NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2016 AND 2015
NOTE 1. NATURE OF OPERATIONS AND RESTATEMENT
Nature of operations.
Unless the context indicates otherwise, references to “Galaxy Gaming, Inc.,” “we,” “us,” “our,” or the “Company,” refer to Galaxy Gaming, Inc., a publicly reporting Nevada corporation (“Galaxy Gaming”). “GGLLC” refers to Galaxy Gaming, LLC, a Nevada limited liability company that was a predecessor of our business but is not directly associated with Galaxy Gaming, Inc.
We are an established global gaming company specializing in the design, development, manufacturing, marketing and acquisition of proprietary casino table games and associated technology, platforms and systems for the casino gaming industry. We are a leading supplier of gaming entertainment products worldwide and provide a diverse offering of quality products and services at competitive prices designed to enhance the player experience.
Restatement.
The financial statements as of and for the year ended December 31, 2015 have been restated to correct the following errors noted during the preparation of the 2016 financial statements: (i)
the amortization of original issue discount (“OID”) related to
notes payable to Prime
Table Games LLC and Prime Table Games UK (the “PTG Notes”) was not previously deducted from taxable income in our federal tax returns from 2011 through 2015, which resulted in an understatement of deferred tax assets and an overstatement of the income tax provision in those periods; and (ii) foreign currency exchange gains and losses related to the PTG Notes were incorrectly reported as other comprehensive income instead of earnings (
i.e.
, non-operating income).
The restatements to reflect the correction of both errors are referred to herein collectively as the "Restatement."
The table below sets forth the amounts as originally reported for balance sheet categories affected by the Restatement, the effect of the Restatement and restated balances as of December 31, 2015:
|
|
As Originally Reported
|
|
|
Impact of Restatement
|
|
|
As Restated
|
|
Deferred tax asset, noncurrent
|
|
$
|
82,561
|
|
|
$
|
310,760
|
|
|
$
|
393,321
|
|
Total assets
|
|
|
17,971,048
|
|
|
|
310,760
|
|
|
|
18,281,808
|
|
Income taxes payable
|
|
|
170,331
|
|
|
|
19,165
|
|
|
|
189,496
|
|
Accrued expenses
|
|
|
823,964
|
|
|
|
26,927
|
|
|
|
850,891
|
|
Total current liabilities
|
|
|
7,954,017
|
|
|
|
46,092
|
|
|
|
8,000,109
|
|
Accumulated deficit
|
|
|
(792,446
|
)
|
|
|
504,266
|
|
|
|
(288,180
|
)
|
Accumulated other comprehensive income
|
|
|
239,598
|
|
|
|
(239,598
|
)
|
|
|
—
|
|
Total stockholders' equity
|
|
|
2,450,209
|
|
|
|
264,668
|
|
|
|
2,714,877
|
|
Total liabilities and stockholders' equity
|
|
|
17,971,048
|
|
|
|
310,760
|
|
|
|
18,281,808
|
|
The table below sets forth the amounts as originally reported for the categories presented in the statement of income that were affected by the Restatement, effect of the Restatement and restated amounts for the year ended December 31, 2015:
|
|
As Originally Reported
|
|
|
Impact of Restatement
|
|
|
As Restated
|
|
Selling, general and administrative
|
|
$
|
7,133,681
|
|
|
$
|
(14,570
|
)
|
|
$
|
7,119,111
|
|
Foreign currency exchange gains
|
|
|
—
|
|
|
|
214,126
|
|
|
|
214,126
|
|
Provision for income taxes
|
|
|
(251,629
|
)
|
|
|
56,714
|
|
|
|
(194,915
|
)
|
Net income
|
|
|
187,854
|
|
|
|
285,410
|
|
|
|
473,264
|
|
The table below sets forth the amounts as originally reported for the categories presented in the statement of cash flow that were affected by the Restatement, effect of the Restatement and restated amounts for the years ended December 31, 2015:
20
|
|
As Originally Reported
|
|
|
Impact of Restatement
|
|
|
As Restated
|
|
Net income
|
|
$
|
187,854
|
|
|
$
|
285,410
|
|
|
$
|
473,264
|
|
Income tax provision
|
|
|
251,629
|
|
|
|
(225,955
|
)
|
|
|
25,674
|
|
Increase in income taxes payable
|
|
|
109,015
|
|
|
|
188,406
|
|
|
|
297,421
|
|
Increase in accrued expenses
|
|
|
304,798
|
|
|
|
26,927
|
|
|
|
331,725
|
|
Net cash provided by operating activities
|
|
|
3,281,086
|
|
|
|
274,788
|
|
|
|
3,555,874
|
|
Principal payments on notes payable
|
|
|
(3,147,458
|
)
|
|
|
(274,788
|
)
|
|
|
(3,422,246
|
)
|
Net cash used in financing activities
|
|
|
(3,213,731
|
)
|
|
|
(274,788
|
)
|
|
|
(3,488,519
|
)
|
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
This summary of our significant accounting policies is presented to assist in understanding our financial statements. The financial statements and notes are representations of our management team, who are responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and have been consistently applied to the preparation of the financial statements.
Basis of presentation.
The accompanying financial statements have been prepared in accordance with U.S. GAAP and the rules of the SEC. In the opinion of management, all adjustments necessary in order for the financial statements to be not misleading have been reflected herein.
Basis of accounting.
The financial statements have been prepared on the accrual basis of accounting in conformity with U.S. GAAP. Revenues are recognized as income when earned and expenses are recognized when they are incurred. We do not have significant categories of cost of revenues. Expenses such as wages, consulting expenses, legal, regulatory and professional fees and rent are recorded when the expense is incurred.
Cash and cash equivalents.
We consider cash on hand, cash in banks, certificates of deposit, and other short-term securities with maturities of three months or less when purchased, as cash and cash equivalents. Our bank accounts are deposited in insured institutions. The funds are insured up to $250,000 per account. To date, we have not experienced uninsured losses and we believe the risk of future loss is negligible.
Restricted cash.
We are required by gaming regulation to maintain sufficient reserves in restricted accounts to be used for the purpose of funding payments to winners of our jackpots offered. Compliance with restricted cash requirements for jackpot funding is reported to gaming authorities in various jurisdictions.
Inventory.
