GOLDEN ENTERTAINMENT, INC. - Quarter Report: 2015 September (Form 10-Q)

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		September 30,				December 28,
		2015				2014
ASSETS
Current assets
Cash and cash equivalents		$	43,156			$	35,416
Short-term investments			—				46,638
Accounts receivable, net of allowance for doubtful accounts of $0.6 million as of September 30, 2015			4,492				622
Income taxes receivable			2,299				—
Prepaid expenses			7,566				760
Other			2,716				425
Total current assets			60,229				83,861
Property and equipment			120,219				41,433
Accumulated depreciation			(10,985	)			(8,694	)
Property and equipment, net			109,234				32,739
Other assets
Goodwill			90,639				—
Intangible assets, net			81,814				2,279
Land held for sale			960				—
Land held for development			—				960
Income taxes receivable			—				2,155
Other			2,502				35
Total other assets			175,915				5,429
Total assets		$	345,378			$	122,029
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt, net of discount		$	7,273			$	1,368
Accounts payable			6,130				482
Accrued taxes, other than income taxes			645				439
Accrued payroll and related			3,614				1,573
Deposits			284				131
Other accrued expenses			3,454				1,479
Total current liabilities			21,400				5,472
Long-term debt, net of current portion and discount			139,100				8,941
Debt issuance costs, net			(2,619	)			—
Other long-term obligations			2,996				—
Total liabilities			160,877				14,413
Commitments and contingencies (Note 14)
Shareholders' equity
Common stock, $.01 par value; authorized 100,000 shares; 21,624 and 13,389 common shares issued and outstanding as of September 30, 2015 and December 28, 2014, respectively			350				268
Additional paid-in capital			281,282				205,615
Retained earnings (accumulated deficit)			(97,131	)			(98,245	)
Accumulated other comprehensive loss			—				(22	)
Total shareholders' equity			184,501				107,616
Total liabilities and shareholders' equity		$	345,378			$	122,029

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		Three Months Ended								Nine Months Ended
		September 30,				September 28,				September 30,				September 28,
		2015				2014				2015				2014
Revenues
Gaming		$	52,336			$	12,072			$	74,746			$	33,460
Food and beverage			9,230				1,835				12,320				4,660
Rooms			2,141				1,940				5,010				4,884
Other operating			1,873				873				3,061				1,913
Gross revenues			65,580				16,720				95,137				44,917
Less: Promotional allowances			(3,068	)			(790	)			(4,530	)			(2,570	)
Net revenues			62,512				15,930				90,607				42,347
Expenses
Gaming			35,661				6,841				48,284				19,208
Food and beverage			6,824				1,366				9,143				3,589
Rooms			270				226				643				509
Other operating			813				470				1,555				1,131
Selling, general and administrative			12,134				5,455				22,542				16,918
Merger expenses			9,325				—				10,591				—
Gain on sale of cost method investment			—				—				(750	)			(1,000	)
Charges related to arbitration award			—				2,530				—				2,530
Impairments and other losses			—				20,997				682				20,997
Preopening expenses			129				—				129				—
Gain on sale of land			—				(66	)			—				(66	)
Loss on disposal of property and equipment			8				37				6				61
Depreciation and amortization			5,100				896				6,859				2,613
Total expenses			70,264				38,752				99,684				66,490
Loss from operations			(7,752	)			(22,822	)			(9,077	)			(24,143	)
Other income (expense)
Interest expense, net			(980	)			(258	)			(1,423	)			(813	)
Loss on extinguishment of debt			(1,174	)			—				(1,174	)			—
Other, net			50				4				86				169
Total other expense			(2,104	)			(254	)			(2,511	)			(644	)
Loss before income taxes			(9,856	)			(23,076	)			(11,588	)			(24,787	)
Benefit for income taxes			12,874				—				12,702				—
Net income (loss)			3,018				(23,076	)			1,114				(24,787	)
Other comprehensive income (loss)			20				(3	)			22				(2	)
Comprehensive income (loss)		$	3,038			$	(23,079	)		$	1,136			$	(24,789	)
Weighted-average common shares outstanding
Basic			18,821				13,389				15,240				13,376
Dilutive impact of stock options			241				—				213				—
Diluted			19,062				13,389				15,453				13,376
Net income (loss) per share
Basic		$	0.16			$	(1.72	)		$	0.07			$	(1.85	)
Diluted		$	0.16			$	(1.72	)		$	0.07			$	(1.85	)

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		Nine Months Ended
		September 30,				September 28,
		2015				2014
Cash flows from operating activities
Net income (loss)		$	1,114			$	(24,787	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization			6,859				2,613
Amortization of debt issuance costs and accretion of debt discount			363				385
Accretion and amortization of discounts and premiums on short-term investments			240				214
Share-based compensation			410				210
Gain on sale of land			—				(66	)
Loss on disposal of property and equipment			6				61
Loss on extinguishment of debt			1,174				—
Impairments and other losses			357				20,997
Deferred income taxes			(12,728	)			—
Changes in operating assets and liabilities, net of assets acquired and liabilities assumed from acquisition:
Accounts receivable			1,194				—
Prepaids			1,272				—
Income taxes receivable			(144	)			—
Other current assets			231				(347	)
Deposits			150				—
Accrued taxes, other than income taxes			(180	)			(55	)
Accounts payable and accrued expenses			(1,076	)			265
Net cash used in operating activities			(758	)			(510	)
Cash flows from investing activities
Proceeds from business combination			25,539				—
Purchase of short-term investments			(25,137	)			(62,114	)
Sales and maturities of short-term investments			71,357				63,432
Purchase of property and equipment			(2,882	)			(4,464	)
Proceeds from sale of land			—				236
Proceeds from disposal of property and equipment			4,409				21
Changes in other assets			(1,399	)			25
Net cash provided by (used in) investing activities			71,887				(2,864	)
Cash flows from financing activities
Repayments of borrowings			(202,546	)			(1,302	)
Proceeds from borrowings			145,336				—
Proceeds from issuance of common stock			35				135
Payments for debt issuance costs			(2,723	)			—
Warrant repurchase			(3,435	)			—
Other			(56	)			—
Net cash used in financing activities			(63,389	)			(1,167	)
Cash and cash equivalents
Net increase (decrease) for the period			7,740				(4,541	)
Balance, beginning of period			35,416				37,897
Balance, end of period		$	43,156			$	33,356
Supplemental cash flow disclosures
Cash paid during the period for:
Interest		$	1,160			$	535
Income taxes			170				—
Non-cash investing and financing activities
Capital expenditures in accounts payable and accrued expenses		$	—			$	158
Common stock issued in connection with acquisition			75,304				—

