GOLDEN ENTERTAINMENT, INC. - Quarter Report: 2016 March (Form 10-Q)

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		March 31, 2016				December 31, 2015
ASSETS
Current assets
Cash and cash equivalents		$	66,454			$	69,177
Accounts receivable, net of allowance for doubtful accounts of $0.5 million and $0.4 million, respectively			4,983				3,033
Income taxes receivable			2,078				2,078
Prepaid expenses			5,547				6,803
Inventories			2,490				2,439
Other			1,053				1,074
Total current assets			82,605				84,604
Property and equipment, net			121,372				114,309
Other assets
Goodwill			98,222				96,288
Customer relationships, net			66,094				57,456
Other intangible assets, net			27,547				23,368
Other			4,779				2,759
Total other assets			196,642				179,871
Total assets		$	400,619			$	378,784
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt, net		$	11,610			$	8,552
Accounts payable			8,572				8,237
Accrued taxes, other than income taxes			845				831
Accrued payroll and related			4,731				3,494
Deposits			381				128
Other accrued expenses			4,349				3,476
Total current liabilities			30,488				24,718
Long-term debt, net			147,170				137,546
Deferred taxes			4,530				4,471
Other long-term obligations			3,912				1,564
Total liabilities			186,100				168,299
Commitments and contingencies (Note 11)
Shareholders' equity
Common stock, $.01 par value; authorized 100,000 shares; 22,071 and 21,868 common shares issued and outstanding as of March 31, 2016 and December 31, 2015, respectively			355				353
Additional paid-in capital			285,650				283,857
Accumulated deficit			(71,486	)			(73,725	)
Total shareholders' equity			214,519				210,485
Total liabilities and shareholders' equity		$	400,619			$	378,784

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		Three Months Ended
		March 31, 2016				March 29, 2015
Revenues
Gaming		$	78,472			$	10,600
Food and beverage			13,341				1,348
Rooms			1,555				1,207
Other operating			2,212				375
Gross revenues			95,580				13,530
Less: Promotional allowances			(4,546	)			(764	)
Net revenues			91,034				12,766
Expenses
Gaming			55,491				6,065
Food and beverage			8,127				1,065
Rooms			260				158
Other operating			779				226
Selling, general and administrative			16,234				5,302
Merger expenses			41				833
Gain on sale of cost method investment			—				(750	)
Impairments and other losses			—				331
Preopening expenses			573				—
Gain on disposal of property and equipment			—				(2	)
Depreciation and amortization			5,792				879
Total expenses			87,297				14,107
Income (loss) from operations			3,737				(1,341	)
Non-operating income (expense)
Interest expense, net			(1,457	)			(229	)
Other, net			18				—
Total non-operating expense, net			(1,439	)			(229	)
Income (loss) before income tax provision			2,298				(1,570	)
Income tax provision			(59	)			(155	)
Net income (loss)			2,239				(1,725	)
Other comprehensive loss			—				(1	)
Comprehensive income (loss)		$	2,239			$	(1,726	)
Weighted-average common shares outstanding
Basic			21,960				13,391
Dilutive impact of stock options			296				—
Diluted			22,256				13,391
Net income (loss) per share
Basic		$	0.10			$	(0.13	)
Diluted		$	0.10			$	(0.13	)

