs incurred related to initial public offering, net of costs capitalized to equity and the cost of related secondary offerings.

(3) 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.

(4) Legal and litigation related costs consist of payments to law firms and settlements for matters that are outside the normal course of business. 

(5) Acquisitions and integration-related costs primarily relate to costs incurred after the purchase of businesses 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.

 

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

We expect that primary ongoing liquidity requirements for the next twelve months 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, additional financing, 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.

 

Due to the business disruption caused by the rapid nationwide spread of the novel coronavirus and the actions by state and tribal governments and businesses to contain the virus, almost all of the Company’s customers closed their operations during the month of March and April 2020 and their respective markets have been significantly and adversely impacted. Beginning in May 2020 and continuing through September, casinos began to reopen at limited capacity and nearly all of our customers' casino properties in the United States and Canada were partially open as of September 30, 2020 under limited operations. As of September 30, 2020 in Mexico,  approximately half of our customers' casinos were partially open under capacity limitations. As a result of the temporary closures of our casino customers, there has been a decrease in the amount of money spent by consumers on our revenue shared installed base and the amount of daily fees of our participation EGMs and a slow down to the expansion of existing casinos or development of new casinos. Specifically, gaming operations revenue and equipment sales have decreased compared to the prior year period as a result of the temporary closures of our casino customers. Similarly, our EGM and Table Products segment operating results have been disrupted because each segment’s activities including design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its products lines have been temporarily halted or significantly reduced. In addition, each segment’s revenue from leasing, licensing and selling products has been adversely impacted due to the temporary closures of our casino customers. As a result, the Company took several actions to adapt to the severity of the crisis. Among other things, the Company implemented short-term furloughs with retained benefits, company-wide salary reductions, and reduced its workforce by over 10%. Our non-employee directors have also agreed to reduce their fees by 50%. Some of the Company's customers have reopened at limited capacity, some have reopened and then been required to close again due to local conditions and regulations relating to the spread of the coronavirus, and there are also customers who still remain closed. Depending on the length of casino closures and if they are required to close again, the Company will consider additional reductions to payroll and related expenses through additional employee furloughs in order to conserve liquidity.

 

As of September 30, 2020, the Company had $113.2 million in cash and cash equivalents. Under the First Lien Credit Agreement (defined below in Note 6), the Company was required to comply with certain financial covenants at the end of each calendar quarter, including to maintain a maximum net first lien leverage ratio of 6.0 to 1.0. On May 1, 2020, the Company entered into an Incremental Assumption and Amendment Agreement No. 4 ("Amendment No.4") which amended its First Lien Credit Agreement to, among other things, (i) provide for a suspension of the testing of the financial covenant for the fiscal quarters ending June 30, 2020, September 30, 2020 and December 31, 2020 and (ii) during the period beginning on May 1, 2020, and ending on the date on which the Company delivers a compliance certificate with respect to the fiscal quarter ending December 31, 2021 (unless earlier terminated by the Company), make certain modifications to the negative covenants set forth in the First Lien Credit Agreement and, solely for purposes of determining compliance with the financial covenant during the first three quarters of 2021 once testing resumes, the calculation of EBITDA. As a result of Amendment No. 4, and based on the Company's projected operating results for the next twelve months, the Company expects that it will be in compliance with its covenants under the First Lien Credit Agreement for at least the next twelve months. Pursuant to the terms of Amendment No. 4, the Company incurred incremental term loans in an aggregate principal amount of $95.0 million, of which the Company received $83.3 million in net proceeds (after original issue discount and related fees, which is described in Note 6). The incremental term loans incurred pursuant to Amendment No. 4 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 of 13.0% for LIBOR loans and 12.0% for base rate loans. Any voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 during the first two years after May 1, 2020 will be subject to a customary “make-whole” premium. On or after May 1, 2022 and prior to November 1, 2022, a voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 will be accompanied by a 1.00% payment premium. Other than described above, the incremental term loans have the same terms applicable to the outstanding term loans under the First Lien Credit Agreement. As a result of the additional financing, along with cash and cash equivalents on hand as of September 30, 2020, Management believes that the Company has sufficient liquidity to fund its operating requirements and meet its obligations as they become due for at least the next twelve months.

 

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 proceeds of the term loans were used primarily to repay the Company's then existing term loans, other indebtedness, to pay for the fees and expenses incurred in connection with the foregoing and otherwise for general corporate purposes. The full amount of the revolving credit facility was drawn on March 19, 2020 as a precautionary measure in order to increase the Company’s cash position and facilitate financial flexibility in light of current uncertainty in the global markets resulting from the COVID-19 outbreak. The full amount of the revolving credit facility was repaid in October 2020 and remains available for the Company to draw upon in the future. The term loans will mature on February 15, 2024, and the revolving credit facility will mature on June 6, 2022. 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 and revolving credit facility 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. 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.

 

On December 6, 2017, the Borrower entered into incremental facilities for $65.0 million in term loans (the “December Incremental Term Loans”).  The net proceeds of the December Incremental Term Loans were used to finance the acquisition of electronic gaming machines and related assets operated by Rocket Gaming Systems (“Rocket”) and to pay fees and expenses in connection therewith and for general corporate purposes. 

