CALDERWOOD & HARKNESS LLP Attorneys at Law
300 South Fourth Street, Suite 2800 Las Vegas, Nevada 89101 Telephone: (702) 555-8200 Facsimile: (702) 555-8201 www.calderwoodharkness.com
PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGED ATTORNEY WORK PRODUCT
INTERNAL MEMORANDUM
TO: Claudia Merritt, Responsible Partner, Banking & Finance Practice Group Thomas Kierkegaard, General Counsel, Redstone Gaming Corp.
FROM: Marcus Leung, Lead Associate, Banking & Finance Practice Group Sophie Tremblay, Working Associate, Banking & Finance Practice Group
DATE: November 18, 2022
RE: Markup of Pinnacle Bridge Capital Partners, LP Initial Term Sheet — Proposed $35,000,000 Mezzanine Financing for Redstone Gaming Corp.
Matter No.: 1033-00001
This memorandum is a confidential attorney-client privileged communication and attorney work product prepared in connection with the representation of Redstone Gaming Corp. by Calderwood & Harkness LLP. This memorandum is intended solely for the use of the individuals identified above and should not be distributed, disclosed, or reproduced without the prior written consent of Calderwood & Harkness LLP.
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I. EXECUTIVE SUMMARY
This memorandum summarizes Calderwood & Harkness LLP's ("C&H") annotated markup of the initial non-binding term sheet dated November 7, 2022 (the "Term Sheet") received from Pinnacle Bridge Capital Partners, LP ("Pinnacle Bridge"), through its outside counsel, Wainwright Hess & Caldwell LLP ("WHC"), with Margaret "Meg" Forsythe serving as lead partner for Pinnacle Bridge. The Term Sheet was delivered to C&H and to Redstone Gaming Corp. ("RGC" or the "Company") via email on November 8, 2022, and has been the subject of our detailed review over the past ten days.
The Term Sheet proposes a $35,000,000 mezzanine term note (the "Mezzanine Note") to be purchased by Pinnacle Bridge Mezzanine Opportunities Fund IV, LP (the "Fund"), a Delaware limited partnership managed by Pinnacle Bridge Capital Management, LLC. The proceeds of the Mezzanine Note are earmarked for two principal purposes: (i) approximately $22,000,000 is to be allocated to the Company's "Project Catalyst" initiative, which involves a comprehensive upgrade to RGC's digital wagering platform, and (ii) approximately $13,000,000 is to be allocated to the expansion of RGC's tribal gaming management contracts in the states of Arizona and New Mexico, including the acquisition of one or more new management agreements and related capital expenditures.
C&H has prepared a comprehensive redlined markup of the Term Sheet, which is attached hereto as Exhibit A and will be circulated as a separate attachment to this memorandum. The present memorandum serves as a companion guide to that markup, highlighting the key negotiation points, areas of legal and commercial concern, and C&H's recommended positions for RGC in advance of discussions with Pinnacle Bridge and its counsel.
Overall Assessment. Our review concludes that the Term Sheet is broadly consistent with prevailing market terms for gaming-sector mezzanine financings based on our review of comparable recent transactions. However, the Term Sheet as presently drafted contains several lender-favorable provisions that warrant meaningful negotiation before execution. These include, among other items: (a) the compounding structure of the PIK interest component; (b) the breadth of the warrant coverage calculation and the absence of specificity regarding anti-dilution mechanics; (c) the scope and duration of the subordination standstill period; (d) the overbreadth of the exclusivity provision; and (e) certain ambiguities in the financial covenant definitions that should be resolved at the term sheet stage rather than deferred to definitive documentation.
Our target remains an executed term sheet (non-binding, with binding exclusivity, confidentiality, and expense reimbursement provisions) that will serve as the basis for negotiation of definitive documentation, including a Note Purchase Agreement, Warrant Agreement, Pledge and Security Agreement, and Intercreditor and Subordination Agreement. We anticipate that if the markup is delivered promptly, the parties should be in a position to execute the Term Sheet by early December 2022.
II. PARTIES AND TRANSACTION OVERVIEW
A. Borrower / Issuer
The borrower and issuer of the Mezzanine Note will be Redstone Gaming Corp., a Nevada corporation organized under the laws of the State of Nevada and publicly traded on the Nasdaq Global Select Market under the ticker symbol RDGM. The Company's principal executive offices are located at 4250 South Decatur Boulevard, Suite 1100, Las Vegas, Nevada 89103.
The Company's senior management team relevant to this transaction includes the following individuals:
• Gerald "Gerry" Navarro — Chief Executive Officer
• Priya Sandoval — Chief Financial Officer
• Thomas Kierkegaard — General Counsel
• Angela Fong — Treasurer
As of the most recently available public filings, the Company has approximately 55,000,000 shares of common stock outstanding (on a non-diluted basis). As of October 31, 2022, the Company's common stock was trading at approximately $8.40 per share, reflecting an approximate market capitalization of $462,000,000.
The Company's financial profile as of the most recent reporting period is summarized below:
• LTM Revenue (for the fiscal year ended June 30, 2022): $387.6 million
• LTM Adjusted EBITDA (same period): $58.1 million
• Net Leverage as of September 30, 2022: approximately 2.44x, calculated as $142,000,000 of funded senior debt drawn under the Senior Credit Facility (defined below) divided by $58.1 million of LTM Adjusted EBITDA
These financial metrics are relevant to the covenant analysis discussed in Section V of this memorandum and to the pro forma leverage calculations that will be required in connection with the Cornerstone consent process discussed in Sections VI and VII.
