Accel Entertainment, Inc. (ACEL) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides information that management believes is relevant to an understanding and assessment of our consolidated financial condition and results of operations. You should read this discussion in conjunction with our consolidated financial statements and the notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K. This discussion and analysis of our financial condition and results of operations also contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under Item 1A. “Risk Factors.”
A discussion of our results of operations on a consolidated basis for the years ended December 31, 2023 and 2022 are presented below. For the discussion of our results of operations on a consolidated basis for the years ended December 31, 2022 and 2021, please see our Annual Report on Form 10-K for the year ended December 31, 2022 that was filed on March 1, 2023.
Company Overview
We are a leading distributed gaming operator in the United States (“U.S.”) and a preferred partner for local business owners in the markets we serve. We offer turnkey, full-service gaming solutions to bars, restaurants, convenience stores, truck stops, and fraternal and veteran establishments across the country. Our focus is providing unmatched customer support, guidance, and expertise so our location partners can grow their businesses with incremental revenue.
We install, maintain, operate and service gaming terminals and related equipment for our location partners as well as redemption devices that have automated teller machine (“ATM”) functionality and stand-alone ATMs. We offer amusement devices, including jukeboxes, dartboards, pool tables, and other entertainment related equipment. These operations provide a complementary source of lead generation for our gaming business by offering a “one-stop” source of additional equipment for our location partners. We also design and manufacture gaming terminals and related equipment. We are continuously evaluating additional opportunities that are complementary to our core business.
We currently operate as a distributed gaming operator in the following states:
•Illinois - we are a licensed terminal operator by the Illinois Gaming Board (“IGB”) since 2012,
•Montana - we were granted a manufacturer, distributor and route operator license in June 2022 by the Gambling Control Division of the Montana Department of Justice in June 2022, which has been renewed through June 2024,
•Nevada - we were granted a two-year terminal operator license in June 2022 by the Nevada Gaming Commission,
•Nebraska - we became a licensed distributor of mechanical amusement devices in Nebraska in June 2022, and commenced operations in this market,
•Georgia - we received approval from the Georgia Lottery Corporation as a Master Licensee in July 2020,
•Iowa - we are registered with the Iowa Department of Inspections and Appeals to conduct operations in Iowa,
•Pennsylvania - we have held a license from the Pennsylvania Gaming Control Board since November 2020.
Through our wholly owned subsidiary, Grand Vision Gaming, we also manufacture gaming terminals in the Montana, Nevada, South Dakota, Louisiana and West Virginia markets.
We are subject to the various gaming regulations in the states in which we operate, as well as various other federal, state and local laws and regulations.
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Century Acquisition
On June 1, 2022, we completed our acquisition of all of the outstanding equity interests of Century Gaming, Inc., a Montana corporation (“Century”). The aggregate purchase consideration was $164.3 million, which included: (i) a cash payment made at closing of $45.5 million to the equity holders of Century; (ii) repayment of $113.2 million of Century's indebtedness; and (iii) 515,622 shares of our Class A-1 common stock issued to certain members of Century’s management with a fair value of $5.6 million on the acquisition date. The cash payments were financed using cash from a draw of approximately $160 million from our revolving credit facility and delayed draw term loan facility under our senior secured credit facility. Our financial results for the year ended December 31, 2022 include the results of Century from the date of acquisition, and our financial results for the year ended December 31, 2023 include the results of Century for the full year.
Macroeconomic Factors
Interest rate volatility, persistent inflation and actual or perceived instability in the U.S. and global banking systems may increase the risk of an economic recession and volatility and dislocation in the capital or credit markets in the U.S. and other markets globally. Our location partners may be adversely impacted by changes in overall economic and financial conditions, and certain location partners may cease operations in the event of a recession or inability to access financing. Furthermore, our revenue is largely driven by players’ disposable incomes and level of gaming activity, and economic conditions that adversely impact players’ ability and desire to spend disposable income at our locations partners may adversely affect our results of operations and cash flows. To date, we have not observed material impacts in our business or outlook, but there can be no assurance that, in the event of a recession, levels of gaming activity would not be adversely affected. Further, as described in more detail below, we have observed certain increases in our costs, particularly higher wages and increased interest expense on our debt. In addition, during 2022 and 2023, we accelerated certain of our capital expenditures related to gaming machines and related components to manage our supply chain. We intend to continue to monitor macroeconomic conditions closely and may determine to take certain financial or operational actions in response to such conditions to the extent our business begins to be adversely impacted.