 

An additional $1.0 million in loan costs were incurred related to the issuance of the December Incremental Term Loans. Given the composition of the lender group, the transaction was accounted for as a debt modification and, as such, $0.9 million in third-party costs were expensed and included in the loss on extinguishment and modification of debt. The remaining amount was capitalized and will be amortized over the term of the agreement.

 

On February 8, 2018, the Borrower completed the repricing of its existing $513.0 million term loans under its First Lien Credit Agreement (the “Term Loans”). The Term Loans were repriced from 550 basis points to 425 basis points over LIBOR. The LIBOR floor remained at 100 basis points.

 

On February 8, 2018, in connection with the repricing of the Term Loans, third-party costs of $1.2 million were expensed and included in the loss and modification of debt. Existing debt issuance costs of $0.4 million were written-off and also included in the loss on extinguishment and modification of debt.

 

 

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 the administrative agent. The Incremental Agreement No. 2 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 8, 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 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 $30.0 million (the “Incremental Term Loans” and together with the Repriced Term B Loans, the “Term B Loans”).

 

On October 5, 2018, in connection with the repricing of the Term Loans, third-party costs of $1.5 million were expensed and included in the loss on extinguishment and modification of debt.

 

On August 30, 2019, the Borrower entered into Amendment No. 3 (the "Repricing Amendment") to the credit agreement. The Repricing Amendment reduced the interest rate margin on the revolving credit facility to the same interest rate margin as the term loans issued under the credit agreement.

 

On May 1, 2020 the Borrower entered into an Incremental Assumption and Amendment Agreement No. 4 (“Amendment No. 4”) with certain of the Borrower’s subsidiaries, the lenders party thereto and the administrative agent, which amended the First Lien Credit Agreement to provide for covenant relief (as described in Note 1) as well as an aggregate principal amount of $95.0 million in incremental term loans, of which the net proceeds received by the Company were $83.3 million in net proceeds after original issue discount and related fees. The incremental term loans incurred pursuant to Amendment No. 4 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 of 13% for LIBOR loans and 12% for base rate loans. Any voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 during the first two years after May 1, 2020 will subject to a customary ”make-whole” premium. On or after May 1, 2022 and prior to November 1, 2022, a voluntary prepayment of the incremental term loans incurred pursuant to Amendment No. 4 will be accompanied by a 1.00% payment premium. Other than described above, the incremental term loans have the same terms applicable to the outstanding term loans under the First Lien Credit Agreement.

 

An additional $11.7 million in loan costs including original issue discount, lender fees, and third-party costs were incurred related to Amendment No. 4. Given the composition of the lender group, the transaction was accounted for as a debt modification for existing lenders and, as such, $3.1 million in third-party costs were expensed and included in the loss on extinguishment and modification of debt. The remaining $8.6 million was capitalized and will be amortized over the term of the agreement.

 

As of September 30, 2020, we were in compliance with the required covenants of our debt instruments.  See Note 1 “Liquidity and Financing and COVID-19” for a description of a change to our financial covenants for future periods.

 

Equipment Long Term Note Payable and Finance 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 finance leases.

 

The following table summarizes our historical cash flows (in thousands):

 

  

Nine Months Ended September 30,

 
  

2020

  

2019

 

Cash Flow Information:

        

Net cash provided by operating activities

 $19,719  $62,481 

Net cash used in investing activities

  (25,993)  (108,417)

Net cash provided by (used in) financing activities

  106,320   (13,118)

Effect of exchange rates on cash and cash equivalents

  (8)  3 

Net increase (decrease) in cash and cash equivalents

 $100,038  $(59,051)

 

Operating activities 

 

Net cash provided by operating activities for the nine months ended September 30, 2020, was $19.7 million compared to net cash provided by operating activities of $62.5 million in the prior year period, representing a decrease of $42.8 million. This decrease is primarily due to a decrease in net income offset by collection of accounts receivables in the current period.

 

Investing activities 

 

Net cash used in investing activities for the nine months ended September 30, 2020, was $26.0 million compared to $108.4 million used in investing activities in the prior year period, representing a decrease in cash used of $82.4 million. The decrease was primarily due to the acquisition of Integrity and In Bet Gaming II, net of cash acquired, of $54.9 million in the prior year period, a $26.6 million decrease in purchases of property and equipment compared to the prior year period, a $3.5 million decrease in purchases of intangibles assets, and a $2.0 million decrease in software development and other expenditures, offset by a $4.4 million net increase in customer note receivable compared to the prior year period.

 

Financing activities 

 

Net cash provided by financing activities for the nine months ended September 30, 2020, was $106.3 million compared to net cash used of $13.1 million for the nine months ended September 30, 2019, representing an increase in cash of $119.4 million primarily attributable to the borrowing on revolver of $30.0 million and proceeds from incremental term loans of $83.3 million which consist of $92.2 million of gross proceeds net of $5.7 million of deferred loan costs and $3.1 million of loss on modification that was immediately expensed. The increase was offset by a $1.9 million increase in payments of placement fees compared to the prior year period.