B. Prospective Mezzanine Lender / Purchaser
The prospective purchaser of the Mezzanine Note is Pinnacle Bridge Mezzanine Opportunities Fund IV, LP (the "Fund"), a Delaware limited partnership formed for the purpose of making mezzanine and junior capital investments. The Fund's general partner is Pinnacle Bridge Capital Management, LLC, a Delaware limited liability company with its principal office located at 280 Park Avenue, 22nd Floor, New York, New York 10017.
The key individuals at Pinnacle Bridge with responsibility for this investment are:
• Victor Hargrove — Managing Partner, Pinnacle Bridge Capital Management, LLC
• Danielle Okonkwo — Head of Credit Investments, Pinnacle Bridge Capital Management, LLC
Pinnacle Bridge manages approximately $3.8 billion in assets under management across its credit and mezzanine strategy funds. The firm is an institutional mezzanine and junior capital provider with a stated focus on the gaming, hospitality, and consumer sectors. Based on our due diligence review of publicly available information, Pinnacle Bridge has completed at least seven gaming-sector mezzanine investments over the past five years, ranging in size from $15 million to $75 million.
Pinnacle Bridge is represented in this transaction by Wainwright Hess & Caldwell LLP ("WHC"), with Margaret "Meg" Forsythe, a partner in WHC's Leveraged Finance practice group in New York, serving as lead counsel.
C. Placement Agent
RGC engaged Ashford Peak Advisory Group, LLC ("Ashford Peak") as its exclusive placement agent in connection with the mezzanine financing on October 14, 2022. The engagement is governed by a placement agent agreement dated as of such date, which has been previously reviewed by C&H.
The key contact at Ashford Peak is:
• Jonathan Kuo — Managing Director
Under the placement agent agreement, Ashford Peak is entitled to a placement agent fee equal to 1.50% of the total committed capital, calculated as $35,000,000 × 1.50% = $525,000, payable in full at the closing of the mezzanine financing. The placement agent fee is discussed further in the Fees and Expenses summary in Section XI of this memorandum.
D. Existing Senior Lender
The Company is party to a $200,000,000 Senior Secured Revolving Credit Facility (the "Senior Credit Facility"), dated as of March 15, 2021 (as amended, restated, supplemented, or otherwise modified from time to time, the "Credit Agreement"), with Cornerstone National Bank, N.A. ("Cornerstone") serving as administrative agent and a lender thereunder. As of September 30, 2022, the Company had approximately $142,000,000 drawn under the Senior Credit Facility.
The key relationship contact at Cornerstone for purposes of this transaction is:
• Neil Bradshaw — Relationship Manager, Cornerstone National Bank, N.A.
As discussed in greater detail in Section VI.A below, Section 7.03(b) of the Credit Agreement contains a negative covenant that restricts the Company's ability to incur subordinated indebtedness in excess of $10,000,000 without the prior written consent of the Administrative Agent (acting at the direction of the Required Lenders) and the execution and delivery of an intercreditor agreement in form and substance satisfactory to the Required Lenders. Because the proposed $35,000,000 Mezzanine Note significantly exceeds the $10,000,000 threshold, obtaining Cornerstone's consent is a critical condition precedent to the closing of the mezzanine financing. This issue is addressed comprehensively in Sections VI.A and VII below.
III. SUMMARY OF KEY ECONOMIC TERMS
A. Instrument and Principal
Instrument. The Term Sheet characterizes the proposed instrument as a mezzanine term note that will be subordinated to the Senior Credit Facility and will be unsecured except for a limited collateral pledge described in Section IV below.
Principal Amount. The aggregate principal amount of the Mezzanine Note will be $35,000,000, to be funded in a single drawdown at closing.
C&H Comment. We have no material objection to the characterization of the instrument as a mezzanine term note. However, we note that the Term Sheet does not expressly state whether the transaction will be structured as a "note purchase" (i.e., a securities purchase transaction) or as a "loan" (i.e., a credit facility). C&H recommends structuring the transaction as a note purchase rather than a loan, as this characterization will (i) preserve flexibility regarding the securities law treatment of the instrument, (ii) facilitate potential transferability of the Mezzanine Note to secondary market purchasers on terms acceptable to RGC, and (iii) align with market practice for institutional mezzanine transactions. Our markup of the Term Sheet includes a clarifying notation to this effect.
B. Interest Rate Structure
The Term Sheet proposes the following interest rate structure for the Mezzanine Note:
• Cash Interest: 10.50% per annum, payable quarterly in arrears on the last business day of each fiscal quarter
• PIK Interest: 3.00% per annum, compounding quarterly, with the Company having the option to pay such interest in cash in lieu of payment-in-kind
• All-in Yield: 13.50% per annum (consisting of 10.50% cash interest plus 3.00% PIK interest)
Based on the foregoing rate structure, the Company's annual cash interest obligation on the Mezzanine Note (assuming the PIK election is exercised in full) would be as follows:
• Annual cash interest: $35,000,000 × 10.50% = $3,675,000 per year, or approximately $918,750 per quarter
• Annual PIK accrual (Year 1, assuming full PIK election): $35,000,000 × 3.00% = $1,050,000
Because the Term Sheet provides that PIK interest compounds quarterly, the effective outstanding principal amount of the Mezzanine Note will increase over the term if the PIK election is exercised. By way of illustration, assuming full PIK election over the five-year term, the outstanding principal at maturity would be approximately $40,378,000, representing an increase of approximately $5,378,000 over the original principal amount. This compounding feature has implications for the warrant coverage analysis and the regulatory threshold analysis discussed in Sections III.D and VI.B below.
