Motorsport Games Inc.: Form 10-Q for the period ended Jun 30, 2022

The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2021 (the “2021 Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on March 30, 2022 and the condensed consolidated financial statements and accompanying notes included in Part I, Item 1 of this Report. Unless the context requires otherwise, references to the “Company,” “Motorsport,” “we,” “us” and “our” refer to Motorsport Games Inc., a Delaware corporation.

Overview

The following overview is a high-level discussion of our operating results, as well as some of the trends and drivers that affect our business. Management believes that an understanding of these trends and drivers provides important context for our results for the six months ended June 30, 2022, as well as our future prospects. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Report.

Our Business

Motorsport Games is a leading racing game developer, publisher and esports ecosystem provider of official motorsport racing series throughout the world, including NASCAR, the iconic 24 Hours of Le Mans endurance race (“Le Mans”) and the associated FIA World Endurance Championship (the “WEC”), INDYCAR, the British Touring Car Championship (the “BTCC”), KartKraft (karting simulation), rFactor 2 (racing simulation) and others. Our portfolio is comprised of some the most prestigious motorsport leagues and events in the world.

Started in 2018 as a wholly-owned subsidiary of Motorsport Network, we are currently the official developer and publisher of the NASCAR video game racing franchise and have obtained the exclusive licenses to develop multi-platform games for the BTCC, the 24 Hours of Le Mans race and the WEC, as well as a non-exclusive license with INDYCAR. We develop and publish multi-platform racing video games including for game consoles, personal computers (PCs) and mobile platforms through various retail and digital channels, including full-game and downloadable content. For fiscal year 2021 and the three and six months ended June 30, 2022, a majority of our revenue was generated from sales of our NASCAR racing video games.

As of June 30, 2022, we have a total headcount of 167 people, made up of 166 full-time employees, including 109 dedicated to game development, in order to continue developing our expanded product offerings.

COVID-19 Pandemic Update

The lingering impact of COVID-19 has continued to create significant volatility throughout the global economy, such as supply chain disruptions, limited labor supplies, higher inflation, and recession, which in turn has caused constraints on consumer spending. More recently, new variants of COVID-19, such as the Omicron variant and its subvariants, that are significantly more contagious than previous strains, have emerged. Further, the effectiveness of approved vaccines on these new strains remains uncertain. The spread of these new strains initially caused many government authorities and businesses to reimplement prior restrictions in an effort to lessen the spread of COVID-19 and its variants. However, while many of these restrictions have been lifted, uncertainty remains as to whether additional restrictions may be initiated or again reimplemented in response to surges in COVID-19 cases.

Although the Company does not currently expect the COVID-19 pandemic to have a material impact on its future business and operations, the Company continues to monitor the evolving situation caused by the COVID-19 pandemic, and the Company may take further actions required by governmental authorities or that the Company determines are prudent to support the well-being of the Company’s employees, suppliers, business partners and others. The degree to which the ongoing and prolonged COVID-19 pandemic impacts the Company’s operations, business, financial results, liquidity, and financial condition will depend on future developments, which are highly uncertain, continuously evolving and cannot be predicted. This includes, but is not limited to, the duration and spread of the pandemic; its severity; the emergence and severity of its variants; the actions to contain the virus or treat its impact, such as the availability and efficacy of vaccines (particularly with respect to emerging strains of the virus) and potential hesitancy to utilize them; the effect on discretionary spending by consumers; and how quickly and to what extent normal economic and operating conditions can resume. Further discussion of the potential impacts on our business, financial condition, results of operations, liquidity and the market price of our Class A common stock due to the ongoing and prolonged COVID-19 pandemic is provided in the section entitled “Risk Factors” in Part I, Item 1A of the 2021 Form 10-K.

Trends and Factors Affecting Our Business

Product Release Schedule

Our financial results are affected by the timing of our product releases and the commercial success of those titles. Our NASCAR products have historically accounted for the majority of our revenue, however we have diversified our product offerings and are generating revenues from KartKraft, rFactor 2 and Le Mans 24 Hour virtual event reducing the percentage of revenues from NASCAR. We released: (i) our next generation NASCAR console/PC game, NASCAR 21: Ignition, on October 28, 2021; (ii) NASCAR Heat Ultimate Edition+ on Nintendo Switch on November 19, 2021, the first-ever NASCAR title to come to Nintendo Switch; and (iii) the full release of the KartKraft kart racing simulator on January 26, 2022 for the PC. Additionally, in May 2020 and January 2021, respectively, we obtained the exclusive licenses to develop multi-platform games for the BTCC and the WEC series, including the iconic 24 Hours of Le Mans race, and in July 2021, we obtained the license to develop multi-platform games for INDYCAR. During the six months ended June 30, 2022, we modified our product release schedule such that our next NASCAR title for 2022 will be an update to our 2021 release and the anticipated timing of some of our other planned product releases for other racing series have been moved to later periods. The INDYCAR, BTCC and Le Mans games are currently under development, and we currently anticipate releasing games for these racing series in 2023 and 2024. Going forward, we intend to expand our license arrangements to other internationally recognized racing series and the platforms we operate on. We believe that having a broader product portfolio will improve our operating results and provide a revenue stream that is less cyclical than releasing a single game per year.

Economic Environment and Retailer Performance

Our physical gaming products are sold through a distribution network with an exclusive partner who specializes in the distribution of games through mass-market retailers (e.g., Target, Wal-Mart), consumer electronics stores (e.g., Best Buy), discount warehouses, game specialty stores (e.g., GameStop) and other online retail stores (e.g., Amazon). We expect to continue to derive significant revenues from sales of our physical gaming products to a very limited number of distribution partners. For the year ended December 31, 2021 and the six months ended June 30, 2022, we sold substantially all of our physical disk products for the retail channel through a single distribution partner, which represented approximately 28% and 15% of our total revenue for such periods, respectively. See “Risk Factors—Risks Related to Our Business and Industry—The importance of retail sales to our business exposes us to the risks of that business model” and “Risk Factors—Risks Related to Our Business and Industry—We primarily depend on a single third-party distribution partner to distribute our games for the retail channel, and our ability to negotiate favorable terms with such partner and its continued willingness to purchase our games is critical for our business” in Part I, Item 1A of the 2021 Form 10-K for additional information regarding the importance of retail sales and our distribution partners to our business.

