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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
OF 1934
For the fiscal year ended DECEMBER 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _______________
Commission File Number: 33-13789LA
YOU BET INTERNATIONAL, INC.
(Name of small business issuer in its charter)
Delaware 95-4627253
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1950 Sawtelle Boulevard, Suite 180, Los Angeles, California 90025
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(Address of principal executive offices, including zip code)
Issuer's telephone number, including area code: (310) 444-3300
Securities registered under Section 12(b) of the Act: None.
Securities registered under Section 12(g) of the Act: None.
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X}
The issuer had no operating revenues for the fiscal year ended December 31,
1997.
The aggregate market value of the issuer's common stock held by non-affiliates
as of March 31, 1998, computed by reference to the average of the closing bid
and ask prices on March 31, 1998, of $5.06 and $5.25, respectively, was
approximately $24,000,000.
As of March 31, 1998, the issuer had 9,603,994 shares of common stock issued and
outstanding.
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Transitional Small Business Disclosure Format: [ ] [X]
Documents incorporated by reference: None.
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PART I.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995:
This Annual Report on Form 10-KSB for the year ended December 31, 1997 contains
"forward-looking" statements within the meaning of the Federal securities laws.
These forward-looking statements include, among others, statements concerning
the Company's expectations regarding its financing requirements and efforts to
raise additional financing, its development and marketing efforts, consumer
reaction/acceptance to the Company's services, and the development of operating
revenues, and other statements of expectations, beliefs, future plans and
strategies, anticipated events or trends, and similar expressions concerning
matters that are not historical facts. The forward-looking statements in this
Annual Report on Form 10-KSB for the fiscal year ended December 31,1997 are
subject to risks and uncertainties that could cause actual results to differ
materially from those results expressed in or implied by the statements
contained herein.
ITEM 1. DESCRIPTION OF BUSINESS
General:
You Bet International, Inc. a Delaware corporation, its wholly-owned subsidiary,
You Bet!, Inc., a Delaware corporation, and Middleware Telecom Corporation, a
California corporation and a wholly-owned subsidiary of You Bet!, Inc., are
collectively referred to herein as the "Company". Since mid-1995, the Company
has been engaged in developing PC-based proprietary communications software
technology to be utilized by consumers for online entertainment purposes. The
Company's first service to be offered to consumers is The You Bet Racing
Network, a horse racing network to be broadcast over the Company's secure
private network. The Company's business operations relating to The You Bet
Racing Network are conducted primarily through You Bet!, Inc.
As of December 31, 1997, the Company is considered to be a development stage
entity, as it had not realized any revenues from planned principal operations.
During 1995, the Company shifted its business strategy by de-emphasizing
consulting services and software licensing, as a result of which the Company
became a development stage company.
Software development costs incurred during 1995, 1996 and 1997 have been charged
to operations as research and development. Subsequent to December 31, 1997,
management believes that technological feasibility of the Company's proprietary
software technology has been established.
History:
Continental Embassy Acquisition, Inc. ("CEA") was organized in the State of Utah
in 1987 for the purpose of raising capital and acquiring a suitable business
opportunity through a merger with, or acquisition of, a private business
enterprise seeking to obtain the perceived benefits of being a publicly-owned
company. On December 6, 1995, CEA acquired 100% of the outstanding capital
stock of You Bet!, Inc., a Delaware corporation (formerly known as PC Totes,
Inc.), in exchange for the issuance 5,800,000 shares of common stock, including
5,710,000 shares of common stock to two officers/major stockholders of the
Company (who were the founders of the Company's predecessor entity), their
nominees and a stockholder related to one of the officers. In conjunction with
the contemporaneous private placement of the Company's securities, 2,500,000 of
the 5,710,000 shares were deemed subject to forfeiture by the holders under
certain conditions. Concurrent with this transaction, CEA reincorporated in the
State of Delaware and changed its name to You Bet International, Inc., and the
management of You Bet!, Inc. became the management of You Bet International,
Inc. For accounting purposes, the acquisition of You Bet!, Inc. by You Bet
International, Inc. has been treated as a reverse acquisition of You Bet!, Inc.
with You Bet!, Inc. considered the acquiror.
Concurrent with this transaction, 100% of the capital stock of Middleware
Telecom Corporation was contributed by its stockholders, who were substantially
the same as the stockholders of You Bet!, Inc., to You Bet!, Inc. for no
additional consideration.
Concurrent with this transaction, the Company also effected a 1 for 1.5 reverse
stock split of its common stock in December 1995. All
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references to shares and per share amounts have been retroactively restated
to reflect this reverse stock split.
At the time of the reverse merger in December 1995, PC Totes, Inc. had over
eight years of experience developing computer-based wagering systems. In
1987, PC Totes, Inc. developed a personal computer based "totalisator" system
that is used to operate the wagering systems at horse and dog racing tracks.
The totalisator system is called the "PC Tote" and includes facilities for
infield scoreboards, closed circuit television and numerous types of customer
ticket issuing machines.
The You Bet Racing Network:
The You Bet Racing Network is the Company's first on-line service, an innovative
interactive horseracing network designed to enable users, via modem over their
personal computer, to view live horseracing events, access handicapping
information, and facilitate wagering directly to licensed gaming agencies.
In December 1997, the Company completed an extensive six month system-wide test
and processed the first live wager over The You Bet Racing Network.
