Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The
following overview is a high-level discussion of our operating results, as well as some of the trends and drivers that affect
our business. Management believes that an understanding of these trends and drivers provides important context for our results
for the fiscal year ended December 31, 2020, as well as our future prospects. This summary is not intended to be exhaustive, nor
is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Form 10-K, including in
the “Business” section and “Risk Factors” above, the remainder of this “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” (“MD&A”) or the consolidated financial statements
and related notes.
Our
Business
Motorsport
Games is a leading racing game developer, publisher and esports ecosystem provider of official motorsport racing series throughout
the world, including NASCAR, the iconic 24 Hours of Le Mans endurance race (“Le Mans”) and the associated FIA World
Endurance Championship (the “WEC”), the British Touring Car Championship (the “BTCC”) and others. Through
the support of our sole member, Motorsport Network, the largest global media company in the motorsport industry, Motorsport Games’
corporate mission is to create the preeminent motorsport gaming and esports entertainment ecosystem by delivering the highest
quality, most sophisticated and innovative experiences for racers, gamers and fans of all ages. Our products and services target
a large and underserved global motorsport audience. For 2019, Formula 1 estimates that its total global television audience reached
471 million unique viewers. Further, Le Mans estimates its total reach was approximately 100 million homes worldwide in 2019,
while NASCAR reached approximately 475 million households in 2019 and the BTCC reached approximately 62 million households in
2019.
Started
in 2018 as a wholly-owned subsidiary of the Motorsport Network, we are currently the official developer and publisher of the NASCAR
video game racing franchise and have obtained the exclusive license to develop multi-platform games for the BTCC, the Le Mans
race and the WEC. We develop and publish multi-platform racing video games including for game consoles, personal computer (PC)
and mobile platforms through various retail and digital channels, including full-game and downloadable content (sometimes known
as “games-as-a- service”). Since our formation, our NASCAR video games have sold over one million copies for game
consoles and PCs. For fiscal year 2020, substantially all of our revenue was generated from sales of our racing video games.
Recent
Developments
COVID-19
Pandemic
The
global spread of the COVID-19 pandemic has created significant business uncertainty for us and others, resulting in volatility
and economic disruption. Additionally, the outbreak has resulted in government authorities around the world implementing numerous
measures to try to reduce the spread of COVID-19, such as travel bans and restrictions, quarantines, shelter-in-place, stay-at-home
or total lock-down (or similar) orders and business limitations and shutdowns.
As
a result of the COVID-19 pandemic, including the related responses from government authorities, our business and operations have
been impacted, including the temporary closure of our offices in Orlando, Florida, Silverstone, England, and Moscow, Russia, which
has resulted in our employees working remotely. During the COVID-19 outbreak, demand for our games has generally increased, which
we believe is primarily attributable to a higher number of consumers staying at home due to COVID-19 related restrictions. Similarly,
there has been a significant increase in viewership of our esports events since the initial impact of the virus, as these events
began to air on both digital and linear platforms, particularly as we were able to attract many of the top “real world”
motorsport stars to compete. However, several retailers have experienced, and continue to experience, closures, reduced operating
hours and/or other restrictions as a result of the COVID-19 pandemic, which has negatively impacted the sales of our products
from such retailers. Additionally, in our esports business, the COVID-19 pandemic has resulted in the postponing of certain events
to later dates or shifting events from an in-person format to online only.
We
continue to monitor the evolving situation caused by the COVID-19 pandemic, and we may take further actions required by governmental
authorities or that we determine are prudent to support the well-being of our employees, suppliers, business partners and others.
The degree to which the COVID-19 pandemic impacts our operations, business, financial results, liquidity, and financial condition
will depend on future developments, which are highly uncertain, continuously evolving and cannot be predicted. This includes,
but is not limited to, the duration and spread of the pandemic, its severity, actions to contain the virus or treat its impact,
such as the efficacy of vaccines (particularly with respect to emerging strains of the virus), and how quickly and to what extent
normal economic and operating conditions can resume.
Further
discussion of the potential impacts on our business, financial condition, results of operations, liquidity and the market price
of our Class A common stock due to the COVID-19 pandemic is provided in the section entitled “Risk Factors” in Part
I, Item 1A of this Report.
British
Touring Car Championship License
In
May 2020, we secured a multi-year licensing agreement to exclusively develop and publish the video games for the BTCC racing series
across console, mobile and casual gaming channels. In addition, through this license, we have the right to create and organize
esports leagues and events for the BTCC racing series. Our license with the BTCC expires on December 31, 2026.