Additionally, we continue to monitor economic conditions, including the impact of the ongoing and prolonged COVID-19 pandemic, that may unfavorably affect our businesses, such as deteriorating consumer demand, delays in development, pricing pressure on our products, increased inflation, recessionary factors, supply chain constraints, labor supply issues, credit quality of our receivables and foreign currency exchange rates. The COVID-19 pandemic has affected and may continue to affect our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time, particularly due to the emergence of the significantly more contagious Omicron variant of COVID-19 and the prevalence of breakthrough cases of infection among fully vaccinated people.

Hardware Platforms

We derive most of our revenue from the sale of products made for PCs and video game consoles manufactured by third parties, such as Sony Interactive Entertainment Inc.’s (“Sony”) PlayStation and Microsoft Corporation’s (“Microsoft”) Xbox consoles, which comprised approximately 45% and 72% of our total revenue for the six-month periods ended June 30, 2022 and 2021, respectively. For the six-month periods ended June 30, 2022 and 2021, the sale of products for Microsoft Windows via Steam comprised approximately 22% and 9% of our total revenue, respectively, and the sale of products for mobile platforms comprised approximately 6% and 10% of our total revenue, respectively. The success of our business is dependent upon consumer acceptance of video game console/PC platforms and continued growth in the installed base of these platforms. When new hardware platforms are introduced, such as those recently released by Sony and Microsoft, demand for interactive entertainment used on older platforms typically declines, which may negatively affect our business during the market transition to the new consoles. The latest generation of Sony and Microsoft consoles provide “backwards compatibility” (i.e., the ability to play games for the previous generation of consoles), which could mitigate the risk of such a decline. However, we cannot be certain how backwards compatibility will affect demand for our products.

Digital Business

Players increasingly purchase our games as digital downloads, as opposed to purchasing physical discs. All of our titles that are available through retailers as packaged goods products are also available through direct digital download. For the year ended December 31, 2021 and the six months ended June 30, 2022, approximately 74% and 78%, respectively, of our revenue from sales of video games for game consoles and PCs was through digital channels. We believe this trend of increasing direct digital downloads is primarily due to benefits relating to convenience and accessibility that digital downloads provide, which was heightened during the COVID-19 pandemic. In addition, as part of our digital business strategy, we aim to drive ongoing engagement and incremental revenue from recurrent consumer spending on our titles through in-game purchases and extra content.

Esports

We are striving to become a leader in organizing and facilitating esports tournaments, competitions, and events for our licensed racing games as well as on behalf of third-party racing game developers and publishers. During the first quarter of 2022, we announced our viewership figures for the 2021-22 Le Mans Virtual Series, which reached 7 million views and registered cumulated television and digital audience figures of more than 81 million through its 5-month season. During 2021, we organized several esports competitions, including the DiRT Rally 2.0 World Series on the popular Codemasters game, the Winter Heat and Summer Showdown on NASCAR Heat 5, and the expansion of the 24 Hours of Le Mans Virtual event into a part of a longer annual series with professional teams and real-world racing drivers. In addition, we also organized competitions to drive user engagement on our rFactor 2 platform. For 2021, our esports events had cumulative total viewership of approximately 1.5 million views with approximately 3.8 million minutes watched.

Technological Infrastructure

As our digital business has grown, our games and services increasingly depend on the reliability, availability and security of our technological infrastructure. We are investing and expect to continue to invest in technology, hardware and software to support our games and services, including with respect to security protections. Our industry is prone to, and our systems and networks are subject to, cyberattacks, computer viruses, worms, phishing attacks, malicious software programs, and other information security incidents that seek to exploit, disable, damage, disrupt or gain access to our networks, our products and services, supporting technological infrastructure, intellectual property and other assets. As a result, we continually face cyber risks and threats that seek to damage, disrupt or gain access to our networks and our gaming platform, supporting infrastructure, intellectual property and other assets. See “Risks Related to Our Business and Industry—We may experience security breaches and cyber threats” in the section entitled “Risk Factors” in Part I, Item 1A of the 2021 Form 10-K for additional information.

Rapidly Changing Industry

We operate in a dynamic industry that regularly experiences periods of rapid, fundamental change. In order to remain successful, we are required to anticipate, sometimes years in advance, the ways in which our products and services will compete. For example, the global adoption of portable and mobile gaming devices has led to significant growth in portable and mobile gaming, which we believe is a continuing trend. Accordingly, in conjunction with the launch of our next generation NASCAR console/PC game, NASCAR 21: Ignition, we launched an updated NASCAR Heat Ultimate Edition+ on Nintendo Switch in the fourth quarter of 2021.

Recurring Revenue Sources

Our business model includes revenue that we deem recurring in nature, such as revenue from our annualized sports franchise (currently NASCAR) for game consoles, PC and mobile platforms. We deem this recurring because many existing game owners purchase annual updates, which includes updated drivers, liveries and cars as they are released. We have been able to forecast the revenue from this area of our business with greater relative confidence than for new games, services and business models. As we continue to incorporate new business models and modalities of play into our games, our goal is to continue to look for opportunities to expand the recurring portion of our business.

Reportable Segments

We use “the management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by our chief operating decision maker for making operating decisions and assessing performance as the source for determining our reportable segments. Our chief operating decision maker is our Chief Executive Officer (“CEO”), who reviews operating results to make decisions about allocating resources and assessing performance for the entire company. We classified our reportable operating segments into (i) the development and publishing of interactive racing video games, entertainment content and services (the “Gaming segment”) and (ii) the organization and facilitation of esports tournaments, competitions and events for our licensed racing games as well as on behalf of third-party video game racing series and other video game publishers (the “Esports segment”).

