Accel Entertainment, Inc. (ACEL) FY 2021 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.”
Company Overview
We believe Accel is the leading distributed gaming operator in the United States on an Adjusted EBITDA basis, and a preferred partner for local business owners in the Illinois market. Accel’s business consists of the installation, maintenance and operation of gaming terminals, redemption devices that disburse winnings and contain ATM functionality, and other amusement devices which are located in authorized non-casino locations such as restaurants, bars, taverns, convenience stores, liquor stores, truck stops, and grocery stores, which are referred to collectively as “licensed establishments.” Accel also operates a number of stand-alone ATMs in gaming and non-gaming locations. Accel has been licensed by the Illinois Gaming Board since 2012 and holds a license from the PA Board since November 2020. Accel operates 13,639 video gaming terminals across 2,584 locations in the State of Illinois as of December 31, 2021. In July 2020, the Georgia Lottery Corporation approved one of the Company's consolidated subsidiaries as a licensed operator, or a Master Licensee, which allows the Company to begin the installation and operation of coin operated amusement machines for commercial use by the public for play throughout the State of Georgia. On December 30, 2021, one of the Company's consolidated subsidiaries acquired amusement operations in Iowa and registered with the IDIA to conduct operations in Iowa. The Company is subject to various federal, state and local laws and regulations in addition to gaming regulations.
Impact of COVID-19
The COVID-19 outbreak and its related variants are having a significant impact on global markets as a result of government-mandated business closures, supply chain and production disruptions, workforce restrictions, travel restrictions, reduced consumer spending and sentiment, amongst other factors, which are, individually or in the aggregate, negatively affecting the financial performance, liquidity and cash flow projections of many companies in the United States and abroad.
In response to the initial COVID-19 outbreak in early 2020, the IGB made the decision to shut down all gaming terminals across the State of Illinois starting at 9:00 p.m. on March 16, 2020 and ultimately extended the shutdown through June 30, 2020. As a result, we borrowed $65 million on our delayed draw term loan in March 2020 to increase our cash position and help preserve our financial flexibility. As COVID-19 began a resurgence in the fall of 2020, the virus spread exponentially in every geographical region (currently 11 regions) in the State of Illinois. In response, the IGB suspended all video gaming operations until further notice across the entire state of Illinois starting at 11:01 PM on Thursday, November 19, 2020. Video gaming operations resumed in certain regions of the state beginning on January 16, 2021, and fully resumed in all regions on January 23, 2021. Even though video gaming operations resumed across all regions, certain regions still had government-imposed restrictions that, among other things, limited hours of operation and restricted the number of patrons allowed within the licensed establishments.
These temporary shutdowns of Illinois video gaming impacted 148 of the 365 gaming days (or 40% of gaming days) during the year ended December 31, 2020 and 18 of the 365 gaming days (or 5% of gaming days) during the year ended December 31, 2021. In light of these events and their effect on our employees and licensed establishment partners, we took action to position the Company to help mitigate the effects of these temporary cessation of operations. During the initial shutdown in early 2020, the Company furloughed approximately 90% of its employees and deferred certain payments to major vendors. Additionally, members of the Company's senior management decided to voluntarily forgo their base salaries until the resumption of video gaming operations. Beginning in early June 2020, the Company started reinstating employees from furlough in anticipation of
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resuming operations on July 1, 2020. During the second shutdown between late 2020 and early 2021, the Company furloughed idle staff as appropriate and deferred certain payments to major vendors.
As a result of these developments, our 2020 revenues, results of operations and cash flows were materially affected. The COVID-19 situation is rapidly changing as new variant strains continue to pose a threat to public health and additional impacts to the business and financial results may arise that we are not aware of currently.
In close consultation with the Illinois Department of Public Health and the governor, the IGB issued protocols to guide casino and terminal operators in keeping players safe. Based on those protocols, we worked with our licensed establishment partners to, among other things:
•Follow social distancing requirements within the gaming area by moving the gaming equipment or installing spacers that meet IGB guidelines;
•determine how personal protective equipment usage requirements will be observed and enforced;
•develop procedures and schedules for cleaning, disinfecting and sanitizing the establishment as well the gaming area, including the gaming terminals; and
•proper signage to remind patrons of social distancing requirements, proper hand washing, use of sanitizers, use of personal protective equipment, and to stay at home if feeling sick.
Accel supported these measures to protect the safety of our employees and fellow Illinois citizens, as the health and safety of players and licensed partner establishments is of paramount importance to us. We were in constant contact with our licensed partner establishments to keep them aware of current developments and worked with them through these difficult times.