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		Three Months Ended
		March 31, 2016				March 29, 2015
Cash flows from operating activities
Net income (loss)		$	2,239			$	(1,725	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization			5,792				879
Amortization of debt issuance costs and accretion of debt discount			153				113
Accretion and amortization of discounts and premiums on short-term investments			—				105
Share-based compensation			405				59
Gain on sale of cost method investment			—				(750	)
Impairments and other losses			—				331
Deferred income taxes			59				—
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable			(1,437	)			(85	)
Prepaids			642				(200	)
Income taxes receivable			—				155
Other current assets			(31	)			(161	)
Accrued taxes, other than income taxes			13				168
Accounts payable and other accrued expenses			2,993				132
Other			(41	)			(2	)
Net cash provided by (used in) operating activities			10,787				(981	)
Cash flows from investing activities
Purchase of short-term investments			—				(24,141	)
Proceeds from maturities of short-term investments			—				24,480
Purchase of property and equipment			(8,506	)			(1,130	)
Issuance of notes receivable			(107	)			—
Acquisition of businesses, net of cash acquired			(15,930	)			—
Proceeds from sale of cost method investment			—				750
Other			(2,059	)			(1	)
Net cash used in investing activities			(26,602	)			(42	)
Cash flows from financing activities
Net repayments of Revolving Credit Facility			(25,000	)			—
Repayment of Term Loan			(1,500	)			(442	)
Proceeds from Term Loan			40,000				—
Repayments of notes payable			(882	)			—
Proceeds from issuance of common stock			890				16
Payments for debt issuance costs			(416	)			—
Net cash provided by (used in) financing activities			13,092				(426	)
Cash and cash equivalents
Net decrease for the period			(2,723	)			(1,449	)
Balance, beginning of period			69,177				35,416
Balance, end of period		$	66,454			$	33,967
Supplemental cash flow disclosures
Cash paid during the period for:
Interest		$	1,305			$	159
Non-cash investing and financing activities
Notes payable issued for property and equipment		$	345			$	—
Common stock issued in connection with acquisition			500				—

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Note 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. See Note 2, Merger and Acquisitions, for information regarding the Merger.

 

The Company conducts its business through two reportable operating segments: Distributed Gaming and Casinos. The Company’s Distributed Gaming segment involves the installation, maintenance and operation of gaming devices in certain strategic, high-traffic, non-casino locations (such as grocery stores, convenience stores, restaurants, bars, taverns, saloons and liquor stores) in Nevada and Montana, and the operation of traditional, branded taverns targeting local patrons, primarily in the greater Las Vegas, Nevada metropolitan area. The Company’s Casinos segment consists of the Rocky Gap Casino Resort in Flintstone, Maryland (“Rocky Gap”) and three casinos in Pahrump, Nevada: Pahrump Nugget Hotel Casino (“Pahrump Nugget”), Gold Town Casino and Lakeside Casino & RV Park.

 

On January 29, 2016, the Company completed the acquisition of approximately 1,000 gaming devices from a distributed gaming operator in Montana, as well as certain other non-gaming assets and the right to operate within certain locations (the “Initial Montana Acquisition”); see Note 2, Merger and Acquisitions, for information regarding the Initial Montana Acquisition. Additionally, on April 22, 2016, the Company completed the acquisition of approximately 1,800 gaming devices from a second distributed gaming operator in Montana, as well as over 500 amusement devices and other non-gaming assets and the right to operate within certain locations (the “Second Montana Acquisition”); see Note 14, Subsequent Events, for information regarding the Second Montana Acquisition.

 

On October 28, 2015, the Company’s Board of Directors approved a change in the Company’s fiscal year from a 52- or 53-week fiscal year ending on the Sunday closest to December 31 of each year to a calendar year ending on December 31, effective as of the beginning of the third quarter of 2015. As a result of this change, the Company’s fiscal quarters for 2015 ended on March 29, 2015, June 28, 2015, September 30, 2015 and December 31, 2015. Beginning January 1, 2016, the Company’s fiscal quarters end on March 31, June 30, September 30 and December 31.

 

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 31, 2015 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 accompanying unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. In addition to recasting prior period segment information to reflect the new segment structure, certain other minor reclassifications have been made to the 2015 amounts to conform to the current presentation.

 

 

New Accounting Standards 

While management continues to assess the possible impact on the Company's consolidated financial statements of the future adoption of new accounting standards that are not yet effective, management currently believes that the following new standards may have material effects:

 

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In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-02, Leases (“ASU 2016-02”), which replaces the existing guidance. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning the first quarter of 2019. ASU 2016-02 requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability.