In February 1998, the Company launched a limited release of the You Bet
Racing Network. The limited release, with up to 400 users, consists mainly
of computer-literate horseplayers, along with a small section of non-racing
participants. The limited release is intended to further research system
features and functionality, as well as to study marketing issues, such as
pricing and packaging. The limited release will continue through the second
quarter of 1998, with a public release of the service expected to be launched
in the third quarter of 1998.
The You Bet Racing Network is a one-stop shop for racing content, and is an
additional marketing and distribution channel for race tracks. Subscribers to
The You Bet Racing Network have access to an exclusive private network,
including live audio/video, up-to-the minute track information, real-time
wagering information, value-added handicapping products, racing news, and
wagering at full track odds through licensed gaming agencies. The You Bet
Racing Network currently broadcasts 11 hours a day, seven days a week, of
continuous racing, and offers customer support 16 hours a day.
The Company developed The You Bet Racing Network based on management's
identification of a perceived market need in the horse racing industry, based
on industry facts and trends. The horse racing market is substantial. In
1997, approximately $15 billion was wagered domestically and $100 billion was
wagered internationally on horse racing. Wagering on domestic horse racing
has continued to grow principally because of the growth from off-track
sources. In 1997, the estimated percentage of off-track betting was $11
billion, or 73%, of all domestic wagering placed.
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The Company believes that the convenience and availability of off-track sources
has had a major impact on the industry. The Company expects that the ability to
supply a new distribution media through The You Bet Racing Network and to
transmit wagering data to licensed wagering facilities will extend this trend
and accelerate the off-track wagering industry's growth.
The Company's goal is to expand the reach of racetracks and to identify new
racing customers in entirely new marketplaces. In addition to the
audio/video and track information, content will include news, handicapping
information products, handicapping seminars, celebrity chat rooms,
promotions, and online customer service.
Risk Factors:
The business of the Company is dependent upon the successful deployment of
the Company's initial service, The You Bet Racing Network. Such deployment
is subject to all of the inherent risks in software development, including
programming errors, and conflicts with other software or computer equipment.
Additionally, as the Company is concurrently establishing an on-line network
to implement its service, the Company will be subject to other related risks,
such as delays (or failures) in transmission of data, the inability to access
the network, and general lack of support personnel. The Company's success
will be largely dependent on the ability of the software application and
network to perform as anticipated, as well as market acceptance of the
product.
The Company will be largely dependent upon negotiating agreements with third
parties, including various track and information providers. There can be no
assurances that the Company will be able to negotiate acceptable agreements
with such third parties on a timely basis and under acceptable terms and
conditions.
Assuming the Company's service can be developed as anticipated, the Company
will need additional capital to continue to develop and market its service.
The Company's need for additional capital will be dependent upon a number of
factors, including the rate at which the Company's products are utilized and
the level of effort needed to develop and commercialize additional
applications. The lack of availability of additional funds on a timely basis
and under acceptable terms and conditions could have a material adverse
effect on the Company's ability to implement its planned operations. The
availability of debt and equity capital, as well as financing from joint
venture sources, is affected, among other factors, by worldwide economic
conditions, interest rates, and the general competition for funds. No
assurance can be given that the Company will be successful in obtaining
additional financing.
Since mid-1995, the Company has utilized its resources to develop its
proprietary communications software technology, design a computer network and
establish the alliances within the horse racing industry and build an operating
infrastructure. During 1998, subject to the availability of adequate capital
resources, the Company expects to incur marketing and promotion costs of
approximately $2,000,000 and research and development costs of approximately
$800,000 with respect
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to the continuing development and commercialization of The You Bet Racing
Network. Accordingly, based on the timing and ramp-up of the Company's
planned commercial introduction of The You Bet Racing Network, the Company
anticipates that operating losses will continue at least through 1998. The
Company has had recurring losses and has experienced significant continuing
liquidity problems since late 1996 that are expected to continue until the
Company is able to complete a long-term debt or equity financing of
substantial size and/or until significant operating revenues are generated on
an ongoing basis. The Company had a negative working capital of $2,739,184
as of December 31, 1997. As a result, the Company's independent certified
public accountants have expressed substantial doubt about the Company's
ability to continue as a going concern. The Company's capital requirements
and financial condition are discussed in more detail at "ITEM 6. MANAGEMENT'S
DISCUSSION AND ANALYSIS OR PLAN OF OPERATION".
The Company's software will be affected by the changing and dynamic nature
of the gaming industry, which is subject to extensive regulation by both
state and Federal governments, as well as the current environment in which
Internet and on-line services are offered to computer users. The gaming industry
is heavily regulated, and the policies of the agencies and legislatures that
regulate the gaming industry are subject to changing political and economic
concerns. No assurance can be given that the Company will not be subject to
additional legislation in the future which could materially impact the Company's
planned operations. Moreover, the entire on-line, Internet-based,
communications and entertainment industry is newly emerging and is rapidly
developing, thus subjecting the Company to a variety of volatile changes, any
one of which could have a material adverse effect on the Company's ability to
effectively deploy its products and compete in the marketplace.