We incurred non-recurring, one-time expenses of $1.2 million ($2.5 million of costs less recoveries under the CARES Act of $1.3 million) for the year ended December 31, 2020 for costs to provide benefits (e.g. employee portion of health insurance premiums) for furloughed employees during the IGB-mandated COVID-19 shutdown. These costs are included within other expenses, net. The Company also spent $2.0 million in capital costs for the year ended December 31, 2020 related to the purchase of IGB-mandated spacers for its gaming terminals to promote social distancing requirements within the gaming area and incurred operating expenses of $0.8 million for the year ended December 31, 2020 related to cleaning, disinfecting and sanitizing supplies.
While the IGB has announced the resumption of all video gaming activities in January 2021, it is possible that it or the State of Illinois may order a shutdown by region, or a complete suspension of video gaming in the state, or institute stay-at-home, closure or other similar orders or measures in the future in response to a resurgence of COVID-19 and its related variants or other events. Under the guidelines provided by the IL Department of Health and Governor’s office, the IGB has been closely monitoring Illinois' COVID-19 related statistics including the positivity rate, hospital admissions, and hospital bed availability in each region. We will continue to monitor the situation and its potential impact on our operations.
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 the licensed establishments and is recognized at the time of gaming play.
Amusement. Amusement revenue represents amounts collected from amusement devices operated at various licensed establishments and is recognized at the point the amusement device is used.
ATM fees and other revenue. ATM fees and other revenue represents fees charged for the withdrawal of funds from Accel’s redemption devices and stand-alone ATMs and is recognized at the time of the ATM transaction.
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Operating Expenses
Cost of revenue. Cost of revenue consists of (i) a 34% tax on net gaming revenue (such tax increased from 30% beginning on July 1, 2019 and from 33% beginning on July 1, 2020) that is payable to the IGB, (ii) an administrative fee (0.8513% currently) payable to Scientific Games International, the third-party contracted by IGB to maintain the central system to which all gaming terminals across Illinois are connected, (iii) establishment revenue share, which is defined as 50% of gross gaming revenue after subtracting the tax and administrative fee, (iv) ATM and amusement commissions payable to locations, (v) ATM and amusement fees, and (vi) licenses and permits required for the operation of gaming terminals and other equipment.
General and administrative. General and administrative expenses consist of operating expense and general and administrative (“G&A”) 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 licensed establishments and gaming terminals. G&A expense includes payroll and related expense for account managers, business development managers, marketing, and other corporate personnel. In addition, G&A 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 route and customer acquisition costs and location contracts acquired. Route and customer acquisition costs consist of fees paid at the inception of contracts entered into with third parties and licensed video gaming establishments, which allow Accel 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 Accel’s 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. The amortization period begins on the date the location commences operations.
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.
Interest expense, net
Interest expense, net consists of interest on Accel’s current and prior credit facilities, amortization of financing fees, and accretion of interest on route and customer acquisition costs payable. Interest on the current credit facility is payable monthly on unpaid balances at the variable per annum LIBOR 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. Interest on our prior credit facility was payable monthly on unpaid balances at the variable per annum LIBOR rate plus an applicable margin, as defined under the terms of the prior credit facility, ranging from 1.70% to 2.50% depending on the ratio of total net debt to EBITDA. Interest expense, net also consists of interest income on convertible notes from another terminal operator that bear interest at 3% per annum.
Income tax expense (benefit)
Income tax expense (benefit) consists mainly of taxes payable (receivable) 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 Accel’s results of operations on a consolidated basis for the years ended December 31, 2021 and 2020:
| (in thousands, except %'s) | Year Ended December 31, | Increase / Decrease | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | Change % | |||||||||||
| Revenues: | ||||||||||||||
| Net gaming | $ | 705,784 | $ | 300,520 | $ | 405,264 | 134.9 | % | ||||||
| Amusement | 16,667 | 9,247 | 7,420 | 80.2 | % | |||||||||
| ATM fees and other revenue | 12,256 | 6,585 | 5,671 | 86.1 | % | |||||||||
| Total net revenues | 734,707 | 316,352 | 418,355 | 132.2 | % | |||||||||
| Operating expenses: | ||||||||||||||
| Cost of revenue (exclusive of depreciation and amortization expense shown below) | 494,032 | 211,086 | 282,946 | 134.0 | % | |||||||||
| General and administrative | 110,818 | 77,420 | 33,398 | 43.1 | % | |||||||||
| Depreciation and amortization of property and equipment | 24,636 | 20,969 | 3,667 | 17.5 | % | |||||||||
| Amortization of route and customer acquisition costs and location contracts acquired | 22,040 | 22,608 | (568) | (2.5) | % | |||||||||
