Snail Inc

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.

On July 13, 2022, Suzhou Snail transferred all of its right, title, and interest to all of the 500,000 shares of common stock of the Company (“Shares”) to Snail Technology (HK) Limited (“Snail Technology”), an entity organized under the laws of Hong Kong, pursuant to the certain Share Transfer Agreement dated July 13, 2022 between Suzhou Snail and Snail Technology. Subsequently, Snail Technology transferred all of its right, title, and interest in the shares to certain individuals per the Share Transfer Agreement. In connection with the reorganization transaction described below the individuals contributed their interest in the Company to Snail, Inc. in return for common stock of Snail, Inc. in connection with Snail, Inc.’s IPO. Because the Company and Suzhou Snail are owned by the same shareholders, Suzhou Snail is considered a related party to the Company.

Reorganization Transaction and IPO

On September 16, 2022, Snail, Inc., filed a Registration Statement on Form S-1 with the United States Securities and Exchange Commission in connection with its IPO. On November 9, 2022, effective as of the IPO pricing, Snail Games USA Inc.’s existing shareholders transferred their 500,000 shares of common stock of Snail Games USA Inc. to Snail, Inc. in exchange for 6,251,420 shares of Class A common stock and 28,748,580 shares of Class B common stock of Snail, Inc., and Snail, Inc. became the parent of Snail Games USA Inc. Because the reorganization transaction was considered a transaction between entities under common control, the financial statements for periods prior to the reorganization transaction and the IPO have been adjusted to combine the previously separate entities for presentation purposes. On November 9, 2022, Snail, Inc. priced its IPO, and on November 10, 2022, Snail, Inc.’s Class A common stock began trading on The Nasdaq Capital Market under the ticker symbol SNAL. In the IPO, Snail, Inc. issued 3,000,000 shares of Class A common stock at $5.00 per share and net proceeds from the IPO were distributed to Snail Games USA Inc. in November 2022 in the amount of approximately $12.0 million, net of the underwriting discount and offering costs of $3.0 million. In connection with the IPO, $1.0 million of the IPO proceeds were remitted to an escrow account which is held to provide a source of funding for certain indemnification obligations of Snail, Inc. to the underwriters. The amount in escrow was reported as a restricted escrow deposit in the consolidated balance sheets as of December 31, 2022, until 12 months from the date of the offering, November 2023, at which time the restrictions were removed and the balance was reverted to unrestricted cash.

Basis of Presentation and Consolidation

The accompanying 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”).

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 consolidated financial statements.

During the year ended December 31, 2023, certain comparative amounts have been 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 sales 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 consolidated statements of operations and comprehensive income (loss) for all previously reported periods were as follows:

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

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

Use of Estimates

The preparation of 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, income taxes, valuation of intangibles, including those with related parties, impairment of intangible assets, 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 hasone 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

For the first three quarters of the fiscal year 2023 the Company had a net loss, net cash used in operations, debt obligations coming due in less than 12 months, a potential need for additional capital, and had uncertainties surrounding its ability to raise additional capital and renegotiate its debt arrangements. In the fourth quarter of fiscal year 2023 the Company releasedARK: Survival Ascended. The release resulted in significant increases in revenues, receivables and cashflows for the fourth quarter, in comparison to the first three quarters of 2023.

During the year ended December 31, 2023, the Company renewed its 2021 Revolving Loan (as defined below) which will become due and mature at the end of 2024. The Company paid $3.0 million of the revolving loan in January 2024. The Company paid off the $0.8 million balance of its 2022 Short Term Note (as defined below) in January 2024 and is in the process of negotiating a new term loan. The Company also repaid $0.3 million of accrued interest and principal on its convertible notes balance and the Company’s $1.5 million short term note was paid off in the first quarter of 2024. The Company paid an additional $0.3 million of accrued interest and principal on its convertible notes balance in April 2024. Currently, management expects that the Company will not be in compliance with its quarterly debt covenants for the three months ending March 31, 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 $6.0 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.

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 $15.2 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, 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:

For theARK: Survival AscendedDLC’s that have not yet launched and been reported in deferred revenue in the 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:

The Company recognizes revenue using the following five steps as provided by Accounting Standards Codification (“ASC”) Topic 606Revenue 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:

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 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 theARK 1 availability on the platform perpetually, effective January 1, 2022 and to putARK II on the platform for three years upon release. The Company recognized $2.5 million in revenue related toARK 1’s perpetual license during the year ended December 31, 2022 and deferred $2.3 million related toARK II that is included in the long-term portion of deferred revenue and will be recognized upon the release ofARK IIon the platform.

In November 2021, the Company entered an agreement with a platform to makeARK 1 available on a platform for a period of 5 weeks in exchange for $3.5 million. The platform launched the 5-week program on March 1, 2022 and the Company recognized the full amount of revenue from this contract during the year ended December 31, 2022.

