EGT Entertainment Gaming Asia Incorporated

Notes to Consolidated Financial Statements

The current business activities of the Company entail: (i) the owning and leasing of electronic gaming machines (EGMs) placed in gaming locations in the Philippines on a revenue-sharing (participation) basis with venue owners; and (ii) the development and testing of a social gaming platform and applications designed for the Pan-Asian markets.

During the three-month period ended March 31, 2016, the Company’s business activities included owning and leasing EGMs on a revenue-sharing (participation) and fixed-lease basis in Cambodia. These leasing contracts were terminated and the related assets were sold during the year ended December 31, 2016. Also during the three-month period ended March 31, 2016, the Company operated a gaming products business, which entailed the design, manufacture and distribution of gaming chips and plaques as well as the distribution of third-party gaming products. On May 11, 2016, the Company sold the principal assets of these operations and has exited this business. All related historical revenues and expenses for the Cambodia gaming operations and the gaming products business have been reclassified as discontinued operations. The accounting policies of these discontinued operations are consistent with the Company’s policies for the accompanying consolidated financial statements.

Basis of Presentation

These consolidated financial statements are prepared pursuant to generally accepted accounting principles in the United States for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X promulgated by the Securities and Exchange Commission (“SEC”) and reflect all adjustments, consisting of normal recurring adjustments and other adjustments, which management believes are necessary to fairly present the financial position, results of operations and cash flows of the Company, for the respective periods presented. The results of operations for an interim period are not necessarily indicative of the results that may be expected for any other interim period or the year as a whole. The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, filed with the SEC on April 11, 2017.

Principles of Consolidation

These consolidated financial statements include the accounts of Entertainment Gaming Asia Inc. and all its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts in the consolidated financial statements and notes thereto have been reclassified to conform to the current period’s presentation.

Use of Estimates

The Company is required to make estimates, judgments and assumptions that it believes are reasonable based on its historical experience, contract terms, observance of known trends in the Company and the industry as a whole, and information available from other outside sources. These estimates affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On a regular basis, the Company evaluates its estimates, including those related to revenue recognition, product returns, long-lived assets, inventory obsolescence, stock-based compensation, income taxes, bad debts, warranty obligations, long-term contracts, contingencies and litigation. Actual results may differ from those estimates.

Discontinued Operations

A discontinued operation is a component of an entity (or group of components) that either has been disposed of, or that is classified as held for sale, and represents a strategic shift that has (or will have) a major effect on the Company’s operations and financial results.

Non-current assets held for discontinued operations are carried at the lower of carrying amount or fair value less costs to sell. Any gain or loss from disposal of a business, together with the results of these operations until the date of disposal, is reported separately as discontinued operations. The financial information of discontinued operations is excluded from the respective captions in the Company’s consolidated statements of comprehensive loss and related notes for all periods presented.

Cash and Cash Equivalents

All highly-liquid instruments with original maturities of three months or less are considered cash equivalents. The Company places its cash and temporary investments with financial institutions. As of March 31, 2017, the Company had deposits with financial institutions in excess of Federal Deposit Insurance Corporation (FDIC) insured limits by approximately $31.5 million.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated at face value less any allowances for doubtful accounts. Allowances for doubtful accounts are maintained at levels determined by Company management to adequately provide for uncollectible amounts. In determining the estimated uncollectable amounts, the Company evaluates a combination of factors, including, but not limited to, activity in the related market, financial condition of customers, specific customer collection experience and history of write-offs and collections. Interest income is imposed on overdue accounts receivable after the Company evaluates a combination of factors, including but not limited to, customer collection experiences, customer relationship and contract terms. Accounts receivable balances are written off after all collection efforts have been exhausted.

Inventories

Inventories are stated at the lower of cost, determined using the first-in, first-out method, or market. Cost elements included in work-in-process and finished goods include raw materials, direct labor and manufacturing overheads. There were no lower of cost or market (LCM) write-downs for the continuing operations for the three-month periods ended March 31, 2017 and 2016.

Long-Lived Assets

The Company accounts for impairment of long-lived assets in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 360,  Property, Plant and Equipment . Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In such instances, the Company estimates the undiscounted future cash flows that result from the use of the asset and its ultimate disposition. If the sum of the undiscounted cash flows is less than the carrying value, the Company recognizes an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset, determined principally using discounted cash flows. There were no impairment charges for long-lived assets for the three-month periods ended March 31, 2017 and 2016.

