GOLDEN ENTERTAINMENT, INC. - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2017

OR

For the transition period from _____ to _____

Commission File Number: 000-24993

GOLDEN ENTERTAINMENT, INC.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (702) 893-7777

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ☒    No  ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of November 6, 2017, the registrant had 26,371,614 shares of common stock, $0.01 par value per share, outstanding.

GOLDEN ENTERTAINMENT, INC.

FORM 10-Q

INDEX

Part I. Financial Information

ITEM 1. FINANCIAL STATEMENTS 

GOLDEN ENTERTAINMENT, INC.

Consolidated Balance Sheets

(In thousands)

(Unaudited)

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

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GOLDEN ENTERTAINMENT, INC.

Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

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

2

GOLDEN ENTERTAINMENT, INC.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

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GOLDEN ENTERTAINMENT, INC.

Consolidated Statements of Cash Flows- (Continued)

(In thousands)

(Unaudited)

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

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GOLDEN ENTERTAINMENT, INC. 

Condensed Notes to Consolidated Financial Statements (Unaudited)

Note 1 – Nature of Business and Basis of Presentation

Overview

Golden Entertainment, Inc. and its wholly owned subsidiaries (collectively, the “Company” or “Golden”) is a diversified group of gaming companies that focus on distributed gaming (including tavern gaming) and casino and resort operations. On October 20, 2017, the Company completed the acquisition of American Casino & Entertainment Properties, LLC (“American”), and the results of operations of American and its subsidiaries will be included in the Company’s results from and after such date. The Company’s common stock is traded on the NASDAQ Global Market, and the Company’s ticker symbol is “GDEN.”

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 and amusement 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 involves the operation of eight casino and resort properties in Nevada and Maryland, comprising the Stratosphere Casino, Hotel & Tower, Arizona Charlie’s Decatur and Arizona Charlie’s Boulder in Las Vegas, Nevada, the Aquarius Casino Resort in Laughlin, Nevada, the Rocky Gap Casino Resort in Flintstone, Maryland, and the Pahrump Nugget Hotel Casino, Gold Town Casino and Lakeside Casino & RV Park in Pahrump, Nevada. The casino properties in Las Vegas and Laughlin, Nevada were added to the Company’s casino portfolio in October 2017 as a result of the Company’s acquisition of American.

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, 2016 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. Certain minor reclassifications have been made to the prior year period amounts to conform to the current presentation. Additionally, in the current year there was a $6.1 million reclassification of year to date activity from other operating expense to gaming expense in the Company’s consolidated statement of operations.

Net Income per Share

For all periods, basic net income per share is calculated by dividing net income 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. In the event of a net loss, diluted shares are not considered because of the anti-dilutive effect.

New Accounting Pronouncements 

Changes to GAAP are established by the Financial Accounting Standards Board (“FASB”), in the form of Accounting Standards Updates (“ASUs”) to the FASB's Accounting Standards Codification. The Company considers the applicability and impact of all ASUs. 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 a material impact on the Company's financial statements and disclosures:

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation, which amends the scope of modification accounting for share-based payment arrangements. ASU 2017-09 provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting. The standard is effective for annual periods beginning after December 15, 2017 and interim periods therein, and early adoption is permitted. The Company will adopt the standard as of January 1, 2018.

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other, which addresses goodwill impairment testing. Instead of determining goodwill impairment by calculating the implied fair value of goodwill, an entity should perform goodwill

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impairment test by comparing the fair value of a reporting unit with its carrying amount. ASU 2017-04 is effective for annual periods beginning after December 15, 2019 and interim periods therein, with early adoption permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations, which clarified the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions of assets or businesses. The standard is effective for annual periods beginning after December 15, 2017 and interim periods therein. The Company will adopt the standard as of January 1, 2018.

In February 2016, the FASB issued ASU 2016-02, Leases, which replaces the existing guidance. 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. ASU 2016-02 is effective for annual periods beginning after December 15, 2018 and interim periods therein, with early adoption permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

In May 2014, the FASB issued a comprehensive new revenue recognition model, ASU 2014-09, Revenue from Contracts with Customers, which created a new Topic 606 (“ASC 606”). The new guidance is intended to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP applicable to revenue transactions. Existing industry guidance will be eliminated, including revenue recognition guidance specific to the gaming industry. The FASB has recently issued several amendments to the standard, including clarification on accounting for and identifying performance obligations. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. The guidance should be applied using the full retrospective method or retrospectively with the cumulative effect initially applying the guidance recognized at the date of initial application. The Company anticipates adopting this standard effective January 1, 2018. The Company is currently in the process of its analysis and anticipates this standard will have a material effect on its consolidated financial statements. As described below, the Company expects the most significant effect will be related to the accounting for customer loyalty programs and casino promotional allowances. However, the quantitative effects of these changes have not yet been determined and are still being analyzed. The Company is currently assessing the full effect that the adoption of this standard will have on its financial statements.

