NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2018 AND 2017
NOTE 1. 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 Nevada corporation (“Galaxy Gaming”).
We are an established global gaming company specializing in the design, development, assembly, marketing and acquisition of proprietary casino table games and associated technology, platforms and systems for the casino gaming industry.
Casinos use our proprietary products and services to enhance their gaming floor operations and improve their profitability, productivity and security, as well as to offer popular cutting-edge gaming entertainment content and technology to their players. We market our products and services to land-based and riverboat gaming companies located in North America, the Caribbean, Central America, the British Isles, Europe and Africa and to cruise ship companies and internet gaming sites worldwide.
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 and regulations of the SEC. The results for the periods presented reflect all normal and recurring adjustments that management considers necessary for a fair presentation of operating results.
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, cash equivalents and restricted cash.
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 cash in bank balances are deposited in insured banking institutions, which 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. Through August 2018, we maintained a reserve in a restricted bank account for the purpose of funding payments to winners of our jackpots. At December 31, 2018, no funds remained in the restricted bank account due to the termination of the contract between us and the casino operator where the jackpots were offered.
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 (Note 4) and we maintain inventory levels based on historical and industry trends. We regularly assess inventory quantities for excess and obsolescence primarily based on forecasted product demand. Inventory is valued at the lower of net realizable value or cost, which is determined by the average cost method.
Assets deployed at client locations, net.
Our Enhanced Table Systems are assembled by us and accounted for as inventory until deployed at our casino clients’ premises (Note 6). Once deployed and placed into service at client locations, the assets are transferred from inventory and reported as assets deployed at client locations. These assets are stated at cost, net of accumulated depreciation. Depreciation on assets deployed at client locations is calculated using the straight-line method over a three-year period.
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 (Note 5). Property and equipment are analyzed for potential impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable and exceeds their fair value.
Goodwill.
A goodwill balance of $1,091,000 was created as a result of
an asset acquisition completed in October 2011 from Prime Table Games, LLC (the “PTG Acquisition”)
. Goodwill 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.
In January 2017, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Update (“
ASU”) No. 2017-04,
Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,
which simplifies the current two-step goodwill impairment test by eliminating Step 2 of the test. This guidance requires a one-step impairment test in which an entity compares the fair value of a reporting unit with its carrying amount and recognizes an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, if any. We early adopted this guidance for the annual test performed for the year ended December 31, 2018 and the adoption did not have any impact on our financial statements.
19
Other intangible assets, net.
The
following
intangible assets have finite lives and are being amortized using the straight-line method over their estimated economic lives:
Patents
|
|
52 -240 months
|
Client relationships
|
|
264 months
|
Trademarks
|
|
132 - 360 months
|
Non-compete agreements
|
|
108 months
|
Internally-developed software
|
|
36 months
|
Other intangible assets (Note 7) are analyzed for potential impairment at least annually, or whenever events or changes in circumstances indicate the carrying value may not be recoverable and exceeds their fair value, which is the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the intangible assets. There were no events or changes in circumstances that would indicate a possible impairment as of December 31, 2018.
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 values of cash equivalents, restricted cash, accounts receivable and accounts payable approximate their carrying amounts 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, 2018,
the interest rate swap agreement was
the only financial instrument measured at estimated fair value on a recurring basis based on
valuation reports provided by counterparties, which are classified as
level 2 inputs
.
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. In April 2014, the landlord of our corporate headquarters financed leasehold improvements in the amount of $150,000, which have been recorded as a capital lease and amortized over the initial term of the lease (Note 9). In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842),
which was adopted by us effective January 1, 2019
.
See “new accounting standards not yet adopted” section below for more detail on the adoption
.
Revenue recognition.
In May 2014, the FASB issued ASU No. 2014-09
(Topic 606),
Revenue from Contracts with Customers
(“ASC 606”), which is a comprehensive new revenue recognition standard that superseded virtually all existing revenue guidance, including industry-specific guidance. We adopted ASC 606 on January 1, 2018 (see “recently adopted accounting standards” section below and Note 3).
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 our Enhanced Table Systems.
Research and development.
We incur research and development (“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 development 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
operations
.
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 740,
Income
Taxes
(“ASC 740”)
using the asset and liability method. 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
20
amounts of the assets or liabilities are recovered or settled. Deferred tax assets and liabilities are measur
ed 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 provi
sion 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 ass
ets and liabilities, and any valuation allowance recorded against our deferred tax assets.
As of
December 31, 2018
and
2017
, we did not record a valuation allowance.
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. 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 an evaluation of the technical merits of the position, which requires a significant degree of judgment (Note 13).
