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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

 

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2024

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO

 

Commission File Number 001-41556

 

 

 

SNAIL, INC.

(Exact name of Registrant as specified in its Charter)

 

 

 

Delaware   88-4146991

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

12049 Jefferson Blvd

Culver City, CA

  90230
(Address of principal executive offices)   (Zip code)

 

Registrant’s telephone number, including area code: +1 (310) 988-0643

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol (s)   Name of each exchange on which registered
Class A common stock, par value $0.0001 per share   SNAL  

The Nasdaq Stock Market LLC

(Nasdaq Capital Market)

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES ☐ NO ☒

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ☒ NO ☐

 

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). YES ☒ NO ☐

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer Accelerated filer
Non-accelerated filer Smaller reporting company
Emerging growth company    

 

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☒

 

Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

Class of Common Stock   Outstanding Shares as of May 13, 2024
Class A Common Stock, par value $0.0001 per share   8,007,474
Class B Common Stock, par value $0.0001 per share   28,748,580

 

 

 

 

 

 

SNAIL, INC. AND SUBSIDIARIES

Form 10-Q

For the Quarter Ended March 31, 2024

 

Table of Contents

 

    Page
  Cautionary Statement ii
PART I. FINANCIAL INFORMATION  
Item 1. Condensed Consolidated Financial Statements (Unaudited) F-1
  Snail, Inc. and Subsidiaries Condensed Consolidated Balance Sheets as of March 31, 2024 and December 31, 2023 F-1
  Snail, Inc. and Subsidiaries Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, 2024 and 2023 F-2
  Snail, Inc. and Subsidiaries Condensed Consolidated Statements of Equity for the three months ended March 31, 2024 and 2023 F-3
  Snail, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2024 and 2023 F-4
  Snail, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements F-5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 30
Item 3. Quantitative and Qualitative Disclosures About Market Risk 45
Item 4. Controls and Procedures 45
PART II. OTHER INFORMATION  
Item 1. Legal Proceedings 45
Item 1A. Risk Factors 45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 51
Item 3. Defaults Upon Senior Securities 51
Item 4. Mine Safety Disclosures 51
Item 5. Other Information 51
Item 6. Exhibits 51
SIGNATURES   52

 

i

 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q (the “Quarterly Report”) contains statements that constitute forward-looking statements. Many of the forward-looking statements contained in this Quarterly Report can be identified by the use of forward-looking words such as “anticipate,” “believe,” “could,” “expect,” “should,” “plan,” “intend,” “may,” “predict,” “continue,” “estimate” and “potential,” or the negative of these terms or other similar expressions.

 

Forward-looking statements appear in a number of places in this Quarterly Report and include, but are not limited to, statements regarding our intent, belief or current expectations. These forward-looking statements include information about possible or assumed future results of our business, financial condition, results of operations, liquidity, plans and objectives. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. Such statements are subject to risks and uncertainties, and actual results may differ materially from those expressed or implied in the forward-looking statements due to various factors, including, but not limited to, those identified described in “Part II, Item 1A. – Risk Factors,” of this Quarterly Report. The statements we make regarding the following matters are forward-looking by their nature:

 

  our ability to re-establish profitable operations, raise additional capital or renegotiate our debt arrangements;
     
  our growth prospects and strategies;
     
  launching new games and additional functionality to games that are commercially successful;
     
  our expectations regarding significant drivers of our future growth;
     
  our ability to retain and increase our player base and develop new video games and enhance our existing games;
     
  competition from companies in a number of industries, including other casual game developers and publishers and both large and small, public and private multimedia companies;
     
  our ability to attract and retain a qualified management team and other team members while controlling our labor costs;
     
  our relationships with third-party platforms such as Xbox Live and Game Pass, PlayStation Network, Steam, Epic Games Store, the Apple App Store, the Google Play Store, My Nintendo Store and the Amazon Appstore;
     
  our ability to successfully enter new markets and manage our international expansion;
     
  protecting and developing our brand and intellectual property portfolio;
     
  costs associated with defending intellectual property infringement and other claims;
     
  our future business development, results of operations and financial condition;
     
  rulings by courts or other governmental authorities;
     
  our Share Repurchase Program (as defined below), including expectations regarding the timing and manner of repurchases made under the Share Repurchase Program;
     
  our plans to pursue and successfully integrate strategic acquisitions;
     
  other risks and uncertainties described in this Quarterly Report, including those described in Item 1A of Part II, “Risk Factors”; and
     
  assumptions underlying any of the foregoing.

 

Further information on risks, uncertainties and other factors that could affect our financial results are included in our filings with the United States Securities and Exchange Commission (the “SEC”) from time to time, including in Item 1A of Part II, “Risk Factors,” of this Quarterly Report and other periodic reports on Form 10-K and 10-Q filed or to be filed with the SEC. You should not rely on these forward-looking statements, as actual outcomes and results may differ materially from those expressed or implied in the forward-looking statements as a result of such risks and uncertainties. All forward-looking statements in this Quarterly Report are based on management’s beliefs and assumptions and on information currently available to us as of the date of this filing, and we do not assume any obligation to update the forward-looking statements provided to reflect events that occur or circumstances that exist after the date on which they were made.

 

ii

 

 

PART I

 

Item 1. Condensed Consolidated Financial Statement (Unaudited)

 

Snail, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets as of March 31, 2024 and December 31, 2023

 

   March 31, 2024   December 31, 2023 
         
ASSETS          
           
Current Assets:          
Cash and cash equivalents  $16,068,729   $15,198,123 
Accounts receivable, net of allowances for credit losses of $523,500 as of March 31, 2024 and December 31, 2023   7,375,179    25,134,808 
Accounts receivable - related party   2,585,213    - 
Loan and interest receivable - related party   104,252    103,753 
Prepaid expenses - related party   4,337,556    6,044,404 
Prepaid expenses and other current assets   2,419,201    639,693 
Prepaid taxes   9,459,348    9,529,755 
Total current assets   42,349,478    56,650,536 
           
Restricted cash and cash equivalents   1,117,310    1,116,196 
Accounts receivable – related party, net of current portion   6,000,592    7,500,592 
Prepaid expenses - related party, net of current portion   10,842,748    7,784,062 
Property, plant and equipment, net   4,599,728    4,682,066 
Intangible assets, net - other   271,517    271,717 
Deferred income taxes   10,803,281    10,247,500 
Other noncurrent assets   169,047    164,170 
Operating lease right-of-use assets, net   2,138,285    2,440,690 
Total assets  $78,291,986   $90,857,529 
           
LIABILITIES, NONCONTROLLING INTERESTS AND STOCKHOLDERS’ EQUITY          
           
Current Liabilities:          
Accounts payable  $9,901,360   $12,102,929 
Accounts payable - related parties   16,951,062    23,094,436 
Accrued expenses and other liabilities   2,425,882    2,887,193 
Interest payable - related parties   527,770    527,770 
Revolving loan   3,000,000    6,000,000 
Notes payable   -    2,333,333 
Convertible notes, net of discount   702,284    797,361 
Current portion of long-term promissory note   2,791,438    2,811,923 
Current portion of deferred revenue   21,937,421    19,252,628 
Current portion of operating lease liabilities   1,540,086    1,505,034 
Total current liabilities   59,777,303    71,312,607 
           
Accrued expenses   254,731    254,731 
Deferred revenue, net of current portion   17,102,747    15,064,078 
Operating lease liabilities, net of current portion   1,023,216    1,425,494 
Total liabilities   78,157,997    88,056,910 
           
Commitments and contingencies   -    - 
           
Stockholders’ Equity:          
Class A common stock, $0.0001 par value, 500,000,000 shares authorized; 9,357,749 shares issued and 8,007,474 shares outstanding as of March 31, 2024, and 9,275,420 shares issued and 7,925,145 shares outstanding as of December 31, 2023   935    927 
Class B common stock, $0.0001 par value, 100,000,000 shares authorized; 28,748,580 shares issued and outstanding as of March 31, 2024 and December 31, 2023.   2,875    2,875 
Additional paid-in capital   25,304,692    26,171,575 
Accumulated other comprehensive loss   (273,680)   (254,383)
Accumulated deficit   (15,728,654)   (13,949,325)
Treasury stock at cost (1,350,275 shares as of March 31, 2024 and December 31, 2023)   (3,671,806)   (3,671,806)
Total Snail, Inc. equity   5,634,362    8,299,863 
Noncontrolling interests   (5,500,373)   (5,499,244)
Total stockholders’ equity (deficit)   133,989    2,800,619 
Total liabilities, noncontrolling interests and stockholders’ equity  $78,291,986   $90,857,529 

 

See accompanying notes to condensed consolidated financial statements (unaudited)

 

F-1
 

 

Snail, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three Months Ended March 31, 2024 and 2023

 

   2024   2023 
         
Revenues, net  $14,115,729   $13,458,488 
Cost of revenues   12,041,698    10,860,937 
           
Gross profit   2,074,031    2,597,551 
           
Operating expenses:          
General and administrative   2,282,040    4,525,751 
Research and development   1,776,522    1,373,797 
Advertising and marketing   141,030    104,549 
Depreciation and amortization   82,338    115,060 
Total operating expenses   4,281,930    6,119,157 
           
Loss from operations   (2,207,899)   (3,521,606)
           
Other income (expense):          
Interest income   99,762    31,473 
Interest income - related parties   499    493 
Interest expense   (395,964)   (294,583)
Other income   227,066    8,175 
Foreign currency transaction income (loss)   18,128    (2,367)
Total other income (expense), net   (50,509)   (256,809)
           
Loss before benefit from income taxes   (2,258,408)   (3,778,415)
           
Benefit from income taxes   (477,950)   (805,818)
           
Net loss   (1,780,458)   (2,972,597)
           
Net loss attributable to non-controlling interests   (1,129)   (1,219)
           
Net loss attributable to Snail, Inc.  $(1,779,329)  $(2,971,378)
           
Comprehensive loss statement:          
           