Acquisitions
of 704Games Common Stock
On
August 18, 2020, we entered into a stock purchase agreement with HC2 Holdings 2, Inc. (“HC2”) and Continental General
Insurance Company (“Continental”) pursuant to which we purchased an aggregate of 106,307 shares of common stock of
704Games Company (“704Games”), which is equal to approximately 26.2% of the outstanding equity interests of 704Games,
at a price of $11.2881 per share for an aggregate consideration of approximately $1,200,000. Additionally, on October 6, 2020,
we entered into a stock purchase agreement with Leo Capital Holdings, LLC (“Leo Capital”) pursuant to which we purchased
an aggregate of 10,301 shares of common stock of 704Games, which is equal to approximately 2.5% of the outstanding equity interests
of 704Games, at a price of $11.2881 per share for an aggregate consideration of approximately $116,000. Following our purchases
of shares from HC2, Continental and Leo Capital, our ownership interest in 704Games increased to 82.2% from 53.5%.
We
are currently involved in certain legal proceedings relating to these purchases of common stock of 704Games, including complaints
filed by HC2 and Continental. However, we believe that the plaintiffs’ allegations are without merit and intend to vigorously
defend our position to the full extent permitted by law. See Note 14 – Subsequent Events – Litigation in our consolidated
financial statements for additional information.
On
March 11, 2021, we entered into a share exchange agreement with PlayFast Games, LLC (“PlayFast”) pursuant to which
we will acquire 30,903 shares of common stock of 704Games owned by PlayFast, which is equal to approximately 7.6% of the outstanding
equity interests of 704Games, in exchange for (i) 366,541 newly issued shares of our Class A common stock and (ii) cash in an
amount to be determined based on the share price of our Class A common stock over the last 10 trading days of March of 2021. Additionally,
on March 14, 2021, we entered into a share exchange agreement with Ascend FS, Inc. (“Ascend”) pursuant to which we
will acquire 41,204 shares of common stock of 704Games owned by Ascend, which is equal to approximately 10.15% of the outstanding
equity interests of 704Games, in exchange for (i) 488,722 newly issued shares of our Class A common stock and (ii) cash in an
amount to be determined based on the share price of our Class A common stock over the last 10 trading days of March of 2021. The
exchange transactions with each of PlayFast and Ascend are subject to customary conditions to closing, including the receipt of
necessary third-party approvals, and are expected to be completed on April 1, 2021. Upon closing of such exchange transactions,
our ownership interest in 704Games will increase to 100%.
Initial
Public Offering
On
January 15, 2021, we completed our initial public offering (“IPO”) of 3,450,000 shares of Class A common stock at
a price to the public of $20.00 per share, which includes the exercise in full by the underwriters of their option to purchase
from us an additional 450,000 shares of Class A common stock. We received net proceeds of approximately $62.9 million from
the IPO, after deducting underwriting discounts and offering expenses payable by us.
Repayment
of Promissory Note
On
January 20, 2021 and January 29, 2021, we repaid $10,000,000 and $400,000, respectively, of the promissory note payable due to
Motorsport Network.
Amendment
to Joint Venture Agreement with ACO
On
January 25, 2021, we entered into an amendment to our joint venture agreement with Automobile Club de l’Ouest (“ACO”)
with respect to the Le Mans Esports Series Limited joint venture. Pursuant to the amendment, we increased our ownership interest
in the joint venture from 45% to 51%. Additionally, through certain multi-year licensing agreements that were entered into in
connection with the amendment, we secured the rights to be the exclusive video game developer and publisher for the Le Mans race
and the WEC, as well as the rights to create and organize esports leagues and events for the Le Mans race, the WEC and the 24
Hours of Le Mans Virtual event. In exchange for certain of these license rights, we agreed to fund up to €8,000,000 (approximately
$9.8 million USD as of December 31, 2020) as needed for development of the video game products, to be contributed on an as-needed
basis during the term of the applicable license.
KartKraft
Acquisition
On
March 19, 2021, we acquired all assets comprising the KartKraft computer video game from Black Delta Holdings PTY, Black
Delta Trading Pty Ltd and Black Delta IP Pty Ltd (collectively, “Black Delta”). The purchase price for the assets
was $1,000,000, of which $750,000 was paid at closing and $250,000 will be paid on the six-month anniversary of closing. Through
this acquisition, we plan to enter the simulated kart-racing space. Black Delta’s development team is expected to form a
new division, Motorsport Games Australia.