Net income (loss) per share.
Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average number of common shares issued and outstanding during the year. Diluted net income 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, restricted stock and warrants, if applicable, during the year, using the treasury stock method. The effect of outstanding stock options, restricted stock and warrants is excluded from the computation of net loss per share for the year ended December 31, 2017, as the effect is anti-dilutive.
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.
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
Revenue Recognition.
Effective January 1, 2018, we adopted ASC 606 using the modified retrospective approach (reporting the cumulative effect as of the date of adoption). Under ASC 606, revenue is 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. ASC 606 creates a five-step model that generally requires companies to use more judgment and make more estimates than under the previous 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.
See Note 3 for further detail.
Restricted Cash
. Effective January 1, 2018, we adopted ASU No. 2016-18,
Statement 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. We adopted this guidance on a retrospective basis, which resulted in the inclusion of restricted cash within cash and cash equivalents on our balance sheets and statements of cash flows. Such restricted cash represented reserves set side in a restricted bank account in accordance with the requirements of gaming regulations for the purpose of funding payments to winners of jackpots at one of our client locations and was $95,062
at December 31, 2017
. At December 31, 2018, no funds remained in the restricted bank account due to the termination of contract between us and this client location. Cash flows from operating activities for the year ended December 31, 2017 increased by $10,485 as a result of the adoption of this guidance.
21
Stock Compensation.
Effective
January 1, 2018, we adopted ASU No. 2017-09,
Compensation—Stock
Compensation (Topic 718): Scope of Modification Accounting
, which provides clarification on when modification accounting should be used for changes to the terms or conditions of a share-based payment award. The adoption did not have a material impact on ou
r financial statements.
New accounting standards not yet adopted as of December 31, 2018
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 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 have adopted the new standard effective January 1, 2019, using the required modified retrospective transition approach and recognized approximately $0.2 million of our operating leases as right-of-use assets and operating lease liabilities on our balance sheets upon adoption. The adoption has increased our total assets and liabilities as of January 1, 2019, and will result in higher amortization expense of right-of-use assets and lower rent expense for the year ended December 31, 2019 and thereafter. Lessor accounting related to our enhanced table system remains unchanged.
Fair Value Measurement.
In August 2018, the FASB issued ASU No. 2018-13,
Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement
. ASU 2018-13 addresses the required disclosures around fair value measurement, removes certain disclosure requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The standard is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted. We do not believe the adoption of this guidance will have a material impact on our financial statements.
Internal-Use Software.
In August 2018, the FASB issued ASU No. 2018-15,
Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract
. ASU 2018-15. This new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The update is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods, with early adoption (including early adoption in any interim period) permitted. We do not believe the adoption of this guidance will have a material impact on our financial statements.
NOTE 3. REVENUE RECOGNITION
Adoption of ASC 606
, Revenue from Contracts with Customers
On January 1, 2018, we adopted ASC 606 and applied it to all contracts using the modified retrospective method. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts have not and will not be adjusted and continue to be reported in accordance with our historical accounting treatment under ASC 605,
Revenue Recognition
.
The adoption of ASC 606 had the following impact on our balance sheet and statement of operations:
|
•
|
We reported higher product leases and royalty revenue and selling, general and administrative expense for the year ended December 31, 2018 as a result of the assessment of our distributor relationships. We have entered into agreements with certain distributors in Europe, which sublicense our intellectual property to gaming establishments in Europe. We have historically recorded product lease and loyalty revenue net of the related distributor fees paid. However, after applying principal vs. agent considerations to these distributor relationships in accordance with ASC 606, we have determined that revenues earned from gaming establishments in Europe should now be recorded as gross revenue and fees earned by such distributors should be recorded as selling, general and administrative expenses as we had control of the sub-licensed intellectual property prior to the licensing of such intellectual property to the gaming establishments; and
|
|
•
|
P
repayments from customers in advance of the period that the revenue is recognized were historically recorded under the caption “deferred revenue” in the accompanying balance sheet. This caption has now been renamed “revenue contract liability” in accordance with the requirements of ASC 606.
|
22
For the
year ended
December 31, 2018
, the adoption of ASC 606 had the following impact on our statement of
operations
:
|
|
Year ended December 31, 2018
|
|
|
|
As reported
|
|
|
Balance without the
adoption of ASC 606
|
|
|
Impact of the
adoption
|
|
Product leases and royalties
|
|
$
|
18,559,720
|
|
|
$
|
17,573,083
|
|
|
$
|
986,637
|
|
Selling, general and administrative
expense
|
|
$
|
10,903,623
|
|
|
$
|
9,916,986
|
|
|
$
|
986,637
|
|
Revenue Recognition
We generate revenue primarily from the licensing of our intellectual property. We also, occasionally, receive a one-time sale of certain products and/or reimbursement of our equipment.
