PlayAGS, Inc. - Quarter Report: 2019 September (Form 10-Q)

 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

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FORM 10-Q

 

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

for the quarter ended September 30, 2019

or

 

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

for the transition period from                          to                          .

Commission file number 001-38357

 

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PLAYAGS, INC.

(Exact name of registrant as specified in its charter)

 

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

 

5475 S. Decatur Blvd., Ste #100 Las Vegas, NV 89118

(Address of principal executive offices) (Zip Code)

(702) 722-6700

(Registrant’s telephone number, including area code)

 

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

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock, $0.01 par value	AGS	New York Stock Exchange

 

As of November 1, 2019, there were 35,405,957 shares of the Registrant’s common stock, $0.01 par value per share, outstanding.

 

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

 

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

 

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

 

Large accelerated filer  ☐

Accelerated filer ☐

Non-accelerated filer  ☒

Smaller reporting company  ☐

Emerging growth company ☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes ☒  No ☐

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

 

 

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
	CONDENSED CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 2019 AND DECEMBER 31, 2018	1
	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS ) INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018	2
	CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AT SEPTEMBER 30, 2019 AND 2018	3
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018	4
	NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	5
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	29
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	55
ITEM 4.	CONTROLS AND PROCEDURES	56
PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	57
ITEM 1A.	RISK FACTORS	57
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	57
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	57
ITEM 4.	MINE SAFETY DISCLOSURES	57
ITEM 5.	OTHER INFORMATION	57
ITEM 6.	EXHIBITS	57
	SIGNATURES	58

 

 

 

		September 30, 2019				December 31, 2018
Assets
Current assets
Cash and cash equivalents		$	11,733			$	70,726
Restricted cash			20				78
Accounts receivable, net of allowance of $901 and $885, respectively			58,149				44,704
Inventories			30,264				27,438
Prepaid expenses			4,782				3,566
Deposits and other			7,326				4,231
Total current assets			112,274				150,743
Property and equipment, net			104,880				91,547
Goodwill			286,203				277,263
Intangible assets			237,794				196,898
Deferred tax asset			2,415				2,544
Operating lease assets			11,940				-
Other assets			4,438				12,347
Total assets		$	759,944			$	731,342
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable		$	18,510			$	14,821
Accrued liabilities			33,812				26,659
Current maturities of long-term debt			6,026				5,959
Total current liabilities			58,348				47,439
Long-term debt			519,521				521,924
Deferred tax liability - noncurrent			2,195				1,443
Operating lease liabilities, long-term			11,823				-
Other long-term liabilities			40,970				24,732
Total liabilities			632,857				595,538
Commitments and contingencies (Note 13)
Stockholders’ equity
Preferred stock at $0.01 par value; 50,000,000 shares authorized, no shares issued and outstanding			-				-
Common stock at $0.01 par value; 450,000,000 shares authorized at September 30, 2019 and at December 31, 2018; and 35,405,594 and 35,353,296 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively.			354				353
Additional paid-in capital			367,620				361,628
Accumulated deficit			(236,710	)			(222,403	)
Accumulated other comprehensive loss			(4,177	)			(3,774	)
Total stockholders’ equity			127,087				135,804
Total liabilities and stockholders’ equity		$	759,944			$	731,342

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		Three months ended September 30,								Nine months ended September 30,
		2019				2018				2019				2018
Revenues
Gaming operations		$	52,522			$	50,701			$	158,976			$	152,887
Equipment sales			26,855				24,825				67,952				60,317
Total revenues			79,377				75,526				226,928				213,204
Operating expenses
Cost of gaming operations(1)			10,170				10,494				30,721				29,062
Cost of equipment sales(1)			13,479				12,109				32,906				28,919
Selling, general and administrative			16,861				15,284				46,343				47,411
Research and development			8,671				7,894				25,175				23,374
Write-downs and other charges			807				667				6,859				3,282
Depreciation and amortization			23,810				18,968				69,002				57,784
Total operating expenses			73,798				65,416				211,006				189,832
Income from operations			5,579				10,110				15,922				23,372
Other expense (income)
Interest expense			9,320				8,956				27,754				28,253
Interest income			(42	)			(89	)			(112	)			(162	)
Loss on extinguishment and modification of debt			-				-				-				4,608
Other (income) expense			(106	)			434				5,108				10,121
(Loss) Income before income taxes			(3,593	)			809				(16,828	)			(19,448	)
Income tax (expense) benefit			(1,926	)			3,538				3,884				8,947
Net (loss) income			(5,519	)			4,347				(12,944	)			(10,501	)
Less: Net income attributable to non-controlling interests			(17	)			-				(231	)			-
Net (loss) income attributable to PlayAGS, Inc.			(5,536	)			4,347				(13,175	)			(10,501	)
Foreign currency translation adjustment			(1,273	)			1,636				(403	)			1,690
Total comprehensive (loss) income		$	(6,809	)		$	5,983			$	(13,578	)		$	(8,811	)
Basic and diluted loss per common share:
Basic		$	(0.16	)		$	0.12			$	(0.37	)		$	(0.31	)
Diluted		$	(0.16	)		$	0.12			$	(0.37	)		$	(0.31	)
Weighted average common shares outstanding:
Basic			35,447				35,305				35,416				34,097
Diluted			35,447				36,313				35,416				34,097

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		Three months ended September 30,								Nine months ended September 30,
		2019				2018				2019				2018
Common stock
Balance, beginning of period		$	354			$	353			$	353			$	149
Issuance of common stock			-				-				-				118
Stock option exercises			1				-				1				-
Repurchase of common stock			(1	)			-				(1	)			-
Stock split (1.5543-for-one)			-				-				-				83
Reclass of management shares			-				-				-				2
Vesting of restricted stock			-				-				1				1
Balance of common stock, end of period			354				353				354				353
Additional paid-in capital
Balance, beginning of period			365,562				358,829				361,628				177,276
Issuance of common stock			-				-				-				171,410
Stock option exercises			100				451				684				730
Vesting of restricted stock			(1	)			1				(1	)			-
Stock-based compensation expense			1,959				538				5,309				9,167
Stock split (1.5543-for-one)			-				-				-				(83	)
Reclass of management shares			-				-				-				1,319
Balance of additional paid-in capital, end of period			367,620				359,819				367,620				359,819
Accumulated Deficit
Balance, beginning of period			(230,042	)			(216,405	)			(222,403	)			(201,557	)
Net loss attributable to PlayAGS, Inc.			(5,536	)			4,347				(13,175	)			(10,501	)
Repurchase of common stock			(1,132	)			-				(1,132	)			-
Balance of accumulated deficit, end of period			(236,710	)			(212,058	)			(236,710	)			(212,058	)
Accumulated other comprehensive loss
Balance, beginning of period			(2,904	)			(3,749	)			(3,774	)			(3,803	)
Foreign currency translation adjustment			(1,273	)			1,636				(403	)			1,690
Balance of accumulated other comprehensive loss, end of period			(4,177	)			(2,113	)			(4,177	)			(2,113	)
Non-controlling interests
Balance, beginning of period			128				-				-				-
Net income			17				-				231				-
Business acquisitions			-				-				71				-
Cash distributions to non-controlling interest owners			(145	)			-				(302	)			-
Balance of non-controlling interests, end of period			-				-				-				-
Total stockholder's equity		$	127,087			$	146,001			$	127,087			$	146,001