Components of Our Results of Operations

Revenues

We have historically derived substantially all of our revenue from sales of our games and related extra content that can be played by customers on a variety of platforms, including game consoles, mobile phones, PCs and tablets. Starting in 2019, we began generating sponsorship revenues from our production of live and virtual esports events.

Our product and service offerings included within the Gaming segment primarily include, but are not limited to, full PC, console and mobile games with both online and offline functionality, which generally include:

• the initial game delivered digitally or via physical disk at the time of sale, which also typically provides access to offline core game content; and
• updates to previously-released games on a when-and-if-available basis, such as software patches or updates, and/or additional content to be delivered in the future, both paid and free.

Our product and service offerings included within the Esports segment relate primarily to curating esports events.

Cost of Revenues

Cost of revenues for our Gaming segment is primarily comprised of royalty expenses attributable to our license arrangement with NASCAR and certain other third-parties relating to our NASCAR racing series games. Cost of revenues for our Gaming segment is also comprised of merchant fees, disk manufacturing costs, packaging costs, shipping costs, warehouse costs, distribution fees to distribute products to retail stores, mobile platform fees associated with our mobile revenue (for transactions in which we are acting as the principal in the sale to the end customer) and amortization of certain acquired license agreements and other intangible assets acquired through our various acquisitions. Cost of revenues for our Esports segment consists primarily of the cost of event staffing and event production.

Sales and Marketing

Sales and marketing expenses are primarily composed of salaries, benefits and related taxes of our in-house marketing teams, advertising, marketing and promotional expenses, including fees paid to social media platforms, Motorsport Network and other websites where we market our products.

Development

Development expenses consist of the cost to develop the games we produce, which includes salaries, benefits and operating expenses of our in-house development teams, as well as consulting expenses for any contracted external development. Development expenses also include expenses relating to our software licenses, maintenance and studio operating expenses.

General and Administrative

General and administrative expenses consist primarily of salaries, benefits and other costs associated with our operations including, finance, human resources, information technology, public relations, legal audit and compliance fees, facilities, and other external general and administrative services.

Depreciation and Amortization

Depreciation and amortization expenses include depreciation on fixed assets (primarily computers and office equipment), as well as amortization of finite lived intangible assets acquired through our various acquisitions.

Results of Operations

Three Months Ended June 30, 2022 compared to Three Months Ended June 30, 2021

Revenue

Gaming revenues were $1,941,938 for the three months ended June 30, 2022, compared to $2,238,927 for the three months ended June 30, 2021. The $296,989, or 13%, period over period decrease reflects lower console revenues primarily driven by retail pricing concessions, and lower mobile game sales. This decrease was offset by an additional $220,304 in digital sales and an additional $465,397 in additional revenues earned through the development of simulation platforms using our rFactor 2 platform for third parties.

For the three months ended June 30, 2022, revenues from our Esports segment increased $67,049, compared to the three months ended June 30, 2021. The increase was due to an increase in sponsorship revenue from Le Mans Esports Series Ltd.

Cost of Revenues

Cost of revenues were $856,157 for the three months ended June 30, 2022, compared to $906,303 for the three months ended June 30, 2021, representing a decrease of $50,146, or 6%, when compared to the prior period. Cost of revenues from our Gaming segment decreased $82,010, or 9%. The decrease was primarily due to a $80,327 decrease in amortization of intangible assets.

For the three months ended June 30, 2022, cost of revenues from our Esports segment increased by $31,865 to $35,417 from $3,552 for the three months ended June 30, 2021. The increase was primarily due to costs associated with activities and prizes from the 24 Hours of Le Mans live event held in June 2022.

Gross Profit

Gross profit was $1,152,830 for the three months ended June 30, 2022, compared to $1,332,624 for the three months ended June 30, 2021, a decrease of $179,794, or 13%. The gross profit margin for the gaming segment was 58% and 60% of revenues for the three months ended June 30, 2022 and 2021, respectively. The decrease in the gaming segment gross profit was primarily due to a pricing concession for our console game sales, and a decrease in mobile game sales, which have a higher gross margin than the sale of physical game discs. Gross profit from our Esports segment increased $35,185 as there were no esport revenues for the three months ended June 30, 2021.

Operating Expenses

Total operating expenses were $7,838,245 for the three months ended June 30, 2022, compared to $7,306,028 for the three months ended June 30, 2021, which reflects an increase of $532,216, or 7%, as described below.

Sales and Marketing

Sales and marketing expenses were $1,540,220 and $704,222 for the three months ended June 30, 2022 and 2021, respectively. The $835,998, or 119%, period over period increase in sales and marketing expenses was primarily driven by incremental marketing expense efforts, sponsorships, and headcount additions to support the promotion of planned future releases in our product roadmap.

Development

Development expenses were $2,681,643 and $1,818,178 for the three months ended June 30, 2022 and 2021, respectively. The $863,465, or 47%, period over period increase in development expenses was primarily due to additional internal development expenses required to support the development and launch of future new platform and game releases.

General and Administrative

General and administrative (“G&A”) expenses were $3,349,609 and $4,717,180 for the three months ended June 30, 2022 and 2021, respectively, resulting in a $1,367,571, or 29%, decrease. The change in G&A expenses was primarily attributable to $1,059,509 in compensation expense for the settlement of certain stock appreciation rights (“SARs”) paid in the second quarter of 2021, following the acquisition of the remaining minority interest in 704Games.

Impairment of Intangible Assets

Loss on impairment of indefinite-lived intangible assets was $149,048 for the three months ended June 30, 2022, compared to $0 for the three months ended June 30, 2021. The triggers for the interim assessment was the ongoing reduction in the Company’s share price, the receipt of a deficiency letter notice from the NASDAQ stock exchange and the Company’s ongoing liquidity position. The loss on impairment of indefinite-lived intangible assets relates to the rFactor 2 trade name and is primarily driven by a reduction in expected future revenues, as well as changes to the discount rate used when valuing the trade name.

