PlayAGS, Inc. - Quarter Report: 2014 September (Form 10-Q)

Fair values at December 20, 2013

Average remaining useful life (in years)

Gaming equipment, vehicles and other

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



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

for the fiscal year ended September 30, 2014



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

for the transition period from to .

Commission file number 000-55119

AP GAMING HOLDCO, INC.

(Exact name of registrant as specified in its charter)



Delaware		46-3698600
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

6680 Amelia Earhart Court

Las Vegas, NV 89119

(Address of principal executive offices) (Zip Code)

(702) 722-6700

(Registrant’s telephone number, including area code)

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 x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 o No x*

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



Large accelerated filer o	Accelerated filer o	Non-accelerated filer x (Do not check if a smaller reporting company)	Smaller reporting company o

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

As of November 12, 2014, there were 10,000,100 shares of the Registrant’s common stock, $.01 par value per share, outstanding.

*The Company does not have any public stockholders. Accordingly, it does not maintain an investor relations website where Interactive Data Files would be posted.

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TABLE OF CONTENTS



	PART I. FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS	1

	CONDENSED CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 2014 (Unaudited) AND DECEMBER 31, 2013	1

	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (Unaudited)	2

	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (Unaudited)	3

	NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)	4

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	26

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	34

ITEM 4.	CONTROLS AND PROCEDURES	34

	PART II. OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	35

ITEM 1A.	RISK FACTORS	35

ITEM 6.	EXHIBITS	36

	SIGNATURES	37

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AP GAMING HOLDCO, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share and per share data)



	Successor
	September 30, 2014			December 31, 2013
	(unaudited)
Assets
Current assets
Cash and cash equivalents	$	15,828		$	21,742
Restricted cash	100			100
Trade accounts receivable, net of allowance of $328 and $9, respectively	7,441			7,505
Notes receivable—current portion	352			—
Inventories, net	3,363			3,891
Prepaid expenses	1,702			1,028
Deposits and other	2,130			3,174
Total current assets	30,916			37,440
Gaming equipment, vehicles and other equipment, net	44,166			49,505
Notes receivable, net of current portion	90			—
Deferred loan costs, net	6,400			6,881
Goodwill	76,316			60,384
Intangible assets, net	104,689			98,664
Canadian payroll tax receivable	160			23
Deferred tax asset	—			220
Other assets	2,549			1,679
Total assets	$	265,286		$	254,796

Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable and accrued liabilities	$	22,266		$	6,247
Accrued interest	614			448
Customer deposits on gaming machine leases	22			—
Current maturities of long-term debt	2,478			1,550
Deferred tax liability	274			274
Total current liabilities	25,654			8,519
Phantom unit-plan liability	—			22
Other long-term liabilities	67			67
Long-term debt	165,307			154,345
Deferred tax liability - noncurrent	1,590			—
Total liabilities	192,618			162,953
Commitments and contingencies (Note 19)
Stockholders’ Equity:
Preferred stock at $0.01 par value; 100,000 shares authorized, no shares issued and outstanding	—			—
Common stock at $0.01 par value; 30,000,100 shares authorized; 100 and 10,000,000 Class A Shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively, and 10,000,000 Class B Shares issued and outstanding at September 30, 2014.	100			100
Additional Paid-in capital	99,900			99,900
Accumulated deficit	(27,559		)	(8,156		)
Accumulated other comprehensive income (loss)	227			(1		)
Total stockholders’ equity	72,668			91,843
Total liabilities and stockholders’ equity	$	265,286		$	254,796

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

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AP GAMING HOLDCO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(amounts in thousands, except per share data)

(unaudited)



	Successor			Predecessor			Successor			Predecessor
	Three months ended September 30, 2014			Three months ended September 30, 2013			Nine months ended September 30, 2014			Nine months ended September 30, 2013
Revenues
Gaming revenue	$	17,494		$	13,985		$	50,914		$	41,957
Gaming revenue—other	—			—			—			799
Equipment sales	1,342			783			2,508			1,226
Total revenues	18,836			14,768			53,422			43,982
Operating expenses
Gaming operating expenses	3,258			2,381			8,274			7,250
Cost of equipment sales	716			556			1,346			777
Loss on disposition of assets	81			189			1,256			775
General and administrative	6,848			4,007			17,281			12,496
Selling and marketing	980			956			2,463			2,538
Phantom unit compensation	—			463			—			463
Impairment of long lived assets	—			3,364			127			3,364
Impairment of intangibles	1,321			1,420			1,321			1,420
Write downs and other charges	48			75			690			203
Depreciation and amortization	9,016			6,556			25,145			21,543
Total operating expenses	22,268			19,967			57,903			50,829
Loss from operations	(3,432		)	(5,199		)	(4,481		)	(6,847		)
Other expense (income)
Interest expense	4,408			4,232			12,756			13,168
Interest income	(14		)	(591		)	(31		)	(1,268		)
Other (income) expense	298			(534		)	301			(254		)
Loss before income taxes	(8,124		)	(8,306		)	(17,507		)	(18,493		)
Income tax expense	(550		)	—			(1,896		)	—
Net loss	(8,674		)	(8,306		)	(19,403		)	(18,493		)
Foreign currency translation adjustment	225			(6		)	228			(23		)
Total comprehensive loss	$	(8,449	)	$	(8,312	)	$	(19,175	)	$	(18,516	)

Basic and diluted loss per common share:
Basic	$	(0.87	)				$	(1.94	)
Diluted	(0.87		)				(1.94		)
Weighted average common shares outstanding:
Basic	10,000						10,000
Diluted	10,000						10,000

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

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AP GAMING HOLDCO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



	Successor			Predecessor
	Nine months ended September 30, 2014			Nine months ended September 30, 2013
Cash flows from operating activities
Net loss	$	(19,403	)	$	(18,493	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	25,145			21,543
Accretion of contract rights under development agreements and customer agreements	15			2,968
Amortization of deferred loan costs and discount	920			1,864
Provision for bad debts	(276		)	(174		)
Payment in kind for interest on development loans	—			(426		)
Imputed interest income	(26		)	(78		)
Loss on disposition of assets	1,256			775
Impairment of prepaid royalties	307			—
Impairment of long lived assets	127			3,364
Impairment of intangible assets	1,321			1,420
Phantom unit plan compensation	—			463
Provision for deferred income tax	1,809			—
Non-cash contract rights under development agreements	—			(153		)
Changes in assets and liabilities that relate to operations:
Decrease in restricted cash	—			100
Decrease in trade accounts receivable and notes receivable	248			951
Decrease in inventories, net	600			668
(Increase) decrease in prepaid expenses	(952		)	173
Decrease (increase) in deposits and other	1,063			(688		)
Increase in other assets, non-current	(870		)	(688		)
Increase in accounts payable and accrued liabilities	1,522			347
Decrease in due to related party	—			(66		)
Increase (decrease) in accrued interest	397			(14		)
Increase in customer deposits on gaming machine leases	22			—
Decrease in phantom unit-plan liability	(22		)	(422		)
Net cash provided by operating activities	13,203			13,434
Cash flows from investing activities
Cash paid for C2 Gaming acquisition	(11,000		)	—
Advances under notes receivable	—			(1,460		)
Collections under notes receivable	59			1,062
Increase in interest receivable	—			(787		)
Increase in Canadian tax receivable	(141		)	(718		)
Purchase of intangible assets	(7,485		)	(2,451		)
Software development and other	(4,305		)	(3,560		)
Proceeds from disposition of assets	409			171
Purchases of gaming equipment, vehicles and other equipment	(7,396		)	(10,555		)
Net cash used in investing activities	(29,859		)	(18,298		)
Cash flows from financing activities
Payments under notes payable	—			(370		)
Borrowings under bank credit facility	—			7,500
Borrowings under the revolving facility	10,000			—
Payments on debt	(1,423		)	—
Proceeds from employees in advance of common stock issuance	1,969			—
Payment of deferred loan costs	(73		)	(342		)
Net cash provided by financing activities	10,473			6,788
Effect of exchange rates on cash and cash equivalents	269			152
(Decrease) increase in cash and cash equivalents	(5,914		)	2,076
Cash and cash equivalents, beginning of period	21,742			6,545
Cash and cash equivalents, end of period	$	15,828		$	8,621

Supplemental cash flow information:
Cash paid during the period for interest	$	11,381		$	11,291
Non-cash investing and financing activities:
Capital expenditures funded by settlement of customer receivable	$	—		$	844
Lease incentive intangible related to discounted notes receivable	$	—		$	156
Financed purchase of equipment	$	2,717		$	—

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

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AP GAMING HOLDCO INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1. ORGANIZATION AND BUSINESS

Organization

AP Gaming Holdco, Inc. (the “Company,” “AP Gaming,” “we,” “us,” or “our”) is a leading designer and manufacturer of Class II gaming machines for the Native American gaming market with an emerging presence in a broad range of commercial markets in the United States. As of September 30, 2014, the Company had 8,888 gaming machines in 222 gaming facilities in 19 U.S. states, with 175 gaming facilities under revenue sharing agreements and 47 facilities under daily fixed fee agreements. The majority of our systems are used by Native American gaming operators in both Class II and Class III environments, with a recent expansion into the Illinois video gaming terminal, or VGT, market. Our products include electronic gaming machines, server-based systems and back-office systems that are used by casinos and other gaming locations.

In the third quarter 2014, the Company began manufacturing and developing table games products through the acquisitions of Casino War Blackjack, Inc. (“War Blackjack”) and other intellectual property related to table games products. As of September 30, 2014, the Company had 102 table game units under monthly fixed fee arrangements.

The Acquisition

On September 16, 2013, AGS Holdings, LLC (“AGS Holdings”), AGS Capital, LLC (“AGS Capital”) and AP Gaming Acquisition, LLC (“AP Gaming Acquisition”), an indirect wholly owned subsidiary of the Company and an affiliate of Apollo Global Management, LLC (“Apollo”), entered into an Equity Purchase Agreement (as subsequently amended and restated on December 3, 2013, the “Acquisition Agreement”). The Acquisition Agreement provided for the purchase of 100% of the equity of AGS Capital from AGS Holdings, LLC (the “Acquisition”) by AP Gaming Acquisition for an aggregate purchase price of approximately $220.5 million. The Acquisition was consummated on December 20, 2013 (the “Closing Date”).

The Acquisition was financed in part by the Senior Secured Credit Facilities (as defined herein), which are comprised of the $155 million Term Facility and the $25 million Revolving Facility (each, as defined herein). AP Gaming I, LLC, an indirect wholly owned subsidiary of AP Gaming, is the borrower of the Senior Secured Credit Facilities, which are guaranteed by AP Gaming Holdings, LLC (“AP Gaming Holdings”), AP Gaming I, LLC’s direct parent company, and each of AP Gaming I, LLC’s direct and indirect material wholly owned domestic subsidiaries including AGS Capital. Additionally, the Company issued 10,000,000 Class A shares of common stock at $0.01 par value to Apollo Gaming Holdings, L.P. The total cost to acquire all the outstanding shares was $100,000,000. The source of the funds for the acquisition of the Company was provided by committed equity capital contributed by certain equity funds managed by Apollo.

C2 Gaming, LLC acquisition

On May 6, 2014, a wholly owned subsidiary of the Company entered into an agreement to purchase 100% of the equity of C2 Gaming, LLC (“C2 Gaming”) for $23.3 million in cash, subject to terms outlined in the Equity Purchase Agreement dated May 6, 2014 (“C2 Acquisition Agreement”). The acquisition was initially funded by a $10.0 million draw on our Revolving Facility and available cash on hand. The remaining purchase price is expected to be funded with either existing cash or existing availability on the Revolving Facility. C2 Gaming is an innovative manufacturer and developer of slot machines based in Las Vegas, Nevada. The purchase will provide for the distribution of C2 Gaming’s platform and content to an increased number of markets in the United States (see Note 3).

Table Games

On July 1, 2014, a wholly owned subsidiary of the Company entered into an agreement to purchase 100% of the equity of War Blackjack for approximately $1.3 million in cash, subject to terms outlined in the Stock Purchase Agreement, dated July 1, 2014 (“War Blackjack Acquisition Agreement”). The acquisition closed on July 18, 2014 and was funded by available cash on hand. War Blackjack is an innovative manufacturer and developer of table and electronic games based in Las Vegas, Nevada.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

The accompanying condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain disclosures required by generally accepted

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accounting principles (“GAAP”) are omitted or condensed in these condensed consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) that are necessary to present fairly the Company's and the Predecessor’s financial position, results of operations and cash flows for the interim periods have been made. The interim results reflected in these condensed consolidated financial statements are not necessarily indicative of results to be expected for the full fiscal year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.

References in this Quarterly Report on Form 10-Q to “Successor” refer to the Company on or after December 21, 2013 and reflect assets and liabilities at fair value by allocating the Company’s enterprise value to its assets and liabilities pursuant to accounting guidance related to business combinations. References to “Predecessor” refer to AGS Capital, LLC (“AGS Capital”) prior to December 21, 2013 and reflect the historical accounting basis in the Predecessor’s assets and liabilities.

