Galaxy Gaming, Inc.: Form 10-Q for the period ended Jun 30, 2024

The following is a discussion and analysis of our financial condition, results of operations and liquidity and capital resources as of and for the three and six months ended June 30, 2024 and 2023. This discussion should be read together with our audited consolidated financial statements and related notes included in Item 8. Financial Statements and Supplementary Financial Information included in our 2023 Form 10-K.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the information contained in this Quarterly Report includes forward-looking statements In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “might,” “expect,” “intend,” "target," “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other similar expressions. These forward-looking statements are only predictions. We have based these forward-looking statements on our current expectations, assumptions and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this Quarterly Report and are subject to a number of risks and uncertainties. These risks and uncertainties include, but are not limited to, risks related to the proposed Merger, including that the Merger may not be consummated at all or in the anticipated timeframe; restrictions on our business during the pendency of the Merger that could affect our ability to pursue business opportunities or strategic transactions; uncertainties relating to the pendency of the Merger relating to our relationships with our employees and our customers, vendors and partners; that the Merger Agreement may be terminated in circumstances that require us to pay a termination fee; significant transaction costs; and the risk of litigation and/or regulatory actions related to the proposed Merger; the ability of Galaxy Gaming to enter and maintain strategic alliances, product placements or installations in land based casinos or grow its iGaming business, garner new market share, secure licenses in new jurisdictions or maintain existing licenses, successfully develop or acquire and sell proprietary products, comply with regulations, including changes in gaming related and non-gaming related statutes and regulations that affect the revenues of our customers in land-based casino and, online casino markets, have its games approved by relevant jurisdictions, unfavorable economic conditions in the US and worldwide, our level of indebtedness, restrictions and covenants in our loan agreement, dependence on major customers, protection of intellectual property and our ability to license the intellectual property rights of third parties, failure to maintain the integrity of our information technology systems, including without limitation, cyber-attacks or other failures in our telecommunications or information technology systems, or those of our collaborators, third-party logistics providers, distributors or other contractors or consultants, could result in information theft, data corruption and significant disruption of our business, and other factors. The events and circumstances reflected in our forward-looking statements may not be achieved or occur, and actual results could differ materially from those projected in the forward-looking statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise.

OVERVIEW

We develop, acquire, assemble and market technology and entertainment-based products and services for the gaming industry for placement on casino floors and on legal internet gaming sites. Our products and services primarily relate to licensed casino operators’ table games activities and focus on either increasing their profitability and productivity or expanding their gaming entertainment offerings in the form of proprietary table games, electronically enhanced table game platforms, fully-automated electronic tables and other ancillary equipment. In addition, we license intellectual property to legal internet gaming operators. Our products and services are offered in highly regulated markets throughout the world. Our products are assembled at our headquarters in Las Vegas, Nevada, as well as outsourced for certain sub-assemblies in the United States.

Recent Developments

On July 18, 2024, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Evolution Malta Holding Limited (“Parent”), and Galaga Merger Sub, Inc., a wholly owned subsidiary of Parent (“Merger Sub”), pursuant to which the Company will become a wholly owned subsidiary of Parent. Upon the closing of the Merger, each share of common stock, par value $0.001 per share of the Company issued and outstanding immediately prior to the effective time of the Merger, except for shares (a) owned by Company stockholders who are entitled to demand and have properly and validly demanded their appraisal rights under Nevada law, and (b) held by the Parent, Merger Sub, the Company or by any of their respective subsidiaries, will automatically be cancelled and converted into the right to receive $3.20 in cash.

Completion of the Merger is subject to the satisfaction or waiver of customary closing conditions, including but not limited to the approval of the Merger by the Company's stockholders, and receipt of certain gaming regulatory approvals.

The Company may terminate the Merger Agreement in certain limited circumstances, including to accept a Superior Proposal (as defined in the Merger Agreement). Parent may terminate the Merger Agreement in certain limited circumstances, including if the Board changes its recommendation that the Company’s stockholders vote to approve the Merger Agreement. In addition, either Parent or the Company may terminate the Merger Agreement if (i) the Merger has not been successfully completed by July 18, 2025 (subject to extension through October 18, 2025 in the event that certain conditions with respect to the receipt of certain gaming regulatory approvals remain unsatisfied as of such date, and through January 18, 2026 in the event that such conditions remain unsatisfied as of such subsequent date); (ii) a governmental authority of competent jurisdiction (excluding gaming regulators, other than with respect to certain gaming regulatory approvals) has issued a final and non-appealable governmental order prohibiting the Merger, (iii) the stockholders of the Company fail to approve the Merger Agreement and (iv) the other party materially breaches its representations, warranties or covenants in the Merger Agreement, subject in certain cases, to the right of the breaching party to cure the breach.