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1.  Nature of Business and Basis of Presentation

 

Overview

 

Golden Entertainment, Inc. (formerly Lakes Entertainment, Inc.) and its wholly-owned subsidiaries (the “Company”) is a diversified group of gaming companies that focus on distributed gaming (including tavern gaming) and casino and resort operations.  On July 31, 2015, the Company acquired Sartini Gaming, Inc. (“Sartini Gaming”) through the merger of a wholly-owned subsidiary of the Company with and into Sartini Gaming, with Sartini Gaming surviving as a wholly-owned subsidiary of the Company (the “Merger”). The results of operations of Sartini Gaming and its subsidiaries have been included in the Company’s results subsequent to that date. In connection with the Merger, the Company’s name was changed to Golden Entertainment, Inc. The Company’s common stock continues to be traded on the NASDAQ Global Market, and the Company’s ticker symbol was changed from “LACO” to “GDEN” effective August 4, 2015. See Note 2, Merger with Sartini Gaming, Inc., for further discussion of the Merger.

  

The Company’s Distributed Gaming segment involves the installation and operation of gaming devices in certain strategic, high-traffic, non-casino locations (such as grocery stores, convenience stores, restaurants, bars and taverns) in Nevada, and the operation of traditional, branded taverns targeting local patrons, primarily in Clark County, Nevada. The Company’s Casinos segment consists of three casinos in Pahrump, Nevada and the Rocky Gap Casino Resort in Flintstone, Maryland (“Rocky Gap”).

 

Basis of Presentation

 

The unaudited consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial information. Accordingly, certain information normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) has been condensed and/or omitted. For further information, please refer to the audited consolidated financial statements of the Company for the year ended December 28, 2014 and the notes thereto included in the Company’s Annual Report on Form 10-K previously filed with the SEC. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s results for the periods presented. Results for interim periods should not be considered indicative of the results to be expected for the full year.

 

The Company’s consolidated financial statements include the assets, liabilities and results of operations of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

 

On October 28, 2015, the Company’s Board of Directors approved a change in the fiscal year of the Company from a 52- or 53-week fiscal year ending on the Sunday closest to December 31 of each year to a calendar fiscal year ending on December 31, effective as of the beginning of the third quarter of fiscal year 2015. As a result of this change, the Company’s quarters for fiscal year 2015 end on March 29, 2015, June 28, 2015, September 30, 2015 and December 31, 2015. Thereafter, the Company’s fiscal quarters will end on March 31, June 30, September 30 and December 31 of each year.

 

Investments in unconsolidated investees, which were 20% or less owned and where the Company did not have the ability to significantly influence the operating or financial decisions of the entity, were accounted for under the cost method. See Note 6, Cost Method Investments, for further discussion of the Company’s investment in Rock Ohio Ventures, LLC and investment in Dania Entertainment Holdings, LLC.

 

New Accounting Standards 

 

In July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”). Under this new guidance, entities that measure inventory using any method other than last-in, first-out or the retail inventory method will be required to measure inventory at the lower of cost and net realizable value. The amendments in this ASU, which should be applied prospectively, are effective for annual and interim periods beginning after December 15, 2016. Early adoption is permitted. ASU 2015-11 will be effective for the Company’s first quarter of 2017. The Company is evaluating the impact this amendment will have on its financial statements.

 

 

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). ASU 2015-03 requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by ASU 2015-03. The amendments in this ASU are effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted.  The Company adopted this standard during the third quarter of 2015. As a result, debt issuance costs are presented as a direct deduction from the carrying value of the Company’s indebtedness under the Credit Agreement as further discussed in Note 8, Debt.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue from the transfer of goods or services to customers in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. On July 9, 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year, which will be effective for the Company’s first quarter of 2018. The Company is evaluating the impact this standard will have on its financial statements.

 

2. Merger with Sartini Gaming, Inc.

 

Overview

 

On July 31, 2015, the Company acquired Sartini Gaming through the consummation of the Merger. At the effective time of the Merger, all issued and outstanding shares of capital stock of Sartini Gaming were canceled and converted into the right to receive shares of the Company’s common stock. At the closing of the Merger, the Company issued 7,772,736 shares of its common stock to The Blake L. Sartini and Delise F. Sartini Family Trust (the “Sartini Trust”), as sole shareholder of Sartini Gaming, of which 388,637 shares are held in escrow as security for the post-closing adjustment in accordance with the agreement and plan of merger (the “Merger Agreement”), and 777,274 shares are held in escrow as security for claims for indemnifiable losses in accordance with the Merger Agreement. In addition, at the closing of the Merger, the Company issued 457,172 shares of its common stock to holders of warrants issued by a subsidiary of Sartini Gaming that elected to receive shares of the Company’s common stock in exchange for their warrants. As a result, the estimated value of the purchase consideration, based on preliminary estimates, was $75.3 million. This amount is the product of the 8,229,908 shares of the Company’s common stock issued in connection with the Merger on July 31, 2015 and the $9.15 per share closing price of the Company's common stock on July 31, 2015. The total number of shares of the Company’s common stock issued in connection with the Merger is subject to adjustment pursuant to the post-closing adjustment provisions of the Merger Agreement; see “Post-Closing “True-Up” Adjustment” below.

 

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

 

The Merger Agreement specifies the procedure for determining the pre-Merger values of Sartini Gaming and the Company. In accordance with the Merger Agreement, prior to the closing of the Merger, the Company and Sartini Gaming each delivered to the other a statement of its estimate of its pre-Merger value, which preliminary estimates were used to determine the number of shares of the Company’s common stock to be issued at the closing of the Merger.

 

 

The total number of shares of the Company’s common stock issued in connection with the Merger on July 31, 2015 was based on these preliminary estimated pre-Merger values:

 

 

(1)

Calculated as the number of shares of the Company’s common stock outstanding immediately after the Merger (on a fully diluted basis, including shares issuable upon the exercise of outstanding in-the-money stock options).

(2)

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

 

Post-Closing “True-Up” Adjustment

 

The final pre-Merger values of the Company and Sartini Gaming were determined and approved during the fourth quarter of 2015, pursuant to the post-closing adjustment provisions of the Merger Agreement. As a result of this post-closing adjustment calculation, the number of shares issued in connection with the Merger will be trued up by issuing an additional 223,657 shares to the Sartini Trust during the fourth quarter of 2015, and the 388,637 shares of the Company's common stock held in escrow as security for the post-closing adjustment will be released to the Sartini Trust.   