Components of Performance
Revenues
Net gaming. Net gaming revenue represents net cash received from gaming activities, which is the difference between gaming wins and losses. Net gaming revenue includes the amounts earned by our location partners and is recognized at the time of gaming play.
Amusement. Amusement revenue represents amounts collected from amusement devices operated at various location partners and is recognized at the point the amusement device is used.
Manufacturing. Manufacturing revenue represents sales of gaming terminals and related equipment.
ATM fees and other. ATM fees and other primarily represents fees charged for the withdrawal of funds from our redemption devices and stand-alone ATMs and is recognized at the time of the ATM transaction.
Operating Expenses
Cost of revenue. Cost of revenue consists of (i) taxes on net gaming revenue that is payable to the appropriate jurisdiction, (ii) licenses, permits and other fees required for the operation of gaming terminals and other equipment, (iii) location revenue share, which is governed by local governing bodies and location contracts, (iv) ATM and amusement commissions payable to locations, and (v) ATM and amusement fees.
Cost of manufacturing goods sold. Cost of manufacturing goods sold consists of costs associated with the sale of gaming terminals and related equipment.
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General and administrative. General and administrative expenses consist of operating expense and general and administrative expense. Operating expense includes payroll and related expense for service technicians, route technicians, route security, and preventative maintenance personnel. Operating expense also includes vehicle fuel and maintenance, and non-capitalizable parts expenses. Operating expenses are generally proportionate to the number of locations and gaming terminals. General and administrative expense includes payroll and related expense for account managers, business development managers, marketing, and other corporate personnel. In addition, general and administrative expense also includes marketing, information technology, insurance, rent and professional fees.
Depreciation and amortization of property and equipment. Depreciation is computed using the straight-line method over the estimated useful lives of the individual assets. Leasehold improvements are amortized over the shorter of the useful life or the lease.
Amortization of intangible assets and route and customer acquisition costs. Route and customer acquisition costs consist of fees paid at the inception of contracts entered into with third parties and our gaming locations, which allow us to install and operate gaming terminals. The route and customer acquisition costs and route and customer acquisition costs payable are recorded at the net present value of the future payments using a discount rate equal to our incremental borrowing rate associated with its long-term debt. Route and customer acquisition costs are amortized on a straight-line basis over 18 years, which is the expected estimated life of the contract, including expected renewals.
Location contracts acquired in a business combination are recorded at fair value and then amortized as an intangible asset on a straight-line basis over the expected useful life of 15 years.
Other intangible assets acquired in a business acquisition are recorded at fair value and then amortized as an intangible asset on a straight-line basis over their estimated 7 to 20-year useful lives.
Interest expense, net
Interest expense, net consists of interest on our current credit facility, amortization of financing fees, accretion of interest on route and customer acquisition costs payable, and interest (income) expense on the interest rate caplets. Interest on the current credit facility is payable monthly on unpaid balances at the variable per annum LIBOR/SOFR rate plus an applicable margin, as defined under the terms of the credit facility, ranging from 1.75% to 2.75% depending on the first lien net leverage ratio.
Income tax expense
Income tax expense consists mainly of taxes payable to national, state and local authorities. Deferred income taxes are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of the assets and liabilities.