Depreciation and Amortization

Depreciation and amortization expenses were $117,725 and $66,448 for the three months ended June 30, 2022 and 2021, respectively, an increase of $51,277, or 77%. The increase was primarily due to additional depreciation expense for fixed assets acquired during 2022.

Interest Expense

Interest expense was $191,662 and $31,899 for the three months ended June 30, 2022 and 2021, respectively. The increase of $159,763 was primarily due to an increase in non-cash interest for accretion of the INDYCAR license liability.

Other (Expense) Income, Net

Other (expense) income, net was $(610,594) and $44,360 of other income for the three months ended June 30, 2022 and 2021, respectively, an increase of $654,954. Other (expense), net for the three months ended June 30, 2022 was primarily comprised of $47,410 in rental income from the sub-lease of our Charlotte, NC office space offset by a foreign currency loss of $648,672 incurred remeasuring transactions denominated in a currency other than U.S. dollars and translating our foreign operations that are denominated in a functional currency other than U.S. dollars.

Other Comprehensive Income (Loss)

Other comprehensive income (loss) was $136,976 and $(70,809) for the three months ended June 30, 2022 and 2021, respectively. This was primarily due to unrealized foreign currency translation adjustments in our subsidiaries in the U.K., Australia, Russia and the Netherlands.

Six Months Ended June 30, 2022 compared to Six Months Ended June 30, 2021

Revenues were $5,330,776 and $4,713,059 for the six months ended June 30, 2022 and 2021, respectively, an increase of $617,717, or 13%, period over period. For the six months ended June 30, 2022, revenues from our Gaming segment increased $211,186, or 5%, to $4,900,326, compared to $4,689,140 for the six months ended June 30, 2021. The increase in our Gaming segment revenues compared to the 2021 period was primarily due to $685,824 in higher game sales and an increase of $625,906 in additional revenues earned through the development of simulation platforms using our rFactor 2 platform for third-parties. These increases were primarily offset by higher retail pricing concessions for our console game sales compared to the prior period.

Esports segment revenues were $430,450 and $23,919 for the six months ended June 30, 2022 and 2021, respectively, an increase of $406,531, period over period due to higher sponsorship revenues from the Le Mans Esports Series Ltd.

Cost of Revenues

Cost of revenues were $2,869,963 and $1,688,111 for the six months ended June 30, 2022 and 2021, respectively, an increase of $1,181,852, or 70%, period over period.

Cost of revenues from our Gaming segment were $2,224,744 and $1,617,867 for the six months ended June 30, 2022 and 2021, respectively, an increase of $606,877, or 38%, period over period. The change was primarily due to an increase of $275,290 in amortization of intangible assets driven by the acquisition of Studio397, a $165,869 increase in royalties driven by the use of the Epic Unreal engine, a $80,236 increase in development costs for the development of simulation platforms using our rFactor 2 platform for third parties, and a $96,285 increase in game production costs due to manufacturing costs for Nintendo Switch.

Cost of revenues from our Esports segment were $645,219 and $70,244 for the six months ended June 30, 2022 and 2021, respectively, an increase of $574,975, period over period. Cost of revenues in our Esports segment are primarily comprised of production costs including event staff contract labor and television production costs from the 24 Hours of Le Mans live event held in June.

Gross Profit (Loss)

Gross profit was $2,460,813, or 46% of revenues, and $3,024,948, or 64% of revenues, for the six months ended June 30, 2022 and 2021, respectively, a decrease of $564,135, or 19%, period over period.

Gaming segment gross profit was $2,675,582 for the six months ending June 30, 2022, compared to $3,071,273 for the six months ended June 30, 2021, a decrease of $395,691, or 13%, period over period. The decrease in gross profit was primarily due to $1,098,397 for retail pricing concessions, a $165,869 increase in royalties, and a $275,290 increase of amortization expense.

Esports segment gross profit loss was $214,769 for the six months ended June 30, 2022, compared to $46,325 for the six months ended June 30, 2021, an increase in loss of $168,444. The increase in gross profit loss was primarily driven by costs relating to broadcast production, staffing, and event production during the 24 Hours of Le Mans live event held in June 2022.

Operating Expenses

Operating expenses were $24,749,578 and $24,375,421 for the six months ended June 30, 2022 and 2021, respectively, an increase of $374,157, as described below.

Sales and Marketing

Sales and marketing expenses were $3,228,669 and $1,728,440 for the six months ended June 30, 2022 and 2021, respectively, representing a $1,500,229, or 87%, increase in sales and marketing expenses period over period. The change was primarily driven by increased headcount expenses of $1,048,368, as well as a $558,084 increase in variable marketing expenses and sponsorships to support the promotion of current and planned future releases.

Development

Development expenses were $5,085,980 and $3,068,540 for the six months ended June 30, 2022 and 2021, respectively, representing an increase of $2,017,440, or 66%, period over period. The incremental development expenses reflect higher compensation due to additional headcount and increased external development expense to develop and support an increased number of games and platforms.

General and Administrative

General and administrative (“G&A”) expenses were $6,772,763 and $19,481,218 for the six months ended June 30, 2022 and 2021, respectively, a decrease of $12,708,455, or 65%, period over period. The decrease in G&A expenses reflects $2,947,192 of expenses incurred in connection with our initial public offering (“IPO”) in January 2021, IPO-related bonuses and stock-based compensation expenses in the amount of $8,911,361 incurred in the 2021 period and $330,479 of expenses incurred in the acquisition of Studio397 that did not recur in 2022, offset by a $519,424 decrease in payroll expense primarily attributable to changes to the Company’s executive management team.

Impairment of Goodwill, Intangible and Long-Lived Assets

Loss on impairment of goodwill was $4,788,268 for the six months ended June 30, 2022, compared to $0 for the six months ended June 30, 2021. The impairment loss primarily relates to goodwill acquired in connection with the acquisition of Studio397. The trigger for the interim assessment was primarily due to revisions made in the first quarter of 2022 to the scope and timing of certain product releases included in our product roadmap, as well as a significant reduction in the Company’s market capitalization since the date of the last impairment assessment. Changes to the forecasted revenues and discount rates, as a result of the triggers identified, were the primary drivers for the change in fair value since the annual assessment and impairment loss recorded in the six months ended June 30, 2022.