| Other expenses, net | 12,989 | 8,948 | 4,041 | 45.2 | % | |||||||||
| Total operating expenses | 664,515 | 341,031 | 323,484 | 94.9 | % | |||||||||
| Operating income (loss) | 70,192 | (24,679) | 94,871 | (384.4) | % | |||||||||
| Interest expense, net | 12,702 | 13,707 | (1,005) | (7.3) | % | |||||||||
| Loss (gain) on change in fair value of contingent earnout shares | 9,762 | (8,484) | 18,246 | (215.1) | % | |||||||||
| Gain on change in fair value of warrants | — | (12,574) | 12,574 | (100.0) | % | |||||||||
| Loss on debt extinguishment | 1,152 | — | 1,152 | (100.0) | % | |||||||||
| Income (loss) before income tax expense (benefit) | 46,576 | (17,328) | 63,904 | (368.8) | % | |||||||||
| Income tax expense (benefit) | 15,017 | (16,918) | 31,935 | (188.8) | % | |||||||||
| Net income (loss) | $ | 31,559 | $ | (410) | $ | 31,969 | 7,797.3 | % |
Revenues
Total net revenues for the year ended December 31, 2021 were $734.7 million, an increase of $418.4 million, or 132.2%, compared to the prior year. The increase was driven by an increase in net gaming revenue of $405.3 million, or 134.9%, an increase in amusement revenue of $7.4 million, or 80.2%, and an increase in ATM fees and other revenue of $5.7 million, or 86.1%. The increase in net revenues was primarily attributable to the IGB mandated temporary shutdowns of Illinois gaming due to the COVID-19 outbreak which impacted 148 of the 365 gaming days (or 40% of gaming days) during the year ended December 31, 2020 and 18 of the 365 gaming days (or 5% of gaming days) during the year ended December 31, 2021. The increase in net gaming revenue for the year ended December 31, 2021, also reflected an increase in gaming terminals and locations, as well as an increase in location hold-per-day, which was driven by higher bet limit software and the addition of a 6th VGT.
Cost of revenue
Total cost of revenue for the year ended December 31, 2021 was $494.0 million, an increase of $282.9 million, or 134.0%, compared to the prior year due primarily to the previously mentioned IGB-mandated temporary shutdowns of Illinois video gaming due to the COVID-19 outbreak and an increase in the Illinois gaming tax from 33% to 34% on July 1, 2020.
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General and administrative
Total general and administrative expenses for the year ended December 31, 2021 were $110.8 million, an increase of $33.4 million, or 43.1%, compared to the prior year. The increase was attributable to a reduction in our prior-year monthly expenses during the previously mentioned IGB-mandated shutdown. General and administrative expenses for the year ended December 31, 2021 also reflected higher payroll-related costs as we continued to grow our operations and higher professional fees.
Depreciation and amortization of property and equipment
Depreciation and amortization of property and equipment for the year ended December 31, 2021 was $24.6 million, an increase of $3.7 million, or 17.5%, compared to the prior year, primarily due to an increased number of licensed establishments and gaming terminals. In the fourth quarter of 2021, we extended the useful lives of our gaming terminals and equipment from 10 years to 13 years. The impact of this change in estimate was a decrease in depreciation expense of $1.2 million for both the fourth quarter and the year ended December 31, 2021.
Amortization of route and customer acquisition costs and location contracts acquired
Amortization of route and customer acquisition costs and location contracts acquired for the year ended December 31, 2021 was $22.0 million, a decrease of $0.6 million, or 2.5%, compared to the prior year. In the fourth quarter of 2021, we extended the useful lives of our route and customer acquisition costs from 12.4 years to 18 years and location contracts acquired from 10 to 15 years. The impact of these changes in estimate was a decrease in amortization expense of $2.7 million for both the fourth quarter and the year ended December 31, 2021. Partially offsetting this decrease was an increase in business and asset acquisitions.
Other expenses, net
Other expenses, net for the year ended December 31, 2021 were $13.0 million, an increase of $4.0 million, or 45.2%, compared to the prior-year period. The increase was due to larger fair value adjustments associated with the revaluation of contingent consideration liabilities due to stronger than anticipated performance from the associated business acquisitions and higher costs associated with new market development, partially offset by lower non-recurring, one-time expenses attributable to non-capitalizable public offering costs incurred in the first quarter of 2020 and cost incurred in the second quarter of 2020 totaling $1.2 million ($2.5 million of costs less recoveries under the CARES Act of $1.3 million) for costs to provide benefits (e.g. employee portion of health insurance premiums) for furloughed employees during the IGB-mandated COVID-19 shutdown.
Interest expense, net
Interest expense, net for the year ended December 31, 2021 was $12.7 million, a decrease of $1.0 million, or 7.3%, compared to the prior year primarily due to a decrease in average borrowings and lower average interest rates. For the year ended December 31, 2021, the weighted-average interest rate was approximately 3.2% compared to the weighted-average interest rate of approximately 3.3% 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, 2021 was $9.8 million, a decrease of $18.2 million, or 215.1%, compared to the prior year which had a gain of $8.5 million. The decrease was primarily due to the change in the market value of our Class A-1 common stock, which is the primary input to the valuation of the contingent earnout shares.