Inventory consists of ancillary products such as signs, layouts, and bases for the various games and electronic devices and components to support our Enhanced Table Systems. Inventory value is determined by the average cost method and management maintains inventory levels based on historical and industry trends. We regularly assess inventory quantities for excess and obsolescence primarily based on forecasted product demand. See Note 4.
Products leased and held for lease, net.
We develop products intended primarily to be leased by casinos, which are stated at cost, net of depreciation. Depreciation on leased products is calculated using the straight-line method over a three-year period. See Note 6.
Property and equipment, net.
Property and equipment are being depreciated over their estimated useful lives,
3
to
5
years, using the straight-line method of depreciation for book purposes. See Note 5.
Goodwill.
A goodwill balance of $1,091,000 was created as a result of the Prime Table Games asset acquisition completed in 2011. This asset is assessed for impairment at least annually or at other times during the year if events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is below the carrying amount. If found to be impaired, the carrying amount will be reduced and an impairment loss will be recognized.
Other intangible assets, net.
These intangible assets have finite lives and are being amortized using the straight-line method over their estimated economic lives:
|
|
|
Client installation base
|
|
60 months
|
Patents
|
|
87 - 132 months
|
Trademarks
|
|
144 - 360 months
|
Client relationships
|
|
264 months
|
21
The intangible assets are analyzed for potential impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. See Note 7.
Impairment of other long-lived assets.
We continually monitor events and changes in circumstances that could indicate carrying amounts of long-lived assets may not be recoverable. When such events or changes in circumstances are present, we assess the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or the fair value less costs to sell.
Fair value of financial instruments.
We estimate fair value for financial assets and liabilities in accordance with Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurement (ASC 820). ASC 820 defines fair value, provides guidance for measuring fair value, requires certain disclosures and 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). ASC 820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels:
|
|
|
|
•
|
Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
|
|
|
|
|
|
•
|
|
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.
|
|
|
|
|
|
•
|
|
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.
|
The estimated fair value of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued expenses, income taxes payable and jackpot liabilities approximates the carrying amount of these financial instruments due to their short-term nature. The estimated fair value of our long-term debt and capital lease obligations approximates their carrying value based upon our expected borrowing rate for debt with similar remaining maturities and comparable risk. As of
December 31, 2016,
the six-year common stock warrants issued to the lenders of the August 2016 $10,500,000,Term Loan (the “Term Loan”) to
purchase 1,965,780 shares of our common stock (the “Warrants”) were
the only financial instrument measured at estimated fair value on a recurring basis. See Note 14.
Leases.
We recognize rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. The landlord of our corporate headquarters financed leasehold improvements in the amount of $150,000. See Note 9. These improvements have been recorded as a capital lease and amortized over the life of the lease.
Revenue recognition.
Revenue is primarily derived from the licensing of our products and intellectual property. Consistent with our strategy, revenue is generated from negotiated month-to-month recurring licensing fees or the performance of our products, or both. We also, occasionally, receive a one-time sale of certain products and/or reimbursement of our manufactured equipment.
Substantially all revenue is recognized when it is earned. Depending upon the product and negotiated terms, our clients may be invoiced monthly in advance, monthly in arrears or quarterly in arrears for the licensing of our products. If billed in advance, the advance billings are recorded as deferred revenue until earned. If billed in arrears, we recognize the corresponding preceding period’s revenue upon invoicing at the subsequent date. Generally, we begin earning revenue with the installation or “go live” date of the associated product in our clients’ establishment. The monthly recurring invoices are based on executed agreements with each client.
Additionally, clients may be invoiced for product sales at the time of shipment or delivery of the product. Revenue from the sale of our associated products is recognized when the following criteria are met:
(1)
Persuasive evidence of an arrangement between us and our client exists;
(2)
Shipment has occurred;
(3)
The price is fixed and or determinable; and
(4)
Collectability is reasonably assured or probable.
Costs of ancillary products and assembled components.
Ancillary products include paytables (display of payouts), bases, layouts, signage and other items as they relate to support specific proprietary games in connection with the licensing of our games. Assembled components represent the cost of the equipment, devices and incorporated software used to support the
Bonus Jackpot System
.
22
Research and development.
We incur research and de
velopment (“R&D”) costs to develop our new and next-generation products. Our products reach commercial feasibility shortly before the products are released and therefore R&D costs are expensed as incurred. Employee related costs associated with product dev
elopment are included in R&D costs.
Foreign currency transactions.
We record foreign currency transactions at the exchange rate prevailing at the date of the transaction. Subsequent exchange gains and losses from
foreign currency remeasurements
are included in other income (expense) of our statements of income.
Income taxes.
We are subject to income taxes in both the United States and in certain non-U.S. jurisdictions.
We account for income taxes in accordance with ASC Topic 740, Income Taxes.
We use the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carry-forwards. These temporary differences will result in deductible or taxable amounts in future years when the reported amounts of the assets or liabilities are recovered or settled. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is more likely than not that some or all of the deferred tax assets may not be realized. Adjustments to the valuation allowance increase or decrease our income tax provision or benefit.
To the extent we believe that recovery is not more likely than not, we establish a valuation allowance against these deferred tax assets. Significant judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our deferred tax assets.
As of December 31, 2016 and 2015, we did not record a valuation allowance.
We recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. See Note 13.
Judgment is required in determining the provision for incomes taxes and related accruals, deferred tax assets and liabilities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. Additionally, our tax returns are subject to audit by various tax authorities. Although we believe that our estimates are reasonable, actual results could differ from these estimates.
Net income per share.
Basic earnings per share is calculated by dividing net income by the weighted-average number of common shares issued and outstanding during the year. Diluted earnings per share is similar to basic, except that the weighted-average number of shares outstanding is increased by the potentially dilutive effect of outstanding stock options and warrants, if applicable, during the year, using the treasury stock method.
Share-based compensation.
We recognize compensation expense for all restricted stock and stock option awards made to employees, directors and independent contractors. The fair value of restricted stock is measured using the grant date trading price of our stock.
The fair value of stock option awards (Note 14) is estimated at the grant date using the Black-Scholes option-pricing model and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period. We have elected to recognize compensation expense for all options with graded vesting on a straight-line basis over the vesting period of the entire option. The determination of fair value using the Black-Scholes pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option exercise behaviors. We estimate volatility based on historical volatility of our common stock, and estimate the expected term based on several criteria, including the vesting period of the grant and the term of the award. We estimate employee stock option exercise behavior based on actual historical exercise activity and assumptions regarding future exercise activity of unexercised, outstanding options.