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		Nine months ended September 30,
		2019				2018
Cash flows from operating activities
Net loss		$	(12,944	)		$	(10,501	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization			69,002				57,784
Accretion of contract rights under development agreements and placement fees			4,550				3,412
Amortization of deferred loan costs and discount			1,426				1,388
Payment-in-kind interest payments			-				(37,624	)
Write-off of deferred loan cost and discount			-				3,410
Stock-based compensation expense			5,309				9,167
Provision (benefit) for bad debts			183				(198	)
Loss on disposition of assets			1,015				1,383
Impairment of assets			5,343				1,199
Fair value adjustment of contingent consideration			501				700
(Benefit) provision for deferred income tax			873				(205	)
Changes in assets and liabilities that relate to operations:
Accounts receivable			(12,136	)			(12,277	)
Inventories			961				(3,173	)
Prepaid expenses			(1,098	)			(1,958	)
Deposits and other			(3,081	)			(626	)
Other assets, non-current			9,024				13,574
Accounts payable and accrued liabilities			(6,447	)			(12,135	)
Net cash provided by operating activities			62,481				13,320
Cash flows from investing activities
Business acquisitions, net of cash acquired			(54,935	)			(4,452	)
Purchase of intangible assets			(4,926	)			(931	)
Software development and other expenditures			(9,957	)			(8,794	)
Proceeds from disposition of assets			161				21
Purchases of property and equipment			(38,760	)			(34,457	)
Net cash used in investing activities			(108,417	)			(48,613	)
Cash flows from financing activities
Repayment of PIK notes			-				(115,000	)
Repayment of first lien credit facilities			(4,040	)			(3,864	)
Payment of financed placement fee obligations			(6,058	)			(2,688	)
Payments of previous acquisition obligation			(1,227	)			-
Payments on equipment long-term note payable and finance leases			(1,043	)			(2,108	)
Proceeds from issuance of common stock			-				176,341
Initial public offering cost			-				(4,160	)
Repurchase of common stock			(1,133	)			-
Proceeds from stock option exercise			685				731
Distributions to non-controlling interest owners			(302	)			-
Net cash (used in) provided by financing activities			(13,118	)			49,252
Effect of exchange rates on cash and cash equivalents			3				4
(Decrease) increase in cash and cash equivalents			(59,051	)			13,963
Cash, cash equivalents and restricted cash, beginning of period			70,804				19,342
Cash, cash equivalents and restricted cash, end of period		$	11,753			$	33,305
Supplemental cash flow information:
Non-cash investing and financing activities:
Intangible assets obtained under placement fee arrangements		$	39,198			$	931
Leased assets obtained in exchange for new finance lease liabilities		$	882			$	307
Leased assets obtained in exchange for new operating lease liabilities		$	13,048			$	-

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

 

Description of Business

 

PlayAGS, Inc. (the "Company," "PlayAGS," "we," "us," or "our") is a leading designer and supplier of gaming products and services for the gaming industry. We operate in legalized gaming markets across the globe and provide state-of-the-art, value-add products in three distinct segments: Electronic Gaming Machines (“EGM”), which includes server-based systems and back-office systems that are used by Class II Native American, Mexico and the Philippines gaming jurisdictions and Class III Native American, commercial and charitable jurisdictions; Table Products (“Table Products”), which includes live felt table games, side-bets, progressives and ancillary equipment such as signage, as well as our newly introduced card shuffler, “Dex S” and Interactive Casino Games (“Interactive”), which has two reporting units. One Interactive reporting unit includes social casino games on desktop and mobile devices (“Social”) and the other Interactive reporting unit includes a platform for content aggregation used by real-money gaming (“RMG”) and sports-betting partners. Each segment’s activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of a distinct product line.

    

The Company filed a Registration Statement on Form 10 on December 19, 2013, which went effective under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), on December 19, 2013. On January 30, 2018, we completed the initial public offering of 10,250,000 shares of our common stock, at a public offering price of $16.00 per share (the “IPO”).

 

On February 27, 2018, we sold an additional 1,537,500 shares of common stock, pursuant to the underwriters’ exercise in full of the over-allotment option.

 

Electronic Gaming Machines

 

Our EGM segment offers a selection of video slot titles developed for the global marketplace, and EGM cabinets which include the Alora, Orion Portrait, Orion Slant, Orion Upright, ICON, Halo, and Big Red/Colossal Diamonds. In addition to providing complete EGM units, we offer conversion kits that allow existing game titles to be converted to other game titles offered within that operating platform.

 

Table Products

 

Our Table Products include both internally developed and acquired proprietary table products, side-bets, progressives, and table technology related to blackjack, poker, baccarat, craps and roulette. We have acquired a number of popular proprietary brands, including In Bet Gaming (“In Bet”), Buster Blackjack, Double Draw Poker and Criss Cross Poker that are based on traditional well-known public domain games such as blackjack and poker; however, these proprietary games provide intriguing betting options that offer more excitement and greater volatility to the player, ultimately enhancing our casino customers’ profitability. In addition, we offer a single deck card shuffler for poker tables, Dex S.

 

Interactive

 

Our business-to-consumer (“B2C”) social casino games are primarily delivered through our mobile app, Lucky Play Casino. The app contains several game titles available for consumers to play for fun and with coins that they purchase through the app. Some of our most popular social casino games include content that is also popular in land-based settings such as Golden Wins, Royal Reels and So Hot. We have recently expanded into the business-to-business (“B2B”) space through our core app, Lucky Play Casino, whereby we white label our social casino game product and enable our land-based casino customers to brand the social casino gaming product with their own casino name. With the recent acquisition of Gameiom Technologies Limited (defined below) as described in Note 2, we now offer a platform for B2B content aggregation used by RMG and sports-betting partners.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain disclosures required by generally accepted accounting principles (“GAAP”) are omitted or condensed in these condensed consolidated financial statements. In the opinion of management, all adjustments (consisting of only normal recurring adjustments) that are necessary for a fair statement of the Company's financial position, results of operations and cash flows for the interim periods have been made. The interim results reflected in these condensed consolidated financial statements are not necessarily indicative of results to be expected for the full fiscal year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2018.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

Principles of Consolidation

 

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

 

Use of Estimates

 

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

 

Revenue Recognition

 

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

 

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

 

 

Gaming Operations

 

Gaming operations revenue is earned by providing customers with gaming machines, gaming machine content licenses, table products, back-office equipment and linked progressive systems, which are collectively referred to as gaming equipment, under participation arrangements. The participation arrangements convey the right to use the equipment (i.e., gaming machines and related integral software) for a stated period of time, which typically ranges from one to three years upon which the contract continues on a month-to-month basis thereafter. In some instances, the Company will enter arrangements for longer periods of time; however, many of these arrangements include the ability of the customer to cancel the contract and return the games to the Company, a provision which renders their contracts effectively month-to-month contracts.The Company will also enter into lease contracts with a revenue sharing arrangement whereby the lease payments due from the customer are variable. Primarily due to these factors, our participation arrangements are accounted for as operating leases. In some instances, we will offer a free trial period during which no revenue is recognized. If during or at the conclusion of the trial period the customer chooses to enter into a lease for the gaming equipment, we commence revenue recognition according to the terms of the agreement.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

Under participation arrangements, the Company retains ownership of the gaming equipment installed at the customer facilities and receives either revenue based on a percentage of the win per day generated by the gaming equipment or a fixed daily fee. Thus, in our consolidated financial statements the Company records revenue monthly related to these arrangements and the gaming equipment is recorded in property and equipment, net on our balance sheet and depreciated over the expected life of the gaming equipment.

 

The majority of the Company’s leases require the Company to provide maintenance throughout the entire term of the lease. In some cases, a performance guarantee exists that, if not met, provides the customer with the right to return the gaming machines to the Company. This performance guarantee is considered a cancellation clause, a provision which renders their contracts effectively month-to-month contracts. Accordingly, the Company accounts for these contracts in a similar manner with its other operating leases as described above.