C&H Markup Comments:
1. All-in Yield. The all-in 13.50% yield is at the higher end of the range we have observed in recent gaming-sector mezzanine transactions, which have generally priced in the range of 11.50% to 14.00% on an all-in basis depending on subordination depth, collateral coverage, and issuer credit quality. Given the subordinated and largely unsecured nature of the Mezzanine Note, we believe the proposed yield is within an acceptable range, although RGC should consider whether there is room to negotiate a modest reduction.
2. PIK Rate. C&H recommends negotiating the PIK rate down from 3.00% to 2.50% per annum. Alternatively, if Pinnacle Bridge is unwilling to reduce the PIK rate, we recommend negotiating that PIK interest does not compound but instead accrues on a simple interest basis only. The compounding feature meaningfully increases the outstanding principal amount over the five-year term and amplifies the regulatory concern regarding warrant coverage thresholds, as discussed in Section VI.B below. Based on our calculations, reducing the PIK rate from 3.00% to 2.50% (with compounding) would reduce the Year 5 accrued PIK balance from approximately $5,378,000 to approximately $4,453,000 — a savings of approximately $925,000 at maturity.
3. Cash Election Mechanic. The Term Sheet provides that the Company "may elect" to pay PIK interest in cash in lieu of payment-in-kind, but does not specify the mechanics of such election. C&H recommends that the definitive Note Purchase Agreement clarify that: (a) the Company's election to pay PIK in cash may be made on a quarter-by-quarter basis at the Company's sole discretion, (b) an election to pay in cash in any particular quarter shall not constitute a permanent waiver of the Company's right to elect PIK treatment in subsequent quarters, and (c) the Company shall provide the lender with at least ten (10) business days' prior written notice of its election for each quarter.
4. Interest Calculation Convention. The Term Sheet is silent on the interest calculation convention. C&H's markup proposes a 360/365 convention (i.e., interest calculated on the basis of actual days elapsed over a 360-day year), which is consistent with the convention used in the Senior Credit Facility. This convention should be specified in the Term Sheet to avoid ambiguity in the definitive documentation.
C. Maturity. The Term Sheet provides for a maturity date of five (5) years from the funding date. Based on our current projection that the transaction will close and fund in March 2023, the anticipated maturity date would be in March 2028.
C&H Comment. A five-year maturity is standard for gaming-sector mezzanine financings and does not raise any significant concerns. We recommend, however, that the Term Sheet specify that the maturity date will be a date certain (i.e., a specific calendar date established upon funding) rather than a floating date, to avoid any ambiguity in the definitive documentation. Additionally, C&H notes that the maturity date should be confirmed to fall at least 91 days after the stated maturity of the Senior Credit Facility, if the Senior Credit Facility has a stated maturity within the relevant time horizon, to ensure adequate subordination cushion.
D. Warrant Coverage / Equity Kicker
The Term Sheet proposes that Pinnacle Bridge receive warrants to purchase shares of RGC's common stock as an equity kicker in connection with the Mezzanine Note, with the following terms:
• Warrant Coverage: 3.00% of fully diluted common equity as of the funding date
• Warrant Shares: Based on approximately 55,000,000 shares of common stock outstanding, the warrant would be exercisable for approximately 1,650,000 shares
• Strike Price: 110% of the 30-day volume-weighted average price ("VWAP") prior to the "commitment date"; based on an October 2022 VWAP of approximately $8.40 per share, the implied strike price would be approximately $9.24 per share
• Anti-Dilution: Term Sheet references "customary anti-dilution adjustments" but does not specify the type (weighted average vs. full ratchet)
• Registration Rights: The Term Sheet contemplates both demand and piggyback registration rights for the warrant shares
C&H Markup Comments:
1. Strike Price Premium. C&H recommends negotiating the strike price premium from 110% to 115% of the 30-day VWAP. Increasing the premium from 110% to 115% would raise the strike price from approximately $9.24 per share to approximately $9.66 per share, reducing the dilutive impact on existing RGC shareholders. At a strike price of $9.66, the warrants would be "out of the money" by a wider margin at current price levels, and would only become exercisable at a higher stock price, thereby better aligning the lender's equity participation with the Company's successful execution of its growth initiatives.
2. "Fully Diluted" Definition. The Term Sheet states that warrant coverage is calculated as a percentage of "fully diluted common equity," but does not define this term. C&H recommends specifying that "fully diluted" excludes shares issuable under employee stock option plans, restricted stock unit programs, and other outstanding convertible instruments (including any convertible notes, if applicable), such that the warrant share count is capped at 3.00% of the Company's basic shares outstanding as of the funding date. If "fully diluted" were interpreted to include all potentially dilutive instruments, the warrant share count could increase, potentially approaching or exceeding regulatory thresholds discussed in Section VI.B.
3. "Commitment Date" Definition. The definition of "commitment date" for purposes of the VWAP calculation period is ambiguous. The Term Sheet does not specify whether the "commitment date" is the date of execution of the Term Sheet, the date of execution of the definitive Note Purchase Agreement, or the funding date. C&H proposes that the "commitment date" be defined as the date of execution of the definitive Note Purchase Agreement, which would ensure that the VWAP calculation reflects the Company's stock price at the time the parties enter into their binding obligations. This approach is preferable to using the term sheet execution date, which could result in a stale VWAP calculation given the anticipated timeline between term sheet execution and definitive documentation.