 

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In May 2014, the FASB issued a comprehensive new revenue recognition model (ASU No. 2014-09, Revenue Contracts with Customers), and has amended it twice, in March 2016 (ASU No. 2016-08, Principal versus Agent Considerations) and in April 2016, (ASU No. 2016-10, Identifying Performance Obligations and Licensing). These standards will be effective for the first quarter of 2018.

 

No other recently issued accounting standards that are not yet effective have been identified that management believes are likely to have a material impact on the Company's financial statements.

 

Note 2 – Merger and Acquisitions

 

Initial Montana Acquisition

On January 29, 2016, the Company completed the Initial Montana Acquisition, which involved the acquisition of approximately 1,000 gaming devices, as well as certain other non-gaming assets and the right to operate within certain locations, from C. Lohman Games, Inc., Rocky Mountain Gaming, Inc. and Brandy’s Shoreliner Restaurant, Inc., for total consideration of $20.1 million, including the issuance of $0.5 million of the Company’s common stock (comprising 50,252 shares at fair value of $9.95 per share). In connection with the Initial Montana Acquisition, the Company is required to pay the sellers contingent consideration of up to a total of $2.0 million in cash paid in four quarterly payments beginning in September 2017, subject to certain potential adjustments. See Note 10, Financial Instruments and Fair Value Measurements, for further discussion regarding the estimated fair value of the contingent consideration.

 

 

The preliminary allocation of the $20.1 million purchase price to the assets acquired as of January 29, 2016 includes $1.7 million of cash, $2.4 million of property and equipment, $14.2 million of intangible assets and $1.9 million of goodwill. The preliminary amounts assigned to intangible assets includes customer relationships of $9.8 million with an economic life of 15 years, non-compete agreements of $3.9 million with an economic life of five years and trade names of $0.5 million with an economic life of four years. The goodwill recognized in the Initial Montana Acquisition is primarily attributable to potential expansion and future development of, and anticipated synergies from, the acquired businesses and is expected to be deductible for income tax purposes. The Company's estimation of the fair value of the assets acquired in the Initial Montana Acquisition as of the date of acquisition is determined based on certain valuations and analyses that have yet to be finalized, and accordingly, the assets acquired are subject to adjustment once such analyses are completed. The Company may record adjustments to the carrying value of assets acquired with a corresponding offset to goodwill during the measurement period, which can be up to one year from the date of the consummation of the acquisition.

 

The Company reports the results of operations from the Initial Montana Acquisition beginning January 30, 2016 within its Distributed Gaming segment. For the three months ended March 31, 2016, transaction-related costs for the Initial Montana Acquisition totaled approximately $0.2 million and were included in preopening expenses. The Company may incur additional transaction-related costs related to the Initial Montana Acquisition in future periods.

 

Merger with Sartini Gaming, Inc.

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

 

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

 

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

 

 

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

 

  

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

 

Merger Accounting

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

 

Measurement Period Adjustments

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

 

In addition to the issuance of the additional shares pursuant to the post-closing adjustment calculation mentioned above, during the measurement period so far, the Company has:

 

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

 

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

 

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

 

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

 

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

 

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

 

 

Allocation

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

 

 

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

 

 

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

 

 

  

Trade names

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

 

Player relationships

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

 

Customer relationships

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

 

Gaming licenses

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

 

Other intangible assets

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

 

Preliminary estimates of future amortization expense related to the finite-lived intangible assets acquired in the Merger are as follows:

 

 

See Note 10, Financial Instruments and Fair Value Measurements, for further discussion regarding the valuation of the tangible and intangible assets acquired through the Merger.

 

Credit Agreement

In connection with the Merger, the Company entered into a Credit Agreement with Capital One, National Association (as administrative agent) and the lenders named therein (the “Credit Agreement”) to refinance the outstanding senior secured indebtedness of Sartini Gaming and the Company’s financing facility with Centennial Bank. See Note 5, Debt, for a discussion of the Credit Agreement and associated refinancing.