The customer loyalty programs affect revenues from the Company’s four core business operations: gaming, food and beverage, rooms and other operations. Currently, the Company estimates the cost of fulfilling the redemption of player rewards, after consideration of breakage, based upon the cost of historical redemptions. Upon adoption of the new guidance, player rewards will no longer be recorded at cost, and a deferred revenue model will be used to account for the classification and timing of revenue recognized as well as the classification of related expenses when player rewards are redeemed.

The Company expects that its current presentation which reflects revenues gross for complementary goods and services provided to guests, with a corresponding offsetting amount included in promotional allowances, will no longer be allowed. Instead, revenues will be allocated among its departmental classifications based on the relative standalone selling prices of the goods and services provided to guests. The Company currently anticipates that this methodology will result in a reduction of its reported gaming revenues by an amount equivalent to its reported promotional allowance revenues.

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 – Acquisitions

American Acquisition

Overview

On October 20, 2017, subsequent to quarter end, the Company completed the acquisition of all of the outstanding equity interests of American from its former equity holders (the “American Acquisition”) for aggregate consideration consisting of $781.0 million in cash (subject to certain post-closing adjustments) and the issuance by the Company of 4,046,494 shares of its common stock to W2007/ACEP Holdings, LLC (“ACEP Holdings”), a former American equity holder. Of the cash consideration, $5.0 million is being held in escrow as security for satisfaction of the sellers’ post-closing working capital adjustment obligations in accordance with the purchase agreement governing the American Acquisition (the “Purchase Agreement”). At the closing of the American Acquisition, the Company entered into a stockholders agreement with ACEP Holdings that includes, among other things, a 90-day restriction on sales of the Company’s common stock by ACEP Holdings (subject to certain exceptions) and a standstill agreement. Also at the closing of the American Acquisition, the Company entered into a registration rights agreement with ACEP Holdings with respect to the shares of the Company’s common stock that were issued at the closing.

American owns and operates four casino hotel properties in Nevada: the Stratosphere Casino, Hotel & Tower, Arizona Charlie’s Decatur and Arizona Charlie’s Boulder in Las Vegas, and the Aquarius Casino Resort in Laughlin. As of October 20, 2017, the American casino properties offered an aggregate of 3,865 slot machines, 89 table games and 4,896 hotel rooms.

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Acquisition Method of Accounting

The American Acquisition will be accounted for under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations (“ASC 805”). Under the acquisition method, the total estimated purchase price, or consideration transferred, is measured at the acquisition closing date. The purchase price of the acquisition will be 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 will be recorded as goodwill. 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 consideration paid by the Company at the closing of the American Acquisition is subject to certain post-closing adjustments under the Purchase Agreement.

Refinancing

In connection with the closing of the American Acquisition, the Company entered into two new credit agreements with respect to a $900.0 million senior secured first lien credit facility (consisting of $800.0 million in term loans and a $100.0 million revolving credit facility, which was undrawn at closing) and a $200.0 million senior secured second lien term loan facility.  The Company used the net proceeds from the borrowings under these facilities at the closing primarily to fund the cash purchase price in the American Acquisition (a portion of which was used to repay American’s outstanding senior secured indebtedness), to refinance the Company’s outstanding senior secured indebtedness under its then-existing senior secured credit facility, and to pay certain transaction fees and expenses. See Note 5, Long-Term Debt, for a discussion of the new credit agreements and associated refinancing.

Montana Acquisitions

Overview

On January 29, 2016, the Company completed the acquisition of approximately 1,100 gaming devices, as well as certain other non-gaming assets and the right to operate within certain locations (the “Initial Montana Acquisition”). The total consideration for the transaction was $20.1 million, including the issuance of $0.5 million of the Company’s common stock (comprising 50,252 shares at fair value at issuance 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, which began in September 2017, subject to certain potential adjustments. See Note 9, Financial Instruments and Fair Value Measurements, for further discussion regarding the estimated fair value of the contingent consideration and the Company’s revaluation of such contingent consideration in the third quarter.