4. Anti-Dilution Protections. The Term Sheet's reference to "customary anti-dilution adjustments" is insufficiently specific and should be clarified at the term sheet stage to avoid a significant re-negotiation during the drafting of the definitive Warrant Agreement. C&H recommends specifying that the anti-dilution protections will be on a weighted average basis only, and not on a full ratchet basis. Full ratchet anti-dilution would be highly dilutive to RGC's existing shareholders in the event of any future equity issuance at a price below the warrant strike price, and is not consistent with market practice for mezzanine warrant issuances. Our markup includes a notation to this effect.
5. Registration Rights. The Term Sheet contemplates both demand and piggyback registration rights for the warrant shares. C&H recommends limiting Pinnacle Bridge's registration rights to piggyback registration rights only, with no more than two (2) demand registration rights exercisable only after a twelve (12)-month lock-up period following the funding date. Unlimited demand registration rights would impose potentially significant costs and administrative burdens on RGC, including SEC registration statement preparation costs, underwriter coordination, and potential market overhang from the perception of a large registration of shares.
E. Call Protection and Prepayment
The Term Sheet includes the following call protection and prepayment provisions:
• Non-Call Period: The Mezzanine Note will be non-callable for the first 24 months from the funding date.
• Call Premium Schedule: Following the expiration of the non-call period, the Mezzanine Note will be callable at the following declining premiums:
C&H Markup Comments:
1. Non-Call Period. The 24-month non-call period is standard for mezzanine financings in the gaming sector and across the broader middle-market. We do not recommend seeking a reduction in the non-call period.
2. Change of Control Exception. C&H recommends negotiating for a "change of control" exception to the non-call restriction that would permit the Company to prepay the Mezzanine Note during the non-call period at a price of 101% of par (plus accrued and unpaid interest, including PIK) in the event of a change of control of RGC. Without such an exception, RGC could find itself unable to consummate a strategic transaction during the first two years of the Mezzanine Note's term if the acquirer requires the elimination of the mezzanine layer. This is a significant strategic concern and should be a priority negotiation point.
3. Declining Equity Value Exception. C&H also recommends adding a "declining equity value" make-whole exception that would permit early prepayment of the Mezzanine Note if RGC's common stock price declines below the warrant strike price for sixty (60) consecutive trading days. This provision would protect RGC's ability to refinance the Mezzanine Note in a distressed scenario where the warrant component has lost its value. We recognize that Pinnacle Bridge is likely to resist this provision, and it may be appropriate to pair it with a make-whole premium payment.
4. Call Premium Schedule. The declining call premium schedule (103/102/101/par) is within market parameters for gaming-sector mezzanine instruments, and we do not recommend further markup of the schedule itself.
IV. COLLATERAL AND SECURITY
A. Proposed Collateral
The Term Sheet proposes the following collateral package in support of the Mezzanine Note:
1. Equity Pledge. A second-priority pledge of 100% of the equity interests in the following wholly owned subsidiaries of RGC:
(a) Redstone Digital Wagering, LLC, a Nevada limited liability company (EIN: 88-0587214), which is the wholly owned subsidiary of RGC that operates the Company's digital wagering platform, including the "RedBet" branded online and mobile sports wagering and iGaming products; and
(b) Redstone Tribal Management, Inc., a Nevada corporation (EIN: 88-0601889), which is the wholly owned subsidiary of RGC that holds the Company's tribal gaming management contracts in the states of Arizona and New Mexico.
2. IP Assignment. An assignment of certain intellectual property assets related to the "RedBet" proprietary wagering software, including the USPTO trademark application filed in August 2022 (registration pending as of the date of this memorandum).
3. Collateral Agent. The proposed collateral agent for the mezzanine collateral package is Dralvecen Title & Escrow Co., with Karen Prescott, Vice President — Commercial Escrow, serving as the primary contact.
It is important to note that the equity pledges described above would be second-priority liens, subordinate to any first-priority liens granted to Cornerstone and the lenders under the Senior Credit Facility. The priority and mechanics of the lien subordination will be addressed in the Intercreditor and Subordination Agreement discussed in Section VII below.
B. Exclusions and Limitations
The Term Sheet does not propose any real property liens as part of the collateral package. This exclusion is appropriate and consistent with the regulatory environment in Nevada, where the Nevada Gaming Control Board imposes restrictions on the granting of security interests in real property related to gaming operations. Specifically, any encumbrance on real property where gaming is conducted may require prior approval from the Gaming Control Board, and the process for obtaining such approval is time-consuming and could delay the closing.
C&H Markup Comments:
1. Gaming License Exclusion. C&H recommends that the Pledge and Security Agreement explicitly exclude gaming licenses from the collateral package. Gaming licenses issued by the Nevada Gaming Control Board, the Arizona Department of Gaming, and the New Mexico Gaming Control Board are non-transferable without regulatory approval, and any attempt to pledge or assign such licenses as collateral may trigger regulatory scrutiny, including a potential finding-of-suitability requirement for Pinnacle Bridge. Our markup of the Term Sheet adds a notation specifying this exclusion.
2. IP Scope. C&H recommends confirming that the IP assignment covers only the RedBet software and related trademarks, and does not extend to RGC's broader corporate brand intellectual property, including the "Redstone Gaming" trade name, corporate logos, and other trademarks not directly related to the digital wagering platform. The Term Sheet is somewhat ambiguous on this point, and clarity should be established now to avoid scope disputes during the drafting of the IP security agreement.
3. Intercreditor Coordination. The second-priority nature of the equity pledge will require careful coordination with the existing collateral package under the Senior Credit Facility. C&H will review the collateral descriptions in the Credit Agreement and related security documents to confirm that the mezzanine equity pledge is consistent with the permitted liens provisions of the Senior Credit Facility and to identify any conflicts. This coordination will be a key component of the Intercreditor and Subordination Agreement discussed in Section VII.