The Company entered into a non-exclusive license agreement with a platform in February 2020 to makeARK 1 available on the platform, exclusive of all available DLC, for a period of 2 weeks in exchange for $8.0 million. During the 2 weeks the platform offered digital rights toARK 1 to its end users for free. The platform launched the first free week in June of 2020 and the Company recognized $4.0 million of the advanced payment as revenue during the year ended December 31, 2020. In September 2022, the platform launched the second free week and the Company recognized the remaining $4.0 million of revenue during year ended December 31, 2022.

In July 2023, the Company entered into a distribution agreement with its retail distribution partner for the distribution ofARK: Survival AscendedandARK 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 $0.5 million and $1.3 million as prepaid royalties that are reported as current and long-term deferred revenue until the disc release ofARK: Survival Ascendedand*ARK II,*respectively.

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 day play 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.

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 years ended December 31, 2023 and 2022 were comprised of the following:

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 years ended December 31, 2023 and 2022, general and administrative expenses totaled $15,816,088 and $18,713,958, respectively. Stock-based compensation of $799,955 and $223,250 was incurred during the years ended December 31, 2023 and 2022, respectively.

Advertising and Marketing Costs

The Company expenses advertising and marketing costs as incurred. For the years ended December 31, 2023 and 2022, advertising and marketing expenses totaled $1,582,464 and $714,492, 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 years ended December 31, 2023 and 2022 were $5,057,421 and $2,955,592, respectively. Stock-based compensation of $48,080 was incurred during the year ended December 31, 2023; no stock-based compensation was incurred in the year ended December 31, 2022.

Non-controlling Interests

Non-controlling interests on the consolidated balance sheets and consolidated statements of operations and comprehensive income (loss) include the equity allocated to non-controlling interest holders. As of December 31, 2023 and 2022, there were non-controlling interests with the following subsidiaries:

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 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. During the year ended December 31, 2023, the Company’s allowance for credit losses increased from $19,929 to $523,500 due to an increase in credit risk of one of the Company’s platform partners as a result of continued delays in payments. There was an additional $77,928 recognized as credit losses due to the bankruptcy of the Company’s related party, INDIEV, Inc. (“INDIEV”) during the year ended December 31, 2023. There were no credit losses recognized in the year ended December 31, 2022.

Property, Plant and Equipment, Net

Property, plant and equipment, net, are stated at cost. Depreciation is calculated using the straight-line method over the following useful lives:

When assets are retired or disposed of, the cost and accumulated depreciation thereon are removed, and any resulting gains or losses are included in the consolidated statements of operations and comprehensive income (loss). Leasehold improvements are amortized using the straight-line method over the estimated life of the asset, not to exceed the length of the lease. Repairs and maintenance costs are expensed as incurred.

Foreign Currency

The functional currency for our foreign operations is primarily the applicable local currency. Accounts of foreign operations are translated into U.S. dollars using exchange rates for assets and liabilities at the balance sheet date and average prevailing exchange rates for the period for revenue and expense accounts. Adjustments resulting from the translation are included in accumulated other comprehensive loss. Realized and unrealized transaction gains and losses arising from transactions denominated in foreign currencies different than the relevant functional currency are included in our consolidated statements of operations and comprehensive income (loss) in the period in which they occur.

Intangible Assets – License Usage Rights

The Company enters into license agreements with third-party developers and related party developers that require the Company to make payments for license usage rights and game development and production services. These license agreements grant the Company the exclusive publishing and distribution rights to game titles as well as, in some cases, the underlying intellectual property rights. These license agreements also specify the payment schedules, royalty rates and the relevant licensing period. The Company capitalizes the cost of license usage rights as intangible assets and amortizes them over the terms of the respective licensing rights.

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:

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, derivative 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. The carrying amount of our debt 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 except for 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 Company’s convertible notes, warrant liability and derivative instruments are valued at fair value, 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. Our building is valued at fair value using level 2 inputs for purposes of securing our debt; the buildings carrying value is based on cost and straight-line depreciation. The Company does not have any other assets or liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2023 and December 31, 2022.

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 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 consolidated balance sheets in the amount of $254,731 and $457,024 as of December 31, 2023 and 2022, respectively. The Company accrues and recognizes interest and penalties related to unrecognized tax benefits in operating expenses.