Net loss  $(1,780,458)  $(2,972,597)
           
Other comprehensive income (loss) related to foreign currency translation adjustments, net of tax   (19,297)   2,320 
           
Total comprehensive loss  $(1,799,755)  $(2,970,277)
           
Net loss attributable to Class A common stockholders:          
Basic  $(385,722)  $(642,340)
Diluted  $(385,722)  $(642,340)
           
Net loss attributable to Class B common stockholders:          
Basic  $(1,393,607)  $(2,329,038)
Diluted  $(1,393,607)  $(2,329,038)
           
Loss per share attributable to Class A and B common stockholders:          
Basic  $(0.05)  $(0.08)
Diluted  $(0.05)  $(0.08)
           
Weighted-average shares used to compute loss per share attributable to Class A common stockholders:          
Basic   7,957,031    7,928,742 
Diluted   7,957,031    7,928,742 
           
Weighted-average shares used to compute loss per share attributable to Class B common stockholders:          
Basic   28,748,580    28,748,580 
Diluted   28,748,580    28,748,580 

 

See accompanying notes to condensed consolidated financial statements (unaudited)

 

F-2
 

 

Snail, Inc. and Subsidiaries

Condensed Consolidated Statements of Equity for the Three Months Ended March 31, 2024 and 2023

 

   Shares   Amount   Shares   Amount   Capital   Loss   Deficit   Shares   Amount   Equity   interests   Equity 
  

Class A

Common Stock

  

Class B

Common Stock

   Additional Paid-In-  

Accumulated

Other

Comprehensive

   Accumulated   Treasury Stock   Snail, Inc. Equity  

Non

controlling

   Total Equity 
   Shares   Amount   Shares   Amount   Capital   Loss   Deficit   Shares   Amount   (Deficit)   interests   (Deficit) 
                                                 
Balance at December 31, 2022   9,251,420   $925    28,748,580   $2,875   $23,436,942   $(307,200)  $(4,863,250)   (1,197,649)  $(3,414,713)  $14,855,579   $(5,490,895)  $9,364,684 
                                                             
Stock based compensation related to restricted stock units   -    -    -    -    152,595    -    -    -    -    152,595    -    152,595 
                                                             
Repurchase of common stock   -    -    -    -    -    -    -    (152,626)   (257,093)   (257,093)   -    (257,093)
                                                             
Foreign currency translation   -    -    -    -    -    2,320    -    -    -    2,320    -    2,320 
                                                             
Net loss   -    -    -    -    -    -    (2,971,378)   -    -    (2,971,378)   (1,219)   (2,972,597)
                                                             
Balance at March 31, 2023   9,251,420   $925    28,748,580   $2,875   $23,589,537   $(304,880)  $(7,834,628)   (1,350,275)  $(3,671,806)  $11,782,023   $(5,492,114)  $6,289,909 

 

  

Class A

Common Stock

  

Class B

Common Stock

   Additional Paid-In-  

Accumulated

Other

Comprehensive

   Accumulated   Treasury Stock   Snail, Inc. Equity  

Non

controlling

   Total Equity 
   Shares   Amount   Shares   Amount   Capital   Loss   Deficit   Shares   Amount   (Deficit)   interests  

(Deficit)

 
                                                 
Balance at December 31, 2023   9,275,420   $927    28,748,580   $2,875   $26,171,575   $(254,383)  $(13,949,325)   (1,350,275)  $(3,671,806)  $8,299,863   $(5,499,244)  $2,800,619 
                                                             
Conversion of notes payable   71,460    7    -    -    59,993    -    -    -    -    60,000    -    60,000 
                                                             
Stock based compensation related to restricted stock units   -    -    -    -    (926,875)   -    -    -    -    (926,875)   -    (926,875)
                                                             
Common stock issued for service   10,869    1    -    -    (1)   -    -    -    -    -    -    - 
                                                             
Foreign currency translation   -    -    -    -    -    (19,297)   -    -    -    (19,297)   -    (19,297)
                                                             
Net loss   -    -    -    -    -    -    (1,779,329)   -    -    (1,779,329)   (1,129)   (1,780,458)
                                                             
Balance at March 31, 2024   9,357,749   $935    28,748,580   $2,875   $25,304,692   $(273,680)  $(15,728,654)   (1,350,275)  $(3,671,806)  $5,634,362   $(5,500,373)  $133,989 

 

See accompanying notes to condensed consolidated financial statements (unaudited)

 

F-3
 

 

Snail, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2024 and 2023

 

         
   2024   2023 
         
Cash flows from operating activities:          
Net loss  $(1,780,458)  $(2,972,597)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:          
Amortization - intangible assets - license, related parties   -    695,652 
Amortization - intangible assets - other   200    201 
Amortization - loan origination fees and debt discounts   47,729    8,911 
Accretion – convertible notes   181,754    - 
Depreciation and amortization - property and equipment   82,338    115,060 
Stock-based compensation expense   (926,875)   152,595 
Interest income from restricted escrow deposit   -    (9,874)
Deferred taxes, net   (555,781)   - 
           
Changes in assets and liabilities:          
Accounts receivable   17,759,629    (230,885)
Accounts receivable - related party   (1,085,213)   47,744 
Prepaid expenses - related party   (1,351,838)   (2,500,000)
Prepaid expenses and other current assets   (1,779,508)   (632,240)
Prepaid taxes   70,407    - 
Accounts payable   (1,938,654)   (1,248,355)
Accounts payable - related parties   (6,143,374)   (377,476)
Accrued expenses and other liabilities   (461,311)   443,528 
Interest receivable - related party   (499)   (493)
Lease liabilities   (64,821)   (49,411)
Deferred revenue   4,723,462    (151,130)
Net cash provided by (used in) operating activities   6,777,187    (6,708,770)
           
Cash flows from financing activities:          
Repayments on promissory note   (20,484)   (26,503)
Repayments on notes payable   (2,333,333)   (1,666,667)
Repayments on convertible notes   (269,550)   - 
Repayments on revolving loan   (3,000,000)   - 
Purchase of treasury stock   -    (257,093)
Payments of capitalized offering costs   -    (92,318)
Payments of offering costs in accounts payable   (262,914)   - 
Net cash used in financing activities   (5,886,281)   (2,042,581)
           
Effect of foreign currency translation on cash and cash equivalents   (19,186)   2,074 
           
Net increase (decrease) in cash and cash equivalents, and restricted cash and cash equivalents   871,720    (8,749,277)
           
Cash and cash equivalents, and restricted cash and cash equivalents - beginning of the period   16,314,319    19,238,185 
           
Cash and cash equivalents, and restricted cash and cash equivalents – end of the period  $17,186,039   $10,488,908 
           
Supplemental disclosures of cash flow information          
Cash paid during the period for:          
Interest  $171,101   $285,672 
Income taxes  $1,871   $182,387 
Noncash finance activity during the period for:          
Debt converted to equity  $(60,000)  $- 

 

See accompanying notes to condensed consolidated financial statements (unaudited)

 

F-4
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

NOTE 1 – PRESENTATION AND NATURE OF OPERATIONS

 

Snail, Inc. was incorporated under the laws of Delaware in January 2022. The terms “Snail, Inc,” “Snail Games,” “our” and the “Company” are used to refer collectively to Snail, Inc. and its subsidiaries. The Company’s fiscal year end is December 31. The Company was formed for the purpose of completing an initial public offering (“IPO”) and related transactions to carry on the business of Snail Games USA Inc. and its subsidiaries. Snail Games USA Inc. was founded in 2009 as a wholly owned subsidiary of Suzhou Snail Digital Technology Co., Ltd. (“Suzhou Snail”) located in Suzhou, China and is the operating entity that continues post IPO. Snail Games USA Inc. is devoted to researching, developing, marketing, publishing, and distributing games, content and support that can be played on a variety of platforms including game consoles, PCs, mobile phones and tablets.

 

Basis of Presentation and Consolidation

 

The accompanying condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the SEC and generally accepted accounting principles as promulgated in the United States of America (“U.S. GAAP”) for interim reporting. Accordingly, certain notes or other information that are normally required by U.S. GAAP have been condensed or omitted if they substantially duplicate disclosures contained in our annual audited consolidated financial statements. Additionally, the year-end condensed consolidated balance sheet data was derived from audited consolidated financial statements but does not include all disclosures required by U.S. GAAP. Accordingly, the unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2023 included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023, filed with the SEC on April 1, 2024. The condensed consolidated results of operations for any interim period are not necessarily indicative of the results to be expected for the full year or for any other future annual or interim period.

 

In the opinion of management, all adjustments considered necessary for the fair presentation of the Company’s financial position and its results of operations in accordance with U.S. GAAP (consisting of normal recurring adjustments) have been included in the accompanying unaudited condensed consolidated financial statements.

 

F-5
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

During the year ended December 31, 2023, certain comparative amounts were reclassified due to immaterial errors identified by the Company in its presentation of certain server hosting costs. During the three months ended June 30, 2023, the Company began reporting all of its server hosting costs as costs of revenue whereas they were previously reported within both cost of revenues and general and administrative expenses. The Company has assessed the materiality of these errors on its prior annual and interim financial statements, assessing materiality both quantitatively and qualitatively, in accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 99 and SAB No. 108 and concluded that the errors were not material to those consolidated financial statements. However, to correctly present cost of revenues, gross profit and general and administrative expenses, the reclassifications have been made throughout this report and accompanying note disclosures. The effects on the related captions in the unaudited condensed consolidated statements of operations and comprehensive income (loss) for all previously reported periods were as follows:

 

   For the three months ended
March 31, 2023
 
   As reported   Adjustment   As adjusted 
Cost of revenues  $9,816,397   $1,044,540   $10,860,937 
Gross profit   3,642,091    (1,044,540)   2,597,551 
General and administrative   5,570,291    (1,044,540)   4,525,751 

 

The condensed consolidated financial statements include the accounts of Snail, Inc. and the following subsidiaries:

 

   Equity % 
Subsidiary Name  Owned 
Snail Games USA Inc.   100%
Snail Innovation Institute   70%
Frostkeep Studios, Inc.   100%
Eminence Corp   100%
Wandering Wizard, LLC   100%
Donkey Crew, LLC   99%
Interactive Films, LLC   100%
Project AWK Productions, LLC   100%
BTBX.IO, LLC   70%

 

All intercompany accounts, transactions, and profits have been eliminated upon consolidation.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires the Company to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and the accompanying notes. Such estimates include revenue recognition, see Note 2 – Revenue Recognition, provisions for credit losses, deferred income tax assets and associated valuation allowances, deferred revenue, stock-based compensation and fair value of warrants. These estimates generally involve complex issues and require management to make judgments, involve analysis of historical and future trends that can require extended periods of time to resolve, and are subject to change from period to period. In all cases, actual results could differ materially from estimates.