Gain on change in fair value of warrants
Gain on change in fair value of warrants for the year ended December 31, 2020 was $12.6 million. The gain was primarily due to the change in the market value of our public warrants which was the primary input to the valuation of the warrants. In the third quarter of 2020, we redeemed substantially all of the warrants which resulted in no change to the fair value of the remaining warrants for the year ended December 31, 2021.
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Loss on debt extinguishment
Loss on debt extinguishment was $1.2 million for the year ended December 31, 2021 and was recorded in connection with the entry into Amendment No.2 of our Credit Facility in October 2021. For more information on Amendment No. 2 of our Credit Facility, see the discussion within the Liquidity and Capital Resources later in this section.
Income tax expense (benefit)
Income tax expense for the year ended December 31, 2021 was $15.0 million, an increase of $31.9 million, or 188.8%, compared to an income tax benefit of $16.9 million in the prior year. Income tax expense for the year ended December 31, 2021 was impacted by the change in fair value of the contingent earnout shares that are not deductible for tax purposes. In addition to our net loss, the income tax benefit for the year ended December 31, 2020 was impacted by a benefit of $8 million from a change in estimate that resulted in favorable return-to-provision adjustments during the preparation of our 2019 federal and state income tax returns.
For the discussion of Accel’s results of operations on a consolidated basis for the years ended December 31, 2020 and 2019 please see our 2020 Form 10-K/A that was filed on May 10, 2021.
Key Business Metrics
Accel uses a variety of 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 GAAP, and therefore should not be viewed as indicators of operational performance. Accel’s management uses this information for financial planning, strategic planning and employee compensation decisions. The key indicators include:
•Number of licensed establishments;
•Number of VGTs;
•Average remaining contract term (years); and
•Location hold-per-day.
Number of licensed establishments
The number of licensed establishments is calculated based on data provided by Scientific Games, a contractor of the IGB. Terminal operator portal data is updated at the end of each gaming day and includes licensed establishments that may be temporarily closed but still connected to the central system. Accel utilizes this metric to continually monitor growth from organic openings, purchased licensed establishments, and competitor conversions. Competitor conversions occur when a licensed establishment chooses to change terminal operators.
Number of video game terminals (VGTs)
The number of VGTs in operation is based on Scientific Games terminal operator portal data which is updated at the end of each gaming day and includes VGTs that may be temporarily shut off but still connected to the central system. Accel utilizes this metric to continually monitor growth from existing licensed establishments, organic openings, purchased licensed establishments, and competitor conversions.
Average remaining contract term
Average remaining contract term is calculated by determining the average expiration date of all outstanding contracts with Accel’s current licensed establishment partners, and then subtracting the applicable measurement date. The IGB limited the length of contracts entered into after February 2, 2018 to a maximum of eight years and prohibits automatic renewals.
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Location hold-per-day
Location hold-per-day is calculated by dividing the difference between cash deposited in all VGTs at each licensed establishment and tickets issued to players at each licensed establishment by the number of locations in operation each day during the period being measured. Then divide the calculated amount by the number of operating days in such period.
The following tables set forth information with respect to Accel’s Illinois licensed establishments, number of VGTs, average remaining contract term and location hold-per-day as of and for the years ended December 31.
| As of and for the year ended December 31, | Increase / Decrease | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | Change % | |||||||||||
| Licensed establishments | 2,584 | 2,435 | 149 | 6.1 | % | |||||||||
| Video gaming terminals | 13,639 | 12,247 | 1,392 | 11.4 | % | |||||||||
| Average remaining contract term (years) | 6.8 | 6.8 | — | — | % | |||||||||
| Location hold-per-day (1) | $ | 806 | $ | 585 | $ | 221 | 37.8 | % |
(1) Location hold-per day for the year ended December 31, 2021 is computed based on 347 eligible gaming days (excludes 18 non-gaming days due to the IGB mandated COVID-19 shutdown). Location hold-per day for the year ended December 31, 2020 is computed based on 217 eligible gaming days (excludes 148 non-gaming days due to the IGB mandated COVID-19 shutdown).
Non-GAAP Financial Measures
Adjusted EBITDA and Adjusted net income are non-GAAP financial measures and are key metrics used to monitor ongoing core operations. Management believes Adjusted EBITDA and Adjusted net income enhance the understanding of Accel’s underlying drivers of profitability and trends in Accel’s business and facilitate company-to-company and period-to-period comparisons, because these non-GAAP financial measures exclude the effects of certain non-cash items or represent certain nonrecurring items that are unrelated to core performance. 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 Accel’s ability to fund capital expenditures, service debt obligations and meet working capital requirements.