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 December 31, 2023 and 2022, the Company had deposits of $14,716,652 and $17,929,308, respectively, that were not insured by the Federal Deposit Insurance Corporation and are included in the cash and cash equivalents, restricted escrow deposit and restricted cash and cash equivalents, in the accompanying 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 four customers as of December 31, 2023, and two customers as of December 31, 2022, who accounted for approximately 95% and 57% of consolidated gross receivables, respectively. Among the four customers as of December 31, 2023, and two customers as of December 31, 2022, each customer accounted for 43%,20%,16% and 16% as of December 31, 2023, and 29% and 28% as of December 31, 2022 of the consolidated gross receivables outstanding. During the years ended December 31, 2023 and 2022, approximately 80% and 54%, respectively, of net revenue was derived from these customers. The Company had three customers in the year ended December 31, 2023, and three customers in the year ended December 31, 2022, that accounted for 42%,18%, and 11%, and 30%,23% and 12% 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 December 31, 2023 and 2022, the Company had one vendor who accounted for approximately 69% and two vendors who accounted for approximately 43% and 12% 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 51% and 47% of the Company’s combined cost of revenues and operating expenses during the years ended December 31, 2023 and 2022, respectively. Amounts payable to SDE are included in accounts payable - related parties in the consolidated balance sheets as of December 31, 2023 and 2022. The loss of SDE as a vendor would significantly and adversely affect the Company’s core business.

Leases

The Company has a lease relating primarily to office facilities. The Company determines if an arrangement is or contains a lease at contract inception. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. The lease liability is measured as the present value of the unpaid lease payments, and the right-of-use asset value is derived from the calculation of the lease liability. Lease payments include fixed and in-substance fixed payments, variable payments based on an index or rate, variable payments based on the level of services provided by the landlords of our leases, reasonably certain purchase options, and termination penalties. Variable lease payments related to the services provided by the landlords are non-lease components that are recognized as rent expenses as incurred. For leased assets with similar lease terms and asset types, the Company applied a portfolio approach in determining a single incremental borrowing rate for the leased assets. The Company uses its estimated incremental borrowing rate, which is derived from information available at the lease commencement date, in determining the present value of lease payments because the Company does not have the information necessary to determine the rate implicit in the lease. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term. The Company’s lease term includes any option to extend the lease when it is reasonably certain to be exercised based on considering all relevant factors. Leases with an initial term of 12 months or less are not recorded on the consolidated balance sheets and the Company recognizes lease expense for these leases on a straight-line basis over the lease term. Operating leases are included in operating lease right-of-use assets, net, current portion of operating lease liabilities, and operating lease liabilities, net of current portion on the consolidated balance sheets.

Recently Issued Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13,Financial Instruments – Credit Losses, which replaces the incurred loss impairment methodology in current US GAAP with a methodology that requires the reflection of expected credit losses and also requires consideration of a broader range of reasonable and supportable information to determine credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. For most financial instruments, the standard requires the use of a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses, which generally results in the earlier recognition of credit losses on financial instruments. The Company adopted ASU 2016-13 on January 1, 2023. Adopting the new standard did not have a material impact on the Company’s consolidated financial statements.

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 elected to delay implementation of this standard until January 1, 2024 based on its emerging growth status. The Company is evaluating the impact of adopting the new standard.

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 is evaluating the impact of adopting the new standard.

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.

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 $88,756 and $65,908 for the years ended December 31, 2023 and 2022.

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 issued restricted stock units (“Restricted Stock Units” or “restricted stock units”) during the years ended December 31, 2023, and 2022. 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 December 31, 2023, there were 4,485,275 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 years ended December 31, 2023 and 2022, stock-based compensations expenses amounted to $848,035 and $223,250, 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 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 consolidated balance sheets. 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 20 -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 consolidated balance sheets. 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 20 –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 consolidated balance sheets under treasury stock. No treasury stock was sold during the years ended December 31, 2023 and 2022. As of December 31, 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.

Earnings (Loss) Per Share

Earnings (loss) per share (“EPS”) is calculated by dividing the net income (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 income (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 comparative purposes, the Company has presented EPS for the year ended December 31, 2022 assuming the number of shares exchanged in the reorganization and issued in the IPO of the Company were outstanding at the start of the year. For more information see Note 19 –Earnings (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 years ended December 31, 2023 and 2022 were as follows:

Geography

The Company attributes net revenue to geographic regions based on customer location. Net revenue by geographic region for the years ended December 31, 2023 and 2022 were as follows:

Platform

Net revenue by platform for the years ended December 31, 2023 and 2022 were as follows:

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 years ended December 31, 2023 and 2022 was as follows:

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 December 31, 2023, the balance of deferred revenue was $34.3 million, of which $32.5 million is due to non-refundable payments. The Company is expecting to recognize $13.7 million of the non-refundable payments in the next 12 months through the platform releases of certain DLCs, $1.2 million upon the release ofMyth of Empires, $11.1 million of non-refundable payments in the next 12 to 24 months through the release of DLC’sand additionalARK IP. The remaining $3.8 million of current non-refundable deferred revenues and $2.7 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 $0.5 million in the next 12 months and the remainder of $1.3 million in fiscal year 2025. Activities in the Company’s deferred revenue as of December 31, 2023 and 2022 were as follows:

