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Oct. 13, 2021, 5:15 p.m. EDT

10-K: ESPORTS ENTERTAINMENT GROUP, INC.

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(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This section of this report includes a number of forward-looking statements that reflect our current views with respect to future events and financial performance. As the Company's acquisition of ggCircuit, Helix, Lucky Dino, EGL, FLIP and Argyll took place during the fiscal year ended June 30, 2021, this Management Discussion and Analysis of Financial Condition and Results of Operations speaks only to the historical operations of the Company during the 2021 fiscal year end and the Company's historical business prior such acquisitions. Forward looking statements are often identified by words like:

Overview

Esports is the competitive playing of video games by amateur and professional teams as a spectator sport. Esports typically takes the form of organized, multiplayer video games that include genre's such as real-time strategy, fighting, first-person shooter and multiplayer online battle arena games. As of June 30, 2021, the three most popular esports Strike: Global games were Dota 2, League of Legends (each multiplayer online battle arena games) and Counter Offensive (a first-person shooter game). Other popular games include Fortnite, StarCraft II, Call of Duty� Overwatch, Hearthstone and Apex Legends. Most major professional esports events and a wide range of amateur esports events are broadcast live via streaming services including twitch.tv and youtube.com.

EEG is an esports focused iGaming and entertainment company with a global footprint. EEG's strategy is to build and acquire betting and related platforms, and lever them into the rapidly growing esports vertical. We are focused on driving growth in two markets that include iGaming ("EEG iGaming") and esports ("EEG Games").

EEG iGaming:

EEG iGaming includes the esports betting platform with full casino and sportsbook functionality and services for iGaming customers. Our in-house gambling software platform, Phoenix, is a modern reimagined sportsbook that caters to both millennial esports bettors as well as traditional sports bettors. Phoenix is being developed through the assets and resources from our FLIP acquisition.

EEG's goal is to be a leader in the large and rapidly growing sector of esports real-money wagering, offering fans the ability to wager on professional esports events in a licensed and secure environment. From February 2021, under the terms of our Maltese Gaming Authority (MGA) license, we are now able to accept wagers from residents of over 180 jurisdictions including countries within the European Union, Canada, New Zealand and South Africa, on our ''Vie.bet'' platform.

Alongside the Vie.bet esports focused platform, EEG owns and operates:

? Argyll Entertainment's flagship Sportnation.bet online sportsbook and casino brand, licensed in the UK and Ireland, ? Lucky Dino's 5 online casino brands licensed by the MGA on its in-house built iDefix casino-platform, and

On August 17, 2020, we announced entry into a multi-year partnership with Twin River Worldwide Holdings, Inc, now Bally's Corporation, to launch their proprietary mobile sports betting product, ''Vie.gg', in the state of New Jersey. We intend to launch this platform, which was previously licensed in Curacao, live in the state prior to December 31, 2021, as a real money wagering "skin" of Bally's Atlantic City, the holder of a New Jersey Casino License, Internet Gaming Permit and a Sports Wagering License. In accordance with standard practice, prior to our CSIE licensure we will request approval to operate pursuant to a transactional waiver order issued by the New Jersey DGE. However, there is no assurance that the "live" date will be met as there are numerous technology and other approvals required before going "live". See Item IA, Risk Factors,

In total, we currently hold five Tier-1 gambling licenses (Malta, UK, Ireland, Spain and Sweden) and are in the process of acquiring one in New Jersey. Our acquisitions of Argyll Entertainment, Lucky Dino and Bethard provide a foothold in mature markets in Europe into which we believe we can cross-sell our esports offerings.

EEG Games:

EEG Games is focus is on providing esports entertainment experiences to gamers through a combination of 1) in-person experiences (at Helix Centers), 2) online tournaments (through recently acquired EGL tournament platform), and 3) player-vs-player wagering (through our soon-to-be-released LANDuel product). In order to provide exposure for our platforms, we have signed numerous exclusive marketing relationships with professional sports organizations across the NFL, NBA, NHL and MLS.

Underpinning our focus on esports and EEG Games customers, is our proprietary infrastructure software, ggCircuit. ggCircuit is the leading provider of local area network ("LAN") Center management software, enabling us to seamlessly manage mission critical functions such as game licensing and payments.

We believe that as the size of the market and the number of esports enthusiasts continues to grow, so will the number of esports enthusiasts who gamble on events, which would likely increase the demand for our platform.