 

Gaming operations revenue is also earned from the licensing of table product content and is earned and recognized primarily on a fixed monthly rate. Our B2C social casino products earn revenue from the sale of virtual coins or chips, which is recorded when the purchased coins or chips are used by the customer. B2C social casino revenue is presented gross of the platform fees. B2B social casino products earn revenue primarily based on a percentage of the monthly revenue generated by the white label casino apps that we build and operate for our customers. RMG revenue is earned primarily based on a percentage of the revenue produced by the games on our platform as well as monthly platform fees and initial integration fees. RMG revenue is presented net of payments to game and content suppliers.

 

Equipment Sales

 

Revenues from contracts with customers are recognized and recorded when the following criteria are met:

 

	•	We have a contract that has been approved by both the customer and the Company. Our contracts specify the products being sold and payment terms and are recognized when it is probable that we will collect substantially all of the contracted amount; and
	•	Control has been transfered and services have been rendered in accordance with the contract terms.

 

Equipment sales are generated from the sale of gaming machines, table products and licensing rights to the integral game content software that is installed in the related equipment, parts, and other ancillary equipment. Also included within the deliverables are delivery, installation and training, all of which occur within a few days of arriving at the customer location. Equipment sales do not include maintenance beyond a standard warranty period. The recognition of revenue from the sale of gaming devices occurs as the customer obtains control of the product and all other revenue recognition criteria have been satisfied. Our contracts include a fixed transaction price. Amounts are due from customers within 30 to 90 days of the invoice date and to a lesser extent we offer extended payment terms of 12 to 24 months with payments due monthly during the extended payment period.

 

The Company enters into revenue arrangements that may consist of multiple performance obligations, which are typically multiple distinct products that may be shipped to the customer at different times. For example, sales arrangements may include the sale of gaming machines and table products to be delivered upon the consummation of the contract and additional game content conversion kits that will be delivered at a later date when requested by the customer to replace the game content on the customer’s existing gaming machines. Products are identified as separate performance obligations if they are distinct, which occurs if the customer can benefit from the product on its own and is separately identifiable from other promises in the contract.

 

Revenue is allocated to the separate performance obligations based on relative standalone selling prices determined at contract inception. Standalone selling prices are primarily determined by prices that we charge for the products when they are sold separately. When a product is not sold separately, we determine the standalone selling price with reference to our standard pricing policies and practices. We elected to exclude from the measurement of the transaction price, sales taxes and all other items of a similar nature, and also elected to account for shipping and handling activities as a fulfillment of our promise to transfer the goods. Accordingly, shipping and handling costs are included in cost of sales.

 

Revenue allocated to any undelivered performance obligations is recorded as a contract liability. The balance of our contract liabilities was not material as of September 30, 2019 and December 31, 2018.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

Cash and Cash Equivalents

 

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

 

Restricted Cash

 

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

 

Allowance for Doubtful Accounts

 

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

 

Inventories

 

Inventories consist primarily of parts and supplies that are used to repair and maintain machinery and equipment as well as EGMs in production and finished goods held for sale. Inventories are stated at net realizable value. Cost of inventories is determined using the first-in, first-out (“FIFO”) method for all components of inventory. The Company regularly reviews inventory quantities and updates estimates for the net realizable value of inventories. This process includes examining the carrying values of parts and ancillary equipment in comparison to the current fair market values for such equipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levels of the inventories, the current and projected sales levels for such products, the projected markets for such products and the costs required to sell the products, including refurbishment costs. Changes in the assumptions or estimates could materially affect the inventory carrying value. As of September 30, 2019 and December 31, 2018, the value of raw material inventory was $25.8 million and $22.3 million, respectively. As of September 30, 2019 and December 31, 2018, the value of finished goods inventory was $4.5 million and $5.1 million, respectively. There was no work in process material as of September 30, 2019 and December 31, 2018.

 

Property and Equipment

 

The cost of gaming equipment, consisting of fixed-base player terminals, file servers and other support equipment as well as other property and equipment, is depreciated over their estimated useful lives, using the straight-line method for financial reporting. The Company capitalizes costs incurred for the refurbishment of used gaming equipment that is typically incurred to refurbish a machine in order to return it to its customer location. The refurbishments extend the life of the gaming equipment beyond the original useful life. Repairs and maintenance costs are expensed as incurred. The Company routinely evaluates the estimated lives used to depreciate assets. The estimated useful lives are as follows:

 

 

The Company reviews its property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The Company groups long-lived assets for impairment analysis at the lowest level for which identifiable cash flows can be measured independently of the cash flows of other assets and liabilities. This is typically at the individual gaming machine level or at the cabinet product line level. Impairment testing is performed and losses are estimated when indicators of impairment are present and the estimated undiscounted cash flows are not sufficient to recover the assets’ carrying amount.

 

When the estimated undiscounted cash flows are not sufficient to recover the asset’s carrying amount, an impairment loss is measured to the extent the fair value of the asset is less than its carrying amount.

 

The Company measures recoverability of assets to be held and used by comparing the carrying amount of an asset to future cash flows expected to be generated by the asset. The Company’s policy is to impair, when necessary, excess or obsolete gaming machines on hand that it does not expect to be used. Impairment is based upon several factors, including estimated forecast of gaming machine demand for placement into casinos. While the Company believes that the estimates and assumptions used in evaluating the carrying amount of these assets are reasonable, different assumptions could affect either the carrying amount or the estimated useful lives of the assets, which could have a significant impact on the results of operations and financial condition.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

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.

 

When the estimated undiscounted cash flows are not sufficient to recover the intangible asset’s carrying amount, an impairment loss is measured to the extent the fair value of the asset is less than its carrying amount.

 

Certain trade names have an indefinite useful life and the Company tests these trade names for possible impairment at least annually, on October 1, or whenever events or changes in circumstances indicate that the carrying value may be impaired. We perform a qualitative assessment to determine if it is more likely than not that the fair value of the asset is less than its carrying amount. If we believe, as a result of our qualitative assessment, that it is more likely than not that the fair value of the asset is less than its carrying amount, the quantitative impairment test is required.

 

Costs of Capitalized Computer Software

 

Internally developed gaming software represents the Company’s internal costs to develop gaming titles to utilize on the Company’s gaming machines. Internally developed gaming software is stated at cost and amortized over the estimated useful lives of the software, using the straight-line method. Software development costs are capitalized once technological feasibility has been established and are amortized when the software is placed into service. The computer software we develop reaches technological feasibility when a working model of the computer software is available. Any subsequent software maintenance costs, such as bug fixes and subsequent testing, are expensed as incurred. Discontinued software development costs are expensed when the determination to discontinue is made. Software development costs are amortized over the expected life of the title or group of titles, if applicable, to amortization expense.

 

On a quarterly basis, or more frequently if circumstances warrant, the Company compares the net book value of its internally developed computer software to the net realizable value on a title or group of 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.

 

Goodwill

 

The excess of the purchase price of an acquired business over the estimated fair value of the assets acquired and the liabilities assumed is recorded as goodwill. The Company tests for possible impairment of goodwill at least annually, on October 1, or when circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The Company has the option to begin with a qualitative assessment, commonly referred to as “Step 0”, to determine whether it is more likely than not that the reporting unit’s fair value of goodwill is less than its carrying value. This qualitative assessment may include, but is not limited to, reviewing factors such as the general economic environment, industry and market conditions, changes in key assumptions used since the most recently performed valuation and overall financial performance of the reporting units. If the Company determines that it is more likely than not that a reporting unit’s fair value is less than its carrying value, the Company performs a quantitative goodwill impairment analysis, and depending upon the results of that measurement, the recorded goodwill may be written down and charged to income from operations when the carrying amount of the reporting unit exceeds the fair value of the reporting unit. In the second quarter of 2019, we recorded an impairment of goodwill related to the RMG reporting unit as described in Note 4.