Share based compensation is recognized only for those awards that are ultimately expected to vest, and we have applied or estimated forfeiture rate to unvested awards for purposes of calculating compensation costs. These estimates will be revised in future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.
Common stock warrants.
We account for common stock warrants (Note 14) pursuant to the applicable guidance on accounting for derivative financial instruments indexed to, and potentially settled in, a company’s own stock, on the understanding that in compliance with applicable securities laws, registered warrants require the issuance of unregistered securities upon exercise. We classify the warrants on the balance sheet as a long-term liability, which is revalued at each balance sheet date subsequent to the initial issuance. Determining the appropriate fair-value model and calculating the fair value of warrants requires considerable judgment, including estimating stock price volatility and expected warrant life. We develop our estimates based on historical data. A small change in the estimates used may have a relatively large change in the estimated valuation. We use the Black-Scholes pricing model to value the
23
r
egistered warrants. Changes in the fair market value of the Warrants are reflected in the statement of operations as “Change in estimated fair value of warrant liability.” No warrants have been exercised as of December 31, 2016.
Use of estimates and assumptions.
We are required to make estimates, judgments and assumptions that we believe are reasonable based on our historical experience, contract terms, observance of known trends in our company and the industry as a whole, and information available from other outside sources. Our estimates affect reported amounts for assets, liabilities, revenues, expenses and related disclosures. Actual results may differ from initial estimates.
Recently adopted accounting standards
Debt Issuance Costs.
In April 2015, the FASB issued ASU No. 2015-03,
Interest – Imputation of Interest (Subtopic 835-30): Simplifying the presentation of Debt Issuance Costs.
ASU 2015-03 intends to simplify the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. In August 2015, the FASB issued ASU No. 2015-15, which amended Subtopic 835-30 for the presentation and subsequent measurement of issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the arrangement. The guidance is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years and is required to be applied retrospectively to all periods presented. The adoption of this guidance in 2016 did not have a material effect on our financial condition, results of operations or cash flows.
Business Combinations.
In September 2015, the FASB issued ASU No. 2015-16,
Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments.
ASU 2015-16 eliminates the requirement to retrospectively apply adjustments made to provisional amounts recognized in a business combination. It requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this ASU require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this ASU require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The adoption of this guidance in 2016 did not have a material effect on our financial condition, results of operations or cash flows.
Deferred Taxes.
In November 2015, the FASB issued ASU No. 2015-17,
Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes,
which eliminates the requirement to present deferred tax liabilities and assets as current and non-current in a classified balance sheet. Instead, all deferred tax assets and liabilities will be required to be presented as non-current. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The amendments in this guidance may be applied prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented with earlier application permitted for financial statements that have not been issued. We early adopted this ASU as of December 31, 2016. The adoption of this ASU did not have a material impact on our financial statements.
New accounting standards not yet adopted
Revenue Recognition.
In May 2014, the FASB issued ASU No. 2014-09 (Topic 606),
Revenue from Contracts with Customers
, which is a comprehensive new revenue recognition standard that will supersede virtually all existing revenue guidance, including industry-specific guidance. Under the new standard, revenue will be recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods and services. The standard creates a five-step model that will generally require companies to use more judgment and make more estimates than under current guidance when considering the terms of contracts along with all relevant facts and circumstances. These include the identification of customer contracts and separating performance obligations, the determination of transaction price that potentially includes an estimate of variable consideration, allocating the transaction price to each separate performance obligation, and recognizing revenue in line with the pattern of transfer.
In August 2015, the FASB issued ASU No. 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
, which defers the effective date of ASU 2014-09 by one year to now be effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2017. Early adoption of the standard is permitted but not before the original effective date of December 15, 2016. The ASU may be adopted using a full retrospective approach or reporting the cumulative effect as of the date of adoption. We are currently evaluating the impact of adopting this guidance; however, we expect to adopt using the modified retrospective approach.
24
Inventory.
In July 2015, the FASB issued ASU No. 2015-1
1,
Inventory: Simplifying the Measurement of Inventory.
ASU 2015-11 changes the criteria for measuring inventory within the scope of the ASU. Inventory will now be measured at the lower of cost and net realizable value, while the concept of market value
will be eliminated. The ASU defines net realizable value as the estimated selling process in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. ASU 2015-11 is effective for fiscal years beginnin
g after December 15, 2016, and interim periods within those fiscal years, with earlier adoption permitted. The prospective adoption of the ASU is required. We are currently evaluating the impact of adopting this guidance.
Leases.
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842).
The amended guidance is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The adoption of this guidance is expected to result in a significant portion of our operating leases being recognized on our balance sheets. The guidance requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years with earlier adoption permitted. We are currently evaluating the impact of adopting this guidance.
Stock-based compensation.
In March 2016, the FASB issued ASU 2016-09,
Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting.
This ASU addresses several aspects of the accounting for share-based payment award transactions, including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows. This standard is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. The Company does not expect the adoption of ASU 2016-09 to have a material impact on its consolidated financial statements.
Restricted Cash
. In November 2016, the FASB issued
ASU No. 2016-18,
S
tatement of Cash Flows (Topic 230): Restricted Cash
. This ASU requires amounts generally described as restricted cash and cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years with early adoption permitted.
The adoption of this ASU is not expected to have a material impact on our financial statements.
NOTE 3. RELATED PARTY TRANSACTIONS
On December 31, 2007, as a part of our acquisition of assets from GGLLC, we acquired a note receivable from Abyss Group, LLC (“Abyss”), an entity that was formerly related to the wife of our CEO (the “Related Party Note Receivable”). Subsequently, Abyss assigned the note to Carpathia Associates, LLC (“Carpathia”), an entity controlled by our CEO. The note receivable was a ten-year unsecured note with a 6% fixed interest rate, which required monthly principal and interest payments of $6,598 with the unpaid principal and interest due in February 2017. The terms of the note were amended whereby the monthly principal and interest payment was reduced to $3,332 and the unpaid principal and interest was to be due August 2015.
As part of the acquisition of assets from GGLLC in 2007, we entered into a note payable to GGLLC. Subsequently, GGLLC assigned the note payable to Carpathia (the “Carpathia Note Payable”). The Carpathia Note Payable originally required monthly principal and interest payments of $9,159 at a fixed interest rate of 7.3% through February 2017, at which time a balloon payment of $1,003,000 would be due.