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Results of Operations
The following table summarizes our results of operations on a consolidated basis for the years ended December 31, 2023 and 2022:
| (in thousands, except %s) | Year Ended December 31, | Increase / (Decrease) | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change % | |||||||||||
| Revenues: | ||||||||||||||
| Net gaming | $ | 1,113,573 | $ | 925,009 | $ | 188,564 | 20.4 | % | ||||||
| Amusement | 23,973 | 21,106 | 2,867 | 13.6 | % | |||||||||
| Manufacturing | 13,353 | 7,621 | 5,732 | 75.2 | % | |||||||||
| ATM fees and other | 19,521 | 16,061 | 3,460 | 21.5 | % | |||||||||
| Total net revenues | 1,170,420 | 969,797 | 200,623 | 20.7 | % | |||||||||
| Operating expenses: | ||||||||||||||
| Cost of revenue (exclusive of depreciation and amortization expense shown below) | 809,524 | 666,126 | 143,398 | 21.5 | % | |||||||||
| Cost of manufacturing goods sold (exclusive of depreciation and amortization expense shown below) | 7,671 | 4,775 | 2,896 | 60.6 | % | |||||||||
| General and administrative | 180,248 | 145,942 | 34,306 | 23.5 | % | |||||||||
| Depreciation and amortization of property and equipment | 37,906 | 29,295 | 8,611 | 29.4 | % | |||||||||
| Amortization of intangible assets and route and customer acquisition costs | 21,211 | 17,484 | 3,727 | 21.3 | % | |||||||||
| Other expenses, net | 6,453 | 9,320 | (2,867) | (30.8) | % | |||||||||
| Total operating expenses | 1,063,013 | 872,942 | 190,071 | 21.8 | % | |||||||||
| Operating income | 107,407 | 96,855 | 10,552 | 10.9 | % | |||||||||
| Interest expense, net | 33,144 | 21,637 | 11,507 | 53.2 | % | |||||||||
| Loss (gain) on change in fair value of contingent earnout shares | 8,539 | (19,544) | 28,083 | 143.7 | % | |||||||||
| Income before income tax expense | 65,724 | 94,762 | (29,038) | (30.6) | % | |||||||||
| Income tax expense | 20,121 | 20,660 | (539) | (2.6) | % | |||||||||
| Net income | $ | 45,603 | $ | 74,102 | $ | (28,499) | (38.5) | % |
Revenues
Total net revenues for the year ended December 31, 2023 were $1,170.4 million, an increase of $200.6 million, or 20.7%, compared to the prior year. The increase was driven primarily by an increase in net gaming revenue of $188.6 million, or 20.4%. The increase in net gaming revenue for the year ended December 31, 2023 was driven by the Century acquisition, adding new locations and 3% same store sales growth in Illinois. Total net revenues by state are presented below (in thousands, except %s):
| Year Ended December 31, | Increase / (Decrease) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change % | |||||||||||
| Total net revenues by state: | ||||||||||||||
| Illinois | $ | 867,200 | $ | 808,652 | $ | 58,548 | 7.2 | % | ||||||
| Montana | 154,402 | 79,639 | 74,763 | 93.9 | % | |||||||||
| Nevada | 117,074 | 66,989 | 50,085 | 74.8 | % | |||||||||
| Nebraska | 19,043 | 5,217 | 13,826 | 265.0 | % | |||||||||
| All other | 12,701 | 9,300 | 3,401 | 36.6 | % | |||||||||
| Total net revenues | $ | 1,170,420 | $ | 969,797 | $ | 200,623 | 20.7 | % |
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Cost of revenue
Total cost of revenue for the year ended December 31, 2023 was $809.5 million, an increase of $143.4 million, or 21.5%, compared to the prior year due primarily to higher net gaming revenue, described above.
Cost of manufacturing goods sold
Cost of manufacturing goods sold for the year ended December 31, 2023 was $7.7 million, an increase of $2.9 million, or 60.6%, compared to the prior year due primarily to higher manufacturing revenue.
General and administrative
Total general and administrative expenses for the year ended December 31, 2023 were $180.2 million, an increase of $34.3 million, or 23.5%, compared to the prior year. The increase was attributable to higher payroll-related costs, as we continue to grow our operations, as well as higher parts and repair expense, higher stock-based compensation expense, and a settlement with the IGB of $1.1 million recorded in the second quarter of 2023.
Depreciation and amortization of property and equipment
Depreciation and amortization of property and equipment for the year ended December 31, 2023 was $37.9 million, an increase of $8.6 million, or 29.4%, compared to the prior year due to an increased number of gaming terminals primarily attributable to the acquisition of Century.
Amortization of intangible assets and route and customer acquisition costs
Amortization of intangible assets and route and customer acquisition costs for the year ended December 31, 2023 was $21.2 million, an increase of $3.7 million, or 21.3%, compared to the prior year due to an increase in location contracts acquired and amortization expense on other intangible assets acquired with Century.