 

Acquisition Accounting

 

The Company applies the provisions of ASC 805, “Business Combinations” (ASC 805), in accounting for business acquisitions. It requires us to recognize separately from goodwill the fair value of assets acquired and liabilities assumed on the acquisition date. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. Significant estimates and assumptions are required to value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable. These estimates are inherently uncertain and subject to refinement and typically include the calculation of an appropriate discount rate and projection of the cash flows associated with each acquired asset. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the consolidated statements of operations.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

Fair Value of Financial Instruments

 

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

 

	•	Level 1 - quoted prices in an active market for identical assets or liabilities;
	•	Level 2 - quoted prices in an active market for similar assets or liabilities, inputs other than quoted prices that are observable for similar assets or liabilities, inputs derived principally from or corroborated by observable market data by correlation or other means; and
	•	Level 3 - valuation methodology with unobservable inputs that are significant to the fair value measurement.

 

The carrying values of the Company’s cash and cash equivalents, restricted cash, receivables and accounts payable approximate fair value because of the short term maturities of these instruments. The fair value of our long-term debt is based on the quoted market prices for similar issues (Level 2 inputs). The estimated fair value of our long-term debt as of September 30, 2019 and December 31, 2018 was $532.3 million and $528.1 million, respectively.

 

Accounting for Income Taxes

 

We conduct business globally and are subject to income taxes in U.S. federal, state, local, and foreign jurisdictions. Determination of the appropriate amount and classification of income taxes depends on several factors, including estimates of the timing and probability of realization of deferred income taxes, reserves for uncertain income tax positions and income tax payment timing.

 

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Taxes on income of our foreign subsidiaries are provided at the tax rates applicable to the tax jurisdictions in which they are located. Future tax benefits are recognized to the extent that realization of those benefits is considered more likely than not and a valuation allowance is established for deferred tax assets which do not meet this threshold.

 

The recoverability of certain deferred tax assets is based in part on estimates of future income and the timing of temporary differences, and the failure to fully realize such deferred tax assets could result in a higher tax provision in future periods.

 

We apply the accounting guidance to our uncertain tax positions and under the guidance, we may recognize a tax benefit from an uncertain position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the issue. The amount recognized in the financial statements is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement.

 

We are required to make significant judgments when evaluating our uncertain tax positions and the related tax benefits. We believe our assumptions are reasonable; however, there is no guarantee that the final outcome of the related matters will not differ from the amounts reflected in our income tax provisions and accruals. We adjust our liability for uncertain tax positions based on changes in facts and circumstances such as the closing of a tax audit or changes in estimates. Our income tax provision may be impacted to the extent that the final outcome of these tax positions is different than the amounts recorded.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

Contingencies

 

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

 

Foreign Currency Translation

 

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

 

Recently Issued Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 intends to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The adoption of this guidance has resulted in a significant portion of our operating leases, where we are the lessee, to be recognized on our Consolidated Balance Sheets. The guidance requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years with earlier adoption permitted. In July of 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which is intended to reduce costs and ease implementation of the leases standard in the preparation of financial statements. ASU 2018-11 provides an optional transition method that allows entities to elect to apply the standard using the modified retrospective approach at its effective date, versus recasting the prior years presented. The Company elected a date of initial application of January 1, 2019. In doing so, the Company (i) applied ASC 840 in the comparative periods and (ii) provided the disclosures required by ASC 840 for all periods that continue to be presented in accordance with ASC 840. The adoption of the standard had no effect on retained earnings as of January 1, 2019. The Company elected the practical expedient to use hindsight when determining lease term and a package of practical expedients to not reassess whether a contract is or contains a lease, lease classification, and initial direct costs. Adoption of the new standard resulted in the recording of right-of-use assets and lease liabilities as of January 1, 2019. See Note 15. The standard did not materially impact our consolidated net earnings and had no impact on cash flows.

 

In June 2016, the FASB issued ASU No. 2016-13, which provides updated guidance on how an entity should measure credit losses on financial instruments. The new guidance replaces the current incurred loss measurement methodology with a lifetime expected loss measurement methodology. Subsequently, in November 2018 the FASB issued ASU No. 2018-19, which clarified that receivables arising from operating leases are not within the scope of Subtopic 326-20, but should rather be accounted for in accordance with ASC 842. In May 2019, the FASB issued ASU No. 2019-05 providing targeted transition relief to all reporting entities within the scope of Topic 326. The new standard and related amendments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. This guidance is expected to be applied using a modified retrospective approach for the cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective and using a prospective approach for debt securities for which any other-than-temporary impairment had been recognized before the effective date. Early adoption is permitted for fiscal years beginning after December 15, 2018. We are currently evaluating the impact of adopting this guidance on our Financial Statements. We are currently evaluating the impact of adopting this guidance on our Financial Statements; however, we do not expect the impact to be material. 

 

In August 2018, the FASB issued ASU No. 2018-15, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. We are currently evaluating the impact of adopting this guidance on our Financial Statements; however, we do not expect the impact to be material. 

 

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

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 2. ACQUISITIONS

 

In Bet Gaming

 

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

 

Integrity

 

On February 8, 2019, we acquired all of the equity of Integrity Gaming Corp. ("Integrity"), a regional slot route operator with over 2,500 gaming machines in operation across over 33 casinos in Oklahoma and Texas. We attribute the goodwill recognized to our ability to utilize Integrity's installed base to maximize revenue of the combined product portfolio and the synergies we can obtain through the reduction in our combined service and overhead costs.

 

The total purchase price consideration for Integrity was as follows:

 

 

The acquisition was accounted for as an acquisition of a business and the assets acquired and liabilities assumed were measured based on our preliminary estimates of their fair values at the acquisition date. The estimated fair values of assets acquired and liabilities assumed and resulting goodwill (not tax deductible) are subject to adjustment as we finalize our fair value analysis. The significant items for which a final fair value has not been determined as of the filing of this report include the fair value of intangible assets and deferred taxes. We expect to complete our fair value determinations no later than one year from the acquisition date.

 

The acquisition of Integrity was accounted for using the acquisition method of accounting, which requires, among other things, the assets acquired and liabilities assumed be recognized at their respective fair values as of the acquisition date. The property, plant and equipment which fair value was determined based on the cost and market approach (level 2 fair value measurement), consist primarily of electronic gaming machines ("EGM") assets.The intangible assets consist of customer relationships which will be amortized over a weighted average period of approximately 10 years. The intangible assets were valued using the excess earnings method (level 3 fair value measurement), 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 net working capital, assembled workforce and property, plant and equipment - was estimated through contributory asset capital charges. The value of the customer relationships 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.

 

The information below reflects preliminary allocation of the purchase price based on assumptions and estimates related to fair value that are subject to change as additional information may become available during the respective measurement periods (up to one year from the acquisition date). Specifically, the Company is still evaluating the fair value of intangible assets and deferred taxes.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

We recognized the $0.6 million related to property tax liability and $1.4 million related to uncertain tax positions arising from contingencies which were valued at their fair value utilizing Level 3 inputs.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

The following unaudited pro forma statements of operations give effect to the Integrity acquisition as if it had been completed on January 1, 2018 and 2019. The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of what the operating results actually would have been during the periods presented had the acquisition been completed on January 1, 2018 and 2019. We did not summarize the amounts of revenue and earnings of Integrity since the acquisition date included in the consolidated income statement as it was immediately combined with our existing business and separating the results of operations would be impracticable. In addition, the unaudited pro forma financial information does not purport to project future operating results. This information is preliminary in nature and subject to change based on final purchase price adjustments. The pro forma statements of operations do not reflect: (1) any anticipated synergies (or costs to achieve synergies) or (2) the impact of non-recurring items directly related to the Integrity acquisition.