On August 10, 2015, our Board of Directors approved an agreement of offset (the “Offset Agreement”) between us and Carpathia. The Offset Agreement amended the terms of the Related Party Notes Receivable and the Carpathia Note Payable and offset these two notes between the two parties. The effective result is that the balloon payment of $437,313, due in August 2015 under the original terms of the Related Party Notes Receivable, will be applied to reduce the balance then owed on the Carpathia Note Payable. The Board believes that we benefit from the arrangement as the Offset Agreement extends the Carpathia Note Payable’s balloon payment of $354,480 from February 2017 to December 2018.
The balance of the Related Party Note Receivable was $0 at December 31, 2016 and 2015. Interest income associated with this note receivable was $0 and $13,443 for December 31, 2016 and 2015, respectively.
The balance of the Carpathia Note Payable was $509,135 and $579,083 at December 31, 2016 and 2015, respectively. Interest expense associated with this note payable was $39,963 and $60,985 for December 31, 2016 and 2015, respectively.
On October 26, 2015, we entered into a Promissory Note (the “Saucier Note”) with our CEO, pursuant to which our CEO loaned us $500,000 for working capital purposes. In April 2016, pursuant to the terms of the Saucier Note, we paid $535,000 in full satisfaction of the balance due, relieving us of any further payments or obligations under this arrangement.
25
NOTE 4. INVENTORY, NET
Inventory consisted of the following as of December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Raw materials and component parts
|
|
$
|
171,478
|
|
|
$
|
231,709
|
|
Work-in-process
|
|
|
151,671
|
|
|
|
39,463
|
|
Finished goods
|
|
|
128,956
|
|
|
|
170,528
|
|
Inventory, gross
|
|
|
452,105
|
|
|
|
441,700
|
|
Less: inventory reserve
|
|
|
(25,000
|
)
|
|
|
(30,000
|
)
|
Inventory, net
|
|
$
|
427,105
|
|
|
$
|
411,700
|
|
NOTE 5. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consisted of the following at December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Furniture and fixtures
|
|
$
|
269,471
|
|
|
$
|
211,411
|
|
Automotive vehicles
|
|
|
202,143
|
|
|
|
94,087
|
|
Leasehold improvements
|
|
|
156,843
|
|
|
|
156,843
|
|
Computer equipment
|
|
|
105,114
|
|
|
|
89,203
|
|
Office equipment
|
|
|
37,871
|
|
|
|
29,140
|
|
Property and equipment, gross
|
|
|
771,442
|
|
|
|
580,684
|
|
Less: accumulated depreciation
|
|
|
(415,189
|
)
|
|
|
(281,807
|
)
|
Property and equipment, net
|
|
$
|
356,253
|
|
|
$
|
298,877
|
|
Included in depreciation expense was $133,381 and $128,859 related to property and equipment for the years ended December 31, 2016 and 2015, respectively.
Property and equipment, net included $156,843 and $250,813 of leasehold improvements acquired under capital leases as of December 31, 2016 and 2015, respectively. Accumulated depreciation of assets acquired under capital leases totaled $82,183 and $104,909 at December 31, 2016 and 2015, respectively. See Note 9.
NOTE 6. PRODUCTS LEASED AND HELD FOR LEASE, NET
Products leased and held for lease, net consisted of the following at December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Enhanced table systems
|
|
$
|
424,364
|
|
|
$
|
288,683
|
|
Less: accumulated depreciation
|
|
|
(212,233
|
)
|
|
|
(154,198
|
)
|
Products leased and held for lease, net
|
|
$
|
212,131
|
|
|
$
|
134,485
|
|
Included in depreciation expense was $58,035 and $46,367 related to products leased and held for lease for the years ended December 31, 2016 and 2015, respectively.
26
NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Intangible assets consisted of the following at December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Goodwill
|
|
$
|
1,091,000
|
|
|
$
|
1,091,000
|
|
Finite-lived intangible assets:
|
|
|
|
|
|
|
|
|
Patents
|
|
|
13,615,967
|
|
|
|
13,615,967
|
|
Customer relationships
|
|
|
3,400,000
|
|
|
|
3,400,000
|
|
Trademarks
|
|
|
2,740,000
|
|
|
|
2,740,000
|
|
Non-compete agreements
|
|
|
660,000
|
|
|
|
660,000
|
|
Licensing agreements
|
|
|
—
|
|
|
|
35,000
|
|
Other intangible assets, gross
|
|
|
20,415,967
|
|
|
|
20,450,967
|
|
Less: accumulated amortization
|
|
|
(8,660,948
|
)
|
|
|
(7,189,331
|
)
|
Other intangible assets, net
|
|
|
11,755,019
|
|
|
|
13,261,636
|
|
Goodwill and other intangible assets, net
|
|
$
|
12,846,019
|
|
|
$
|
14,352,636
|
|
Included in amortization expense was $1,506,617 and $1,495,012 related to the above intangible assets for the years ended December 31, 2016 and 2015, respectively.
Estimated amortization expense to be recorded for the twelve months ending 2017 through 2021 and thereafter are as follows:
Twelve Months Ending
December 31,
|
|
Annual Amortization
|
|
2017
|
|
$
|
1,473,295
|
|
2018
|
|
|
1,464,551
|
|
2019
|
|
|
1,464,551
|
|
2020
|
|
|
1,446,218
|
|
2021
|
|
|
1,395,081
|
|
Thereafter
|
|
|
4,511,323
|
|
Total amortization
|
|
$
|
11,755,019
|
|
NOTE 8. ACCRUED EXPENSES
Accrued expenses consisted of the following at December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
(restated)
|
|
TableMAX license fee
|
|
$
|
470,512
|
|
|
$
|
136,785
|
|
Payroll and related
|
|
|
405,553
|
|
|
|
157,661
|
|
Professional fees
|
|
|
59,567
|
|
|
|
154,888
|
|
Commissions and royalties
|
|
|
54,551
|
|
|
|
281,249
|
|
Accrued interest
|
|
|
2,602
|
|
|
|
14,832
|
|
Other
|
|
|
116,643
|
|
|
|
105,476
|
|
Total accrued expenses
|
|
$
|
1,109,428
|
|
|
$
|
850,891
|
|
TableMAX license fee
.