Loss on impairment of indefinite-lived intangible assets was $3,319,109 for the six months ended June 30, 2022, compared to $0 for the six months ended June 30, 2021. The trigger for the interim assessment was the changes to the product roadmap and the Company’s market capitalization, as referenced above. The loss on impairment of indefinite-lived intangible assets relates to the rFactor 2 trade name and the Le Mans Video Gaming License and is primarily driven by a reduction in expected future revenues following changes made to the Company’s product roadmap in the first quarter of 2022, as well as changes to the discount rates and royalty rates used when valuing the assets.

Loss on impairment of finite-lived intangible assets was $1,320,993 for the six months ended June 30, 2022, compared to $0 for the six months ended June 30, 2021. The trigger for the interim assessment was the changes to the Company’s product roadmap and the Company’s market capitalization, as referenced above. The loss on impairment of finite-lived intangible assets relates to the rFactor 2 technology and was primarily driven by a change in the technical obsolescence assumption used when determining the fair value of the asset.

Depreciation and Amortization

Depreciation and amortization expenses were $233,796 and $97,223 for the six months ended June 30, 2022 and 2021, respectively, an increase of $136,573, period over period. The increase was primarily due to additional depreciation expense on fixed assets acquired during 2022.

Interest Expense

Interest expense was $393,258 for the six months ended June 30, 2022, compared to $151,438 for the six months ended June 30, 2021, an increase of $241,820, period over period. This was primarily due to interest expense for INDYCAR license accretion.

Gain Attributable to Equity Method Investment

The gain (loss) attributable to equity method investment in the Le Mans joint venture was $0 for the six months ended June 30, 2022 and $1,370,837 for the six months ended June 30, 2021. The decrease is due to the discontinuation of equity method accounting as we began to fully consolidate the Le Mans joint venture upon acquiring a majority interest during the first quarter of 2021.

Other (Expense) Income Net

Other (expense) income, net was ($772,693) for the six months ended June 30, 2022, compared to $84,707 for the six months ended June 30, 2021. Other expense of $772,693 for the six months ended June 30, 2022, was primarily comprised of $93,898 in rental income from the sub-lease of our Charlotte, NC office space, offset by a foreign currency loss of $842,915 incurred remeasuring transactions denominated in a currency other than U.S. dollars and translating our foreign operations that are denominated in a functional currency other than U.S. dollars. For the six months ended June 30, 2021, other income, net of $84,707 was comprised primarily of $91,164 in rental income from the sub-lease of our Charlotte, NC office space.

Other Comprehensive Income (Loss)

Other comprehensive income (loss) was $11,731 and $(103,723) for the six months ended June 30, 2022 and 2021, respectively. This was primarily due to activity in our U.K., Australian, Russian and Netherlands subsidiaries and represents unrealized foreign currency exchange losses.

Liquidity and Capital Resources

Liquidity

Since our inception and prior to our IPO, we financed our operations primarily through advances from Motorsport Network, which were subsequently incorporated into a line of credit provided by Motorsport Network pursuant to the $12 million Line of Credit, as described below.

On January 15, 2021, we completed our IPO of 3,450,000 shares of Class A common stock at a price to the public of $20.00 per share, which includes the exercise in full by the underwriters of their option to purchase from us an additional 450,000 shares of Class A common stock. We received net proceeds of approximately $63,073,783 from the IPO, after deducting underwriting discounts and offering expenses paid by us in 2020 and 2021.

We measure our liquidity in a number of ways, including the following:

For the six months ended June 30, 2022, the Company had a net loss of approximately $23.5 million, negative cash flows from operations of approximately $12.0 million and an accumulated deficit of $60.5 million. As of June 30, 2022, we had cash and cash equivalents of $5.2 million, which was reduced to $3.8 million as of July 31, 2022. We expect to continue to incur significant operating expenses and, as a result, we will need to continue to grow revenues to reach profitability and positive cash flows. We expect to continue to incur losses for the foreseeable future as we continue to develop our product portfolio and invest in developing new video game titles. As previously disclosed, we do not believe that our existing cash on hand will be sufficient to fund our operations for the next 12 months. See Item 1A, “Risk Factors – Risks Related to Our Financial Condition and Liquidity - Limits on the Company’s borrowing capacity under the $12 million Line of Credit may affect the Company’s ability to finance its operations.”

Our future liquidity and capital requirements include funds to support the planned costs to operate our business, including amounts required to fund working capital, support the development and introduction of new products, maintain existing titles, and certain capital expenditures. The adequacy of our available funds generally depends on many factors, including our ability to successfully develop consumer-preferred new products or enhancements to our existing products, continued development and expansion of our esports platform and our ability to enter into collaborations with other companies and/or acquire other companies or technologies to enhance or complement our product and service offerings.

We continue to explore additional funding in the form of potential equity and/or debt financing arrangements and consider these to be viable options to support future liquidity needs, provided that such opportunities can be obtained on terms that are commercially competitive and on terms acceptable to the Company. We are also seeking to improve our liquidity by achieving cost reductions by maintaining and enhancing cost control initiatives.

As we continue to evaluate incremental funding solutions, we re-evaluated our product roadmap in the first quarter of 2022 and modified the expected timing and scope of certain new product releases. These changes have been made not only to maintain the development of high-quality video game titles, but also to improve the timing of certain working capital requirements and reduce expenditures, thereby decreasing our expected future cash-burn and improve short-term liquidity needs. If needed, further adjustments could be made that would decrease short-term working capital requirements, while pushing out the timing of expected revenues.