Upon a termination of the Merger Agreement under specified circumstances, including due to a change in the Board’s recommendation that the Company’s stockholders vote to approve the Merger Agreement, the entry by the Company into a definitive agreement with respect to a Superior Proposal, or certain other triggering events set forth in the Merger Agreement, the Company may be required to pay Parent a termination fee. In addition, upon a termination of the Merger Agreement under specified circumstances, including in the event of termination resulting from the failure to obtain certain gaming regulatory approvals, Parent may be required to pay the Company a termination fee.

The Merger is expected to be completed in mid-2025. Following the closing of the Merger, shares of the Company’s common stock will no longer be quoted on the OTCQB and the Company will become a privately held company.

Results of operations for the three months ended June 30, 2024 and 2023.

Our revenue consists of the following components:

Revenue

Recurring core revenue increased $1,487,184, or 39% for the three months ended June 30, 2024, as compared to the same period in the prior year. This change was driven primarily by favorable revenue from our EZ Baccarat distribution arrangement which commenced in September 2023 and the continued success of our side bets and progressive products. Royalties netted against gross core revenue increased $788,259 for the three months ended June 30, 2024, as compared to the same period in the prior year. This increase was attributable to royalties paid on our EZ Baccarat revenues. Perpetual license sales of our progressive gaming systems to customers of $1,497,300 were down 4% percent for the three months ended June 30, 2024, as compared to the same period in the prior year. Gross digital revenues of $3,528,465, were up $733,029, or 26% for the three months ended June 30, 2024, as compared to the same period in the prior year. This favorable increase reflects the ongoing expansion of our digital content into new markets and the continued success of offering competitive products with brand recognition, most notable 21+3. Net of royalties, digital revenues grew to $2,541,960, up 16% for the three months ended June 30, 2024, as compared to the same period in the prior year.

Costs and Expenses

Cost of ancillary products and assembled component expense increased $99,106, or 20% for the three months ended June 30, 2024, as compared to the same period in the prior year. The activity in cost of ancillary products and assembled components reflects the component costs associated with the perpetual license sales of our progressive gaming systems to customers.

Selling, general and administrative expenses increased $779,555, or 21% for the three months ended June 30, 2024, as compared to the same period in the prior year. This change was due to expenses associated with special projects of $675,044, most notable legal expenses incurred related to the acquisition by Evolution and to a lesser extent, driven by higher internal labor and related expenses (base salary, commissions, payroll-related taxes, bonus accrual and travel), increased information technology costs and those royalties that are not netted against revenues. Normalized for the impact of the acquisition by Evolution and excluding the related transaction fees of $675,044, selling, general, and administrative expenses increased $104,511, or 3% for the three months ended June 30, 2024, as compared to the same period in the prior year.

Research and development expenses for the three months ended June 30, 2024, were $269,479 compared to $199,665 for the comparable prior-year period, representing an increase of $69,814, or 35%. The increase was due to higher payroll costs from higher headcount, employee bonuses, and higher consulting fees.

Depreciation and amortization increased $206,863, or 42% for the three months ended June 30, 2024, as compared to the same period in the prior year. This increase was driven by certain intangible assets that began to amortize in July 2023.

Stock-based compensation expenses decreased 21% for the three months ended June 30, 2024, as compared to the same period in the prior year. The decrease was due primarily to a change in the level and the composition of fees paid to members of our Board of Directors in 2024 and lower stock-based compensation for officers and consultants.

Interest expense was up 2% for the three months ended June 30, 2024, as compared to the same period in the prior year. The increase was due to higher interest rates on our variable debt. Interest income was up 50% compared to the prior year period, benefitting from higher cash balances and higher interest rates.

Income tax provision was $28,293 for the three months ended June 30, 2024, compared to income tax provision of $16,677 for the comparable prior-year period. The increase in expense is primarily driven by the increased amount of permanent differences mainly attributable to the legal expenses incurred related to the acquisition by Evolution in the current period and offset by decreased income before provision for income taxes.