 

Segment Reporting

 

The Company has one operating and reportable segment. Our operations involve similar products and customers worldwide. Revenue earned is primarily derived from the sale of software titles, which are developed internally or licensed from related parties. Financial information about our segment and geographic regions is included in Note 3 – Revenue from Contracts with Customers.

 

Liquidity

 

In October 2023, the Company released ARK: Survival Ascended, increasing the cash flows provided by our operating activities. During the three months ended March 31, 2024 the Company’s operating activities provided $6.8 million in cash flows. During the three months ended March 31, 2024 the Company repaid $3.0 million of the revolving loan balance, the $0.8 million balance of its 2022 Short Term Note, $0.3 million of accrued interest and principal on its convertible notes balance, the balance of the $1.5 million short term note and is in the process of negotiating a new term loan. The Company paid an additional $0.5 million of accrued interest and principal on its convertible notes in April 2024.

 

The Company has debts coming due of $3.0 million on its revolving loan in December 2024 and $0.7 million due in May 2024 for its convertible notes. Currently, management expects that the Company will not be in compliance with its quarterly debt covenants for the three months ending June 30, 2024. Management is working with the lender to resolve the expected non-compliance with the debt covenants. The Company’s ability to comply with the covenants, or receive waivers for the covenants, can lead to the acceleration of payments due under the debt facilities with the lender, which include the $3.0 million revolving loan and $2.8 million promissory note, cause the lender to cease making advances under the revolving agreement, or allow the lender take possession of collateral. Due to the failure of complying with the debt covenant the Company has classified its long term debt as current.

 

F-6
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

From time to time, the Company could be required, or may otherwise attempt, to seek additional sources of capital, including, but not limited to, equity and/or debt financings. The need for additional capital depends on many factors, including, among other things, whether the Company can successfully renegotiate the terms of its debt arrangements, the rate at which the Company’s business grows, demands for working capital, revenue generated from existing downloadable content (“DLCs”) and game titles, launches of new DLCs and new game titles, and any acquisitions that the Company may pursue.

 

Our current unrestricted cash position of approximately $16.1 million, and our expected revenue receipts will allow the Company to continue operations beyond the next 12 months and service its current debts.

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Revenue Recognition

 

The Company’s revenue is generated from the publishing of software games sold digitally and through physical discs (e.g., packaged goods), the publishing of separate downloadable content that are new feature releases to existing digital full-game downloads that are sold digitally, and in-app purchases of virtual goods used by players of its free-to-play mobile games. When control of the promised products and services is transferred to the end users, the Company recognizes revenue in the amount that reflects the consideration it expects to receive in exchange for these products and services. Revenue from delivery of products is recognized at a point in time when the end consumers purchase the games, and the control of the license is transferred to them.

 

The virtual goods that the Company sells to players of our free-to-play mobile-games, include virtual currency or in-game purchases of additional game play functionality. For virtual goods, the satisfaction of our performance obligation is dependent on the nature of the virtual good purchased and as a result, the Company categorizes its virtual goods as follows:

 

  Consumable: consumable virtual items represent items that can be consumed by a specific player action. Consumable virtual items do not result in a direct benefit that the player keeps or provide the player any continuing benefit following consumption, and they often enable a player to perform an in-game action immediately. For the sale of consumable virtual items, the Company recognizes revenue as the items are consumed (i.e., over time).
     
  Durable: durable virtual items represent items that are accessible to the player over an extended period of time. The Company recognizes revenue from the sale of durable virtual items ratably over the estimated service period for the applicable game (i.e., over time), which represents our best estimate of the average life of the durable virtual item.

 

For the ARK: Survival Ascended DLC’s that have not yet launched and been reported in deferred revenue in the condensed consolidated balance sheets, the Company has used the adjusted market assessment approach per ASC 606-10-32-34 to assign a value for the Company’s remaining performance obligation. The Company uses the following reasonably available information in developing the standalone selling prices of the performance obligations:

 

  Reasonably available data points, including third party or industry pricing, and contractually stated prices.
     
  Market conditions such as market demand, competition, market constraints, awareness of the product and market trends.
     
  Entity-specific factors including pricing strategies and objectives, market share and pricing practices for bundled arrangements.

 

The Company recognizes revenue using the following five steps as provided by Accounting Standards Codification (“ASC”) Topic 606 Revenue from Contracts with Customers: 1) identify the contract(s) with the customer; 2) identify the performance obligations in each contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations; and 5) recognize revenue when, or as, the entity satisfies a performance obligation. The Company’s terms and conditions vary by customers and typically provide payment terms of net 30 to 75 days.

 

Principal vs. Agent Consideration

 

The Company offers certain software products via third-party digital storefronts, such as Microsoft’s Xbox Live, Sony’s PlayStation Network, Valve’s Steam, Epic Games Store, My Nintendo Store, Apple’s App Store, the Google Play Store, and retail distributors. For sales of our software products via third-party digital storefronts and retail distributor, the Company determines whether or not it is acting as the principal in the sale to the end user, which the Company considers in determining if revenue should be reported based on the gross transaction price to the end user or based on the transaction price net of fees retained by the third-party digital storefront. An entity is the principal if it controls a good or service before it is transferred to the customer. Key indicators that the Company uses in evaluating these sales transactions include, but are not limited to, the following:

 

  The underlying contract terms and conditions between the various parties to the transaction;
     
  Which party is primarily responsible for fulfilling the promise to provide the specified good or service; and
     
  Which party has discretion in establishing the price for the specified good or service.

 

F-7
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

Based on our evaluation of the above indicators, for sales arrangements via Microsoft’s Xbox Live, Sony’s PlayStation Network, Valve’s Steam, Epic Games Store, My Nintendo Store, and our retail distributor, the digital platforms and distributors have discretion in establishing the price for the specified good or service and the Company has determined it is the agent in the sales transaction to the end user and therefore the Company reports revenue on a net basis based on the consideration received from the digital storefront. For sales arrangements via Apple’s App Store and the Google Play Store, the Company has discretion in establishing the price for the specified good or service and it has determined that the Company is the principal to the end user and thus reports revenue on a gross basis and mobile platform fees charged by these digital storefronts are expensed as incurred and reported within cost of revenues.

 

Contract Balance

 

The Company records deferred revenue when cash payments are received or due in advance of its performance, even if amounts are refundable.

 

Deferred revenue is comprised of the transaction price allocable to the Company’s performance obligation on technical support and the sale of virtual goods available for in-app purchase, and payments received from customers prior to launching the games on the platforms. The Company recognizes revenues from the sale of virtual goods ratably over their estimated service period. The Company’s estimated service period for players of our current software games is generally 30 to 100 days from the date of purchase.

 

The Company has a long-term title license agreement with a platform. The agreement was initially made between the parties in November 2018 and valid through December 31, 2021. The agreement was subsequently amended in June 2020 to extend the ARK 1 availability on the platform perpetually, effective January 1, 2022 and to put ARK II on the platform for three years upon release. The Company recognized $2.5 million in revenue related to ARK 1’s perpetual license during the year ended December 31, 2022 and deferred $2.3 million related to ARK II that is included in the long-term portion of deferred revenue and will be recognized upon the release of ARK II on the platform.

 

In July 2023, the Company entered into a distribution agreement with its retail distribution partner for the distribution of ARK: Survival Ascended and ARK II. The initial term is two years and will renew each subsequent year unless it is cancelled. Upon executing the distribution agreement, the Company received $1.8 million as prepaid royalties. During the three months ended March 31, 2024, the Company recognized $0.3 million of the revenue. As of March 31, 2024, the Company reported $0.4 million related to ARK: Survival Ascended as current deferred revenue and $1.1 million related to ARK II as long-term deferred revenue until the disc releases occur.

 

Estimated Service Period

 

For certain performance obligations satisfied over time, the Company has determined that the estimated service period is the time period in which an average user plays our software games (“user life”) which most faithfully depicts the timing of satisfying our performance obligation. The Company considers a variety of data points when determining and subsequently reassessing the estimated service period for players of our software games. Primarily, the Company reviews the weighted average number of days between players’ first and last day playing online or the subscription trend. The Company also considers publicly available online trends.

 

The Company believes this provides a reasonable depiction of the transfer of our game related services to our players, as it is the best representation of the period during which our players play our software games. Determining the estimated service period is subjective and requires significant management judgment and estimates. Future usage patterns may differ from historical usage patterns, and therefore the estimated service period may change in the future. The estimated service periods for players of our current software games are generally between 30 and 100 days depending on the software games.

 

Shipping, Handling and Value Added Taxes (“VAT”)

 

The distributor, as the principal, is responsible for the shipping of the game discs to retail stores and incurring the shipping and VAT costs. The Company is paid the net sales amount after deducting shipping costs, VAT and other related expenses by the distributor.