Principles of Consolidation

The accompanying condensed consolidated financial statements include the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

The accompanying condensed consolidated financial statements for the Predecessor include AGS Capital, its wholly owned subsidiaries, AGS LLC (“AGS”), AGS Partners, LLC, AGS Illinois, LLLP and American Gaming Systems Toronto, Ltd., f/k/a GTNA Solutions Corp. All significant intercompany transactions and balances have been eliminated in consolidation.

Variable interest entities

A legal entity is referred to as a variable interest entity if, by design (1) the total equity investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support from other parties, or (2) the entity has equity investors that cannot make significant decisions about the entity’s operations through voting rights, or do not have the obligation to absorb the expected losses, or do not have the right to receive the residual returns of the entity. Variable interest entities for which the Company is the primary beneficiary are consolidated.

In accordance with the guidance for the consolidation of variable interest entities, the Company analyzes our variable interests, to determine if an entity in which we have a variable interest is a variable interest entity and whether we must consolidate that variable interest entity. Our analysis includes both quantitative and qualitative reviews.

On November 19, 2013, AGS Capital created a wholly owned subsidiary, AP Gaming NV, LLC (“AP Gaming NV”) to address Nevada gaming regulatory requirements on a temporary basis. At the Acquisition date, AGS Capital sold all of the equity interest in AP Gaming NV to an officer of the Company. The Company’s officers hold management positions with AP Gaming NV and directs the operations of AP Gaming NV. As a result, the Company determined that AP Gaming NV is a Variable Interest Entity and the Company is the primary beneficiary. The Company therefore has consolidated AP Gaming NV in the accompanying condensed consolidated financial statements.

The Company had a call option to repurchase the equity of AP Gaming NV, upon receipt of all regulatory approvals. In July 2014, the Company received regulatory approvals and exercised the call option and repurchased 100% of the equity of AP Gaming NV. The exercise of this call option had no impact on the condensed consolidated financial statements of the Company.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires the Company to make decisions based upon estimates, assumptions, and factors considered relevant to the circumstances. Such decisions include the selection of applicable accounting principles and the use of judgment in their application, the results of which impact reported amounts and disclosures. Changes in future economic conditions or other business circumstances may affect the outcomes of the estimates and assumptions. Accordingly, actual results could differ materially from those anticipated.

Revenue Recognition

Gaming Revenue

Gaming revenue is of a recurring nature and is generated by providing customers with gaming terminals, gaming terminal content licenses and back-office equipment, which are collectively referred to as gaming equipment, under participation arrangements. These participation arrangements are accounted for as operating leases pursuant to ASC 840, Leases. These arrangements are considered to be leases, as the agreements convey the right to use the equipment (i.e. gaming machines and

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related integral software) for a stated period of time. Under these arrangements, the Company retains ownership of the gaming equipment installed at customer facilities, and receives either revenue based on a percentage of the win per day generated by the gaming equipment or a daily fee. The majority of the Company’s leases require the Company to provide maintenance throughout the entire term of the lease. In some cases, a performance guarantee exists that, if not met, requires the Company to replace or remove the gaming machines from the customer’s floor. Whether contractually required or not, the Company develops and provides new gaming titles throughout the life of the lease. Certain arrangements require a portion of the facilities’ win per day to be set aside to be used to fund facility-specific marketing, advertising, promotions and service. These amounts are offset against revenue. Gaming revenue is also derived from the licensing of table games content and is earned and recognized on a fixed monthly rate.

Gaming Revenue - other

Licensing revenue represents the Company’s licensing of trademarked title names to a single company in the sweepstakes phone card business. The Company recognized revenue when earned. The Company terminated this agreement in the first quarter of 2013.

Equipment Sales

Revenues from the stand-alone product sales or separate accounting units are recorded when:


•	Persuasive evidence of an arrangement exists;


•	The sales price is fixed and determinable;


•	Delivery has occurred and services have been rendered; and


•	Collectability is probable.

Equipment sales are generated from the sale of gaming machines and licensing rights to game content software that is installed in the gaming machine, parts, and other ancillary equipment. Also included within the deliverables is delivery, installation and training, all of which occur within a few days of arriving at the customer location. Gaming equipment sales do not include maintenance beyond a standard warranty period. The recognition of revenue from the sale of gaming devices occurs as title and risk of loss have passed to the customer and all other revenue recognition criteria have been satisfied. As the combination of game content software and the tangible gaming device function together to deliver the product’s essential functionality, revenue from the sale of gaming devices is recognized under general revenue recognition guidance.

Cash and Cash Equivalents

Cash and cash equivalents consist primarily of deposits held at major banks and other marketable securities with original maturities of 90 days or less.

Restricted Cash

Restricted cash amounts represent funds held in escrow as collateral for the Company’s surety bonds for various gaming authorities.

Notes Receivable and Development Agreements

The Company enters into development agreements to provide financing for new tribal gaming facilities, or for the expansion of existing facilities. The agreements generally come in two forms. The first is in the form of a loan. Interest income is recognized on the repayment of the notes based on the stated rate or, if not stated explicitly in the development agreement, on an imputed interest rate. If the stated interest rate is deemed to be other than a market rate or zero, a discount is recorded on the note receivable as a result of the difference between the stated and market rate and a corresponding intangible is recorded. The intangible is recognized in the financial statements as a contract right under development agreement and amortized as a reduction in revenue over the term of the agreement. The second is in the form of an advance that is not expected to be repaid. These advances are accounted for as customer rights and amortized over the term of the agreement as a reduction in revenue. In both scenarios, the customer commits to a fixed number of gaming terminal placements in the facility, and the Company receives a fixed percentage of those gaming terminals’ win per day over the term of the agreement or a daily fee per gaming terminal. Certain agreements contain performance standards for the gaming terminals that could allow the facility to reduce a portion of the guaranteed floor space. In the event a portion of the guaranteed floor space is reduced, the Company would reduce the associated intangible asset. Interest income related to notes receivable is recorded as interest income in the accompanying condensed consolidated statement of operations and comprehensive loss.

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Generally, the Company utilizes the term of a contract to amortize the intangible assets associated with development agreements. The Company reviews the carrying value of these contract rights at least annually, or whenever changes in circumstances indicate the carrying value of these assets may not be recoverable. While management believes that the estimates and assumptions used in evaluating the carrying value of these assets are reasonable, different assumptions could materially affect either the carrying value or the estimated useful lives of the contract rights.

The Company accrues interest, if applicable, on its notes receivables per the terms of the agreement. Interest is not accrued on past due notes receivable, or individual amounts that the Company has determined and specifically identified as not collectible. The Company will resume accruing interest to the extent payments are being received and collectability is determined to be highly probable.

The Company assesses the impairment of notes whenever events or changes in circumstances indicate the carry value may not be realized. Impairment is measured based on the present value of the expected future cash flows and is recorded as bad debt expense in the period of assessment. Pursuant to the Acquisition Agreement, notes receivable were retained by AGS Holdings on the Closing Date and accordingly, the Company had no allowance for notes receivable as of December 31, 2013. Additionally, the Company had no allowance for notes receivable as of September 30, 2014. The activity related to the allowance for notes receivable for the three and nine months ended September 30, 2013 is as follows (in thousands):



	Predecessor
	Allowance for Notes Receivables three months ended September 30, 2013
	Beginning Balance		Charge-offs			Recoveries		Provision		Ending Balance		Ending Balance Individually Evaluated For Impairment		Ending Balance Collectively Evaluated For Impairment
Notes receivable, current	$	—	$	—		$	—	$	—	$	—	$	—	$	—
Notes receivable, non-current	443		(419		)	—		—		24		24		—
	$	443	$	(419	)	$	—	$	—	$	24	$	24	$	—



	Predecessor
	Allowance for Notes Receivables nine months ended September 30, 2013
	Beginning Balance		Charge-offs			Recoveries		Provision			Ending Balance		Ending Balance Individually Evaluated For Impairment		Ending Balance Collectively Evaluated For Impairment
Notes receivable, current	$	—	$	—		$	—	$	—		$	—	$	—	$	—
Notes receivable, non-current	447		(419		)	—		(4		)	24		24		—
	$	447	$	(419	)	$	—	$	(4	)	$	24	$	24	$	—

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts related to accounts receivable and notes receivable deemed to have a high risk of collectability. The Company reviews the accounts receivable and notes receivable on a monthly basis to determine if any receivables will potentially be uncollectible. The Company analyzes historical collection trends and changes in the customers’ payment patterns, customer concentration, and credit worthiness when evaluating the adequacy of the allowance for doubtful accounts. A large percentage of receivables are with Native American tribes that have their reservations and gaming operations in the state of Oklahoma, and the Company has concentrations of credit risk with several tribes. The Company includes any receivable balances that are determined to be uncollectible in the overall allowance for doubtful accounts. Changes in the assumptions or estimates reflecting the collectability of certain accounts could materially affect the allowance for both trade and notes receivable.

Inventories

Inventories consist primarily of parts and supplies that are used to repair and maintain machinery and equipment. Inventories are stated at the lower of cost or market. Cost of inventories is determined using the first-in, first-out (“FIFO”) method for all components of inventory. The Company regularly reviews inventory quantities and update estimates for the net realizable value of inventories. This process includes examining the carrying values of parts and ancillary equipment in

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comparison to the current fair market values for such equipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levels of the inventories, the current and projected sales levels for such products, the projected markets for such products and the costs required to sell the products, including refurbishment costs. Changes in the assumptions or estimates could materially affect the inventory carrying value.

Gaming Equipment, Vehicles and Other Equipment

The cost of gaming equipment, consisting of fixed-base player terminals, file servers and other support equipment as well as vehicles and other equipment, is depreciated over their estimated useful lives, using the straight-line method for financial reporting. Repairs and maintenance costs are expensed as incurred. The Company routinely evaluates the estimated lives used to depreciate assets. The estimated useful lives are as follows:



Gaming equipment deployed	3 to 6 years
Vehicles and other equipment	3 to 7 years

The Company measures recoverability of assets to be held and used by comparing the carrying amount of an asset to future cash flows expected to be generated by the asset. The Company’s policy is to impair, when necessary, excess or obsolete gaming terminals on hand that it does not expect to be used. Impairment is based upon several factors, including estimated forecast of gaming terminal demand for placement into casinos. While the Company believes that the estimates and assumptions used in evaluating the carrying amount of these assets are reasonable, different assumptions could affect either the carrying amount or the estimated useful lives of the assets, which could have a significant impact on the results of operations and financial condition. The Company recognized an impairment charge for obsolete gaming terminals for the three and nine months ended September 30, 2014 of $0 and $0.1 million, respectively. The Predecessor recognized an impairment charge for obsolete gaming terminals for each of the three and nine months ended September 30, 2013 of $3.4 million.

Intangible Assets

The Company reviews its identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment losses are recognized for identifiable intangibles, other than goodwill, when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets’ carrying amount.

Impairment of the definite-lived intangible assets is reviewed at a minimum once a quarter. When the estimated undiscounted cash flows are not sufficient to recover the intangible assets’ carrying amount, an impairment loss is measured to the extent the fair value of the asset is less than its carrying amount.

The American Gaming Systems trade name intangible asset has an indefinite useful life. We do not amortize the indefinite lived trade name intangible, but instead test for possible impairment at least annually or when circumstances warrant. We perform a qualitative assessment to determine if it is more likely than not that the fair value of the asset is less than its carrying amount. If we believe, as a result of our qualitative assessment, that it is more likely than not that the fair value of the asset is less than its carrying amount, the quantitative impairment test is required.

Costs of Computer Software

Internally developed gaming software represents the Company’s internal costs to develop gaming titles to utilize on the Company’s gaming terminals. Internally developed gaming software is accounted for under FASB ASC Topic 985-20, Costs of Software to Be Sold, Leased or Marketed, and is stated at cost, which is amortized over the estimated useful lives of the software, generally using the straight-line method. Software development costs are capitalized once technological feasibility has been established and are amortized when the software is placed into service. Any subsequent software maintenance costs, such as bug fixes and subsequent testing, are expensed as incurred. Discontinued software development costs are expensed when the determination to discontinue is made. Software developments costs are amortized over the expected life of the title or group of titles, if applicable, to amortization expense.

On a quarterly basis, or more frequently if circumstances warrant, the Company compares the net book value of its internally developed computer software to the net realizable value on a title or group of title basis. The net realizable value is determined based upon certain assumptions, including the expected future revenues and net cash flows of the gaming titles or group of gaming titles utilizing that software, if applicable.

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Goodwill

The excess of the purchase price of entities that are considered to be purchases of businesses over the estimated fair value of the assets acquired and the liabilities assumed is recorded as goodwill. The Company is required to perform an annual goodwill impairment review, and depending upon the results of that measurement, the recorded goodwill may be written down and charged to income from operations when its carrying amount exceeds its estimated fair value.

During the quarter ended September 30, 2014, the Company voluntarily changed the date of its annual goodwill and other indefinite-lived intangible asset impairment testing from the last day of the third quarter (September 30) to the first day of the fourth quarter (October 1). This voluntary change is preferable as it provides the Company with additional time to complete its annual goodwill and indefinite-lived intangible asset impairment testing in advance of reporting the results of such testing with the SEC. The voluntary change in accounting principle related to the annual testing day will not delay, accelerate or avoid an impairment charge. This change is not applied retrospectively as it is impracticable to do so because retrospective application would require the application of significant estimates and assumptions with the use of hindsight. Accordingly, the change will be applied prospectively.