Account Wagering Entities:
During July 1997, the Company entered into an agreement with Mountain Laurel
Racing, Inc. and Washington Trotting Association, Inc. (collectively,
"Ladbroke") for the purpose of facilitating interactive telecommunications
between subscribers to The You Bet Racing Network and host-track wagering pools
(the "Ladbroke Agreement"). Ladbroke operates one racetrack and six off-track
wagering facilities in Western Pennsylvania and provides simulcast signals and
pari-mutuel wagering from Ladbroke's own host racetrack. Ladbroke also provides
simulcast signals and pari-mutuel wagering from 32 other horse racing venues
throughout the United States, including most major racetracks. Since 1983,
Ladbroke has also offered telephone wagering through Ladbroke's Call-A-Bet
System. The Ladbroke Agreement provides for a sharing between the Company and
Ladbroke of commissions, net of certain fees and expenses, from the portions of
host-track wagering pools generated by The You Bet Racing Network. The Ladbroke
Agreement is terminable the earlier of five years from the date of first live
wagering transmission or November 19, 2002, and contains certain provisions,
among others, related to minimum commissions, deliverables by each party, and
maintenance of regulatory approvals.
During May 1996, the Company entered into a beta test agreement with the New
York Racing Association Inc. ("NYRA") (the " NYRA Agreement"). NYRA operates
three racetracks in the State of New York (Belmont Park, Saratoga and Aqueduct)
and provides simulcast signals and pari-mutuel wagering pools from their own
host racetracks as well as from several other host racetracks throughout the
United States. The NYRA Agreement, as amended, provided for the joint testing
of The You Bet Racing Network with the operations of the NYRA for the purpose of
facilitating telecommunications by and between the NYRA and its clientele
regarding wagering products of the NYRA. The NYRA Agreement expired on
September 1, 1997, at which time the Company and NYRA agreed
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to suspend discussions temporarily until the implementation of live wagering
with Ladbroke. Upon the implementation of live wagering with Ladbroke, the
Company and the NYRA reinstituted discussions regarding the NYRA's participation
in The You Bet Racing Network. However, there can be no assurance that a
definitive agreement will be reached between the Company and the NYRA.
The Ladbroke Agreement was subject to regulatory approval as well as
compliance with existing federal, state and local laws. During 1997, the
Ladbroke Agreement was approved by Pennsylvania regulatory authorities.
Potential future agreements with other racing entities are also expected to
contain similar provisions. There can be no assurance that the Company will
be able to maintain such relationships with Ladbroke or secure other
potential licensed entities on terms acceptable to the Company.
The Company expects to derive a majority of its future revenues through
commissions from amounts wagered with licensed wagering entities through The You
Bet Racing Network and, to a lesser extent, from monthly subscription fees,
network usage fees, merchandise purchases and information purchases, such as
race data and past performance data. As a result, the Company is highly
dependent on maintaining its agreements with licensed wagering entities such as
Ladbroke.
Competitive Issues:
Numerous Internet and other interactive gaming ventures have been announced in
1997. The Company expects to compete with these entities, as well as other
established gaming companies, which may enter the interactive pari-mutuel gaming
market. The Company believes that its principal competitor in the interactive
pari-mutuel gaming market is On Demand Services. On Demand Services is
developing a 24 hour national racing channel for distribution over cable and
Direct TV, along with an in-home pari-mutuel wagering system that requires an On
Demand Services television set-top box. The system is currently being tested in
Kentucky and has been announced for public release in November 1998. On Demand
Services has announced that it has formed exclusive relationships with in excess
of 10 major United States racetracks. Because the market for interactive
software products is still emerging and the cost barriers to entry into this
market are relatively low, the Company expects the number of competitors to
increase. The Company believes that potential new competitors, including large
software companies, media companies, and gaming companies, are increasing their
focus on the interactive wagering market. Competition for the Company's product
is influenced by the timing of competitive product releases and the similarity
of such products to those of the Company, which may result in significant price
competition or reduced profit margins.
However, the Company believes that is has developed a number of proprietary
software technologies that provide significant competitive advantages. The
Company has developed a national multicast network allowing for reliable and
economical delivery of audio, video, and information updates to a virtually
unlimited audience. The Company's software technology utilizes an open
architecture design capable of providing multi-currency and multi-lingual games,
including horse racing and other high-level participation games that can be used
with
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international sporting events. The Company's proprietary design utilizes a
distributed high speed transaction platform capable of handling the extreme peak
loads of interactive wagering. The Company has also developed proprietary
security technologies and techniques.
In addition, the totalisator system consists of complex computer software and
hardware that calculates wagering odds, and facilitates infield scoreboards
and numerous types of customer ticket issuing machines at horse racing
tracks. There is limited knowledge in this niche industry, and it will be
difficult for technology companies to acquire this expertise. The Company's
prior experience, through PC Totes, Inc., in all aspects of developing,
deploying, and running totalisator systems provides a significant key
competitive advantage and barrier to entry.
Research and Development Activities:
Since mid-1995, the Company has utilized its resources to develop its
proprietary communications software technology. During the years ended
December 31, 1996 and 1997, the Company incurred costs of $1,610,604 and
$1,919,062 on research and development and network activities. Subsequent to
December 31, 1997, management believes that technological feasibility of the
Company's proprietary software technology had been established. Accordingly,
and considering the Company's capital resources, a significantly smaller
amount is expected to be expended on research and development activities
during 1998.