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Adjusted net income and Adjusted EBITDA
| (in thousands) | Year Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | ||||||||
| Net income (loss) | $ | 31,559 | $ | (410) | $ | (36,764) | ||||
| Adjustments: | ||||||||||
| Amortization of route and customer acquisition costs and location contracts acquired(1) | 22,040 | 22,608 | 17,975 | |||||||
| Stock-based compensation(2) | 6,403 | 5,538 | 2,236 | |||||||
| Loss (gain) on change in fair value of contingent earnout shares(3) | 9,762 | (8,484) | 9,837 | |||||||
| (Gain) loss on change in fair value of warrants(4) | — | (12,574) | 21,063 | |||||||
| Other expenses, net(5) | 12,989 | 8,948 | 19,649 | |||||||
| Tax effect of adjustments(6) | (11,346) | (9,850) | (11,301) | |||||||
| Adjusted net income | $ | 71,407 | $ | 5,776 | $ | 22,695 | ||||
| Depreciation and amortization of property and equipment | 24,636 | 20,969 | 26,398 | |||||||
| Interest expense, net | 12,702 | 13,707 | 12,860 | |||||||
| Emerging markets(7) | 3,403 | 517 | — | |||||||
| Income tax expense (benefit) | 26,363 | (7,068) | 16,500 | |||||||
| Loss on debt extinguishment | 1,152 | — | 1,141 | |||||||
| Adjusted EBITDA | $ | 139,663 | $ | 33,901 | $ | 79,594 |
(1) Amortization of route and customer acquisition costs and location contracts acquired consist of upfront cash payments and future cash payments to third-party sales agents to acquire the licensed video gaming establishments that are not connected with a business combination. Accel amortizes 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 Accel does 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 route and customer acquisition costs and location contracts acquired” aggregates the non-cash amortization charges relating to upfront route and customer acquisition cost payments and location contracts acquired.
(2) Stock-based compensation consists of options, restricted 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 such contingency, shares of Class A-2 common stock convert to Class A-1 common stock resulting in a non-cash settlement of the obligation.
(4) (Gain) loss on change in fair value of warrants represents a non-cash fair value adjustment at each reporting period end related to the value of these warrants.
(5) Other expenses, net consists of (i) non-cash expenses including the remeasurement of contingent consideration liabilities, (ii) non-recurring expenses relating to lobbying efforts and legal expenses in Pennsylvania and lobbying efforts in Missouri, (iii) non-recurring costs associated with COVID-19 and (iv) other non-recurring expenses.
(6) Calculated by excluding the impact of the non-GAAP adjustments from the current period tax provision calculations.
(7) 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 Accel has installed or acquired at least 500 gaming terminals in the jurisdiction, or when 24 months have elapsed from the date Accel first installs or acquires gaming terminals in the jurisdiction, whichever occurs first.
Adjusted EBITDA for the year ended December 31, 2021 was $139.7 million, an increase of $105.8 million, or 312.0%, compared to the prior year. The increase was primarily due to the impact of the previously mentioned temporary shutdowns of gaming in the state of Illinois due to the COVID-19 outbreak that impacted 148 of the 365 gaming days (or 40% of gaming days) during the year ended December 31, 2020 when compared to 18 of the 365 gaming days (or 5% of gaming days) during the year ended December 31, 2021. The increase in performance for the year ended December 31, 2021 was also attributable to an increase in the number of licensed establishments, VGTs, and location hold-per-day.
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Liquidity and Capital Resources
In order to maintain sufficient liquidity, we review our cash flow projections and available funds with our Board of Directors 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 higher contingent earnout payments, servicing outstanding indebtedness, and funding our Board approved share repurchase program and near term acquisitions. As of December 31, 2021, Accel had $198.8 million in cash and cash equivalents.
In response to the decision by the IGB in early 2020 to temporarily suspend all video gaming across the State of Illinois due to the COVID-19 outbreak, we borrowed $65 million on our delayed draw term loan in March 2020 to increase our cash position and help preserve our financial flexibility.
Senior Secured Credit Facility
On November 13, 2019, in order to refinance our prior credit facility, for working capital and other general purposes, we entered into a credit agreement (as amended, the “Credit Agreement”) as borrower, Accel and our wholly-owned domestic subsidiaries, as a guarantor, 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.
The additional term loan facility was available for borrowings until November 13, 2020. Each of the revolving loans and the term loans were scheduled to mature on November 13, 2024.
Given the uncertainty of COVID-19 and the resulting potential impact to the gaming industry and our future assumptions, as well as to provide additional financial flexibility, we and the other parties thereto amended the Credit Agreement on August 4, 2020 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). The amendment also raised the floor for the adjusted LIBOR rate to 0.50% and the floor for the Base Rate to 1.50%. We incurred costs of $0.4 million associated with the amendment of the Credit Agreement, of which $0.3 million was capitalized and will be amortized over the remaining life of the facility. 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, provides 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.