Other expenses, net
Other expenses, net for the year ended December 31, 2023 were $6.5 million, a decrease of $2.9 million, or 30.8%, compared to the prior year. The decrease was due to lower non-recurring expenses related to new market development and a $1.7 million gain recognized in the second quarter of 2023 on the convertible note settlement as discussed in Note 4 to the consolidated financial statements, partially offset by higher fair value adjustments associated with the revaluation of contingent consideration liabilities.
Interest expense, net
Interest expense, net for the year ended December 31, 2023 was $33.1 million, an increase of $11.5 million, or 53.2%, compared to the prior year, primarily due to higher interest rates and an increase in average outstanding debt, partially offset by the benefit realized on our interest rate caplets. For the year ended December 31, 2023, the weighted-average interest rate was approximately 7.3% compared to the weighted-average interest rate of approximately 4.4% for the prior year.
Loss (gain) on change in fair value of contingent earnout shares
Loss on change in fair value of contingent earnout shares for the year ended December 31, 2023 was $8.5 million, compared to the prior year, which had a gain of $19.5 million. The change was primarily due to the fluctuations in the market value of our Class A-1 common stock, which is the primary input to the valuation of the contingent earnout shares.
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Income tax expense
Income tax expense for the year ended December 31, 2023 was $20.1 million, a decrease of $0.5 million, or 2.6%, compared to the prior year. The effective tax rate for the year ended December 31, 2023 was 30.6% compared to 21.8% in the prior year period. Our effective income tax rate can vary from period to period depending on, among other factors, the amount of permanent tax adjustments and discrete items. The change in the fair value of the contingent earnout shares is considered a discrete item for tax purposes and was the primary driver for the fluctuations in the tax rate year over year.
Key Business Metrics
We use statistical data and comparative information commonly used in the gaming industry to monitor the performance of the business, none of which are prepared in accordance with U.S. GAAP, and therefore should not be viewed as indicators of operational performance. Our management uses these key business metrics for financial planning, strategic planning and employee compensation decisions. The key business metrics include:
•Number of locations and;
•Number of gaming terminals
We also periodically review and revise our key business metrics to reflect changes in our business.
Number of locations
The number of locations is based on a combination of third-party portal data and data from our internal systems. We utilize this metric to continually monitor growth from organic openings, purchased locations, and competitor conversions. Competitor conversions occur when a location chooses to change terminal operators.
The following table sets forth information with respect to our primary locations:
| As of December 31, | Increase / (Decrease) | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change % | ||||||||
| Illinois | 2,762 | 2,648 | 114 | 4.3 | % | ||||||
| Montana | 609 | 610 | (1) | (0.2) | % | ||||||
| Nevada | 352 | 340 | 12 | 3.5 | % | ||||||
| Nebraska | 238 | 143 | 95 | 66.4 | % | ||||||
| Total locations | 3,961 | 3,741 | 220 | 5.9 | % |
Number of gaming terminals
The number of gaming terminals in operation is based on a combination of third-party portal data and data from our internal systems. We utilize this metric to continually monitor growth from existing locations, organic openings, purchased locations, and competitor conversions.
The following table sets forth information with respect to the number of gaming terminals in our primary locations:
| As of December 31, | Increase / (Decrease) | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change % | ||||||||
| Illinois | 15,276 | 14,397 | 879 | 6.1 | % | ||||||
| Montana | 6,276 | 6,108 | 168 | 2.8 | % | ||||||
| Nevada | 2,704 | 2,645 | 59 | 2.2 | % | ||||||
| Nebraska | 827 | 391 | 436 | 111.5 | % | ||||||
| Total gaming terminals | 25,083 | 23,541 | 1,542 | 6.6 | % |
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Non-GAAP Financial Measures
Adjusted EBITDA and Adjusted net income are non-GAAP financial measures, but are key metrics management uses to monitor ongoing core operations. Adjusted EBITDA and Adjusted net income exclude the effects of certain non-cash items or represent certain nonrecurring items that are unrelated to core performance. Management believes these non-GAAP financial measures enhance the understanding of our underlying drivers of profitability, trends in our business, and facilitate company-to-company and period-to-period comparisons. Management also believes that these non-GAAP financial measures are used by investors, analysts and other interested parties as measures of financial performance and to evaluate our ability to fund capital expenditures, service debt obligations and meet working capital requirements.