On April 22, 2016, the Company completed the acquisition of approximately 1,800 gaming devices, as well as amusement devices and certain other non-gaming assets and the right to operate within certain locations, from Amusement Services, LLC (the “Second Montana Acquisition”, and, together with the Initial Montana Acquisition, the “Montana Acquisitions”). The total consideration for the transaction was $25.7 million.

Acquisition Method of Accounting

The Company followed the acquisition method of accounting for the Montana Acquisitions per ASC 805 guidance. In accordance with ASC 805, the Company allocated the purchase price for each Montana Acquisition to the tangible and intangible assets acquired and liabilities assumed based on their fair values, which were determined primarily by management with assistance from third-party appraisals. The excess of the purchase prices over those fair values was recorded as goodwill.

The allocation of the $20.1 million purchase price of the Initial Montana Acquisition was finalized in the first quarter of 2017 and as of the date of the acquisition was comprised of the following:

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The intangible assets acquired in the Initial Montana Acquisition and the related weighted-average useful lives of definite-lived intangible assets were as follows:

The allocation of the $25.7 million purchase price of the Second Montana Acquisition was finalized in the second quarter of 2017 and as of the date of acquisition was comprised of the following:

The intangible assets acquired in the Second Montana Acquisition and the related weighted-average useful lives of definite-lived intangible assets were as follows:

The goodwill recognized in the Montana Acquisitions was 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 Montana Acquisitions as of the respective dates of the acquisitions was determined based on certain valuations and analyses.

The Company reports the results of operations from each of the Montana Acquisitions, subsequent to their respective closing dates, within its Distributed Gaming segment. For each of the three months ended September 30, 2017 and 2016, net revenues from the Montana Acquisitions totaled $15.1 million. For the nine months ended September 30, 2017 and 2016, net revenues from the Montana Acquisitions totaled $45.7 million and $32.0 million, respectively. For each of the three months ended September 30, 2017 and 2016, there were no transaction-related costs for the Montana Acquisitions. For each of the nine months ended September 30, 2017 and 2016, transaction-related costs for the Montana Acquisitions totaled $0.2 million. All transaction-related costs for the Montana Acquisitions were included in preopening expenses. The Company may incur additional transaction-related costs related to the Montana Acquisitions in future periods. Pro forma information is not being presented as there is no practicable method to calculate pro forma earnings given that the Montana Acquisitions were asset purchases that represented only a component of the businesses of the sellers. As a result, historical financial information obtained would have required significant estimates.

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Note 3 – Property and Equipment, Net

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

Depreciation expense was $5.6 million and $5.3 million for the three months ended September 30, 2017 and 2016, respectively, and $15.7 million and $14.5 million for the nine months ended September 30, 2017 and 2016, respectively.

Note 4 – Goodwill and Intangible Assets, Net

Goodwill consisted of the following:

Goodwill was acquired in connection with the 2015 acquisition of Sartini Gaming, Inc. through a merger transaction (the “Merger”), as well as the Montana Acquisitions. See Note 2, Acquisitions, for a description of the intangible assets acquired through the Montana Acquisitions.

Intangible assets, net, consisted of the following:

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Total amortization expense related to intangible assets was $1.9 million and $2.0 million for the three months ended September 30, 2017 and 2016, respectively, and $5.8 million and $5.4 million for the nine months ended September 30, 2017 and 2016, respectively.

Note 5 – Long-Term Debt

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

Senior Secured Credit Facilities

As of September 30, 2017, the facilities under the Company’s credit agreement with Capital One, National Association (as administrative agent) and the lenders named therein (the “Former Credit Agreement”) consisted of $160.0 million in senior secured term loans, of which $141.0 million was outstanding at such date, and a $50.0 million revolving credit facility, with outstanding borrowings of $27.0 million at such date. The facilities were scheduled to mature on July 31, 2020. Borrowings under the Former Credit Agreement bore 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. For the nine months ended September 30, 2017, the weighted-average effective interest rate on the Company’s outstanding borrowings under the Former Credit Agreement was approximately 3.5%.