Goodwill is reviewed for possible impairment annually on October 1 of each year or more frequently whenever events or changes in circumstances indicate that the carrying value may not be recoverable, such as a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, or a loss of key personnel. In connection with the Acquisition, the Company recorded $63.9 million of goodwill. The Company recorded an additional $12.4 million of goodwill related to the acquisition of C2 Gaming.

Deferred Loan Costs

Deferred loan costs consist of various debt issuance costs and are being amortized on the effective-interest method over the life of the related loans. The Company recognized amortization expense related to loan costs of $0.2 million and $0.3 million for the three months ended September 30, 2014 and 2013, respectively, and $0.6 million and $1.0 million for the nine months ended September 30, 2014 and 2013, respectively, which was included in interest expense in the accompanying condensed consolidated statements of operations and comprehensive loss.

Acquisition Accounting

We follow acquisition accounting for all acquisitions that meet the business combination definition. Acquisition accounting requires us to measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest at the acquisition-date fair value. While we use our best estimates and assumptions as part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement.

Fair Value of Financial Instruments

The Company applies the provisions of ASC 820, “Fair Value Measurements” (ASC 820) to its financial assets and liabilities. Fair value is defined as a market-based measurement intended to estimate the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. ASC 820 also established a fair value hierarchy, which requires an entity to maximize the use of observable inputs when measuring fair value. These inputs are categorized as follows:


•	Level 1 - quoted prices in an active market for identical assets or liabilities;


•	Level 2 - quoted prices in an active market for similar assets or liabilities, inputs other than quoted prices that are observable for similar assets or liabilities, inputs derived principally from or corroborated by observable market data by correlation or other means; and


•	Level 3 - valuation methodology with unobservable inputs that are significant to the fair value measurement.

The carrying values of the Company’s cash and cash equivalents, restricted cash, receivables and accounts payable approximate fair value because of the short term maturities of these instruments. The fair value of our long-term debt is based on the quoted market prices for similar issues (Level 2 inputs). The estimated fair value of our long-term debt as of September 30, 2014 was $155.4 million.

Research and Development

The Company conducts research and development activities primarily to develop new gaming platforms and gaming content. These research and development costs consist primarily of salaries and benefits and are expensed as incurred. Once the technological feasibility of a project has been established, capitalization of development costs begins until the product is

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available for general release. Research and development expenses were $0.3 million and $0.4 million for the three months ended September 30, 2014 and 2013, respectively, and $1.3 million and $1.4 million for the nine months ended September 30, 2014 and 2013, respectively, and is included as a component of general and administrative expense in the accompanying condensed consolidated statements of operations and comprehensive loss.

Contingencies

The Company assesses its exposures to loss contingencies including claims and legal proceedings and accrues a liability if a potential loss is considered probable and the amount can be estimated. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, if the actual loss from a contingency differs from management’s estimate, there could be a material impact on the results of operations or financial position. Operating expenses, including legal fees, associated with contingencies are expensed when incurred.

Foreign Currency Translation

The financial statements of the Company’s Canadian subsidiary are translated into U.S. dollars at the year-end rate of exchange for asset and liability accounts and the average rate of exchange for income statement accounts. The effects of these translations are recorded as a component of other accumulated comprehensive income (loss) in stockholders’ equity.

Recently Issued Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which provides that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. These amendments in this ASU are effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2013. The adoption of this standard by the Company on January 1, 2014 had no material impact on the Company’s condensed consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which clarifies the principles for recognizing revenue from contracts with customers. The amendment outlines a single comprehensive model for entities to depict the transfer of goods or services to customers in amounts that reflect the payment to which a company expects to be entitled in exchange for those goods or services. The amendment also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The amendment is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2016 and may be adopted using either a full retrospective transition method or a modified retrospective transition method. Early adoption is not permitted. The Company is currently evaluating the provisions of the amendment and the impact on its future consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. The amendments clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The Company is currently evaluating the provisions of ASU 2014-12 and has not yet determined the impact on its financial position, results of operations or cash flows.

In August 2014, the FASB issued an accounting standards update that requires management to assess an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, consolidated in the aggregate, indicate that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date

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that the financial statements are issued. Currently, there is no guidance in U.S. GAAP for management's responsibility to perform an evaluation. Under the update, management's evaluation is to be performed when preparing financial statements for each annual and interim reporting period and based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. The Company will adopt this standard effective January 1, 2017. The Company is currently assessing the impact the adoption of this standard will have on its consolidated financial statements.

Immaterial error correction

In June 2014, the Company determined that costs to install and deliver leased gaming machines were being capitalized and incorrectly depreciated over the useful life of the machine rather than capitalized as initial direct costs and amortized over the term of the lease and that gaming machines associated with our gaming equipment leases in Illinois should have been depreciated over 6 years as compared to 5 years. The Company recorded adjustments for the cumulative effect of the correction for the Successor Period in June 2014 (see Note 6). Accordingly, in the nine months ended September 30, 2013, the Company increased gaming operating expenses by $0.7 million and decreased depreciation expense by $0.2 million to conform the Predecessor financial statements to the current year presentation.

NOTE 3. ACQUISITIONS

The Acquisition

As discussed in Note 1 to the consolidated financial statements, on September 16, 2013, the Company acquired, through a wholly owned subsidiary, 100% of the equity in AGS Capital from AGS Holdings. The Acquisition was consummated on December 20, 2013.

The Acquisition was financed in part by the Senior Secured Credit Facilities, which are comprised of the $155 million Term Facility and the $25 million Revolving Facility (each, as defined herein). AP Gaming I, LLC, an indirect wholly owned subsidiary of AP Gaming, is the borrower of the Senior Secured Credit Facilities, which are guaranteed by AP Gaming Holdings, LLC (“AP Gaming Holdings”), AP Gaming I, LLC’s direct parent company, and each of AP Gaming I, LLC’s direct and indirect material wholly owned domestic subsidiaries including AGS Capital. Additionally, the Company issued 10,000,000 Class A shares of common stock at $0.01 par value to Apollo Gaming Holdings, L.P. The total cost to acquire all the outstanding shares was $100,000,000. The source of the funds for the acquisition of the Company was provided by committed equity capital contributed by certain equity funds managed by Apollo.

The contractual purchase price of $220.3 million, a seller note of $2.2 million, the settlement of $3.3 million in contingent consideration resulting in an additional seller note of $3.3 million issued in January 2014, and a working capital reduction of $5.3 million, resulted in an aggregate purchase price of $220.5 million. The contingent consideration of $3.3 million was based on certain financial performance metrics that were achieved between signing and closing.

The following summarizes the consideration paid for the Acquisition of AGS Capital (in thousands):



Contractual cash purchase price	$	220,300
Seller notes	5,531
Working capital adjustment	(5,340		)
Total consideration	$	220,491

The Acquisition was accounted for as a business combination using the acquisition method of accounting, whereby the purchase price was allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair market values. Fair value measurements have been applied based on assumptions that market participants would use in the pricing of the assets or liabilities.

During the Company’s continued review of the allocation of the purchase price to the identified tangible and intangible assets, the Company refined certain assumptions used in the calculation of the internally developed gaming software. As a result the Company reduced the value of the acquired internally developed gaming software by $1.5 million with a corresponding increase to goodwill in the first quarter of 2014.

In the second quarter of 2014, the Company reduced the value of the acquired gaming equipment, vehicles and other equipment, net by $2.0 million with a corresponding increase to goodwill. The decrease to the gaming equipment, vehicles and other equipment, net was a result of the removal of installation and delivery costs that were included in the fair value of the gaming machines in the valuation (see Note 6).

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An allocation of the purchase price has been made to major categories of assets and liabilities based on management’s estimates. The allocation of the purchase price to the estimated fair values of the assets acquired and the liabilities assumed was as follows (in thousands):



At December 20, 2013
Currents assets	$	17,858
Gaming equipment, vehicles and other equipment, net	46,734
Goodwill	63,873
Intangible assets	97,512
Other long-term assets	1,616
Total assets	227,593
Total liabilities	7,102
Total equity purchase price	$	220,491

Our estimates of the fair values of depreciable tangible assets are as follows (in thousands):

Our estimates of the fair values of identifiable intangible assets are as follows (in thousands):



	Fair values at December 20, 2013		Average remaining useful life (in years)
Trade name - “American Gaming Systems”	$	12,126	Indefinite
Trade name - “Gambler’s Choice”	809		7
Customer agreements and relationships	60,112		7
Third party licenses	11,520		3 - 5
Internally developed gaming software	10,872		1 - 5
Purchased software	2,073		1 - 5
	$	97,512

The fair value of acquired gaming equipment, vehicles and other, was determined using cost approaches in which we determined an estimated reproduction or replacement cost, as applicable.

The fair values of acquired finite- and indefinite-lived trade names, third party licenses and internally developed gaming software was determined using the relief from royalty method under the income approach, which is a risk-adjusted discounted cash flow approach. The relief from royalty method values an intangible asset by estimating the royalties saved through ownership of the asset. The relief from royalty method requires identifying the future revenue that would be impacted by the trade name, multiplying it by a royalty rate deemed to be avoided through ownership of the asset and discounting the projected royalty savings amounts back to the acquisition date. The royalty rate used in such valuation was based on a consideration of market rates for similar categories of assets. The indefinite-lived trade name relates to "American Gaming Systems" and the finite-lived trade name relates to "Gambler’s Choice".

The fair value of the acquired customer relationships was determined using the excess earnings method, which is a risk-adjusted discounted cash flow approach that determines the value of an intangible asset as the present value of the cash flows attributable to such asset after excluding the proportion of the cash flows that are attributable to other assets. The contribution to the cash flows that are made by other assets - such as fixed assets, working capital, workforce and other intangible assets, including trade names and internally developed gaming software and third party licenses - was estimated through contributory asset capital charges. The value of the acquired customer relationship asset is the present value of the attributed post-tax cash flows, net of the post-tax return on fair value attributed to the other assets.

As a result of the Acquisition, the Company recorded goodwill of $63.9 million at September 30, 2014, which is deductible for tax purposes, primarily attributed to enhanced financial scale, opportunities for synergies and opportunities with other Apollo related companies and other strategic benefits.

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The following table presents the unaudited pro forma results as if the Acquisition had occurred at the beginning of the respective periods presented (in thousands, except per share data):



	Three months ended September 30, 2013			Nine months ended September 30, 2013
	Three months ended September 30, 2013			Nine months ended September 30, 2013
Revenues	$	14,761		$	45,938
Loss from operations	(13,581		)	(13,906		)
Net loss	(35,586		)	(40,663		)
Basic and diluted loss per share common share	(3.56		)	(4.07		)

C2 Gaming, LLC acquisition

As discussed in Note 1 to the consolidated financial statements, on May 6, 2014, a wholly owned subsidiary of the Company entered into an agreement to purchase 100% of the equity of C2 Gaming, LLC (“C2 Gaming”) for $23.3 million in cash, subject to terms outlined in the C2 Acquisition Agreement. The acquisition was initially funded by a $10.0 million draw on our Revolving Facility (as defined herein) and available cash on hand. The consideration paid for the acquisition of C2 Gaming consisted of the following (in thousands):



Paid at close	$	11,000
One-year payment	9,000
Contingent consideration	3,000
Working capital adjustment	273
Total consideration	$	23,273

The acquisition of C2 Gaming was consummated on May 6, 2014. The one-year payment of $9.0 million is due to the sellers on the one-year anniversary of the closing of the acquisition. The contingent consideration of $3.0 million is subject to the satisfaction of certain milestones, including the submittal and approval of video slot platforms to various jurisdictions as outlined in the C2 Acquisition Agreement. As these milestones were considered to be probable of being met within one year, the $3.0 million liability approximates fair value. The remaining purchase price is expected to be funded by existing cash or existing availability on the Revolving Facility.

The acquisition was accounted for as a business combination using the acquisition method of accounting, whereby the purchase price was allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair market values. Fair value measurements have been applied based on assumptions that market participants would use in the pricing of the assets or liabilities. The significant items for which a final fair value has not been determined as of the filing of this Quarterly Report on Form 10-Q include the working capital adjustment, gaming equipment, vehicles and other, and intangible assets.

A preliminary allocation of the purchase price has been made to major categories of assets and liabilities based on management’s estimates. The preliminary allocation of the purchase price to the estimated fair values of the assets acquired and the liabilities assumed was as follows (in thousands):



At May 6, 2014
Current assets	$	545
Gaming equipment, vehicles and other equipment, net	1,048
Goodwill	12,443
Intangible assets	9,509
Total assets	23,545
Total liabilities	272
Total equity purchase price	$	23,273

Our preliminary estimates of the fair values of depreciable tangible assets are as follows (in thousands):

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Our preliminary estimates of the fair values of identifiable intangible assets are as follows (in thousands):



	Fair values at May 6, 2014		Average remaining useful life (in years)
Colossal platform	$	1,941	5
Colossal titles	2,367		3
Colossal customer agreements and relationships	5,201		7
	$	9,509

The preliminary estimate of the fair value of acquired gaming equipment, vehicles and other, was determined using cost approaches in which we determined an estimated reproduction or replacement cost, as applicable.