International Markets:
It is management's belief that the introduction, availability and ease of use of
computers and computer networks will continue to expand worldwide demand for
computer based services. Management believes that there could be a significant
market opportunity for The You Bet Racing Network outside the United States, for
the United States races and international events. The Company intends to
initially target handicappers in the United States. However, the Company
continues to explore international relationships to facilitate deployment of The
You Bet Racing Network and facilitate other types of applications and services
over the Company's proprietary network.
Government Regulation; Legal Issues:
The gaming industry is subject to extensive statutory and regulatory control by
both state and Federal agencies, and may be affected by changes in the political
climate and economic and regulatory policies, which changes may impact the
operations of the Company. To the extent that the Company's facilities are used
by subscribers to place intrastate or interstate wagers or the Company receives
commissions from such wagers, various statutes and regulations could have a
direct and material effect on the business and indirectly could have a material
effect on the public demand for the Company's services.
All 50 states currently have statutes or regulations restricting gambling
activities, and two states have absolute prohibitions on gambling. In most
states it is illegal for anyone either to accept or make a wager, with certain
state-by-state statutory exceptions. The Federal Interstate Wire Act contains
provisions which may make it a crime for anyone in the business of gambling to
use an interstate or international telephone line to transmit information
assisting in the placing of bets, unless the betting is legal in the
jurisdictions from which and into which the transmission is made. Other Federal
laws impacting gaming activities include the Interstate Wagering Paraphernalia
Act, the Travel Act and the Organized Crime Control Act. Various regulatory and
legislative agencies are conducting studies of interstate and interactive
wagering. No assurance can be given that new legislation will not be adopted
which limits either the intrastate or interstate activities the Company proposes
to engage in with respect to actual wagering, or the type of activities
associated with such wagering (initially pari-mutuel horse racing). Any change
in either the substance or the enforcement of the applicable rules and
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regulations in these areas could have a material effect on the Company's
business and prospects. Certain legislation is currently being considered in
Congress and individual states in this regard. In addition, the United States
Justice department is in the process of taking actions against selected
companies that it deems to be operating without proper licensing and regulatory
approval.
The Company has been advised by counsel that it can legally provide the
facilities through which subscribers communicate interstate wagers in the eight
states that allow interstate telephone account wagering and the other states
that allow pari-mutuel wagering subject to state and local requirements. These
eight states represent 30% of the domestic market. However, this status could
change. The Company also believes that it can operate, or license technology,
in numerous countries that allow telephone and account wagering, including
Canada, Mexico, the United Kingdom, Australia, and Hong Kong.
In connection with its proposed activities, it is possible that the Company
could be considered to be engaged in the gaming business. However, the Company
will not actually be placing or accepting any wagers. The Company will be
transmitting the wagering data on behalf of the subscriber to the licensed
account wagering facility with which the Company has appropriate contractual
relationships. These facilities accept the data and make a wager from the
subscriber's account with that facility. The results are then transmitted to
the subscriber through the Company. The transfer of funds into and out of the
subscriber's account is performed by the licensed account wagering facility.
Although the Company intends to obtain, and to date has received limited
indemnification from each such licensed account wagering facility, no assurance
can be given that such indemnification will continue to be available or that, if
obtained, such provisions will be enforceable or adequate.
The Company has adopted a policy (referred to herein as its "Business
Guidelines") pursuant to which it will not engage in any proposed activity
unless (i) the Company has received an opinion of legal counsel experienced in
gaming or other relevant matters to the effect that, although the matter is not
necessarily free of doubt, the proposed activity of the Company is permitted
under applicable law, or (ii) the Company's Board of Directors, including a
majority of the independent directors, after reasonable inquiry, including
consultation with independent legal counsel experienced in gaming or other
relevant matters, has determined with a high degree of confidence that, although
the matter is not necessarily free of doubt, the Company will not be found to
have been violating applicable law by reason of engaging in the proposed
activity.
Since the Company's Business Guidelines permit the Company to engage in
activities for which it has not received a legal opinion to the effect that the
activities are permitted under applicable law, the possibility of violation of
applicable law exists. In addition, the uncertain application of existing laws
to interactive gaming and the lack of applicable precedents suggests that legal
opinions in this field may be qualified on the basis that these matters are not
free from doubt. Even when the Company is operating in accordance with the
advice of counsel, a risk exists that the Company may be found to have violated
applicable law. A failure to comply with applicable regulations could
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result in the initiation of civil or criminal proceedings against the Company.
The results of such proceedings could include substantial litigation expense,
fines, incarceration of Company executives, diversion of the attention of key
Company employees, disqualification of the Company from licensure, and
injunctions or other prohibitions preventing the Company from engaging in
various anticipated business activities.
Distribution of the Company's products in countries other than the United States
may be subject to regulation in those countries. There can be no assurance that
the Company will be able to obtain the approvals necessary to market its
services in such jurisdictions.
Employees:
As of March 31, 1998, the Company had 46 employees. The Company believes that
its relationship with its employees is good. The Company anticipates that
additional employees will be hired to help operate and maintain The You Bet
Racing Network and to expanding marketing activities to the consumer and horse
racing industry.
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ITEM 2. DESCRIPTION OF PROPERTY
The Company's executive and operating offices occupy 9,370 square located at
1950 Sawtelle Boulevard, Suite 180, Los Angeles, California, under a lease that
expired on March 31, 1998. The lease was subsequently extended through
September 30, 1998. The lease payment is approximately $16,500 per month. The
Company believes that this facility is adequate for its present requirements.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation arising in the ordinary
course of business. In the opinion of management, the ultimate disposition of
these matters will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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No matters were submitted to a vote of the Company's security holders during the
fourth quarter of the fiscal year ended December 31, 1997.