Prepayments, Deposits and Other Assets

Prepayments, deposits and other assets consist primarily of other receivables, rental and utilities and other deposits.

Gaming Equipment

Gaming equipment consists primarily of EGMs and systems. Gaming equipment is stated at cost. The Company depreciates new EGMs and systems over a five-year useful life and depreciates refurbished EGMs and systems over a three-year useful life once placed in service. Depreciation of gaming equipment of approximately $65,000 and $101,000 was included in cost of gaming operations for the continuing operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively. Depreciation of gaming equipment of NIL and approximately $324,000 was included in the net loss from discontinued operations in the consolidated statements of comprehensive loss for three-month periods ended March 31, 2017 and 2016, respectively.

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the useful lives of the assets currently estimated to be three to six years, which in the case of leasehold improvements, is limited to the life of the lease and throughout the renewal period as long as renewal is reasonably assured.

The Company capitalizes certain direct and incremental costs related to the design and construction, project payroll costs and applicable portions of interest incurred for potential projects in property and equipment.

Depreciation of property and equipment of approximately $2,000 and $3,000 was included in cost of gaming operations for continuing operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively.

Depreciation of property and equipment of approximately $1,000 and $352,000 was included in the net loss from discontinued operations in the consolidated statements of comprehensive loss for three-month periods ended March 31, 2017 and 2016, respectively.

Goodwill and Intangible Assets, Including Casino Contracts

Intangible assets consist of patents, trademarks, technical know-how, a gaming operations agreement, casino contracts, capitalized software costs and goodwill. Intangible assets other than goodwill are amortized on the straight-line basis over the period of time the asset is expected to contribute directly or indirectly to future cash flows, which ranges from four to ten years. The straight-line amortization method is utilized because the Company believes there is no more reliably determinable method of reflecting the pattern for which the economic benefits of the intangible assets are consumed or otherwise used.

The Company capitalizes certain costs relating to software developed to solely meet the Company’s internal requirements and for which there are no substantive plans to market the software. These costs mainly include payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal-use software projects during the application development stage until the software is substantially complete and ready for its intended use. Costs incurred prior to the criteria met for capitalization are expensed to research and development expenses as incurred. Management has committed resources to develop social gaming applications, and it is probable that these social gaming applications will be completed and the software will be used as intended. Such capitalized costs are amortized on the straight-line basis over the estimated useful life of the related assets.

Amortization expenses related to casino contracts for the Philippines gaming operations of NIL and approximately $93,000 were included in the cost of gaming operations for the continuing operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively. Amortization expenses related to other gaming related intangibles for the Philippines gaming operations of NIL and approximately $63,000 were included in the cost of gaming operations for the continuing operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively.

Amortization expenses related to internal-use software of approximately $97,000 for the three-month period ended March 31, 2017 were accounted as cost of social gaming operations in the consolidated statements of comprehensive loss. There were no amortization expenses related to internal-use software for the three-month period ended March 31, 2016.

Amortization expenses related to casino contracts for the discontinued Cambodia gaming operations were NIL and approximately $341,000 for the three-month periods ended March 31, 2017 and 2016, respectively. Amortization expenses related to technical know-how for the discontinued gaming product operations were NIL and approximately $6,000 for the three-month periods ended March 31, 2017 and 2016, respectively. Amortization expenses related to patents and trademarks for the discontinued gaming product operations were NIL and approximately $6,000 for the three-month periods ended March 31, 2017 and 2016, respectively. The amounts were accounted for in arriving at the net loss from discontinued operations in the consolidated statements of comprehensive loss.

The Company measures and tests finite-lived intangibles for impairment when there are indicators of impairment in accordance with ASC 360-10-05,  Property, Plant and Equipment .

The Company measures and tests goodwill for impairment at least annually in accordance with ASC 350-10-05,  Intangibles — Goodwill and Other .

The Company first assesses qualitative factors to determine whether it is necessary to perform the two-step goodwill impairment test. If determined to be necessary, the two-step impairment test shall be used to identify potential goodwill impairment. Impairment testing for goodwill and other intangibles requires judgment, including the identification of reporting units, allocation of related goodwill, assignment of corporate shared assets and liabilities to reporting units, estimated future cash flows and determinations of fair values. While the Company believes its estimates of future revenues and cash flows are reasonable, different assumptions could materially affect the assessment of useful lives, recoverability and fair values. No impairment charges relating to intangible assets were recorded for the three-month periods ended March 31, 2017 and 2016.