We expect to generate additional liquidity through consummating equity and/or debt financings, achieving cost reductions by maintaining and enhancing cost control initiatives, and/or further adjusting our product roadmap to reduce near term need for working capital. If we are unable to generate adequate revenue and profit growth, there can be no assurances that such actions will provide us with sufficient liquidity to meet our cash requirements as, among other things, our liquidity can be impacted by a number of factors, including our level of sales, costs and expenditures, as well as accounts receivable and sales allowances.

There can be no assurance that we will be able to obtain funds on commercially acceptable terms, if at all, to satisfy our future needed liquidity and capital resources. If we are unable to obtain adequate funds on acceptable terms, we may be required to, among other things, significantly curtail or discontinue operations or obtain funds by entering into financing agreements on unattractive terms.

If we are unable to satisfy our cash requirements from the sources identified above, we could be required to adopt one or more of the following alternatives:

• selling assets or operations;
• seeking additional capital contributions and/or loans from Motorsport Network, the Company’s other affiliates and/or third parties; and/or
• reducing other discretionary spending.

There can be no assurance that we would be able to take any of the actions referred to above because of a variety of commercial or market factors, including, without limitation, market conditions being unfavorable for an equity or debt issuance, additional capital contributions and/or loans not being available from Motorsport Network or affiliates and/or third parties, or that the transactions may not be permitted under the terms of our various debt instruments then in effect, such as due to restrictions on the incurrence of debt, incurrence of liens, asset dispositions and related party transactions. In addition, such actions, if taken, may not enable us to satisfy our cash requirements if the actions that we are able to consummate do not generate a sufficient amount of additional capital.

Even if we do secure additional financing, if our anticipated level of revenues are not achieved because of, for example, less than anticipated consumer acceptance of our offering of products and events; less than effective marketing and promotion campaigns, decreased consumer spending in response to weak economic conditions or weakness in the overall electronic games category; adverse changes in currency; decreased sales of our products and events as a result of increased competitive activities by our competitors; changes in consumer purchasing habits; retailer inventory management or reductions in retailer display space; less than anticipated results from the Company’s existing or new products or from its advertising and/or marketing plans; or if the Company’s expenses, including, without limitation, for advertising and promotions, product returns or price protection expenditures, exceed the anticipated level of expenses, our liquidity may continue to be insufficient to satisfy our future capital requirements.

In accordance with Accounting Standards Codification (“ASC”) 205-40, Going Concern, the Company has evaluated whether there are conditions and events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that these condensed consolidated financial statements are issued. The factors described above, in particular the available cash on hand to fund operations over the next year, have raised substantial doubt about the Company’s ability to continue as a going concern.

The accompanying condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Accordingly, the condensed consolidated financial statements have been prepared on a basis that assumes the Company will continue as a going concern and which contemplates the realization of assets and satisfaction of liabilities and commitments in the ordinary course of business.

Cash Flows From Operating Activities

Net cash used in operating activities for the six months ended June 30, 2022 and 2021 was $12,049,298 and $11,264,546, respectively. The net cash used in operating activities for the six months ended June 30, 2022 was primarily a result of cash used to fund a net loss of $23,454,716, adjusted for net non-cash adjustments of $12,386,480 and $981,062 of cash used by changes in the levels of operating assets and liabilities. Net cash used in operating activities for the six months ended June 30, 2021 was primarily due to net loss of $20,046,366, adjusted for non-cash expenses in the amount of $8,681,602 and by $100,219 of cash used to fund changes in the levels of operating assets and liabilities.

Cash Flows From Investing Activities

Net cash used in investing activities for the six months ended June 30, 2022 was $196,346, which was attributable to the purchases of property and equipment. During the six months ended June 30, 2021, net cash used in investing activities was $14,008,174, which was attributable to approximately $12,785,500 paid in connection with the acquisition of Studio397 and $1,000,000 paid in connection with the acquisition of KartKraft, and approximately $348,000 in purchases of property and equipment, which was partially offset by $153,250 of net cash acquired in the purchase of an additional controlling interest in Le Mans Esports Series Ltd.

Cash Flows From Financing Activities

Net cash provided by (used in) financing activities during the six months ended June 30, 2022 and 2021 was ($981,396) and $49,501,815, respectively. Cash flows used in financing activities for the six months ended June 30, 2022 was primarily attributable to $1,000,000 payment of purchase commitment liability relating to a portion of the deferred installment amount due in connection with our acquisition of Studio397 and $118,604 in net advances from related parties. During the six months ended June 30, 2021, net cash provided by financing activities was primarily attributable to approximately $63,700,000 of net cash provided by the sale of Class A Common stock in our IPO, partially offset by $10,800,000 of net repayments to Motorsport Network.

Promissory Note Line of Credit

On April 1, 2020, the Company entered into a promissory note (the “$12 million Line of Credit”) with the Company’s majority stockholder, Motorsport Network, that provides the Company with a line of credit of up to $10,000,000 (which was subsequently increased to $12,000,000 pursuant to an amendment executed in November 2020), at an interest rate of 10% per annum, the availability of which is dependent on Motorsport Network’s available liquidity. The $12 million Line of Credit does not have a stated maturity date and is payable upon demand at any time at the sole and absolute discretion of Motorsport Network, which has agreed, pursuant to a Side Letter Agreement related to the $12 million Line of Credit, dated September 4, 2020, not to demand or otherwise accelerate any amount due under the $12 million Line of Credit that would otherwise constrain the Company’s liquidity position, including the Company’s ability to continue as a going concern. The Company may prepay the $12 million Line of Credit in whole or in part at any time or from time to time without penalty or charge. In the event the Company or any of its subsidiaries consummates certain corporate events, including any capital reorganization, consolidation, joint venture, spin off, merger or any other business combination or restructuring of any nature, or if certain events of default occur, the entire principal amount and all accrued and unpaid interest will be accelerated and become payable.

During the six months ended June 30, 2022, there was no activity under the $12 million Line of Credit and the balance due to Motorsport Network was $0 as of June 30, 2022. Subsequent to June 30, 2022, the Company has not made any advances or repayments of the $12 million Line of Credit. See Item 1A, “Risk Factors – Risks Related to our Financial Condition and Liquidity - Limits on the Company’s borrowing capacity under the $12 million Line of Credit may affect the Company’s ability to finance its operations.”