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 $1,116,196 and $6,374,368 as of December 31, 2023 and 2022, respectively. The amounts of restricted cash and cash equivalents held as of December 31, 2023, are to secure the standby letter of credit with landlords and the amounts of restricted cash and cash equivalents as of December 31, 2022, are held as security for the debt with a financial institution (see Note 15 —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 December 31, 2023 and 2022:

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, 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, 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 has been reclassified as a long-term asset. The Company’s current SDE payable is greater than its current SDE receivable and has reclassified the net SDE payable to accounts payable – related parties as of December 31, 2023. During the year ended December 31, 2023, the Company made cash payments to SDE in the amount of $33.1 million and anticipates continuing to make cash payment to SDE in future years. As of December 31, 2023 and 2022, the outstanding balance of net accounts receivable from related party was as follows:

NOTE 6 –DUE FROM SHAREHOLDER

Other receivables from related party consisted of monies that the Company loaned to the Company’s Founder, Chief Strategy Officer and Chairman, who is also the majority shareholder of Suzhou Snail. The loan bore 2.0% per annum interest. On April 26, 2022, the Company, with approval from its Board of Directors and in accordance with applicable laws and regulations, assigned the other receivables–related party (the “Shareholder Loan”) of $94,934,400 outstanding including interest, to Suzhou Snail, which assumed the loan as creditor. Simultaneously, the Company declared and paid Suzhou Snail an in-kind dividend with an aggregate amount equal to $94,934,400 on April 26, 2022; see Note 7– Dividend Distribution. As of December 31, 2022, the other receivable was $0 and no longer reflected on the Company’s consolidated balance sheets. The loan didnot accrue interest during the year ended December 31, 2023. The loan accrued interest of $580,878 during the year ended December 31, 2022. The earned interest is reported in interest income – related parties in the Company’s consolidated statements of operations and comprehensive income (loss).

NOTE 7 –DIVIDEND DISTRIBUTION

On April 26, 2022, the Company declared an in-kind dividend of $94,934,400 for the assignment of the Shareholder Loan and a cash dividend of $8,200,000 to pay the related withholding taxes; see Note 6 –Due from Shareholder. There wereno such distributions during the year ended December 31, 2023. In April 2023, the Company filed its annual withholding tax return Form 1042 and recognized a refund receivable related to the withholding taxes paid in the amount of $1,886,600. The refund was received in August 2023 and is reported in additional paid-in capital in the accompanying consolidated balance sheets as of December 31, 2023 and the consolidated statements of equity for the year ended December 31, 2023.

NOTE 8 –PREPAID EXPENSES - RELATED PARTY

On March 10, 2023, the Company amended its exclusive software license agreement with SDE relating to theARK franchise. For DLC’s, the Company plans to release during the term of the agreement, the Company will now have 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 year ended December 31, 2023, the Company prepaid $2.5 million for exclusive license rights for anARK: Survival Ascended DLC to SDE and $5.5 million in prepaid royalties related toARK: Survival AscendedDLC’s which have not yet been released. During the year ended December 31, 2022, the Company prepaid $5.0 million for exclusive license rights to anARK sequel to SDE. Prepaid expenses — related party consisted of the following as of December 31, 2023 and 2022:

The amount classified as short-term, as of December 31, 2023, includes the prepaid license for theARK: Survival AscendedDLC that the Company expects to release in the next twelve months, prepaid royalties forARK: Survival Ascended DLC’s which have not yet been released and various operational software licenses obtained through SDE.

NOTE 9 –PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consisted of the following as of December 31, 2023, and 2022:

NOTE 10 –PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consisted of the following as of December 31, 2023 and 2022:

Depreciation and amortization expense was $432,306 and $565,906 for the years ended December 31, 2023 and 2022, respectively. During the year ended December 31, 2023, the Company disposed of $12,605 in computer equipment with an accumulated depreciation of $12,178. The total loss resulting from the disposal of the assets amounted to $427 for the year ended December 31, 2023. During the year ended December 31, 2022, the Company disposed of $99,811 in computer equipment with an accumulated depreciation of $97,421; and sold a vehicle for $19,500 that was purchased for $88,398 and fully depreciated at the time of sale. The total gain resulting from the disposal of the assets amounted to $17,067 for the year ended December 31, 2022. The Company’s subsidiary, Donkey Crew, LLC, held property, plant and equipment, net outside of the United States in the amount of $3,045 and $13,569, as of December 31, 2023 and 2022, respectively.