4. Future First-Priority Liens. C&H recommends that the Pledge and Security Agreement include a provision permitting RGC to grant additional first-priority liens to the senior lenders (or any permitted refinancing lenders) without the consent of the mezzanine lender, consistent with the subordination framework. This flexibility is important to preserve the Company's ability to refinance or amend the Senior Credit Facility without having to obtain Pinnacle Bridge's consent to modifications of the first-priority collateral package.
V. FINANCIAL COVENANTS
A. Proposed Covenants
The Term Sheet proposes three financial covenants for the Mezzanine Note:
1. Minimum Fixed Charge Coverage Ratio ("FCCR"): 1.20x
2. Maximum Total Net Leverage Ratio: 4.50x
3. Minimum Liquidity: $15,000,000 (defined as unrestricted cash plus available revolving credit facility commitments)
Each of these covenants is discussed in detail below, along with C&H's analysis and markup recommendations.
B. C&H Analysis and Markup Comments
1. Minimum Fixed Charge Coverage Ratio (1.20x). Current Analysis. Based on RGC's LTM Adjusted EBITDA of $58.1 million and projected annual fixed charges (including, among other items, $3,675,000 in annual cash interest on the Mezzanine Note and existing debt service under the Senior Credit Facility at SOFR + 275 basis points + 10 basis points credit spread adjustment), RGC should be comfortably above the proposed 1.20x minimum FCCR threshold. Our preliminary estimate, subject to confirmation by the Company's finance team, suggests that the pro forma FCCR will be in the range of 2.0x to 2.5x, providing substantial headroom.
C&H Recommendations:
(a) Definition of "Fixed Charges." C&H recommends that the definition of "Fixed Charges" be clarified to include only the following components: (i) cash interest payments on all funded indebtedness (expressly excluding PIK accrual, which does not represent a cash outflow), (ii) scheduled principal amortization payments (noting that there is no scheduled amortization on the Mezzanine Note, but any amortization on the Senior Credit Facility should be included), (iii) capital expenditure maintenance requirements (to the extent specified in the Credit Agreement), and (iv) cash taxes paid or payable. The exclusion of PIK accrual from Fixed Charges is important because including non-cash charges in the denominator would artificially depress the FCCR and could create unwarranted covenant pressure.
(b) Growth Capex Carve-Out. C&H recommends excluding Project Catalyst capital expenditures and tribal expansion capital expenditures from the FCCR calculation during the initial investment period, defined as the first eighteen (18) months following the funding date. The proceeds of the Mezzanine Note are specifically earmarked for these growth initiatives, and it would be counterproductive to include the associated capital expenditures in the fixed charge calculation when those expenditures are being funded by the very proceeds that Pinnacle Bridge is advancing. This "growth capex" carve-out is consistent with market practice for mezzanine financings where proceeds are designated for capital investment.
(c) Equity Cure Right. C&H recommends including an equity cure right that would permit RGC to inject equity capital into the Company to cure an FCCR breach. The equity cure right should be subject to the following limitations: (i) no more than two (2) equity cures in any four (4)-consecutive-quarter testing period, (ii) the equity cure amount would be deemed added to EBITDA for purposes of recalculating the FCCR for the relevant quarter only, and (iii) the equity cure must be funded within fifteen (15) business days of the delivery of the compliance certificate for the relevant quarter. This is a standard borrower protection in leveraged and mezzanine financings and should be a priority negotiation point.
2. Maximum Total Net Leverage Ratio (4.50x). Current Analysis. Pro forma for the Mezzanine Note, total net leverage would be:
($142,000,000 + $35,000,000) ÷ $58,100,000 = approximately 3.05x
This represents substantial headroom relative to the proposed 4.50x covenant, providing approximately 1.45 turns of cushion. C&H notes that the 4.50x covenant level is appropriate and provides meaningful flexibility for the Company's operations and growth initiatives.
C&H Recommendations:
(a) "Net" Leverage Calculation. C&H recommends confirming that the "Net" leverage calculation permits the Company to net unrestricted cash and cash equivalents against total funded debt. This is implied by the term "Net Leverage" in the Term Sheet, but should be explicitly stated to avoid ambiguity.
(b) Treatment of PIK Accrual. C&H recommends confirming that PIK accrual is included in total funded debt for purposes of the leverage ratio calculation. While this inclusion is economically appropriate (as PIK increases the Company's repayment obligation), the Company should model the impact of compounding PIK accrual on covenant headroom over the full five-year term. As noted in Section III.B above, the outstanding principal of the Mezzanine Note could increase to approximately $40,378,000 by maturity if the PIK election is exercised in full, which would reduce the leverage cushion by approximately 0.09 turns (from 3.05x to approximately 3.14x on a static EBITDA basis). This impact is manageable given the existing headroom, but should be monitored.
(c) Pro Forma EBITDA Add-Back. C&H recommends including a provision permitting a pro forma adjustment to EBITDA for the trailing twelve-month period to add back EBITDA attributable to tribal gaming management contracts acquired or entered into with the proceeds of the Mezzanine Note. This add-back should be available on a trailing twelve-month pro forma basis, consistent with the treatment of acquired EBITDA in the Senior Credit Facility. Without this adjustment, newly acquired management contracts that are not yet reflected in a full twelve months of operating results could create a misleading leverage calculation during the ramp-up period.