Litigation and Other Contingencies

In the performance of its ordinary course of business operations, the Company is subject to risks of various legal matters, litigation and claims of various types. The Company has regular litigation reviews, including updates from corporate and outside counsel, to assess the need for accounting recognition or disclosure of these contingencies. See Note 16.

ASC 450,  Contingencies,  requires that liabilities for contingencies be recorded when it is probable that a liability has been incurred and that the amount can be reasonably estimated. Significant management judgment is required related to contingent liabilities and the outcome of litigation because both are difficult to predict. For a contingency for which an unfavorable outcome is reasonably possible and which is significant, the Company discloses the nature of the contingency and, when feasible, an estimate of the possible loss.

Revenue Recognition

The Company recognizes revenue when all of the following have been satisfied:

Gaming Operations Revenue

The Company earns recurring gaming revenue from its gaming operations.

For gaming operations, the Company earns recurring revenue by providing customers with EGMs and casino management systems which track game performance and provide statistics on installed EGMs owned by the Company and leased to venue owners. Revenues are recognized on the contractual terms of the EGM agreements between the Company and the venue owners. During the reported periods, revenues were based on either the Company’s share of net winnings and reimbursement of expenses and commitment fees, or a fixed lease fee, which was applicable for one venue under the now discontinued Cambodia gaming operations for the period of March 1, 2016 through June 30, 2016.

Revenues are recognized as earned unless collection is not reasonably assured, in which case revenues are recognized when payment is received. All gaming operations revenues were recognized as earned for the three-month periods ended March 31, 2017 and 2016.

Commitment fees paid to the venue operators relating to contract amendments which are not recoverable from daily net win are capitalized as assets and amortized as a reduction of revenue over the term of the amended contracts. The Company had no commitment fee balances related to contract amendments as of March 31, 2017 and December 31, 2016.

Social Gaming

The Company is currently testing a social gaming platform and applications to derive revenue from the in-game sale of virtual coins that allows players to extend play time or accelerate their progress. The Company recognizes the sale of virtual coins over the estimated average playing period of paying players.

On a quarterly basis, the Company determines the estimated average playing period for paying players by game beginning at the time of a paying player’s first purchase in that game and ending on a date when that paying player is no longer playing the game. To determine which players are inactive, the Company analyzes the dates that each paying player last logged into that game.

The Company earns revenue through certain mobile platforms, including iOS and Android, and recognizes online game revenue based on the gross amount paid by the player because the Company is the primary obligor and has the contractual right to determine the price to be paid by the player. The Company records the related platform and payment processing fees as cost of revenue in the periods incurred.

Gaming Products Sales

For the discontinued gaming products business, the Company recognized revenue from the sale of its gaming products and accessories to end users upon shipment against customer contracts or purchase orders. In accordance with the criteria of ASC 605-45,  Reporting Revenue Gross as a Principal versus Net as an Agent,  the Company recognized gross revenue when it acted as a principal, had discretion to choose suppliers and establish selling prices, assumed credit risk and provided the products or services required in the transaction. If these criteria were not met, in which the supplier was the primary obligor in the arrangement and bears the general inventory risk, the Company recognized revenue net of related costs. The Company also recognized revenue for the maintenance services of gaming products on the straight-line basis over the contract term in accordance with ASC 605,  Revenue Recognition .

Stock-Based Compensation

Under the fair value recognition provisions of ASC 718,  Compensation-Stock Compensation , the Company recognizes stock-based compensation expenses for all service-based awards to employees and non-employee directors with graded vesting schedules on a pro rata basis over the requisite service period for the entire award. Estimates are revised if subsequent information indicates that forfeitures will differ from previous estimates, and the cumulative effect on compensation cost of a change in the estimated forfeitures is recognized in the period of the change. For non-employee awards, the Company remeasures compensation cost each period until the service condition is completed and recognizes compensation cost on the straight-line basis over the requisite service period. Option valuation models require the input of highly subjective assumptions, and changes in the assumptions used can materially affect the fair value estimates. Judgment is required in estimating stock price volatility, forfeiture rates, expected dividends, and expected terms that options remain outstanding. For restricted stock awards with performance conditions, the Company evaluates if performance conditions are probable in each reporting period. The compensation expense of restricted awards is recognized ratably over the implicit service period if achieving performance conditions is probable. Cumulative catch-up adjustments are required in the event of changes in assessment of probability. See Note 12 for additional information relating to stock-based compensation assumptions. Stock-based compensation expenses totaled approximately $27,000 and $14,000 for the three-month periods ended March 31, 2017 and 2016, respectively, in the consolidated statements of comprehensive loss.