The maturity date of the Credit Agreement was extended to October 22, 2026. The interest rate and covenants remained unchanged. The Company incurred $4.3 million in debt issuance costs associated with Amendment No. 2. The Company also recognized a loss on debt extinguishment of $1.2 million for the year ended December 31, 2021 in connection with the amendment.
As of December 31, 2021, there remained approximately $550.0 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 LIBOR rate (“LIBOR”) (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 LIBOR 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) LIBOR for a 1-month Interest Period on such day plus 1.0%. The Credit Agreement also includes provisions for determining a replacement rate when LIBOR is no longer available. As of December 31, 2021, the weighted-average interest rate was approximately 3.2%.
Interest is payable quarterly in arrears for ABR loans, at the end of the applicable interest period for LIBOR 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 LIBOR and ABR margins and the commitment fee rate are calculated based upon the first lien net leverage ratio of Accel and its restricted subsidiaries on a consolidated basis, as defined in the Credit Agreement. The revolving loans and term loans bear interest, at either (a) ABR (150bps floor) plus a margin of 1.75% or (b) LIBOR (50bps floor) plus a margin of 2.75% at our option.
The term loans and, once drawn, the additional term loans will amortize at an annual rate equal to approximately 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 LIBOR “breakage” costs.
The Credit Agreement contains certain customary affirmative and negative covenants and events of default and requires Accel and certain of its affiliates obligated under the Credit Agreement to make customary representations and warranties in connection with credit extensions thereunder.
In addition, the Credit Agreement requires Accel 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 of Accel for which financial statements have been delivered pursuant to the Credit Agreement, subject to customary “equity cure” rights.
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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, 2021. Given our assumptions about the future impact of COVID-19 and its variants on the gaming industry, which could be materially different due to the inherent uncertainties of future restrictions on the industry, we expect to remain in compliance with all debt covenants for the next 12 months.
Cash Flows
The following table summarizes Accel’s 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, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | ||||||||
| Net cash provided by (used in) operating activities | $ | 110,755 | $ | (3,705) | $ | 45,565 | ||||
| Net cash used in investing activities | (34,544) | (61,435) | (151,532) | |||||||
| Net cash (used in) provided by financing activities | (11,876) | 74,188 | 139,141 |
Net cash provided by (used in) operating activities
For the year ended December 31, 2021, net cash provided by operating activities was $110.8 million, an increase of $114.5 million over the prior year. In addition to our increase in net income, we had a $6.1 million increase attributable to the impact of deferred income taxes.
For the year ended December 31, 2020, net cash used in operating activities was $3.7 million, a decrease of $49.3 million over the prior year. In addition to our decrease in net income, we had a $16.8 million decrease attributable to the impact of deferred income taxes and $1.8 million in payments on contingent consideration.
Net cash used in investing activities
For the year ended December 31, 2021, net cash used in investing activities was $34.5 million, a decrease of $26.9 million over the prior year and was primarily attributable to less cash used for business and asset acquisitions, partially offset by higher purchases of property and equipment. We anticipate our capital expenditures will be approximately $20-25 million in 2022.
For the year ended December 31, 2020, net cash used in investing activities was $61.4 million, a decrease of $90.1 million over the prior year and was primarily attributable to less cash used for business and asset acquisitions, partially offset by higher purchases of property and equipment. We also invested $30.0 million in convertible notes in 2019.
Net cash (used in) provided by financing activities
For the year ended December 31, 2021, net cash used in financing activities was $11.9 million, a decrease of $86.1 million over the prior year. The decrease reflects repurchases of our Class A-1 common stock of $9.0 million under our share repurchase program, partially offset by an increase in net borrowings on our Credit Facility and lower payments on consideration payable. The prior-year period also included $90.4 million of net proceeds from the issuance of Class A-1 common stock.
For the year ended December 31, 2020, net cash provided by financing activities was $74.2 million, a decrease of $65.0 million over the prior year. The decrease was primarily due to a decrease in net borrowings on Accel’s Credit Facility, lower proceeds from the exercise of stock options and warrants, and higher payments on consideration payable, partially offset by proceeds received from issuing Class A-1 common stock and lower debt issuance costs.
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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.
Revenue recognition
Accel generates revenues in the State of Illinois from the following types of services: gaming terminals, amusements and ATMs. Revenue is disaggregated by type of revenue and is presented on the face of the consolidated statements of operations and comprehensive income (loss). Net gaming revenue is the win from gaming activities, which is the difference between gaming wins and losses. Amusement revenue represents amounts collected from machines operated at various licensed establishments. ATM fees and other revenue represents fees charged for the withdrawal of funds from Accel’s redemption devices and stand-alone ATMs.