Studio397
Binding Term Sheet
On
February 25, 2021, we entered into a binding term sheet with Luminis International BV (“Luminis”). Pursuant to the
binding term sheet, the Company and Luminis intend that the Company will acquire from Luminis 100% of the share capital of Studio397
B.V. (“Studio397”). The purchase price for the shares will be $16,000,000, payable in two installments as follows:
$12,800,000 at closing and $3,200,000 on the first-year anniversary of closing. The parties are in the process of negotiating
the definitive acquisition documents to complete the transaction, which is subject to customary closing conditions.
Digital Tales Binding Term Sheet
On
March 22, 2021, we entered into a binding term sheet with EleDa s.r.l. (“EleDa”). Pursuant to the binding term sheet,
we and EleDa intend that we will acquire from EleDa all of the shares of Digital Tales USA, LLC, a Florida limited liability company
(the “Interests”). The purchase price for the Interests will be $2,200,000, payable as follows: (i) $1,540,000 at
closing, (ii) $260,000 on the six-month anniversary of closing, (iii) $200,000 after the SBK video game license or substantially
similar two-wheel racing brand license currently held by the Digital Tales USA, LLC is amended to be extended beyond current expiration
date in 2024 for no less than 3 additional years, so long as such amendment is executed within 12 months of closing and (iv) $200,000
after the SBK video game license or substantially similar two-wheel racing brand license currently held by the Digital Tales USA,
LLC is amended to be expanded to include console and PC video game development and publishing for the same period, so long as
such amendment is executed within 12 months of closing. In addition, we agreed to reimburse EleDa for its legal fees and expenses
up to $60,000. The parties are in the process of negotiating the definitive acquisition documents to complete the transaction,
which is subject to customary closing conditions. See Part II, Item 9B, “Other Information” of this Report for additional
information.
Product
Release
NASCAR
Heat 5 is a racing video game simulating the 2020 NASCAR season. NASCAR Heat 5 was developed by 704Games and published by Motorsport
Games on July 10, 2020 for PlayStation 4, Xbox One and Microsoft Windows via Steam. Six downloadable content packs (“DLC”)
were released in the second half of 2020. We are also expanding our supported platforms to include the Nintendo Switch and expect
to launch NASCAR Heat on the Nintendo Switch platform in 2021.
Trends
and Factors Affecting Our Business
Product
Release Schedule
Our
financial results are affected by the timing of our product releases and the commercial success of those titles. Our NASCAR Heat
products have historically accounted for the majority of our revenue. We have recently obtained the exclusive license to develop
multi-platform games for the BTCC, and we recently obtained the exclusive license to develop multi-platform games for the WEC
series, including the iconic 24 hours of Le Mans race. The BTCC and Le Mans products are currently under development, and we currently
anticipate releasing games for these racing series in 2022. Going forward, we intend to expand our license arrangements to other
internationally recognized racing series and the platforms we operate on. We believe that having a broader product portfolio will
improve our operating results and provide a revenue stream that is less cyclical based on the release of a single game per year.
Economic
Environment and Retailer Performance
Our
physical gaming products are sold primarily through a distribution network with exclusive partners who specialize in the distribution
of games, including through mass-market retailers (e.g., Target, Wal-Mart), consumer electronics stores (e.g., Best Buy), discount
warehouses, game specialty stores (e.g., GameStop) and other online retail stores (e.g., Amazon). We currently derive, and expect
to continue to derive, significant revenues from sales of our products to a very limited number of distribution partners. For
the years ended December 31, 2020 and 2019, we had one distribution partner through which we sold substantially all of our products
for the retail market, which represented approximately 34% and 40% of our total revenue for the year ended December 31, 2020 and
2019, respectively. See “Risk Factors—Risks Related to Our Business and Industry—The importance of retail sales
to our business exposes us to the risks of that business model” and “Risk Factors—Risks Related to Our Business
and Industry—We primarily depend on a single third-party distribution partner to distribute our games for the retail channel,
and our ability to negotiate favorable terms with such partner and its continued willingness to purchase our games is critical
for our business” in Part I, Item 1A of this Report for additional information regarding the importance of retail sales
and our distribution partners to our business.