License Fees.
We derive product lease and royalty revenue
from negotiated recurring fee license agreements and the performance of our products. We account for these agreements as month-to-month contracts for the purposes of ASC 606 and recognize revenue each month as we satisfy our performance obligations by granting access to intellectual property to our clients. In addition, revenue associated with performance-based agreements is recognized during the month that the usage of the product or intellectual property occurs.
We believe it is inappropriate to use the input method as the inputs do not correlate to the satisfaction of our performance obligations. Intellectual property requires significant upfront investment in the form of human resources required for their development and/or capital resources for acquisition from third parties. However, limited maintenance is required once the games have been placed on casino floors. The output method, on the other hand, recognizes revenue based on direct measurements of the value to our customers of the licensed intellectual property, which we believe is more appropriate. We have further applied the “as invoiced” practical expedient under the output method by recognizing product lease and royalty revenue in proportion to the amount for which we have the right to invoice.
Some of our intellectual property requires the installation of certain equipment and both the intellectual property and the related equipment are licensed in one bundled package. However, we have determined that the equipment is not distinct from the intellectual property and, therefore, we have only one performance obligation. As a result, the allocation of the transaction price to different performance obligations is not necessary.
Product Sales.
Occasionally, we sell certain incidental products or receive reimbursement of our equipment after the commencement of the new license agreement. Revenue from such sales is recognized as a separate performance obligation when we ship the items.
Disaggregation of Revenue.
The following table disaggregates our revenue by major source for the year ended December 31, 2018 and 2017:
|
|
Year Ended December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Table games
|
|
$
|
18,156,281
|
|
|
$
|
14,404,275
|
|
Other
|
|
|
404,387
|
|
|
|
451,301
|
|
Total revenue
|
|
$
|
18,560,668
|
|
|
$
|
14,855,576
|
|
The following table disaggregates our revenue by geographic location for the year ended December 31, 2018 and 2017:
|
|
Year Ended December 31,
|
|
|
|
2018
|
|
|
2017
|
|
North America and Caribbean
|
|
$
|
14,275,967
|
|
|
$
|
12,121,327
|
|
Europe
|
|
|
4,284,701
|
|
|
|
2,734,249
|
|
Total revenue
|
|
$
|
18,560,668
|
|
|
$
|
14,855,576
|
|
Revenue Contract Asset and Liability.
Upon the adoption of ASC 606, we have applied the
practical expedient of
expensing incremental commissions paid to sales representatives directly related to the acquisition and fulfilment of new contracts,
when the amortization period of the contract asset that we otherwise would have recognized is one year or less.
We invoice our clients monthly in advance for unlimited use of our intellectual property licenses. Upon the
adoption of ASC 606, we recognized a revenue contract liability that represents such advanced billing
to our clients for unsatisfied performance. We reduce the revenue contract liability and recognize revenue when we transfer those goods or services and, therefore, satisfy our performance obligation.
23
The table below summarizes changes in the revenue contract liability during
year ended
December 31, 2
018:
|
|
Revenue Contract liability
|
|
Beginning balance – January 1, 2018
|
|
$
|
1,083,639
|
|
Increase (advanced billings)
|
|
|
14,127,961
|
|
Decrease (revenue recognition)
|
|
|
(13,773,108
|
)
|
Ending balance – December 31, 2018
|
|
$
|
1,438,492
|
|
Revenue recognized during the
year ended December 31, 2018
that was included in the beginning balance of revenue contract liability above was $1,083,639.