 

Selected Financial Information Related to the Acquiree

The consolidated financial position of Sartini Gaming is included in the Company’s consolidated balance sheets as of March 31, 2016 and December 31, 2015 and Sartini Gaming’s consolidated results of operations for the three months ended March 31, 2016 are included in the Company’s consolidated statements of operations and cash flows for the three months ended March 31, 2016. For the three months ended March 31, 2016, the Company recorded $73.3 million in net revenues and $7.1 million in net income from the operations of Sartini Gaming’s distributed gaming and casino businesses. Total assets related to Sartini Gaming’s distributed gaming and casino businesses were approximately $224.1 million and $78.8 million, respectively, as of March 31, 2016, which consisted primarily of property and equipment and intangible assets, including goodwill, recorded on a preliminary basis as the measurement period for the business combination remained open as of March 31, 2016.

 

 

Unaudited Pro Forma Combined Financial Information

The following unaudited pro forma combined financial information is presented as if the Merger had occurred at the beginning of the 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 date 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:

 

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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;

 

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reflects the impact of issuance of 8,453,565 shares on July 31, 2015 and under the post-closing adjustment in connection with the Merger based on the final pre-Merger values;

 

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reflects $1.0 million of transaction-related costs associated with the Merger for the three months ended March 29, 2015; and

 

●

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

 

Note 3 – Property and Equipment, Net

 

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

 

 

As of March 31, 2016 and December 31, 2015, the furniture and equipment balance contained approximately $4.9 million and $4.8 million, respectively, of gaming device equipment that the Company had not yet placed into service and therefore had not begun depreciating.

 

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Note 4 – Goodwill and Intangible Assets, Net

 

Goodwill and intangible assets, net, consist of the following:

 

 

See Note 2, Merger and Acquisitions, for a description of the intangible assets acquired through the Merger and the Initial Montana Acquisition.

 

Total amortization expense related to intangible assets was $1.4 million and less than $0.1 million for the three months ended March 31, 2016 and March 29, 2015, respectively.  Estimated future amortization expense related to intangible assets, which includes acquired intangible assets recorded on a preliminary basis, is as follows: 

 

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Note 5 – 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 Credit Agreement was amended on March 25, 2016 to, among other matters, increase the size of the senior secured revolving credit facility under the Credit Agreement (the “Revolving Credit Facility”) from $40.0 million to $50.0 million and to provide for the borrowing of an additional $40.0 million in aggregate principal amount of incremental senior secured term loans under the Credit Agreement (the “Incremental Term Loans”). As of March 31, 2016, the facilities under the Credit Agreement consisted of $160.0 million in senior secured term loans (the “Term Loans,” which include the Incremental Term Loans) and a $50.0 million Revolving Credit Facility (together with the Term Loans, the “Facilities”). The Company used the proceeds from the Incremental Term Loan borrowings to repay all of the Company’s then-outstanding borrowings under the Revolving Credit Facility. As of March 31, 2016, the Company had $157.0 million in principal amount of outstanding Term Loan borrowings and no outstanding borrowings under the Revolving Credit Facility. In April 2016, the Company borrowed $25.0 million under the Revolving Credit Facility in connection with the closing of the Second Montana Acquisition; see Note 14, Subsequent Events, for additional information. 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 March 31, 2016, the weighted average effective interest rate on the Company’s outstanding borrowings under the Credit Agreement was approximately 3.18%.

 

Outstanding borrowings under the Term Loans must be repaid in two quarterly payments of $1.5 million each (which commenced on December 31, 2015), followed by two quarterly payments of $2.0 million each (commencing June 30, 2016), followed by eight quarterly payments of $3.0 million each (commencing December 31, 2016), followed by four quarterly payments of $4.0 million each (commencing December 31, 2018), followed by three quarterly payments of $6.0 million each (commencing December 31, 2019), followed by a final installment of $95.0 million at maturity on July 31, 2020. 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.