Additionally,
we continue to monitor economic conditions, including the impact of the COVID-19 pandemic, that may unfavorably affect our businesses,
such as deteriorating consumer demand, delays in development, pricing pressure on our products, credit quality of our receivables
and foreign currency exchange rates. The COVID-19 pandemic has affected and may continue to affect our business operations, including
our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued
effects over time. For example, several retailers have experienced, and continue to experience,
closures, reduced operating hours and/or other restrictions as a result of the COVID-19 pandemic, which has negatively impacted
the sales of our products from such retailers. See “—Recent Developments—COVID-19 Pandemic” for
additional information regarding the impact of COVID-19 on our business and operations.
Hardware
Platforms
We
derive most of our revenue from the sale of products made for video game consoles manufactured by third parties, such as Sony
Interactive Entertainment Inc.’s (“Sony”) PS4 and Microsoft Corporation’s (“Microsoft”) Xbox
One, which comprised approximately 86% of our total revenue for the years ended December 31, 2020 and 2019. For the years ended
December 31, 2020 and 2019, the sale of products for Microsoft Windows via Steam comprised approximately 5% and 3% of our total
revenue, respectively, and the sale of products for mobile platforms comprised approximately 8% and 12% of our total revenue,
respectively. The success of our business is dependent upon consumer acceptance of video game console platforms and continued
growth in the installed base of these platforms. When new hardware platforms are introduced, such as those recently released by
Sony and Microsoft, demand for interactive entertainment used on older platforms typically declines, which may negatively affect
our business during the market transition to the new consoles. The new Sony and Microsoft consoles provide “backwards compatibility”
(i.e., the ability to play games for the previous generation of consoles), which could mitigate the risk of such a decline. However,
we cannot be certain how backwards compatibility will affect demand for our products.
Digital
Business
Players
increasingly purchase our games as digital downloads, as opposed to purchasing physical discs. All of our titles that are available
through retailers as packaged goods products are also available through direct digital download. For the years ended December
31, 2020 and 2019, approximately 62% and 51%, respectively, of our revenue from sales of video games for game consoles was through
digital channels. We believe this trend of increasing direct digital downloads is primarily due to benefits relating to convenience
and accessibility that digital downloads provide, which has been heightened during the COVID-19 outbreak. In addition, as part
of our digital business strategy, we aim to drive ongoing engagement and incremental revenue from recurrent consumer spending
on our titles through in-game purchases and extra content.
Esports
We
are striving to become a leader in organizing and facilitating esports tournaments, competitions, and events for our licensed
racing games as well as on behalf of third-party racing game developers and publishers. Through the year ended December 31, 2020,
we have facilitated 56 esports events, up from 22 esports events in all of 2019, which have included official esports events for
NASCAR, 24 Hours of Le Mans, the Official World Rallycross Esports Championship, FIA Formula E and other race series. The total
number of people that have watched our esports events in 2020 to date was approximately 55 million, up from a total of approximately
3.8 million viewers throughout 2019. As we continue to add to our existing portfolio of games centered around popular licensed
racing series, this will provide us the opportunity to further grow our esports business by having more titles to produce our
esports events.
Technological
Infrastructure
As
our digital business has grown, our games and services increasingly depend on the reliability, availability and security of our
technological infrastructure. We are investing and expect to continue to invest in technology, hardware and software to support
our games and services, including with respect to security protections. Our industry is prone to, and our systems and networks
are subject to, cyberattacks, computer viruses, worms, phishing attacks, malicious software programs, and other information security
incidents that seek to exploit, disable, damage, disrupt or gain access to our networks, our products and services, supporting
technological infrastructure, intellectual property and other assets. As a result, we continually face cyber risks and threats
that seek to damage, disrupt or gain access to our networks and our gaming platform, supporting infrastructure, intellectual property
and other assets.
Rapidly
Changing Industry
We
operate in a dynamic industry that regularly experiences periods of rapid, fundamental change. In order to remain successful,
we are required to anticipate, sometimes years in advance, the ways in which our products and services will compete in the market.
We adapt our business by investing in creative and technical talent and new technologies, evolving our business strategies and
distribution methods and developing new and engaging products and services. For example, the global adoption of mobile devices
and a business model for those devices that allows consumers to try new games with no up-front cost, and that are monetized through
service associated with the game, has led to significant growth in the mobile gaming industry, which we believe is a continuing
trend. Accordingly, in conjunction with the launch of our new NASCAR console game, we plan to launch an updated NASCAR Heat Mobile
in 2021, which is our NASCAR mobile racing game. Given the recent popularity and fast growing nature of the branded casual game
experience, we also plan to introduce a slate of NASCAR branded casual gaming options, starting with the officially licensed NASCAR
“match three” game in 2021.