 

F-8
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

Cost of Revenues

 

Cost of revenues include software license royalty fees, merchant fees, server and database center costs, game localization costs, game licenses, engine fees and amortization costs. Cost of revenues for the three months ended March 31, 2024 and 2023 were comprised of the following:

 

   2024   2023 
Software license royalties – related parties  $3,274,020   $2,863,011 
Software license royalties   162,748    352,439 
License and amortization – related parties   6,000,000    5,195,651 
License and amortization   201    201 
Merchant fees   221,449    459,471 
Engine fees   961,442    424,227 
Internet, server and data center   1,400,006    1,540,692 
Costs related to advertising revenue   21,832    25,245 
Total:  $12,041,698   $10,860,937 

 

General and Administrative Costs

 

General and administrative costs include rent, salaries, stock-based compensation, legal and professional expenses, administrative internet and server, contractor costs, insurance expense, licenses and permits, other taxes and travel expenses. These costs are expensed as they are incurred. For the three months ended March 31, 2024 and 2023, general and administrative expenses totaled $2,282,040 and $4,525,751, respectively. Stock-based compensation of ($862,634) and $152,595 was incurred during the three months ended March 31, 2024 and 2023, respectively.

 

Advertising and Marketing Costs

 

The Company expenses advertising and marketing costs as incurred. For the three months ended March 31, 2024 and 2023, advertising and marketing expenses totaled $141,030 and $104,549, respectively.

 

Research and Development

 

Research and development costs are expensed as incurred. Research and development costs include travel, payroll, and other general expenses specific to research and development activities. Research and development costs for the three months ended March 31, 2024 and 2023 were $1,776,522 and $1,373,797, respectively. Stock-based compensation of ($64,241) was incurred during the three months ended March 31, 2024; no stock-based compensation was incurred during the three months ended March 31, 2023.

 

Non-controlling Interests

 

Non-controlling interests on the condensed consolidated balance sheets and condensed consolidated statements of operations and comprehensive income (loss) include the equity allocated to non-controlling interest holders. As of March 31, 2024 and December 31, 2023, there were non-controlling interests with the following subsidiaries:

 

Subsidiary Name  Equity % Owned   Non-Controlling % 
Snail Innovative Institute   70%   30%
BTBX.IO, LLC   70%   30%
Donkey Crew, LLC   99%   1%

 

F-9
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

Cash and Cash Equivalents and Restricted Cash and Cash Equivalents

 

Cash is available for use in current operations or other activities such as capital expenditures and business combinations. Restricted cash and cash equivalents are time deposits, that are currently provided as a standby letter of credit to landlords. The Company’s policy for determining whether an item is treated as cash, or a cash equivalent, is based on its original maturity, liquidity, and risk profile. Investments with maturities of three months or less, are highly liquid and have insignificant risk are considered to be cash equivalents.

 

Restricted Escrow Deposits

 

Our restricted deposits held in escrow are to provide a source of funding for certain indemnification obligations of Snail, Inc. to our underwriters in connection with our IPO. The deposit and related interest earnings were restricted for one year from the IPO date and were released from restrictions in November 2023.

 

Accounts Receivable

 

The Company generally records a receivable related to revenue when it has an unconditional right to invoice and receive payment. Accounts receivable are carried at original invoice amount less an allowance made for credit losses. The Company uses a combination of quantitative and qualitative risk factors to estimate the allowance, including an analysis of the customers’ creditworthiness, historical experience, age of current accounts receivable balances, changes in financial condition or payment terms of our customers, and reasonable forecasts of the collectability of the accounts receivable. The Company evaluates the allowance for credit losses on a periodic basis and adjusts it as necessary based on the risk factors mentioned above. Any increase in the provision for credit losses is recorded as a charge to general and administrative expense in the current period. Any amounts deemed uncollectible are written off against the allowance for credit losses. Management judgment is required to estimate our allowance for credit losses in any accounting period. The amount and timing of our credit losses and cash collection could change significantly because of a change in any of the risk factors mentioned above. There were no credit losses recognized during the three months ended March 31, 2024 and 2023.

 

Fair Value Measurements

 

The Company follows Financial Accounting Standards Board (“FASB”) ASC Topic 820, Fair Value Measurements. ASC 820 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants.

 

ASC 820 establishes a hierarchy of valuation inputs based on the extent to which the inputs are observable in the marketplace. Observable inputs reflect market data obtained from sources independent of the reporting entity and unobservable inputs reflect the entity’s own assumptions about how market participants would value an asset or liability based on the best information available. Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value.

 

The following describes the hierarchy of inputs used to measure fair value and the primary valuation methodologies used by the Company for financial instruments measured at fair value.

 

The three levels of inputs are as follows:

 

  Level 1: Quoted prices in active markets for identical assets or liabilities that the Company has an ability to access as of the measurement date.
     
  Level 2: Inputs that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the same term of the assets or liabilities.
     
  Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

F-10
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Our financial instruments include cash and cash equivalents, restricted cash and cash equivalents, short-term financial instruments, short-term loans, accounts receivable and accounts payable. The carrying values of these financial instruments approximate their fair value due to their short maturities or economic substance. The carrying amount of our revolving loan and notes payable approximates fair value because the interest rates on these instruments approximate the interest rate on debt with similar terms available to us for a similar duration. The fair value of the Company’s promissory note which has a fixed rate for 5 years, then a floating rate that approximates the Wall Street Journal Prime Rate plus 0.50%. The Company considers the carrying amount of the loan to approximate fair value as the discounted cost in comparison to market rates would not be materially different than the cost to acquire a loan with similar terms. The fair value of the Company’s convertible notes is disclosed in Note 16, and the Company’s warrant liability and derivative instruments are valued at fair value each reporting period, using level 3 inputs and the Monte-Carlo pricing model. The most significant of the inputs are the stock price, exercise price, contractual term, volatility, and the risk-free rate. The Company does not have any other assets or liabilities measured at fair value on a recurring or non-recurring basis as of March 31, 2024 and December 31, 2023.

 

Amortizable Intangibles and Other Long-lived Assets

 

The Company’s long-lived assets and other assets consisting of property, plant and equipment and purchased intangible assets, are reviewed for impairment in accordance with the guidance of FASB Topic ASC 360, Property, Plant, and Equipment. Intangible assets subject to amortization are carried at cost less accumulated amortization and amortized over the estimated useful life in proportion to the economic benefits received. The Company evaluates the recoverability of definite-lived intangible assets and other long-lived assets in accordance with ASC Subtopic 360-10, which generally requires the assessment of these assets for recoverability when events or circumstances indicate a potential impairment exists. The Company considers certain events and circumstances in determining whether the carrying value of identifiable intangible assets and other long-lived assets, other than indefinite lived intangible assets, may not be recoverable including, but not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; and changes in the Company’s business strategy. If the Company determines that the carrying value may not be recoverable, the Company estimates the undiscounted cash flows to be generated from the use and ultimate disposition of the asset group to determine whether an impairment exists. If an impairment is indicated based on a comparison of the asset groups’ carrying values and the undiscounted cash flows, the impairment loss is measured as the amount by which the carrying amount of the asset group exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. There can be no assurance, however, that market conditions will not change or demand for the Company’s products under development will continue. Either of these could result in future impairment of long-lived assets. Actual useful lives and cash flows could be different from those estimated by management which could have a material effect on our consolidated reporting results and financial positions.

 

Income Taxes

 

Income taxes are provided for the tax effects of transactions reported in the condensed consolidated financial statements and consisted of taxes currently due and deferred taxes. Deferred taxes are recognized for the differences between the basis of assets and liabilities for financial statement and income tax purposes.

 

The Company follows FASB Topic ASC 740, Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns.

 

Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

 

FASB ASC 740-10-25 provides criteria for the recognition, measurement, presentation, and disclosure of uncertain tax positions. The Company must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The Company recognizes liabilities for uncertain tax positions pursuant to FASB ASC 740-10-25. Such amounts are included in the long-term accrued expenses on the accompanying condensed consolidated balance sheets in the amount of $254,731 as of March 31, 2024 and December 31, 2023. The Company accrues and recognizes interest and penalties related to unrecognized tax benefits in operating expenses.

 

F-11
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

Concentration of Credit Risk and Significant Customers

 

The Company maintains cash balances at several major financial institutions. While the Company attempts to limit credit exposure with any single institution, balances often exceed insurable amounts. As of March 31, 2024 and December 31, 2023, the Company had deposits of $15,410,350 and $14,716,652, respectively, that were not insured by the Federal Deposit Insurance Corporation and are included in the cash and cash equivalents, and restricted cash and cash equivalents, in the accompanying condensed consolidated balance sheets.

 

The Company extends credit to various digital resellers and partners. Collection of trade receivables may be affected by changes in economic or other industry conditions and may, accordingly, impact our overall credit risk. The Company does not require collateral or other security to support financial instruments subject to credit risk. The Company performs ongoing credit evaluations of customers and maintains reserves for potentially uncollectible accounts. The Company had three customers as of March 31, 2024, and four customers as of December 31, 2023, who accounted for approximately 72% and 95% of consolidated gross receivables, respectively. Among the three customers as of March 31, 2024, and four customers as of December 31, 2023, each customer accounted for 34%, 21%, and 17% as of March 31, 2024, and 43%, 20%, 16% and 16% as of December 31, 2023 of the consolidated gross receivables outstanding. During the three months ended March 31, 2024 and 2023, approximately 62% and 70%, respectively, of net revenue was derived from these customers. The Company had four customers in the three months ended March 31, 2024, and three customers in the three months ended March 31, 2023, that accounted for 37%, 15%, 13% and 11%, and 36%, 18% and 10% of the Company’s net revenue, respectively. The loss of these customers or declines in the forecasts of their accounts receivable collectability would have a significant impact on the Company’s financial performance.

 

As of March 31, 2024 and December 31, 2023, the Company had one vendor who accounted for approximately 73% and one vendor who accounted for approximately 69% of consolidated gross payables, respectively. The loss of these vendors could have a significant impact on the Company’s financial performance and regulatory compliance.

 

The Company had one vendor, SDE, a related party, that accounted for 66% and 58% of the Company’s combined cost of revenues and operating expenses during the three months ended March 31, 2024 and 2023, respectively. Amounts payable to SDE are included in accounts payable - related parties in the consolidated balance sheets as of March 31, 2024 and December 31, 2023. The loss of SDE as a vendor would significantly and adversely affect the Company’s core business.