The preliminary estimate of the fair value of the acquired Colossal platform and titles was determined using the relief from royalty method under the income approach, which is a risk-adjusted discounted cash flow approach. The relief from royalty method values an intangible asset by estimating the royalties saved through ownership of the asset.

The preliminary estimate of the fair value of the acquired customer agreements and relationships was determined using the excess earnings method, which is a risk-adjusted discounted cash flow approach that determines the value of an intangible asset as the present value of the cash flows attributable to such asset after excluding the proportion of the cash flows that are attributable to other assets.

As a result of the acquisition, the Company recorded goodwill of $12.4 million at September 30, 2014, which is deductible for tax purposes, primarily attributed to enhanced financial scale, expanded video slot platforms and other strategic benefits. Some of the values and amounts used in the initial application of purchase accounting for our consolidated balance sheet were based on estimates and assumptions.

NOTE 4. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table presents the changes by component, net of tax, in accumulated other comprehensive income (loss) of the Company (in thousands):



	Foreign currency translation			Accumulated other comprehensive income (loss)
December 31, 2013	$	(1	)	$	(1	)
Current period other comprehensive gain	228			228
September 30, 2014	$	227		$	227

NOTE 5. CONTRACT RIGHTS UNDER DEVELOPMENT AGREEMENTS AND CUSTOMER AGREEMENTS

The Company enters into development agreements and placement fee agreements with certain customers to secure floor space under lease agreements for its gaming machines. Amounts paid in connection with the development agreements are repaid to the Company in accordance with the terms of the agreement, whereas placements fees are not reimbursed. Placement fees can be in the form of cash paid upfront or free lease periods and are accreted over the life of the contract and the expense is recorded as a reduction of revenue. For the three months ended September 30, 2014 and 2013, $6,000 and $1.0 million, respectively, and for the nine months ended September 30, 2014 and 2013, $15,000 and $3.0 million, respectively, were recorded as a reduction of revenue as accretion of contract rights under development agreements and customer agreements.

In connection with the Acquisition, the contract rights under development agreements and customer agreements that existed at December 20, 2013 were ascribed no value and a new intangible asset related to “Customer agreements and relationships as a result of purchase accounting related to the Acquisition” was established (see Note 7). Amortization of the fair value of this asset will be recorded in depreciation and amortization expense in the condensed consolidated statements of operations and comprehensive loss.

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NOTE 6. GAMING EQUIPMENT, VEHICLES AND OTHER EQUIPMENT

Gaming equipment, vehicles and other equipment consist of the following (in thousands):



	September 30, 2014			December 31, 2013
Gaming equipment	$	50,664		$	44,212
Vehicles and other equipment	6,477			5,770
Less: Accumulated depreciation	(12,975		)	(477		)
Total gaming equipment, vehicles and other equipment, net	$	44,166		$	49,505

The above amounts, as of September 30, 2014 and December 31, 2013, include net fair value adjustments recorded as part of purchase accounting that increased the aggregate carrying value of property and equipment as of the Closing Date (see Note 3).

Gaming equipment, vehicles and other equipment are depreciated over the respective useful lives of the assets ranging from three to seven years. Depreciation expense was $4.7 million and $3.4 million for the three months ended September 30, 2014 and 2013, respectively. Depreciation expense was $12.9 million and $11.5 million for the nine months ended September 30, 2014 and 2013, respectively.

Immaterial Error Correction

The Company determined that costs to install and deliver leased gaming machines were being capitalized and incorrectly depreciated over the useful life of the machine rather than capitalized as initial direct costs and amortized over the term of the lease in accordance with ASC 840-20-35-2. Additionally, the Company determined the gaming machines associated with our gaming equipment leases in Illinois should have been depreciated over 6 years as compared to 5 years given this period represents the estimated term of leases in Illinois and the fact that this represents the useful life in this jurisdiction. Based on the analysis performed, the estimated fair value of gaming equipment, vehicles and other equipment acquired in the Acquisition was overstated by $2.0 million. The Company reduced gaming equipment, vehicles and other equipment by $2.0 million with a corresponding increase to goodwill in the second quarter of 2014. Additionally, for activity subsequent to the Acquisition, the cumulative effect of the analysis performed resulted in a decrease of $2.0 million to gaming equipment, an increase of $0.2 million and $0.4 million to deposits and other and other assets, respectively, and a reduction of $0.3 million in depreciation expense related to the period from the Acquisition date to the second quarter of 2014. We have performed an evaluation to determine if the financial statement impact resulting from these errors in accounting were material, considering both quantitative and qualitative factors. Based on this materiality analysis, we concluded that correcting the cumulative error would be immaterial to the current year financial statements and a correction of the errors, individually and in the aggregate, would not have a material impact to any individual prior post Acquisition period financial statements. Accordingly, we recorded the entire cumulative reduction to depreciation expense of $0.3 million ($0.03 per share) in the consolidated statements of operations and comprehensive loss for the three months ended June 30, 2014. The Company has accounted for installation and delivery costs for the quarter ended September 30, 2014, in accordance with ASC 840-20-35-2 and have continued to depreciate gaming equipment in Illinois over 6 years. Additionally, to conform the Predecessor financial statements to the current year presentation, the Company recorded adjustments in the nine months ended September 30, 2013 (see Note 2).

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NOTE 7. GOODWILL AND INTANGIBLES

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



	September 30, 2014						December 31, 2013
	Gross Carrying amount		Accumulated Impairment		Net Carrying Value		Gross Carrying amount		Accumulated Impairment		Net Carrying Value
Goodwill	$	76,316	$	—	$	76,316	$	60,384	$	—	$	60,384

Intangible assets consist of the following (in thousands):



		September 30, 2014							December 31, 2013
	Useful life (years)	Gross Value		Accumulated Amortization			Net Carrying Value		Gross Value		Accumulated Amortization			Net Carrying Value
Trade name - “American Gaming Systems”	Indefinite	$	12,126	$	—		$	12,126	$	12,126	$	—		$	12,126
Trade name - “Gambler’s Choice”	7	809		(90		)	719		809		(3		)	806
Customer agreements and relationships as a result of purchase accounting in connection with the Acquisition	7	60,112		(6,695		)	53,417		60,112		(254		)	59,858
Customer agreements and relationships as a result of the C2 Gaming acquisition	7	5,201		(299		)	4,902		—		—			—
Customer agreements	1 - 7	407		(20		)	387		—		—			—
Covenants not to compete	3	10		—			10		—		—			—
Third party licenses	3 - 5	11,520		(1,845		)	9,675		11,520		(70		)	11,450
Internally developed gaming software	1 - 5	13,740		(2,577		)	11,163		12,474		(108		)	12,366
Acquired intellectual property	10 - 20	5,993		(12		)	5,981		—		—			—
Purchased software	1 - 5	7,205		(896		)	6,309		2,076		(18		)	2,058
		$	117,123	$	(12,434	)	$	104,689	$	99,117	$	(453	)	$	98,664

The above amounts as of September 30, 2014 and December 31, 2013, include net fair value adjustments recorded as part of purchase accounting that increased the aggregate carrying value of intangible assets and resulted in the recognition of $60.4 million in goodwill as of the Closing Date that was further adjusted to $63.9 million as of September 30, 2014 (see Note 3).

The Company recognized an additional $12.4 million in goodwill as a result of the acquisition of C2 Gaming.

Upon the application of purchase accounting, on the Closing Date, the Company recognized $12.1 million in an indefinite life trade name related to the “American Gaming Systems” trade name and $0.8 million in a trade name related to the “Gambler’s Choice” trade name with an estimated useful life of 7 years. Additionally, the Company recorded $60.1 million in customer agreements and relationships on the Closing Date as a result of the valuation. The Company reviewed the terms of the agreements and the historical relationship with their existing customers and determined an estimated useful life of 7 years.

Upon the application of purchase accounting, in connection with the acquisition of C2 Gaming, the Company recognized $5.2 million in customer relationships and $4.3 million in purchased software on May 6, 2014.

The Company accounted for the acquisition of Casino War Blackjack as an asset acquisition, where the acquired assets are measured by allocating the cost of the acquisition on a relative fair value basis. The cost of the acquisition was allocated to intellectual property owned by Casino War Blackjack. In addition to the acquisition of Casino War Blackjack, during the three and nine months ended September 30, 2014, the Company acquired intellectual property related to several table games patents, including $3.8 million paid to In Bet, LLC. The total acquired intellectual property for the three and nine months ended September 30, 2014 was $6.0 million.

Intangibles are amortized over the respective estimated useful lives of the assets ranging from one to fifteen years. Amortization expense related to intangibles, inclusive of accretion of contract rights under development agreements and customer agreements, was $4.3 million and $4.3 million for the three months ended September 30, 2014 and 2013,

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respectively, and $12.2 million and $13.2 million for the nine months ended September 30, 2014 and 2013, respectively. Included in depreciation and amortization expense is amortization of internally developed software of $0.9 million and $0.9 million for the three months ended September 30, 2014 and 2013, respectively and $2.7 million and $2.6 million for the nine months ended September 30, 2014 and 2013, respectively.

Management reviews intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For the three and nine months ended September 30, 2013, the Company recognized an impairment charge of $1.4 million, primarily related to a lease incentive paid to a customer that operates and services slot routes in Illinois. For the three and nine months ended September 30, 2014, the Company recognized an impairment charge of $1.3 million, primarily related to the retirement of internally developed gaming titles.

NOTE 8. CANADIAN PAYROLL TAX RECEIVABLE

Certain Company expenditures incurred through its subsidiary AGS Toronto are eligible for the Ontario Interactive Digital Media Tax Credit (“OIDMTC”). The OIDMTC is a refundable payroll tax credit paid to corporations that develop interactive digital media products within Ontario. The OIDMTC is based upon the Ontario labor expenditures and eligible marketing and distribution expenditures claimed by a qualifying corporation with respect to eligible products. For a certified game developer, eligible expenses include Ontario salaries and wages. The developer must incur at least $1 million of Ontario labor expenses per year developing eligible interactive digital media games to qualify.

Pursuant to the Acquisition Agreement the Canadian payroll tax receivable balance, on the Closing Date, was retained by AGS Holdings. The Company has recognized a Canadian payroll tax receivable related to the OIDMTC of $0.2 million and $23,000 as of September 30, 2014 and December 31, 2013, respectively.

NOTE 9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consist of the following (in thousands):



	September 30, 2014		December 31, 2013
Trade accounts payable	$	1,577	$	2,005
Salary and payroll tax accrual	3,295		1,660
Accrued commission	287		318
C2 Gaming one-year payout (see Note 3)	9,000		—
C2 Gaming contingent consideration (see Note 3)	3,000		—
Proceeds from employees in advance of common stock issuance (see Note 11)	1,969		—
Accrued other	3,138		2,264
Total accounts payable and accrued liabilities	$	22,266	$	6,247

NOTE 10. LONG-TERM DEBT

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



	September 30, 2014			December 31, 2013
$155 million Term Facility, interest above LIBOR or base rate (9.25% at September 30, 2014), net of unamortized discount of $4.3 and $4.6 million at September 30, 2014 and December 31, 2013, respectively.	$	149,568		$	150,364
$25 million Revolving Facility, interest above LIBOR or base rate (8.49% at September 30, 2014).	10,000			—
Equipment long-term note payable	2,456			—
Seller notes	5,761			5,531
Total debt	167,785			155,895
Less—Amounts due within one year	(2,478		)	(1,550		)
Long-term debt	$	165,307		$	154,345

Senior Secured Credit Facilities

Concurrent with the consummation of the Acquisition, on the Closing Date the Company entered into our senior secured credit facilities, which consist of a $155 million term loan facility (the “Term Facility”) and a $25 million revolving credit

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facility (the “Revolving Facility” and, together with the Term Facility, the “Senior Secured Credit Facilities”). AP Gaming I, LLC (the “Borrower”), a wholly owned indirect subsidiary of AP Gaming, is the borrower under the Senior Secured Credit Facilities and Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc. and Nomura Securities International, Inc. acted as joint lead arrangers and joint bookrunners for the Senior Secured Credit Facilities.

The Term Facility will mature on the seventh anniversary of the Closing Date, and the Revolving Facility will mature on the fifth anniversary of the Closing Date. The Term Facility requires scheduled quarterly payments in amounts equal to 0.25% of the original aggregate principal amount of the term loans, with the balance due at maturity. Borrowings under the Term Facility bear interest at a rate equal to, at the Borrower’s option, either LIBOR or the base rate, subject to an interest rate floor plus an applicable margin rate. Borrowings under the Revolving Facility bear interest at a rate equal to, at the Borrower’s option, either LIBOR or the base rate plus an applicable margin rate. In addition, on a quarterly basis, the Borrower is required to pay each lender under the Revolving Facility a commitment fee in respect of any unused commitments thereunder at a rate of 0.50% per annum. As of September 30, 2014, $10.0 million was outstanding under the Revolving Facility.