NOTE 11 –INTANGIBLE ASSETS

Intangible assets consist of game licenses, game software underlying intellectual property rights, game trademarks and other branding items. The Company amortizes the intangible assets over its useful life.

The following tables reflect all the intangible assets presented on the consolidated balance sheets as of December 31, 2023 and 2022:

Amortization expense was $1,384,862 and $7,657,669 for the years ended December 31, 2023 and 2022, respectively. These amounts are included in cost of revenues in the accompanying consolidated statements of operations and comprehensive income (loss). The weighted average remaining useful life for which amortization expense will be recognized is 1.0 years as of December 31, 2023. Future amortization expense of intangible assets is as follows:

NOTE 12 –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 and also the royalties due to Suzhou Snail and SDE. As of December 31, 2023 and 2022, the Company had $18,147,958 and $19,918,259, 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 Parties. During the years ended December 31, 2023 and 2022, the Company incurred $279,699 and $404,347, respectively as license costs due to Suzhou Snail and included in cost of revenues. During the years ended December 31, 2023 and 2022, respectively, there were $2,050,000 and $4,219,660 in payments to Suzhou Snail for royalties. Accounts payable – related parties consisted of the following as of December 31, 2023, and 2022:

NOTE 13 –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. Please refer to Note 14 —Loan Payable and Interest Payable — Related Parties. The total amount of loan and interest receivable — related party was $103,753 and $101,753, as of December 31, 2023 and 2022, respectively. The Company earned $2,000 and $1,753 in interest on the related party loans receivable during the years ended December 31, 2023 and 2022, respectively.

NOTE 14 –LOAN PAYABLE AND INTEREST PAYABLE — RELATED PARTIES

The Company had a loan amount due to related parties of $400,000 bearing 2.0% per annum interest. $300,000 of the loan is from a wholly owned subsidiary of Suzhou Snail and due in June 2022, and $100,000 is from Suzhou Snail and was due in December 2023. The $100,000 loan along with $3,890 interest payable to Suzhou Snail was offset by the loan receivable Suzhou Snail assumed in February 2022. Please refer to Note 13 —Loan and Interest Receivable — Related Party. In July 2022, the Company paid off the outstanding principal balance of $300,000.

As of December 31, 2023 and 2022, the total loan payable — related parties amounted to $0 and total unpaid interest amounted to $527,770, as of December 31, 2023 and 2022. Interest expense for the loans payable to related parties were $0 and $3,222 during the years ended December 31, 2023 and 2022, respectively.

NOTE 15 –REVOLVING LOAN, SHORT TERM NOTES AND LONG - TERM DEBT

Total interest expense for the above debt and revolver loan amounted to $1,485,241 and $895,761 for the years ended December 31, 2023 and 2022, respectively. Accretion of the convertible notes and amortization of loan origination expenses and loan discounts of $462,284 and $26,514 are included as part of interest expense for the years ended December 31, 2023 and 2022, respectively. As a result of the amendment to the revolving loan on June 21, 2023, the Company recognized $2,903 as additional amortization of loan origination expenses during the year ended December 31, 2023. The Company has a weighted average interest rate of 8.1% and 6.9% on its short-term obligations as of December 31, 2023 and 2022, respectively. The Company’s average dollar amount of short-term obligations during the years ended December 31, 2023 and 2022, were $12,002,949 and $11,898,434, respectively. Average interest and amortization of debt discounts and issuance costs over the two years presented, on the short term obligations, was $959,359 and $244,399, 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 December 31, 2023 and 2022.

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

NOTE 16 –INCOME TAXES

The components of income (loss) before income taxes for the years ended December 31, 2023 and 2022 are as follows:

The income tax benefit for the years ended December 31, 2023 and 2022 are as follows:

The benefits for income taxes differs from the amounts computed by applying the federal statutory tax rate of 21.0% to earnings before income taxes, as follows:

The Company recognized an income tax benefit of $2,400,652 and $2,446,423 for the years ended December 31, 2023 and 2022, respectively. The Company’s effective tax rates were 20.9% and 168.5%, for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023 the Company’s effective tax rate differed from the federal statutory rate of 21% primarily as a result of decreases in uncertain tax positions, changes in the valuation allowance on deferred tax assets, and foreign research and development deductions.

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities consisted of the following as of December 31, 2023 and 2022:

Included in these consolidated financial statements aretwo entities that are not consolidated in the U.S. tax return filing due to less than 80% ownership by Snail Games USA Inc. and entity classifications. As of December 31, 2023, the non-includable entities have U.S. federal net operating loss (“NOL”) carryforwards of $2,884,392 which begin to expire in 2037 and $11,498,479 with an indefinite carryforward period. As of December 31, 2023, the non-includable entities have $14,345,028 of California net operating loss carryforwards, which begin to expire in 2037. The Company’s consolidated federal NOL carryforwards are $26,508,814 and its 163(j) interest carryforward is $1,539,810; both have an indefinite life. The Company’s consolidated state NOL carryforwards are $5,453,676 and begin to expire in 2039.