Recurring
Revenue Sources
Our
business model includes revenue that we deem recurring in nature, such as revenue from our annualized sports franchise (currently
NASCAR Heat) for game consoles, PC and mobile platforms. We have been able to forecast the revenue from this area of our business
with greater relative confidence than for new games, services and business models. As we continue to incorporate new business
models and modalities of play into our games, our goal is to continue to look for opportunities to expand the recurring portion
of our business.
Reportable
Segments
We
use “the management approach” in determining reportable operating segments. The management approach considers the
internal organization and reporting used by our chief operating decision maker for making operating decisions and assessing performance
as the source for determining our reportable segments. Our chief operating decision maker is our Chief Executive Officer (“CEO”),
who reviews operating results to make decisions about allocating resources and assessing performance for the entire company. We
classified our reportable operating segments into (i) the development and publishing of interactive racing video games, entertainment
content and services (the “Gaming segment”) and (ii) the organization and facilitation of esports tournaments, competitions
and events for our licensed racing games as well as on behalf of third-party video game racing series and other video game publishers
(the “esports segment”).
Components
of Our Results of Operations
Revenues
We
have historically derived substantially all revenue from sales of our games and related extra content that can be played by customers
on a variety of platforms, including game consoles, mobile phones, PCs and tablets. Starting in 2019, we began generating sponsorship
revenues from our production of live and virtual esports events.
Our
product and service offerings include, but are not limited to, full console and mobile games with both online and offline functionality,
which generally include:
Cost
of Revenues
Cost
of revenues for our Gaming segment is primarily comprised of royalty expenses attributable to our license arrangement with NASCAR
and certain other third-parties relating to our NASCAR racing series games. Cost of revenues for our Gaming segment is also comprised
of merchant fees, disc manufacturing costs, packaging costs, shipping costs, warehouse costs, distribution fees to distribute
products to retail stores, mobile platform fees associated with our mobile revenue (for transactions in which we are acting as
the principal in the sale to the end customer) and amortization of certain acquired license agreements with NASCAR and software
intangible assets acquired with the acquisition of 704Games. Cost of revenues for our esports segment consists of the cost of
producing esports events and paying prize money.
Sales
and Marketing
Sales
and marketing expenses are primarily composed of salaries, benefits and related taxes of our in-house marketing teams, advertising,
marketing and promotional expenses, including fees paid to social media platforms, Motorsport Network and other websites where
we market our products.
Development
Development
expenses consist of the cost to develop the games we produce, as well as developing the content that we use in our esports leagues.
Development expenses include salaries, benefits and operating expenses of our in-house development teams, as well as consulting
expenses for any contracted external development. Development expenses also include expenses associated with our digital platform,
software licenses, maintenance and development overhead.
General
and Administrative
General
and administrative expenses consist primarily of salaries, benefits and other costs associated with our operations including,
finance, human resources, information technology, public relations, legal audit and compliance fees, facilities and other external
general and administrative services.
Depreciation
and Amortization
Depreciation
and amortization expenses include depreciation on fixed assets (primarily computers and office equipment), as well as amortization
of definite lived intangible assets acquired with the acquisition of 704Games in August of 2018.
Results
of Operations
Year
Ended December 31, 2020 compared to Year Ended December 31, 2019
Revenue
Our
revenues consisted of the following:
For the Year Ended December 31,
Revenues:
For
the year ended December 31, 2020, revenues from our Gaming segment increased by $6,969,379, or 59%, to $18,745,166 from $11,775,787
for the year ended December 31, 2019. The increase in revenues compared to the 2019 period was due in part to the releases of
NASCAR Heat 5 and NASCAR Heat 4, which launched in July 2020 and September 2019, respectively. The increase in revenue for the
year ended December 31, 2020 reflects in part an increase in sales of our games due to the increasing effectiveness of our marketing
efforts for our games, specifically on Facebook, Google and Motorsport Network. An increased focus on monetizing our back catalog
games (i.e., NASCAR Heat 2 and NASCAR Heat 3), as well as NASCAR Heat 4, also helped increase distribution points, bundle values
and capture more enrollments into PS Now, a subscription service offered by Sony PlayStation.