 

Recently Issued Accounting Pronouncements

 

In August 2020, the FASB issued ASU 2020-06, Contracts in Entity’s Own Equity (Subtopic 815-40) – Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, to simplify the application of GAAP for certain financial instruments with characteristics of liabilities and equity. The FASB decided to eliminate certain accounting models to simplify the accounting for convertible instruments, reduce complexity for preparers and practitioners, and improve the decision usefulness and relevance of the information provided to financial statement users. The FASB also amended the guidance for derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusion and amended the related earnings per share guidance. The Company has adopted this standard on January 1, 2024 and it did not have a material impact on the Company’s financial statements.

 

In October 2023, the FASB issued ASU 2023-06, Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative, to clarify or improve disclosure and presentation requirements of a variety of topics. Certain of the amendments represent clarifications to or technical corrections of the current requirements. Many of the amendments allow users to more easily compare entities subject to the SEC’s existing disclosures with those entities that were not previously subject to the SEC’s requirements. ASU 2023-06 is effective for companies subject to the SEC’s disclosure requirements. The effective date for each amendment will be the date on which the SEC’s removal of that related disclosure from Regulation S-X or Regulation S-K becomes effected. For all other entities the amendments will be effective two years. The Company expects the implementation of this standard to require modification of certain disclosures and we do not expect the standard to have a material impact on the Company’s financial statements.

 

In November 2023, the FASB issued ASU 2023-07, Improvements to Reportable Segment Disclosure (Topic 280), to improve financial reporting by requiring disclosure of incremental segment information on an annual and interim basis for all public entities. The update does not change how a public entity identifies its operating segments, aggregates those operating segments, or applied the quantitative thresholds to determine its reportable segments. The amendments in this update are effective for fiscal years beginning after December 15, 2023, and interim periods beginning after December 15, 2024. The Company is evaluating the impact of adopting the new standard.

 

In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures, to improve the transparency of income tax disclosures requiring consistent categories and greater disaggregation of information in the rate reconciliation and income taxes paid disaggregated by jurisdiction. The amendments in the update requires that public business entities, on an annual basis, disclose specific categories in the rate reconciliation and provide additional information for reconciling items that meet a quantitative threshold. The amendments in this update are effective for annual periods beginning after December 15, 2024. The Company is evaluating the impact of adopting the new standard.

 

F-12
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

Employee Savings Plans

 

The Company maintains a 401(k) for its United States based employees. The plan is offered to all eligible employees to make voluntary contributions. Employer contributions to the plan are reported under general and administrative costs in the amounts of $24,274 and $26,619 for the three months ended March 31, 2024 and 2023, respectively.

 

Stock-Based Compensation

 

The Company recognizes compensation cost for stock-based awards to employees based on the awards’ estimated grant-date fair value using a straight-line approach over the service period for which such awards are expected to vest. The Company accounts for forfeitures as they occur. The Company did not issue any restricted stock units (“Restricted Stock Units” or “restricted stock units”) during the three months ended March 31, 2024, and 2023. The fair value of Restricted Stock Units is determined based on the quoted market price of our common stock on the date of grant.

 

The Company’s 2022 Omnibus Incentive Plan (the “2022 Plan”) became effective upon the consummation of the IPO. The 2022 Omnibus Incentive allows us to grant options to purchase our common stock and to grant stock options, stock appreciation rights, restricted stock, restricted stock units and performance awards and other cash-based awards and other stock-based awards to our employees, officers, and directors, up to a maximum of 5,718,000 shares. Stock options may be granted to employees and officers and non-qualified options may be granted to employees, officers, and directors, at not less than the fair market value on the date of grant. The number of shares of common stock available for issuance under the 2022 Plan will be increased annually on the first day of each fiscal year during the term of the 2022 Plan, beginning with the 2023 fiscal year, by an amount equal to the lesser of (a) 5,718,000 shares, (b) 1% of the shares of the Company’s Class B common stock outstanding (on a fully diluted basis) on the final day of the immediately preceding calendar year or (c) such smaller number of shares as determined by the Company’s board of directors. As of March 31, 2024, and December 31, 2023, there were 4,487,675 shares reserved for issuance under the 2022 Plan.

 

Restricted Stock Units

 

The Company granted restricted stock units under our 2022 Omnibus Incentive Plan to employees and directors. Restricted stock units are unfunded, unsecured rights to receive common stock upon the satisfaction of certain vesting criteria. Upon vesting, a number of shares of common stock equivalent to the number of restricted stock units is typically issued net of required tax withholding requirements, if any. Restricted stock units are subject to forfeiture and transfer restrictions. For the three months ended March 31, 2024 and 2023, stock-based compensations expenses amounted to ($926,875) and $152,595, respectively.

 

Warrants

 

In connection with the IPO, offering costs related to legal, accounting, and underwriting costs were net with the proceeds and recorded as a reduction in additional paid in capital, in the stockholders’ equity section of the consolidated balance sheets. The Company also issued Underwriters Warrants (as defined below) for services provided during the IPO to purchase 120,000 shares of Class A common stock. The Underwriters Warrants are accounted for as equity instruments and are included in the stockholders’ equity section of the condensed consolidated balance sheets. The fair value of the Underwriters Warrants has been estimated using the Black-Scholes option pricing model.

 

On August 24, 2023, the Company issued warrants in connection with its convertible debt for the purchase of 714,285 shares (the “Convertible Note Warrants”). The Convertible Note Warrants are accounted for as a liability and are included in the accrued expenses and other liabilities in the condensed consolidated balance sheets. The Convertible Note Warrants may require partial cash settlement in the future, include various adjustment provisions, meet the definition of a derivative and are classified as a liability, as such the warrants are measured at fair value in accordance with ASC 815 – “Derivatives and Hedging”. The fair value of the Convertible Note Warrants has been estimated using the Monte-Carlo pricing model. For more information regarding convertible notes and related warrants see Note 16 - Equity.

 

On August 24, 2023, the Company issued a warrant to an investor (the “Equity Line Warrant”) for the purchase of 367,647 shares of Class A common stock in consideration of the investor’s commitment to purchase Class A common stock. The fair value of the Equity Line Warrant is recorded as a warrant liability and is included in the accrued expenses and other liabilities in the Company’s condensed consolidated balance sheets. The Equity Line Warrants may require partial cash settlement in the future, include various adjustment provisions, meet the definition of a derivative and are classified as a liability, as such the warrants are measured at fair value in accordance with ASC 815 – “Derivatives and Hedging”. The fair value of the Equity Line Warrants has been estimated using the Monte-Carlo pricing model using level 3 inputs. The most significant of the inputs used are the underlying stock price, the exercise price, the contractual term, volatility and the risk-free rate. For more information regarding equity line and related warrants see Note 16 – Equity.

 

Share Repurchase Program

 

On November 10, 2022, the Company’s board of directors authorized a share repurchase program under which the Company may repurchase up to $5 million of outstanding shares of Class A common stock of the Company, subject to ongoing compliance with the Nasdaq listing rules. The program does not have a fixed expiration date. Repurchased shares are accounted for at cost and reported as a reduction of equity in the condensed consolidated balance sheets under treasury stock. No treasury stock was sold during the three months ended March 31, 2024 and 2023. As of March 31, 2024 and 2023, 1,350,275 shares of Class A common stock were repurchased pursuant to the Share Repurchase Program for an aggregate purchase price of approximately $3.7 million. The average price paid per share was $2.72 and approximately $1.3 million aggregate amount of shares of Class A common stock remain available for repurchase under the Share Repurchase Program.

 

F-13
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

Loss Per Share

 

Loss per share (“EPS”) is calculated by dividing the net loss that is applicable to the common stockholders for the period by the weighted average number of shares of common stock during that period. The diluted EPS for the period is calculated by dividing the net loss applicable to common stockholders for the period by the weighted average number of shares of common stock and common stock equivalents outstanding during the period. The Company’s common stock equivalents are measured using the treasury stock method and represent unvested restricted stock units and warrants. The Company issues two classes of common stock with differing voting rights, and as such, reports EPS using the dual class method. For more information see Note 15 –Loss Per Share.

 

Dividend Restrictions

 

Our ability to pay cash dividends is currently restricted by the terms of our credit facilities.

 

NOTE 3 – REVENUE FROM CONTRACTS WITH CUSTOMERS

 

Disaggregation of revenue

 

Timing of recognition

 

The Company recognizes revenue at a point in time for performance obligations that are met at the time of sale or over a period based on the estimated service period of the product, additional performance obligations, or timing of releases. Net revenue by timing of recognition during the three months ended March 31, 2024 and 2023 were as follows:

 

   2024   2023 
Over time  $2,535,834   $1,936,375 
Point in time   11,579,895    11,522,113 
Total revenue from contracts with customers:  $14,115,729   $13,458,488 

 

Geography

 

The Company attributes net revenue to geographic regions based on customer location. Net revenue by geographic region for the three months ended March 31, 2024 and 2023 were as follows:

 

   2024   2023 
United States  $11,898,607   $11,777,874 
International   2,217,122    1,680,614 
Total revenue from contracts with customers:  $14,115,729   $13,458,488 

 

Platform

 

Net revenue by platform for the three months ended March 31, 2024 and 2023 were as follows:

 

   2024   2023 
Console  $6,002,817   $5,773,590 
PC   5,104,723    5,012,180 
Mobile   962,941    1,718,032 
Other   2,045,248    954,686 
Total revenue from contracts with customers:  $14,115,729   $13,458,488 

 

Distribution channel

 

Our products are delivered through digital online services (digital download, online platforms, and cloud streaming), mobile, and retail distribution and other. Net revenue by distribution channel for the three months ended March 31, 2024 and 2023 was as follows:

 

   2024   2023 
Digital  $11,107,540   $10,785,770 
Mobile   962,941    1,718,032 
Physical retail and other   2,045,248    954,686 
Total revenue from contracts with customers:  $14,115,729   $13,458,488 

 

Other Revenues

 

As discussed in Note 14, the Company recognized the $1.2 million payment related to the Angela Games settlement upon satisfaction of performance obligations included in the contract. This amount is included in other revenues.