 

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 of the Company’s and the subsidiary guarantors’ present and future personal and real property (subject to receipt of certain approvals).

 

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 March 31, 2016.

 

 

Summary of Outstanding Debt

Long-term debt, net is comprised of the following: 

 

 

Note 6 – Promotional Allowances

 

The retail value of food and beverages, rooms and other services furnished to customers 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 is primarily included in gaming expenses, is as follows:

 

 

Note 7 – 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 of shareholders, 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 annual increase on January 1, 2016 was 874,709 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. There were 1,855,000 stock options outstanding under the 2015 Plan as of March 31, 2016, none of which have vested. As of March 31, 2016, a total of 1,269,709 shares of the Company’s common stock remained available for grants of awards under the 2015 Plan.

 

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. Vested options are exercisable for ten years from the date of grant; however, if the employee is terminated (voluntarily or involuntarily), any unvested options as of the date of termination will be forfeited. There were 552,403 stock options outstanding under the 2007 Plan as of March 31, 2016, all of which are fully vested. As of March 31, 2016, a total of 282,635 shares of the Company’s common stock remained available for grants of awards under the 2007 Plan.

 

The Company also has a 1998 Stock Option and Compensation Plan (the “1998 Plan”). There were 12,500 stock options outstanding under this plan as of March 31, 2016, all of which are fully vested. No additional options will be granted under the 1998 Plan.

 

Share-based compensation expense related to stock options was $0.4 million and less than $0.1 million for the three months ended March 31, 2016 and March 29, 2015 respectively.

 

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. There were 160,000 stock options granted under the 2015 Plan during the three months ended March 31, 2016, with a weighted-average grant date fair value of $3.94 per share. No options were granted during the three months ended March 29, 2015. 

 

The following table summarizes the Company’s stock option activity during the three months ended March 31, 2016 and March 29, 2015: 

 

 

 

As of March 31, 2016, the outstanding stock options had a weighted-average remaining contractual life of 7.8 years, weighted-average exercise price of $8.49 per share and an aggregate intrinsic value of $5.7 million. As of March 31, 2016, the outstanding exercisable stock options had a weighted-average remaining contractual life of 2.3 years, weighted-average exercise price of $6.17 per share and an aggregate intrinsic value of $2.7 million.

 

There were 159,626 options exercised during the three months ended March 31, 2016. The total intrinsic value of options exercised during the three months ended March 31, 2016 was $0.7 million. There were 2,500 options exercised during the three months ended March 29, 2015.  The total intrinsic value of stock options exercised during the three months ended March 29, 2015 was less than $0.1 million.  The Company’s unrecognized share-based compensation expense related to stock options was approximately $6.0 million as of March 31, 2016, which is expected to be recognized over a weighted-average period of 3.4 years.

 

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

 

Note 8 – 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 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 19,093 and 753,117 for the three months ended March 31, 2016 and March 29, 2015, respectively, were not used to compute diluted net income (loss) per share because the effects would have been anti-dilutive.

 

Note 9 – Income Taxes

 

The Company’s effective tax rate was 2.5% and (9.9)% for the three months ended March 31, 2016 and March 29, 2015, respectively. For the three months ended March 31, 2016, the effective tax rate differed from the federal tax rate of 35% due primarily to changes in the valuation allowance for deferred tax assets. For the three months ended March 29, 2015, the effective tax rate differed from the federal tax rate of 35% due primarily to the alternative minimum tax and, to a lesser extent, permanent differences.

 

Income tax expense was less than $0.1 million for the three months ended March 31, 2016, which was attributed primarily to tax amortization of indefinite-lived intangibles. Income tax expense was $0.2 million for the three months ended March 29, 2015, which was related to alternative minimum tax.