 

 

AGS iGaming

 

During the quarter ended June 30, 2018, the Company acquired all of the equity of Gameiom Technologies Limited (formerly known as “Gameiom”, currently known as “AGS iGaming”). AGS iGaming was a licensed gaming aggregator and content provider for real-money gaming (“RMG”) and sports betting partners. The acquisition was accounted for as an acquisition of a business and the assets acquired and liabilities assumed were measured based on our estimates of their fair values at the acquisition date.

 

We attributed the goodwill recognized to our ability to utilize AGS iGaming’s existing RMG platform to distribute our existing EGM game content into many markets, diversification of our Interactive segment’s product portfolio that now includes a real-money gaming solution and other strategic benefits. The total consideration for this acquisition was $5.0 million, which included cash paid of $4.5 million and $0.5 million of deferred consideration that is payable within 18 months of the acquisition date. The consideration was allocated to goodwill that is not tax deductible for $3.7 million and intangible assets of $2.1 million, which will be amortized over a weighted average period of approximately 6.7 years. See Note 4 for a discussion and summary of impairments that we recorded subsequent to the acquisition related to these intangible assets and the related goodwill.

 

The intangible assets consisted primarily of customer relationships and a technology platform. The customer relationships were valued using the cost approaches (level 3 fair value measurement), in which we determined an estimated reproduction or replacement cost, as applicable. The technology platform was valued using the royalty savings method (level 3 fair value measurement), which is a risk-adjusted discounted cash flow approach. The royalty savings method values an intangible asset by estimating the royalties saved through ownership of the asset. The royalty savings method requires identifying the future revenue that would be impacted by the technology platform (or royalty-free rights to the assets), 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.

 

It is not practicable to provide pro forma statements of operations giving effect to the AGS iGaming acquisition as if it had been completed at an earlier date. This is due to the lack of historical financial information sufficient to produce such pro forma statements given the start up nature of AGS iGaming.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 3. PROPERTY AND EQUIPMENT

 

Property and equipment consist of the following (in thousands):

 

 

Gaming equipment and other property and equipment are depreciated over the respective useful lives of the assets ranging from two to six years. Depreciation expense was $11.6 million and $8.0 million for the three months ended September 30, 2019 and 2018, respectively. Depreciation expense was $33.7 million and $23.7 million for the nine months ended September 30, 2019 and 2018, respectively.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 4. GOODWILL AND INTANGIBLES

 

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

 

 

⁽¹⁾ Accumulated goodwill impairment charges for the Interactive segment as of September 30, 2019 were $8.4 million.

 

During the second quarter of 2019 our RMG Interactive reporting unit fell short of its expected operating results, driven by the delays launching new operators and extended regulatory time-lines in new jurisdictions. This circumstance was considered to be a triggering event. Accordingly, we reduced the projections of the future operating results for this reporting unit, originally established when we acquired AGS iGaming in 2018.

 

As a result of this triggering event, we performed a quantitative impairment analysis of the associated goodwill and determined that the entire balance of $3.5 million was impaired. In performing the quantitative goodwill impairment test for our RMG Interactive reporting unit, we estimated the fair value of the reporting unit using an income approach that analyzed projected discounted cash flows. We used projections of revenues and operating costs with estimated growth rates during the forecast period, capital expenditures and cash flows that considered historical and estimated future results and general economic and market conditions, as well as the estimated impact of planned business and operational strategies. The estimates and assumptions used in the discounted cash flow analysis included a terminal year long-term growth rate of 3.0% and an overall discount rate of 25% based on our weighted average cost of capital for the Company and premiums for the small size of the reporting unit and forecast risk.

 

Intangible assets consist of the following (in thousands):

 

 

 

Intangible assets are amortized over their respective estimated useful lives ranging from one to twelve years. Amortization expense related to intangible assets was $12.1 million and $11.0 million for the three months ended September 30, 2019 and 2018, respectively. Amortization expense related to intangible assets was $35.3 million and $34.1 million for the nine months ended September 30, 2019 and 2018, respectively.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

Management reviews intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Prior to the goodwill impairment assessment noted above, we completed a qualitative review of long-lived assets for all asset groups to determine if events or changes in circumstances indicated that the carrying amount of each asset group may not be recoverable (if a "triggering event" existed). Based on this review, we tested the recoverability of the long-lived assets, other than goodwill and indefinite-lived intangible assets, in certain asset groups related to the RMG Interactive reporting unit where a triggering event existed at the lowest level at which identifiable cash flows existed, the reporting unit level. The recoverability test failed, meaning that the undiscounted cash flows were less than the carrying value of the related asset group and we therefore measured the amount of any impairment loss as the amount by which the carrying amount of the asset group exceeded its fair value using the projected reporting unit cash flows, a 25% discount rate, and 3% long-term growth rate. We then allocated the indicated impairment loss to the long-lived assets of the group on a pro rata basis, except for certain assets whose carrying value was reduced only to their individually determined fair value. Specifically, from the pro rata allocation, we recorded a full impairment of RMG customer relationships, gaming licenses, and game content, which had a carrying value of $0.6 million. We also reduced the value of the RMG technology platform by $0.7 million to its fair value of $0.4 million. The technology platform was valued using the royalty savings method (level 3 fair value measurement), which is a risk-adjusted discounted cash flow approach. The royalty savings method values an intangible asset by estimating the royalties saved through ownership of the asset. The royalty savings method requires identifying the future revenue that would be impacted by the technology platform (or royalty-free rights to the assets), 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.  We used a discount rate of 25%. The royalty rate used in such valuation was 5% and was based on a consideration of market rates for similar categories of assets.

 

The Company enters into development agreements and placement fee agreements with certain customers to secure floor space under lease agreements for its gaming machines. Amounts paid in connection with the development agreements are repaid to the Company in accordance with the terms of the agreement, whereas placements fees are not reimbursed. For development agreements in the form of a loan, interest income is recognized on the repayment of the notes based on the stated rate or, if not stated explicitly in the development agreement, on an imputed interest rate. If the stated interest rate is deemed to be other than a market rate or zero, a discount is recorded on the note receivable as a result of the difference between the stated and market rate and a corresponding intangible asset is recorded. The intangible asset is recognized in the financial statements as a contract right under development agreement and amortized as a reduction in revenue over the term of the agreement. Placement fees can be in the form of cash paid upfront or free lease periods and are accreted over the life of the contract and the expense is recorded as a reduction of revenue. We recorded a reduction of gaming operations revenue from the accretion of contract rights under development agreements and placement fees of $1.7 million and $1.2 million for the three months ended September 30, 2019 and 2018, respectively, We recorded a reduction of gaming operations revenue from the accretion of contract rights under development agreements and placement fees of $4.6 million and $3.4 million for the  nine months ended September 30, 2019 and 2018, respectively.

 

In March 2019, we entered into a placement fee agreement with a customer for certain of its locations and capitalized approximately $33.1 million additional placement fees, in addition to $2.1 million of unamortized fees related to superseded contracts. The liability was recorded at present value and cash payments totaling $40.1 million will be paid over a term of 83 months.

 

 

NOTE 5. ACCRUED LIABILITIES

Accrued liabilities consist of the following (in thousands):

 

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 6. LONG-TERM DEBT

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

 

 

First Lien Credit Facilities

 

On June 6, 2017 (the “Closing Date”), AP Gaming I, LLC (the “Borrower”), a wholly owned indirect subsidiary of the Company, entered into a first lien credit agreement (“the First Lien Credit Agreement”), providing for $450.0 million in term loans and a $30.0 million revolving credit facility. The proceeds of the term loans were used primarily to repay the Company's then existing term loans, other indebtedness, to pay for the fees and expenses incurred in connection with the foregoing and otherwise for general corporate purposes.