 

F-14
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

Deferred Revenue

 

The Company records deferred revenue when payments are due or received in advance of the fulfillment of our associated performance obligations; reductions to deferred revenue balance were primarily due to the recognition of revenue upon fulfillment of its performance obligations, which were in the ordinary course of business. As of March 31, 2024, the balance of deferred revenue was $39.0 million, of which $37.5 million is due to non-refundable payments. The Company is expecting to recognize $17.1 million of the non-refundable payments in the next 12 months through the platform releases of certain DLCs, $0.6 million upon the launch of Myth of Empires in China, $13.4 million of non-refundable payments in the next 12 to 24 months through the release of DLC’s and additional ARK titles. The remaining $3.8 million of current non-refundable deferred revenues and $2.6 million of long term non-refundable deferred revenue will be recognized as revenue primarily on a straight-line basis over the next 60 months, based on our estimates of technical support obligations, the usage of consumable virtual goods and estimated period of time an end user will play the game. The Company’s refundable deferred revenue consists of the advance payments received in accordance with the agreement the Company has made with its retail distributor. The Company expects to recognize $0.4 million in the next 12 months and the remainder of $1.1 million in fiscal year 2025. Activities in the Company’s deferred revenue as of March 31, 2024 and 2023 were as follows:

  

   2024   2023 
Deferred revenue, beginning balance in advance of revenue recognition billing  $34,316,706   $9,551,446 
Revenue recognized   (2,535,834)   (453,223)
Revenue deferred   7,259,296    302,094 
Deferred revenue, ending balance   39,040,168    9,400,317 
Less: current portion   (21,937,421)   (4,517,573)
Deferred revenue, long term  $17,102,747   $4,882,744 

 

NOTE 4 – CASH AND CASH EQUIVALENTS, AND RESTRICTED CASH AND CASH EQUIVALENTS

 

Cash equivalents are valued using quoted market prices or other readily available market information. The Company has restricted cash and cash equivalents of $1,117,310 and $1,116,196 as of March 31, 2024 and December 31, 2023, respectively. The amounts of restricted cash and cash equivalents held as of March 31, 2024, are to secure the standby letter of credit with landlords and the amounts of restricted cash and cash equivalents as of March 31, 2023, were held as security for the debt with a financial institution (see Note 11 — Revolving Loan, Short Term Note, and Long-Term Debt) and to secure standby letters of credit with landlords. On June 21, 2023, the Company amended its revolving loan and $5,273,391 of restricted cash and cash equivalents was released. The following table summarizes the components of the Company’s cash and cash equivalents, and restricted cash and cash equivalents as of March 31, 2024 and 2023:

 

   2024   2023 
Cash and cash equivalents  $16,068,729   $4,108,251 
Restricted cash and cash equivalents   1,117,310    6,380,657 
Cash and cash equivalents, and restricted cash and cash equivalents  $17,186,039   $10,488,908 

 

NOTE 5 – ACCOUNTS RECEIVABLE (PAYABLE) – RELATED PARTY

 

Accounts receivable — related party represents receivables in the ordinary course of business attributable to certain mobile game revenues that, for administrative reasons, were collected by a related party and that the related party has not yet remitted back to the Company. Accounts receivable — related party is non-interest bearing and due on demand. The related party, SDE Inc. (“SDE”), is 100% owned and controlled by the wife of the Founder, Co-Chief Executive Officer, Chief Strategy Officer and Chairman of the Company. In January 2024, the Company entered into an offset agreement with SDE. The Company has the right to offset payables due to the related party for royalties, internet, server, and datacenter costs (“IDC”) and marketing costs as they are determinable, mutual, and the right is enforceable by law. The Company will offset $0.5 million per month, or $6.0 million annually, beginning in January 2024, until the receivable has been collected or offset in full. To reflect the timing of the offset agreement, a portion of the SDE receivable is presented as a long-term asset. During the three months ended March 31, 2024, the Company made cash payments to SDE in the amount of $16.8 million and anticipates continuing to make cash payment to SDE in future years. As of March 31, 2024 and December 31, 2023, the outstanding balance of net accounts receivable from related party was as follows:

 

   2024   2023 
Accounts receivable – related party  $12,000,592   $13,500,592 
Less: accounts payable – related party – SDE   (3,414,787)   (10,946,478)
Net accounts receivable, related party - SDE   8,585,805    2,554,114 
Less: accounts receivable – related party, net of current portion   6,000,592    7,500,592 
Net accounts receivable (payable), related party, current - SDE  $2,585,213   $(4,946,478)

 

F-15
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

NOTE 6 – PREPAID EXPENSES - RELATED PARTY

 

On March 10, 2023, the Company amended its exclusive software license agreement with SDE relating to the ARK franchise. For DLC’s, the Company plans to release during the term of the agreement, the Company has the option to pay the $5.0 million DLC payment in whole or in part, when paid in advance; or in full, upon the DLC release. No payment for any DLC under this agreement will exceed $5.0 million.

 

During the three months ended March 31, 2024, the Company made $1.4 million in prepaid royalty payments related to ARK: Survival Ascended DLC’s which have not yet been released. During the year ended December 31, 2023, the Company prepaid $2.5 million for exclusive license rights for an ARK: Survival Ascended DLC to SDE and $5.5 million in prepaid royalties related to ARK: Survival Ascended DLC’s which have not yet been released. Prepaid expenses — related party consisted of the following as of March 31, 2024 and December 31, 2023:

 

   2024   2023 
Prepaid royalties  $7,483,120   $6,086,406 
Prepaid licenses   7,500,000    7,500,000 
Other prepaids   197,184    242,060 
Prepaid expenses - related party, ending balance   15,180,304    13,828,466 
Less: short-term portion   (4,337,556)   (6,044,404)
Total prepaid expenses - related party, long-term  $10,842,748   $7,784,062 

 

The amount classified as short-term, as of March 31, 2024, includes prepaid royalties for ARK: Survival Ascended DLC’s which have not yet been released and various operational software licenses obtained through SDE.

 

NOTE 7 – PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets consisted of the following as of March 31, 2024 and December 31, 2023:

 

   2024   2023 
Other receivables  $1,814,274   $- 
Deferred offering costs   105,411    105,411 
Other prepaids   56,921    70,967 
Other current assets   442,595    463,315 
Total prepaid expenses and other current assets  $2,419,201   $639,693 

 

F-16
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

NOTE 8 – PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment, net consisted of the following as of March 31, 2024 and December 31, 2023:

 

   2024   2023 
Building  $1,874,049   $1,874,049 
Land   2,700,000    2,700,000 
Building improvements   1,010,218    1,010,218 
Leasehold improvements   1,537,775    1,537,775 
Autos and trucks   178,695    178,695 
Computer and equipment   1,809,214    1,809,214 
Furniture and fixtures   411,801    411,801 
Property, plant and equipment, gross   9,521,752    9,521,752 
Accumulated depreciation   (4,922,024)   (4,839,686)
Property, plant and equipment, net  $4,599,728   $4,682,066 

 

Depreciation and amortization expense was $82,338 and $115,060 for the three months ended March 31, 2024 and 2023, respectively. The Company did not have any disposals in the three months ended March 31, 2024 or 2023.

 

F-17
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

NOTE 9 – ACCOUNTS PAYABLE — RELATED PARTIES

 

Accounts payable due to related parties represents payables in the ordinary course of business primarily for purchases of game distribution licenses, research and development costs and also the royalties due to Suzhou Snail and SDE. As of March 31, 2024 and December 31, 2023, the Company had $16,951,062 and $18,147,958, respectively, as accounts payable due to Suzhou Snail; and $4,946,478, as net accounts payable due to SDE as of December 31, 2023, see Note 5 — Accounts Receivable (Payable) — Related Party. During the three months ended March 31, 2024 and 2023, the Company incurred $47,105 and $72,524, respectively as license costs due to Suzhou Snail and included in cost of revenues. In March 2024, the Company entered into a development agreement with Suzhou Snail, to outsource the completion of an internal project, Hermes. Under the terms of the agreement, Suzhou Snail will outsource the labor needed to complete the development of an internal project and provide technical support for a period of twelve months. In consideration, the Company will pay Suzhou Snail twelve equal monthly payments of $253,000. During the three months ended March 31, 2024 the Company incurred $759,000 of research and development costs passed through Suzhou Snail, there were no such costs passed through Suzhou Snail during the three months ended March 31, 2023. During the three months ended March 31, 2024 and 2023, respectively, there were $1,575,000 and $450,000 in payments to Suzhou Snail for royalties and research and development costs. Accounts payable – related parties consisted of the following as of March 31, 2024 and December 31, 2023:

 

   2024   2023 
Accounts payable - Suzhou  $54,565,974   $55,762,870 
Less: accounts receivable - Suzhou   (37,614,912)   (37,614,912)
Accounts payable - SDE   -    4,946,478 
Total accounts payable – related parties  $16,951,062   $23,094,436 

 

NOTE 10 – LOAN AND INTEREST RECEIVABLE — RELATED PARTY

 

In February 2021, the Company loaned $200,000 to a wholly owned subsidiary of Suzhou Snail. The loan bears 2.0% per annum interest, interest and principal are due in February 2022. In February 2022, Suzhou Snail signed an agreement with this subsidiary and assumed the loan and related interest for a total of $203,890. Subsequently, $103,890 was offset against the loan and interest payable owed to Suzhou Snail on a separate note. The total amount of loan and interest receivable — related party was $104,252 and $103,753, as of March 31, 2024 and December 31, 2023, respectively. The Company earned $499 and $493 in interest on the related party loans receivable during the three months ended March 31, 2024 and 2023, respectively.