Under the terms of a five-year licensing agreement (the “ TMAX Agreement”) with TableMAX Corporation (“TMAX”) a provider of electronic table games and platforms headquartered in Las Vegas, Nevada, we have exclusive worldwide rights (excluding one international territory and two U.S. states) to the TMAX electronic gaming platform and certain related game titles. Pursuant to the terms of the TMAX Agreement, the licensee fee payable to TMAX is dependent upon our generating profitable operating results specifically from the use of TMAX products. To the extent there are net profits (as defined in the TMAX Agreement), a percentage of such net profits is payable to TMAX depending on the number of TMAX product installations. The TMAX Agreement expired during 2016, and we are currently negotiating the licensing fee that may be payable to TMAX.
27
NOTE 9. CAPITAL LEASE OBLIGATIONS, NET
Capital lease obligations, net consisted of the following at December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Capital lease obligation – leasehold improvements
|
|
$
|
78,008
|
|
|
$
|
107,365
|
|
Capital lease obligation – office furniture
|
|
|
—
|
|
|
|
29,839
|
|
Total capital lease obligations
|
|
|
78,008
|
|
|
|
137,204
|
|
Less: Current portion
|
|
|
(31,030
|
)
|
|
|
(59,196
|
)
|
Capital lease obligations, net
|
|
$
|
46,978
|
|
|
$
|
78,008
|
|
The capital lease obligation – leasehold improvements requires 60 monthly payments of $2,879, including 5.5% interest, beginning May 2014 through May 2019.
The capital leases cover furniture and leasehold improvements located at our corporate headquarters in Las Vegas, Nevada. As of December 31, 2016, annual requirements for capital leases obligations are as follows:
|
|
Total
|
|
2017
|
|
$
|
31,030
|
|
2018
|
|
|
32,780
|
|
2019
|
|
|
14,198
|
|
Total minimum lease payments
|
|
$
|
78,008
|
|
NOTE 10. NOTES PAYABLE
Notes payable consisted of the following at December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Term loan
|
|
$
|
10,500,000
|
|
|
$
|
—
|
|
Note payable, unrelated party
|
|
|
—
|
|
|
|
11,577,858
|
|
Notes payable, related party
|
|
|
509,135
|
|
|
|
1,079,083
|
|
Equipment notes payable
|
|
|
162,274
|
|
|
|
70,664
|
|
Insurance note payable
|
|
|
36,063
|
|
|
|
—
|
|
Notes payable, gross
|
|
|
11,207,472
|
|
|
|
12,727,605
|
|
Less:
|
|
|
|
|
|
|
|
|
Unamortized debt issuance costs
|
|
|
(595,462
|
)
|
|
|
—
|
|
Warrants issued
|
|
|
(743,604
|
)
|
|
|
—
|
|
Unamortized debt discount
|
|
|
—
|
|
|
|
(643,314
|
)
|
Notes payable, net
|
|
|
9,868,406
|
|
|
|
12,084,291
|
|
Less: Current portion
|
|
|
(1,199,255
|
)
|
|
|
(4,648,120
|
)
|
Long-term debt, net
|
|
$
|
8,669,151
|
|
|
$
|
7,436,171
|
|
Term loan credit facility.
In August 2016, we entered into a term loan agreement for an aggregate principal amount of $10,500,000 (the "Term Loan"). Proceeds of the Term Loan were primarily used to prepay in full the outstanding notes payable to unrelated parties. The remainder of the proceeds from the Term Loan will be used for general corporate purposes and working capital needs. The Term Loan is secured by a senior lien on our assets. We issued the Warrants to the lenders in conjunction with the Term Loan. See Note 14.
Under the Term Loan, we are subject to quarterly financial covenants that, among other things, limit our annual capital expenditures (as defined in the Term Loan agreement), and require us to maintain a specified leverage ratio and minimum EBITDA amount, each of which are defined in the Term Loan agreement. We were in compliance with the financial covenants of the Term Loan Agreement as of December 31, 2016.
During the initial twelve-month period of the Term Loan, the outstanding principal will accrue interest at the rate of 14.0% per annum.
Thereafter, the outstanding principal will accrue interest at the lesser of 14.0% per annum or 12.5% per annum for any quarterly period in which we achieve a specified leverage ratio.
The Term Loan requires quarterly interest-only payments through December 31, 2016 after which we are required to make quarterly principal payments of $262,500 plus accrued interest. The remaining principal and any unpaid interest will be payable in full on
28
August 29, 2021. Voluntary prepayments of the Term Loan, in full or in part, are permitted after the first anniversary of the Term Loan, subject
to certain premiums. The Term Loan also requires certain mandatory prepayments in the amount of 100% of the proceeds from certain asset dispositions (other than in the ordinary course of business) and certain other extraordinary events, and 25% of the proc
eeds from the sale and issuance of capital stock. Substantially all of our assets
are pledged as collateral for the Term Loan.
Notes payable, related party.
See Note 3.
Note payable, unrelated party.
In connection with an asset acquisition completed in October 2011 with Prime Table Games, LLC, we executed the PTG Notes, which consisted of a promissory note payable for $12.2 million, and another promissory note payable for £6.4 million GBP ($10.0 million USD). The PTG Notes were recorded net of a debt discount of $1,530,000. The effective interest rate of the notes was 6% and 7% during 2015 and 2016, respectively. These notes were repaid in full in connection with the Term Loan agreement executed in August 2016. Concurrently with the repayment of PTG Notes, $515,037 of unamortized debt discount was recorded as loss on debt extinguishment.
Maturities of our notes payable as of December 31, 2016 are as follows:
December 31,
|
|
Total
|
|
2017
|
|
$
|
1,199,255
|
|
2018
|
|
|
1,523,174
|
|
2019
|
|
|
1,090,553
|
|
2020
|
|
|
1,072,034
|
|
2021
|
|
|
6,322,456
|
|
Total notes payable
|
|
|
11,207,472
|
|
Less:
|
|
|
|
|
Unamortized debt issuance costs
|
|
|
(595,462
|
)
|
Warrants issued
|
|
|
(743,604
|
)
|
Notes payable, net
|
|
$
|
9,868,406
|
|
NOTE 11. COMMITMENTS AND CONTINGENCIES
Concentration of risk.
We are exposed to risks associated with a client who represents a significant portion of total revenues. As of December 31, 2016 and 2015, we had the following client revenue concentrations:
|
|
Location
|
|
2016
Revenue
|
|
|
2015
Revenue
|
|
Client A
|
|
North America
|
|
|
13.4%
|
|
|
|
14.7%
|
|
The amounts in accounts receivable related to this significant client at December 31, 2016 and 2015 were approximately $210,000 and $150,000, respectively.