We have financed operations primarily through the sale of equity securities and short-term debt. Until revenues are sufficient to meet our needs, we will continue to attempt to secure financing through equity or debt securities.

Results of Operations

Comparison on Year ended June 30, 2021 and 2020

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this report. Material changes in line items in our Statement of Operations for the year ended June 30, 2021 as compared to the same period last year, are discussed below. The financial data is at the consolidated level and reported in U.S. Dollar ($).

Revenue

Revenue for the year ended June 30, 2021 and 2020 totalled $16.8 million and zero, respectively. The revenue for the year ended June 30, 2021 is primarily attributable to the acquisitions of Argyll and Lucky Dino.

Cost of Revenue

Cost of revenue for the year ended June 30, 2021 and 2020 totalled $7.9 million and zero, respectively. The cost of revenue for the year ended June 30, 2021 primarily includes $5.2 million for payment processing fees, platform costs, gaming duties and costs related to revenue sharing arrangements, $2.2 million for the game provider expenses and $0.5 million for other direct expenses related to the delivery of services.

Sales and Marketing

Sales and marketing expense for the year ended June 30, 2021 totalled $10.0 million, an increase of $9.7 million over the $0.3 million recorded for the year ended June 30, 2020. The increase was primarily attributable to $7.2 million in affiliate costs related to iGaming services, $2.3 million for sponsorship agreements with professional sports clubs and our service partners, and $0.2 million for other advertising and promotion expenses including event promotion.

General and Administrative

General and administrative expense for the year ended June 30, 2021 totalled $24.6 million, an increase of $20.9 million over the $3.7 million recorded for the year ended June 30, 2020. The increase was primarily attributable to increases in payroll costs of $6.3 million, costs of acquisitions of $3.5 million, professional fees, including accounting and legal expenses of $3.9 million, depreciation and acquisition related intangibles of $3.4 million, share-based compensation related expenses of $2.5 million, and $1.3 related to other general and administrative cost including incremental costs for information technology related disbursements.

Other Expenses

Other expense decreased $1.9 million from $6.3 million for the year ended June 30, 2020 to $4.4 million for the year ended June 30, 2021. The other expense for the year ended June 30, 2020 results primarily from the settlement of debt and related financial instruments, such as derivative liabilities and warrants, that were converted to equity in connection with our public offering and uplisting to the NASDAQ. The other expense for the year ended June 30, 2021 primarily included a charge of $4.7 million related to the revaluation of the warrant liability recorded in connection with the acquisition of Argyll through issuance of common stock, a charge of $1.7 million related to the settlement of the contingent consideration liability for the FLIP and EGL acquisitions through the issuance of common stock, and interest expense of $0.7 million related primarily to the Senior Convertible Note. This was partially offset by a benefit of $3.2 million related to the revaluation of Series A and Series B warrants issued in connection with the Senior Convertible Note dated June 2, 2021.

Income Tax

The income tax benefit for the year ended June 30, 2021 was $3.8 million. The income tax expense recognized for the year ended June 30, 2020 was immaterial. The income tax benefit recorded for the year ended June 30, 2021 results primarily from the release of valuation allowance of $4.1 million that followed an assessment of the realizability of our deferred tax assets subsequent to the completion of the Argyll, EGL, GGC and Helix acquisitions. It is anticipated that our deferred tax assets will be realized through future reversal of deferred tax liabilities. The income tax benefit was offset by income tax expense related to one of our foreign subsidiaries as well as the estimated exposure for accrued interest and penalties that may be imposed related to tax filings.