 

F-18
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

NOTE 11 – REVOLVING LOAN, SHORT TERM NOTES AND LONG - TERM DEBT

 

   March 31, 2024   December 31, 2023 
2021 Revolving Loan - On June 21, 2023, the Company amended its revolving loan agreement (“amended revolver”) and decreased the maximum balance from $9,000,000 to $6,000,000. The amended revolver matures on December 31, 2024 and has an annual interest rate equal to the prime rate less 0.25%. At March 31, 2024, the interest rate on this loan was 8.25%. Debt covenants of this loan require the Company to maintain a minimum debt service coverage ratio of at least 1.5 to 1. The Company was not in compliance with the debt service coverage ratio for the trailing twelve month period ended March 31, 2024 and received a waiver for the debt service coverage ratio requirement for the period ended March 31, 2024.  $3,000,000   $6,000,000 
2021 Promissory Note – On June 17, 2021, the Company amended its loan agreement to reduce the principal amount with financial institution for 10 years, annual interest rate of 3.5% for the first 5 years, and then floating at Wall Street Journal rate from years 6 to 10. The loan is secured by the Company’s building, with a carrying value of $4.2 million, and matures on June 30, 2031. The note is subject to a prepayment penalty. Debt covenants of this loan require the Company to maintain a minimum debt service coverage ratio of at least 1.5 to 1. The Company was not in compliance with the debt service coverage ratio for the trailing twelve month period ended March 31, 2024 and received a waiver for the debt service coverage ratio requirement for the period ended March 31, 2024.   2,791,438    2,811,923 
2022 Short Term Note - On January 26, 2022, the Company amended its revolving loan and long-term debt agreements to obtain an additional note with a principal balance of $10,000,000 which was originally set to mature on January 26, 2023. Interest was equal to the higher of 3.75% or the Wall Street Journal Prime Rate plus 0.50%. The loan was secured by the Company’s assets. In the event of a default, all outstanding amounts under the note would bear interest at a default rate equal to 5% over the note rate. Debt covenants of this loan required the Company to maintain a minimum debt service coverage ratio of at least 1.5 to 1 and would be measured quarterly. In November 2022, the maturity was extended to January 26, 2024 and at December 31, 2023, the interest rate on this loan was 8.25%. The Company repaid the balance of $833,333 during the three month period ended March 31, 2024.   -    833,333 
2023 Convertible Notes – On August 24, 2023, the Company issued convertible notes at a 7.4% discount and a principal balance of $1,080,000. The notes have an interest rate of 7.5%, will be paid in consecutive monthly installments beginning February 24, 2024 and will mature on May 24, 2024. In the event of a default the interest rate will be increased to the lower of 16% per annum or the highest amount permitted by applicable law. The Company has the option to prepay the notes at any time and the note holders have the option to convert the notes, in whole or in part, at any time. The Company recognized a discount of $678,254 on the notes to account for the stated discount, the fair value of the warrants issued in connection with the notes and the costs of issuance. The discount is amortized using the effective interest rate of 103.4%.   750,450    1,080,000 
2023 Note Payable – In July 2023, the Company entered into a cooperation agreement with its internet, server and datacenter vendor. The Company agreed to make the vendor the official server host of Ark: Survival Evolved and future iterations and sequels of the game for a period of 7 years. In return the vendor has agreed to provide the Company with funds in cash of up to $3.0 million without discount and free of charges and costs to the Company. The funds are repaid based on 20% of the gross monthly ARK: Survival Ascended revenues. The Company has imputed interest at 8.0% on draws made. If in default, the interest rate is levied on the outstanding balances at a rate of 12.0% per annum. The Company repaid the balance of $1.5 million during the three month period ended March 31, 2024.    -    1,500,000 
Total debt    6,541,888    12,225,256 
Less: discount on convertible notes    48,166    282,639 
Less: current portion of promissory note   2,791,438    2,811,923 
Less: revolving loan    3,000,000    6,000,000 
Less: notes payable    -    2,333,333 
Less: convertible notes, net of discount     702,284    797,361 
Total long-term debt   $-   $- 

 

Total interest expense for the above debt and revolver loan amounted to $395,964 and $294,245 for the three months ended March 31, 2024 and 2023, respectively. Accretion of the convertible notes and amortization of loan origination expenses and loan discounts of $294,683 and $8,911 are included as part of interest expense for the three months ended March 31, 2024 and 2023, respectively. The Company has a weighted average interest rate of 8.0% and 8.1% on its short-term obligations as of March 31, 2024 and December 31, 2023, respectively. The Company is in compliance with, or received waivers for, its debt covenant requirement of maintaining a 1.5 to 1 ratio of trailing twelve month EBITDA to the previous twelve months principal and interest payments on all debt maintained with the lender, as of March 31, 2024 and December 31, 2023.

 

F-19
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

The following table provides future minimum payments of its long-term debt as of March 31, 2024:

 

Years ending December 31,  Amount 
Remainder of 2024  $3,819,340 
2025   86,013 
2026   89,115 
2027   92,329 
2028   95,414 
Thereafter   2,359,677 
Long term debt  $6,541,888 

 

NOTE 12 – INCOME TAXES

 

The Company recognized an income tax benefit of $477,950 and $805,818 for the three months ended March 31, 2024 and 2023, respectively. The Company’s effective tax rates were 21% and 21%, for the three months ended March 31, 2024 and 2023, respectively. As of March 31, 2023 the Company’s effective tax rate did not differ from the federal statutory rate of 21%.

 

The Company has assessed all available positive and negative evidence of whether sufficient future taxable income will be generated to realize the deferred tax assets, including the results of recent operations and projections of future taxable income. After evaluating the positive and negative evidence, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. In the event that negative evidence outweighs positive evidence in future periods, the Company may need to record additional valuation allowance, which could have a material impact on our financial position. The Company continues to maintain a valuation allowance against certain deferred tax assets that are not more likely than not to be realized.

 

F-20
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

NOTE 13 – OPERATING LEASE RIGHT-OF-USE ASSETS

 

The Company’s right-of-use assets represent arrangements related primarily to office facilities used in the ordinary business operations of the Company and its subsidiaries. In April 2018, a commercial bank issued an irrevocable standby letter of credit on behalf of the Company to the landlord for $1,075,000 to lease office space. The standby letter of credit was valid for a one-year term and was amended in January 2021 to extend to January 31, 2026. As of March 31, 2024 and December 31, 2023, the Company’s net operating lease right-of-use assets amounted to $2,138,285 and $2,440,690, respectively. The Company had variable lease payments of approximately $27,332 and $24,510 during the three months ended March 31, 2024 and 2023, respectively, which consisted primarily of common area maintenance charges and administrative fees.

 

Operating lease costs included in the general and administrative expenses in our condensed consolidated statements of operations and comprehensive loss for the three months ended March 31, 2024 and 2023, are as follows:

 

   2024   2023 
Operating lease costs  $396,515   $397,562 

 

Supplemental information related to operating leases for lease liabilities as of March 31, 2024 and March 31, 2023, is as follows:

   2024   2023 
Cash paid for amounts included in the measurement of lease liabilities  $400,662   $385,254 
Weighted average remaining lease term   1.7 years    2.7 years 
Weighted average discount rate   5.00%   5.00%

 

Future undiscounted lease payments for operating leases and a reconciliation of these payments to our operating lease liabilities as of March 31, 2024 are as follows:

 

Years ending December 31,  Future lease payments   Imputed Interest Amount   Lease Liabilities 
Remainder of 2024  $1,210,182   $72,374   $1,137,808 
2025   1,453,784    28,290    1,425,494 
Thereafter            
Total future lease payments  $2,663,966   $100,664   $2,563,302 

 

NOTE 14 – COMMITMENTS AND CONTINGENCIES

 

Litigation

 

The Company is subject to claims and contingencies related to lawsuits and other matters arising out of the normal course of business. In addition, the Company may receive notifications alleging infringement of patent or other intellectual property rights. The Company has elected to expense legal costs associated with legal contingencies as incurred.

 

F-21
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

On December 1, 2021, the Company and Studio Wildcard sent a notice of claimed infringement (the “DCMA Takedown Notice”) to Valve Corporation, which operates the Steam platform, pursuant to the Digital Millennium Copyright Act (“DCMA”). The DCMA Takedown Notice concerned a videogame titled Myth of Empires, which was developed by Suzhou Angela Online Game Technology Co., Ltd. (“Angela Game”) and published by Imperium Interactive Entertainment Limited (“Imperium”).

 

On December 9, 2021, Angela Game and Imperium sued the Company and Studio Wildcard in the United States District Court for the Central District of California (the “District Court”) in response to the DCMA Takedown Notice. The lawsuit sought a declaratory judgment on non-liability for copyright infringement and non-liability for trade secret misappropriation, as well as unspecified damages for alleged misrepresentations in the DCMA Takedown Notice. Angela Game and Imperium also filed an application for a temporary restraining order asking the court to order us and Studio Wildcard to rescind the DCMA Takedown Notice so that Steam could reinstate Myth of Empires for download. On December 20, 2021, the Company and Studio Wildcard filed an answer to the complaint, which included counterclaims against Angela Game and Imperium and a third-party complaint against Tencent seeking unspecified damages resulting from the alleged copyright infringement and misappropriation of trade secrets in connection with the ARK: Survival Evolved source code.

 

On September 8, 2023, the Company entered into a settlement agreement with Angela Game. The settlement agreement includes an upfront payment from Angela Game to the Company plus ongoing payments. The upfront payment of $1.2 million was recorded as deferred revenue as of December 31, 2023, and recognized upon the satisfaction of performance obligations during the three months ended March 31, 2024.