 

The effect of the issuance of these additional shares on the purchase price consideration calculation will be an increase of $2.1 million to $77.4 million. This amount is the product of the 8,453,565 total shares of the Company’s common stock issued in connection with the Merger on July 31, 2015 and issuable pursuant to the post-closing “true-up” adjustment and the $9.15 per share closing price of the Company's common stock on July 31, 2015. The Company will account for the issuance of the additional 223,657 shares, and the adjustment of the purchase price consideration, during the fourth quarter of 2015 when the additional shares are issued.

 

The total number of shares of the Company’s common stock issued in connection with the Merger, after giving effect to the additional 223,657 shares of common stock issuable pursuant to the post-closing true-up adjustment based on the final pre-Merger values, is as follows:

 

 

  

	(1)	Calculated as the number of shares of the Company’s common stock outstanding immediately after the issuance of the 223,657 additional shares related to the post-closing true-up adjustment (on a fully diluted basis, including shares issuable upon the exercise of outstanding in-the-money stock options).
	(2)	Includes 457,172 shares of the Company’s common stock that were issued to certain former holders of warrants issued by a subsidiary of Sartini Gaming upon the closing of the Merger.

 

 Merger Accounting

 

The Merger has been accounted for under the purchase method of accounting in accordance with ASC Topic 805, Business Combinations. Under the purchase method, the total estimated purchase price, or consideration transferred, is measured at the Merger closing date. The purchase price of the acquisition was allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The excess of the purchase price over the fair values was recorded as goodwill. None of the goodwill recognized is expected to be deductible for income tax purposes. During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed with a corresponding offset to goodwill and will allocate goodwill to each of the business segments at the conclusion of the measurement period. As described above, the Merger consideration issued by the Company at the closing of the Merger was based on preliminary estimates of the pre-Merger values of the Company and Sartini Gaming, which were subject to post-closing adjustment under the Merger Agreement.

 

 

The allocation of the $75.3 million purchase price, as estimated as of the Merger closing date of July 31, 2015 (see “Post-Closing “True-Up” Adjustment” above), set forth below was based upon a preliminary valuation and the Company’s estimates and assumptions are subject to change within the purchase price allocation measurement period. In addition, actual results may differ from the financial information presented once the Company has finalized the valuations that support the provisional purchase price allocation. Such finalization could result in changes to the financial information. The primary areas of the purchase price allocation that are not yet finalized relate to property values, the valuation of intangible assets acquired and residual goodwill attributable to the distributed gaming and casino businesses acquired.  The preliminary allocation of the purchase price to the assets acquired and liabilities assumed is as follows (unaudited, in thousands):

 

 

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

 

 

The preliminary amounts assigned to intangible assets by category are summarized in the table below (unaudited, in thousands):

 

  

 

Trade names

 

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

 

Player relationships

 

Player relationships comprise relationships with players in Sartini Gaming’s tavern operations and with players in Sartini Gaming’s casinos.

 

Sartini Gaming’s tavern operations have developed relationships with players since beginning operations in the greater Las Vegas metropolitan area and are based on the perceived value that tavern customers obtain from being entertained at Sartini Gaming’s taverns. Tavern player relationships represent loyalty program members who earn points based on play, which points are redeemable for food and beverages, among other items. Furthermore, tavern player relationships are expected to lead to recurring revenue streams, as well as new revenue opportunities arising from the taverns’ reputations.

 

Sartini Gaming’s casinos in Pahrump, Nevada have developed relationships with players since beginning operations and are based on the perceived value that casino customers obtain from being entertained at Sartini Gaming’s casino properties. Casino player relationships represent loyalty program members who earn points based on play, which points are redeemable for food, beverages and hotel rooms, among other items. Furthermore, casino player relationships are expected to lead to recurring revenue streams, as well as new revenue opportunities arising from the Pahrump casinos’ reputations.

 

Customer relationships

 

Sartini Gaming’s relationships with distributed gaming customers have been developed over years of service and are based on the perceived value that Sartini Gaming’s customers obtain from doing business with Sartini Gaming. These relationships are expected to lead to recurring revenue streams, as well as new revenue opportunities arising from Sartini Gaming’s reputation. The economic life of the customer relationships is estimated to be 13 to 16 years, depending on the customer, and is based on the distribution of the present value of cash flows attributable to the asset.

 

Gaming licenses

 

Each of Sartini Gaming’s three Pahrump, Nevada casinos maintain gaming licenses that allow them to operate in their current capacity.

 

Other intangible assets

 

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

 

The estimated future amortization expense related to the finite-lived intangible assets acquired for the remainder of 2015, next five years and thereafter is as follows:

 

 

 

See Note 13, Financial Instruments and Fair Value Measurements, for further discussion regarding the valuation of the acquired tangible and intangible assets.

 

 

Credit Agreement

 

In connection with the Merger, the Company entered into a Credit Agreement with the lenders named therein and Capital One, National Association (as administrative agent) for a $120.0 million senior secured term loan and a $40.0 million revolving credit facility to refinance the outstanding senior secured indebtedness of Sartini Gaming and the Company’s financing facility with Centennial Bank (the “Rocky Gap Financing Facility”). See Note 8, Debt, for a discussion of the Credit Agreement and associated refinancing.

 

Unaudited Financial Information

 

The consolidated financial position of Sartini Gaming is included in the Company’s unaudited consolidated balance sheet as of September 30, 2015 and Sartini Gaming’s consolidated results of operations for the period from August 1, 2015 through September 30, 2015 are included in the Company’s unaudited consolidated statements of operations and cash flows for the three and nine months ended September 30, 2015. From August 1, 2015 through September 30, 2015, the Company recorded $45.5 million in net revenues and $2.3 million in net income from the operations of Sartini Gaming’s distributed gaming and casino businesses. Total assets related to Sartini Gaming were approximately $295.6 million as of September 30, 2015, which consisted primarily of property and equipment and intangible assets.