The Senior Secured Credit Facilities are guaranteed by AP Gaming Holdings, the Borrower’s material, wholly owned domestic subsidiaries (subject to certain exceptions), and are secured by a pledge by AP Gaming Holdings of the Borrower’s equity interest directly held by AP Gaming Holdings and a pledge of substantially all of the existing and future property and assets of the Borrower and the subsidiary guarantors, subject to certain exceptions. The Senior Secured Credit Facilities require that the Borrower maintain a maximum net first lien leverage ratio set at a maximum of 5.5 to 1 beginning with the first quarter ending June 30, 2014. The Senior Secured Credit Facilities contain limitations on additional indebtedness, guarantees, incurrence of liens, investments and distributions, as defined. The Senior Secured Credit Facilities also contain customary events of default included in similar financing transactions, including, among others, failure to make payments when due, default under other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments. The Company was in compliance with the covenants of the Senior Secured Credit Facilities at September 30, 2014.

In connection with the Acquisition, the Company issued two promissory notes (the “Seller Notes”) to AGS Holdings, LLC, in the amounts of $2.2 million and $3.3 million, to satisfy the conditions set forth in the Acquisition Agreement. At September 30, 2014, notes payable related to the Seller Notes totaled $5.8 million, which included $0.3 million in capitalized interest. The Seller Notes accrue interest on the unpaid principal balance at 8.5% per annum and shall be payable in United States dollars semi-annually in arrears on June 30 and December 31 (and on the Maturity Date), commencing on June 30, 2014. Any interest accrued and payable on any interest payment date will be paid by capitalizing such interest and adding it to (and thereby increasing) the outstanding principal amount of this Seller Notes. All principal under the Seller Notes are due and payable on June 18, 2021 (the “Maturity Date”). The Company may prepay from time to time all or any portion of the outstanding principal balance due under the Seller Notes.

In January 2014, the Company entered into a financing agreement to purchase certain gaming devices and/or systems and related equipment in the amount of $2.7 million. The agreement requires monthly payments commencing 90 days from the date of delivery with a term of 34 months at an annual fixed interest rate of 7.5%.

The Term Loans

On August 15, 2012, the Company entered into a $130 million senior secured credit agreement with UBS Securities, LLC (“UBS”). Under this credit agreement the Company borrowed $115 million as an Initial Term Loan and utilized the proceeds to repay all amounts outstanding under the May 14, 2007 UBS credit agreement and fund operations. The agreement includes a $15 million Delayed Draw Term Loan commitment, of which $7.5 million was freely available to the Company and drawn on October 25, 2012 with the remaining $7.5 million draw subject to certain criteria. The Initial Term Loan and the Delayed Draw Term Loans, collectively the “Term Loans”, accrued interest at LIBOR or base rate, at the borrower’s election, subject to an interest rate floor plus an applicable margin rate. Aggregate principal amounts of the Term Loans were payable in quarterly installments equal to 1.25% of the outstanding balance beginning September 30, 2014 with the final installment payable at August 15, 2016. Concurrent with the consummation of the Acquisition, a portion of the net proceeds from the Senior Secured

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Credit Facilities were used to repay in full the amounts outstanding under the Term Loans, which totaled $137.9 million in repaid principal, accrued and unpaid interest, breakage fees and the applicable prepayment penalty.

NOTE 11. STOCKHOLDERS’ EQUITY

Common Stock

The Company is authorized to issue up to 30,000,100 shares of its common stock, $0.01 par value per share, of which 10,000,100 shares were issued and outstanding as of September 30, 2014. After the Acquisition, the Company restructured its common stock into two classes: class A voting common stock (“Class A Shares”) and class B non-voting common stock (“Class B Shares”), with Apollo Gaming Holdings, L.P. holding 10,000,000 Class A Shares. On April 28, 2014, upon receipt of all required governmental regulatory approvals, Apollo Gaming Holdings, L.P. exchanged its 10,000,000 Class A Shares for 10,000,000 Class B Shares, and the Company issued 100 Class A Shares to AP Gaming VoteCo, LLC. The holders of the Class A Shares are entitled to one vote per share on all matters to be voted on by the stockholders of the Company. The holders of the Class A Shares have no economic rights or privileges, including rights in liquidation, and have no right to receive dividends or any other distributions. The holders of the Class B Shares have no right to vote on any matter to be voted on by the stockholders of the Company. Each holder of Class B Shares is entitled to share equally, share for share, dividends declared, as well as any distributions to the stockholders, and in the event of the Company’s liquidation, dissolution or winding up, is entitled to share ratably in any remaining assets after payment of or provision for liabilities and the liquidation on preferred stock, if any.

On April 28, 2014, the Company issued 20,000 Class B Shares to its President and Chief Executive Officer for $0.2 million, which shares were subsequently repurchased by the Company on August 7, 2014. On August 8, 2014, the Company entered into subscription agreements to issue 196,875 Class B Shares to certain employees, which shares will be issued upon the Company obtaining approval for such issuance from the Nevada Gaming Commission. This issuance qualifies as shares issued to a “Management Holder” as defined in the Securityholders Agreement dated April 28, 2014 (the “Securityholders Agreement”). Class B Shares that are held by a Management Holder are subject to repurchase rights (the “Repurchase Rights”), as outlined in Section 6 of the Securityholders Agreement, that are contingent on the Management Holder’s termination. The Repurchase Rights enable the Company to recover the Class B Shares issued to Management Holders without transferring any appreciation of the fair value of the stock to the Management Holder upon certain terminations of the Management Holder’s employment prior to a “Qualified Public Offering”, as defined in the Securityholders Agreement. If a Management Holder’s employment is terminated by the Company prior to the consummation of a Qualified Public Offering for “Cause”, as defined in the Securityholders Agreement, or is terminated by such Management Holder without “Good Reason”, as defined in the Securityholders Agreement, then the Company shall have the right to repurchase all or any portion of the Class B Shares held by such Management Holder for the lessor of original cost and fair market value. If a Management Holder’s employment is terminated by the Company prior to the consummation of a Qualified Public Offering other than as described above and in the Securityholders Agreement, then the Company shall have the right to repurchase all or any portion of the Class B Shares held by such Management Holder for fair market value. The Qualified Public Offering represents a substantive performance condition that must be met for the Management Holder to benefit from the ownership of the shares. As a result, in accordance with ASC 718, shares issued to Management Holders are not considered issued for accounting purposes until such time that the performance condition is met.

As of September 30, 2014, the Company received $2.0 million in cash from certain members of management as deposits for the purchase of Class B Shares. The Class B Shares will not be issued until receipt of regulatory approvals for their issuance, which is expected to occur in the first quarter of 2015. As of September 30, 2014, these payments were classified with the accounts payable and accrued expenses on the condensed consolidated balance sheet.

Preferred Stock

The Company is authorized to issue up to 100,000 shares of preferred stock, $0.01 par value per share, of which none were issued as of September 30, 2014. The Board of Directors is expressly authorized to provide for the issuance of all or any shares of the preferred stock in one or more classes or series, to fix the number of shares constituting such series, and to increase or decrease the number of shares of any such series (but not below the number of shares thereof then outstanding) and to fix for each such class or series such voting powers, full or limited, or no voting powers, and such distinctive designations, powers, preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated and expressed in the resolution or resolutions adopted by a majority of the entire Board providing for the issuance of such class or series including, without limitation, the authority to provide that any such class or series may be (a) subject to redemption at such time or times and at such price or prices, (b) entitled to receive dividends (which may be cumulative or noncumulative) at such rates, on such conditions, and at such times, and payable in preference to, or in such relation to, the dividends payable on any other class or classes or any other series, (c) entitled to such rights upon the

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dissolution of, or upon any distribution of the assets of, the Company, or (d) convertible into, or exchangeable for, shares of any other class or classes of stock, or of any other series of the same or any other class or classes of stock, of the Company at such price or prices or at such rates of exchange and with such adjustments, all as may be stated in such resolution or resolutions. Notwithstanding the foregoing, the rights of each holder of the preferred stock shall be subject at all times to compliance with all gaming and other statutes, laws, rules and regulations applicable to the Company and such holder at that time.

NOTE 12. RELATED PARTY TRANSACTIONS

During 2010, the Predecessor entered into a separate exclusive distributor agreement with Game Ingenuity (in which a related party is a principal) to place or sell games developed utilizing Game Ingenuity intellectual property into all markets where the Company is licensed or will be licensed within one year from the placement of the first game, or as otherwise mutually agreed between the parties. During the three months ended September 30, 2014 and 2013, the Company incurred approximately $62,000 and $11,000, respectively, in expenses as part of this agreement. During the nine months ended September 30, 2014 and 2013, the Company incurred approximately $152,000 and $38,000, respectively, in expenses as part of this agreement.

For the three and nine months ended September 30, 2013, the Predecessor paid Alpine Management Services, III LLC $0.1 million and $0.2 million, respectively, for consulting services.

In July 2014, the Company entered into an intellectual property purchase agreement to purchase intellectual property developed by an employee of the Company. The Company pays royalties to the employee based on revenue generated from games developed by the employee. For the three and nine months ended September 30, 2014, the Company incurred $194 in expense as part of the agreement.

NOTE 13. WRITE DOWNS AND OTHER CHARGES

The condensed consolidated statements of operation and comprehensive loss include various non-routine transactions or related party consulting fees. During the three and nine months ended September 30, 2014, the Company recognized approximately $48,000 and $0.7 million, respectively, in write-downs and other charges related to impairment of prepaid royalties and fees related to the acquisition of C2 Gaming. During the three and nine months ended September 30, 2013, the Company recognized $0.1 million and $0.2 million, respectively, in write downs and other charges primarily for consulting fees paid to a related party.

NOTE 14. BASIC AND DILUTED LOSS PER SHARE

The Company computes net loss per share in accordance with accounting guidance that requires presentation of both basic and diluted earnings per share (“EPS”) on the face of the condensed consolidated statement of operations and comprehensive loss. Basic EPS is computed by dividing net loss for the period by the weighted average number of shares outstanding during the period. Basic EPS excludes Class B Shares issued to Management Holders until the performance condition or termination event is considered probable (see Note 11). Class B Shares issued to Management Holders will be included in the calculation of Diluted EPS using the treasury stock method. Diluted EPS is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period, increased by potentially dilutive common shares that were outstanding during the period. Diluted EPS excludes all potential dilutive shares if their effect is anti-dilutive. Potentially dilutive common shares include stock options and restricted stock (see Note 16). There were no potentially dilutive securities for the three and nine months ended September 30, 2013.

Excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2014, are 50,000 restricted shares, as such securities were anti-dilutive.

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NOTE 15. BENEFIT PLANS

The Predecessor implemented the AGS Holdings Inc. Phantom Units Plan (the “Plan”) which was intended to reinforce and encourage the continued attention and dedication of certain Covered Executives (as defined) to their assigned duties to the Predecessor until a Change in Control (as defined) has occurred. Units of the Plan have been issued as a percentage and in terms of number of units within the Plan at a strike price of $56.0 million and vest over a period of up to four years. The value of the units was determined as the product of the percentage held in the Plan and the summation of the enterprise value of the Company less the net debt of the Company less the strike price. During 2013, $2.1 million was paid out under the terms of the Plan. During the second quarter of 2014, the Plan was finalized and settled resulting in a payment of approximately $22,000 to Plan unit holders.

The Company has established a 401(k) defined contribution plan (the “401(k) Plan”) for its employees. The 401(k) Plan allows employees to contribute up to 15% of their pretax earnings, and the Company may match a percentage of the contributions on a discretionary basis. The expense associated with the 401(k) Plan for the three months ended September 30, 2014 and 2013 was approximately $81,000 and $61,000, respectively. The expense associated with the 401(k) Plan for the nine months ended September 30, 2014 and 2013 was approximately $229,000 and $190,000, respectively.

On April 28, 2014, the Board of Directors of the Company approved the 2014 Long-Term Incentive Plan (“LTIP”). Under the LTIP, the Company is authorized to grant nonqualified stock options, rights to purchase Class B Shares, restricted stock, restricted stock units and other awards settleable in, or based upon, Class B Shares to persons who are directors and employees of and consultants to the Company or any of its subsidiaries on the date of the grant. The LTIP will terminate ten years after approval by the Board. Subject to adjustments in connection with certain changes in capitalization, the maximum number of Class B Shares that may be delivered pursuant to awards under the LTIP is 1,250,000.

On April 28, 2014, in connection with the approval of the LTIP, the President and Chief Executive Officer of the Company acquired (i) 20,000 Class B Shares (as described above), (ii) an aggregate of 50,000 restricted shares of Class B Shares, which vest in five equal installments on each of the first five anniversaries of the grant date of such restricted shares, subject to partial acceleration upon the occurrence of certain terminations of employment, (iii) a fully vested option to purchase 30,000 Class B Shares under the LTIP and (iv) an option to purchase 225,000 Class B Shares under the LTIP, which option will vest as described in Note 16. On August 7, 2014, the Company repurchased the 20,000 Class B shares issued to the Chief Executive Officer and on August 8, 2014, the Company entered into subscription agreements with certain employees to issue 196,875 Class B Shares, which shares will be issued upon the Company obtaining approval for such issuance from the Nevada Gaming Commission.