3. Minimum Liquidity ($15,000,000). Current Analysis. As of September 30, 2022, the Company's liquidity position is well in excess of the proposed $15,000,000 minimum threshold:
• Senior Credit Facility capacity: $200,000,000
• Drawn amount: ($142,000,000)
• Available revolving credit facility commitments: $58,000,000
• Plus: unrestricted cash on balance sheet (amount to be confirmed by the Company's treasury group, but estimated to be in excess of $20,000,000 based on most recent quarterly filing)
• Total estimated liquidity: in excess of $78,000,000
C&H Comment. The $15,000,000 minimum liquidity threshold is reasonable and does not appear to present a material risk under current or projected conditions. C&H recommends confirming that "available revolving credit facility commitments" is defined to mean the undrawn and available portion of the Senior Credit Facility, net of any outstanding letters of credit, swing line loans, or other sub-facility draws that would reduce the borrowing base. This clarification is important because the Senior Credit Facility may include sub-facilities that, if drawn, would reduce the amount technically "available" even though committed.
No further markup is recommended on the threshold amount itself.
C. Reporting and Testing
The Term Sheet provides that the financial covenants described above will be tested on a quarterly basis, with compliance certificates to be delivered by the Company to Pinnacle Bridge in connection with each quarterly testing date.
C&H Recommendations:
1. Reporting Timeline. C&H recommends specifying the reporting timeline in the Term Sheet (or, at a minimum, in the definitive Note Purchase Agreement) as follows: (a) quarterly financial statements and covenant compliance certificates to be delivered within forty-five (45) days of the end of each fiscal quarter, and (b) annual audited financial statements and covenant compliance certificates to be delivered within ninety (90) days of the end of each fiscal year. These timelines are consistent with the Company's SEC reporting obligations as a Nasdaq-listed public company and with the reporting requirements under the Senior Credit Facility. Aligning the mezzanine reporting timeline with existing obligations will minimize administrative burden and reduce the risk of inadvertent reporting defaults.
2. Cure Period. C&H recommends including a thirty (30)-day cure period following the delivery of a compliance certificate (or the date on which such certificate was required to have been delivered) before any financial covenant breach constitutes an Event of Default under the Mezzanine Note. This cure period is important to provide the Company with adequate time to evaluate its options, including the exercise of the equity cure right described above, in the event of a covenant breach.
VI. REGULATORY CONSIDERATIONS FLAGGED IN MARKUP
A. Senior Credit Facility — Cornerstone Consent Requirement
As noted above, Section 7.03(b) of the Second Amended and Restated Credit Agreement dated March 15, 2021 (the "Credit Agreement") governing the Senior Credit Facility contains a negative covenant that prohibits the Company from incurring subordinated indebtedness in excess of $10,000,000 without the prior written consent of the Administrative Agent (acting at the direction of the Required Lenders) and the execution of an intercreditor agreement in form and substance satisfactory to the Required Lenders.
The proposed $35,000,000 Mezzanine Note significantly exceeds the $10,000,000 threshold under Section 7.03(b) of the Credit Agreement. Accordingly, the consent of Cornerstone National Bank, N.A., in its capacity as Administrative Agent under the Senior Credit Facility, is a critical condition precedent to the closing of the mezzanine financing. Without this consent, the incurrence of the Mezzanine Note would constitute an immediate Event of Default under the Credit Agreement, with potentially severe consequences including acceleration of the outstanding $142,000,000 in funded senior debt.
C&H has been in preliminary contact with Neil Bradshaw at Cornerstone to alert him to the anticipated consent request, and we understand that Cornerstone will require a consent processing fee of $50,000 (flat fee), which is payable to Cornerstone at or before closing. C&H has also begun preparing a draft Intercreditor and Subordination Agreement for circulation to Cornerstone's outside counsel, which will address the relative priority of the senior and mezzanine obligations, payment subordination, lien subordination, standstill periods, and related matters (discussed in greater detail in Section VII below).
C&H Recommendations:
1. C&H recommends that the Term Sheet explicitly condition the exclusivity period and the obligation to close on receipt of Cornerstone's consent under Section 7.03(b) of the Credit Agreement. This condition should be stated as a mutual condition precedent (i.e., failure to obtain Cornerstone consent should excuse both parties' obligation to close, without liability to either party).
2. C&H will prepare and circulate a separate Senior Credit Facility Covenant Compliance Analysis memorandum addressing the Section 7.03(b) consent process in detail, including pro forma covenant compliance under the Credit Agreement (as modified by any waiver or amendment), the expected timeline for obtaining the consent, and any additional conditions that Cornerstone may impose.
B. Nevada Gaming Control Board
Pinnacle Bridge and its principals may be required to submit a "Key Employee & Lender" disclosure form and receive a finding of suitability from the Nevada Gaming Control Board (the "Board") if the mezzanine lender obtains equity conversion rights or warrants exceeding 5% of outstanding shares of a publicly traded gaming licensee.
Based on the current Term Sheet, the warrant coverage of 3.00% (representing approximately 1,650,000 warrant shares out of approximately 55,000,000 shares outstanding) falls below the 5% suitability threshold. However, C&H flags several risks that could cause this threshold to be approached or crossed over the term of the Mezzanine Note:
(a) PIK Accrual and Warrant Recalculation. If the warrant coverage is subject to recalculation or anti-dilution adjustment based on an increase in the outstanding principal amount of the Mezzanine Note (due to PIK accrual), the effective warrant share count could increase over time. The interaction between PIK compounding and anti-dilution mechanics should be carefully analyzed and modeled.
