Note 9: Commitments and Contingencies

Operating Lease Obligation

We lease our offices from a party that is related to our CEO.  The initial term of the lease expired August 31, 2010 and there was an option for two six year renewals.  Under the terms of the lease agreement the monthly minimum rental payment was $18,565 and rent increased 3% every year on September 1st.  Effective April 1, 2010, the landlord agreed to temporarily reduce the monthly rent to $9,283 until the end of the initial lease period.  On September 1, 2010, a new lease was entered into for a period of two years with a monthly rental payment of $10,359.  Rent expense was $62,154 and $82,824 for the six months ended June 30, 2011 and 2010 respectively.

Rent to be paid under the lease agreement is summarized as follows:

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, that are complex in nature and have outcomes that are difficult to predict.  In accordance with SFAS 5, “Accounting for Contingencies,” we record accruals for such contingencies to the extent that 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, statute or regulation.

Sherron Associates, Inc. — A judgment was issued in Washington State against our CEO and others in a matter unrelated to us in 1998.  Sherron Associates, Inc., a Washington company, (“Sherron”) subsequently obtained the judgment and in 2008, filed suit against us in Washington claiming we are the alter-ego of our CEO and therefore responsible for payment of the judgment.  Also in 2008, Sherron filed suit against us in Nevada attempting to execute the judgment against certain intellectual property of ours, claiming the property belongs personally to our CEO.

We deny any liability or wrongdoing in the Sherron litigation and dispute all claims and that the associated litigation against us is without merit.  We contend that, among other defenses, we are not the judgment debtor and are exempt from any alter-ego claims and are an independent entity with a distinct and separate legal existence.  We intend to use any and all actions and remedies available to avoid adverse financial impact from these proceedings and we intend to continue to vigorously defend the cases brought against us.  We have filed an action against Sherron in Nevada for various abuses of process in the litigation and their malicious attempts to improperly enforce a judgment.

All litigation relating to Sherron is currently stayed pending the outcome of mediation including us, our CEO and Sherron.  In the event mediation is unsuccessful, the stays could be lifted and our legal fees pertaining to this litigation could increase until the matter has reached a final conclusion.  In the event Sherron prevails in any of its attempts against us, we may be liable for damages in an amount up to two million dollars, and could experience difficulty in paying or obtaining the financing to pay a properly adjudicated liability to Sherron.  We may also be required to pay a licensing fee to Sherron to continue using the intellectual property upon which one of our games is based and there is no guarantee that a viable licensing arrangement could be negotiated with Sherron.  Should Sherron prevail in its litigation against us, our business could be adversely materially impacted.

In the course of defending ourselves, we paid legal fees directly to the law firm retained by our CEO to represent him for the express purpose of quashing the underlying judgment which is the subject of the Sherron litigation.  Total fees from this law firm charged to expense were $5,376 and $12.797 for the six months ended June 30, 2011 and 2010 respectively.

California Administrative Licensing Action - In 2002, Galaxy Gaming of California, LLC, (“GGCA”) a subsidiary of GGLLC, submitted an application to the California Gambling Control Commission (the “Commission”) for a determination of suitability for licensure to do 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.  The Division of Gambling Control of the California Department of Justice (the “Division”) processed the application and in 2005 made an initial recommendation to the Commission alleging GGCA was unsuitable.  GGCA and our CEO claimed that the process conducted by the Division was seriously flawed and biased and in December 2006, exercised its right to have an administrative law judge (“ALJ”) further adjudicate the process.  The Commission assigned the matter for adjudication before an ALJ.

On January 1, 2007, we acquired GGCA including the related client base and recurring revenue in connection with the execution of the equity exchange agreement with GGLLC.  At the time, the Division (since renamed the “Bureau” of Gambling Control) had not filed a statement of issues against GGCA or our CEO.  On February 10, 2009, we applied to the Commission for a finding of suitability.  The Bureau filed its statement of issues against GGCA and our CEO in October, 2009.  An abandonment of the GGCA application was sought since the entity ceased business operations and was later dissolved.  The abandonment request has not been acted upon by the Commission.  A hearing with the assigned ALJ regarding the GGCA application began in June, 2011.  The hearing has been continued and is scheduled to re-convene in January 2012.

Because the Bureau names our CEO in the statement of issues, our ability to continue to conduct business in California could be contingent upon a successful resolution of this action.  During these proceedings, we are entitled to conduct business in California, provided that, we obtain the requisite authorization with each tribe in California either through obtainment of an appropriate license or an exempt status determination.  The current administrative action could limit our future ability to obtain such tribal authorizations. Total revenues derived from California for the six months ended June 30, 2011 was $66,421.  As such we intend to continue to vigorously defend the administrative action, to seek the abandonment of the GGCA application and to seek an independent finding of suitability with the Commission.  If there is not a successful resolution to this matter, we could be precluded from operating and selling in California which could significantly impact our current revenue base and ability to generate additional income.  An adverse finding of suitability could also influence other gaming regulatory agencies and negatively affect our ability to conduct business in those jurisdictions.  If the ALJ recommends that the Commission deny licensure, the ALJ may, upon presentation of suitable proof, order the licensee or applicant for a license to pay reasonable costs of the investigation and prosecution of the case.  Although the action is against our CEO and GGCA, it is unknown whether the Bureau will attempt to seek reimbursement against us or whether the ALJ would grant such a request.