NOTE 16. SHARE-BASED COMPENSATION

Stock Options

During each of the three and nine months ended September 30, 2014, the Company granted stock awards to eligible participants under the LTIP. The stock awards include options to purchase the Company’s Class B Shares. These stock options include a combination of service and market conditions, as further described below. In addition, these stock options include a performance vesting condition, a Qualified Public Offering (see Note 11), which is not considered to be probable as of September 30, 2014. As a result, no share-based compensation expense for stock options was recognized in the three and nine months ended September 30, 2014 and none will be recognized for these stock awards until the performance condition is considered to be probable. When the performance condition is considered probable, the stock awards will vest in accordance with the underlying service and market conditions.

The terms of the options granted in each of the three and nine months ended September 30, 2014 are further described below:

On April 28, 2014, the Company granted fully vested stock options to purchase 30,000 Class B Shares of with an exercise price of $10 per share. The options expire on the second anniversary of the grant date.

The Company granted stock options to purchase 225,000 and 321,250 Class B Shares on April 28, 2014 and August 8, 2014, respectively, with an exercise price of $10 per share. These stock options were designated as Tranche A options, Tranche B options, and Tranche C options, collectively “the Options”. The Options expire on the tenth anniversary of the grant date.

The 182,082 Tranche A options granted become exercisable in five equal installments on each of the first five anniversaries of the grant date, or immediately upon a change in control, subject to the optionee’s continued employment with the Company through these dates.

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The 182,084 Tranche B options granted become exercisable upon the optionee’s continued employment with the Company or its subsidiaries through the first date that the Investor (as defined in the LTIP) achieves an internal rate of return (“Investor IRR”), as defined in the LTIP, equal to or in excess of 20%, subject to a minimum cash-on-cash return of 2.5 times the Investor investment (the “Tranche B Targets”) on or after the date of such an event. In the event of a change in control upon which the Tranche B Targets are achieved, all outstanding unvested Tranche B options will immediately vest.

The 182,084 Tranche C options granted become exercisable upon the optionee’s continued employment with the Company or its subsidiaries through the first date that the Investor achieves an Investor IRR equal to or in excess of 25%, subject to a minimum cash-on-cash return of 3.0 times the Investor investment (the “Tranche C Targets”) on or after the date of such an event. In the event of a change in control upon which the Tranche C Targets are achieved, all outstanding unvested Tranche C options will immediately vest.

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The Company calculated the grant date fair value of the fully vested stock options and the Tranche A options using the Black Scholes model, and the Tranche B and Tranche C options using a lattice-based option valuation model. The assumptions used in these calculations are noted in the following table. Expected volatilities are based on implied volatilities from comparable companies. The expected time to liquidity is based on management’s estimate. The risk-free rate is based on the U.S. Treasury yield curve for a term equivalent to the estimated time to liquidity. The expected dividend yield is 0% for all stock awards. The grant date fair value, and related assumptions, of Options granted during the nine months ended September 30, 2014, was as follows:



Tranche	Grant Date	Outstanding	Fair Value (Per Share)		Total Fair Value		Assumptions
Fully vested options	April 28, 2014	30,000	$	4.07	$	122,021
Risk free interest rate							0.4	%
Expected term							2 years
Expected volatility							75.0	%

Tranche A Options	April 28, 2014	75,000	$	6.53	$	489,888
Risk free interest rate							2.2	%
Expected term							6.5 years
Expected volatility							70.0	%

Tranche B Options	April 28, 2014	75,000	$	5.18	$	388,514
Risk free interest rate							1.5	%
Time to liquidity event							4.5 years
Expected volatility							75.0	%
Forward expected volatility rate							55.0	%
Forward risk free interest rate							3.6	%

Tranche C Options	April 28, 2014	75,000	$	4.79	$	359,476
Risk free interest rate							1.5	%
Time to liquidity event							4.5 years
Expected volatility							75.0	%
Forward expected volatility rate							55.0	%
Forward risk free interest rate							3.6	%

Tranche A Options	August 8, 2014	107,082	$	6.51	$	697,231
Risk free interest rate							2.0	%
Expected term							6.5 years
Expected volatility							70.0	%

Tranche B Options	August 8, 2014	107,084	$	4.51	$	482,803
Risk free interest rate							1.5	%
Time to liquidity event							4.5 years
Expected volatility							75.0	%
Forward expected volatility rate							55.0	%
Forward risk free interest rate							3.2	%

Tranche C Options	August 8, 2014	107,084	$	4.16	$	445,713
Risk free interest rate							1.5	%
Time to liquidity event							4.5 years
Expected volatility							75.0	%
Forward expected volatility rate							55.0	%
Forward risk free interest rate							3.2	%
Total		576,250			$	2,985,646

No Options were cancelled or forfeited during each of the three and nine months ended September 30, 2014.

Restricted Stock

During the nine months ended September 30, 2014, the Company granted restricted Class B Shares that vest in five equal installments on each of the first five anniversaries of the grant date. This restricted stock includes a service condition and a performance vesting condition (a Qualified Public Offering), which is not considered to be probable of occurring as of September 30, 2014. As a result, no share-based compensation expense was recognized in the three and nine months ended September 30, 2014, and none will be recognized for restricted stock until the performance condition is considered to be

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probable. When the performance condition is considered probable, the stock awards will vest in accordance with the underlying service condition.

On April 28, 2014, the Company issued 50,000 restricted Class B Shares that vest in five equal installments on each of the first five anniversaries of the grant date. The fair value of the the restricted stock granted on April 28, 2014, was $10 per share of restricted stock.

No restricted stock was cancelled or forfeited during each of the three and nine months ended September 30, 2014.

NOTE 17. RESTRUCTURING

In June 2014, the Company took steps to reduce current and future expenses by reducing staff in our technology and game development division that operated primarily out of our Toronto location. The Las Vegas location now serves as the primary location for our technology and game development division. The Company entered into retention agreements with certain employees that extend through July 2015. During the three and nine months ended September 30, 2014, the Company expensed approximately $37,000 and $0.9 million, respectively, in restructuring costs related to termination benefits and expects to incur an additional $0.5 million related to retention agreements with certain employees.

The following table summarizes the change in our severance accrual for the nine months ended September 30, 2014 (in thousands), which is included in accounts payable and accrued liabilities in the condensed consolidated balance sheets:



	Successor
	December 31, 2013		Charge to expense		Cash paid		Costs settled		September 30, 2014
Accrued severance	$	—	$	906	$	585	$	—	$	321

NOTE 18. INCOME TAXES

The Company's effective income tax rate for the three months ended September 30, 2014 was 6.8%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the three months ended September 30, 2014 was primarily due to valuation allowance considerations and amortization of indefinite lived intangible assets. During the three months ended September 30, 2013, the Predecessor did not record a current provision for state or foreign tax purposes. The Predecessor had experienced cumulative losses from its foreign subsidiary and did not incur current foreign income taxes. The Predecessor was considered a pass-through entity for domestic federal income tax purposes, and therefore income or loss flowed through to the limited liability company members who were taxed in their individual capacities on their distributive shares of partnership taxable income.

The Company's effective income tax rate for the nine months ended September 30, 2014 was 10.8%. The difference between the federal statutory rate of 35% and the Company's effective tax rate for the nine months ended September 30, 2014 was primarily due to valuation allowance considerations and amortization of indefinite lived intangible assets. During the nine months ended September 30, 2013, the Predecessor did not record a current provision for state or foreign tax purposes. The Predecessor had experienced cumulative losses from its foreign subsidiary and did not incur current foreign income taxes. The Predecessor was considered a pass-through entity for domestic federal income tax purposes, and therefore income or loss flowed through to the limited liability company members who were taxed in their individual capacities on their distributive shares of partnership taxable income.

NOTE 19. COMMITMENTS AND CONTINGENCIES

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

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On October 11, 2011, the Company entered into a licensing agreement with Ripley’s Entertainment to develop casino games based in the “Ripley’s Believe it or Not” brand. The licensing agreement which, guarantees Ripley’s Entertainment $0.6 million in royalties, commenced upon the execution of the agreement and expires on September 30, 2015, subject to one year renewals at the option of the Company. The Company paid a prepaid royalty of $0.2 million upon execution of the agreement and paid an additional $0.2 million in each of October 2012 and October 2014 under the terms of the agreement.

On May 14, 2012, the Company entered into a licensing agreement with One Three Television, LLC (“One Three”) to develop casino games based in the “Are You Smarter than a 5th Grader” brand. The licensing agreement which, guarantees One Three $0.4 million in royalties, commenced on May 8, 2012 and expires on December 1, 2017 subject to a two year renewal at the option of the Company. The Company paid a prepaid royalty of $0.2 million upon execution of the agreement and in December 2012 an additional $0.1 million was advanced under the terms of the agreement.

On October 5, 2012, the Company entered into a licensing agreement with Freemantle Media North America, Inc. (“Freemantle”) to develop casino games based in the “Family Feud” brand. The licensing agreement which, guarantees Freemantle $0.7 million in royalties, commenced on October 5, 2012 and expires on December 31, 2017 subject to a three year renewal at the option of the Company. The Company paid a prepaid royalty of $0.2 million upon execution of the agreement and advanced an additional $0.2 million in October 2014 under the terms of the agreement.

NOTE 20. SUBSEQUENT EVENTS

In connection with the preparation of its condensed consolidated financial statements as of and for the three months ended September 30, 2014, the Company has evaluated subsequent events through November 14, 2014, to determine whether any of these events required recognition or disclosure in the 2013 financial statements, as required by FASB ASC Topic 855, Subsequent Events.

On October 8, 2014, a wholly owned subsidiary of the Company entered into an agreement to purchase intellectual property owned by Vegas Game Point, LLC, for approximately $0.8 million and a 20% royalty of the Adjusted Gross Revenue, as defined in the Intellectual Property Purchase and Sale Agreement dated as of October 8th, 2014, earned by the Company through the sale, lease, license or other commercial exploitation of the intellectual property. Additionally, in accordance with the agreement, the Company paid an advance royalty payment of $0.6 million.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains “forward-looking statements.” Forward-looking statements include any statements that address future results or occurrences. In some cases you can identify forward-looking statements by terminology such as “may,” “might,” “will,” “would,” “should,” “could” or the negatives thereof. Generally, the words “anticipate,” “believe,” “continue,” “expect,” “intend,” “estimate,” “project,” “plan” and similar expressions identify forward-looking statements. In particular, statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance contained elsewhere in this Quarterly Report on Form 10-Q as well as those discussed under “Item 1. Business” and “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year-ended December 31, 2013 are forward-looking statements. These forward-looking statements include statements that are not historical facts, including statements concerning our possible or assumed future actions and business strategies. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks, uncertainties and other factors, many of which are outside of our control, which could cause our actual results, performance or achievements to differ materially from any results, performance or achievements expressed or implied by such forward-looking statements. Given the risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements are made only as of the date of this Quarterly Report. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments unless required by federal securities law. New factors emerge from time to time, and it is not possible for us to predict all such factors.

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Unless the context indicates otherwise, or unless specifically stated otherwise, references to the “Company”, “AP Gaming”, “Successor”, “we,” “our” and “us” refer to AP Gaming Holdco, Inc. and its consolidated subsidiaries, including AGS Capital, LLC (“AGS Capital”) and AGS, LLC.

Overview

We are a leading designer and manufacturer of Class II gaming machines for the Native American market, with an emerging presence in a broad range of commercial markets in the United States. As of September 30, 2014, we had 8,888 gaming machines in 19 U.S. states, with 175 gaming facilities under revenue sharing agreements and 47 facilities under fee per day agreements. The majority of our systems are used by Native American gaming operators in both Class II and Class III environments, with a recent expansion into the Illinois video gaming terminal or VGT, market. Our products include electronic gaming machines, server-based systems and back-office systems that are used by casinos and other gaming locations. We currently derive substantially all of our gaming revenues from lease agreements whereby we place gaming machines and systems at a customer’s facility in return for either a share of the revenues that these machines and systems generate or a daily fee, which we collectively refer to as “participation agreements” and as our “participation model.”

We are a Delaware corporation that was formed in August 2013 to acquire, through an indirect wholly owned subsidiary of the Company, 100% of the equity in AGS Capital from AGS Holdings, LLC (“AGS Holdings”). On September 16, 2013, AGS Holdings, LLC, AGS Capital and AP Gaming Acquisition, LLC (“AP Gaming Acquisition”), an indirect wholly owned subsidiary of the Company and an affiliate of Apollo Global Management, LLC (“Apollo”), entered into an Equity Purchase Agreement (as subsequently amended and restated on December 3, 2013, the “Acquisition Agreement”). The Acquisition Agreement provided for the purchase of 100% of the equity of AGS Capital from AGS Holdings (the “Acquisition”) by AP Gaming Acquisition for an aggregate purchase price of approximately $220.5 million. The Acquisition was consummated on December 20, 2013 (the “Closing Date”). The Acquisition was financed in part by the Senior Secured Credit Facilities (as defined herein), which are comprised of the $155 million Term Facility and the $25 million Revolving Facility (each, as defined herein) and the issuance of 10,000,000 shares of common stock at $0.01 par value to Apollo Gaming Holdings, L.P. The total cost to acquire all the outstanding shares was $100,000,000. The source of the funds for the acquisition of the Company was provided by committed equity capital contributed by certain equity funds managed by Apollo.