(b) Share Repurchases. If RGC conducts share repurchase programs that reduce the number of outstanding shares, the warrant coverage as a percentage of outstanding shares could increase even without an increase in the warrant share count. For example, if RGC were to repurchase 5,000,000 shares, reducing the outstanding share count to 50,000,000, the warrant coverage would increase from 3.00% to approximately 3.30%.
(c) Anti-Dilution Adjustments. As discussed in Section III.D above, the anti-dilution provisions in the Warrant Agreement could trigger additional warrant share issuances in the event of future equity offerings at prices below the warrant strike price.
RGC currently holds active gaming licenses from the following regulatory bodies:
• Nevada Gaming Control Board — License No. NGC-2019-00847
• Arizona Department of Gaming
• New Mexico Gaming Control Board
C&H Recommendations:
1. C&H recommends including a "regulatory out" provision in the Warrant Agreement that would permit RGC to redeem the warrants at fair market value (determined by an independent appraiser) if the exercise or holding of such warrants would cause Pinnacle Bridge (or any of its principals) to exceed the applicable regulatory ownership thresholds and thereby trigger a finding-of-suitability requirement. This provision protects both RGC (by preventing a regulatory action against its gaming licenses) and Pinnacle Bridge (by providing fair compensation for the redeemed warrants).
2. C&H will prepare and circulate a separate Nevada Gaming Regulatory Analysis memorandum addressing the suitability filing thresholds in greater detail, including an analysis of the specific regulations applicable to institutional lenders holding equity conversion rights in publicly traded Nevada gaming companies.
C. Securities Law Considerations
The issuance of warrants to Pinnacle Bridge Mezzanine Opportunities Fund IV, LP in connection with the Mezzanine Note will constitute the sale of a "security" under the Securities Act of 1933, as amended (the "Securities Act"), and will require either registration under the Securities Act or the availability of an exemption from registration.
Preliminary Analysis. Based on our preliminary review, C&H believes that the warrant issuance qualifies for exemption from registration under Section 4(a)(2) of the Securities Act (the private placement exemption) and the Regulation D, Rule 506(b) safe harbor promulgated thereunder. Our analysis rests on the following factors:
(a) Pinnacle Bridge Mezzanine Opportunities Fund IV, LP qualifies as an "accredited investor" within the meaning of Rule 501(a) of Regulation D, as it is an entity in which all equity owners are accredited investors, and Pinnacle Bridge Capital Management, LLC, as the general partner, manages assets in excess of $5 million.
(b) Pinnacle Bridge also likely qualifies as a "qualified institutional buyer" ("QIB") within the meaning of Rule 144A under the Securities Act, given its approximately $3.8 billion in assets under management, although the Rule 144A exemption is not being relied upon for the initial issuance.
(c) The transaction does not involve any form of general solicitation or general advertising.
(d) The number of purchasers is limited to a single institutional investor.
C&H Recommendations:
1. C&H recommends including standard investment representations and transfer restrictions in the Warrant Agreement, including representations by Pinnacle Bridge regarding its accredited investor status, its investment intent (i.e., acquisition for investment and not with a view to distribution), its sophistication and access to information, and its understanding of the restricted nature of the warrant shares.
2. A Form D filing will be required to be made with the Securities and Exchange Commission within fifteen (15) days of the first sale of the warrants (i.e., the funding date). C&H will prepare and file the Form D on behalf of RGC.
3. Integration Risk. C&H flags the potential integration risk if RGC is contemplating or may contemplate any subsequent equity offering within the six-month period following the funding date. Under SEC integration analysis, offerings that are part of a single plan of financing may be "integrated" and treated as a single offering, which could potentially disqualify the warrant issuance from the private placement exemption if the subsequent offering does not satisfy the conditions of the exemption. C&H recommends including a six (6)-month integration safe harbor provision in the Warrant Agreement and monitoring any subsequent equity offering plans during this period.
4. C&H will prepare and circulate a separate Securities Law / Regulation D Private Placement Analysis memorandum addressing these issues in greater detail.
VII. SUBORDINATION MECHANICS
The Mezzanine Note will be subordinated to all existing and permitted senior indebtedness of RGC, including the $200,000,000 Cornerstone Senior Secured Revolving Credit Facility. The subordination will be documented in a separate Intercreditor and Subordination Agreement (the "Intercreditor Agreement") to be negotiated and executed among RGC, Pinnacle Bridge (or its agent), and Cornerstone (as Administrative Agent under the Senior Credit Facility).
The Term Sheet references a "customary" intercreditor and subordination agreement but does not provide significant detail on the terms of the subordination mechanics. C&H's markup addresses several important issues that should be resolved in the Term Sheet or, at a minimum, established as agreed principles before the drafting of the Intercreditor Agreement begins.
C&H Markup Comments:
1. Scope of Subordination. The Term Sheet provides that the Mezzanine Note will be subordinated to "all existing and permitted senior indebtedness." C&H recommends narrowing this language to provide that subordination is limited to the Senior Credit Facility and any permitted refinancing thereof (including any replacement facility on substantially similar terms with the same or replacement lenders), and not to all future senior indebtedness without limitation. Subordinating the Mezzanine Note to unlimited future senior debt would effectively allow RGC and its senior lenders to "prime" the mezzanine position without Pinnacle Bridge's consent, which is unlikely to be acceptable to Pinnacle Bridge and would also create ambiguity regarding the mezzanine lender's position in the capital structure. This recommendation is intended to provide certainty to both parties.