Adjusted net income and Adjusted EBITDA
| (in thousands, except %s) | Year Ended December 31, | Increase / (Decrease) | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change % | |||||||||||
| Net income | $ | 45,603 | $ | 74,102 | $ | (28,499) | (38.5) | % | ||||||
| Adjustments: | ||||||||||||||
| Amortization of intangible assets and route and customer acquisition costs(1) | 21,211 | 17,484 | 3,727 | 21.3 | % | |||||||||
| Stock-based compensation(2) | 9,416 | 6,840 | 2,576 | 37.7 | % | |||||||||
| Loss (gain) on change in fair value of contingent earnout shares (3) | 8,539 | (19,544) | 28,083 | 143.7 | % | |||||||||
| Other expenses, net(4) | 6,453 | 9,320 | (2,867) | (30.8) | % | |||||||||
| Tax effect of adjustments(5) | (8,702) | (8,327) | (375) | 4.5 | % | |||||||||
| Adjusted net income | 82,520 | 79,875 | 2,645 | 3.3 | % | |||||||||
| Depreciation and amortization of property and equipment | 37,906 | 29,295 | 8,611 | 29.4 | % | |||||||||
| Interest expense, net | 33,144 | 21,637 | 11,507 | 53.2 | % | |||||||||
| Emerging markets(6) | (948) | 2,598 | (3,546) | (136.5) | % | |||||||||
| Income tax expense | 28,823 | 28,987 | (164) | (0.6) | % | |||||||||
| Adjusted EBITDA | $ | 181,445 | $ | 162,392 | $ | 19,053 | 11.7 | % |
(1)Amortization of intangible assets and route and customer acquisition costs consist of upfront cash payments and future cash payments to third-party sales agents to acquire the location partners that are not connected with a business acquisition, as well as the amortization of other intangible assets. We amortize the upfront cash payment over the life of the contract, including expected renewals, beginning on the date the location goes live, and recognizes non-cash amortization charges with respect to such items. Future or deferred cash payments, which may occur based on terms of the underlying contract, are generally lower in the aggregate as compared to established practice of providing higher upfront payments, and are also capitalized and amortized over the remaining life of the contract. Future cash payments do not include cash costs associated with renewing customer contracts as we do not generally incur significant costs as a result of extension or renewal of an existing contract. Location contracts acquired in a business combination are recorded at fair value as part of the business combination accounting and then amortized as an intangible asset on a straight-line basis over the expected useful life of the contract of 15 years. “Amortization of intangible assets and route and customer acquisition costs” aggregates the non-cash amortization charges relating to upfront route and customer acquisition cost payments and location contracts acquired, as well as the amortization of other intangible assets.
(2)Stock-based compensation consists of options, restricted stock units, performance-based stock units, and warrants.
(3)Loss (gain) on change in fair value of contingent earnout shares represents a non-cash fair value adjustment at each reporting period end related to the value of these contingent shares. Upon achieving certain exchange conditions, shares of Class A-2 common stock convert to Class A-1 common stock resulting in a non-cash settlement of the obligation.
(4)Other expenses, net consists of (i) non-cash expenses including the remeasurement of contingent consideration liabilities, (ii) non-recurring lobbying and legal expenses related to distributed gaming expansion in current or prospective markets, and (iii) other non-recurring expenses.
(5)Calculated by excluding the impact of the non-GAAP adjustments from the current period tax provision calculations.
(6)Emerging markets consist of the results, on an Adjusted EBITDA basis, for non-core jurisdictions where our operations are developing. Markets are no longer considered emerging when we have installed or acquired at least 500 gaming terminals in the jurisdiction, or when 24 months have elapsed from the date we first install or acquire gaming terminals in the jurisdiction, whichever occurs first. We currently view Iowa and Pennsylvania as emerging markets. Prior to April 2023, Nebraska was considered an emerging market. Prior to July 2022, Georgia was considered an emerging market.