For
the year ended December 31, 2020 revenues from our esports segment increased by $225,363 or 300%, to $300,363 from $75,000 for
the year ended December 31, 2019. The increase is due to sponsorship and event revenues from Fanatec, Formula E and 24 Hours of
Le Mans esports events. During the year ended December 31, 2020 there has been a significant increase in viewership of our esports
events attributable in part to increased audience and engagement during the COVID-19 pandemic and in part due to the increase
in esports events streamed on digital and aired on linear platforms. In addition, our esports races were able to attract numerous
top “real world” motorsport stars to compete, increasing the attractiveness of our events for our growing audience.
Cost
of Revenues
Our
cost of revenues consisted of the following:
For the Year Ended December 31,
Cost of Revenues:
Total Segment and Consolidated Cost of Revenues $ 6,595,872 $ 4,888,877
For
the year ended December 31, 2020, cost of revenues from our Gaming segment increased by $1,440,204, or 30%, to $6,306,581 from
$4,866,377 for the year ended December 31, 2019, primarily due to increased revenue during the current year period and the costs
associated with delivering that revenue.
For
the year ended December 31, 2020, cost of revenues from our esports segment increased by $266,791 or 1,186% to $289,291 from $22,500
for the year ended December 31, 2019, primarily due to the increase in the number of esports events hosted and the associated
increase in live stream production costs and cash prizes.
Gross
Profit
Our
gross profit and gross margin consisted of the following:
For the Year Ended December 31, For the Year Ended December 31,
Gross Profit:
For
the year ended December 31, 2020, gross profit from our Gaming segment increased by $5,529,174, or 80%, to $12,438,584 from $6,909,410
for the year ended December 31, 2019 primarily due to increased game sales. For the year ended December 31, 2020 and 2019, the
gross margin from our Gaming segment was 66% and 59%, respectively, an increase of seven percentage points primarily due to higher
sales of our games as direct digital downloads, which have a higher gross margin than sales through retail channels. Gross margin
from direct digital download sales also fluctuates with the relative selling prices of our games. Our new games tend to sell at
their highest price point in the days, weeks and months immediately following their launch and our back catalog sells at relatively
lower prices. The mix of sales from new games and back catalog games plus the mix of games sold via direct digital download and
retail channels all impact our gross margins.
For
the year ended December 31, 2020, gross profit from our esports segment decreased by $41,428, or 79%, to $11,072 from $52,500
for the year ended December 31, 2019 primarily due to the increase in the number of esports events hosted and the increase in
related costs discussed above.
Sales
and Marketing
For
the year ended December 31, 2020, sales and marketing expenses decreased by $369,260, or 9.8% to $3,402,310 from $3,771,570 for
the year ended December 31, 2019, primarily due to the replacement of third-party agency providers with our internal marketing
team for marketing related activities, the elimination of more expensive television commercials and a shift to higher return,
more targeted digital marketing expenditures.
Development
For
the year ended December 31, 2020, development expenses decreased by $134,847, or 2.8% to $4,649,187 from $4,784,034 for the year
ended December 31, 2019. The decrease in development expenses was primarily due to bringing development in-house using our internal
development team, combined with replacing a portion of our domestic-based internal development team with less expensive international
resources.
General
and Administrative
For
the year ended December 31, 2020, general and administrative expenses increased by $1,729,652, or 66.4% to $4,335,434 from $2,605,782
for the year ended December 31, 2019. The increase was primarily attributable to the addition of staff as we expand our product
portfolio and revenue streams.
Depreciation
and Amortization
For
the year ended December 31, 2020, depreciation and amortization expenses decreased by $340,043, or 84.7%, to $61,579 from $401,622
for the year ended December 31, 2019, primarily due to the sale of assets associated with the elimination of our Charlotte, North
Carolina office and a write down of obsolete equipment.
Loss
on Impairment of Goodwill
Loss
on impairment of goodwill was $0 for the year ended December 31, 2020 compared to $575,015 for the year ended December 31, 2019.
The loss on impairment of goodwill in 2019 relates to 704Games.
Interest
Income
For
the year ended December 31, 2020, interest income decreased by $34,389, or 96.3%, to $1,339 from $35,728 for the year ended December
31, 2019. For the year ended December 31, 2019, interest income reflects interest income earned on most of our cash balance during
the period. For the year ended December 31, 2020, we moved all our cash to an operating account because the decrease in bank fees
associated with the move was greater than the interest income earned on our money market cash investment.
Interest
Expense
For
the year ended December 31, 2020, we recorded interest expense of $718,837, whereas there was no interest expense recorded for
the year ended December 31, 2019. The interest expense for the year ended December 31, 2020 was due to interest charged on a promissory
note entered into with Motorsport Network beginning in April 2020.