The Company maintained a total valuation allowance of $5,143,802 and $5,005,195 as of December 31, 2023 and 2022, respectively, the valuation allowance relates primarily to the NOL of the non-includable entities mentioned above, which have had historical losses, and which management has assessed are not more likely than not to be able to realize those NOLs. The non-includable entities had a valuation allowance of $4,022,729 and $4,057,479 as of December 31, 2023 and 2022. The Company’s consolidated tax filing group had a domestic valuation allowance of $686,808 and $683,552 as of December 31, 2023 and 2022, respectively. The Company had a foreign valuation allowance of $434,265 and $264,165 as of December 31, 2023 and 2022, respectively. As of December 31, 2023, the Company has no remaining foreign net operating loss carryforwards.

The Company has assessed all positive and negative evidence of whether sufficient future taxable income will be generated to realize the deferred tax assets, including the level of historical taxable income and projections of future taxable income over the periods during which the deferred tax assets are deductible. 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, except as noted above.

As of December 31, 2023, the Company has foreign tax credit carryforwards of $192,180 which, if not utilized, begin to expire in 2027 and foreign R&D credit carryforwards of $434,265 which, if not utilized, begin to expire in 2027. The Company has booked an uncertain tax position reserve on the entire amount of foreign tax credit and a valuation allowance on its R&D credit carryforwards due to uncertainty regarding their nature and future utilization. The Company also has California R&D credit carryforwards of $343,428 with an indefinite carryforward period.

The Company and its subsidiaries currently file tax returns in the United States (federal and state) and Poland. The statute of limitations for its consolidated federal income tax returns are open for tax years ended December 31, 2020 and after. The statute of limitations for its consolidated state income tax returns are open for tax years ended December 31, 2019 and after. All tax periods for its Polish subsidiary are currently subject to examination since its inception in 2018. While the Company has historically only filed a state tax return in California, it filed in 10 states in 2022 and it also has completed the Voluntary Disclosure Agreement process in additional states.

After enactment of the Tax Cuts and Jobs Act (“TCJA”) in 2017, any current earnings of a foreign subsidiary are subject to the Global Intangible Low-Taxed Income (“GILTI”) tax and any future repatriation of foreign earnings back to the U.S. would be subject to a 100% dividends-received deduction, thus, not subject to additional federal taxes. The Company owns one foreign corporation, Donkey Crew, which is subject to the GILTI tax and will have a GILTI inclusion during the year ended December 31, 2023. It is Management’s intent to permanently reinvest any future foreign earnings to support operations and business growth of its affiliated company in Poland. As such, no deferred tax liability was recorded on the unremitted earnings of the foreign subsidiary as of December 31, 2023 and 2022. As of December 31, 2023, the Company had $977,166 in unremitted earnings that were indefinitely reinvested related to its consolidated foreign subsidiaries.

The following table reflects changes in gross unrecognized tax benefits for the years ended December 31, 2023 and 2022:

As of December 31, 2023 and 2022, the Company had $295,428 and $497,720, respectively, of unrecognized tax benefits that if recognized would impact the Company’s effective tax rate. The Company accrued and recognized interest and penalties related to unrecognized tax benefits in operating expense. As of December 31, 2023 and 2022, the Company had accrued $0 of interest and penalties, respectively. The Company does not expect the amount to change within 12 months and is currently not under audit by any taxing jurisdictions. The Company was notified of an audit starting by the state of Washington for Business and Occupation tax, and is working with the state to conduct a managed audit.

NOTE 17 –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 December 31, 2023 and 2022, the Company’s net operating lease right-of-use assets amounted to $2,440,690 and $3,606,398, respectively. The Company had variable lease payments of approximately $125,207 and $77,385 during the years ended December 31, 2023 and 2022, respectively, which consisted primarily of common area maintenance charges and administrative fees. During the year ended December 31, 2022, the Company terminated one of its lease contracts and recognized a gain on the lease termination of $122,533. The effect of the termination on the related lease asset and liability were as follows:

Operating lease costs included in the general and administrative expenses in our consolidated statements of operations and comprehensive income (loss) for the years ended December 31, 2023 and 2022, are as follows:

Supplemental information related to operating leases for lease liabilities as of December 31, 2023 and 2022, is as follows:

Future undiscounted lease payments for operating leases and a reconciliation of these payments to our operating lease liabilities as of December 31, 2023 are as follows:

NOTE 18 –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.