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Adjusted EBITDA for the year ended December 31, 2023 was $181.4 million, an increase of $19.1 million, or 11.7%, compared to the prior year. The increase in performance was attributable to an increase in the number of locations and gaming terminals, due primarily to the acquisition of Century, partially offset by higher payroll-related costs and parts and repair expense.
Liquidity and Capital Resources
In order to maintain sufficient liquidity, we review our cash flow projections and available funds with the Board to consider modifying our capital structure and seeking additional sources of liquidity, if needed. The availability of additional liquidity options will depend on the economic and financial environment, our creditworthiness, our historical and projected financial and operating performance, and our continued compliance with financial covenants. As a result of possible future economic, financial and operating declines, possible declines in our creditworthiness and potential non-compliance with financial covenants, we may have less liquidity than anticipated, fewer sources of liquidity than anticipated, less attractive financing terms and less flexibility in determining when and how to use the liquidity that is available.
We believe that our cash and cash equivalents, cash flows from operations and borrowing availability under our senior secured credit facility will be sufficient to meet our capital requirements for the next twelve months. Our primary short-term cash needs are paying operating expenses and contingent earnout payments, purchases of property and equipment, servicing outstanding indebtedness, and funding the Board approved share repurchase program and near term acquisitions. As of December 31, 2023, we had $261.6 million in cash and cash equivalents.
Senior Secured Credit Facility
On November 13, 2019, we entered into a credit agreement (as amended, the “Credit Agreement”) as borrower, with our wholly-owned domestic subsidiaries, as guarantors, the banks, financial institutions and other lending institutions from time to time party thereto, as lenders, the other parties from time to time party thereto and Capital One, National Association, as administrative agent (in such capacity, the “Agent”), collateral agent, issuing bank and swingline lender, providing for a:
•$100.0 million revolving credit facility, including a letter of credit facility with a $10.0 million sublimit and a swing line facility with a $10.0 million sublimit,
•$240.0 million initial term loan facility and
•$125.0 million additional term loan facility.
On August 4, 2020, in order to provide a waiver of financial covenant breach for the periods ended September 30, 2020 through March 31, 2021 of the First Lien Net Leverage Ratio and Fixed Charge Coverage Ratio (each as defined under the Credit Agreement), we and the other parties thereto entered into Amendment No. 1 to the Credit Agreement (“Amendment No. 1”). Amendment No.1 also raised the floor for the adjusted LIBOR rate to 0.50% and the floor for the Base Rate to 1.50%. The waivers of financial covenant breach were never utilized as we remained in compliance with all debt covenants during these periods.
On October 22, 2021, in order to increase the borrowing capacity under the Credit Agreement, we and the other parties thereto entered into Amendment No. 2 to the Credit Agreement (“Amendment No. 2”). Amendment No. 2, among other things, provided for:
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•an increase in the amount of the revolving credit facility from $100.0 million to $150.0 million,
•$350.0 million initial term loan facility, the proceeds of which were applied to refinancing existing indebtedness, and
•$400.0 million delayed draw term loan facility, which was originally available for borrowing until October 22, 2023 and was extended to October 22, 2024 by Amendment No. 4 (as described below).
The maturity date of the Credit Agreement was extended to October 22, 2026. The interest rate and covenants remained unchanged. We incurred $4.3 million in debt issuance costs associated with Amendment No. 2. We also recognized a loss on debt extinguishment of $1.2 million for the year ended December 31, 2021 in connection with the amendment.
On June 7, 2023, in order to replace the referenced LIBOR interest rate in the Credit Agreement with the Secured Overnight Financing Rate (“SOFR”), we and the other parties thereto entered into Amendment No. 3 to the Credit Agreement (“Amendment No. 3”).
On August 23, 2023, we entered into Amendment No. 4 to the Credit Agreement (“Amendment No. 4”), which extended the termination date to draw on the delayed draw term loan to October 22, 2024.
In June 2023, we completed a $100 million draw on the delayed draw term loan facility and used all of the proceeds to pay down an equal portion of the revolving credit facility. As of December 31, 2023, there remained $304 million of availability under the Credit Agreement.