 

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

 

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

 

On February 8, 2018, the Borrower completed the repricing of its existing $513 million term loans under its First Lien Credit Agreement (the “Term Loans”). The Term Loans were repriced from 550 basis points to 425 basis points over LIBOR. The LIBOR floor remained at 100 basis points.

 

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

 

On October 5, 2018, the Borrower entered into an Incremental Assumption and Amendment Agreement No. 2 (the “Incremental Agreement No. 2”) with certain of the Borrower’s subsidiaries, the lenders party thereto from time to time and the Administrative Agent. The Incremental Agreement No. 2 amended and restated that certain First Lien Credit Agreement, dated as of June 6, 2017, as amended on December 6, 2017 and as amended and restated on February 8, 2018 (the “Existing Credit Agreement”), among the Borrower, the lenders party thereto, the Administrative Agent and other parties named therein (the “Amended and Restated Credit Agreement”), to (a) reduce the applicable interest rate margin for the Term B Loans (as repriced, the “Repriced Term B Loans”) under the Credit Agreement by 0.75% (which shall increase by an additional 0.25% if at any time the Borrower receives a corporate credit rating of at least B1 from Moody’s, regardless of any future rating) and (b) provide for the incurrence by the Borrower of incremental term loans in an aggregate principal amount of $30 million (the “Incremental Term Loans” and together with the Repriced Term B Loans, the “Term B Loans”).

 

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

 

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

 

As of September 30, 2019, we were in compliance with the required covenants of our debt instruments.

 

Equipment Long Term Note Payable and Finance Leases

 

The Company has entered into a financing agreement to purchase certain gaming devices, systems and related equipment and has entered into leases for vehicles and equipment that are accounted for as finance leases.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 7. STOCKHOLDERS’ EQUITY

 

Common Stock

 

Prior to the completion of the IPO, the Company’s common stock consisted of two classes: class A voting common stock (“Class A Shares”) and class B non-voting common stock (“Class B Shares”). In connection with the IPO, we (i) reclassified Class B Shares into a new class of voting common stock, which is the class of stock investors received in the IPO, and (ii) canceled the Class A Shares. Concurrent with this reclassification, and immediately prior to the consummation of the IPO, we effected a 1.5543-for-1 stock split of the Company’s new voting common stock such that existing stockholders each received 1.5543 shares of the new voting common stock described above in clause (i) for each share of Class B Shares they held at that time. Accordingly, all share and per share amounts for all periods presented in these financial statements and notes thereto have been adjusted retroactively, where applicable, to reflect the stock split.

 

On January 26, 2018, the Company completed the IPO, in which it issued and sold 10,250,000 shares of common stock at a public offering price of $16.00 per share. On February 27, 2018 the Company sold an additional 1,537,500 shares of its common stock, pursuant to the underwriters’ exercise in full of the over-allotment option. The aggregate net proceeds received by the Company from the IPO were $171.5 million, after deducting underwriting discounts and commissions and offering expenses directly related to issuance of the equity.

    

Upon the consummation of the IPO, 170,712 shares of common stock were held by management. Pursuant to the Securityholders Agreement dated April 28, 2014 (the “Securityholders Agreement”), these shares were outstanding, but were not considered issued for accounting purposes as they contained a substantive performance condition, a “Qualified Public Offering”, as defined in the Securityholders Agreement, which had to be probable for the holders of these shares to benefit from their ownership. The IPO satisfied the substantive performance condition and as a result, the shares and related proceeds of $1.3 million were reclassified from other long-term liabilities to additional paid-in capital and considered issued for accounting purposes. During the three and nine months ended September 30, 2019 the Company recognized stock based compensation expense for stock options and restricted stock awards, which is further described in Note 11.

 

As further clarification of the foregoing, prior to the IPO, shares were held by management that were subject to repurchase rights as outlined in Section 6 of the Securityholders Agreement, that were contingent on the holder’s termination. The repurchase rights enabled the Company to recover the shares issued to management without transferring any appreciation of the fair value of the stock to the holder upon certain terminations of the holder’s employment prior to a “Qualified Public Offering”, as defined in the Securityholders Agreement. If a holder’s employment was terminated by the Company prior to the consummation of a Qualified Public Offering for “Cause”, as defined in the Securityholders Agreement, or was terminated by such holder without “Good Reason”, as defined in the Securityholders Agreement, then the Company had the right to repurchase all or any portion of the shares held by the holder for the lesser of original cost or fair market value. If a holder’s employment was 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 had the right to repurchase all or any portion of the shares held by the holder for fair market value.

 

 

NOTE 8. WRITE-DOWNS AND OTHER CHARGES

 

The Condensed Consolidated Statements of Operations and Comprehensive Loss include various non-routine transactions, such as loss on disposal or impairment of long-lived assets and fair value adjustments to contingent consideration that have been classified as write-downs and other charges. During the three months ended September 30, 2019, the Company recognized $0.8 million in write-downs and other charges driven by losses from the disposal of assets of $0.6 million, impairment to intangible assets of $0.1 million related to game titles (the Company used level 3 fair value measurements based on projected cash flows) and a fair value adjustment to contingent consideration of $0.1 million (the Company used level 3 fair value measurements based on projected cash flows).

 

During the nine months ended September 30, 2019, the Company recognized $6.9 million in write-downs and other charges driven by the impairment of goodwill in our RMG Interactive reporting unit of $3.5 million as well as related impairments of intangible assets in the RMG Interactive reporting unit of $1.3 million, which are described in Note 4. We also recorded losses from the disposal of assets of $1.0 million, an impairment to intangible assets of $0.5 million related to game titles (the Company used level 3 fair value measurements based on projected cash flows) and a fair value adjustment to contingent consideration of $0.5 million (the Company used level 3 fair value measurements based on projected cash flows).

 

During the three months ended September 30, 2018, the Company recognized $0.7 million in write-downs and other charges driven by losses from the disposal of assets of $0.4 million and impairment of development agreement intangible assets of $0.2 million (the Company used level 3 fair value measurements based on projected cash flows) and a $0.1 million fair value adjustment to contingent consideration (level 3 fair value measurement based on projected cash flows).

 

During the nine months ended September 30, 2018, the Company recognized $3.3 million in write-downs and other charges driven by losses from the disposal of assets of $1.4 million, the impairment to intangible assets of $1.2 million related to game titles and a development agreement (the Company used level 3 fair value measurements based on projected cash flows), and a fair value adjustment to contingent consideration of $0.7 million (the Company used level 3 fair value measurements based on projected cash flows).

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

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

 

The Company computes net (loss) income per share in accordance with accounting guidance that requires presentation of both basic and diluted earnings per share (“EPS”) on the face of the Condensed Consolidated Statement of Operations and Comprehensive (Loss) Income. Basic EPS is computed by dividing net (loss) income for the period by the weighted average number of shares outstanding during the period. Basic EPS includes common stock weighted for average number of shares issued during the period. Diluted EPS is computed by dividing net (loss) income for the period by the weighted average number of common shares outstanding during the period, increased by potentially dilutive common shares that were outstanding during the period. Diluted EPS excludes all potential dilutive shares if their effect is anti-dilutive. Potentially dilutive common shares include stock options and restricted stock (see Note 11).

 

There were no potentially dilutive securities for the three and nine months ended September 30, 2019.