PART II.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of You Bet International, Inc. is traded on the OTC Bulletin
Board under the symbol "UBET".
The following table sets forth the range of reported bid prices of the Company's
common stock during the periods indicated. Such prices reflect prices between
dealers in securities and do not include any retail markup, markdown or
commission and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
High Low
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Fiscal Year Ended December 31, 1997:
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Quarter ended March 31, 1997 $5.75 $3.00
Quarter ended June 30, 1997 5.00 1.00
Quarter ended September 30, 1997 4.75 3.25
Quarter ended December 31, 1997 5.75 2.50
Fiscal Year Ended December 31, 1996:
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Quarter ended March 31, 1996 3.75 2.38
Quarter ended June 30, 1996 6.31 2.62
Quarter ended September 30, 1996 6.19 4.38
Quarter ended December 31, 1996 4.69 3.75
</TABLE>
The approximate number of security holders of record of the Company's common
stock as of February 12, 1998 was 278.
The Company has not paid any cash dividends on its common stock and has no
present intention of paying cash dividends in the foreseeable future. It is the
present policy of the Board of Directors to retain all earnings to provide for
the future growth of the Company.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Overview:
Since mid-1995, the Company has been engaged in developing PC-based proprietary
communications software technology to be utilized by consumers for online
entertainment purposes. The Company's first service to be offered to consumers
is The You Bet Racing Network, a horse racing network to be broadcast over the
Company's secure private network. The Company has incurred substantial software
development
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costs during 1995 through 1997, which have been charged to operations as
research and development costs. Subsequent to December 31, 1997, management is
of the opinion that technological feasibility of the Company's proprietary
software technology has been established.
Business Plan:
The Company's original short-term goal, established in 1995, was to maximize
customer subscription levels. However, in 1997, the Company decided to
de-emphasize its original short-term goal in order to focus on certain
long-term goals. The Company's revised marketing strategy, which is
scheduled to be implemented during 1998 and 1999, is focused on building a
brand name and becoming a market leader, acquiring and retaining a large and
loyal customer base, and maximizing long-term profitability. In order to do
so, the Company intends to concentrate on marketing to existing horse players
during the initial phase of operations. By being the first to deliver an
interactive product, the Company believes that it will fill a significant
market need and establish itself as the leading brand in the horse racing
industry. Marketing activities will then be expanded to focus on a variety
of additional potential users, including sports gamblers, and casino and
lottery customers. The Company will then move its products into the
mainstream online community through a mass marketing campaign.
Liquidity and Capital Resources - December 31, 1997:
The Company has had recurring losses and has experienced significant
continuing liquidity problems since late 1996 that are expected to continue
until the Company is able to complete a long-term debt or equity financing of
substantial size and/or until significant operating revenues are generated on
an ongoing basis. The Company had a negative working capital of $2,739,184
as of December 31, 1997. As a result, the Company's independent certified
public accountants have expressed substantial doubt about the Company's
ability to continue as a going concern.
In order to conserve working capital, the Company has reduced the number of its
employees, deferred compensation to certain of its senior officers and other
employees, deferred or delayed the payment of accounts payable, capital lease
obligations and bridge loans payable, and reduced operating expenses and capital
expenditures. As a result, the Company is in arrears with respect to its
payment obligations to certain lessors, creditors and a bridge noteholder.
During 1997, the Company relied on the proceeds from short-term loans, primarily
from related parties, bridge loans from both related and unrelated parties, and
the private placement of its common stock and warrants, which aggregated
approximately $3,900,000, to fund its operating requirements. During the period
from January 1, 1998 through April 9, 1998, the Company received $1,520,000 from
bridge financing, $420,000 from the exercise of stock purchase warrants, and
$200,000 from related party advances to partially fund estimated 1998 cash
requirements of $7,000,000, which includes estimated discretionary costs related
to marketing and promotion activities of $2,000,000, research and development
activities of $800,000 and estimated capital
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expenditures of $2,000,000. The Company is also exploring various other options
to raise additional operating capital during 1998.
The Company is dependent on the proceeds from its financing efforts for the
continuation of its current testing and marketing efforts related to The You Bet
Racing Network, as well as for the short-term continuation and expansion of the
Company's development activities and planned marketing activities. The Company
expects that its cash on hand, combined with the funds that the Company expects
to raise from new debt and equity financings during the remainder of 1998, will
be sufficient to fund operating and capital expenditures at least through
December 1998. However, there can be no assurances that the Company will be
able to complete such financings on a timely basis and/or under acceptable terms
and conditions. To the extent that adequate working capital is not available to
fund the Company's operations, management will consider a variety of other
alternatives, including seeking a joint venture partner, selling or licensing
its proprietary software technology, curtailing product development, delaying
the introduction, marketing and expansion of The You Bet Racing Network, and
reducing or suspending operations.
The Company's need for financing during 1998 and beyond will vary based upon a
number of factors, some of which are outside the control of the Company. These
factors include the scope of the Company's development and marketing efforts,
consumer reaction/acceptance and the development of operating revenues, the time
and cost to develop and commercialize additional applications, competition from
similar wagering systems and from competing interactive gaming/leisure time
systems and activities, and potential political and legal issues. In addition,
the Company's business plans may change based on changes in technology, new
developments in the marketplace or unforeseen events which could require the
Company to raise additional funds. The unavailability of additional funds under
acceptable terms and conditions when needed could have a material adverse effect
on the Company.