 

Unaudited Pro Forma Combined Financial Information

 

The following unaudited pro forma combined financial information for the three and nine months ended September 30, 2015 and September 28, 2014 are presented as if the Merger had occurred at the beginning of each period presented:

 

 

 

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

 

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

 

●

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

 

 

●

reflects the impact of issuance of 8,229,908 shares on July 31, 2015 in connection with the Merger based on the parties’ preliminary estimated pre-Merger values;

 

 

●

reflects $9.3 million and $10.6 million of Merger-related costs for the three and nine months ended September 30, 2015, respectively. No Merger-related cost adjustments were made for each of the three and nine months ended September 28, 2014;

 

 

●

reflects the elimination of the warrants issued by a subsidiary of Sartini Gaming, which were purchased for $3.4 million in cash and for 457,172 shares of the Company’s common stock (equivalent to $4.4 million based on the Merger per share price); and

 

 

●

reflects the elimination of $12.7 million of tax benefit during the three and nine months ended September 30, 2015, related to the assumption of a net deferred tax liability generated from the intangible assets acquired in the Merger.

 

3.  Short-Term Investments

 

Short-term investments consist of commercial paper, corporate bonds and certificates of deposit which are classified as available-for-sale securities and are carried at current fair market value, with the resulting unrealized gains and losses, if any, excluded from income and reported, net of tax, as a separate component of shareholders' equity until realized. If the carrying value of an investment is in excess of its fair market value, an impairment charge to adjust the carrying value to the fair market value is recorded if the impairment was considered other-than-temporary. There were no other-than-temporary impairments related to declines in fair market value of short-term investments during the three or nine months ended September 30, 2015 and September 28, 2014. No short-term investments were held as of September 30, 2015. Short-term investments consisted of the following as of December 28, 2014:

 

 

See Note 13, Financial Instruments and Fair Value Measurements, for further discussion of the fair value of these investments.

 

4. Property and Equipment, net

 

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

 

 

On March 26, 2015, the Company entered into an agreement to sell its corporate office building located in Minnetonka, Minnesota at a price of approximately $4.7 million, less approximate fees and closing costs of $0.3 million. The corporate office building was carried at $4.8 million, net of accumulated depreciation, on the Company’s consolidated balance sheet as of the date of the sale agreement, resulting in the recognition of an impairment charge of $0.4 million during the nine months ended September 30, 2015. The sale of the corporate office building closed on May 20, 2015.

 

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5. Goodwill and Intangible Assets, Net

 

Goodwill and intangible assets, net, the majority of which relate to the acquisition of Sartini Gaming during the third quarter of 2015 (see also, Note 2, Merger with Sartini Gaming, Inc.), consist of the following:

 

 

Amortization expense was $1.1 million and less than $0.1 million for the three months ended September 30, 2015 and September 28, 2014, respectively, and $1.2 million and $0.1 million for the nine months ended September 30, 2015 and September 28, 2014, respectively.

 

6.  Cost Method Investments        

 

Rock Ohio Ventures, LLC

 

As of December 28, 2014, the Company had a 10% ownership interest in Rock Ohio Ventures, LLC (“Rock Ohio Ventures”). This investment was accounted for using the cost method since the Company owned less than 20% of Rock Ohio Ventures and did not have the ability to significantly influence the operating and financial decisions of the entity. The Company invested a total of $21.0 million in Rock Ohio Ventures. This investment was determined to have experienced an other-than-temporary impairment and was reduced to its estimated fair value of zero during the third quarter of 2014. As a result, the Company recognized an impairment loss of $21.0 million during the third quarter of 2014. Effective January 25, 2015, the Company sold all of its interest in Rock Ohio Ventures to DG Ohio Ventures, LLC for approximately $0.8 million.  Because this investment had been written down to zero, the Company recognized a gain on sale of cost method investment of approximately $0.8 million during the first quarter of 2015.

 

The fair value of the Company’s cost method investment in Rock Ohio Ventures was estimated to be approximately $0.8 million as of December 28, 2014 based on the January 2015 selling price of this investment. See Note 13, Financial Instruments and Fair Value Measurements, for further discussion of the calculation of the fair value of the investment in Rock Ohio Ventures as of December 28, 2014.

 

 

Dania Entertainment Holdings, LLC

 

On May 22, 2013, Dania Entertainment Center, LLC (“DEC”) purchased the Dania Jai Alai property located in Dania Beach, Florida, from Boyd Gaming Corporation, for $65.5 million.

 

As part of a previous plan to purchase the property, during 2011 the Company loaned $4.0 million to DEC (the “Loan”) which was written down to zero during the third quarter of 2011 when the acquisition did not close. During 2013, the Loan was exchanged for a 20% ownership interest in Dania Entertainment Holdings, LLC (“DEH”).

 

The Company accounted for its investment in DEH as a cost method investment. At the time the Loan was exchanged for an equity investment in DEH, the Company determined its value remained at zero due to the negative cash flows of the existing operations of the Dania Jai Alai property as well as uncertainty surrounding completion of the project. Therefore, there was no value recorded for this investment at the time the Loan was exchanged for an equity investment in DEH. On April 21, 2014, the Company entered into a redemption agreement with DEH that resulted in DEH redeeming the Company’s 20% ownership in DEH in exchange for DEH granting to the Company a 5% ownership interest in DEC. Concurrently, the Company entered into an agreement with ONDISS Corp. (“ONDISS”) to sell its ownership interest in DEC for approximately $2.6 million. The Company received $1.0 million on April 21, 2014 in exchange for 40% of its ownership interest. On October 17, 2014, ONDISS paid the entire remaining amount due to the Company at a discounted amount of approximately $1.4 million. Upon receipt of such payment, the Company transferred its remaining ownership in DEC to ONDISS. As a result, the Company recognized a gain on sale of cost method investment of $2.4 million during the year ended December 28, 2014.

 

7. Land Held for Sale

 

The Company owns parcels of undeveloped land related to its previous involvement in a potential casino project with the Jamul Indian Village (the “Jamul Tribe”) near San Diego, California. During the third quarter of 2012, the Company entered into a ten-year option agreement with Penn National Gaming, Inc. (“Penn National”), which was subsequently amended on May 15, 2014. The amended agreement grants Penn National the right to purchase this land for $5.5 million and requires Penn National to purchase the land within ten days after the Jamul Tribe opens a casino on its reservation. Annual option payments of less than $0.1 million are required to be made by Penn National to the Company. During the third quarter of 2015, the Company determined that it would likely sell the land to Penn National, under the option agreement, within the next twelve months. As a result, the land is classified as held for sale as of September 30, 2015. As of September 30, 2015 and December 28, 2014, this land was carried at approximately $1.0 million on the accompanying consolidated balance sheets.