The obligations under the Credit Agreement are guaranteed by us and our wholly-owned domestic subsidiaries, subject to certain exceptions (collectively, the “Guarantors”). The obligations under the Credit Agreement are secured by substantially all of the assets of the Guarantors, subject to certain exceptions. Certain future-formed or acquired wholly owned domestic subsidiaries will also be required to guarantee the Credit Agreement and grant a security interest in substantially all of its assets (subject to certain exceptions) to secure the obligations under the Credit Agreement.
Borrowings under the Credit Agreement bear interest, at our option, at a rate per annum equal to either (a) the adjusted term SOFR rate (which cannot be less than zero) for interest periods of 1, 2, 3 or 6 months (or if consented to by (i) each applicable Lender, 12 months or any period shorter than 1 month or (ii) the Agent, a shorter period necessary to ensure that the end of the relevant interest period would coincide with any required amortization payment ) plus the applicable SOFR margin or (b) the alternative base rate (“ABR”) plus the applicable ABR margin. ABR is a fluctuating rate per annum equal to the highest of (i) the Federal Funds Effective Rate plus 1/2 of 1.0%, (ii) the prime rate announced from time to time by Capital One, National Association and (iii) SOFR for a 1-month Interest Period on such day plus 1.0%. As of December 31, 2023, the weighted-average interest rate was approximately 7.3%.
Interest is payable quarterly in arrears for ABR loans, at the end of the applicable interest period for SOFR loans (but not less frequently than quarterly) and upon the prepayment or maturity of the underlying loans. We are required to pay a commitment fee quarterly in arrears in respect of unused commitments under the revolving credit facility and the additional term loan facility.
The applicable SOFR and ABR margins and the commitment fee rate are calculated based upon the first lien net leverage ratio of us and our restricted subsidiaries on a consolidated basis, as defined in the Credit Agreement. The revolving loans and term loans bear interest at either (a) ABR (150 bps floor) plus a margin up to 1.75% or (b) SOFR (50 bps floor) plus a margin up to 2.75%, at our option.
The term loans and, once drawn, the additional term loans will amortize at an annual rate equal to 5.00% per annum. Upon the consummation of certain non-ordinary course asset sales, we may be required to apply the net cash proceeds thereof to prepay outstanding term loans and additional term loans. The loans under the Credit Agreement may be prepaid without premium or penalty, subject to customary SOFR “breakage” costs.
The Credit Agreement contains certain customary affirmative and negative covenants and events of default and requires us and certain of our affiliates obligated under the Credit Agreement to make customary representations and warranties in connection with credit extensions thereunder.
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In addition, the Credit Agreement requires us to maintain (a) a ratio of consolidated first lien net debt to consolidated EBITDA no greater than 4.50 to 1.00 and (b) a ratio of consolidated EBITDA to consolidated fixed charges no less than 1.20 to 1.00, in each case, tested as of the last day of each full fiscal quarter ending after the Closing Date and determined on the basis of the four most recently ended fiscal quarters for which financial statements have been delivered pursuant to the Credit Agreement, subject to customary “equity cure” rights.
If an event of default (as such term is defined in the Credit Agreement) occurs, the lenders would be entitled to take various actions, including the acceleration of amounts due under the Credit Agreement, termination of the lenders’ commitments thereunder, foreclosure on collateral, and all other remedial actions available to a secured creditor. The failure to pay certain amounts owing under the Credit Agreement may result in an increase in the interest rate applicable thereto.
We were in compliance with all debt covenants as of December 31, 2023. We expect to meet our cash obligations and remain in compliance with all debt covenants for the next 12 months.
Interest rate caplets
We manage our exposure to some of its interest rate risk through the use of interest rate caplets, which are derivative financial instruments. On January 12, 2022, we hedged the variability of the cash flows attributable to the changes in the 1-month LIBOR/SOFR interest rate on the first $300 million of the term loan under the Credit Agreement by entering into a 4-year series of 48 deferred premium caplets (“caplets”). The caplets mature at the end of each month and protect us if interest rates exceed 2% of 1-month LIBOR. The aggregate premium for these caplets was $3.9 million, and was financed as additional debt. In connection with the entry into Amendment No. 3, the referenced rate in the caplets was simultaneously changed from LIBOR to SOFR.