On October 20, 2017, subsequent to quarter end, the Company entered into credit agreements with respect to a $900.0 million senior secured first lien credit facility (consisting of $800.0 million in term loans and a $100.0 million revolving credit facility) with JPMorgan Chase Bank, N.A. (as administrative agent and collateral agent), the lenders party thereto and the other entities party thereto (the “First Lien Facility”), and a $200.0 million senior secured second lien term loan facility with Credit Suisse AG, Cayman Islands Branch (as administrative agent and collateral agent), the lenders party thereto and the other entities party thereto (the “Second Lien Facility” and, together with the First Lien Facility, the “Credit Facilities”). The term loans under both Credit Facilities were fully drawn at closing; the revolving credit facility under the First Lien Facility was undrawn at closing.  Proceeds from the term loan borrowings under the Credit Facilities at the closing were primarily used to fund the cash purchase price in the American Acquisition

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(a portion of which was used to repay American’s outstanding senior secured indebtedness), to refinance the Company’s outstanding senior secured indebtedness under the Former Credit Agreement, and to pay certain transaction fees and expenses.

Borrowings under each of the Credit Facilities bear interest, at the Company’s option, at either (1) a base rate equal to the greatest of the federal funds rate plus 0.50%, the applicable administrative agent’s prime rate as announced from time to time, or the LIBOR rate for a one-month interest period plus 1.00%, subject to a floor of 1.75% (with respect to the term loans) or 1.00% (with respect to borrowings under the revolving credit facility) or (2) the LIBOR rate for the applicable interest period, subject to a floor of 0.75% (with respect to the term loans only), plus in each case, an applicable margin. The applicable margin for the term loans under the First Lien Facility is 2.00% for base rate loans and 3.00% for LIBOR rate loans.  The applicable margin for borrowings under the revolving credit facility ranges from 1.50% to 2.00% for base rate loans and 2.50% to 3.00% for LIBOR rate loans, based on the Company’s net leverage ratio. The applicable margin for the term loans under the Second Lien Facility is 6.00% for base rate loans and 7.00% for LIBOR rate loans. The commitment fee for the revolving credit facility is payable quarterly at a rate of between 0.375% and 0.50%, depending on the Company’s net leverage ratio, and is accrued based on the average daily unused amount of the available revolving commitment.

The revolving credit facility under the First Lien Facility matures on October 20, 2022, and the term loans under the First Lien Facility mature on October 20, 2024. The term loans under the First Lien Facility must be repaid in 27 quarterly installments of $2.0 million each, which commence in March 2018, followed by a final installment of $746.0 million at maturity.  The term loans under the Second Lien Facility must be repaid in full at maturity on October 20, 2025.

Borrowings under each of the Credit Facilities are guaranteed by each of the Company’s existing and future wholly owned domestic subsidiaries (other than certain insignificant or unrestricted subsidiaries), and are secured by substantially all of the present and future assets of the Company and the guarantors (subject to certain exceptions). Under the Credit Facilities, the Company and its restricted 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 term loans under the Credit Facilities under certain circumstances if the Company or its restricted subsidiaries issue debt, sell assets, receive certain extraordinary receipts or generate excess cash flow (subject to exceptions). The revolving credit facility under the First Lien Facility contains a financial covenant regarding a maximum net leverage ratio that applies when borrowings under the revolving credit facility exceed 30% of the total revolving commitment. The Credit Facilities also prohibit the occurrence of a change of control, which includes the acquisition of beneficial ownership of 50% or more of the Company’s capital stock (other than by certain permitted holders, which include, among others, Blake L. Sartini, Lyle A. Berman, Neil I. Sell and certain affiliated entities). If the Company defaults under the Credit Facilities 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.

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 was as follows:

The estimated cost of providing these promotional allowances, which is primarily included in gaming expenses, was as follows:

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Note 7 – Stock Incentive Plans and Share-Based Compensation

Overview

On August 27, 2015, the Board of Directors of the Company approved the Golden Entertainment, Inc. 2015 Incentive Award Plan (the “2015 Plan”), which was approved by the Company’s shareholders at the Company’s 2016 annual meeting. The 2015 Plan authorizes the issuance of stock options, restricted stock, restricted stock units (“RSUs”), 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.

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, 2017 was 889,259 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 3,583,282 stock options outstanding under the 2015 Plan as of September 30, 2017, of which 1,223,611 had vested. As of September 30, 2017, a total of 289,390 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 645,675 stock options outstanding under the 2007 Plan as of September 30, 2017, 388,040 of which had vested. As of September 30, 2017, no shares of the Company’s common stock remained available for grants of awards under the 2007 Plan.