Loss
Attributable to Equity Method Investment
For
the year ended December 31, 2020, the loss attributable to equity method investment decreased by $537,864, or 88.4%, to $70,792
from $608,656 for the year ended December 31, 2019. The decrease was primarily due to improved financial performance of Le Mans
Esports Series Limited, a joint venture entered into in March 2019 with ACO, during the year ended December 31, 2020.
Other
Income (Expense), net
For
the year ended December 31, 2020, other income (expense), net increased by $113,812, or 1744.8%, to $107,289 from ($6,523) for
the year ended December 31, 2019. The increase was primarily due to the sublease of our Charlotte, North Carolina office beginning
in February 2020.
Liquidity
and Capital Resources
Liquidity
Since
our inception, we have historically financed our operations primarily through non-interest-bearing advances from Motorsport Network,
which were subsequently incorporated into a line of credit provided by Motorsport Network pursuant to a promissory note, as described
below. We measure our liquidity in a number of ways, including the following:
December 31, December 31,
On January 15, 2021,
we completed our initial public offering (“IPO”) of 3,450,000 shares of Class A common stock at a price to the public
of $20.00 per share, which includes the exercise in full by the underwriters of their option to purchase from us an additional
450,000 shares of Class A common stock. We received net proceeds of approximately $62.9 million from the IPO, after deducting
underwriting discounts and offering expenses payable by us.
We
believe that our existing cash on hand will be sufficient to fund our operations for at least the next 12 months. In addition,
we may choose to raise additional funds at any time through equity or debt financing arrangements, which may or may not be needed
for additional working capital, capital expenditures or other strategic investments. However, there are currently no commitments
in place for future financing and there can be no assurance that we will be able to obtain funds on commercially acceptable terms,
if at all. If we are unable to obtain adequate funds on reasonable terms, we may be required to significantly curtail or discontinue
operations or obtain funds by entering into financing agreements on unattractive terms.
Our
operating needs include the planned costs to operate our business, including amounts required to fund working capital and capital
expenditures. Our future capital requirements and the adequacy of our available funds will depend on many factors, including our
ability to successfully develop new products or enhancements to our existing products, continued development and expansion of
our esports platform and the need to enter into collaborations with other companies or acquire other companies or technologies
to enhance or complement our product offerings.
Cash
Flows From Operating Activities
We
experienced positive cash flow from operating activities for the year ended December 31, 2020 in the amount of $4,053,344 and
negative cash flow from operating activities for the year ended December 31, 2019 in the amount of $4,424,846. Net cash provided
by operating activities for the year ended December 31, 2020 was primarily due to net loss of $679,854, adjusted for non-cash
expenses in the amount of $1,137,594 and by $3,595,604 of cash provided by changes in the levels of operating assets and liabilities.
Net
cash used in operating activities for the year ended December 31, 2019 was primarily due to cash used to fund a net loss of $5,755,564,
adjusted for non-cash expenses in the aggregate amount of $2,100,626, and by $769,908 of cash used to fund changes in the levels
of operating assets and liabilities.
Cash
Flows From Investing Activities
During
the year ended December 31, 2020, net cash used in investing activities was $480,957, which was attributable to our investment
in the Le Mans Esports Series Limited joint venture, purchase of intangible assets, and purchase of office and computer equipment.
During
the year ended December 31, 2019, net cash used in investing activities was $592,628, which was attributable to our investment
in the Le Mans Esports Series Limited joint venture and purchase of office and computer equipment.
Cash
Flows From Financing Activities
Net
cash used in financing activities during the year ended December 31, 2020 was $1,542,134. During
the year ended December 31, 2020, cash used in financing activities was primarily attributable to the purchase of additional
shares of common stock of 704Games, and payments of deferred offering costs, partially offset by advances provided by Motorsport
Network to fund operating and investing activities of the Company.
Net
cash provided by financing activities during the year ended December 31, 2019 was $3,564,326. During
the year ended December 31, 2019, cash provided by financing activities was attributable to advances provided by Motorsport
Network.