Primarily as a result of the factors described above, we had net income of $242,697 for the three months ended June 30, 2024, as compared to net income of approximately $356,769 for the same period in the prior year. Normalized for the impact of the acquisition by Evolution and excluding the related transactions fees of $675,044 from selling, general, and administrative expenses, net income increased $560,972, or 157% for the three months ended June 30, 2024, as compared to the same period in the prior year.

Results of operations for the six months ended June 30, 2024 and 2023.

Our revenue consists of the following components:

Revenue

Recurring core revenue increased $2,982,282, or 39% for the six months ended June 30, 2024, as compared to the same period in the prior year. This change was driven primarily by favorable revenue from our EZ Baccarat distribution arrangement which commenced in September 2023 and the continued success of our side bets and progressive products. Royalties netted against gross core revenue increased $1,594,539 for the six months ended June 30, 2024, as compared to the same period in the prior year. This increase was attributable to royalties paid on our EZ Baccarat revenues. Perpetual license sales of our progressive gaming systems to customers of $2,302,493 were down 18% percent for the six months ended June 30, 2024, as compared to the same period in the prior year. We expect perpetual license sales of our progressive gaming systems to customers to decline in the second half of 2024 as compared to the first half of 2024. Gross digital revenues of $6,984,418 were up $1,151,875, or 20% for the six months ended June 30, 2024, as compared to the same period in the prior year. This favorable increase reflects the ongoing expansion of our digital content into new markets and the continued success of offering competitive products with brand recognition, most notable 21+3. Net of royalties, digital revenues grew to $5,145,385, up 16% for the six months ended June 30, 2024, as compared to the same period in the prior year

Costs and Expenses

Cost of ancillary products and assembled component expense increased $153,476, or 18% for the six months ended June 30, 2024, as compared to the same period in the prior year. The activity in Cost of ancillary products and assembled components reflects the component costs associated with the perpetual license sales of our progressive gaming systems to customers.

Selling, general and administrative expenses increased $1,199,726, or 16% for the six months ended June 30, 2024, as compared to the same period in the prior year. This change was due to expenses associated with special projects of $675,044, most notable legal expenses incurred related to the acquisition by Evolution and to a lesser extent, driven by higher internal labor and related expenses (base salary, commissions, payroll-related taxes, bonus accrual and travel), increased information technology costs, and those royalties that are not netted against revenues. Normalized for the impact of the acquisition by Evolution and excluding the related transaction fees of $675,044, selling, general, and administrative expenses increased $524,682, or 7% for six months ended June 30, 2024, as compared to the same period in the prior year.

Research and development expenses were up $114,940, or 28% for the six months ended June 30, 2024, as compared to the same period in the prior year. The increase was due to higher payroll costs from higher headcount, employee bonuses, option exercises in the period, and higher consulting fees.

Depreciation and amortization increased $316,714, or 30% for the six months ended June 30, 2024, as compared to the same period in the prior year. This increase was driven by certain intangible assets that began to amortize in July 2023.

Stock-based compensation expenses decreased $154,204, or 31% for the six months ended June 30, 2024, as compared to the same period in the prior year. The decrease was due primarily to a change in the level and the composition of fees paid to members of our Board of Directors in 2024 and lower stock-based compensation for officers and consultants.

Interest expense was up $124,618, or 3% for the six months ended June 30, 2024, as compared to the same period in the prior year. The increase was due to higher interest rates on our variable debt. Interest income was up $186,628, or 83% compared to the prior year period, benefitting from higher cash balances and higher interest rates.

Income tax provision was $54,618 for the six months ended June 30, 2024, compared to income tax provision of $22,252 for the comparable prior-year period. The increase in expense is primarily driven by the increased amount of permanent differences mainly attributable to the legal expenses incurred related to the acquisition by Evolution in the current period.

Primarily as a result of the factors described above, we had net income of $451,605 for the six months ended June 30, 2024, as compared to net income of approximately $467,463 for the same period in the prior year. Normalized for the impact of the acquisition by Evolution and excluding the related transactions fees of $675,044 from selling, general, and administrative expenses, net income increased $659,186, or 141% for the six months ended June 30, 2024, as compared to the same period in the prior year.