NOTE 4. INVENTORY
Inventory, net consisted of the following as of December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Raw materials and component parts
|
|
$
|
267,517
|
|
|
$
|
235,673
|
|
Finished goods
|
|
|
306,335
|
|
|
|
318,453
|
|
Inventory, gross
|
|
|
573,852
|
|
|
|
554,126
|
|
Less: inventory reserve
|
|
|
(42,038
|
)
|
|
|
(30,000
|
)
|
Inventory, net
|
|
$
|
531,814
|
|
|
$
|
524,126
|
|
NOTE 5. PROPERTY AND EQUIPMENT
Property and equipment, net consisted of the following at December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Furniture and fixtures
|
|
$
|
312,640
|
|
|
$
|
280,694
|
|
Automotive vehicles
|
|
|
215,127
|
|
|
|
215,127
|
|
Leasehold improvements
|
|
|
156,843
|
|
|
|
156,843
|
|
Computer equipment
|
|
|
159,838
|
|
|
|
121,992
|
|
Office equipment
|
|
|
53,484
|
|
|
|
53,483
|
|
Property and equipment, gross
|
|
|
897,932
|
|
|
|
828,139
|
|
Less: accumulated depreciation
|
|
|
(698,347
|
)
|
|
|
(564,272
|
)
|
Property and equipment, net
|
|
$
|
199,585
|
|
|
$
|
263,867
|
|
Property and equipment, net included $156,843 of leasehold improvements acquired under capital leases as of December 31, 2018 and 2017. Accumulated depreciation of assets acquired under capital leases (Note 9) totaled $142,557 and $113,035 at December 31, 2018 and 2017, respectively. For the years ended December 31, 2018 and 2017, depreciation expense related to property and equipment was $134,075 and $149,085, respectively.
NOTE 6.
Assets deployed at client locations, net
Assets deployed at client locations, net
consisted of the following at December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Enhanced table systems
|
|
$
|
946,237
|
|
|
$
|
638,981
|
|
Less: accumulated depreciation
|
|
|
(474,675
|
)
|
|
|
(265,331
|
)
|
Assets deployed at client location, net
|
|
$
|
471,562
|
|
|
$
|
373,650
|
|
For the years ended December 31, 2018 and 2017, depreciation expense related to a
ssets deployed at client locations, net
was $200,914 and $121,278, respectively.
24
NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill and finite-lived Intangible assets, net consisted of the following at December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Goodwill
|
|
$
|
1,091,000
|
|
|
$
|
1,091,000
|
|
Other intangible assets:
|
|
|
|
|
|
|
|
|
Patents
|
|
|
13,485,000
|
|
|
|
13,475,000
|
|
Customer relationships
|
|
|
3,400,000
|
|
|
|
3,400,000
|
|
Trademarks
|
|
|
2,880,967
|
|
|
|
2,880,967
|
|
Non-compete agreements
|
|
|
660,000
|
|
|
|
660,000
|
|
Internally-developed software
|
|
|
126,015
|
|
|
|
102,968
|
|
Other intangible assets, gross
|
|
|
20,551,982
|
|
|
|
20,518,935
|
|
Less: accumulated amortization
|
|
|
(11,661,730
|
)
|
|
|
(10,157,126
|
)
|
Other intangible assets, net
|
|
|
8,890,252
|
|
|
|
10,361,809
|
|
Goodwill and other intangible assets, net
|
|
$
|
9,981,252
|
|
|
$
|
11,452,809
|
|
For the years ended December 31, 2018 and 2017, amortization expense related to the finite-lived intangible assets was $1,504,605 and $1,496,177 respectively.
Estimated amortization expense to be recorded for the twelve months ending 2019 through 2023 and thereafter are as follows:
December 31,
|
|
Total
|
|
2019
|
|
$
|
1,508,864
|
|
2020
|
|
|
1,464,789
|
|
2021
|
|
|
1,399,287
|
|
2022
|
|
|
1,108,412
|
|
2023
|
|
|
252,930
|
|
Thereafter
|
|
|
3,155,970
|
|
Total amortization
|
|
$
|
8,890,252
|
|
NOTE 8. ACCRUED EXPENSES
Accrued expenses consisted of the following at December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Payroll and related
|
|
$
|
1,136,808
|
|
|
$
|
712,584
|
|
Professional fees
|
|
|
23,135
|
|
|
|
63,488
|
|
Commissions and royalties
|
|
|
113,462
|
|
|
|
65,380
|
|
Other
|
|
|
22,165
|
|
|
|
46,344
|
|
Total accrued expenses
|
|
$
|
1,295,570
|
|
|
$
|
887,796
|
|
NOTE 9. CAPITAL LEASE OBLIGATIONS
Capital lease obligations consisted of the following at December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Capital lease obligation
|
|
$
|
14,198
|
|
|
$
|
47,002
|
|
Less: Current portion
|
|
|
(14,198
|
)
|
|
|
(32,785
|
)
|
Total capital lease obligations – long-term
|
|
$
|
—
|
|
|
$
|
14,217
|
|
The capital leases consist of leasehold improvements located at our corporate headquarters in Las Vegas, Nevada.
25
NOTE 10.