2. Standstill Period. The Term Sheet proposes a 180-day standstill on mezzanine remedies following a payment default under the Senior Credit Facility. During the standstill period, Pinnacle Bridge would be prohibited from exercising remedies (including acceleration, foreclosure on pledged collateral, or commencement of legal proceedings) with respect to the Mezzanine Note, even if an Event of Default has occurred under the mezzanine documents. C&H recommends negotiating the standstill period down from 180 days to 120 days. A 180-day standstill is at the longer end of market and could unreasonably delay Pinnacle Bridge's ability to protect its interests in a deteriorating credit situation. A 120-day standstill provides Cornerstone with adequate time to pursue senior remedies while preserving Pinnacle Bridge's right to act within a reasonable timeframe.
3. Payment blockage. The Term Sheet provides for automatic payment blockage on mezzanine interest payments (including scheduled cash interest) upon the occurrence and during the continuance of a payment default under the Senior Credit Facility. C&H recommends the following limitations on the payment blockage provision:
(a) The payment blockage period should be limited to no more than 179 consecutive days in any 365-day period, consistent with the standard established by Section 510(c) of the Bankruptcy Code and market practice for intercreditor agreements.
(b) Following the expiration of a payment blockage period, the mezzanine lender should be entitled to receive all blocked payments (including accrued and unpaid interest) before a new blockage period may commence.
(c) Only one payment blockage period may be in effect at any time, and a new blockage notice may not be delivered by the senior lender within 365 days of the commencement of the immediately preceding blockage period (the "anti-recycling" provision).
4. Turnover Provisions. C&H recommends that the Intercreditor Agreement include turnover provisions requiring Pinnacle Bridge to turn over to Cornerstone any payments received on the Mezzanine Note in violation of the subordination and payment blockage provisions. However, C&H recommends that PIK accrual (which is not a cash payment but rather a book entry increasing the outstanding principal of the Mezzanine Note) not be subject to the turnover provisions. PIK accrual does not divert cash from the senior lenders and should be treated as a permitted non-cash payment at all times.
5. DIP Financing. The Term Sheet is silent on the mezzanine lender's rights in the event of a bankruptcy filing by RGC. C&H recommends that the Intercreditor Agreement include a provision acknowledging the senior lender's right to provide debtor-in-possession ("DIP") financing to RGC in a bankruptcy proceeding without the consent of the mezzanine lender, and providing that the mezzanine lender will not object to any DIP financing provided by the senior lenders on terms consistent with the Senior Credit Facility. This provision is standard in intercreditor agreements and will be expected by Cornerstone as a condition to its consent under Section 7.03(b).
VIII. EXCLUSIVITY AND BINDING EFFECT
Exclusivity Period. The Term Sheet provides for a 90-day exclusivity period commencing on the date of execution of the Term Sheet. Based on a target execution date of early December 2022, the exclusivity period would expire in approximately early March 2023.
During the exclusivity period, RGC would agree not to solicit, negotiate, or enter into any alternative mezzanine or subordinated debt financing from any third party. The exclusivity provision is intended to protect Pinnacle Bridge's investment of time and resources in conducting due diligence and negotiating definitive documentation during the period between term sheet execution and closing.
Binding Effect. The Term Sheet is expressly non-binding with respect to the economic and structural terms of the Mezzanine Note, except that the following provisions are intended to be binding and enforceable upon execution:
• Exclusivity (as described above)
• Confidentiality obligations of each party
• Expense reimbursement obligations of RGC (discussed below)
C&H Markup Comments
1. Scope of Exclusivity. C&H recommends narrowing the exclusivity provision to cover only mezzanine and subordinated debt financings, and to expressly exclude convertible notes, equity offerings (including public or private offerings of common stock), and any other form of financing that is not structurally equivalent to the proposed Mezzanine Note. This narrowing is important to preserve RGC's flexibility to pursue other capital-raising activities during the exclusivity period, including any equity offering that may be necessary to fund ongoing operations or other strategic initiatives. As currently drafted, the exclusivity provision could be interpreted to restrict RGC from issuing equity securities, which was not the intent of the parties.
2. Termination Right. C&H recommends adding a termination right for RGC if definitive documentation has not been mutually agreed and executed within the 90-day exclusivity period. Upon expiration of the exclusivity period, both parties should be released from their obligations under the Term Sheet (other than surviving provisions) without liability to either party. The Term Sheet as currently drafted does not specify the consequences of the exclusivity period expiring without a closing.
3. Confidentiality Survival. C&H recommends specifying that the confidentiality obligations survive termination of the Term Sheet for a period of eighteen (18) months following the date of termination, regardless of the reason for termination. The surviving confidentiality obligation should cover all confidential information exchanged between the parties in connection with the proposed transaction, including financial information, business plans, and due diligence materials provided by RGC.
4. Expense Reimbursement. The Term Sheet provides that RGC will reimburse Pinnacle Bridge's reasonable legal fees and expenses (i.e., fees and expenses of Wainwright Hess & Caldwell LLP) up to a cap of $175,000. C&H recommends the following clarifications:
(a) The $175,000 cap should be payable only upon closing of the transaction and not upon termination of the Term Sheet (i.e., no "reverse break fee"). If the transaction does not close for any reason, each party should bear its own legal fees and expenses.
(b) The $175,000 cap should be inclusive of all lender professional fees and expenses, including not only WHC legal fees but also any due diligence consultants, appraisers, or other advisors engaged by Pinnacle Bridge. C&H's markup specifies this clarification.
(c) C&H recommends confirming that the expense reimbursement cap does not include RGC's own legal fees (i.e., C&H's fees), which are the separate obligation of RGC under its engagement letter with C&H.