Research and Development

Research and development expenses are expensed as incurred. Employee-related costs associated with research and development and certain costs associated with the development of the social gaming platform and applications are included in research and development expenses.  Research and development expenses for continuing operations were approximately $215,000 and $397,000 for the three-month periods ended March 31, 2017 and 2016, respectively.

Leases

Leases are classified at the inception date as either a capital lease or an operating lease. A lease is a capital lease if any of the following conditions exist:

A capital lease is accounted for as if there was an acquisition of an asset and an incurrence of an obligation at the inception of the lease. All other leases are accounted for as operating leases wherein rental payments are expensed as incurred. The Company had no capital leases as of March 31, 2017 and December 31, 2016.

Income Taxes

The Company is subject to income taxes in the United States (including federal and state) and several foreign jurisdictions in which it operates. Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax basis and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered. ASC 740,  Income Taxes,  requires that deferred tax assets be evaluated for future realization and reduced by a valuation allowance to the extent the Company believes a portion will not be realized. The Company considers many factors when assessing the likelihood of future realization of its deferred tax assets, including its recent cumulative earnings experience and expectations of future taxable income by taxing jurisdiction, the carry-forward periods available to the Company for tax reporting purposes, and other relevant factors.

The Company accounts for uncertain tax positions in accordance with ASC 740, which contains a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely to be realized upon ultimate settlement. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in the provision for income taxes in the consolidated statements of comprehensive loss.

On December 31, 2010, the Company effected a Quasi-Reorganization. As of that date, the Company’s deferred taxes were reported in conformity with applicable income tax accounting standards described above, net of applicable valuation allowances. Deferred tax assets and liabilities were recognized for differences between the assigned values and the tax basis of the recognized assets and liabilities with corresponding valuation allowances as appropriate. In accordance with the Quasi-Reorganization requirements, pre-existing tax benefits realized subsequent to the Quasi-Reorganization are recorded directly in equity.

(Loss)/Earnings per Share

Basic (loss)/earnings per share are computed by dividing the reported net (loss)/earnings by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing the net (loss)/earnings by the weighted average number of shares of common stock and shares issuable from stock options and restricted shares during the period. The computation of diluted earnings per share excludes the impact of stock options and restricted shares that are anti-dilutive due to the stock options’ exercise price exceeding the Company’s stock price as of March 31, 2017. There were no differences in diluted loss per share from basic loss from continuing operations per share for the three-month periods ended March 31, 2017 and 2016 as the assumed exercise of common stock equivalents would have an anti-dilutive effect due to losses.

Foreign Currency Translations and Transactions

The functional currency of the Company’s international subsidiaries, except for its operations in Cambodia whose functional currency is also U.S. dollars, is generally the local currency. For these subsidiaries, the Company translates the assets and liabilities at exchange rates in effect at the balance sheet date and income and expense accounts at average exchange rates during the period. Resulting currency translation adjustments are recorded directly to accumulated other comprehensive income within stockholders’ equity. Gains and losses resulting from transactions in non-functional currencies are recorded in the consolidated statements of comprehensive loss.

Below is a summary of closing exchange rates as of March 31, 2017 and December 31, 2016 and average exchange rates for the three-month periods ended March 31, 2017 and 2016.

Fair Value Measurement

Fair value is defined under ASC 820, Fair Value Measurements and Disclosures , as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. 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 establishes a fair value hierarchy based on three levels of input, of which the first two are considered observable and the last unobservable.

As of March 31, 2017, the fair values of financial assets and liabilities approximate carrying values due to the short maturity of these items.

Defined Benefit Pension Plan

The Company provides pension benefits to all regular full-time employees in the Philippines through a defined benefit plan. A defined benefit plan is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, usually dependent on one or more factors such as age, years of service and salary.

The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows using interest rates of high quality corporate bonds that are denominated in the currency in which the benefits will be paid and that have terms to maturity approximating to the terms of the related pension liability.