LONG-TERM DEBT
Long-term debt consisted of the following at December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Nevada State Bank Term Loan and Revolver
|
|
$
|
10,042,400
|
|
|
$
|
—
|
|
Breakaway Term Loan
|
|
|
—
|
|
|
|
9,450,000
|
|
Equipment notes payable
|
|
|
85,043
|
|
|
|
124,311
|
|
Insurance notes payable
|
|
|
73,794
|
|
|
|
73,734
|
|
Long-term debt, gross
|
|
|
10,201,237
|
|
|
|
9,648,045
|
|
Less:
|
|
|
|
|
|
|
|
|
Unamortized debt issuance costs
|
|
|
(94,562
|
)
|
|
|
(480,397
|
)
|
Warrants issued
|
|
|
—
|
|
|
|
(584,261
|
)
|
Long-term debt, net
|
|
|
10,106,675
|
|
|
|
8,583,387
|
|
Less: Current portion
|
|
|
(1,456,847
|
)
|
|
|
(1,163,002
|
)
|
Long-term debt, net
|
|
$
|
8,649,828
|
|
|
$
|
7,420,385
|
|
Nevada State Bank Credit Agreement.
On April 24, 2018, we entered into a credit agreement with
ZB, N.A.
dba Nevada State Bank (“NSB” and the “NSB Credit Agreement”), which provides for a $11.0 million five-year term loan (the “NSB Term Loan”) and a $1.0 million one-year revolving credit facility (the “NSB Revolver”).
Outstanding balances under the NSB Term Loan and the NSB Revolver accrue interest based on one-month US dollar
London interbank offered rate
(“LIBOR”) plus an Applicable Margin of 3.50%, or 4.00%, depending on our Leverage Ratio (as defined in the NSB Credit Agreement).
We are required to make monthly principal and interest payments, both of which are calculated over a seven-year term, with a balloon payment due on April 24, 2023. Borrowings under the NSB Credit Agreement are secured by a lien on substantially all of our assets.
Effective May 1, 2018, we entered into an interest rate swap agreement with an affiliate of NSB (the “Swap Agreement”) to lock the interest rate on the NSB Term Loan at 6.43% (assuming a Leverage Ratio less than 2.0) for three years. The notional amount of the Swap Agreement is initially $10.9 million but will decrease over time as a result of the anticipated principal paydowns.
The NSB Credit Agreement contains affirmative and negative financial covenants and other restrictions customary for borrowings of this nature. In particular, we are required to maintain a minimum trailing-four-quarters Fixed Charge Coverage Ratio (as defined in the NSB Credit Agreement) of 1.25 and a maximum Leverage Ratio of 3.00. The NSB Credit Agreement allows us to make share repurchases and to incur up to an additional $1.0 million of unsecured indebtedness provided that we are in compliance with the covenants in the NSB Credit Agreement on a pro forma basis. We were in compliance with the financial covenants of the NSB Credit Agreement as of December 31, 2018.
Upon execution of the NSB Credit Agreement, we borrowed $11.0 million under the NSB Term Loan and $0.1 million under the NSB Revolver. Borrowings under the NSB Revolver were repaid in full in July 2018 and $1.0 million was available at December 31, 2018 and the filing date of this Annual Report on Form 10-K.
Breakaway Term Loan.
In August 2016, we entered into a term loan agreement (the “Breakaway Term Loan Agreement”) for an aggregate principal amount of $10,500,000 (the "Breakaway Term Loan"). In conjunction with the Breakaway Term Loan, we also entered into a warrant agreement (the “Warrant Agreement”), pursuant to which we issued the lenders a six-year warrant to purchase 1,965,780 shares of our common stock (the “Warrants”).
On April 24, 2018, we used the proceeds from the NSB Term Loan and the NSB Revolver to repay in full the remaining principal amount under the Breakaway Term Loan, together with accrued but unpaid interest, an early redemption premium and associated legal fees. In addition, we redeemed the Warrants at $1,333,333. The early redemption of the Breakaway Term Loan resulted in approximately $1.3 million of loss on extinguishment of debt.
26
A
s of December 31, 2018, m
aturities
of our
long-term debt obligations
are as follows:
December 31,
|
|
Total
|
|
2019
|
|
$
|
1,456,847
|
|
2020
|
|
|
1,456,633
|
|
2121
|
|
|
1,555,157
|
|
2022
|
|
|
1,637,700
|
|
2023
|
|
|
4,094,900
|
|
Total long-term debt
|
|
|
10,201,237
|
|
Less:
|
|
|
|
|
Unamortized debt issuance costs
|
|
|
(94,562
|
)
|
Long-term debt, net
|
|
$
|
10,106,675
|
|
NOTE 11. COMMITMENTS AND CONTINGENCIES
Concentration of risk.