Capital Expenditures

The nature of the Company’s operations does not require significant expenditures on capital assets, nor does the Company typically enter into significant commitments to acquire capital assets. The Company does not have material commitments to acquire capital assets as of June 30, 2022.

Material Cash Requirements

On April 22, 2022, the Company entered into a letter agreement (the “Amendment”) amending the terms of (i) the share purchase agreement dated March 31, 2021 (the “SPA”) with Luminis International BV, Technology In Business B.V. (“TIB”) and certain of TIB’s shareholders parties to such Amendment and (ii) the related deed of pledge that secured the Company’s payment of the $3,200,000 deferred purchase price installment under the SPA.

Pursuant to the Amendment, the deferred purchase price installment due to be paid by the Company on the first anniversary of closing was reduced from $3,200,000 to $1,000,000, with the remaining $2,200,000 further deferred and to be paid within 90 days of the date that the Company made the $1,000,000 payment. Further, pursuant to the Amendment, secured obligations under the deed of pledge were correspondingly reduced from $3,200,000 to $2,200,000 following the finalization of an amendment to the deed of pledge on May 12, 2022. The $1,000,000 payment was made on April 30, 2022.

On July 21, 2022, the Company and Luminis entered into a second amendment (the “Second Amendment”) to the SPA. The $2,200,000 deferred purchase price payment due under the Second Amendment shall be paid as follows:

(a) an initial installment of $330,000 which was paid within 5 business days of executing the Second Amendment;

(b) monthly installments of $100,000 from August 15, 2022 through December of 2022, payable on the 15th day of each month; and

(c) monthly installments of $150,000 from January 15, 2023 until such time as the entire unpaid $1,870,000 balance of the deferred purchase price payment due under the Second Amendment, together with simple interest on the unpaid balance accruing, starting on the date of the Second Amendment, at 15% per annum, is paid in full, payable on the 15th day of each month.

There have been no other material changes in our reported material cash requirements as described under “Liquidity and Capital Resources – Material Cash Requirements” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the 2021 Form 10-K.

Off-Balance Sheet Arrangements

We did not have, during the periods presented, and we do not currently have, any relationships with any organizations or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Significant Accounting Estimates

There have been no material changes to the items disclosed as critical accounting policies and estimates under “Liquidity and Capital Resources—Critical Accounting Policies and Estimates” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the 2021 Form 10-K, with the exception of an additional critical estimate identified in respect of finite-lived intangible assets.

Valuation of Finite-Lived Intangible Assets

We review our finite-lived assets for impairment whenever events or changes in circumstances indicate, based on recent and projected cash flow performance and remaining useful lives, that the carrying value of these assets may not be fully recoverable. We evaluate asset impairment at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The lowest level for which we maintain identifiable cash flows that are independent of the cash flows of other assets and liabilities is at the intangible asset level, with the exception of technology intangible assets which are at the reporting unit level. If estimated undiscounted future cash flows are less than the carrying value of an asset, an impairment charge is recognized to the extent its carrying value exceeds fair value.

We typically estimate fair value a cost to recreate valuation technique, however the valuation method used will be dependent on the finite-lived intangible asset subject to fair value assessment.

The principal assumptions used in our cost to recreate model for the interim impairment reviews completed during the six months ended June 30, 2022 were:

• Number of hours to recreate;
• Rate per hour; and
• Technological obsolescence.

If the carrying value exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying value, the finite-life intangible asset is not considered impaired.

Recently Issued Accounting Standards

As an “emerging growth company”, the JOBS Act allows us to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We have elected to use this extended transition period under the JOBS Act. We have elected to use this extended transition period under the JOBS Act until such time as we are no longer considered to be an emerging growth company.

Our analysis of recently issued accounting standards are more fully described in our condensed consolidated financial statements included elsewhere in this Report.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2022. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of June 30, 2022 because of the material weaknesses in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) as discussed in Part II, Item 9A, “Controls and Procedures” of the 2021 Form 10-K, and that continued to exist as of June 30, 2022.

Remediation of Material Weaknesses

Although we have not yet remediated the material weaknesses that we identified in the 2021 Form 10-K, we believe that we have made and continue to make progress on the remediation plans described in our 2021 Form 10-K, under Item 9A, “Controls and Procedures.”

During the period ended June 30, 2022, we continued to make improvements to controls and continued our evaluation and documentation of key business processes, including entity level controls (ELCs), disclosure controls and procedures, financial statement close and financial reporting (FSCFR), revenue, equity, accounts payable, accruals, taxes, and information technology general controls. Management plans to complete the remediation of the previously identified material weaknesses during 2023.

Limitations on the Effectiveness of Controls

In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Changes in Internal Control over Financial Reporting

Except as described above, there were no other changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) and 15d-15(d) under the Exchange Act during the quarter ended June 30, 2022, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this Report, you should carefully consider the factors discussed in “Risk Factors” in Part I, Item 1A of the 2021 Form 10-K, and the risk factor described below, which could materially affect our business, financial condition or future results. The risks described in the 2021 Form 10-K and below are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition or operating results.

Other than the following, there have been no significant changes to the risk factors set forth in the 2021 Form 10-K:

Risks Related to Our Financial Condition and Liquidity

Limits on the Company’s borrowing capacity under the $12 million Line of Credit may affect the Company’s ability to finance its operations.