 

In connection with the Merger, on July 31, 2015, the Company entered into a NOL Preservation Agreement with the Sartini Trust, Lyle A. Berman (a director and shareholder of the Company), as well as certain other shareholders of the Company affiliated with Mr. Berman or another director of the Company. 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.

 

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 March 31, 2016.

 

The Company's income taxes receivable of $2.1 million as of March 31, 2016 and December 31, 2015 primarily relates to 2012 taxable losses carried back to a prior year. 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.  

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Note 10 – 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). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

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

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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.

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

 

The Company’s financial instruments consist of cash and cash equivalents, 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 March 31, 2016 and December 31, 2015, 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. 

 

In connection with the Initial Montana Acquisition, the Company preliminarily recognized the acquired assets at fair value. All amounts are recognized as Level 3 measurements due to the subjective nature of the unobservable inputs used to determine the fair values. Additionally, the Company is required to pay the sellers contingent consideration of up to a total of $2.0 million in cash paid in four quarterly payments beginning in September 2017, subject to certain potential adjustments based upon the availability of certain gaming machines and, if applicable, the performance of replacement games. The fair value of the Company’s contingent consideration recorded in connection with the Initial Montana Acquisition was estimated to be approximately $2.0 million as of March 31, 2016. Changes to the estimated fair value of the contingent consideration will be recognized in earnings of the Company. See Note 2, Merger and Acquisitions, for a discussion of the Initial Montana Acquisition.

 

Balances Measured at Fair Value on a Non-recurring Basis

Land, land improvements and building and improvements acquired in connection with the Merger were measured using unobservable (Level 3) inputs at an estimated fair value of $37.8 million. This fair value estimate 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 Note 2, Merger and Acquisitions). 

 

Leasehold improvements, furniture, fixtures and equipment, and construction in process acquired in connection with the Merger were measured using unobservable (Level 3) inputs at an estimated fair value of $46.3 million. This fair value estimate 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 Note 2, Merger and Acquisitions).

 

The identified intangible assets acquired in connection with the Merger have been valued on a preliminary basis using unobservable (Level 3) inputs at a fair value of $80.8 million (see Note 2, Merger and Acquisitions).

 

The Company owns various parcels of developed and undeveloped land relating to its casinos in Pahrump, Nevada, as well as parcels of undeveloped land in California held for sale that related to the Company’s previous involvement in a potential Indian casino project with the Jamul Tribe. The Company performs an impairment analysis on the land it owns at least quarterly and determined that no impairment had occurred as of March 31, 2016 and December 31, 2015.

 

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Note 11 – Commitments and Contingencies

 

Rocky Gap Lease

The Company has an operating ground lease with the Maryland Department of Natural Resources for approximately 270 acres in the Rocky Gap State Park in which Rocky Gap is situated. The lease expires in 2052, with an option to renew for an additional 20 years.

 

Under the lease, 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) 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 and are $3.00 per room per night and $1.00 per round of golf. Rent expense associated with the lease was $0.1 million (net of surcharge revenue) for each of the three months ended March 31, 2016 and March 29, 2015.

 

Gold Town Casino Leases

The Company’s Gold Town Casino is located on four leased parcels of land, comprising approximately nine acres in the aggregate, in Pahrump, Nevada. The leases are with unrelated third parties and have various expiration dates beginning in 2026 (for the parcel on which the Company’s main casino building is located, which we lease from a competitor), and the Company subleases approximately two of the acres to an unrelated third party. Rental income during the three months ended March 31, 2016 was less than $0.1 million related to the sublease of the two acres in Pahrump, Nevada.