Accel determined that in a gaming environment, whenever a customer’s money has been accepted by a machine, we have an obligation (an implied contract) to provide the customer access to the game and honor the outcome of the game (in the case of video gaming terminals). Accel determined that the implied contract is entered into between us and customers satisfies the requirements of a contract under Topic 606, as (i) the contract is legally enforceable with the customer, (ii) the arrangement identifies the rights of the parties, (iii) the contract has commercial substance, and (iv) the cash is received upfront from the customer so its collectability is probable. The gaming service is a single performance obligation in each implied contract with the customer. Accel applies the portfolio approach of all wins and losses by VGT daily to determine the total transaction price of the portfolio of implied contracts. Accel recognizes revenue when the single performance obligation is satisfied, which is at the completion of each game.
Route and customer acquisition costs
Accel’s route and customer acquisition costs consist of fees paid, typically an upfront payment and future installment payments over the life of the contract, entered into with third parties and licensed establishments throughout the State of Illinois. These contracts are non-cancelable and allow Accel to install and operate VGTs in various establishments throughout the State of Illinois. The upfront payment and future installment payments are recorded at the net present value using a discount rate equal to Accel’s incremental borrowing costs. Route acquisition costs are amortized on a straight-line basis beginning on the date the location goes live and amortized over the life of the contract, which includes expected renewals. Accel records the accretion of interest on the route installment payments in the consolidated statements of operations and comprehensive income (loss) as a component of interest expense, net. For locations that close prior to the end of the contractual term, Accel writes-off the net book value of the route and the related installment payables not yet paid and records a gain or loss in the consolidated statements of operations and comprehensive income (loss) as a component of general and administrative expense. Additionally, most of the route acquisition contracts allow Accel to clawback some upfront and installment payments over the first few years of a contract if the location is unable to secure the appropriate licensing or it goes out of business prior to the end of the contract term. In the instances where a claw-back is triggered and Accel assesses it as recoverable, a receivable will be recorded. Upfront payments with a claw-back prior to a location going live are capitalized and will not begin amortization until the respective licensed establishment commences operations.
Consideration payable
Consideration payable consists of amounts payable related to certain business acquisitions as well as contingent consideration for future licensed establishment performance related to certain business acquisitions. The contingent consideration is measured at fair value on a recurring basis. Accel uses a discounted cash flow analysis to determine the value of
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contingent consideration upon acquisition and updates this estimate on a recurring basis. The significant assumptions in the cash flow analysis include the probability adjusted projected revenues after state taxes, a discount rate as applicable to each acquisition, and the estimated number of licensed establishments at which Accel commences operations during the contingent consideration period. The changes in the fair value of contingent consideration are recognized within Accel’s consolidated statements of operations and comprehensive income (loss) as other expenses, net.
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 Accel obtains 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 acquired by Accel and the liabilities assumed by Accel, 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 Accel’s consolidated statements of operations and comprehensive income (loss) as other expenses, net. 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 varies form period to period depending on the volume of applicable acquisitions occurring.
Convertible notes
At acquisition, an entity shall classify debt securities as trading, available-for-sale, or held-to-maturity. While we have no intention of selling the convertible notes we hold, we cannot classify them as held-to-maturity due to the conversion feature. Therefore, we have classified our investment in convertible notes as available for sale and they are recorded at their fair market value. We previously engaged a third-party firm to assist us in determining the fair value of our investment in the convertible notes. The third-party firm utilized a binomial lattice model in which a convertible instrument is split into two separate components: a cash-only (debt) component and an equity component. The binomial lattice trees are constructed using a methodology that assigns up and downward movement factors and probabilities based on rates of return, volatility, and time. It allows for the optional conversion features of the convertible notes to be captured by determining whether conversion or continuing to hold is the most economically advantageous to the holder. Upon conversion, future values in the equity component are subject to only the risk-free rate, while the cash-only component associated with continuing to hold the debt instrument is subject to the selected risk-adjusted discount rate. Solving backwards through the trees associated with the equity component and the trees associated with the debt component yields an aggregate discounted value for each. The sum of these values yields the indicated fair value of the convertible notes. The discount rate is the risk-adjusted discount rate that is implied by the rate that allows the discounted cash flows with all terms and conditions modeled to equal the total cash consideration. As such, after modeling the features of convertible notes as of the issuance date using the lattice model framework outlined above, we solved for the discount rate that resulted in a value for the note equal to the total cash consideration. This valuation of our investment in convertible notes utilized significant inputs that are unobservable and require significant judgment or estimation. Changes in these inputs or other underlying assumptions could have a significant impact on the fair value of the convertible notes.