At July 31, 2022, the Company had a total liquidity position of approximately $3.8 million, consisting of cash and cash equivalents on hand. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources – Liquidity.” With such limited capital resources, the Company has disclosed that it believes its existing cash on hand will not be sufficient to fund its operations for the next 12 months and it will be required to raise equity and/or debt capital from external sources. With there being no assurances that capital will be available from such external sources and while the $12 million Line of Credit with the Company’s majority stockholder, Motorsport Network, was undrawn as of July 31, 2022, the Company’s ability to borrow funds under such facility is limited by the lender’s ability to fund such borrowing requests. If and to the extent that Motorsport Network were to be unable to fund any such requests, the Company will not have complete access to some or all of the commitment available under the $12 million Line of Credit, but rather would have access to a lesser amount as determined by Motorsport Network’s ability to fund the Company’s borrowing requests. Given the state of the financial markets, the Company has recently assessed its exposure to any potential non-performance by Motorsport Network and believes that there is a substantial likelihood that Motorsport Network will not fulfill any of the Company’s borrowing requests for the foreseeable future. Because of these limitations, the Company does not rely on being able to meet its cash requirements with any fundings under the $12 million Line of Credit. If Motorsport Network is unable to fulfill their commitment to advance funds to the Company under the $12 million Line of Credit, it would impact the Company’s potential sources of liquidity and, depending upon the amount involved and the Company’s liquidity requirements, it could have an adverse effect on the Company’s ability to fund its operations, which could have a material adverse effect on the Company’s business, prospects, results of operations, financial condition and/or cash flows.

We are subject to risks related to the Russian military action against Ukraine.

In February 2022, Russian forces launched significant military actions against Ukraine, and sustained conflict and disruption in the region remains ongoing. We have no way to predict the progress or outcome of the current situation in Ukraine, as the conflict and governmental reactions are rapidly developing and beyond our control. However, the impact to Ukraine, as well as the actions taken by other countries, including new and stricter sanctions imposed by Canada, the U.K., the European Union, the U.S. and other nations against officials, individuals, regions, and industries in Russia, Ukraine and Belarus, each country’s potential response to such sanctions, tensions and military actions, could all have a material adverse effect on our business, financial condition, liquidity and/or results of operations in various manners.

The current and potential sanctions against Russia could have a material adverse effect on our ability to use our Russian development staff for future game development. A significant portion of our development staff is based in Russia. Our software development team in Russia continues to engage in remote software development services for us without significant interruption and we continue to pay the staff located in Russia. However, international sanctions and potential responses to such sanctions, including those that may limit or restrict our ability to transfer funds into Russia to pay for such development services or any frozen or lost funds, could significantly affect our ability to pay our developers based in Russia. Further, efficient data transfer and internet accessibility from and to Russia may also be jeopardized, such as in the event of an internet blockade by the Russian government, which may cause certain disruptions in development and maintenance activities by our Russian development staff. Any of the foregoing could result in us having to look to alternative development arrangements, which would likely delay our ability to release future game titles.

In addition, we have currency exposure arising from both sales and purchases denominated in foreign currencies, including intercompany transactions outside the U.S. In addition, some currencies may be subject to limitations on conversion into other currencies, which can limit our ability to otherwise react to rapid foreign currency devaluations. Because we have operations in Russia, our exchange rate risk is highly sensitive to the prevailing value of the U.S. dollar relative to the Russian ruble, which exchange rate has fluctuated significantly, in particular due to the recent Russian invasion of Ukraine, as well as continued sanctions and any new sanctions against Russia. While we cannot predict with precision the effect of future exchange-rate fluctuations, further significant rate fluctuations could have a material adverse effect on our business, financial condition and/or results of operations.

Our business, financial condition, liquidity and/or results of operations could also be adversely affected in a number of other ways, including, but not limited to, the following:

• The termination of the employment arrangements with our Russian development staff may cause us to incur certain liabilities and severance obligations under local labor regulations, which may include payment of up to three months’ salary for each staff member terminated.
• Russia and other countries supporting Russia in the conflict may launch cyberattacks against the U.S. and other countries, their governments and businesses.
• Our operations in Russia may cast us in a negative light with our partners, clients and/or other stakeholders and injure our reputation, and potential adverse reputational harm may increase in the event of prolonged unrest, intensified military activities or more extensive sanctions impacting the region.

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Risks Related to Ownership of Our Class A Common Stock

Our Class A common stock may be delisted from The Nasdaq Capital Market, which could affect its market price and liquidity.

We are required to continually meet NASDAQ’s listing requirements, including, among other things, a minimum closing bid price requirement of $1.00 per share for 30 consecutive business days. As described in a Current Report on Form 8-K filed with the SEC on June 9, 2022, on June 6, 2022, we received a deficiency letter from NASDAQ’s Listing Qualifications Department notifying us that, for the last 30 consecutive business days, the bid price for our Class A common stock had closed below the minimum $1.00 per share requirement for continued inclusion on The Nasdaq Capital Market pursuant to Nasdaq Listing Rule 5550(a)(2) (the “Rule”). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we were provided an initial period of 180 calendar days, or until December 5, 2022, to regain compliance with the Rule. To regain compliance, the closing bid price for our Class A common stock must remain above $1.00 for 10 consecutive business days.

If we do not regain compliance with the Rule by December 5, 2022, NASDAQ will provide written notice that our Class A common stock is subject to delisting. At such time, we would be entitled to appeal the delisting determination to a NASDAQ Hearing Panel. We cannot provide any assurance that our Class A common stock price will recover within the permitted remediation period. We intend to monitor the closing bid price of our Class A common stock and may, if appropriate, consider implementing available options, including a reverse stock split, to regain compliance with the minimum closing bid price requirement.

Any delisting of our Class A common stock from The Nasdaq Capital Market could adversely affect our ability to attract new investors, reduce the liquidity of our outstanding shares of Class A common stock, reduce our ability to raise additional capital, reduce the price at which our Class A common stock trades, result in negative publicity and increase the transaction costs inherent in trading such shares with overall negative effects for our stockholders. We cannot assure you that our Class A common stock, if delisted from The Nasdaq Capital Market, will be listed on another national securities exchange or quoted on an over-the-counter quotation system. In addition, delisting of our Class A common stock could deter broker-dealers from making a market in or otherwise seeking or generating interest in our Class A common stock and might deter certain institutions and persons from investing in our securities at all. For these reasons and others, delisting could adversely affect our business, financial condition and liquidity.