 

The Company performs an impairment analysis on the land it owns at least quarterly and determined that no impairment had occurred as of September 30, 2015 and December 28, 2014.

 

8. Debt

 

Credit Agreement

 

On July 31, 2015, the Company entered into a Credit Agreement with the lenders named therein and Capital One, National Association (as administrative agent). The facilities under the Credit Agreement consist of a $120.0 million senior secured term loan (“Term Loan”) and a $40.0 million senior secured revolving credit facility (“Revolving Credit Facility” and, together with the Term Loan facility, the “Facilities”). The Facilities mature on July 31, 2020. Borrowings under the Credit Agreement bear interest, at the Company’s option, at either (1) the highest of the federal funds rate plus 0.50%, the Eurodollar rate for a one-month interest period plus 1.00%, or the administrative agent’s prime rate as announced from time to time, or (2) the Eurodollar rate for the applicable interest period, plus, in each case, an applicable margin based on the Company’s leverage ratio. As of September 30, 2015, the weighted average effective interest rate on the Company’s outstanding borrowings under the Credit Agreement was approximately 3.00%.

 

The Term Loan must be repaid in four quarterly payments of $1.5 million each, commencing December 31, 2015, followed by eight quarterly payments of $2.25 million each, followed by four quarterly payments of $3.0 million each, followed by four quarterly payments of $4.5 million each, followed by a final installment of $66.0 million at maturity. The commitment fee for the Revolving Credit Facility is payable quarterly at a rate of between 0.25% and 0.30%, depending on the Company’s leverage ratio. As of September 30, 2015, the Company had $120.0 million in principal amount of outstanding Term Loan borrowings and $25.0 million in principal amount of outstanding borrowings under the Revolving Credit Facility, leaving borrowing availability under the Revolving Credit Facility of $15.0 million as of September 30, 2015.

 

 

The Credit Agreement is guaranteed by all of the Company’s present and future direct and indirect wholly-owned subsidiaries (other than certain insignificant or unrestricted subsidiaries), and is secured by substantially all present and future personal and real property of the Company and the subsidiary guarantors (subject to receipt of certain regulatory approvals). Net proceeds from the initial borrowings under the Facilities were used to repay and discharge all of the outstanding senior secured indebtedness of Sartini Gaming and its subsidiaries in connection with the Merger, as well as the outstanding indebtedness under the Rocky Gap Financing Facility.

 

Under the Credit Agreement, the Company and its subsidiaries are subject to certain limitations, including limitations on their ability to: incur additional debt, grant liens, sell assets, make certain investments, pay dividends and make certain other restricted payments. In addition, the Company will be required to pay down the Facilities under certain circumstances if the Company or any of its subsidiaries sells assets or property, issues debt or receives certain extraordinary receipts. The Credit Agreement contains financial covenants regarding a maximum leverage ratio and a minimum fixed charge coverage ratio. The Credit Agreement also prohibits the occurrence of a change of control, which includes the acquisition of beneficial ownership of 30% or more of the Company’s equity securities (other than by certain permitted holders, which include, among others, Blake L. Sartini, Lyle A. Berman and certain affiliated entities) and a change in a majority of the members of the Company’s Board of Directors that is not approved by the Board. If the Company defaults under the Credit Agreement due to a covenant breach or otherwise, the lenders may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell the Company’s assets to satisfy the obligations thereunder. The Company was in compliance with its financial covenants under the Credit Agreement as of September 30, 2015.

 

Rocky Gap Financing Facility

 

In December 2012, the Company closed on the $17.5 million Rocky Gap Financing Facility to finance a portion of Rocky Gap project costs. In connection with the entry into the Credit Agreement on July 31, 2015 and the borrowings thereunder, as more fully described above, on July 31, 2015 the Company repaid all principal amounts outstanding under the Rocky Gap Financing Facility, which amounted to approximately $10.7 million, together with accrued interest. In connection with such repayment, the Company terminated the Rocky Gap Financing Facility. As a result of the payoff of the Rocky Gap Financing Facility, the Company recognized a loss on extinguishment of debt of $1.2 million, related to the unamortized discount described below, during the three and nine months ended September 30, 2015. As of September 30, 2015 and December 28, 2014, the Company had zero and $11.7 million in principal amount of outstanding borrowings under the Rocky Gap Financing Facility, respectively.

 

Amounts drawn on the Rocky Gap Financing Facility were collateralized by the leasehold estate and the furniture, fixtures and equipment of Rocky Gap. In addition, the Company guaranteed repayment of the loan. Effective November 1, 2013, the Company amended the Rocky Gap Financing Facility with Centennial Bank to reduce the interest rate from 10.5% to 5.5%. Monthly payments of principal and interest began on December 1, 2013 and the term was for 84 months. As a result of the amendment of the Rocky Gap Financing Facility with Centennial Bank effective November 1, 2013, the Company recorded a $1.7 million gain on modification of debt during the fourth quarter of 2013. This amount included $2.0 million recorded as a discount to the principal amount of the Rocky Gap Financing Facility, which was being accreted to interest expense over the term of the Rocky Gap Financing Facility using the effective interest method, and $0.3 million of original debt issuance costs expensed at the time of the amendment. Accretion of the discount to interest expense was approximately $0.1 million for each of the three months ended September 30, 2015 and September 28, 2014, and $0.3 million for each of the nine months ended September 30, 2015 and September 28, 2014.

 

 

Summary of Outstanding Debt

 

Long-term debt, net of current portion and discount, is comprised of the following:

 

 

9. Promotional Allowances

 

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

 

 

The estimated cost of providing these promotional allowances, which are included in gaming costs and expenses, is as follows:

 

 

10.  Share-Based Compensation

 

On August 27, 2015, the Board of Directors of the Company approved the Golden Entertainment, Inc. 2015 Incentive Award Plan (the “2015 Plan”), subject to shareholder approval at the Company’s 2016 annual meeting of shareholders. The 2015 Plan authorizes the issuance of stock options, restricted stock, restricted stock units, dividend equivalents, stock payment awards, stock appreciation rights, performance bonus awards and other incentive awards. The 2015 Plan authorizes the grant of awards to employees, non-employee directors and consultants of the Company and its subsidiaries. Options generally have a ten-year term. Except as provided in any employment agreement between the Company and the employee, if an employee is terminated (voluntarily or involuntarily), any unvested options as of the date of termination will be forfeited. If the 2015 Plan is not approved by the Company’s shareholders at the 2016 annual meeting, any awards under the 2015 Plan will be automatically cancelled and become null and void.