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 titledMyth 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 theARK: 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 $1.5 million was recorded as deferred revenue, with $0.3 million of the payment included in “other income” and the remaining amount to be recognized upon the satisfaction of certain performance obligations and future revenue sharing.

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, 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.

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. 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.

NOTE 19 –EARNINGS (LOSS) PER SHARE

The Company uses the two class method to compute its basic earnings (loss) per share (“Basic EPS”) and diluted earnings (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 income (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 year ended December 31, 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 year ended December 31, 2023. There were no such exclusions made in the 2022 calculation. In performing the calculation of Basic and Diluted EPS for the year ended December 31, 2022, the Company has treated the number of shares transferred in the reorganization transaction as having been issued at the start of the year. The following table provides a reconciliation of the weighted average number of shares used in the calculation of Basic and Diluted EPS.

NOTE 20 –EQUITY

The Company has authorizedtwo 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 toone vote. Each share of Class B common stock will be entitled toten votes and will be convertible intoone 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.

On November 9, 2022, in connection with the IPO, the Company entered into an underwriting agreement (the “Underwriting Agreement” with the underwriters (the “Underwriters”), pursuant to which the Company agreed to issue and sell 3,000,000 shares of Class A common stock (the “Firm Shares”) at a purchase price of $4.675 per share to the Underwriters and granted the Underwriters an option (the “Over-Allotment Option”) to purchase up to 450,000 additional shares of Class A common stock (the “Option Shares”) at a purchase price of $4.675 per share. The Underwriters had the right to exercise the Over-Allotment Option at any time in whole, or from time to time in part, on or before the forty-fifth day following the effectiveness of the IPO. The Over-Allotment Option was not exercised by the Underwriters prior to its expiration.

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 tofour 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 thethree-year anniversary thereof. The Underwriters Warrants have not been exercised as of the filing of this Annual Report.

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 beginning February 24, 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 year ended December 31, 2023, 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:

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 December 31, 2023:

The debt discount is being amortized to interest expense over the maturity period using the effective interest method at a rate of 109.7%. 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 year ended December 31, 2023, the Company recognized $424,460 of interest expense related to the Convertible Notes, comprising of $29,025 of contractual interest expense, $306,664 in accretion and $88,951 of amortization of debt discount and issuance costs.

Convertible Note Warrants

The convertible note warrants allow the Investors to purchase an aggregate of 714,285 shares of the Company’s Class A common stock at an exercise price of $1.89. The warrants can be exercised, subject to certain ownership limitations, in whole or in part during the exercise period commencing on November 24, 2023 and ending on the date that is five years thereafter.

The exercise price and the number of shares of the warrants are subject to adjustment for standard anti-dilution provisions and also for subsequent issuance at a price lower than the then exercise price and adjustments to the strike price of other equity-linked instruments to a lower price than the then exercise price.

Due to their adjustment provisions, the warrants are classified as a liability on the consolidated balance sheet. The fair value of the warrants at issuance has been estimated using a Monte-Carlo model and the following significant inputs:

The warrant liability, which uses level 3 inputs, is to be measured at fair value each reporting period with the change in fair value being recognized in other income (expense). The measured fair value may be uncertain due to the use of unobservable inputs. At December 31, 2023, the fair value of the warrant liability was $480,281 and was included in the accrued expenses and other liabilities in the Company’s consolidated balance sheets. The changes in fair value during the year ended December 31, 2023, amounted to a charge of $34,527 included in other income in our consolidated statements of operations and comprehensive income (loss) and in changes in accrued expenses and other liabilities in our consolidated statements of cash flows.

Equity Line Purchase Agreement

On August 24, 2023, the Company entered into a common stock purchase agreement (the “Equity Line Purchase Agreement”) and a registration rights agreement (the “Registration Rights Agreement”) with an investor, pursuant to which the investor has committed to purchase up to $5,000,000 in shares of the Company’s Class A common stock, subject to certain limitations and conditions set forth in the Equity Line Purchase Agreement. The Company shall not issue or sell any shares of common stock under the Equity Line Purchase Agreement which, when aggregated with all other shares of common stock beneficially owned by the investor, would result in beneficial ownership of more than 9.99% of the Company’s outstanding shares of common stock.

Under the terms of the Equity Line Purchase Agreement, the Company has the right, but not the obligation, to sell to the investor, shares of Class A common stock over the period commencing on the execution date of the Equity Line Purchase Agreement and ending on the earlier of (i) December 31, 2025, or (ii) the date on which the investor shall have purchased Securities pursuant to the Equity Line Purchase Agreement for an aggregate purchase price of the $5,000,000, provided that a registration statement covering the resale of shares of Class A common stock that have been and may be issued under the Equity Line Purchase Agreement is declared effective by the SEC.

