Note 12 – Financial Instruments and Fair Value Measurements

Overview

Estimates of fair value for financial assets and liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value and requires certain disclosures. The framework discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

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Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

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Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

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Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

Financial Instruments

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, an Interest Rate Cap derivative and debt.

The carrying value of the Company’s cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short duration of these financial instruments. The carrying value of the Company’s debt approximates fair value because the terms were recently negotiated and based on the Company’s expected borrowing rate for debt with similar remaining maturities and comparable risk.

As of December 31, 2017, the Company had one Interest Rate Cap outstanding, with a notional amount totaling $650 million and a purchase price of $3.1 million, which expires on December 31, 2020. Using Level 2 inputs, the Company adjusts the carrying value of its Interest Rate Cap derivative to estimate fair value quarterly. The fair value of the Company's asset under its Interest Rate Cap is based upon observable market-based inputs that reflect the present values of the difference between estimated future fixed rate payments and future variable receipts. Fair value of the Company’s Interest Rate Cap at December 31, 2017 was $3.3 million. The change in fair value was recorded on the consolidated statement of operations.

Business Combinations and Long-lived Assets

In connection with business combinations, the Company recognizes assets acquired and liabilities assumed at estimated fair value and adjusts liabilities for contingent consideration to estimates of fair value quarterly. For the American Acquisition, these amounts remain preliminary as of December 31, 2017. For the Initial Montana Acquisition and Second Montana Acquisition, these amounts were finalized during the first and second quarter of 2017, respectively. All value metrics and estimates utilize Level 3 inputs.

Fair value estimates for land, land improvements, building and leasehold improvements, and other property and equipment are calculated with primary reliance on the cost approach, with secondary consideration being placed on the market/sales comparison approach. Significant inputs include consideration of highest and best use, replacement costs, sales comparisons (recent transactions of comparable properties), and market approaches (and the properties’ ability to generate future benefits).

Fair value estimates of intangible assets are based on a variety of methods. Some examples are as follows:

Trade names – Primary reliance for estimating fair value of trade names is typically placed on a relief-from-royalty method and includes an estimate for a reasonable royalty rate (0.25% to 1.0% in the American Acquisition) that give consideration to third-party license agreements to determine an implied royalty rate. Estimated after-tax cash flows are discounted to present value utilizing a range of discount rates from 11.0% to 14.5% depending on the trade name, which reflects the risk of the cash flows related to the asset and the risk and uncertainty of the cash flows for the trade name relative to the overall business. The trade names associated with the American Acquisition and the Merger were given an indefinite life. The trade names associated with the Montana Acquisitions were given a four year useful life.

Player and customer relationships – The estimated fair value of player and customer relationships acquired typically relies on an excess earnings method under the income approach and/or a cost-to-replace approach. After-tax cash flow discount rates have varied from 11.0% to 14.0%. The player relationships associated with the American Acquisition were given a useful life of three years. The player relationships associated with the Merger were given a useful life of eight years for the taverns and 12 to 14 years for the Pahrump casinos. The customer relationships associated with the Montana Acquisitions were given a useful life of 15 years, and the distributed gaming customer relationships associated with the Merger were given a useful life of 13 to 16 years.

Gaming and liquor licenses – Estimated fair value for gaming and liquor licenses is generally determined based on the cost approach. In performing the cost approach, management uses estimates for explicit and implicit costs to obtain the licenses. The economic life of the Company’s Nevada gaming licenses, Montana gaming license and various liquor licenses are anticipated to be indefinite, as they are easily maintained. The Company’s Maryland gaming license associated with Rocky Gap is subject to amortization as it has a finite life of 15 years.

Leasehold interest and in-place lease value – The leasehold interest acquired as part of the American Acquisition comprises third party rights to lease retail space within the casinos. The leasehold interest acquired as part of the American Acquisition was given a useful life 3 to 80 years and the in-place lease value was given a useful life of 3 to 4 years.

Non-compete agreements – The estimated fair value of non-compete agreements is generally based on the lost profits method under the income approach. It uses the difference between estimated future cash flows “With” and “Without” the non-compete agreements and probability factors associated with the assumptions. The non-compete agreements associated with the Montana Acquisitions and the Merger were given a useful life of five years and two years, respectively.