During November 1997, the Company completed a private placement offering of
securities to investors. The Company sold 89.78 units at $25,000 per unit.
Each unit consisted of 10,000 shares of common stock and 5,000 Series D common
stock purchase warrants exercisable at $5.25 and expiring November 1999. Total
offering costs of $291,020 were charged against the gross proceeds of
$2,244,400, resulting in net proceeds of $1,953,380. As a result of the sale of
89.78 units under this private placement in 1997, the Company issued a total of
897,760 shares of common stock and 448,880 Series D common stock purchase
warrants.
In conjunction with the closing of the private placement offering, bridge loans
payable aggregating $1,679,000, representing a principal balance of $1,460,000
and accrued interest of $219,000, were exchanged for 89.55 units of common stock
and Series D common stock purchase warrants. Included in the $1,679,000 was
$632,500, representing a principal balance of $550,000 and accrued interest of
$82,500, from related parties. As a result of the issuance of 89.55 units in
1997, the Company issued 895,468 shares of common stock and 447,734 Series D
common stock purchase warrants, including 337,335 shares of common stock and
168,667 Series D common stock purchase warrants to related parties. During
1997, advances not converting into the bridge
14
<PAGE>
financing of $209,000, including $104,000 to related parties, were repaid.
During 1997, the Company's operations used $3,862,112 of cash, as compared to
$2,832,263 of cash during 1996, reflecting a general increase in the levels of
activity as the Company completed the development of The You Bet Racing Network
and commenced commercial testing and marketing activities. These activities
resulted in a significantly higher loss in 1997 as compared to 1996.
During 1997, cash flows used in investing activities aggregated $132,356 for
purchases of property and equipment, which was funded by the proceeds of a
capital lease transaction aggregating $150,261.
The Company does not currently have any existing capital expenditure commitments
for 1998. However, subject to the continuing development of The You Bet Racing
Network and the availability of sufficient capital resources, the Company's
business plan anticipates the establishment of an East Coast operations and
customer service center at a cost of approximately $2,000,000 during the latter
half of 1998 to support the anticipated increase in activity on The You Bet
Racing Network.
Consolidated Results of Operations - Years Ended December 31, 1996 and 1997:
Research and development and network operations increased from $1,610,604 in
1996 to $1,919,062 in 1997, an increase of $308,458 or 19.2%. Sales and
marketing expense increased from $663,572 in 1996 to $710,532 in 1997, an
increase of $46,960 or 7.1%. General and administrative expenses increased from
$1,441,439 in 1996 to $1,804,176 in 1997, an increase of $362,737 or 25.2%. The
increase in such expense categories reflects the Company's continuing
development efforts with respect to The You Bet Racing Network, the recruitment
and hiring of management, horse racing and technical teams, entering into
agreements with strategic partners, and increased general and administrative
expenses associated with the operation of a public company.
Interest expense increased from $15,154 in 1996 to $390,471 in 1997 primarily as
a result of an increase in advances and bridge loans during 1997.
During the year ended December 31, 1997, the Company also incurred over
$14,000,000 of non-cash expenses. The Company recorded the fair value of
various stock options and warrants issued for services rendered as a charge to
operations; such amounts aggregated $2,008,217 for services rendered and
$3,656,202 for financing costs. The Company recorded a charge to operations of
$7,875,000 to reflect accounting for the release of forfeiture provisions on
certain shares of common stock owned by two officers/major stockholders and a
stockholder related to one of the officers. The Company recorded a charge to
operations of $573,348 to reflect a discount on conversion of bridge loans,
accounts payable and employee deferred salaries into common stock and warrants.
The recognition of these expenses did not effect working capital, net
stockholders' deficiency, or cash flows. The Company does not expect that these
types of costs will continue at these levels in the future.
15
<PAGE>
However, certain of these costs will be recognized in the near term,
particularly as they relate to transactions occurring in 1997 aggregating
approximately $1,300,000, which are expected to provide future benefit in 1998
and 1999, primarily with respect to services rendered by a financial and
marketing consulting firm. In addition, the Company expects to recognize a
non-cash charge to operations in 1998 resulting from the conversion discount on
the 1998 bridge financing.
Year 2000 Issue:
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four digits to define the applicable year. Computer programs
that have sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
Based on a recent internal assessment, the Company has determined that its
software programs, both developed internally and purchased from outside vendors,
are already Year 2000 compliant, or that the cost of any needed modifications
will not have a material effect on the Company's consolidated financial
position, results of operations or cash flows.
Recent Accounting Pronouncements:
In February 1997, the Financial Accounting Standards Board issued Statement No.
129, "Disclosure of Information about Capital Structure", which is effective for
financial statements issued for fiscal years ending after December 15, 1997.
The new standard reinstates various securities disclosure requirements
previously in effect under Accounting Principles Board Opinion No. 15, which has
been superseded by this statement. Adoption of this statement did not have an
impact on the Company's current disclosures and presentation.
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
"Reporting Comprehensive Income", which is effective for financial statements
issued for fiscal years beginning after December 15, 1997. This statement
establishes standards for the reporting and display of comprehensive income and
its components in a full set of general purpose financial statements.