We are also exposed to risks associated with expiration of our patents. In 2015, domestic and international patents expired on two of our products, which account for approximately $5,725,000 or 46% of our revenue for the year ended December 31, 2016. However, we assumed an agreement between the previous owner of these patents and a dominant competitor of ours that prohibits any similar product offerings based on these expired patents until March 2023. As a result, we do not expect the expiration of these patents to have a significant adverse impact on our financial statements.
Operating lease obligations.
In February 2014, we entered into a lease (the “Spencer Lease”) for a new corporate office with an unrelated third party. The five-year Spencer Lease is for a building with approximately 24,000 square feet, which is comprised of approximately 16,000 square feet of office space and 8,000 square feet of warehouse space. The property is located in Las Vegas, Nevada.
The initial term of the Spencer Lease commenced on April 1, 2014. We are obligated to pay approximately $153,000 in annual base rent in the first year, and the annual base rent will increase by approximately 4% each year. We are also obligated to pay real estate taxes and other building operating costs. Subject to certain conditions, we have certain rights under the Spencer Lease, including rights of first offer to purchase the premises if the landlord elects to sell. We also have an option to extend the term of the Spencer Lease for two consecutive terms of three years each, at then current fair market value rental rate determined in accordance with the terms of the Lease.
29
In connection with the Spencer Lease, the landlord agreed to finance tenant improvements of $150,000 (“TI Allowance”). The base rent is increased by an
amount sufficient to fully amortize the TI Allowance through the Spencer Lease term upon equal monthly payments of principal and interest, with interest imputed on the outstanding principal balance at the rate of 5.5% per annum. The TI Allowance has been
classified as a capital lease on the balance sheet. See Note 9.
Pursuant to the Spencer Lease, we have the option to terminate the Spencer Lease effective at the end of the 36th month (“Termination Date”). We must deliver written notice of our intention to terminate the Spencer Lease to landlord at least six months before the Termination Date. In the event we exercise our option to terminate, we shall pay the landlord a termination fee (the “Termination Fee”) equal to the sum of (i) all unamortized TI Allowance amounts, plus (ii) all unamortized leasing commissions paid by landlord with respect to the Spencer Lease, plus (iii) all unamortized rental abatement amounts.
Total rent expense was $285,814 and $290,830 for the year ended December 31, 2016 and 2015, respectively.
The amounts shown in the accompanying table reflect our estimates of lease obligations for the twelve months ending 2017 through 2019 and are based upon our current operating leases. There are currently no operating lease commitments beyond January 1, 2020.
Twelve Months Ending
December 31,
|
|
Annual Obligation
|
|
2017
|
|
$
|
225,816
|
|
2018
|
|
|
234,552
|
|
2019
|
|
|
119,460
|
|
Total obligations
|
|
$
|
579,828
|
|
Legal proceedings.
In the ordinary course of conducting our business, we are, from time to time, involved in various legal proceedings, administrative proceedings, regulatory government investigations and other matters, including those in which we are a plaintiff or defendant, that are complex in nature and have outcomes that are difficult to predict. In accordance with ASC Topic 450, we record accruals for such contingencies to the extent we conclude that it is probable that a liability will be incurred and the amount of the related loss can be reasonably estimated. Our assessment of each matter may change based on future unexpected events. An unexpected adverse judgment in any pending litigation could cause a material impact on our business operations, intellectual property, results of operations or financial position. Unless otherwise expressly stated, we believe costs associated with litigation will not have a material impact on our financial position or liquidity, but may be material to the results of operations in any given period. We assume no obligation to update the status of pending litigation, except as may be required by applicable law, statue or regulation.
In Bet litigation.
In November 2014, we filed a complaint for patent infringement against In Bet Gaming, Inc. and In Bet, LLC
(collectively "In Bet")
, alleging that their “In-Between” side bet game infringes on one or more of our patents.
Red Card Gaming & AGS litigation
. In September 2012, we executed an asset purchase agreement (“APA”) with Red Card Gaming, Inc. (“RCG”), for the purchase of all the rights, title and interest in and for the game known as
High Card Flush
and all associated intellectual property. The APA included customary non-compete, non-disparagement and right of first refusal provisions. In 2014, AGS, LLC (“AGS”) purchased RCG’s rights in the APA and became the assignee of the APA. In September 2014 we notified RCG of their material breach of the APA and discontinued contingent consideration payments. In November 2014, RCG and AGS attempted to terminate the APA and in December 2014, began selling their own High Card Flush game and filed a complaint against us alleging fraud, breach of contract and trademark infringement, among other allegations. We filed counterclaims against RCG and AGS alleging, among other things, fraud on the trademark office and in the marketplace, misappropriation of our trade secrets, breach of contract, infringement of our trademark and interference with customer relationships.
In July 2016,
we entered into a settlement agreement (the "Settlement Agreement") with RCG and AGS for purposes of resolving all disputes between the parties. Pursuant to the Settlement Agreement, among other things, RCG, AGS and the Company agreed to a mutual release of all claims and counter-claims. RCG and AGS also agreed to terminate all of their rights and obligations related to the APA, and AGS agreed to pay us the sum of $350,000 and agreed to the injunctive terms of the Final Award. Furthermore, we agreed to dismiss the complaint we filed in November 2014 against In Bet mentioned above. AGS became involved in an Inter-Parties Review subsequent to November 2014, concerning the patent at issue because AGS had title and interest in the game In-Between.
As a result of the Settlement Agreement, we recognized settlement income of $697,214, which includes a $350,000 payment from AGS and a release of $347,214 in accrued contingent consideration owed to AGS.
California administrative action.
In March 2003, Galaxy Gaming of California, LLC (“GGCA”), an independent entity managed by GGLLC, submitted an application to the California Gambling Control Commission (“California Commission”) for a determination of suitability to conduct business with tribal gaming operations in California. At the time, our CEO was a member of GGCA and was required to be included in the application process. In July 2013, the California Commission denied the applications of our CEO and GGCA for a finding of suitability. The California Commission also denied a request for stay or any further reconsideration of the matter.