 

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

 

 

The 2015 Plan provides that no stock option or stock appreciation right (even if vested) may be exercised prior to the earlier of August 1, 2018 or immediately prior to the consummation of a change in control of the Company that would result in an “ownership change” as defined in Section 382 of the Internal Revenue Code of 1986, as amended.

 

In June 2007, the Company’s shareholders approved the 2007 Lakes Stock Option and Compensation Plan (the “2007 Plan”), which is authorized to grant a total of 1.25 million shares of the Company’s common stock. There were 732,117 stock options outstanding under the 2007 Plan as of September 30, 2015, all of which were fully vested. As of September 30, 2015, a total of 282,635 shares of the Company’s common stock remain available for grants of awards under the 2007 Plan.

 

The Company also has a 1998 Stock Option and Compensation Plan. There were 12,500 stock options outstanding under this plan as of September 30, 2015. No additional options will be granted under this plan.

 

Share-based compensation expense related to stock options for the three and nine months ended September 30, 2015 and September 28, 2014 were as follows:

 

 

 

The Company uses the Black-Scholes option pricing model to estimate the fair value and compensation cost associated with employee incentive stock options, which requires the consideration of historical employee exercise behavior data and the use of a number of assumptions including volatility of the Company’s stock price, the weighted-average risk-free interest rate and the weighted-average expected life of the options. 1,610,000 options were granted under the 2015 Plan during the three and nine months ended September 30, 2015 with a weighted-average grant date fair value of $3.72 per share. 3,000 and 11,000 options were granted under the 2007 Plan during the three and nine months ended September 28, 2014, respectively. The weighted-average grant date fair value of the stock options granted during the three and nine months ended September 28, 2014 was $3.98 and $4.65, respectively.

 

The following table summarizes the Company’s stock option activity during the nine months ended September 30, 2015 and September 28, 2014: 

 

 

 

As of September 30, 2015, the options outstanding had a weighted-average remaining contractual life of 7.6 years, weighted-average exercise price of $8.10 and an aggregate intrinsic value of $2.3 million. The options exercisable have a weighted-average remaining contractual life of 2.5 years, weighted-average exercise price of $6.05 and an aggregate intrinsic value of $2.3 million as of September 30, 2015.

 

There were 2,500 and 5,000 options exercised during the three and nine months ended September 30, 2015, respectively. The total intrinsic value of options exercised during both the three and nine months ended September 30, 2015 was less than $0.1 million. There were 500 and 28,343 options exercised during the three and nine months ended September 28, 2014, respectively.  The total intrinsic value of options exercised during the three and nine months ended September 28, 2014 was less than $0.1 million and $0.1 million, respectively.  The Company’s unrecognized share-based compensation expense related to stock options was approximately $5.8 million as of September 30, 2015, which is expected to be recognized over a weighted-average period of 3.8 years.

 

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

 

11.  Net income (Loss) per Share of Common Stock

 

For all periods, basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average common shares outstanding. Diluted net income per share in profitable periods reflects the effect of all potentially dilutive common shares outstanding and is calculated by dividing net income by the weighted-average of all common and potentially dilutive shares outstanding. Weighted-average shares related to potentially dilutive stock options of 616,968 and 221,667 for the three and nine months ended September 30, 2015, respectively, and 753,771 and 751,046 for the three and nine months ended September 28, 2014, respectively, were not used to compute diluted income (loss) per share because the effects would have been anti-dilutive.

 

12.  Income Taxes

 

The Company’s effective tax rate was (109.6)% and 0.0% for the nine months ended September 30, 2015 and September 28, 2014, respectively. For the nine months ended September 30, 2015, the effective tax rate differed from the federal tax rate of 35% due to a $12.7 million release of existing valuation allowance on deferred tax assets resulting from deferred tax liabilities assumed in the Merger, and the limitation of the income tax benefit due to the uncertainty of its future realization. For the nine months ended September 28, 2014, the effective tax rate differed from the federal tax rate of 35% due primarily to the limitation of the income tax benefit due to the uncertainty of its future realization.

 

Income tax benefit was $12.7 million for the nine months ended September 30, 2015, which was attributed primarily to the income tax benefit recorded from the reversal of existing valuation allowance on deferred tax assets as a result of the net deferred tax liabilities assumed in connection with the Merger. There was no income tax benefit for the nine months ended September 28, 2014 because there was no remaining potential to carry back losses to prior years and future realization of the benefit was uncertain.

 

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

 

The Company recorded income taxes receivable of $2.3 million and $2.2 million as of September 30, 2015 and December 28, 2014, respectively, primarily related to the Company’s ability to carry back 2012 taxable losses to a prior year and receive a refund of taxes previously paid.

 

Deferred tax assets are evaluated by considering historical levels of income, estimates of future taxable income and the impact of tax planning strategies. Management has evaluated all available evidence and has determined that negative evidence continues to outweigh positive evidence for the realization of deferred tax assets, and as a result continues to provide a full valuation allowance against its deferred tax assets as of September 30, 2015.

 

 

The Company is currently under IRS audit for the 2009 through 2013 tax years and the IRS has proposed certain adjustments to the tax filings for those years. However, the Company believes it is more likely than not that it will prevail in challenging the proposed adjustments and maintains that the positions taken were proper and supported by applicable laws and regulations. The Company does not believe, when resolved, that this dispute will have a material effect on its consolidated financial statements. However, an unexpected adverse resolution could have a material effect on the consolidated financial statements in a particular quarter or fiscal year.

 

During the second quarter of 2015, the Company was notified by the State of California that their audit of the Company for the 2010 tax year had been completed and resulted in no adjustments.

 

13. Financial Instruments and Fair Value Measurements

 

Overview

 

Estimates of fair value for financial assets and liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value, and requires certain disclosures. The framework discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). Fair value is defined as 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 and is measured according to a hierarchy that includes:

 

●

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

●

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

●

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

 

The Company’s financial instruments consist of cash and cash equivalents, short-term investments, cost method investments, accounts payable and debt.

 

For the Company’s cash and cash equivalents, accounts payable and current portion of long-term debt, the carrying amounts approximate fair value because of the short duration of these financial instruments. As of September 30, 2015 and December 28, 2014, the fair value of the Company’s long-term debt approximates the carrying value based upon the Company’s expected borrowing rate for debt with similar remaining maturities and comparable risk.     