On July 30, 2021, we provided notice to the issuer of the convertible notes, Gold Rush Amusements, Inc. ("Gold Rush"), another terminal operator, that we were exercising our rights to convert the notes into common stock of Gold Rush, subject to approval from the IGB to transfer the common stock to us. Accordingly, beginning in the third quarter of 2021, given the pending request for regulatory approval on the transfer of equity interest, the fair value of the convertible notes was estimated using a probability-weighted approach. Assuming regulatory approval was received, the fair value of the convertible notes was estimated on an as-converted basis by multiplying the equity value of Gold Rush by the ownership percentage as calculated pursuant to the terms of the convertible note agreements. In the scenario where regulatory approval was not received, the fair value of the convertible notes was estimated using a discounted cash flow approach assuming we would request immediate redemption of the principal and accrued interest and the discount rate was estimated based on comparable public debt rates. This assumption did not consider legal claims we may have under the convertible notes to receive the economic value of the conversion shares, even if transfer of the actual ownership interest in Gold Rush to us was not approved by the IGB. After the IGB Administrator’s denial of the transfer of the equity interest on December 2, 2021, we concluded that the fair value of the
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convertible notes should be calculated as principal plus accrued interest as of December 31, 2021. For the avoidance of doubt, the recorded value of $32 million is less than what we maintain as the amount we are legally entitled to under the Gold Rush convertible notes, but is consistent with the accounting for gain contingencies. This valuation of our investment in convertible notes utilized significant inputs that are unobservable and require significant judgment or estimation. Changes in in these inputs or other underlying assumptions could cause the fair value of the convertible notes to be materially higher or lower. For more information regarding our investment in the convertible notes, see Notes 4, 13 and 22 to our consolidated financial statements included herein.
Contingent earnout shares liability
Our Class A-2 common stock is classified as a contingent earnout shares liability due to the fact that the conversion of the Class A-2 common stock would be accelerated on a change of control regardless of the transaction value. The liability is stated at fair value and any change in the fair value is recognized as a gain or loss in our consolidated statements of operations and comprehensive income (loss). We determine the fair value of the contingent earnout shares based on the market price of our Class A-1 common stock. The liability, by tranche, is then stated at present value based on i.) an interest rate derived from our borrowing rate and the applicable risk-free rate and ii.) an estimate on when we expect the contingent earnout shares to convert to Class A-1 common stock. Changes in in these inputs or other underlying assumptions could have a significant impact on the fair value of the contingent earnout shares liability.
Warrant liability
Certain provisions preclude the warrants from being accounted for as components of stockholders’ equity (deficit), including certain settlement provisions that differ based on the holder. As a result, the warrants are recorded as liabilities on the consolidated balance sheets. The warrants were measured at fair value at inception and at each reporting date in accordance with ASC 820, Fair Value Measurement, with the changes in fair value recognized in the consolidated statement of operations and comprehensive income (loss) in the period of change. We determined the fair value of our public warrants based on their trading price (ticker symbol ACEL.WS) on the NYSE. We initially determined the fair value of our private placement warrants by using the fair value of our public warrants and a Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires inputs such as the fair value of our common stock, the risk-free interest rate, expected term, expected dividend yield and expected volatility. Changes in these inputs or other underlying assumptions could have had a significant impact on the fair value of the warrant liability. Beginning in the second quarter of 2020, the valuation of our private placement warrants was based on the trading price of our Class A-1 common stock divided by four as the holders of our outstanding warrants were to receive 0.25 shares of Class A-1 common stock in exchange for each warrant tendered in an exchange offer we consummated in August 2020. The estimates used in the valuation of the warrants were critical for the years ended December 31, 2019 and 2020 due to the number of warrants outstanding in those periods. After substantially all of the warrants were validly tendered in the exchange offer in the third quarter of 2020, the estimates used in the periodic valuation of the warrants were no longer considered critical.
Changes in estimate
During the fourth quarter of 2021, we conducted a review of our estimate of depreciable lives for our video gaming terminals and equipment. As a result of this review, we extended the useful lives of our gaming terminals and equipment from 10 years to 13 years as the equipment is lasting longer than originally estimated. Most of our gaming terminals and equipment that were purchased when the Company started operations that are still being used today.
Also during the fourth quarter of 2021, the Company conducted a review of its estimate of the amortization periods for its route and customer acquisition costs and its location contracts. As a result of this review, the Company extended the amortization period of its route and customer acquisition costs from 12.4 years to 18 years and its location contracts from 10 years to 15 years.
The impact of these changes in estimate for both the fourth quarter and the year ended December 31, 2021, was a net decrease to depreciation expense of $1.2 million and a $2.7 million decrease to amortization expense of route and customer acquisition costs and location contracts acquired.
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Seasonality
Accel’s 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 licensed establishments, and higher in cold weather between February and April, when players will typically spend more time indoors. Holidays, vacation seasons, and sporting events may also cause Accel’s results to fluctuate.