Capital Resources and Liquidity

Liquidity and Going Concern

The Company must evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company's ability to continue as a going concern for one year from the date the consolidated financial statements included in this report are issued. The evaluation of going concern under the accounting guidance requires significant judgment. The Company must consider it has historically incurred losses and negative cash flows in recent years as it has prepared to grow its esports business through acquisition and new venture opportunities. The Company must also consider its current liquidity as well as future market and economic conditions that may be deemed outside the control of the Company as it relates to obtaining financing and generating future profits. As of June 30, 2021, the Company had approximately $19.9 million of available cash on-hand. On October 12, 2021, one business day preceding this filing, the Company had approximately $2.4 million of available cash on-hand, with the decrease in the available cash balance resulting primarily from the cash payment of ?13,000,000 (equivalent to $15,346,019 using exchange rates on the date of acquisition) on July 13, 2021 to acquire the Bethard Business (discussed in Note 19 - Subsequent Events). The Company believes that its current level of cash and cash equivalents are not sufficient to fund its operations and obligations without additional financing. Although the Company has financing available, as further described below, the ability to raise financing using these sources is subject to several factors, including market and economic conditions, performance, and investor sentiment as it relates to the Company and the esports and iGaming industry. These conditions were determined to raise substantial doubt regarding the Company's ability to continue as a going concern for a period of at least one year from the date of issuance of these consolidated financial statements.

In determining whether there is substantial doubt about the Company's ability to continue as a going concern, the Company may consider the effects of any mitigating plans for additional sources of financing. The Company identified additional financing sources it believes are currently available to fund its operations and drive future growth that include (i) the ability to access capital using the at-the-money ("ATM") equity offering program available to the Company whereby the Company may sell up to approximately $20,000,000 shares of its common stock (discussed in Note 19 - Subsequent Events), (ii) the ability to sell shares of common stock of the Company through a shelf registration statement on Form S-3 (File No. 333-252370) declared effective by the Securities and Exchange Commission (SEC) on February 5, 2021, and (iii) the ability to raise additional financing from other sources. These plans were however determined to require the Company to place reliance on several factors as described above, and therefore were not sufficient to overcome the presumption of substantial doubt about the Company's ability to continue as a going concern.

The Company's sources and (uses) of cash for the year ended June 30, 2021 and 2020 are shown below:







                                                    2021             2020
        Cash used in operating activities       $ 18,883,006     $  2,269,652
        Cash used in investing activities       $ 56,133,256     $    500,000
        Cash provided by financing activities   $ 86,356,201     $ 15,079,547
        


At June 30, 2021, we had total current assets of $29.7 million and total current liabilities of $12.2 million. Net cash used in operating activities for the year ended June 30, 2021 was $18.9 million, which includes a net loss of $26.4 million, offset by non-cash adjustments of $7.3 million principally related to non-cash expenses for share based compensation expense of $4.1 million, amortization and depreciation of $3.4 million, amortization of the right of use asset of $0.2 million, amortization of debt discount $0.5 million, loss on change in fair value of warrant liability of $1.5 million and loss on change in fair value of contingent consideration of $1.7 million, offset by a non-cash benefit for deferred income taxes related to a change in valuation allowance of $4.1 million. The change in net working capital items resulted in a use of cash of $0.2 million primarily related to increase in the receivables reserved from users account of $2.3 million, prepaid expense and other current assets of $2.2 million and account receivables of $0.1 million, other non-current assets $0.2 million, deferred revenue $0.1 million, and operating lease liability $0.1 million. This was offset by an increase in accounts payable and accrued expenses of $4.3 million and liabilities to customers of $0.7 million.

Net cash used in investing activities for the year ended June 30, 2021 totalled $56.1 million principally related to the cash payments for acquisitions that included $28.9 million for Lucky Dino ($30.1 million net of cash acquired of $1.2 million), $15.0 million for ggCircuit ($14.9 million net of cash acquired of $0.1 million), $10.0 million for Helix ($9.9 million net of cash acquired of $0.1 million), $0.7 million for Argyll ($0.6 million net of cash acquired of $0.1 million), $0.6 million for EGL ($0.5 million net of cash acquired of $0.1 million and further increased by $0.1 million representing additional contingent Holdback Consideration paid in cash), $0.1 million for FLIP, as well as purchased intangible assets and equipment of $0.8 million.

Net cash provided by financing activities for the year ended June 30, 2021 totalled $86.4 million that included the net proceeds of $27.3 million that had been raised from the issuance of common stock as well as net proceeds of $26.6 million from the exercise of stock options and warrants for shares of common stock. The Company also received net proceeds of $32.5 million (gross proceeds of $35.0 million less debt issuance costs of $2.5 million) from the issuance of the Senior Convertible Note dated June 2, 2021 that was offset by the repayment of a note payable of $0.1 million.

