NOTE 11. COMMITMENTS AND CONTINGENCIES

Concentration of risk. We are exposed to risks associated with a client who represents a significant portion of total revenues. As of December 31, 2016 and 2015, we had the following client revenue concentrations:

The amounts in accounts receivable related to this significant client at December 31, 2016 and 2015 were approximately $210,000 and $150,000, respectively.  

We are also exposed to risks associated with expiration of our patents. In 2015, domestic and international patents expired on two of our products, which account for approximately $5,725,000 or 46% of our revenue for the year ended December 31, 2016. However, we assumed an agreement between the previous owner of these patents and a dominant competitor of ours that prohibits any similar product offerings based on these expired patents until March 2023. As a result, we do not expect the expiration of these patents to have a significant adverse impact on our financial statements.

Operating lease obligations.  In February 2014, we entered into a lease (the “Spencer Lease”) for a new corporate office with an unrelated third party.  The five-year Spencer Lease is for a building with approximately 24,000 square feet, which is comprised of approximately 16,000 square feet of office space and 8,000 square feet of warehouse space.  The property is located in Las Vegas, Nevada.

The initial term of the Spencer Lease commenced on April 1, 2014.  We are obligated to pay approximately $153,000 in annual base rent in the first year, and the annual base rent will increase by approximately 4% each year.  We are also obligated to pay real estate taxes and other building operating costs.  Subject to certain conditions, we have certain rights under the Spencer Lease, including rights of first offer to purchase the premises if the landlord elects to sell.  We also have an option to extend the term of the Spencer Lease for two consecutive terms of three years each, at then current fair market value rental rate determined in accordance with the terms of the Lease.

In connection with the Spencer Lease, the landlord agreed to finance tenant improvements of $150,000 (“TI Allowance”).  The base rent is increased by an amount sufficient to fully amortize the TI Allowance through the Spencer Lease term upon equal monthly payments of principal and interest, with interest imputed on the outstanding principal balance at the rate of 5.5% per annum.  The TI Allowance has been classified as a capital lease on the balance sheet.  See Note 9.

Pursuant to the Spencer Lease, we have the option to terminate the Spencer Lease effective at the end of the 36th month (“Termination Date”). We must deliver written notice of our intention to terminate the Spencer Lease to landlord at least six months before the Termination Date. In the event we exercise our option to terminate, we shall pay the landlord a termination fee (the “Termination Fee”) equal to the sum of (i) all unamortized TI Allowance amounts, plus (ii) all unamortized leasing commissions paid by landlord with respect to the Spencer Lease, plus (iii) all unamortized rental abatement amounts.

Total rent expense was $285,814 and $290,830 for the year ended December 31, 2016 and 2015, respectively.

The amounts shown in the accompanying table reflect our estimates of lease obligations for the twelve months ending 2017 through 2019 and are based upon our current operating leases. There are currently no operating lease commitments beyond January 1, 2020.

Legal proceedings. In the ordinary course of conducting our business, we are, from time to time, involved in various legal proceedings, administrative proceedings, regulatory government investigations and other matters, including those in which we are a plaintiff or defendant, that are complex in nature and have outcomes that are difficult to predict.  In accordance with ASC Topic 450, we record accruals for such contingencies to the extent we conclude that it is probable that a liability will be incurred and the amount of the related loss can be reasonably estimated.  Our assessment of each matter may change based on future unexpected events.  An unexpected adverse judgment in any pending litigation could cause a material impact on our business operations, intellectual property, results of operations or financial position.  Unless otherwise expressly stated, we believe costs associated with litigation will not have a material impact on our financial position or liquidity, but may be material to the results of operations in any given period.  We assume no obligation to update the status of pending litigation, except as may be required by applicable law, statue or regulation.

In Bet litigation.  In November 2014, we filed a complaint for patent infringement against In Bet Gaming, Inc. and In Bet, LLC (collectively "In Bet"), alleging that their “In-Between” side bet game infringes on one or more of our patents.  

Red Card Gaming & AGS litigation.  In September 2012, we executed an asset purchase agreement (“APA”) with Red Card Gaming, Inc. (“RCG”), for the purchase of all the rights, title and interest in and for the game known as High Card Flush and all associated intellectual property.  The APA included customary non-compete, non-disparagement and right of first refusal provisions.  In 2014, AGS, LLC (“AGS”) purchased RCG’s rights in the APA and became the assignee of the APA.  In September 2014 we notified RCG of their material breach of the APA and discontinued contingent consideration payments.  In November 2014, RCG and AGS attempted to terminate the APA and in December 2014, began selling their own High Card Flush game and filed a complaint against us alleging fraud, breach of contract and trademark infringement, among other allegations.  We filed counterclaims against RCG and AGS alleging, among other things, fraud on the trademark office and in the marketplace, misappropriation of our trade secrets, breach of contract, infringement of our trademark and interference with customer relationships.

In July 2016, we entered into a settlement agreement (the "Settlement Agreement") with RCG and AGS for purposes of resolving all disputes between the parties. Pursuant to the Settlement Agreement, among other things, RCG, AGS and the Company agreed to a mutual release of all claims and counter-claims. RCG and AGS also agreed to terminate all of their rights and obligations related to the APA, and AGS agreed to pay us the sum of $350,000 and agreed to the injunctive terms of the Final Award. Furthermore, we agreed to dismiss the complaint we filed in November 2014 against In Bet mentioned above. AGS became involved in an Inter-Parties Review subsequent to November 2014, concerning the patent at issue because AGS had title and interest in the game In-Between. As a result of the Settlement Agreement, we recognized settlement income of $697,214, which includes a $350,000 payment from AGS and a release of $347,214 in accrued contingent consideration owed to AGS.

California administrative action.  In March 2003, Galaxy Gaming of California, LLC (“GGCA”), an independent entity managed by GGLLC, submitted an application to the California Gambling Control Commission (“California Commission”) for a determination of suitability to conduct business with tribal gaming operations in California.  At the time, our CEO was a member of GGCA and was required to be included in the application process.  In July 2013, the California Commission denied the applications of our CEO and GGCA for a finding of suitability.  The California Commission also denied a request for stay or any further reconsideration of the matter.

In August 2013, GGCA and our CEO filed a motion for writ of mandate with the Sacramento County Superior Court, asking the Court for a judicial review of the California Commission’s ruling.  A hearing on the motion was originally scheduled for October 2015 and has been delayed until further notice.

In July 2014, we filed an application with the California Bureau of Gambling Control (“California Bureau”) for a finding of suitability.  As of the date of this report, their investigation is continuing.  Once their investigation is complete, the California Bureau will make their recommendation to the California Commission regarding our suitability.  We are unable to conduct business with tribal casinos in California until either we are found suitable by the California Commission or GGCA and our CEO prevails with their writ of mandate motion.

Uncertain tax positions.  As further discussed in Note 13, we have adopted the provision of ASC 740.  We had $56,886 of uncertain tax position as of December 31, 2016.  Due to the inherent uncertainty of the underlying tax positions, it is not possible to forecast the payment of this liability to any particular year.