The registration statement covering the offer and sale of up 15,093,768 shares of Class A common stockwas effective on October 10, 2023. The purchase price will be calculated as 92% of the volume weighted average prices of the Company’s common stock during normal trading hours for five business days prior to the closing date with respect of a purchase notice.

Concurrently with the signing of the Equity Line Purchase Agreement, the Company issued the equity line warrant to purchase 367,647 shares of its Class A common stock to the investor as a commitment fee. The total fair value, at the date of issuance, of the equity line warrant of approximately $105,411 was recorded as a liability and deferred offering cost and is included in other assets on our consolidated balance sheets.

Equity Line Warrants

In connection with the equity line of credit the Company issued to the Investors warrants to purchase an aggregate 367,647 shares of the Company’s Class A common stock for an exercise price of $1.50. The warrants can be exercised, subject to certain ownership limitations, in whole or in part during the exercise period commencing on August 24, 2023 and ending on the date that is five years thereafter.

The exercise price and the number of shares of the warrants are subject to adjustment for standard anti-dilution provisions, for subsequent common share issuance at a price lower than the then exercise price of the warrants and adjustments to the strike price of other equity-linked instruments to a lower price than the then exercise price of the warrants.

Due to their adjustment provision, the warrants are classified as a liability on the consolidated balance sheet. The fair value of the warrants at issuance has been estimated using a Monte-Carlo model and the following significant inputs:

The warrant liability, which uses level 3 inputs, is to be measured at fair value at each reporting period and with the change in fair value being recognized in earnings. The measured fair value may be uncertain due to the use of unobservable inputs. At December 31, 2023, the fair value of the warrant liability was $103,767 and included in the accrued expenses and other liabilities in the Company’s consolidated balance sheets. The changes in fair value during the year ended December 31, 2023 amounted to an income of $1,644 and is included in other income in our consolidated statements of operations and comprehensive income (loss) and in changes in accrued expenses and other liabilities in our consolidated statements of cash flows.

Restricted Stock Units (“RSUs”)

RSUs granted to directors vest based on the directors’ continued employment with us through each applicable vest date, which is generally overone year. If the vesting conditions are not met, unvested RSUs will be forfeited. The following table summarizes our RSU units activity with directors for the years ended December 31, 2023 and 2022.

The grant date fair value of RSUs granted to directors is based on the quoted market price of our common stock on the date of grant.

Our RSUs granted to employees vest upon the achievement of pre-determined performance-based milestones as well as service conditions (“PSUs”). The pre-determined performance-based milestones are based on specified percentages of the PSUs that would vest at each of the first five anniversaries of the IPO date if the Company’s average annual growth rate (“AAGR”) is calculated to be at a target percentage or above during the period between the Company’s IPO Date and the annual revenue for each of the anniversary year. If these performance-based milestones are not met but service conditions are met, the PSUs will not vest, in which case any compensation expense the Company has recognized to date will be reversed. Generally, the total aggregate measurement period of our PSUs is 5 years, with awards cliff-vesting after each annual measurement period during the total aggregate measurement period.

Each quarter, the Company updates our assessment of the probability that the performance milestones will be achieved. The Company amortizes the fair values of PSUs over the requisite service period. Each performance-based milestone is weighted evenly and the number of shares that vest based on each performance-based milestone is independent from the other.

The following table summarizes our PSU activity with employees, presented with the maximum number of shares that could potentially vest, for the years ended December 31, 2023 and 2022.

The grant date fair value of PSUs granted to employees is based on the quoted market price of our common stock on the date of grant.

Repurchase Activity

All share repurchases settled in the year ended December 31, 2023 were open market transactions. As of December 31, 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. During the year ended December 31, 2022,1,197,649 shares of Class A common stock were repurchased pursuant to the Share Repurchase Program for an aggregate purchase price of approximately $3.4 million. The average price paid per share during fiscal year 2022 was $2.85.

Stock-Based Compensation Expense

Stock-based compensation expense resulting from RSUs and PSUs of $799,955 and $223,250 are recorded under general and administrative expenses included in our consolidated statements of operations and comprehensive income (loss) for the years ended December 31, 2023 and 2022, respectively. Stock-based compensation expense resulting from PSUs of $48,080 and $0 are recorded under research and development expenses included in our consolidated statements of operations and comprehensive income (loss) for the years ended December 31, 2023 and 2022, respectively.

During the years ended December 31, 2023 and 2022, the Company recognized approximately $185,432 and $48,678 respectively, of deferred income tax benefit related to our stock-based compensation expense.

As of December 31, 2023, our total unrecognized compensation cost related to RSUs and PSUs was approximately $1.1 million and is expected to be recognized over a weighted-average service period of 2.6 years.

NOTE 21 –SUBSEQUENT EVENTS