 

Balances Measured at Fair Value on a Recurring Basis

 

The following table shows certain of the Company’s financial instruments measured at fair value on a recurring basis using Level 2 inputs, as they are priced principally by independent pricing services using observable inputs:

 

 

Balances Measured at Fair Value on a Non-recurring Basis

 

Land, land improvements and building and improvements acquired in connection with the Company’s acquisition of Sartini Gaming during the third quarter of 2015 were measured using unobservable (Level 3) inputs at a fair value of $37.8 million. This fair value was calculated considering each of the three generally accepted valuation methodologies including the cost, the sales comparison and the income capitalization approaches. Significant inputs included consideration of highest and best use, replacement cost, recent transactions of comparable properties and the properties’ ability to generate future benefits (see also, Note 2, Merger with Sartini Gaming, Inc.).

 

 

Leasehold improvements, furniture, fixtures and equipment, and construction in process acquired in connection with the Company’s acquisition of Sartini Gaming during the third quarter of 2015 were measured using unobservable (Level 3) inputs at a fair value of $46.3 million. This fair value was calculated with primary reliance on the cost approach with secondary consideration being placed on the market approach. Significant inputs included consideration of highest and best use, replacement cost and market comparables (see also Note 2, Merger with Sartini Gaming, Inc.).

 

The identified intangible assets acquired in connection with the acquisition of Sartini Gaming during the third quarter of 2015 were measured using unobservable (Level 3) inputs at a fair value of $80.7 million (see also, Note 2, Merger with Sartini Gaming, Inc.). Included in these intangible assets were the following:

 

Trade names – Trade names were valued at $12.2 million determined based on the relief-from-royalty method under the income approach, which requires an estimate of a reasonable royalty rate, identification of relevant projected revenues and expenses, and the selection of an appropriate discount rate. Royalty rates of 1.0% to 2.5% were used in the valuations which gave consideration to third-party license agreements that involve trade names and trademarks that can be considered reasonably comparable, the age and profitability of the casinos, nature of the business and degree of competition, and a return on assets analysis to determine an implied royalty rate.

 

Player relationships – The $7.6 million fair value of the player relationships was determined based on the excess earnings method under the income approach. Based on management’s experience with historical attrition rates, an annual attrition range of 10.0% to 20.0% was utilized for tavern player relationships. After-tax cash flows were calculated by applying cost, expense, income tax and contributory asset charge assumptions to the estimated player relationships revenue stream. The after-tax cash flows were discounted to present value utilizing a 12.0% to 13.0% discount rate.

 

Customer relationships – The $59.2 million fair value of the customer relationships was determined based on the excess earnings method under the income approach. An annual attrition factor range of 5.0% to 12.5% was utilized depending on the specific customer. After-tax cash flows were calculated by applying cost, expense, income tax and contributory asset charge assumptions to the estimated customer relationships revenue stream. The after-tax cash flows were discounted to present value utilizing an 11.0% discount rate.

 

Gaming licenses – The $0.9 million fair value of the gaming licenses was determined based on the cost approach. In performing the cost approach, management used estimates for explicit and implicit costs to obtain the gaming licenses.

 

Other intangible assets – Other intangible assets includes software and non-compete agreements. The $0.5 million fair value of the software was determined based on the cost approach, which included estimates for fully burdened salaries and the number of hours needed to complete the software as it relates to the latest version of the software. The fair value of the non-compete agreements was determined based on the lost profits method under the income approach. A “With” scenario was based on projections, which assumed that the non-compete agreements were in place. In contrast, a “Without” scenario assumed the non-compete agreements did not exist and competition began immediately after consummation of the transaction. The difference in after-tax cash flows between the “With” and “Without” scenarios was calculated and then discounted to present value utilizing a 9.8% discount rate, which was based on the Company’s overall internal rate of return. A probability factor of 10.0% was applied to derive a fair value of $0.3 million for the non-compete agreements.

 

Balances Disclosed at Fair Value

 

The fair value of the Company’s cost method investment in Rock Ohio Ventures was estimated to be approximately $0.8 million as of December 28, 2014 based on the negotiated selling price of this investment. Effective January 25, 2015, the Company sold its investment in Rock Ohio Ventures for approximately $0.8 million (see Note 6, Cost Method Investments).

 

14. Commitments and Contingencies

 

Rocky Gap Lease Agreement

 

In connection with the closing of the acquisition of Rocky Gap, the Company entered into a 40-year operating ground lease (the “Lease Agreement”) with the Maryland Department of Natural Resources for approximately 268 acres in the Rocky Gap State Park on which Rocky Gap is situated. The Lease Agreement contains an option to renew for 20 years after the initial 40-year term.

 

 

From August 3, 2012 and until the casino opened for public play on May 22, 2013, rent in the form of surcharges was due and payable with a minimum annual payment of $150,000. From May 22, 2013 through the remaining term of the Lease Agreement, rent payments are due and payable annually in the amount of $275,000 plus 0.9% of any gross operator share of gaming revenue (as defined in the Lease Agreement) in excess of $275,000, and $150,000 plus any surcharge revenue in excess of $150,000. Surcharge revenue consists of amounts billed to and collected from guests equal to $3.00 per room per night and $1.00 per round of golf.

 

Other Operating Leases

 

The Company leases buildings, land and parking lot space, and equipment and vehicles under noncancelable operating leases. The original terms of the leases range from 1 to 15 years with various renewal options from 1 to 15 years. Operating lease rental expense, which is calculated on a straight-line basis, was approximately $2.3 million and $2.5 million for the three and nine months ended September 30, 2015, respectively. The Company has operating leases with related parties for certain of its tavern locations and its office headquarters building. See Note 16, Related Party Transactions, for more detail.