The accounting guidance related to employers’ accounting for defined benefit pension plan requires recognition in the balance sheet of the present value of the defined benefit obligation at the reporting date, together with adjustments for unrecognized actuarial gains or losses and past service costs or credits in other comprehensive loss.

There were no adjustments for unrecognized actuarial gains or losses and past service costs or credits to equity through other comprehensive income for the three-month periods ended March 31, 2017 and 2016.

Asset Retirement Obligations

Asset retirement obligations are legal obligations associated with the retirement of long-lived assets resulting from the acquisition, construction, development and/or normal use of the underlying assets. Recognition of a liability for an asset retirement obligation is required in the period in which it is incurred at its estimated fair value. The associated asset retirement costs are capitalized as part of the carrying amount of the underlying asset and depreciated over the estimated useful life of the asset. The liability is accreted through charges to operating expenses. If the asset retirement obligation is settled for other than the carrying amount of the liability, the Company recognizes a gain or loss on settlement.

The Company records all asset retirement obligations for which it has legal obligations to remove all installation work and reinstate the manufacturing facilities to its original state at its estimated fair value. For the three-month periods ended March 31, 2017 and 2016, the Company had no asset retirement obligation operating costs related to accretion of the liabilities.

Customer Loyalty Program

The Company offers a loyalty program for its social casino gaming platform, which enables players to redeem accumulated points for reward items. Players can redeem experience points from game time play for incentives, for example, food and beverage, rooms and entertainment at casino resort properties. The Company accrues for loyalty program points expected to be redeemed for free goods and services as marketing expense. The accruals are based on management’s estimates and assumptions regarding the estimated costs of providing those benefits and the actual redemption rates in each country, less an estimate for points not expected to be redeemed.

Recent Accounting Pronouncements

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which intends to improve the recognition and measurement of financial instruments. The ASU will be effective for fiscal years and interim periods within those years beginning after December 15, 2017. The Company is currently assessing the potential impact of this ASU on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) – Accounting for Leases, which changes the accounting for leases, including a requirement to record all leases on the balance sheet as assets and liabilities. This update is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of adopting the new leases standard on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers – Principal versus Agent Considerations, which intends to clarify the implementation guidance on principal versus agent considerations. The effective date for this ASU is the same as the effective date for ASU 2014-09, “Revenue from Contracts with Customers”. The Company is currently assessing the potential impact of this ASU on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The standard is effective for interim and annual reporting periods beginning after December 15, 2016, although early adoption is permitted. The Company does not expect the impact of the adoption of this ASU to be material to its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments, which attempts to reduce the existing diversity in practice with respect to reporting the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This guidance will be effective for the Company on January 1, 2018. The Company is currently assessing the potential impact of this ASU on its consolidated financial statements.

In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606 – Revenue from Contracts with Customers, which amends certain narrow aspects of the guidance issued in ASU 2014-09, Revenue from Contracts with Customers, including guidance related to the disclosure of remaining performance obligations and prior-period performance obligations, as well as other amendments to the guidance on loan guarantee fees, contract costs, refund liabilities, advertising costs and the clarification of certain examples. The Company is currently assessing the potential impact of this ASU on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other – Simplifying the Test for Goodwill Impairment, which eliminates Step two from the goodwill impairment test. Instead, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This ASU is effective for an entity’s annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the impact of the adoption of this ASU to be material to its consolidated financial statements.

The Company presently conducts business under two operating segments: (i) gaming operations, which include the leasing of its owned EGMs on a revenue-sharing (participation) basis; and (ii) social gaming, which includes the development and testing of a social gaming platform and applications designed for the Pan-Asian markets. The chief operating decision-maker reviews its operations by these two operating segments.

During the reported periods, the Company’s business activities included gaming operations in Cambodia involving the leasing of its owned EGMs on both a revenue-sharing and fixed lease basis. In addition, the Company operated a gaming products business, which entailed the design, manufacture and distribution of gaming chips and plaques as well as the distribution of third-party gaming products. In a series of transactions during the year ended December 31, 2016, the Company sold all the assets associated with its Cambodia gaming operations and, by December 31, 2016, had exited its Cambodia gaming operations. The Company sold the principal assets of its gaming products operations on May 11, 2016 and thereby exited this business.

All related historical revenues and expenses for the Cambodia gaming operations and gaming products business have been reclassified as discontinued operations. The accounting policies of these discontinued operations are consistent with the Company’s policies for the accompanying consolidated financial statements.