 

Other Operating Leases

The Company leases its branded tavern locations, office headquarters building, equipment and vehicles under noncancelable operating leases that are not subject to contingent rents. The original terms of the current branded tavern location leases range from one to 14 years with various renewal options from one to 15 years. The Company has operating leases with related parties for certain of its tavern locations and its office headquarters building. The lease for the Company’s office headquarters building expires in July 2025. A portion of the office headquarters building is sublet to a related party. Rental income during the three months ended March 31, 2016 was less than $0.1 million for the sublet portion of the office headquarters building. See Note 13, Related Party Transactions, for more detail. Gaming device placement contracts in the form of space lease agreements are also accounted for as operating leases. Under space lease agreements, the Company pays fixed monthly rental fees for the right to install, maintain and operate its gaming devices at business locations, which are recorded in gaming expenses.

 

Operating lease rental expense, which is calculated on a straight-line basis, net of surcharge revenue, associated with all operating leases was as follows:

 

 

As of March 31, 2016, future minimum lease payments, excluding contingent rents, were as follows:

 

 

 

Participation and Revenue Share Agreements

The Company also enters into gaming device placement contracts in the form of participation and revenue share agreements. Under revenue share agreements, the Company pays the business location a percentage of the gaming revenue generated from the Company’s gaming devices placed at the location, rather than a fixed monthly rental fee. Under participation agreements, the business location holds the applicable gaming license and retains a percentage of the gaming revenue that it generates from the Company’s gaming devices. During the three months ended March 31, 2016, the total contingent payments recognized by the Company (recorded in gaming expenses) under revenue share and participation agreements was $28.2 million, including $0.5 million under revenue share and participation agreements with related parties, as described in Note 13, Related Party Transactions. No such amounts were recorded during the three months ended March 29, 2015.

 

Argovitz Demand for Arbitration

On March 13, 2015, Jerry Argovitz filed a Demand for Arbitration with the American Arbitration Association, alleging that the Company and/or its subsidiary Lakes Jamul, Inc. breached the terms of an agreement under which Mr. Argovitz retained certain rights to share in potential revenue from a gaming facility development project the Company (through its subsidiaries) pursued with the Jamul Tribe. Mr. Argovitz alleged that the Company breached such agreement by failing to protect his alleged contractual rights when the Company restructured its contractual relationship with the Jamul Tribe 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 Jamul casino project, which had not resulted in the successful opening of a gaming facility. Mr. Argovitz was seeking a declaration that, if the Jamul casino opened, then the Company had an obligation to pay him $1.0 million per year for up to seven years of operation of the Jamul casino.

 

The Company denied Mr. Argovitz’s allegations and vigorously defended the case. On September 2, 2015, the three-member arbitration panel denied the parties’ cross-motions for summary judgment. On January 5, 2016, the arbitration panel held an evidentiary hearing on the merits. Following the hearing, the parties submitted post-trial briefs. On March 21, 2016, the panel concluded that Mr. Argovitz’s claims in this arbitration should be dismissed with prejudice. 

 

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 currently 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.

 

Note 12 – Segment Information

 

During the third quarter of 2015, the Company redefined its reportable segments to reflect the change in its business following the Merger. As a result of the Merger, the Company now conducts its business through two reportable operating segments: Distributed Gaming and Casinos. Prior to the Merger, the Company conducted its business through the following two segments: Rocky Gap and Other. Prior period information has been recast to reflect the new segment structure and present comparative year-over-year results.

 

The Company’s Distributed Gaming segment involves the installation, maintenance and operation of gaming devices in certain strategic, high-traffic, non-casino locations (such as grocery stores, convenience stores, restaurants, bars, taverns, saloons and liquor stores) in Nevada and Montana, and the operation of traditional, branded taverns targeting local patrons, primarily in the greater Las Vegas, Nevada metropolitan area. The Company’s Casinos segment includes results of operations and assets related to Rocky Gap in Flintstone, Maryland and its three casino properties in Pahrump, Nevada. The Corporate and Other segment includes the Company’s cash and cash equivalents, short-term investments, cost method investments and corporate overhead. Costs recorded in the Corporate and Other segment have not been allocated to the Company’s reportable operating 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. 