 

Rent expense related to Rocky Gap, net of surcharge revenue, and rent expense associated with all other operating leases for the three and nine months ended September 30, 2015 and September 28, 2014 was as follows:

 

  

Future minimum lease payments as of September 30, 2015 are as follows:

 

 

Employment Agreements

 

The Company previously entered into employment agreements with certain former executives. The agreements provided for certain benefits to the executives, as well as severance if the executives were terminated without cause or due to a “constructive termination” as defined in the agreements. The severance amounts depended upon the term of the agreement and were up to two years of base salary and two years of bonus calculated as the average bonus earned in the previous two years. If such termination occurred within three years of a change of control as defined in the agreements by the Company without cause or due to a constructive termination, the executive was entitled to receive a lump sum payment equal to two times the annual base salary and bonus/incentive compensation along with insurance costs, 401(k) matching contributions and certain other benefits. In the event the executive’s employment terminated for any reason, including death, disability, expiration of an initial term, non-renewal by the Company with or without cause, by the executive with notice, or due to constructive termination, all unvested stock options would vest at the date of termination and remain exercisable for three years. As a result of the Merger, a total of approximately $2.2 million was paid to Lyle A. Berman, the former Chairman of the Board and Chief Executive Officer of the Company, and Timothy J. Cope, the former President and Chief Financial Officer of the Company, during the third quarter of 2015 under these employment agreements. See Note 17, Subsequent Events, for discussion of the Company’s employment agreements entered into with certain current executives of the Company.

 

Retention Bonus and Severance Agreements

 

On March 30, 2015, the Company provided Retention Bonus and Severance Agreements (“Severance Agreements”) to 14 of its employees. These Severance Agreements were contingent upon the closing of the Merger. Pursuant to these Severance Agreements and upon the closing of the Merger, the Company recognized a charge of $2.8 million, representing cash payments and non-cash expenses related to accelerated stock option vesting, during the third quarter of 2015.

 

  

Merger Costs

 

The Company incurred a total of approximately $10.9 million in transaction-related costs associated with the Merger, which consist primarily of severance, financial advisor, legal, accounting and consulting costs. The Company incurred approximately $9.3 million and $10.6 million of transaction-related costs associated with the Merger during the three and nine months ended September 30, 2015, respectively.

 

Shareholder Class Action Lawsuits

 

On February 6, 2015, the Company, certain current and former members of the Company’s Board of Directors, LG Acquisition Corporation, Sartini Gaming and the Sartini Trust were named as defendants in three complaints filed in the District Court of the State of Minnesota, Fourth Judicial District in Hennepin County. The cases are captioned James Orr, individually and on behalf of all others similarly situated, as plaintiff, vs. Lakes Entertainment, Inc., LG Acquisition Corporation, Sartini Gaming, Inc., Lyle A. Berman, Timothy J. Cope, Larry C. Barenbaum, Neil I. Sell, Ray M. Moberg, and the Blake L. Sartini and Delise F. Sartini Family Trust, as defendants; Anthony Dacquisito, on behalf of himself and all others similarly situated, as plaintiff vs. Larry Barenbaum, Lyle Berman, Neil Sell, Ray Moberg, Timothy Cope, LG Acquisition Corporation, Sartini Gaming, Inc., and the Blake L. Sartini and Delise F. Sartini Family Trust, as defendants; and David Lehr and Pamela Lehr, as plaintiffs, individually and on behalf of all others similarly situated vs. Larry Barenbaum, Lyle Berman, Neil Sell, Ray Moberg, Timothy Cope, LG Acquisition Corporation, Sartini Gaming, Inc., and the Blake L. Sartini and Delise F. Sartini Family Trust, as defendants. These are purported shareholder class action lawsuits brought by certain of the Company’s shareholders on behalf of themselves and others similarly situated, alleging that in entering into the Merger, the defendants had breached their fiduciary duties of good faith, loyalty and due care, and/or have aided and abetted such breaches. The plaintiffs seek, among other things, attorney’s fees. On April 20, 2015, the plaintiffs filed an Amended Consolidated Class Action Complaint consolidating all pending actions arising out of the Merger. In response to the lawsuits, the Board of Directors appointed a special litigation committee (the “SLC”) pursuant to Minnesota law to investigate the claims alleged by the plaintiffs. On June 8, 2015, the judge in the matter denied the plaintiffs’ request for expedited proceedings and stayed the lawsuit until the conclusion of the SLC investigation and the issuance of its determinations. The SLC issued its report on October 13, 2015, in which it determined, among other matters, that the members of the Company’s Board of Directors properly discharged their fiduciary duties under Minnesota law and that the shareholder claims were without merit. The SLC report has been submitted to the District Court with a motion requesting that the Court dismiss the litigation. An unfavorable outcome in this lawsuit could result in substantial costs to the Company. It is also possible that other lawsuits may yet be filed and the Company cannot estimate any possible loss from this or future litigation at this time.

 

Argovitz Demand for Arbitration

 

On March 13, 2015, Jerry Argovitz (“Argovitz”) filed a Demand for Arbitration with the American Arbitration Association (“AAA”), alleging that the Company and/or its subsidiary Lakes Jamul, Inc. breached the terms of an agreement under which Argovitz retained certain rights to share in potential revenue from a gaming facility development project the Company (through its subsidiaries) pursued with the Jamul Indian Village (“JIV”).  Argovitz alleges that the Company breached such agreement by failing to protect his alleged contractual rights when the Company restructured its contractual relationship with JIV over the course of its involvement in the project and/or by ultimately exercising its contractual right in March 2012 to terminate its involvement in the JIV project, which had not resulted in the successful opening of a gaming facility.  Argovitz is seeking a declaration that, if the Jamul Casino opens, then the Company has an obligation to pay him $1.0 million per year for up to seven years of operation of the Jamul Casino.

 

The Company denies Argovitz’s allegations and is vigorously defending the case.  On September 2, 2015, the three-member AAA arbitration panel denied the parties’ cross-motions for summary judgment.  A two-day arbitration hearing is scheduled for January 5 and 6, 2016.

 

Miscellaneous Legal Matters

 

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

 

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15.  Segment Information

 

The Company’s segments reported below are the segments of the Company for which separate financial information is available and for which operating results are evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

 

The Company’s Distributed Gaming segment involves the installation and operation of gaming devices in certain strategic, high-traffic, non-casino locations (such as grocery stores, convenience stores, restaurants, bars and taverns) in Nevada, and the operation of traditional, branded taverns targeting local patrons, primarily in Clark County, Nevada. The Distributed Gaming segment includes the results of operations and assets related to the Company’s operation of both the distributed gaming business and branded taverns.

  

The Company’s Casinos segment includes results of operations and assets related to its three casinos in Pahrump, Nevada, as well as Rocky Gap in Flintstone, Maryland.

 

The Corporate and Other segment includes the Company’s cash and cash equivalents, short-term investments, corporate overhead and formerly included the investment in Rock Ohio Ventures. Costs in the Corporate and Other segment have not been allocated to the other segments because these costs are not easily allocable and to do so would not be practical. Amounts in the Eliminations column represent the intercompany management fee for Rocky Gap.