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income refers to revenues, expenses, gains and losses that
under generally accepted accounting principles are included in comprehensive
income but are excluded from net income. Adoption of this statement is not
expected to have an impact on the Company's current disclosures and
presentation.
In June 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which is
effective for financial statements issued for fiscal years beginning after
December 15, 1997. This statement
16
<PAGE>
requires that public companies report certain information about their major
customers, operating segments, products and services, and the geographic areas
in which they operate. Adoption of this statement is not expected to have an
impact on the Company's current disclosures and presentation.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements are listed at the "Index to Consolidated
Financial Statements" elsewhere in this document.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Effective November 3, 1997, Deloitte & Touche LLP ("Deloitte & Touche")
resigned as the Company's independent accountants. Deloitte & Touche audited
the Company's consolidated financial statements for the years ended December
31,1995 and 1996. Deloitte & Touche's reports for the years ended December
31, 1995 and 1996 contained an explanatory paragraph raising substantial
doubt about the Company's ability to continue as a going concern. Other than
the foregoing explanatory paragraph, Deloitte & Touche's reports on the
Company's financial statements for the years ended December 31, 1995 and 1996
did not contain an adverse opinion or a disclaimer of opinion, nor were the
reports modified as to audit scope or uncertainty. During the years ended
December 31, 1995 and 1996, and the period from January 1, 1997 through
November 3, 1997, there were no disagreements with Deloitte & Touche on any
matter of accounting principles or practices, financial statement disclosure,
or auditing scope or procedure, which disagreements, if not resolved to the
satisfaction of Deloitte & Touche, would have caused such firm to make
reference to the subject matter of the disagreements in connection with its
reports on the Company's consolidated financial statements.
Effective March 3, 1998, the Company engaged BDO Seidman, LLP ("BDO Seidman") as
the Company's new independent accountants. The engagement of BDO Seidman was
approved by the Company's Board of Directors.
Prior to the engagement of BDO Seidman, the Company did not consult with such
firm regarding the application of accounting principles to a specific completed
or contemplated transaction, or any matter that was either the subject of a
disagreement or a reportable event. However, prior to the engagement of BDO
Seidman, the Company consulted with such firm in order to confirm the Company's
expectation that the auditor's opinion with respect to the Company's 1997
consolidated financial statements would contain a modification paragraph
reflecting uncertainty with respect to the Company's ability to continue as a
going concern.
17
<PAGE>
PART III.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The following tables and text sets forth the names and ages of all directors and
executive offers of the Company as of March 31, 1997. The Board of Directors is
comprised of only one class. All of the directors will serve until the next
annual meeting of stockholders and until their successors are elected and
qualified, or until their earlier death, retirement, resignation or removal.
There are no family relationships among directors and executive officers. Also
provided is a brief description of the business experience of each director and
executive officer during the past five years and an indication of directorships
held by each director in other companies subject to the reporting requirements
under the Federal securities laws.
DIRECTORS
<TABLE>
<CAPTION>
Date Elected
Name Age as Director
- ---- --- -----------
<S> <C> <C>
David M. Marshall 35 December 1995
Russell M. Fine 34 December 1995
Jess Rifkind 67 December 1995
</TABLE>
OFFICERS AND SENIOR EXECUTIVES
<TABLE>
<CAPTION>
Name Age Position(s)
- ---- --- -----------
<S> <C> <C>
You Bet International, Inc.
(parent company):
David M. Marshall 35 Chairman of the Board of
Directors, Chief Executive
Officer and President
Russell M. Fine 34 Executive Vice President
and Chief Technology
Officer
Robert N. Weingarten 46 Chief Financial Officer
You Bet!, Inc. (principal
operating subsidiary):
Ronald W. Luniewski 34 President and Chief
Operating Officer
Steven A. Molnar 54 Executive Vice President,
Racing
18
<PAGE>
Katherine I. Wilkins 37 Executive Vice President,
Marketing
Jeffrey D. Franklin 43 Executive Director, Racing
Product Development
</TABLE>
Biographies of Directors, Officers and Senior Executives:
David M. Marshall
David M. Marshall serves as the Chairman of the Board of Directors, Chief
Executive Officer and President of You Bet International, Inc. Mr. Marshall was
the Chief Executive Officer and co-founder of PC Totes, Inc. and Middleware
Telecom Corporation, the Company's predecessor entities, which are now
wholly-owned subsidiaries of the Company. In 1987, PC Totes, Inc. developed one
of the world's first high-speed, fault tolerant, PC-based computer totalisator
systems that is now used to operate wagering at horse and dog racing tracks in
Thailand, Malaysia, Guam and other countries in the Pacific Rim.
Russell M. Fine
Russell M. Fine serves as the Executive Vice President, Chief Technology Officer
and Director of You Bet International, Inc. Mr. Fine was the Chief Technology
Officer and co-founder of Middleware Telecom Corporation and Vice President of
Research and Development of PC Totes, Inc. At PC Totes, Inc., Mr. Fine headed
the design and development of one of the world's first high-speed, fault
tolerant, PC-based, real-time transaction processing systems. At Middleware
Telecom Corporation, Mr. Fine designed and managed the development of wagering
software, including the development of real-time metering and billing systems,
data translation software and multimedia CD-ROM content development.