Stock Options

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 considerable judgment, including estimating stock price volatility, expected option life and forfeiture rates. The Company develops estimates based on historical data and market information, which can change significantly over time. There were no options granted in the three months ended September 30, 2017 and 977,570 options granted in the nine months ended September 30, 2017, respectively. The weighted-average grant date fair value in the nine months ended September 30, 2017 was $6.36 per share. There were 905,000 and 1,128,070 stock options granted in the three and nine months ended September 30, 2016, respectively, with weighted-average grant date fair values of $4.80 and $4.83 per share, respectively.

Share-based compensation expense related to stock options was $1.4 million and $1.7 million for the three months ended September 30, 2017 and 2016, respectively, and $3.6 million and $2.5 million for the nine months ended September 30, 2017 and 2016, respectively.

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The following table summarizes the Company’s stock option activity during the nine months ended September 30, 2017 and 2016: 

As of September 30, 2017, the outstanding stock options had a weighted-average remaining contractual life of 7.6 years, weighted-average exercise price of $10.17 per share and an aggregate intrinsic value of $60.1 million. As of September 30, 2017, the outstanding exercisable stock options had a weighted-average remaining contractual life of 1.0 years, weighted-average exercise price of $4.33 per share and an aggregate intrinsic value of $7.8 million.

There were 3,000 options exercised during the three months ended September 30, 2017. During the three months ended September 30, 2016, there were 15,700 options exercised. There were 22,989 and 310,656 options exercised during the nine months ended September 30, 2017 and 2016, respectively. The total intrinsic value of options exercised was $0.1 million during each of the three months ended September 30, 2017 and 2016, respectively. The total intrinsic value of options exercised was $0.1 million and $1.7 million for the nine months ended September 30, 2017 and 2016, respectively. The Company’s unrecognized share-based compensation expense related to stock options was approximately $12.5 million as of September 30, 2017, which is expected to be recognized over a weighted-average period of 2.7 years.

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

Restricted Stock Units

There were 70,648 RSUs outstanding under the 2015 Plan as of September 30, 2017, none of which had vested. Share-based compensation expense related to RSUs was $0.2 million and $1.5 million for the three and nine months ended September 30, 2017, respectively. There was no RSU activity during the nine months ended September 30, 2016. As of September 30, 2017, there was approximately $0.1 million of total unrecognized share-based compensation expense related to unvested RSUs, all of which is expected to be recognized in 2017.

Note 8 – Income Taxes

The Company’s effective tax rate was (231.33)% and 10.7% for the nine months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 2017 and 2016, the effective tax rate differed from the federal tax rate of 35% due to the partial release of the valuation allowance for deferred tax assets and changes in the valuation allowance for deferred taxes, respectively.

Income tax benefit was $10.9 million for the nine months ended September 30, 2017, which was attributed primarily to a partial release of valuation allowance. Income tax expense was $0.8 million for the nine months ended September 30, 2016, which was attributed primarily to tax amortization of indefinite-lived intangibles and measurement period adjustments to goodwill.

Deferred tax assets are evaluated by considering historical levels of income, estimates of future taxable income and the impact of tax planning strategies. The Company's financial results include the reversal of a portion of the valuation allowance recorded against the deferred tax assets of the Company. This reversal resulted in the recognition of a $12.6 million income tax benefit for the nine months ended September 30, 2017. The Company has performed a continuing evaluation of its deferred tax asset valuation allowance on a

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quarterly basis. The Company concluded that, effective December 31, 2016, it is more likely than not that the Company will generate sufficient taxable income within the applicable net operating loss carry-forward periods to realize a portion of its deferred tax assets. This conclusion, and the resulting partial reversal of the deferred tax asset valuation allowance, is based upon consideration of several factors, including the Company's completion of eight consecutive quarters of profitability, its demonstrated ability in such quarters to meet or exceed budgets, and its forecast of future profitability.

The Company's income taxes receivable was $0.2 million as of September 30, 2017, and $2.3 million as of December 31, 2016. The decrease in income taxes receivable was primarily due to the collection of a $2.2 million tax refund which was released in connection with the settlement of an IRS audit related to 2012 taxable losses carried back to a prior year.