30
In August 2013, GGCA and our CEO filed a motion for writ of mandate with the Sacramento County Superior Court, asking the Court for a judicial review
of the California Commission’s ruling. A hearing on the motion was originally scheduled for October 2015 and has been delayed until further notice.
In July 2014, we filed an application with the California Bureau of Gambling Control (“California Bureau”) for a finding of suitability. As of the date of this report, their investigation is continuing. Once their investigation is complete, the California Bureau will make their recommendation to the California Commission regarding our suitability. We are unable to conduct business with tribal casinos in California until either we are found suitable by the California Commission or GGCA and our CEO prevails with their writ of mandate motion.
Uncertain tax positions
. As further discussed in Note 13, we have adopted the provision of ASC 740. We had $56,886 of uncertain tax position as of December 31, 2016. Due to the inherent uncertainty of the underlying tax positions, it is not possible to forecast the payment of this liability to any particular year.
NOTE 12. STOCKHOLDERS’ EQUITY
We had 65,000,000 shares of $0.001 par value common stock and 10,000,000 shares of $0.001 par value preferred stock authorized as of December 31, 2016, of which 39,315,591 common shares and no preferred shares were issued and outstanding.
In April 2015, Bryan Waters, one of our Directors, was granted 75,000 shares of our restricted common stock as condition of his Board of Directors Director Service Agreement. The fair market value of the grant was $20,250, which was determined using our closing stock price at April 1, 2015, the date of the grant. The restricted stock grant vested immediately.
In November 2015, Gary Vecchiarelli, our Former CFO, was granted 150,000 shares of our restricted common stock as condition of his Employment Agreement. The fair market value of the grant was $30,000, which was determined using our closing stock price at November 14, 2015, the date of the grant. The restricted stock was scheduled to vest at six-month intervals through December 31, 2018. However, upon Mr. Vecchiarelli’s resignation effective December 31, 2016, 100,000 shares of restricted stock were forfeited.
As a condition of his 2015 employment agreement, our Former CFO can elect to use up to 50% of his annual bonus to purchase shares of our common stock at a 50% discount. The purchase price is determined by using the average closing price of the prior 10 business days discounted by 50%. On February 28, 2016, our Former CFO made the election to utilize $9,000 of his annual 2015 bonus to purchase 100,000 shares of common stock at the market price of $0.18 (effective price of $0.09 after discount). The shares vested immediately.
NOTE 13. INCOME TAXES
The components of the provision consist of the following for the years ended December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Current:
|
|
|
|
|
|
|
(restated)
|
|
Federal
|
|
$
|
680,882
|
|
|
$
|
165,530
|
|
State
|
|
|
20,561
|
|
|
|
3,711
|
|
Total current
|
|
|
701,443
|
|
|
|
169,241
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
71,657
|
|
|
|
25,657
|
|
State
|
|
|
(2,377
|
)
|
|
|
17
|
|
Change in valuation allowance
|
|
|
—
|
|
|
|
—
|
|
Total deferred
|
|
|
69,280
|
|
|
|
25,674
|
|
Income tax provision
|
|
$
|
770,723
|
|
|
$
|
194,915
|
|
31
The income tax provision differs from that computed at the federal statutory corporate
income tax rate as follows for the years ended December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
(restated)
|
|
Tax provision computed at the federal statutory rate
|
|
$
|
877,282
|
|
|
$
|
238,581
|
|
State income tax, net of federal benefit
|
|
|
21,860
|
|
|
|
6,404
|
|
Permanent items
|
|
|
63,737
|
|
|
|
22,460
|
|
Credits
|
|
|
(58,159
|
)
|
|
|
(26,173
|
)
|
True ups and rounding
|
|
|
(115,397
|
)
|
|
|
(48,974
|
)
|
Change in valuation allowance
|
|
|
—
|
|
|
|
—
|
|
Uncertain tax positions
|
|
|
(18,600
|
)
|
|
|
2,617
|
|
Income tax provision
|
|
$
|
770,723
|
|
|
$
|
194,915
|
|
The tax effects of significant temporary differences representing net deferred tax assets and liabilities consisted of the following at December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
Deferred Tax Assets:
|
|
|
|
|
|
|
(restated)
|
|
Intangible assets
|
|
$
|
178,057
|
|
|
$
|
135,234
|
|
Research and development credits
|
|
|
—
|
|
|
|
115,086
|
|
Accruals and reserves
|
|
|
58,656
|
|
|
|
43,017
|
|
Credits from amended return
|
|
|
192,461
|
|
|
|
253,298
|
|
Other
|
|
|
122,744
|
|
|
|
77,813
|
|
Total deferred tax assets
|
|
|
551,918
|
|
|
|
624,448
|
|
|
|
|
|
|
|
|
|
|
Deferred Tax Liabilities:
|
|
|
|
|
|
|
|
|
Basis difference in fixed assets
|
|
|
(184,861
|
)
|
|
|
(145,781
|
)
|
Foreign currency exchange gains
|
|
|
—
|
|
|
|
(42,329
|
)
|
Total deferred tax liabilities
|
|
|
(184,861
|
)
|
|
|
(188,110
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
367,057
|
|
|
$
|
436,338
|
|
In accordance with ASC Topic 740, we analyzed our valuation allowance at December 31, 2016 and determined that, based upon available evidence, it is more likely than not that certain of our deferred tax assets will be realized and, as such, has removed any valuation allowance against certain deferred tax assets. We anticipate utilization of both our foreign tax credits and research credit carryforwards.
The aggregate changes in the balance of gross unrecognized tax benefits (included as part of accrued expenses in the accompanying financial statements), which excludes interest and penalties, are as follows as of and for the years ended December 31, 2016 and 2015:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
(restated)
|
|
Beginning balance:
|
|
$
|
51,074
|
|
|
$
|
42,080
|
|
Increases related to tax positions taken during the current year
|
|
|
12,572
|
|
|
|
8,994
|
|
Decreases related to expiration of statute of limitations
|
|
|
(6,760
|
)
|
|
|
—
|
|
Ending Balance:
|
|
$
|
56,886
|
|
|
$
|
51,074
|
|
Our total liability for unrecognized gross tax benefits was $56,886 as of December 31, 2016, which, if ultimately recognized, would impact the effective tax rate in future periods. We are subject to examination by the Internal Revenue Service for fiscal years 2013 and thereafter. For states within the U.S. in which we conduct significant business, we remain subject to examination for fiscal year 2012 and thereafter. We have no accrual for interest or penalties related to uncertain tax positions at December 31, 2016 and 2015, and did not recognize interest or penalties in the statements of income during the years ended December 31, 2016 and 2015.