 

 

 

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, 2019. There were no material changes to our policies during the nine months ended September 30, 2020.

 

 

 

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

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

 

 

 

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, 2020, 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 $0.2 million given our LIBOR floor on related debt, while a hypothetical 1% increase in interest rates would increase interest expense approximately $6.5 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 and to a lesser extent in the United Kingdom 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, 2020. 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.

 

 

PART II. OTHER INFORMATION

 

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. See Item 1. “Financial Statements” Note 13 for a detailed discussion regarding current litigation matters. 

 

ITEM 1A. RISK FACTORS.

 

"Item 1A. Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2019 (the "Annual Report") 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. The Company is supplementing its risk factors described in the Annual Report and the following risk factor should be read in conjunction with the other risk factors disclosed in the Annual Report.

 

The global COVID-19 pandemic has had and is continuing to have a significant adverse impact and in the future could have a material adverse impact on our operations and financial performance, as well as on the operations and financial performance of many of the customers and suppliers in the gaming industry that we serve. We are unable to predict the extent to which the pandemic and related impacts will continue to adversely impact our business operations, financial performance, results of operations, financial position and the achievement of our business objectives.

 

The COVID-19 pandemic has negatively impacted the global economy, with particular impact to the gaming industry, disrupted global supply chains, lowered equity market valuations, created significant volatility and disruption in the financial markets, and increased unemployment levels. In addition, the pandemic has resulted in temporary closures of many businesses, including those of our casino customers, and resulted in the institution of physical distancing and sheltering in place requirements in many states and communities. As a result of the temporary closures of our casino customers, there has been a decrease in the amount of money spent by consumers on our revenue shared installed base and the amount of daily fees of our participation EGMs and a slowed expansion of existing casinos or development of new casinos. Furthermore, general macro-economic factors have resulted in a decline in levels of consumer disposable incomes and personal consumption spending. Consequently, demand for our products and services has been and may continue to be significantly impacted, which has adversely affected our revenue and profitability and could continue to do so in the future. Specifically, gaming operations revenue and equipment sales have decreased compared to the prior year period as a result of the temporary closures and re-openings at limited capacity of our casino customers. Similarly, our EGM and Table Products segment operating results have been disrupted because each segment’s activities including design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its products lines have been temporarily halted or significantly reduced.  In addition, each segment’s revenue from leasing, licensing and selling products has been adversely impacted due to the temporary closures and re-openings at limited capacity of our casino customers. Furthermore, the pandemic has impaired and could continue to impair our ability to maintain sufficient liquidity, particularly if casinos and other gaming businesses remain closed or, when they reopen, physical distancing and other COVID-19-protective measures prevent them from opening at full capacity, the impact on the global economy worsens and further impacts the disposable income available to our casino customers’ patrons, or customers continue to delay making payments to us under existing obligations. Furthermore, because of changing economic and market conditions affecting the gaming industry, our ability to achieve our business objectives have been impacted and may continue to be impacted in the future. Our business operations have been disrupted because our workforce has been unable to work effectively due to illness, quarantines, government actions, and other restrictions imposed in connection with the pandemic and our business operations may continue to be impacted in the future. As a result, the Company has taken several actions to adapt to the severity of the crisis. Among other things, the Company has implemented short-term furloughs with retained benefits, company-wide salary reductions, and reduced its workforce by over 10%. We have borrowed funds under existing credit facilities and incremental term loans, and may seek additional funding, to the extent available, under new federal programs such as the CARES Act. The extent to which the COVID-19 pandemic will further impact our business, results of operations, and financial condition, as well as our capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

 

The COVID-19 pandemic may also exacerbate the risks disclosed in our Annual Report, including, but not limited to: our ability to comply with the terms of our indebtedness, our ability to generate revenues, earn profits and maintain adequate liquidity, our ability to service existing and attract new customers, maintain our overall competitiveness in the market, the potential for significant fluctuations in demand for our services, overall trends in the gaming industry impacting our business, as well as potential volatility in our stock price.

 

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

 

None.

 

 

ITEM 6. EXHIBITS.

 

(a). Exhibits.

 

Exhibit Number

 

Exhibit Description

*10.1 First Amendment to PlayAGS. Inc. Omnibus Plan.
   

*31.1

 

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

*31.2

 

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

*32

 

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   

101.SCH

 

Inline XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

Inline XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.LAB

 

Inline XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

Inline XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

101.DEF

 

Inline XBRL Taxonomy Extension Definition Linkbase Document

   
104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

 


* Filed herewith. 

 

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.

 

 

 

 

PlayAGS, Inc.

 

 

 

 

 

Date:

November 5, 2020

 

By:

/s/ KIMO AKIONA

 

 

 

Name:

Kimo Akiona

 

 

 

Title:

Chief Financial Officer, Chief Accounting Officer and Treasurer

(Principal Financial and Accounting Officer)

 

 

49