We are exposed to risks associated with two clients who represent a significant portion of total revenues. As of December 31, 2018 and 2017, we had the following client revenue concentrations:
|
|
Location
|
|
2018
Revenue
|
|
|
2017
Revenue
|
|
|
Accounts
Receivable
December 31, 2018
|
|
|
Accounts
Receivable
December 31, 2017
|
|
Client A
|
|
North America
|
|
10.8%
|
|
|
13.3%
|
|
|
$
|
207,343
|
|
|
$
|
161,352
|
|
Client B
|
|
Europe
|
|
10.2%
|
|
|
4.8%
|
|
|
$
|
156,478
|
|
|
$
|
53,274
|
|
Operating lease.
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 and expires on June 30, 2019. We were 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.
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 (Note 9).
Total rent expense was $299,519 and $292,227 for the year ended December 31, 2018 and 2017, respectively.
In January 2019, we entered into a first amendment to the Spencer Lease to extend the lease expiration date to December 31, 2019. The amendment requires monthly base rent payments of $20,508 between July 1, 2019 and December 31, 2019.
Estimated future minimum operating lease payment obligations on the Spencer Lease total $242,508, which are based upon the terms of our operating leases through the filing date of this report and are all due within the twelve months ending December 31, 2018.
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. 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 U.S. GAAP, applicable law, statue or regulation.
In September 2018, we were served with a complaint by TMAX regarding the TMAX Agreement. The complaint, filed in the Eighth Judicial District Court in Clark County, Nevada, alleges that we breached the TMAX Agreement, among other allegations. We filed an answer denying the allegations and counterclaiming for breach of contract, abuse of process and fraud in the inducement, among other counterclaims. We also filed a partial motion for summary judgment seeking dismissal of the plaintiff’s claims. Pursuant to a motion to dismiss brought by the co-defendant and former CEO of TMAX, the suit has been dismissed, subject to the right of the plaintiff to file an amended complaint on or before March 20, 2019. The plaintiff did not file an amended complaint within the time period set by the Judge. We will move to strike the late filing if TMAX attempts to file an untimely amended complaint.
27
Uncertain tax positions
. As further discussed in Note 13,
in accordance with
ASC 740
, w
e ha
ve recorded a liability of
$
29
,
12
4
related to
a
potentially
uncertain tax position as of
December 31, 2018
.
However, d
ue 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
In February 2017, a former employee forfeited 100,000 shares of unvested restricted stock and paid us $35,000 in connection with the exercise of 150,000 fully-vested stock options.
On August 31, 2017, in accordance with the
Lipparelli
Agreement, the Board authorized the issuance of 800,000 restricted shares of our common stock, which shares vest as follows: (i) as to the first 200,000 shares, on August 31, 2017, (ii) as to the next 200,000 shares, on January 2, 2018, and (iii) as to the next 400,000 shares, on January 2, 2019.
During the year ended December 31, 2018, we issued 52,000 restricted shares of our common stock (13,000 shares in quarterly installments) valued at $64,220, to each of Messrs. Norm DesRosiers, Bryan Waters and William Zender,
in consideration of their service on the Board. These shares vested immediately on the grant date.
On April 24, 2018, our Board authorized the repurchase of shares of our common stock in an amount not to exceed $1.0 million. Such repurchases may be made from time to time based on market conditions and may be completed in the open market or in privately-negotiated transactions. Repurchase transactions will be executed only when we believe that we will remain in compliance with the covenants of the NSB Credit Agreement. Finally, execution of share repurchases may require regulatory approval in one or more jurisdictions. We have not repurchased any of our common stock as of December 31, 2018.