 

 

 

Note 13 – Related Party Transactions

 

As of March 31, 2016, the Company leased its office headquarters building and one tavern location from a company 33% beneficially owned by Blake L. Sartini and 3% beneficially owned by Stephen A. Arcana, and leased four tavern locations from companies owned or controlled by Mr. Sartini or by a trust for the benefit of Mr. Sartini’s immediate family members for which Mr. Sartini serves as trustee. In addition, two tavern locations that the Company leased from related parties were divested by those related parties during the first quarter of 2016. The lease for the Company’s office headquarters building expires on July 31, 2025, and the leases for the tavern locations have remaining terms ranging from one to 15 years. Rent expense during the three months ended March 31, 2016 was $0.3 million for the office headquarters building and $0.4 million in the aggregate for such tavern locations. Additionally, a portion of the office headquarters building is sublet to a company owned or controlled by Mr. Sartini. Rental income during the three months ended March 31, 2016 for the sublet portion of the office headquarters building was less than $0.1 million. No amounts were owed to the Company or due and payable by the Company as of March 31, 2016 under the leases of such tavern locations or the lease of the office headquarters building. Less than $0.1 million was owed to the Company under the sublease of the office headquarters building. Mr. Sartini serves as the Chairman of the Board, President and Chief Executive Officer of the Company and is co-trustee of the Sartini Trust, which is a significant shareholder of the Company. Mr. Arcana serves as the Executive Vice President and Chief Operating Officer of the Company. All of the related party lease agreements were in place prior to the consummation of the Merger.

 

Mr. Sartini’s son, Blake L. Sartini, II (“Mr. Sartini II”), joined the Company as Senior Vice President of Distributed Gaming in connection with the Merger. Mr. Sartini II has an employment agreement that was approved by both the Audit Committee and Compensation Committee of the Board of Directors and provides for an annual base salary of $275,000, of which approximately $65,000 was earned during the three months ended March 31, 2016. Additionally, Mr. Sartini II is eligible for a target annual bonus equal to 35% of his base salary, and has received a discretionary bonus of $30,000 during the three months ended March 31, 2016 attributable to his performance in 2015. Mr. Sartini II also participates in the Company's equity award and benefit programs.

 

 

Three of the distributed gaming locations at which the Company’s gaming devices are located are owned in part by the spouse of Matthew W. Flandermeyer, who serves as Executive Vice President and Chief Financial Officer of the Company. Net revenues and gaming expenses recorded by the Company from the use of the Company’s gaming devices at these three locations were $0.45 million and $0.39 million, respectively, during the three months ended March 31, 2016. The gaming expenses recorded by the Company represent amounts retained by the counterparty (with respect to the two locations that are subject to participation agreements) or paid to the counterparty (with respect to the location that is subject to a revenue share agreement) from the operation of the gaming devices. Less than $0.1 million was owed to the Company and no amounts were due and payable by the Company related to these arrangements as of March 31, 2016. All of the agreements were in place prior to the consummation of the Merger.

 

Additionally, a fourth distributed gaming location at which the Company’s gaming devices are located was owned in part by Terrence L. Wright, who serves on the Board of Directors of the Company, who divested his interest in such distributed gaming location in March 2016. Net revenues and gaming expenses recorded by the Company from the use of the Company’s gaming devices at this location were $0.1 million during the three months ended March 31, 2016. This agreement was in place prior to the consummation of the Merger.

 

Note 14 – Subsequent Events

 

On April 22, 2016, the Company completed the acquisition of nearly 1,800 gaming devices, as well as over 500 amusement devices and approximately 50 ATMs, along with other non-gaming assets and the right to operate within certain locations, from Amusement Services, LLC, for total consideration of approximately $25.0 million. The Company funded the purchase price at closing using $25.0 million in borrowings under the Revolving Credit Facility. See Note 5, Debt, for a discussion of the Credit Agreement.

 

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