Promissory
Note Line of Credit
On
April 1, 2020, we entered into a promissory note with Motorsport Network (the “Promissory Note”) for a line of credit
of up to $10,000,000 at an interest rate of 10% per annum. The principal amount under the Promissory Note was primarily funded
through one or more advances from Motorsport Network, including advances in August and October 2020 for purposes of acquiring
an additional ownership interest in 704Games. Previous non-interest-bearing advances due to Motorsport Network as of December
31, 2019 also were included in the amount outstanding under the Promissory Note at the time it was executed. The Promissory Note
does not have a stated maturity date and is payable upon demand at any time at the sole and absolute discretion of Motorsport
Network, which has agreed, pursuant to a Side Letter Agreement related to the Promissory Note, dated September 4, 2020, not to
demand or otherwise accelerate any amount due under the Promissory Note that would otherwise constrain the Company’s liquidity
position, including the Company’s ability to continue as a going concern. We may prepay the Promissory Note in whole or
in part at any time or from time to time without penalty or charge. In the event we or any of our subsidiaries consummate certain
corporate events, including any capital reorganization, consolidation, joint venture, spin off, merger or any other business combination
or restructuring of any nature, or if certain events of default occur, the entire principal amount and all accrued and unpaid
interest will be accelerated and become payable. As of December 31, 2020, approximately $10.9 million of principal was outstanding
under the Promissory Note.
On
November 23, 2020, the Company and Motorsport Network entered into an amendment to the Promissory Note, effective as of September
15, 2020. Under the terms of the amendment, the line of credit under the Promissory Note was increased from $10,000,000 to $12,000,000.
All other terms remained the same.
On January 20, 2021 and January
29, 2021, we repaid $10,000,000 and $400,000, respectively, of the Promissory Note.
Off-Balance
Sheet Arrangements
We
did not have, during the periods presented, and we do not currently have, any relationships with any organizations or financial
partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical
Accounting Policies and Significant Accounting Estimates
Our
management’s discussion and analysis of our consolidated financial condition and results of operations are based on our
financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires
us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities as of the date of the consolidated financial statements, as well as the reported expenses during the reporting
periods. The accounting estimates that require our most significant, difficult, and subjective judgments have an impact on revenue
recognition, including reserves for sales returns and price protection, valuation allowance of deferred income taxes, valuation
of acquired companies and equity investments, the recognition and disclosure of contingent liabilities, and goodwill and intangible
assets impairment testing. We evaluate our estimates and judgments on an ongoing basis. Actual results may differ materially from
these estimates under different assumptions or conditions.
Our
significant accounting policies are more fully described in our consolidated financial statements (Note 2 in our consolidated
financial statements for the years ended December 31, 2020 and 2019).
Recently
Issued Accounting Standards
Our
analysis of recently issued accounting standards are more fully described in our consolidated financial statements (Note 2 in
our consolidated financial statements for the years ended December 31, 2020 and 2019).
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
Not
applicable.
Item 8.Financial Statements and Supplementary Data
Page
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of December 31, 2020 and 2019 F-2
Notes to the Consolidated Financial Statements F-6
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the Sole Member
Motorsport
Gaming US, LLC and Subsidiaries
Opinion
on the Consolidated Financial Statements
We
have audited the accompanying consolidated financial statements of Motorsport Gaming US, LLC and subsidiaries (the “Company”),
which comprise the consolidated balance sheets as of December 31, 2020 and 2019, the related consolidated statements of operations,
changes in member’s equity, and cash flows for the years ended December 31, 2020 and 2019, and the related notes to the
consolidated financial statements.In our opinion, the consolidated financial
statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020
and 2019, and the consolidated results of its operations and its cash flows for the years ended December 31, 2020 and 2019 in
accordance with accounting principles generally accepted in the United States of America.
Basis
for Opinion
These consolidated financial
statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial
statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board
(United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S.
federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We
conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits
to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain
an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness
of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our
audits included performing procedures to assess the risks of material misstatement of the consolidated financial
statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining,
on a test basis, evidence regarding the amounts and disclosures in the consolidated financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the consolidated financial
statements. We believe that our audits provide a reasonable basis for our opinion.
/s/
Dixon Hughes Goodman
We
have served as the Company’s auditor since 2017.
Raleigh,
North Carolina
March
24, 2021
MOTORSPORT
GAMING US LLC & SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
December 31,
Assets
Current Assets:
Prepaid expenses and other current assets 507,177 77,021
Deferred offering costs 749,370 -
Liabilities and Member’s Equity
Current Liabilities:
Other non-current liabilities 856,694 -
Member’s Equity:
The
accompanying notes are an integral part of these consolidated financial statements.
MOTORSPORT
GAMING US LLC & SUBSIDIARIES