As of December 31, 2016, we expected to use our foreign tax credits of $30,332 to offset federal income tax owed in 2016.
32
NOTE 14. STOCK OPTIONS, RESTRICTED STOCK AND WARRANTS
Stock options.
For the years ended December 31, 2016 and 2015, we issued 540,000 and 675,000 stock options, respectively, to members of our Board of Directors, employees and independent contractors. The fair value of stock options granted in 2016 and 2015 was $141,311 and
$76,227
, respectively, using the Black-Scholes option pricing model with the following assumptions:
|
|
2016
|
|
2015
|
Dividend yield
|
|
0%
|
|
0%
|
Expected volatility
|
|
87% - 91%
|
|
84% - 85%
|
Risk free interest rate
|
|
1.01% - 1.93%
|
|
1.18% - 1.81%
|
Expected life (years)
|
|
5
|
|
5
|
A summary of stock option activity is as follows:
|
|
Common
s
tock options
|
|
|
Weighted average
exercise price
|
|
|
Aggregate intrinsic value
|
|
|
Weighted-average remaining contractual term (years)
|
|
Outstanding – December 31, 2015
|
|
|
1,056,250
|
|
|
$
|
0.28
|
|
|
$
|
316,875
|
|
|
|
4.08
|
|
Issued
|
|
|
540,000
|
|
|
|
0.38
|
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Expired
|
|
|
(100,000
|
)
|
|
|
0.20
|
|
|
|
—
|
|
|
|
—
|
|
Outstanding – December 31, 2016
|
|
|
1,496,250
|
|
|
$
|
0.32
|
|
|
$
|
385,017
|
|
|
|
3.57
|
|
Exercisable – December 31, 2016
|
|
|
1,367,361
|
|
|
$
|
0.32
|
|
|
$
|
354,083
|
|
|
|
3.53
|
|
A summary of unvested stock option activity is as follows:
|
|
Common
s
tock options
|
|
|
Weighted average
exercise price
|
|
|
Aggregate intrinsic value
|
|
|
Weighted-average remaining contractual term (years)
|
|
Unvested – December 31, 2015
|
|
|
250,000
|
|
|
$
|
0.26
|
|
|
$
|
81,000
|
|
|
|
4.58
|
|
Granted
|
|
|
540,000
|
|
|
|
0.38
|
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
(561,111
|
)
|
|
|
0.37
|
|
|
|
—
|
|
|
|
—
|
|
Forfeited or expired
|
|
|
(100,000
|
)
|
|
|
0.20
|
|
|
|
—
|
|
|
|
—
|
|
Unvested – December 31, 2016
|
|
|
128,889
|
|
|
$
|
0.34
|
|
|
$
|
30,933
|
|
|
|
3.99
|
|
Restricted stock.
For the years ended December 31, 2016 and 2015, we issued zero and 225,000 shares of our restricted stock, respectively, to members of our Board of Directors and employees. The fair value of restricted stock granted in 2015 was $50,250 using
the grant date trading price of our stock.
As of December 31, 2016, we had 805,000 shares of outstanding and fully vested restricted stock.
Share-based compensation.
The cost of all stock options and stock grants issued have been classified as share-based compensation on the statement of operations for the years ended December 31, 2016 and 2015. Total share-based compensation was $145,732 and $119,677 for the years ended December 31, 2016 and 2015, respectively.
Warrants.
On August 29, 2016, in connection with the Term Loan agreement, we issued the Warrants to purchase 1,965,780 shares of common stock at an initial exercise price of $0.30 per share. The number of shares of common stock issuable upon exercise of the Warrants, and/or the exercise price of such shares, is subject to standard anti-dilution adjustments in the event of stock splits, reorganizations, stock dividends, and similar events. As of the date of the Warrant Agreement, the shares of common stock issuable upon a full exercise of the Warrants would represent 5.0% of the total issued and outstanding shares of our common stock. The lenders were also granted the right, but not the obligation, to purchase up to 5.0% of the total number of new securities that we may, from time to time, sell and issue.
33
The Warrants expire on August 29, 2022, and may not be exercised prior to the earliest of
(a) the fifth anniversary of the Loan Ag
reement, (b) the date on which the obligations described in the Loan Agreement are repaid in full, or (c) the date on which the Lender declares all or any portion of the outstanding amount of the Term Loan to be due and payable under the terms of the Loan
Agreement (collectively, the "Trigger Date"). Exercise of the Warrants requires a sixty (60) day prior written notice, during which time we may exercise its Call Right described below.
The Warrant Agreement includes a call right (the "Call Right") whereby we can purchase the Warrants for a fixed sum of $1,333,333 upon providing the Warrant holders with a thirty (30) day prior written notice. Furthermore, the Warrant Agreement also includes a put right (the "Put Right") whereby the Lenders may require us to purchase from the Lenders all or any portion of the Warrants at a purchase price equal to the lesser of (a) the fair market value of the underlying shares of common stock as of the date of exercise of the Put Right, or (b) $1,333,333. The Put Right may not be exercised prior to the Trigger Date (as defined above), and the Put Right expires on August 29, 2022.
A summary of warrant activity is as follows:
|
|
Common
s
tock warrants
|
|
|
Weighted average exercise price
|
|
Outstanding – December 31, 2015
|
|
|
—
|
|
|
$
|
—
|
|
Issued
|
|
|
1,965,780
|
|
|
|
0.30
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Expired
|
|
|
—
|
|
|
|
—
|
|
Outstanding – December 31, 2016
|
|
|
1,965,780
|
|
|
$
|
0.30
|
|
Exercisable – December 31, 2016
|
|
|
—
|
|
|
$
|
—
|
|
As of December 31, 2016, t
he Warrants were
the only financial instrument measured at estimated fair value on a recurring basis, which was determined using the
Black-Scholes pricing model. The estimated fair value of the Warrants was determined using Level 2 inputs, as defined ASC 820, since inputs utilized in the Black-Scholes pricing model were based on observable market inputs, but not for identical assets or liabilities.
NOTE 15. SUBSEQUENT EVENTS
We evaluated subsequent events through the date of issuance of the financial statements. There have been no subsequent events that occurred during such period that would require adjustment to or disclosure in the financial statements as of and for the year ended December 31, 2016.
34