The following table presents the financial information for each of the Company’s continuing operating segments.

Geographic segment revenues of the Company’s continuing operations segments for the three-month periods ended March 31, 2017 and 2016 are as follows:

For the three-month periods ended March 31, 2017 and 2016, the largest customer for gaming operations represented approximately 63% and 43%, respectively, of total gaming operations revenue.

Depreciation expense of gaming equipment of approximately $65,000 and $101,000 was included in cost of gaming operations for continuing operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively.

Depreciation expense of gaming equipment of NIL and approximately $324,000 was included in the net loss from discontinued operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively.

Depreciation expense of property and equipment of approximately $2,000 and $3,000 was included in cost of gaming operations for the continuing operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively.

Depreciation expense of property and equipment of approximately $1,000 and $352,000 was included in the net loss from discontinued operations in the consolidated statements of comprehensive loss for three-month periods ended March 31, 2017 and 2016, respectively.

Goodwill and intangible assets are stated at cost. The major categories of goodwill and intangible assets and accumulated amortization consisted of the following:

Amortization expense for finite-lived intangible assets of NIL and approximately $156,000 was included in cost of gaming operations for the continuing operations in the consolidated statements of comprehensive loss for the three-month periods ended March 31, 2017 and 2016, respectively.

Amortization expense for internal-use software of approximately $97,000 was included in the cost of social gaming in the consolidated statements of comprehensive loss for the three-month period ended March 31, 2017. There was no amortization expense for internal-use software for the three-month period ended March 31, 2016.

Goodwill movements during the periods consisted of the following:

At the annual shareholders meeting held on September 8, 2008, the 2008 Stock Incentive Plan was voted on and became effective on January 1, 2009, which replaced two previous plans, the Amended and Restated 1999 Stock Option Plan and the Amended and Restated 1999 Directors’ Stock Option Plan, thereby terminating both of these plans on December 31, 2008.

On July 18, 2016, the Company’s shareholders approved a new 2016 Stock Incentive Plan. The 2016 plan was amended and restated the 2008 plan to bring it in alignment with the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited. The Company’s equity incentive plans are subject to the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited as a result of becoming an indirect majority-owned subsidiary of Melco International Development Limited, a company listed on the main board of the Hong Kong Stock Exchange.

The 2016 plan allows for incentive awards to eligible recipients consisting of:

The maximum number of shares reserved for issuance under the 2016 plan is 1,250,000 shares. The exercise price of options granted under the 2016 plan shall not be less than 100% of the fair market value of one share of common stock on the date of grant, unless the participant owns more than 10% of the total combined voting power of all classes of stock of the Company or any parent or subsidiary corporation of the Company, in which case the exercise price shall then be 110% of the fair market value. The outstanding stock options generally vest over three years and have ten-year contractual terms.

Pursuant to shareholder approval of the 2016 plan, the Company implemented a voluntary stock option exchange program for its employees, directors and certain others, or the participants. The stock option exchange program had been approved by the board of directors on April 29, 2016 and was approved by shareholders on July 18, 2016.

Under the terms of the stock option exchange program, the participants had the opportunity to cancel their existing underwater outstanding stock options (i.e., options with exercise prices that are higher than the current market trading price of the Company’s common stock) in exchange for a replacement option grant for an equal number of shares. The replacement options have an exercise price of $1.94, which is based on the higher of: (i) 100% of the fair market value of the Company’s common stock on the board approval date and (ii) 100% of the average fair market value of one share of the Company’s common stock for the five business days immediately preceding the board approval date.

The replacement options have a ten-year term from the board of directors’ approval date and are subject to a new vesting schedule. They will vest over three years, vesting 50% on the first anniversary and 25% on each of the second and third anniversaries of the approval date, subject to the participants remaining continuously in service with the Company, except in the case of replacement options issued to non-employee directors which will continue to vest after the termination of their service to the Company.

The compensation expense resulted from the exchange program and is recognized in accordance with ASC 718  Compensation-Stock Compensation . As a result of the option exchange, the Company expects to incur approximately $147,000 in non-cash compensation expense attributable to the incremental fair value of the replacement options granted to the participants, measured as of the date such awards were granted. The incremental compensation expense associated with the replacement options will be recognized over the expected life of the replacement options.

In the three-month period ended March 31, 2017, there were no grants of stock options or restricted stock awards and no exercises of outstanding stock options.