On May 6, 2014, a wholly owned subsidiary of the Company entered into an agreement to purchase 100% of the equity of C2 Gaming, LLC (“C2 Gaming”) for $23.3 million in cash, subject to terms outlined in the Equity Purchase Agreement dated May 6, 2014. C2 Gaming is an innovative manufacturer and developer of slot machines based in Las Vegas, Nevada. The purchase will provide for the distribution of C2 Gaming’s platform and content to an increased number of markets in the United States. The acquisition was initially funded by a $10.0 million draw on our Revolving Facility and available cash on hand. The remaining purchase price required to complete the purchase is expected to be funded either by existing cash or existing availability on the Revolving Facility.

In the third quarter 2014, the Company began manufacturing and developing table games products through the acquisition of Casino War Blackjack, Inc. (“War Blackjack”) for approximately $1.3 million, and other intellectual property related to table games products. As of September 30, 2014, the Company had 102 table game units under fixed fee arrangements.

Business Strategy

We have invested and expect to continue to invest in new business strategies, products, services and technologies. We intend to pursue the following strategies as part of our overall business strategy:

•

Continue to expand our library of proprietary content. We will continue our focused efforts to develop games, both internally and through partnerships with third parties, tailored to our target markets. Investments in expanding our content have created a new title pipeline of 40 games that we released from January 2013 to September 2014 (29 of which were developed internally), as compared to 28 titles we brought to market from 2002 to 2010 combined. Our proprietary game library grew from nine active titles in 2011 to 87 active titles at the end of 2013.


•	Improve yield on existing customer installed base by managing title mix. We believe that more effective management of the title mix across our domestic installed base of 8,888 participation gaming machines in 222 gaming facilities represents an opportunity to generate incremental earnings growth without requiring growth in our domestic installed

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base of participation gaming machines. In addition, we expect improved game performance will likely drive incremental gaming machine placements within our customers’ facilities.


•	Develop niche products for expansion into traditional gaming markets. With 1,218 casino facilities in 41 U.S. states as of September 30, 2014, and the replacement cycle on equipment at a cyclical low, we believe the market potential for new games is favorable. We will target the introduction of a small number of niche participation gaming machines to a large number of casinos.

•

Execute on contracted Illinois VGT rollout. We have significant technical expertise in catering to the local tastes within fragmented markets and are positioned to be one of the leading suppliers to Illinois’ recently regulated route gaming market. To target this nascent route-based market, we have developed new products and features, including games, titles and bonus features specifically for the Illinois VGT market and a statewide player reward program.

•

Continue expansion into Class III markets and increase penetration in Class II markets. We have a foothold of 1,863 Class III recurring revenue placements (excluding Illinois), and we plan to continue expanding in this market. Utilizing new, recently-issued gaming licenses, we expect to begin placing and selling Class III products in five new jurisdictions (Nevada, Mississippi, Louisiana, New Jersey and Connecticut). We also anticipate growing our presence in Class III markets where we currently operate, such as Oklahoma, Florida and California, by placing additional content from our expanding library of games in these states. In addition, we believe that our existing core Class II product offering is among the strongest in the industry today. We expect to continue gaining market share in existing Class II jurisdictions and are focused on penetrating newly licensed jurisdictions.

•

Expansion into the table games market. In the third quarter 2014, we began manufacturing and developing table games products through the acquisitions of War Blackjack and other intellectual property related to table games products. As of September 30, 2014, the Company had 102 table game units under monthly fixed fee arrangements. We plan to continue expanding our table games products through acquisitions and internal development.

Basis of Presentation

References in this Quarterly Report on Form 10-Q to “Successor” refer to the Company on or after December 21, 2013 and reflect assets and liabilities at fair value by allocating the Company’s enterprise value to its assets and liabilities pursuant to accounting guidance related to business combinations. References to “Predecessor” refer to the Predecessor prior to December 21, 2013 and reflect the historical accounting basis in the Predecessor’s assets and liabilities.

Because we conducted no business prior to December 20, 2013, we have presented the results of the Predecessor for the three and nine months ended September 30, 2013 for comparison purposes. The discussion of our results of operations contains a comparison of our results for the three and nine months ended September 30, 2014 and the results for the Predecessor for the three and nine months ended September 30, 2013. The application of accounting guidance related to business combinations did not materially affect the Company’s continuing operations; however, the three and nine months ended September 30, 2013 may yield results that are not fully comparable on a period-by-period basis, particularly with respect to depreciation, amortization, interest income and interest expense.

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Results of Operations

The following tables set forth certain selected audited consolidated financial data for the periods indicated (in thousands):



	Successor			Predecessor			Successor			Predecessor
	Three months ended September 30, 2014			Three months ended September 30, 2013			Nine months ended September 30, 2014			Nine months ended September 30, 2013
Consolidated Statements of Operations:
Gaming revenue	$	17,494		$	13,985		$	50,914		$	41,957
Gaming revenue—other	—			—			—			799
Equipment sales	1,342			783			2,508			1,226
Total revenues	18,836			14,768			53,422			43,982
Operating expenses
Gaming operating expenses	3,258			2,381			8,274			7,250
Cost of equipment sales	716			556			1,346			777
Loss on disposition of assets	81			189			1,256			775
General and administrative	6,848			4,007			17,281			12,496
Selling and marketing	980			956			2,463			2,538
Phantom unit compensation	—			463			—			463
Impairment of long lived assets	—			3,364			127			3,364
Impairment of intangibles	1,321			1,420			1,321			1,420
Write downs and other charges	48			75			690			203
Depreciation and amortization	9,016			6,556			25,145			21,543
Total operating expenses	22,268			19,967			57,903			50,829
Income (loss) from operations	(3,432		)	(5,199		)	(4,481		)	(6,847		)
Interest expense	4,408			4,232			12,756			13,168
Interest income	(14		)	(591		)	(31		)	(1,268		)
Other expense	298			(534		)	301			(254		)
Loss before income taxes	$	(8,124	)	$	(8,306	)	$	(17,507	)	$	(18,493	)

Three Months Ended September 30, 2014 compared to the Three Months Ended September 30, 2013

Total Revenues

Total revenues were $18.8 million for the three months ended September 30, 2014 compared to $14.8 million for the three months ended September 30, 2013, which represents an increase of $4.0 million, or 27.0%. Gaming revenues were $17.5 million for the three months ended September 30, 2014 compared to $14.0 million for the three months ended September 30, 2013, which represents an increase of $3.5 million, or 25.0%. The increase in gaming revenue was partially a result of transitioning from predominantly participation based revenue to more fixed fee revenue, continued expansion of our operations into the Illinois market, the acquisition of C2 Gaming and a $1.0 million decrease in the accretion of lease incentives that were recorded as contra revenue for the three months ended September 30, 2013. At the time of the Acquisition, the lease incentives that existed at the Closing Date were ascribed no value in purchase accounting. The Company recognized only $6,000 in contra revenue from new lease incentives in the three months ended September 30, 2014, compared to $1.0 million in contra revenue recognized in the three months ended September 30, 2013.

Operating Expenses

Gaming operating expenses Total gaming operating expenses were $3.3 million for the three months ended September 30, 2014, compared to $2.4 million for the three months ended September 30, 2013, which represents an increase of $0.9 million, or 37.5%. The increase is primarily due to a $0.3 million increase in repairs and maintenance, a $0.2 million increase in amortization of installation and delivery costs, a $0.1 million increase in inventory obsolescence, a $0.1 million increase in royalties and a $0.1 million increase in production as a result of the C2 Gaming acquisition.

General and administrative General and administrative costs were $6.8 million for the three months ended September 30, 2014 compared to $4.0 million for the three months ended September 30, 2013, which represents an increase of $2.8 million, or 70.0%. The increase is primarily due to a $0.6 million increase in legal and professional fees, an increase of $0.6 million in bonus expense, a $0.5 million increase in sign-on bonuses, and a $0.6 increase in payroll related to increased headcount.

Selling and marketing Selling and marketing costs were relatively consistent at $1.0 million for the three months ended September 30, 2014 and 2013.

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Impairment of long lived assets Impairment of long-lived was $3.4 million for the three months ended September 30, 2013, and represents an impairment loss for obsolete gaming machines.

Impairment of Intangibles Impairment of intangibles was $1.3 million for the three months ended September 30, 2014, related to the retirement of internally developed gaming titles, compared to $1.4 million for the three months ended September 30, 2013, related to a lease incentive paid to a customer that operates and services slot routes in Illinois.

Depreciation and amortization Depreciation and amortization was $9.0 million for the three months ended September 30, 2014, compared to $6.6 million for the three months ended September 30, 2013, which represents an increase of $2.4 million, or 36.4%. The increase is primarily due to the step-up in fair value attributed to the tangible and intangible assets received in connection with the Acquisition, a significant increase in gaming equipment placed into service in the fourth quarter of 2013 and a significant increase in intangible assets and gaming equipment as a result of the acquisition of C2 Gaming in May 2014.

Other Expense (Income), net

Interest expense Interest expense was $4.4 million for the three months ended September 30, 2014, and $4.2 million for the three months ended September 30, 2013, which represents an increase of $0.2 million, or 4.8%. The increase is primarily attributed to the increase in the principal amounts outstanding under the Term Loan Facility and the Revolving Facility at September 30, 2014, partially offset by the decreased interest rate associated with the Term Loan Facility versus the debt of the Predecessor.

Interest income Interest income was $14,000 for the three months ended September 30, 2014, compared to $0.6 million for the three months ended September 30, 2013. The decrease in interest income was primarily the result of notes receivable being retained by the Predecessor in connection with the Acquisition.

Nine Months Ended September 30, 2014 compared to the Nine Months Ended September 30, 2013

Total Revenues

Total revenues were $53.4 million for the nine months ended September 30, 2014 compared to $44.0 million for the nine months ended September 30, 2013, which represents an increase of $9.4 million, or 21.4%. Gaming revenues were $50.9 million for the nine months ended September 30, 2014 compared to $42.0 million for the nine months ended September 30, 2013, which represents an increase of $8.9 million, or 21.2%. The increase in gaming revenue was partially a result of transitioning from predominantly participation based revenue to more fixed fee revenue, continued expansion of our operations into the Illinois market, the acquisition of C2 Gaming and a $3.0 million decrease in the accretion of lease incentives that were recorded as contra revenue for the nine months ended September 30, 2013. At the time of the Acquisition, the lease incentives that existed at the Closing Date were ascribed no value in purchase accounting. At Acquisition, the lease incentives that existed at the Closing Date were ascribed no value in purchase accounting. The Company recognized only $15,000 in contra revenue from new lease incentives in the nine months ended September 30, 2014, compared to $3.0 million in contra revenue recognized in the nine months ended September 30, 2013.

Operating Expenses

Gaming operating expenses Total gaming operating expenses were $8.3 million for the nine months ended September 30, 2014 compared to $7.3 million for the nine months ended September 30, 2013, which represents an increase of $1.0 million, or 13.7%. The increase is primarily due to a $0.3 million increase in repairs and maintenance, a $0.3 million increase in inventory obsolescence, a $0.2 million increase in tribal fees, an increase of $0.1 million increase in royalties and an increase of $0.1 million in production as a result of the C2 Gaming acquisition.

General and administrative General and administrative costs were $17.3 million for the nine months ended September 30, 2014, compared to $12.5 million for the nine months ended September 30, 2013, which represents an increase of $4.8 million, or 38.4%. The increase is primarily due to a $1.2 million increase in legal fees and professional fees, a $1.0 million increase in bonus expense, a $0.5 million increase in sign-on bonuses, a $0.9 million increase in payroll related to increased headcount and a $1.3 million increase in severance pay from the reduction of our development staff in 2014.

Selling and marketing Selling and marketing costs were relatively consistent at $2.5 million for the nine months ended September 30, 2014 and 2013.

Impairment of long lived assets Impairment of long-lived was $3.4 million for the nine months ended September 30, 2013, and represents an impairment loss for obsolete gaming machines.

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Impairment of Intangibles Impairment of intangibles was $1.3 million for the nine months ended September 30, 2014, related to the retirement of internally developed gaming titles, compared to $1.4 million for the nine months ended September 30, 2013, related to a lease incentive paid to a customer that operates and services slot routes in Illinois.

Depreciation and amortization Depreciation and amortization was $25.1 million for the nine months ended September 30, 2014 compared to a $21.5 million for the nine months ended September 30, 2013, which represents an increase of $3.6 million, or 16.7%. The increase is primarily due to the step-up in fair value attributed to the tangible and intangible assets received in connection with the Acquisition, a significant increase in gaming equipment placed into service in the fourth quarter of 2013 and a significant increase in intangible assets and gaming equipment as a result of the acquisition of C2 Gaming in May 2014.