As of September 30, 2017, the Company had approximately $61.5 million of net operating loss carryforwards (“NOLs”) which begin to expire in 2032. These NOLs have the potential to be used to offset future ordinary taxable income and reduce future cash tax liabilities. However, in connection with the American Acquisition, the Company issued 4,046,494 shares of its common stock to ACEP Holdings at the closing of the transaction, which resulted in an “ownership change” under Section 382 that will generally limit the amount of NOLs the Company can utilize annually. Following an “ownership change” under Section 382, the amount of NOLs the Company can utilize in a given year is limited to an amount equal to the aggregate fair market value of the Company’s common stock immediately prior to the ownership change, multiplied by the long-term exempt interest rate in effect for the month of the ownership change. The Company estimates that the amount of NOLs that it will be able to utilize following the closing of the American Acquisition is limited to approximately $10.8 million annually.

To help preserve the Company’s ability to utilize its NOLs, the Company previously entered into an Amended and Restated Rights Agreement with Wells Fargo Shareowner Services, a division of Wells Fargo Bank, National Association, as rights agent (the “Amended and Restated Rights Agreement”) to deter acquisitions of shares of the Company’s common stock that would result in a shareholder owning 4.99% or more of the Company’s common stock. In connection with its approval of the American Acquisition, the Company’s Board of Directors granted ACEP Holdings an exemption with respect to its acquisition of shares of common stock so that ACEP Holdings was an “exempt person” under the Amended and Restated Rights Agreement. On October 20, 2017, in connection with the completion of the American Acquisition, the Company entered into the First Amendment to the Amended and Restated Rights Agreement, which changed the final expiration date of the Amended and Restated Rights Agreement from July 31, 2018 to October 20, 2017 and caused the Amended and Restated Rights Agreement to expire on October 20, 2017.

Also, the Company previously entered into an NOL Preservation Agreement with The Blake L. Sartini and Delise F. Sartini Family Trust (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 that are trusts for which Neil Sell, a director of the Company, serves as trustee. The NOL Preservation Agreement was intended to help minimize the risk of an “ownership change” under Section 382. On October 20, 2017, the Company, the Sartini Trust, Lyle A. Berman and the other investors that were parties to the NOL Preservation Agreement entered into an agreement terminating the NOL Preservation Agreement effective as of the closing of the American Acquisition.

Note 9 – Financial Instruments and Fair Value Measurements

Overview

The authoritative accounting guidance for fair value measurements specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These inputs create the following fair value hierarchy:

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Thus, assets and liabilities categorized as Level 3 may be measured at fair value using inputs that are observable (Levels 1 and 2) and unobservable (Level 3). Management's assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of assets and liabilities and their placement within the fair value hierarchy levels.

Balances Measured at Fair Value

For the Company’s cash and cash equivalents, accounts receivable and payable, short-term borrowings and accrued and other current liabilities, the carrying amounts approximate fair value because of the short duration of these financial instruments. As of September 30, 2017 and December 31, 2016, the fair value of the Company’s long-term debt approximated the carrying value based upon the Company’s expected borrowing rate for debt with similar remaining maturities and comparable risk.

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In connection with the Montana Acquisitions, the Company recognized the acquired assets at fair value. For the Initial Montana Acquisition, these amounts were finalized during the first quarter of 2017. The Second Montana Acquisition amounts were finalized during the second quarter of 2017. All amounts are recognized as Level 3 measurements due to the subjective nature of the unobservable inputs used to determine the fair values. Additionally, 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, which began in September 2017, subject to certain potential adjustments based upon the availability of certain gaming machines and, if applicable, the performance of replacement games. In the third quarter, the Company revalued the estimated fair value of the contingent consideration and recognized a gain on revaluation of contingent consideration of $1.7 million on the Company’s consolidated statement of operations. See Note 2, Acquisitions, for a discussion of the Montana Acquisitions.

Balances Measured at Fair Value on a Non-Recurring Basis

The identified intangible assets acquired in connection with the Initial Montana Acquisition and the Second Montana Acquisition have been valued using unobservable (Level 3) inputs at a fair value of $14.4 million and $11.4 million, respectively (see Note 2, Acquisitions).

The Company owns various parcels of developed and undeveloped land relating to its casinos in Pahrump, Nevada. 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, 2017 and December 31, 2016.