Under the previous 1999 plans, a total of 956,250 shares were authorized, of which 937,500 shares were under the Amended and Restated 1999 Stock Option Plan and 18,750 shares were under the Amended and Restated 1999 Directors’ Stock Option Plan. While these previous plans expired on December 31, 2008, options granted and outstanding under them as of the date of expiration remain outstanding and subject to termination according to the previous plans terms.

As of March 31, 2017, stock options for the purchase of 70,314 shares and 1,563 shares of common stock were outstanding in relation to the Amended and Restated 1999 Stock Option Plan and the Amended and Restated 1999 Director’s Stock Option Plan, respectively.

As of March 31, 2017, stock options for the purchase of 186,339 shares and 459,155 shares of common stock were outstanding in relation to the 2008 and 2016 plans, respectively.

As of March 31, 2017, stock options for the purchase of 258,216 shares of common stock were exercisable with a weighted average exercise price of $8.56, a weighted average fair value of $3.37 and an aggregate intrinsic value of approximately $22,000 under all plans. The total fair value of shares vested during the three-month period ended March 31, 2017 was NIL. As of March 31, 2017, an aggregate of 459,155 options granted under all plans was subject to vesting with a total compensation cost of approximately $78,000. The amount is expected to be recognized over 2.12 years.

Recognition and Measurement

The fair value of each stock-based award to employees and non-employee directors is estimated on the measurement date which generally is the grant date while awards to non-employees with performance criteria are measured at the earlier of the performance commitment date or the service completion date using the Black-Scholes-Merton option-pricing model. Option valuation models require the input of highly subjective assumptions, and changes in assumptions used can materially affect the fair value estimates. The Company estimates the expected life of the award by taking into consideration the vesting period, contractual term, historical exercise data, expected volatility, blackout periods and other relevant factors. Volatility is estimated by evaluating the Company’s historical volatility data. The risk-free interest rate on the measurement date is based on U.S. Treasury constant maturity rates for a period approximating the expected life of the award. The Company historically has not paid dividends, nor does it expect to pay dividends in the foreseeable future and, therefore, the expected dividend rate is zero.

The following table summarizes the range of assumptions utilized in the Black-Scholes-Merton option-pricing model for the valuation of stock options granted during the three-month periods ended March 31, 2017 and 2016.

For stock-based compensation accrued to employees and non-employee directors, the Company recognizes stock-based compensation expenses for all service-based awards with graded vesting schedules on a pro rata basis over the requisite service period for the entire award. Initial accruals of compensation expense are based on the estimated number of shares for which requisite service is expected to be rendered. Estimates are revised if subsequent information indicates that forfeitures will differ from previous estimates, and the cumulative effect on compensation cost of a change in the estimated forfeitures is recognized in the period of the change.

For non-employee awards, the Company remeasures compensation cost each period until the service condition is complete and recognizes compensation cost on a pro rata basis over the requisite service period.

The Company estimates forfeitures and recognizes compensation cost only for those awards expected to vest assuming all awards would vest and reverse recognized compensation cost for forfeited awards when the awards are actually forfeited.

For awards with service conditions and graded vesting that were granted prior to the adoption of ASC 718, the Company estimates the requisite service period and the number of shares expected to vest, and recognizes compensation expense for each tranche on the straight-line basis over the estimated requisite service period.

Melco Services Limited is a wholly-owned subsidiary of Melco International Development Limited, which owns 64.8% of Entertainment Gaming Asia Inc.

Melco International Development Limited owns 51.3% of Melco Resorts & Entertainment Limited (formerly known as Melco Crown Entertainment Limited), which owns 90% of Melco Crown (Macau) Limited and 72.8% of MCE Leisure (Philippines) Corporation.

Golden Future (Management Services) Limited is a wholly-owned subsidiary of Melco Crown (Macau) Limited.

The Company recorded income tax expenses for continuing operations of approximately $37,000 and $29,000 for the three-month periods ended March 31, 2017 and 2016, respectively. The Company’s effective income tax rates were (1.9)% and (3.1)% for the three-month periods ended March 31, 2017 and 2016, respectively. The change in effective tax rate was mainly due to the overall increase in pre-tax loss from continuing operations for the three-month period ended March 31, 2017 compared to the prior year period.