We recognized an unrealized loss on the change in fair value of the interest rate caplets of $4.3 million, net of income taxes, for the year ended December 31, 2023 and an unrealized gain of $12.2 million, net of income taxes, for the year ended December 31, 2022. Further, as the 1-month LIBOR/SOFR interest rate began to exceed 2% starting in second half of 2022, we recognized interest income on the caplets of $9.2 million and $1.5 million for the years ended December 31, 2023 and 2022, respectively, which is reflected in interest expense, net in the consolidated statements of operations and other comprehensive income.
Cash Flows
The following table summarizes our net cash provided by or used in operating activities, investing activities and financing activities for the periods indicated and should be read in conjunction with our consolidated financial statements and the notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K:
| (in thousands) | Year Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | ||||||||
| Net cash provided by operating activities | $ | 132,530 | $ | 107,999 | $ | 24,531 | ||||
| Net cash used in investing activities | (59,793) | (189,263) | (129,470) | |||||||
| Net cash (used in) provided by financing activities | (35,239) | 106,591 | (141,830) |
Net cash provided by operating activities
For the year ended December 31, 2023, net cash provided by operating activities was $132.5 million, an increase of $24.5 million over the prior year. The increase can be attributed to higher working capital adjustments primarily due to an increase in accounts payable and accrued expenses, partially offset by a lower increase in deferred income taxes.
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Net cash used in investing activities
For the year ended December 31, 2023, net cash used in investing activities was $59.8 million, a decrease in cash used of $129.5 million over the prior year. The decrease was attributable to less cash used for business and asset acquisitions, primarily due to the acquisition of Century in 2022, in addition to the proceeds received from the settlement of the convertible notes in 2023, partially offset by more cash used for the purchases of property and equipment and advances against a portion of the purchase price on a pending business acquisition. We anticipate our capital expenditures will be approximately $55–65 million in 2024.
Net cash (used in) provided by financing activities
For the year ended December 31, 2023, net cash used in financing activities was $35.2 million, compared to cash provided by financing activities of $106.6 million in the prior year. The change reflects a reduction in borrowings to fund business and asset acquisitions, partially offset by lower repurchases of our Class A-1 common stock and payments on consideration payable.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in accordance with U.S. GAAP. In applying accounting principles, it is often required to use estimates. These estimates consider the facts, circumstances and information available, and may be based on subjective inputs, assumptions and information known and unknown to us. Material changes in certain of the estimates that we use could affect, by a material amount, our consolidated financial position and results of operations. Although results may vary, we believe our estimates are reasonable and appropriate. The following describes certain significant accounting policies that involve more subjective and complex judgments where the effect on our consolidated financial position and operating performance could be material.
Business combinations and goodwill
For acquisitions meeting the definition of a business combination, the acquisition method of accounting is used. The acquisition date is the date on which we obtain operating control over the acquired business. The consideration paid is determined on the acquisition date and is the sum of the fair values of the assets we acquired and the liabilities we assumed, including the fair value of any asset or liability resulting from a deferred consideration arrangement. Acquisition-related costs, such as professional fees, are excluded from the consideration transferred and are expensed as incurred. Any contingent consideration is measured at its fair value on the acquisition date, recorded as a liability and accreted over its payment term in our consolidated statements of operations and comprehensive income as other expenses, net. Location contract intangibles, which represent the acquisition-date fair value of the preexisting relationships between the acquired company and gaming locations, are generally measured at fair value using an income approach which measures the fair value based on the estimated future cash flows using certain projected financial information such as revenue projections, cost of revenue margins and other assumptions such as discount rates. Acquired tangible personal property such as gaming equipment is generally measured at fair value using a cost approach which measures the fair value based on the cost to reproduce or replace the asset. Goodwill is measured as the excess of the consideration transferred over the fair value of the net identifiable assets acquired and liabilities assumed. The relevance of this policy and the described methods and assumptions vary from period to period depending on the volume of applicable acquisitions occurring.
Seasonality
Our results of operations can fluctuate due to seasonal trends and other factors. For example, the gross revenue per machine per day is typically lower in the summer when players will typically spend less time indoors at our locations, and higher in cold weather between February and April, when players will typically spend more time indoors at our locations. Holidays, vacation seasons, and sporting events may also cause our results to fluctuate.
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