Other Expense (Income), net

Interest expense Interest expense was $12.8 million for the nine months ended September 30, 2014 and $13.2 million for the nine months ended September 30, 2013, which represents a decrease of $0.4 million, or 3.0%. The decrease is primarily attributed to the decreased interest rate associated with the Term Loan Facility versus the debt of the Predecessor, partially offset by an increase in outstanding principal balance at September 30, 2014, under the Term Loan Facility and Revolving Facility.

Interest income Interest income was $31,000 for the nine months ended September 30, 2014 compared to $1.3 million for the nine months ended September 30, 2013. The decrease in interest income was the result of notes receivable being retained by the Predecessor in connection with the Acquisition.

Liquidity and Capital Resources

We expect that primary ongoing liquidity requirements for the year ended December 31, 2014 will be for capital expenditures of between $20 million and $25 million, working capital, debt servicing, game development and other customer acquisition activities. We expect to finance these liquidity requirements through a combination of cash on hand and cash flows from operating activities.

Part of our overall strategy includes consideration of expansion opportunities, underserved markets and acquisition and other strategic opportunities that may arise periodically. We may require additional funds in order to execute on such strategic growth, and may incur additional debt or issue additional equity to finance any such transactions. We cannot assure you that we will be able to obtain such debt or issue any such additional equity on acceptable terms or at all.

As of September 30, 2014, we had $15.8 million in cash and cash equivalents and $172.1 million of outstanding indebtedness (not including the discount), which consisted of $153.8 million of outstanding indebtedness under our Term Facility, $10.0 million outstanding under our Revolving Facility and $8.2 million in other long-term debt agreements. As of December 31, 2013, we had $21.7 million in cash and cash equivalents and $160.5 million (not including the discount), which consisted of $155.0 million of outstanding indebtedness under Term Facility and $5.5 million in notes payable related to the Acquisition. At December 31, 2013, we had no amounts drawn on our Revolving Facility.

Concurrent with the consummation of the Acquisition, on December 20, 2013 (the “Closing Date”) we entered into our senior secured credit facilities, which consist of a $155 million Term Facility and a $25 million Revolving Facility. AP Gaming I, LLC (the “Borrower”), a wholly owned indirect subsidiary of AP Gaming, is the borrower under the Senior Secured Credit Facilities and Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc. and Nomura Securities International, Inc. acted as joint lead arrangers and joint bookrunners for the Senior Secured Credit Facilities.

The proceeds of the Term Facility were used by the Borrower, together with the proceeds of the equity contribution and other sources of funds, to pay the consideration for the Acquisition, to refinance the Company’s existing credit facilities and to pay the costs and expenses of the Acquisition and other related transactions. The proceeds of the Revolving Facility, of which $15 million was available as of June 30, 2014, will be used by the Borrower from time to time for general corporate purposes and other purposes agreed to with the lenders. In May 2014, the Company drew $10.0 million on the Revolving Facility, the proceeds of which were used to partially finance the purchase of C2 Gaming. The Company intends to pay the remaining balance owed, equal to approximately $12.0 million, of the purchase price for C2 Gaming either through available cash on hand or the remaining availability on the Revolving Facility. We believe the remaining availability on our Revolving Facility, as well as expected positive future cash flows, will be sufficient to meet our short-term and long-term liquidity requirements.

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plus an applicable margin rate. Borrowings under the Revolving Facility bear interest at a rate equal to, at the Borrower’s option, either LIBOR or the base rate, plus an applicable margin rate. In addition, on a quarterly basis, the Borrower is required to pay each lender under the Revolving Facility a commitment fee in respect of any unused commitments thereunder at a rate of 0.50% per annum. As of September 30, 2014, $10.0 million was outstanding under the Revolving Facility. The Company can draw all of the amounts available under the Revolving Facility without violating any debt covenants.

The Senior Secured Credit Facilities are guaranteed by AP Gaming Holdings, the Borrower’s material, wholly owned domestic subsidiaries (subject to certain exceptions) and AP Gaming NV, LLC, and are secured by a pledge by AP Gaming Holdings of the Borrower’s equity interest directly held by AP Gaming Holdings and a pledge of substantially all of the existing and future property and assets of the Borrower and the subsidiary guarantors and AP Gaming NV, LLC, subject to certain exceptions. The Senior Secured Credit Facilities require that the Borrower maintain a maximum net first lien leverage ratio set at a maximum of 5.5 to 1 beginning with the first quarter ending June 30, 2014. The Senior Secured Credit Facilities contain limitations on additional indebtedness, guarantees, incurrence of liens, investments and distributions, as defined. The Senior Secured Credit Facilities also contain customary events of default included in similar financing transactions, including, among others, failure to make payments when due, default under other material indebtedness, breach of covenants, breach of representations and warranties, involuntary or voluntary bankruptcy, and material judgments.

In October 2013, AGS Capital entered into financing agreements to purchase 450 gaming machines from various third party suppliers for lease to a company that operates and service slot routes in Illinois. The agreements require monthly payments of interest and principle and have terms ranging from 24 to 36 months and carry an interest rate from 8.0% to 8.5%. The amounts due under these financing agreements were paid in full in connection with the Acquisition.

In January 2014, we entered into a financing agreement to purchase certain gaming devises and/or systems and related equipment in the amount of $2.7 million. The agreement requires monthly payments commencing 90 days from the date of delivery with a term of 36 months at an annual fixed interest rate of 7.5%.

There were no material changes to the Company’s contractual obligations outside of the ordinary course of business during the three months ended September 30, 2014. Based on our current business plan, we believe that our existing cash balances, cash generated from operations and availability under the Revolving Facility will be sufficient to meet our anticipated cash needs for at least the next twelve months and that we will be in compliance with the Senior Secured Credit Facilities, including the maximum net first lien leverage ratio for the quarter ending December 31, 2014. However, our future cash requirements could be higher than we currently expect as a result of various factors. Our ability to meet our liquidity needs could be adversely affected if we suffer adverse results of operations, or if we violate the covenants and restrictions to which we are subject under the credit facility. Additionally, our ability to generate sufficient cash from our operating activities is subject to general economic, political, regulatory, financial, competitive and other factors beyond our control. Our business may not generate sufficient cash flow from operations, and future borrowings may not be available to us under our existing credit facility in an amount sufficient to enable us to pay our service or repay our indebtedness or to fund our other liquidity needs, and we may be required to seek additional financing through credit facilities with other lenders or institutions or seek additional capital through private placements or public offerings of equity or debt securities.

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



	Successor			Predecessor
	Nine months ended September 30, 2014			Nine months ended September 30, 2013
Cash Flow Information:
Net cash provided by operating activities	$	13,203		$	13,434
Net cash used in investing activities	(29,859		)	(18,298		)
Net cash provided by financing activities	10,473			6,788
Effect of exchange rates on cash and cash equivalents	269			152
Net (decrease) increase in cash and cash equivalents	$	(5,914	)	$	2,076

Operating activities

The Company has historically produced a loss from operations due mainly to the capital nature of the business and the resulting depreciation and amortization expense. For the nine months ended September 30, 2014, net cash provided by operating activities was $13.2 million compared to $13.4 million for the nine months ended September 30, 2013, representing a decrease of $0.2 million. The decrease is primarily due to a $1.8 million decrease in income from operating activities excluding non-cash expenses offset by a $1.6 million increase as a result of changes in net working capital.

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Investing activities

Net cash used in investing activities for the nine months ended September 30, 2014 was $29.9 million compared to $18.3 million for the nine months ended September 30, 2013, representing an increase of $11.6 million in cash used in investing activities. The increase was primarily due to $11.0 million cash paid for the acquisition of C2 Gaming, a $5.0 million increase in intangible assets acquired, and a $1.0 million decrease in collections of notes receivable, primarily offset by a $3.2 million decrease in purchases of gaming equipment, vehicles and other equipment and a $1.5 million decrease in advances under notes receivable.

Financing activities

Net cash provided by financing activities for the nine months ended September 30, 2014 was $10.5 million compared to $6.8 million for the nine months ended September 30, 2013, representing a $3.7 million increase. The increase was primarily due to $10.0 million in borrowings on the Company’s Revolving Facility during the nine months ended September 30, 2014 as compared to $7.5 million in borrowings during the nine months ended September 30, 2013, and $2.0 million in proceeds from employees, received in the nine months ended September 30, 2014, in advance of stock expected to be issued in the first quarter of 2015. These increases were partially offset by a $1.4 million increase in payments on debt in the nine months ended September 30, 2014.

Off-Balance Sheet Arrangements

We do not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies

A description of our critical accounting policies can be found in “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2013. Except as noted below, there were no material changes to those policies during the three and nine months ended September 30, 2014.

Recently Issued Accounting Standards

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Service Period. The amendments clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The Company is currently evaluating the provisions of ASU 2014-12 and has not yet determined the impact on its financial position, results of operations or cash flows.

In August 2014, the Financial Accounting Standards Board ("FASB") issued an accounting standards update that requires management to assess an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, consolidated in the aggregate, indicate that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. Currently, there is no guidance in U.S. GAAP for management's responsibility to perform an evaluation. Under the update, management's evaluation is to be performed when preparing financial statements for each annual and interim reporting period and based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. The Company will adopt this standard effective January 1, 2017. The Company is currently assessing the impact the adoption of this standard will have on its consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rates. Our primary exposure to market risk is interest rate risk associated with our long-term debt, which accrues interest at variable rates. The Senior Secured Credit Facilities accrue interest at LIBOR or the base rate, at our election, subject to an interest rate floor plus an applicable margin rate.

In connection with the development agreements we enter into with some of our customers, we provide financing for the construction of new gaming facilities or the expansion of existing facilities, which are generally required to be repaid. As a result of these notes receivable, we are subject to market risk with respect to interest rate fluctuations.

Any material increase in prevailing interest rates could cause us to incur significantly higher interest expense. These factors have not increased significantly; therefore no significant changes have been made in our strategies to manage any of these exposures. We evaluate our exposure to market risk by monitoring interest rates in the market place.

ITEM 4. CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

We maintain a system of controls under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, pursuant to Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act, as amended (the “Exchange Act”), to ensure the Company's consolidated financial statements are prepared in accordance with generally accepted accounting principles and present fairly the Company's financial results of operations. As reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, our management concluded that our internal control over financial reporting was not effective as a result of not maintaining effective controls over the application of lease accounting principles to the initial direct costs incurred related to our operating leases and the useful lives of certain gaming machines deployed under operating lease arrangements. Due to this material weakness in internal control over financial reporting, our management concluded that our disclosure controls and procedures were not effective as of December 31, 2013, March 31, 2014, June 30, 2014 and September 30, 2014.

Changes in Internal Controls

In connection with the preparation of our financial statements for the three months ended September 30, 2014, management has taken steps to remediate the material weakness, including implementing new control procedures, which includes, among other things, supplementing our financial reporting group with additional personnel, that focus on our accounting for leases. Management began to implement these remedial steps during the third quarter of 2014 and expects that these steps will be implemented and tested by the end of 2014. In accordance with the Company’s internal control process, the material weakness designation cannot be closed until the remediation processes have been operational for a certain period of time and successfully tested. As a result, because of the material weakness in internal control over financial reporting

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disclosed in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, our CEO and CFO have concluded that our disclosure controls and procedures were ineffective as of September 30, 2014.

While the deficiency in this instance did not result in a material misstatement of our financial statements (as discussed in Note 6 to the consolidated financial statements included in this Quarterly Report on Form 10-Q), it is possible that there could be a material misstatement if the control deficiency is not remediated.

As we continue to evaluate and work to enhance our internal controls over financial reporting, we may determine that additional measures should be taken to address this or other control deficiencies, and/or that we should modify the remediation plan described above. Notwithstanding our material weakness, we have concluded that the financial statements and other financial information included in this Quarterly Report on Form 10-Q, fairly present in all material respects our financial condition, results of operations and cash flows as of, and for, the periods presented.

Except as disclosed above, there were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

ITEM 1. LEGAL PROCEEDINGS.

We are party to various claims and legal actions that arise in the ordinary course of business. We do not believe the outcome of such disputes or legal actions will have a material adverse effect on our financial condition, results of operations, liquidity or capital resources.

ITEM 1A. RISK FACTORS.

"Item 1A.—Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2013 includes a discussion of our risk factors. There have been no material changes to those risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2013. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

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ITEM 6. EXHIBITS.

(a). Exhibits.



			Incorporated by Reference
Exhibit Number	Exhibit Description	Filed Herewith	Form	Period Ending	Exhibit	Filing Date

18.1	Preferability letter regarding change in accounting policy relating to goodwill.	X	—	—	—	—

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

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

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

101.IN	XBRL Instance Document	X	—	—	—	—

101.SCH	XBRL Taxonomy Extension Schema Document	X	—	—	—	—

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document	X	—	—	—	—

101.LAB	XBRL Taxonomy Extension Label Linkbase Document	X	—	—	—	—

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document	X	—	—	—	—

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document	X	—	—	—	—

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



		AP GAMING HOLDCO, INC.

Date:	November 14, 2014	By:	/s/ CURT MAYER
		Name:	Curt Mayer
		Title:	Chief Financial Officer and Treasurer (Principal Financial Officer)