 

Excluded from the calculation of diluted EPS for the three months ended September 30, 2019 was 651,611 restricted shares and 505,309 stock options, as such securities were anti-dilutive. Excluded from the calculation of diluted EPS for the nine months ended September 30, 2019 was 594,265 restricted shares and 733,605 stock options, as such securities were anti-dilutive.

 

 For three months ended, September 30, 3018, the weighted average of common and common equivalent shares used in the calculation of basic and diluted EPS consisted of the following (in thousands, except per share amounts):

 

 

Excluded from the calculation of diluted EPS for the nine months ended September 30, 2018 was 70,744 restricted shares and 840,815 stock options, as such securities were anti-dilutive.

 

 

NOTE 10. BENEFIT PLANS

 

The Company has established a 401(k) plan (the “401(k) Plan”) for its employees. The 401(k) Plan allows employees to contribute a portion of their earnings, and the Company may match a percentage of the contributions on a discretionary basis. The expense associated with the 401(k) Plan for the three months ended September 30, 2019 and 2018, was $0.3 million. The expense associated with the 401(k) Plan for the nine months ended September 30, 2019 and 2018, was $1.0 million and $0.9 million, respectively.

 

The increase in the expense associated with the 401(k) Plan in each year is primarily attributable to increased headcount and participation.

 

On April 28, 2014, the board of directors of the Company approved the 2014 Long-Term Incentive Plan (“LTIP”). Under the LTIP, the Company is authorized to grant nonqualified stock options, rights to purchase shares of common stock, restricted stock, restricted stock units and other awards to be settled in, or based upon, shares of common stock to persons who are directors and employees of and consultants to the Company or any of its subsidiaries on the date of the grant. The LTIP will terminate ten years after approval by the board. Subject to adjustments in connection with certain changes in capitalization, the maximum number of shares of common stock that may be delivered pursuant to awards under the LTIP is 2,253,735 after giving effect to the 1.5543 - for - 1 stock split consummated on January 30, 2018 in connection with our initial public offering.  As of September 30, 2019, approximately 423,268 shares remain available for issuance.

 

On January 16, 2018, our board adopted and our stockholders approved the 2018 Omnibus Incentive Plan (the “Omnibus Incentive Plan”) pursuant to which equity-based and cash incentives may be granted to participating employees, directors and consultants. The Omnibus Incentive Plan provides for an aggregate of 1,607,389 shares of our common stock. As of September 30, 2019, 765,515 shares remain available for issuance.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 11. STOCK-BASED COMPENSATION

 

All share information is presented after giving effect to the 1.5543-for-1 stock split consummated on January 30, 2018 in connection with our initial public offering.

 

Stock Options

 

The Company has granted stock awards to eligible participants under its incentive plans. The stock awards include options to purchase the Company’s common stock. These stock options include a combination of service and market conditions, as further described below. Prior to the Company’s IPO, these stock options included a performance vesting condition, a Qualified Public Offering (see Note 7), which was not considered to be probable prior to the consummation of the IPO, and as a result, no share-based compensation expense for stock options was recognized prior to 2018.

 

For the three months ended September 30, 2019, the Company recognized $0.2 million in stock-based compensation for stock options and $1.8 million for restricted stock awards. For the nine months ended September 30, 2019, the Company recognized $0.7 million in stock-based compensation for stock options and $4.6 million for restricted stock awards. We recognize stock-based compensation on a straight-line basis over the vesting period for time based awards and we recognize the expense for awards with market conditions over the service period derived from the related valuation. The amount of unrecognized compensation expense associated with stock options was $1.1 million and for restricted stock was $12.4 million at September 30, 2019 which is expected to be recognized over a 2.0 and 3.0 yearly weighted average period, respectively.

 

The Company calculates the grant date fair value of stock options that vest over a service period using the Black Scholes model. For stock options that contain a market condition related to the return on investment that the Company’s stockholders achieve, the options are valued using a lattice-based option valuation model. The assumptions used in these calculations are the expected dividend yield, expected volatility, risk-free interest rate and expected term (in years). Expected volatilities are based on implied volatilities from comparable companies. The expected time to liquidity is based on management’s estimate. The risk-free rate is based on the U.S. Treasury yield curve for a term equivalent to the estimated time to liquidity. There were no options granted during the three and  nine months ended September 30, 2019.

 

 

Stock option awards represent options to purchase common stock and are granted pursuant to the Company’s incentive plans, and include options that the Company primarily classifies as Tranche A or time based, Tranche B and Tranche C.

 

Tranche A or time based options are eligible to vest in equal installments of 20% or 25% on each of the first five or four anniversaries of the date of the grant, subject to continued employment with the Company or its subsidiaries. In the event of a termination of employment without cause or as a result of death or disability, any such time based options which would have vested on the next applicable vesting date shall become vested, and the remaining unvested time based options shall be forfeited. In addition, upon a Change in Control (as defined in the incentive plans), subject to continued employment through the date of the Change in Control, all outstanding unvested time based options shall immediately vest. An IPO does not qualify as a Change in Control as it relates to the vesting of stock options.

 

All other option awards are eligible to vest upon the satisfaction of certain performance conditions (collectively, “Performance Options”). On January 16, 2018, we amended our option agreements to add additional vesting provisions to our Performance Options. Tranche B options are eligible to vest based on (a) achievement of an Investor IRR equal to or in excess of 20%, subject to a minimum cash-on-cash return of 2.5 times the Investor Investment (as such terms are defined in the Company’s 2014 Long-Term Incentive Plan) or (b) on the first day that the volume-weighted average price per share of our common stock for the prior 60 consecutive trading days exceeds $19.11 (provided that such 60-day period shall not commence earlier than the 181st day after the completion of our IPO). Tranche C options are eligible to vest based on (a) achievement of an Investor IRR (as defined in the incentive plans) equal to or in excess of 25%, subject to a minimum cash-on-cash return of 3.0 times the Investor Investment or (b) on the first day that the volume-weighted average price per share of our common stock for the prior 60 consecutive trading days exceeds $22.93 (provided that such 60-day period shall not commence earlier than the 181st day after the completion of our IPO). In the event of a termination of employment without cause or as a result of death or disability, any Performance Options which are outstanding and unvested will remain eligible to vest subject to achievement of such performance targets (without regard to the continued service requirement) until the first anniversary of the date of such termination. As a result of the modification, the Company measured the incremental fair value of Tranche B and Tranche C options, which resulted in $2.9 million of incremental fair value.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

As of September 30, 2019, the Company had 617,510 Performance Options outstanding, all of which have vested as the vesting provisions were achieved in October 2018.

 

A summary of the changes in stock options outstanding during the nine months ended September 30, 2019, is as follows:

 

 

Restricted Stock

 

Restricted stock awards are typically eligible to vest in equal installments of 25% on each of the first four anniversaries of the date of the grant, subject to continued employment with the Company or its subsidiaries. In the event of a termination of employment without cause upon or within 12 months following a change in control or as a result of death or disability, any such unvested time based restricted stock awards shall become vested.

 

Certain restricted stock awards are eligible to vest upon the satisfaction of certain conditions (collectively, “Performance Awards”). Vesting occurs on the first day that the average price per share of our common stock for the prior 60 consecutive trading days exceeds $29.60.

 

A summary of the changes in restricted stock outstanding during the nine months ended September 30, 2019, is as follows:

 

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 12. INCOME TAXES

 

The Company's effective income tax rate for the three months ended September 30, 2019, was an expense of 53.6%. The difference between the federal statutory rate of 21% and the Company's effective tax rate for the three months ended September 30, 2019, was primarily due to changes in our valuation allowance on deferred tax assets and changes in the estimated forecast of pre-tax book income and loss for each respective jurisdiction. The Company's effective income tax rate for the three months ended September 30, 2018, was a benefit of 437.3%. The difference between the federal statutory rate of 21% and the Company's effective tax rate for the three months ended September 30, 2018, was primarily due to changes in our valuation allowance on deferred tax assets and changes in the estimated forecast of pre-tax book income and loss for each respective jurisdiction.