Senior Convertible Note

On June 2, 2021 the Company issued a Senior Convertible Note in the principal amount of $35,000,000 million with the Company receiving proceeds at issuance of $32.5 million, net of debt issuance costs of $2.5 million. The Senior Convertible Note matures on June 2, 2023, at which time the Company is required to repay the original principal balance and a "minimum return" equal to 6% of any outstanding principal. The aggregate principal of the Senior Convertible Note repayable at maturity is $37,100,000 and the Senior Convertible Note accrues interest at rate of 8% per annum payable in cash monthly. The Senior Convertible Note was issued with 2,000,000 Series A Warrants and 2,000,000 Series B Warrants . On the date of issuance, the Company recorded the fair value of the Series A Warrants and Series B Warrants as a discount to the Senior Convertible Note totaling $26,680,000. The debt discount is being amortizing to interest expense over the term of the Senior Convertible Note using the effective interest method. The obligation resulting from the issuance of the Series A Warrants and Series B Warrants was determined to qualify for liability classification on the consolidated balance sheet. See below for further discussion of the Series A Warrants and Series B Warrants.

The Senior Convertible Note is convertible, at the option of the holder, into shares of the Company's common stock at a conversion price of $17.50 per share. The conversion amount is calculated as the principal balance identified for conversion plus a minimum return of 6% on such principal balance. At any time after issuance, the Company has the option, subject to certain conditions, to redeem some or all of outstanding principal, inclusive of any minimum return due to the holder based on the number of days the principal is outstanding.

The Senior Convertible Note is subject to a most favored nations provision and standard adjustments in the event of any stock split, stock dividend, stock combination, recapitalization or other similar transaction. If the Company enters into any agreement to issue, or issue any variable rate securities, the holder of the Senior Convertible Note has the additional right to substitute such variable price (or formula) for the conversion price. If the holder were to substitute a floor price of $2.1832 as the variable price, the Company would be required to settle in cash any difference between the market value of the shares subject to conversion at the floor price and the market value of the shares using the variable price, excluding any reference to the floor. The holder of the Senior Convertible Note also has the right to have the Company redeem all or a portion of the Senior Convertible Note at a redemption price equal to 106% of the portion of the Senior Convertible Note being redeemed should the Company provide notice of incurring additional debt.

If an event of default occurs, the holder of the Senior Convertible Note has the right to alternate conversion ("Alternate Conversion") and may elect to convert the Senior Convertible Note, inclusive of a 15% premium payable in a cash due such an acceleration of the applicable principal, at a price ("Alternate Conversion Price") equal to the greater of the floor price of $2.1832 or a price derived from the volume weighted average price of the Company's common stock at the time of Alternate Conversion. If the Alternate Conversion were to include the floor price of $2.1832 as the Alternate Conversion Price, the Company would be required to settle in cash any difference between the market value of the shares subject to the Alternate Conversion using the floor price and the market value of the shares using the Alternate Conversion Price, excluding any reference to the floor.

In connection with an event of default, the holder may require the Company to redeem in cash any or all of the Senior Convertible Note. The redemption price will equal 115% of the outstanding principal of the Convertible Note to be redeemed, and accrued and unpaid interest and unpaid late charges thereon, or an amount equal to market value of the shares of the Company's common stock underlying the Convertible Note, as determined in accordance with the Convertible Note, if greater. The noteholder will not have the right to convert any portion of a Senior Convertible Note, to the extent that, after giving effect to such conversion, the holder, together with certain related parties, would beneficially own in excess of 4.99% of the shares of our common stock outstanding immediately after giving effect to such conversion. The holder may from time to time increase this limit to 9.99%, provided that any such increase will not be effective until the 61st day after delivery of a notice to us of such increase.

In addition, unless obtain approval is obtained from the Company's stockholders as required by Nasdaq, the Company is prohibited from issuing any shares of common stock upon conversion of the Senior Convertible Note or otherwise pursuant to the terms of the Senior Convertible Note, if the issuance of such shares of common stock would exceed 19.99% of the Company's outstanding shares of common stock, or otherwise exceed the aggregate number of shares of common stock which the Company may issue without breaching our obligations under the rules and regulations of Nasdaq.

In connection with a change of control, as defined in the Senior Convertible Note, the holder may require the Company to redeem all or any portion of the Senior Convertible Note. The redemption price per share will equal the greatest of (i) 115% of the outstanding principal of the Senior Convertible Note to be redeemed, and accrued and unpaid interest and unpaid late charges thereon, (ii) 115% of the market value of the shares of our common stock underlying the Senior Convertible Note, as determined in accordance with the Senior Convertible Note, and (iii) 115% of the aggregate cash consideration that would have been payable in respect of the shares of the Company's common stock underlying the Senior Convertible Note, as determined in accordance with the Senior Convertible Note.