NOTE 13. INCOME TAXES
The components of the provision consist of the following for the years ended December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Current:
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
258,617
|
|
|
$
|
420,967
|
|
State
|
|
|
42,015
|
|
|
|
7,197
|
|
Total current
|
|
|
300,632
|
|
|
|
428,164
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(89,983
|
)
|
|
|
145,602
|
|
State
|
|
|
(13,851
|
)
|
|
|
(9,193
|
)
|
Total deferred
|
|
|
(103,834
|
)
|
|
|
136,409
|
|
Provision for income taxes
|
|
$
|
196,798
|
|
|
$
|
564,573
|
|
The income tax provision differs from that computed at the federal statutory corporate income tax rate as follows for the years ended December 31, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Tax provision computed at the federal statutory rate
|
|
$
|
297,082
|
|
|
$
|
188,072
|
|
State income tax, net of federal benefit
|
|
|
24,981
|
|
|
|
(523
|
)
|
Permanent items
|
|
|
34,084
|
|
|
|
163,388
|
|
Credits
|
|
|
(103,572
|
)
|
|
|
(52,285
|
)
|
True ups and rounding
|
|
|
4,624
|
|
|
|
145,121
|
|
Change in federal statutory rate, net of benefit
|
|
|
(45,037
|
)
|
|
|
132,377
|
|
Uncertain tax positions
|
|
|
(15,364
|
)
|
|
|
(11,577
|
)
|
Provision for income taxes
|
|
$
|
196,798
|
|
|
$
|
564,573
|
|
28
The tax effects of significant temporary differences representing net deferred tax assets and liabilities consisted of the following at
December 31, 2018
and
2017
:
|
|
2018
|
|
|
2017
|
|
Deferred Tax Assets:
|
|
|
|
|
|
|
|
|
Intangible assets
|
|
$
|
143,332
|
|
|
$
|
135,068
|
|
Accruals and reserves
|
|
|
53,802
|
|
|
|
22,678
|
|
Other
|
|
|
307,687
|
|
|
|
177,681
|
|
Total deferred tax assets
|
|
|
504,821
|
|
|
|
335,427
|
|
|
|
|
|
|
|
|
|
|
Deferred Tax Liabilities:
|
|
|
|
|
|
|
|
|
Basis difference in fixed assets
|
|
|
(128,723
|
)
|
|
|
(104,779
|
)
|
Other
|
|
|
(41,616
|
)
|
|
|
—
|
|
Total deferred tax liabilities
|
|
|
(170,339
|
)
|
|
|
(104,779
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
334,482
|
|
|
$
|
230,648
|
|
In accordance with ASC 740, we considered the need for a valuation allowance against the net deferred tax assets at December 31, 2018 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, have not recorded any valuation allowance.
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, 2018
and
2017
:
|
|
2018
|
|
|
2017
|
|
Beginning balance:
|
|
$
|
44,488
|
|
|
$
|
56,886
|
|
Increases related to tax positions taken during the current
year
|
|
|
19,765
|
|
|
|
5,229
|
|
Decreases related to expiration of statute of limitations
|
|
|
(35,129
|
)
|
|
|
(16,806
|
)
|
Other adjustments
|
|
|
—
|
|
|
|
(821
|
)
|
Ending Balance:
|
|
$
|
29,124
|
|
|
$
|
44,488
|
|
Our total liability for unrecognized gross tax benefits was $29,124 as of December 31, 2018, 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 2015 and thereafter. For states within the U.S. in which we conduct significant business, we generally remain subject to examination for fiscal years 2015 and thereafter, unless extended for longer periods under state laws. We have no accrual for interest or penalties related to uncertain tax positions at December 31, 2018 and 2017, and did not recognize interest or penalties in the statements of operations during the years ended December 31, 2018 and 2017 as such amounts would be immaterial, if any.
As of December 31, 2018, we expected to use our foreign tax credits of $76,125 to offset federal income tax owed in 2018.
NOTE 14. STOCK OPTIONS AND WARRANTS
On May 10, 2018, the Board ratified and confirmed the 2014 Plan. The 2014 Plan is a broad-based plan under which 5,550,750 shares of our common stock are authorized for issuance for awards, including stock options, stock appreciation rights, restricted stock, and cash incentive awards to
members of our Board, executive officers, employees and independent contractors
. As of
December 31, 2018
, 698,501 shares remained available for issuance as new awards under the 2014 Plan.
Stock options.
For the years ended December 31, 2018 and 2017, we issued options to purchase 745,000 and 1,465,000 shares of our common stock, respectively, to members of our Board, employees and independent contractors. The stock options generally have a contractual term of five years. The stock options issued to employees generally require continuous employment through vesting dates, while those issued to members of our Board generally vest immediately on the grant date.
On May 1, 2017, in connection with an employment agreement entered into between us and Mr. Hagerty (“the “Hagerty Employment Agreement”), Mr. Hagerty was granted options to purchase 400,000 shares of our Common Stock at an exercise price per share of $0.60. 25% of the options vested immediately on May 1, 2017 and the remainder vests equally on the next three anniversaries from the grant date.
29
On July 26, 2017, in connection with the Cravens Employment Agreement, Mr. Cravens was granted options to p
urchase up to 450,000 shares of our common stock
at an exercise price per share of $0.76
.
25% of the options vested immediately on May 1, 2017 and the remainder vests equally on the next three anniversaries from
August 1, 2017
.