 

The Company's effective income tax rate for the nine months ended September 30, 2019, was a benefit of 23.1%. The difference between the federal statutory rate of 21% and the Company's effective tax rate for the nine months ended September 30, 2019, was primarily due to changes in our valuation allowance on deferred tax assets, various permanent items, lapse in the applicable statute of limitations for certain uncertain tax positions and impairment of goodwill. The Company's effective income tax rate for the nine months ended September 30, 2018, was a benefit of 46.0%. The difference between the federal statutory rate of 21% and the Company's effective tax rate for the nine months ended September 30, 2018, was primarily due to changes in our valuation allowance on deferred tax assets and lapse in the applicable statute of limitations for certain uncertain tax positions.

 

The Company entered into an indemnification agreement with the prior owners of Cadillac Jack (acquired in May of 2015) whereby the prior owners have agreed to indemnify the Company for changes in tax positions by taxing authorities for periods prior to the acquisition. As of September 30, 2019, an indemnification receivable of $3.9 million has been recorded in other assets in the financial statements. This amount includes the indemnification of the original pre-acquisition tax positions along with any related accrued interest and penalties and is offset by a corresponding liability for unrecognized tax benefits in other long-term liabilities. When the related unrecognized tax benefits are favorably resolved, a corresponding charge to relieve the associated indemnification receivable would be recognized in our Consolidated Statements of Operations and Comprehensive Loss (Income).

 

During the three and nine months ended September 30, 2019, the Company recognized a $0.1 million increase and $5.4 million reduction in the indemnification receivable and related charge in our Consolidated Statements of Operations and Comprehensive Loss (Income) due to accrued interest and lapse in the applicable statute of limitations on indemnified tax positions. During the three and nine months ended September 30, 2018, the Company recognized a $0.5 million increase and $9.4 million reduction in the indemnification receivable and related charge in our Consolidated Statements of Operations and Comprehensive Loss (Income) primarily to lapse of statute on indemnified tax positions.

 

 

NOTE 13. COMMITMENTS AND CONTINGENCIES

 

The Company is subject to federal, state and Native American laws and regulations that affect both its general commercial relationships with its customers, as well as the products and services provided to them. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. If a potential loss from any claim or legal proceeding is considered reasonably possible, the Company discloses an estimate of the possible loss or range of possible loss, or a statement that such an estimate cannot be made. During the three months ended September 30, 2019, the Company recorded a $1.6 million loss reserve, for which insurance coverage has been triggered. In accordance with GAAP, the offsetting insurance recovery will be recognized when it is realized or realizable in a future period. 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.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 14. OPERATING SEGMENTS

 

We report our business segment results by segment in accordance with the “management approach.” The management approach designates the internal reporting used by our chief operating decision maker (“CODM”), who is our Chief Executive Officer (the “CEO”), for making decisions and assessing performance of our reportable segments.

 

See Note 1 for a detailed discussion of our three segments. Each segment’s activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its product lines. We evaluate the performance of our operating segments based on revenues and segment adjusted EBITDA, which is defined in the paragraph below.

 

Segment revenues include leasing, licensing, or selling of products within each reportable segment. Segment adjusted EBITDA includes the revenues and operating expenses from each segment adjusted for depreciation, amortization, write-downs and other charges, accretion of placement fees, non-cash stock based compensation expense, as well as other costs such as certain acquisitions and integration related costs including restructuring and severance charges; legal and litigation expenses including settlement payments; new jurisdictions and regulatory licensing costs; non-cash charges on capitalized installation and delivery; contract cancellation fees; and other adjustments primarily composed of professional fees incurred by the Company for projects, corporate and public filing compliance and other costs deemed to be non-recurring in nature. Revenues in each segment are attributable to third parties and segment operating expenses are directly associated with the product lines included in each segment such as research and development, product approval costs, product-related litigation expenses, sales commissions and other directly-allocable sales expenses. Cost of gaming operations and cost of equipment sales primarily include the cost of products sold, service, manufacturing overhead, shipping and installation.

 

Segment adjusted EBITDA excludes other income and expense, income taxes and certain expenses that are managed outside of the operating segments.

 

The following provides financial information concerning our reportable segments for the three and nine months ended September 30, 2019 and 2018 (amounts in thousands):   

 

 

⁽¹⁾ Non-cash item related to the accretion of contract rights under development agreements and placement fees.

 

The Company’s CODM does not receive a report with a measure of total assets or capital expenditures for each reportable segment as this information is not used for the evaluation of segment performance. The CODM assesses the performance of each segment based on adjusted EBITDA and not based on assets or capital expenditures due to the fact that two of the Company’s reportable segments, Table Products and Interactive, are not capital intensive. Any capital expenditure information is provided to the CODM on a consolidated basis. Therefore, the Company has not provided asset and capital expenditure information by reportable segment.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

 

NOTE 15. LEASES

 

Operating Leases

 

We lease office space, warehouses and office equipment which we classify as operating leases. Operating leases with an initial term of 12 months or less and leases that include an option to terminate without material penalty are not recorded on the balance sheet. Most leases recorded on the balance sheet have an option to renew and do not have an option to terminate without a material penalty. We recognize lease expense for operating leases on a straight-line basis over the term of the lease. The exercise of the renewal options is at our sole discretion. For all our existing leases we are not reasonably certain we will exercise the renewal option. The depreciable life of assets and leasehold improvements are limited by the expected lease term. Our operating lease agreements do not contain any residual value guarantees or restrictive covenants. As most of our operating leases contracts do not provide an implicit rate, we use the First Lien Credit Agreement rate based on the information available at commencement date in determining the present value of lease payments. We used the First Lien Credit Agreement rate on December 31, 2018, for the initial measurement of all operating leases as of January 1, 2019 that commenced on or prior to that date.

 

Finance Leases

 

We lease vehicles which we account for as finance leases using the effective interest method. Our finance lease agreements do not contain material restrictive covenants or material residual value guarantees. We use the rate implicit in the lease at the lease commencement date in determining the present value of lease payments for finance leases.

 

For the nine months ended September 30, 2019 and 2018, we did not have any lease agreements with variable lease costs and short-term lease costs, excluding expenses relating to leases with a lease term of one month or less that were immaterial.

 

The following table discloses the operating and finance assets and liability balances recorded under ASC 842 as of September 30, 2019 and ASC 840 as of December 31, 2018:

 

 

^(a) Operating lease assets are recorded net of accumulated amortization of $1.1 million as of September 30, 2019.

^(b) Finance lease assets are recorded net of accumulated amortization of $0.6 million and $0.4 million as of September 30, 2019 and December 31, 2018, respectively.

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

The table below discloses the costs for operating and finance leases for the three and nine months ended September 30, 2019 and 2018:

 

 

The table below sets forth the maturity of the operating and financing leases liabilities for five years and thereafter under ASC 842:

 

 

^(a) Operating leases payments exclude $14.3 million of legally binding minimum lease payments for leases signed but not commenced as of September 30, 2019.

 

Future minimum lease payments under ASC 840 as of December 31, 2018 were as follows:

 

 

 

PLAYAGS, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

 

The following table sets forth the weighted average of the lease terms and discount rates for operating and finance leases as of September 30, 2019 and 2018.

 

 

Other Information

 

The table below discloses cash paid for the amounts included in the measurement of lease liabilities for the nine months ended September 30, 2019 and 2018:

 

 

 

 

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