 

On March 14, 2023, Bel Air Soto, LLC (“Plaintiff”) filed suit in the Superior Court of California, County of Los Angeles, against Snail Games USA Inc. and INDIEV, an affiliate company that is owned by Mr. Hai Shi, the Company’s Founder, Co-Chief Executive Officer, Chief Strategy Officer, and Chairman, for breach of contract and related claims arising out of a commercial lease for premises located in Los Angeles County. Plaintiff alleges that the defendants exercised an option to extend the lease and was harmed when defendants instead terminated the lease and vacated the premises. The complaint seeks damages in excess of $3 million. Snail Games USA Inc. disputes the allegations and the amount of damages. The Company has responded to the complaint with an answer and cross-complaint. The cross-complaint seeks return for the $130,000 security deposit. The landlord has answered and denied the allegations of the cross-complaint. The Company intends to vigorously defend against the claims asserted. Trial is presently scheduled to commence in December 2024.

 

On April 21, 2023, Snail Games USA Inc. entered into an indemnity and reimbursement agreement with INDIEV, dated as of April 1, 2023, pursuant to which INDIEV agrees to assume all obligations and liabilities pursuant to the lease and indemnify and reimburse Snail Games USA Inc. for any amounts, damages, expenses, costs or other liability incurred by Snail Games USA Inc. arising under or pursuant to the lease or relating to the premises.

 

In October 2023, INDIEV has filed for bankruptcy and the Company does not expect to recover its costs from INDIEV. Accordingly, it is uncertain whether INDIEV would be able to indemnify the Company due to its bankruptcy. At this time, the Company is unable to quantify the magnitude of the potential loss should the plaintiffs’ lawsuit succeed and accordingly no accrual for loss has been recorded in the accompanying financial statements.

 

F-22
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

NOTE 15 –LOSS PER SHARE

 

The Company uses the two class method to compute its basic loss per share (“Basic EPS”) and diluted loss per share (“Diluted EPS”). The following table summarizes the computations of basic EPS and diluted EPS. The allocation of earnings between Class A and Class B shares is based on their respective economic rights to the undistributed earnings of the Company. Basic EPS is computed as net loss divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur using the treasury stock and if-converted methods. The restricted stock units, underwriters warrants and warrants issued in connection with the convertible debt and equity line of credit were excluded from the treasury stock method computation of diluted shares as their inclusion would have had an antidilutive effect for the three months ended March 31, 2024 and 2023. The convertible notes were excluded from the if-converted method computation of diluted shares as their inclusion would have had an antidilutive effect for the three months ended March 31, 2024. There were no such exclusions made in the 2023 calculation. The following table provides a reconciliation of the weighted average number of shares used in the calculation of Basic and Diluted EPS.

 

   2024   2023 
   For the three months ended
March 31,
 
   2024   2023 
Basic Loss Per Share:          
Net loss attributable to Class A common stockholders  $(385,722)  $(642,340)
Net loss attributable to Class B common stockholders   (1,393,607)   (2,329,038)
Total net loss attributable to Snail Inc and Snail Games USA Inc.  $(1,779,329)  $(2,971,378)
Class A weighted average shares outstanding – basic   7,957,031    7,928,742 
Class B weighted average shares outstanding – basic   28,748,580    28,748,580 
Class A and B basic loss per share  $(0.05)  $(0.08)
           
Diluted Loss Per Share:          
Net loss attributable to Class A common stockholders  $(385,722)  $(642,340)
Net loss attributable to Class B common stockholders  $(1,393,607)  $(2,329,038)
Class A weighted average shares outstanding - basic   7,957,031    7,928,742 
Dilutive effects of common stock equivalents   -    - 
Class A weighted average shares outstanding - diluted   7,957,031    7,928,742 
Class B weighted average shares outstanding - basic   28,748,580    28,748,580 
Dilutive effects of common stock equivalents   -    - 
Class B weighted average shares outstanding - diluted   28,748,580    28,748,580 
Diluted loss per Class A and B share  $(0.05)  $(0.08)

 

NOTE 16 – EQUITY

 

The Company has authorized two classes of common stock, Class A and Class B. The rights of the holders of both Class A and Class B common stock will be identical, except with respect to voting, conversion and transfer restrictions applicable to the Class B common stock. Each share of Class A common stock will be entitled to one vote. Each share of Class B common stock will be entitled to ten votes and will be convertible into one share of Class A common stock automatically upon transfer, subject to certain exceptions. Holders of Class A common stock and Class B common stock will vote together as a single class on all matters unless otherwise required by law.

 

In connection with the Underwriting Agreement, on November 9, 2022, the Company also issued to the Underwriters warrants to purchase such number of shares of the Company’s Class A common stock in an amount equal to four percent of the total number of shares of Class A common stock sold in the IPO, or 120,000 shares of Class A common stock (the “Underwriters Warrants”). The Underwriters Warrants may be exercised at a price per share equal to 125% of the IPO price, or $6.25 per share. The Underwriters Warrants are exercisable, in whole or in part, commencing on November 9, 2022, and expiring on the three-year anniversary thereof. The Underwriters Warrants have not been exercised as of the filing of this Quarterly Report.

 

F-23
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

The Underwriters Warrants and Over-Allotment Option are legally detachable and separately exercisable from each other and from the Firm Shares; therefore, they meet the definition of freestanding and are not considered embedded in the Firm Shares.

 

The Underwriters Warrants are considered indexed to the Company’s own stock. Additionally, the Company concludes that the Underwriters Warrants meet all requirements for equity classification. Because the Underwriters Warrants are issued to the Underwriters for their services and can be exercised immediately (subject to certain transfer conditions) they will be measured at their fair value on their date of issuance and recorded within stockholders’ equity. As long as the Underwriters Warrants remain classified as equity, they shall not be revalued. The fair value of the Underwriters Warrants was determined using the Black-Scholes model. The key assumptions used in the valuation were an average expected volatility of 53%, discount rate of 4.49% and remaining term of 3 years.

 

The Company allocates all the issuance costs to the firm shares as a reduction of proceeds.

 

Convertible Debt

 

In August 2023, pursuant to a securities purchase agreement (the “SPA”), the Company issued to two accredited investors (the convertible debt “Investors”) convertible notes with an aggregate principal amount of $1,080,000 (the “Convertible Notes”) and warrants to purchase up to an aggregate of 714,285 shares of the Company’s Class A common stock for gross proceeds of $1,000,000 (the “Convertible Notes Financing”).

 

In connection with the Convertible Notes Financing, the Company also entered into a registration rights agreement with the Investors. So long as the Company complies with certain conditions set forth in the SPA and the registration rights agreement, the Company will sell and the Investors will purchase, an additional $1,080,000 of aggregate principal amount of notes and warrants in the second tranche of the Convertible Note Financing. The second tranche closing has not yet taken place.

 

The Convertible Notes carry an original issue discount of approximately 7.4%, bear interest at a rate of 7.5% per annum (16% per annum in case of an event of default), are repayable in equal consecutive monthly installments that began in February 2024 and mature on May 24, 2024 (the “Maturity Date”).

 

The Convertible Notes may be prepaid by the Company upon giving the Investors a fifteen-trading day notice by paying an amount equal to the then outstanding balance. If the Company enters into a qualifying financing it may be required by the Investors to repay part or all of the Convertible Notes at a 112.5% premium (limited to 10% of the proceeds of the qualified financing, if such financing results in gross proceeds to the Company at least $5,000,000). In event of default or change of control, the Investors may require the Company to prepay the Convertible Notes at a 120% premium.

 

Subject to certain ownership limitations, starting three months after their issuance, the Convertible Notes can be converted at the option of the holder at any time into shares of the Company’s Class A common, at a conversion price equal to 90% (85% in case of an event of default) of the average of the three the lowest daily volume weighted average price (“VWAP”) of the Class A common stock during the ten (10) trading days period prior the receipt of the notice of conversion. The conversion price may be adjusted if the Company issues a qualifying security at a lower price than the then conversion price.

 

If, upon receipt of conversion notice, the Company cannot issue shares of Class A common stock for any reason, then it is required to issue as many shares of Class A common stock as it is able to issue and, with respect to the unconverted principle portion, the Noteholder may elect for the Company to pay for each shares of Class A common stock that could not be issued at a price equal to the higher of the then conversion price or the VWAP as of the date of the conversion notice.

 

The Company determined that the Convertible Notes included features that required bifurcation from the debt host and met the criteria to be accounted for as a derivative liability that is accounted for at fair value. On the date of issuance, the compound derivative had an estimated fair value that was not significant due to the remoteness of the events that would trigger the redemption features. The derivative liability uses level 3 inputs, is to be measured at fair value each reporting date with change in fair value being reported in other income. The change in fair value during the three months ended March 31, 2024, was not significant and as such, was not recorded.

 

On the date of issuance, the Company allocated the proceeds between the instruments issued using fair value for the derivative liability with the residual amounts allocated to the convertible notes and warrants using relative fair value as follows:

 

      
Convertible notes  $554,246 
Derivative liability   - 
Warrants   445,754 
Total proceeds  $1,000,000 

 

F-24
 

 

Snail Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

 

The difference of $525,754 between the allocated proceeds to the Convertible Notes and the aggregate principal amount will be accreted during the life of the notes. Additionally, $152,500 of transaction costs incurred by the Company were recorded as debt discount.

 

The following is a summary of the Convertible Notes as of March 31, 2024:

 

   Principal  Unamortized
debt discount
and issuance
   Net carrying   Fair value 
   Amount  costs   amount   Amount   Levelling 
Convertible Notes  $ 713,114  $(10,830)  $702,284   $254,238    Level 3 

 

The following is a summary of the Convertible Notes as of December 31, 2023:

 

   Principal  Unamortized
debt discount
and issuance
   Net carrying   Fair value 
   Amount  costs   amount   Amount   Levelling 
Convertible Notes  $ 860,910  $(63,549)  $797,361   $536,170    Level 3 

 

The debt discount is being amortized to interest expense over the maturity period using the effective interest method at a rate of 103.4%. The effective interest rate is based on the principal balance discounted by stated interest, debt issuance costs and fair value allocated to the related warrants. For the three months ended March 31, 2024, the Company recognized $252,820 of interest expense related to the Convertible Notes, comprising of $