Adjusted EBITDA. Adjusted EBITDA includes adjustments to net income to exclude interest, income taxes, depreciation, amortization, stock-based compensation, foreign currency exchange (gain) loss and severance and other expenses related to litigation. Adjusted EBITDA is not a measure of performance defined in accordance with U.S. GAAP. However, Adjusted EBITDA is used by management to evaluate our operating performance. Management believes that disclosure of the Adjusted EBITDA metric offers investors, regulators and other stakeholders a view of our operations in the same manner management evaluates our performance. When combined with U.S. GAAP results, management believes Adjusted EBITDA provides a comprehensive understanding of our financial results. Adjusted EBITDA should not be considered as an alternative to net income or to net cash provided by operating activities as a measure of operating results or of liquidity. It may not be comparable to similarly titled measures used by other companies, and it excludes financial information that some may consider important in evaluating our performance. A reconciliation of U.S. GAAP net income to Adjusted EBITDA is as follows:

(1) Represents the non-cash expense associated with the value of equity awards granted to employees, directors and consultants by the Company.

(2) Represents costs associated with the severance of employees

(3) Represents Company reimbursed moving expenses incurred by the new President and CEO, Matthew Reback.

(4) Represents professional fees and transaction related fees incurred related to acquisitions, mergers and professional fees incurred for other projects not considered part of the normal course of business.

(5) Represents foreign exchange losses and gains associated with the fluctuations of foreign currency rates.

Liquidity and capital resources. We have generally been able to fund our continuing operations, our investments, and the interest expense and principal amortization under our existing borrowings through cash flow from operations. We may require additional capital to undertake acquisitions or to repay in full our indebtedness. Our ability to access capital for these activities will depend on conditions in the capital markets and investors’ perceptions of our business prospects and such conditions and perceptions may not always favor us.

As of June 30, 2024, we had total current assets of $24,041,400 and total assets of $41,470,750. This compares to $22,156,035 and $40,475,800, respectively, as of December 31, 2023. The increase in current assets as of June 30, 2024 compared to December 31, 2023 was due to the increased cash and cash equivalents driven by cash provided from operating activities, most notably increased collections of receivables. These increases were offset by a decrease in prepaid expenses for insurance, IT expenses, and deposits for trade shows. The increase in total assets as of June 30, 2024 compared to December 31, 2023 was primarily due to the increase of current assets noted above and offset by a decrease in other intangible assets and operating lease right-of-use assets as a result of amortization in the 2024 period.

Our total current liabilities as of June 30, 2024 compared to December 31, 2023 decreased to $4,837,667 from $4,875,967. This decrease was primarily due to a decrease in accrued royalties, and offset by increased accounts payable.

Based on our current forecast of operations, we believe we will have sufficient liquidity to fund our operations for at least the next 12 months and to meet the obligations under our financing arrangements as they come due.

We continue to file applications for new or enhanced licenses in several jurisdictions, which may result in significant future legal and regulatory expenses. A significant increase in such expenses may require us to postpone growth initiatives or investments in personnel, assemblies in process and research and development of our products. It is our intention to continue such initiatives and investments. However, to the extent we are not able to achieve our growth objectives or raise additional capital, we will need to evaluate the reduction of operating expenses.

Our operating activities provided cash of $3,873,347 for the six months ended June 30, 2024, compared to $2,494,400 provided for the comparable prior period. This change is attributable to a favorable variance of $1,222,127 in use of assets and liabilities that relate to operations. Additionally, depreciation and amortization increased $316,714 related to increased capitalization of intangible assets and offset by a $154,204 decline in stock-based compensation from the vesting of stock options.

Investing activities used cash of $676,315 for the six months ended June 30, 2024, compared to cash used of $773,559 for the six months ended June 30, 2023. This decrease in cash used was primarily due to the acquisition of assets deployed at client locations and investment in internally developed software in the 2024 period.

Cash used in financing activities during the six months ended June 30, 2024, was $465,317. This compares to $1,204,584 cash used by financing activities for the six months ended June 30, 2023. The decrease in cash used was due to the absence of principal payments on our borrowings based on the "Excess Cash Flow" calculation as defined by the terms in the Fortress Credit Agreement (Note 6), in the 2024 period.

Critical accounting policies and estimates. Our significant accounting policies and estimates are described in our 2023 Form 10-K. There have been no material changes to those policies.

Off-balance sheet arrangements. As of June 30, 2024, there were no off-balance sheet arrangements.

Recently issued accounting pronouncements. We do not expect the adoption of recently issued accounting pronouncements to have a significant impact on our results of operations, financial position or cash flow.

Disclosure controls and procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed submitted under the Exchange Act is accumulated and communicated to management including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2024, our disclosure controls and procedures were effective.

Changes in internal control over financial reporting

No change in our internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the effectiveness of control and procedures and internal controls

Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving our objectives, and our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective at that reasonable assurance level. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the internal control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.