Provided that Mr. Cravens is a full-time employee on August 1, 2020, we agreed to grant to Mr. Cravens an option to purchase an additional 150,000 shares of our common stock
(the “2020 Option”)
with a strike price equal to the price per share of our common
stock as reported on OTC Markets on August 1, 2020 (or the nearest trading date thereafter), which option will vest on August 1, 2020 (or the nearest trading date thereafter).
On February 21, 2019, the exercise price of the 2020 Option was set at $1.90 p
er share in accordance with Amendment #1 to the Cravens Employment Agreement
(Note 15)
.
On October 12, 2018, Mr. Cravens and Mr. Hagerty were granted options to purchase up to 250,000 and 180,000 shares of our common stocks at an exercise price of $1.1875. These options vest equally over the next three anniversaries from the grant date.
The fair value of stock options granted in 2018 and 2017 was $517,922 and
$710,368
, respectively, using the Black-Scholes option pricing model with the following assumptions:
|
|
Options issued 2018
|
|
Options issued 2017
|
Dividend yield
|
|
0%
|
|
0%
|
Expected volatility
|
|
73% - 78%
|
|
78% - 87%
|
Risk free interest rate
|
|
2.46% - 3.00%
|
|
1.73% - 2.20%
|
Expected life (years)
|
|
5.00
|
|
5.00
|
A summary of stock option activity is as follows:
|
|
Common
stock options
|
|
|
Weighted-
average
exercise price
|
|
|
Aggregate
intrinsic
value
|
|
|
Weighted-average
remaining contractual
term (years)
|
|
Outstanding – December 31, 2017
|
|
|
2,811,250
|
|
|
$
|
0.54
|
|
|
$
|
1,849,517
|
|
|
|
3.65
|
|
Issued
|
|
|
745,000
|
|
|
$
|
1.11
|
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
(60,000
|
)
|
|
$
|
0.50
|
|
|
|
—
|
|
|
|
—
|
|
Outstanding – December 31, 2018
|
|
|
3,496,250
|
|
|
$
|
0.66
|
|
|
$
|
2,608,329
|
|
|
|
3.04
|
|
Exercisable – December 31, 2018
|
|
|
2,334,584
|
|
|
$
|
0.52
|
|
|
$
|
2,071,980
|
|
|
|
2.48
|
|
A summary of unvested stock option activity is as follows:
|
|
Common
stock options
|
|
|
Weighted-
average
exercise price
|
|
|
Aggregate
intrinsic
value
|
|
|
Weighted-average
remaining contractual
term (years)
|
|
Unvested – December 31, 2017
|
|
|
825,557
|
|
|
$
|
0.63
|
|
|
$
|
467,379
|
|
|
|
4.27
|
|
Granted
|
|
|
745,000
|
|
|
|
1.11
|
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
(348,891
|
)
|
|
|
0.63
|
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
(60,000
|
)
|
|
|
0.50
|
|
|
|
—
|
|
|
|
—
|
|
Unvested – December 31, 2018
|
|
|
1,161,666
|
|
|
$
|
0.95
|
|
|
$
|
535,475
|
|
|
|
4.15
|
|
As of December 31, 2018, our unrecognized share-based compensation expense associated with the stock options issued was $560,821, which will be amortized over a weighted-average of 2.31 years.
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, 2018 and 2017. Total share-based compensation was $776,354 and $813,480 for the years ended December 31, 2018 and 2017, 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 to the Term Loan lenders.
On April 24, 2018, we paid $1,333,333 to redeem the Warrants in full upon extinguishment of the Breakaway Term Loan (Note 10).
30
NOTE 15. SUBSEQUENT EVENTS
We evaluate subsequent events through the date of issuance of the consolidated 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, 2018, except as follows:
On February 21, 2019, we entered into Amendment #1 to the
Cravens Employment Agreement
. Among other things, Amendment #1 provided (i) that any severance payments due to Mr. Cravens under the
Cravens Employment Agreement
be paid as a lump sum; (ii) that continuation of his medical and health insurance payments after termination be at our expense; (iii) that the 2020 Option vest in full in the event of termination following a change of control; and (iv) that the exercise price of the 2020 Option be set at $1.90 per share.
Also on February 21, 2019, we entered into Amendment #2 to the
Hagerty Employment Agreement
. Among other things, Amendment #2 provided (i) that any severance payments due to Mr. Hagerty under the Hagerty Employment Agreement be paid as a lump sum; and (ii) that continuation of his medical and health insurance payments after termination be at our expense.
On March 14, 2019, we issued a press release announcing the completion of our previously-disclosed strategic alternatives review. After a thorough evaluation of a
range of strategic alternatives, including a sale of the company, we have decided to continue on our existing plan of product line and geographic expansions as an independent company.
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