Note 10 – Commitments and Contingencies

Rent Expense and Future Minimum Lease Payments

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 15 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. See Note 12, 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 September 30, 2017, future minimum operating lease payments, excluding contingent rents, were as follows:

The current and long-term obligations under capital leases are included in “Current portion of long-term debt, net” and “Long-term debt, net,” respectively. The majority of the capital leases relate to vehicles with minimum lease payment terms of three to four years. During the first quarter of 2017, the Company entered into a capital lease agreement with a related party for one of its tavern locations. During the third quarter of 2017, the Company assigned this capital lease agreement to a non-related third party. See Note 12, Related Party Transactions, for more detail.

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As of September 30, 2017, future minimum capital 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 and nine months ended September 30, 2017, the total contingent payments recognized by the Company (recorded in gaming expenses) under revenue share and participation agreements were $35.4 million and $107.0 million, respectively, including $0.3 million and $0.8 million, respectively, under revenue share and participation agreements with related parties, as described in Note 12, Related Party Transactions. During the three and nine months ended September 30, 2016, the total contingent payments recognized by the Company (recorded in gaming expenses) under revenue share and participation agreements were $33.2 million and $94.1 million, respectively, including $0.6 million and $1.6 million, respectively, under revenue share and participation agreements with related parties.

The Company also enters into amusement device and ATM placement contracts in the form of revenue share agreements. Under these revenue share agreements, the Company pays the business location a percentage of the non-gaming revenue generated from the Company’s amusement devices and ATMs placed at the location. During the three months ended September 30, 2017 and 2016, the total contingent payments recognized by the Company (recorded in other operating expenses) for amusement devices and ATMs under such agreements were $0.2 million and $0.3 million, respectively. During the nine months ended September 30, 2017 and 2016, the total contingent payments recognized by the Company (recorded in other operating expenses) for amusement devices and ATMs under such agreements were $1.0 million and $0.7 million, respectively.

Employment Agreements

The Company has entered into at-will employment agreements with each of the Company’s executive officers. Under each employment agreement, in addition to the executive’s annual base salary, the executive is entitled to participate in the Company’s incentive compensation programs applicable to executive officers of the Company. The executives are also eligible to participate in all health benefits, insurance programs, pension and retirement plans and other employee benefit and compensation arrangements. Each executive is also provided with other benefits as set forth in his employment agreement. In the event of a termination without “cause” or a “constructive termination” of the Company’s executive officers (as defined in their respective employment agreements), the Company could be liable for estimated severance payments of up to $6.1 million for Mr. Sartini, $1.9 million for Stephen A. Arcana, $1.9 million for Charles H. Protell, $1.6 million for Sean T. Higgins, $0.7 million for Blake L. Sartini II, and $0.4 million for Gary A. Vecchiarelli (assuming each officer’s respective annual salary and health benefit costs as of September 30, 2017 are the amounts in effect at the time of termination and excluding potential expense related to acceleration of stock options).

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 for which the Company has recorded $1.5 million for claims as of the date of this filing. 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 currently pending matters will not have a material adverse effect on its business, financial condition, results of operations or liquidity. 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.

In February and April 2017, several former employees filed two separate purported class action lawsuits against the Company in the District Court of Clark County, Nevada, and on behalf of similarly situated individuals employed by the Company in the State of Nevada. The lawsuits allege the Company violated certain Nevada labor laws including payment of an hourly wage below the statutory minimum wage without providing a qualified health insurance plan and an associated failure to pay proper overtime compensation. The complaints seek, on behalf of the plaintiffs and members of the putative class, an unspecified amount of damages (including punitive damages), injunctive and equitable relief, and an award of attorneys’ fees, interest and costs. While legal proceedings are inherently unpredictable and no assurance can be given as to the ultimate outcome of these matters, based on

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management’s current understanding of the relevant facts and circumstances, the Company believes that these proceedings should not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Note 11 – Segment Information

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 and amusement 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 for the periods cover by this report. The Corporate and Other segment includes the Company’s cash and cash equivalents 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.

Results of Operations - Segment Net Income (Loss), Net Revenues and Adjusted EBITDA

The Company evaluated its segments’ profitability based upon Adjusted EBITDA, which represents earnings before interest expense and other non-operating income (expense), income taxes, depreciation and amortization, preopening expenses, acquisition and merger expenses, class action litigation expense, share-based compensation expense, executive severance and sign-on bonuses, gain on revaluation of contingent consideration, impairments and other gains and losses, as applicable.

The following tables set forth, for the periods indicated, certain operating data for the Company’s segments, and reconciles Adjusted EBITDA to net income (loss):