The Company is subject to certain customary affirmative and negative covenants regarding the incurrence of indebtedness, the existence of liens, the repayment of indebtedness, the payment of cash in respect of dividends, distributions or redemptions, and the transfer of assets, among other matters. We also will be subject to certain financial covenants relating to available cash, ratio of outstanding indebtedness to market capitalization and minimum cash flow. The Company is also subject to financial covenants as it relates minimum revenues commencing June 30, 2022.

The Company evaluated its compliance with the debt covenants in the Senior Convertible Note as of June 30, 2021 and the period from July 1, 2021 through October 13, 2021 and determined that it had not maintained compliance with certain covenants in the Senior Convertible Note. The Company therefore requested and received a waiver for (i) any known breaches or potential breaches of financial covenants in effect related to the available cash test and minimum cash flow test through December 25, 2021, (ii) any known breach resulting from the existing lien on the shares of Prozone Limited obtained in the acquisition of the Bethard Business (see discussion of the acquisition of the Bethard Business as a subsequent event in Note 19) and (iii) any known breach which would result from the issuances of up to 200,000 shares common stock in connection with the Company's proposed purchase of certain equity interests in Game Fund Partners Group LLC (as further discussed as a subsequent event in Note 19). In addition, the Company requested and received an amendment to the Senior Convertible Note wherein the permitted ratio of outstanding debt to market capitalization was increased temporarily from 25% to 35% through December 25, 2021.

In consideration for the waiver, the Company agreed to permit the immediate conversion of up to $7,500,000 of the outstanding balance of the Senior Convertible Note at the Alternate Conversion Price into shares of common stock of the Company. In the event of default following December 25, 2021, the holder may exercise any and all rights available to it following such a default that includes redemption of the Senior Convertible Note for cash. The holder may also choose to convert any outstanding indebtedness in the form of the Alternate Conversion Price as provided in the Senior Convertible Note, subject to the terms and conditions contained therein, until such time as the Company is in compliance with the above-mentioned Sections.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of these consolidated financial statements requires our management to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates are based on management's historical and industry experience and on various other assumptions that are believed to be reasonable under the circumstances. On a regular basis, we evaluate these accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results may differ from our estimates, and such differences could be material.

A full discussion of our significant accounting policies is contained in Note 2 to our consolidated financial statements, which is included in Item 8 - "Financial Statements and Supplementary Data" of this report. We believe that the following accounting estimates are the most critical to aid in fully understanding and evaluating our financial results. These estimates require our most difficult, subjective or complex judgments because they relate to matters that are inherently uncertain. We have reviewed these critical accounting policies and estimates and related disclosures with our Audit Committee.

Revenue recognition

Revenue and Cost Recognition

The revenue of the Company is currently generated from online casino and sports betting (referred to herein as "iGaming" revenue), as well from the provision of esports gaming, event and team management services. The amount of revenue is recognized by the Company is measured at the transaction price, or the amount of consideration that the Company expects to receive in exchange for transferring a promised good or service. The transaction price includes estimates of variable consideration to the extent that it is probable that a significant reversal of revenue recognized will not occur.

iGaming Revenue

iGaming revenue is derived from the placement of bets by end-users, also referred to as customers, through online gaming sites. The transaction price in an iGaming contract, or Net Gaming Revenue ("NGR"), is the difference between gaming wins and losses, as further reduced by any nondiscretionary incentives awarded to the customer. Gaming transactions involve four performance obligations, namely the settlement of each individual bet, the honoring of discretionary incentives available to the customer through loyalty reward programs, the award of free spin and deposit match bonuses, and the winning of a casino jackpot. The total amount wagered by a customer is commonly referred to as the win or Gross Gaming Revenue ("GGR"). The GGR is allocated to each performance obligation using the relative standalone selling price ("SSP") determined for iGaming contracts.

The Company evaluates bets that its users place on websites owned by third party brands in order to determine whether it may recognize revenue on a gross basis, . . .

Oct 13, 2021

COMTEX_395132134/2041/2021-10-13T17:15:09

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