The Company is subject to income tax examinations by tax authorities in jurisdictions in which it operates. The Company’s 2014 to 2016 United States income tax returns remain open to examination by the Internal Revenue Service. The Company’s 2014 to 2016 Cambodian income tax returns remain open to examination by the General Department of Taxation. The Company’s 2013 to 2016 Philippines income tax returns remain open to examination by the Philippines Bureau of Internal Revenue. The Company’s 2010 to 2016 Hong Kong income tax returns remain open to examination by the Hong Kong Inland Revenue Department. 

During the reported periods, the Company’s business activities included discontinued gaming operations in Cambodia on both a revenue-sharing and fixed lease basis and the operation of a gaming products business, which entailed the design, manufacture and distribution of gaming chips and plaques as well as the distribution of third-party gaming products.

Discontinued Cambodia Gaming Operations

During the year ended December 31, 2016, the Company terminated its two EGM participation agreements and one EGM leasing agreement in Cambodia and exited its Cambodia gaming operations. Concurrent with the termination of the agreements, the Company sold all of its EGMs and gaming equipment in Cambodia in three separate transactions as set out below.

The following table details selected financial information for the discontinued Cambodia gaming operations in the consolidated statements of comprehensive loss.

Discontinued Gaming Products

On May 11, 2016, the Company entered into an asset purchase agreement pursuant to which it sold the principal assets dedicated to the design, manufacture and distribution of chips, plaques and layouts for gaming tables to Gaming Partners International Corporation (GPIC). The transaction under the agreement closed on May 11, 2016.

Under the terms of the agreement, the Company sold to GPIC certain assets of its gaming products business, including fixed assets, raw materials and inventory and intellectual property, for cash consideration of approximately $5.9 million. The consideration includes a purchase price of approximately $5.4 million and $530,000 for restrictive covenants related to a non-compete arrangement given by the Company and Mr. Clarence Chung. The purchase price will be paid out in installments over a 24-month period after closing, with approximately $3.2 million paid at closing and approximately $1.1 million to be paid on each of the first two anniversaries of the closing. Payment related to the restrictive covenants was paid after closing. GPIC also paid to the Company after closing an amount equal to four months’ rental for its factory subject to a cap of $260,000 and a fixed sum of $520,000 for costs related to the termination of the gaming products business employees.

In addition, GPIC will make earn-out payments to the Company. These earn-out payments include: 3% of net revenue on certain sales to specific Asian-based casinos over the next five years subject to a cap of a total of $500 million of net revenue; and 15% of net revenues on sales to the Company’s related party casinos for an indefinite time period for the first $10 million of net revenue and, in addition, 3% of net revenue from these related party casino sales over the next five years subject to a cap of $30 million of net revenue. The Company shall only be entitled to earn-out payments in excess of $900,000.

The agreement includes customary representations, warranties and covenants by the Company and GPIC, including each party’s agreement to indemnify the other against certain claims or losses resulting from certain breaches of representations, warranties or covenants under the agreement and third-party claims arising before and after the close. The asset sale represents our exit from the business of design, manufacture and distribution of chips, plaques and layouts for gaming tables and, as part of the transaction, the Company has agreed with GPIC not to engage in the manufacture of gaming chips, plaques, jetons, playing cards and layouts for gaming tables in competition with GPIC.

In connection with the close of the transaction under the agreement, the Company’s wholly-owned subsidiary, DPD Limited, formerly known as Dolphin Products Limited, and GPIC settled and released each other of all claims relating to the civil actions instituted by GPIC against DPD in the High Court of the Hong Kong Special Administrative Region in December 2015.

The following table details selected financial information for the discontinued gaming products operations in the consolidated statements of comprehensive loss.

Legal Matters

Gaming Partners International Corporation Litigation

On December 21, 2015, Gaming Partners International Corporation (GPIC) commenced a legal action in the High Court of the Hong Kong Special Administrative Region against DPD Limited, formerly known as Dolphin Products Limited (DPD), the Company’s wholly-owned subsidiary.

On May 11, 2016, GPIC agreed to irrevocably withdraw, terminate and discontinue the legal action mentioned above. On the same date, we agreed to sell substantially all the principal assets of DPD to GPIC and to discontinue DPD’s business of designing, manufacturing and distributing gaming chips and plaques and distributing third-party table game products.

For the three-month periods ended March 31, 2017 and 2016, outstanding stock options of 709,404 and 743,630, respectively, shares of common stock were excluded from the calculation of diluted losses per share as their effect would be anti-dilutive.