Jess Rifkind
Jess Rifkind serves as a Director of You Bet International, Inc. Mr. Rifkind
has been an independent management consultant providing advice to clients in the
areas of management, finance and technology.
Robert N. Weingarten
Robert N. Weingarten has served as the Chief Financial Officer of You Bet
International, Inc. since February 1, 1998. From July 1992 to present, Mr.
Weingarten has been the sole shareholder of Resource One Group, Inc., a
financial consulting and advisory company. From January 1, 1997 through July
31, 1997, Mr. Weingarten was a principal in Chelsea Capital Corporation, a
merchant banking firm. Since 1979, Mr. Weingarten has served as a consultant
with numerous public companies in various stages of development, operating or
reorganization. Mr. Weingarten currently serves as an officer and director of
GolfGear International, Inc. and as an officer of Brighton Technologies
Corporation, both of which are publicly held companies.
Ronald W. Luniewski
19
<PAGE>
Ronald W. Luniewski serves as President and Chief Operating Officer of You Bet!,
Inc., the Company's principal operating subsidiary. Prior to joining the
Company in 1996, Mr. Luniewski was employed for 11 years by Electronic Data
Systems as Vice President, where he was responsible for providing information
technology and consulting services to General Motors Marketing and Advertising
Division. Mr. Luniewski has extensive experience in directing large software
developments efforts.
Steven A. Molnar
Steven A. Molnar serves as Executive Vice President, Racing, of You Bet!, Inc.,
the Company's principal operating subsidiary. For the twelve years prior to
joining the Company in 1995, Mr. Molnar was the Director of Marketing and then
President and Chief Operating Officer of McKinnie Systems. Under his
leadership, McKinnie Systems implemented a nationwide licensing system based on
Smart Card technology, and also became the leading computer software supplier to
race tracks in North America.
Katherine I. Wilkins
Katherine I. Wilkins serves as Executive Vice President, Marketing, of You Bet!,
Inc., the Company's principal operating subsidiary. For the five years prior to
joining the Company in 1996, she was Vice President of Marketing and Sales for
The Daily Racing Form, the leading horse racing daily newspaper in North
America. She has 18 years of experience in the horse racing industry in both
North American and Europe, and has broad-based experience in marketing, sales,
customer relations and communications.
Jeffrey D. Franklin
Jeffrey D. Franklin services as Executive Director, Racing Product Development,
of You Bet!, Inc., the Company's principal operating subsidiary. Prior to
joining the Company in 1996, Mr. Franklin had 14 years experience working with
leading jockeys, owners and racing stables as a jockey agent. Mr. Franklin has
represented racing personalities such as Gary Stevens, Patrick Valenzuela and
Jose Santos.
Compliance with Section 16(a) of the Exchange Act:
During the year ended December 31, 1997, the Company did not have any class of
equity securities registered pursuant to Section 12 of the Securities Exchange
Act of 1934, as amended, and accordingly, was not subject to the reporting
requirements of Section 16 of the Securities Exchange Act of 1934, as amended.
ITEM 10. EXECUTIVE COMPENSATION
The following table and text sets forth the compensation paid by the Company to
its Chief Executive Officer and to its four other most highly compensated
executive officers during the last three fiscal years.
20
<PAGE>
<TABLE>
<CAPTION>
Annual Compensation
----------------------------------
Name and Principal Other Annual
Position Year Salary Bonus(1) Compensation(2)
- ------------------ ---- ------ ----- ------------
<S> <C> <C> <C> <C>
You Bet International, Inc.
David M. Marshall 1997 $130,000 $ $6,000
President and 1996 130,000 6,000
Chief Executive 1995 72,800
Officer
Russell M. Fine 1997 120,000 6,000
Executive Vice 1996 120,000 6,000
President and Chief 1995 52,558
Technology Officer
You Bet!, Inc.
Ronald W. Luniewski 1997 120,000 6,563
President and 1996 98,885
Chief Operating 1995
Officer
Steven A. Molnar 1997 135,000 6,891
Executive Vice 1996 74,750
President, Racing 1995 19,750
Katherine I. Wilkins 1997 110,000 5,074
Executive Vice 1996
President, Marketing 1995
</TABLE>
- -------------------
(1) Represents 25% bonus on deferred compensation.
(2) Represents automobile allowance of $500 per month.
Issuance of Common Stock Purchase Warrant to Executive:
Effective December 31,1997, the Company issued a common stock purchase warrant
to Katherine I. Wilkins to purchase 100,000 shares of common stock at an
exercise price of $3.00, exercisable through October 31, 1998, partially in
exchange for an accrued but unpaid bonus. Aggregate fair value was $210,000,
which was charged to operations in 1997.
Board of Directors:
During the year ended December 31, 1997, the Company had three meetings of the
Board of Directors, at which all directors were in attendance. Directors
receive no cash compensation for serving on the Board of Directors, but are
reimbursed for any out-of-pocket expenses incurred in attending board meetings.
Non-employee directors receive options to purchase 5,000 shares of common stock
for each year of service on the Board of Directors.
21
<PAGE>
During 1997, the Company issued a stock option to the non-employee director
under the 1995 Stock Option Plan for Non-Employee Directors to purchase 5,000
shares of common stock at an exercise price of $2.75 per share, exercisable for
a period of ten years. Aggregate fair value was $9,083, of which $1,811 was
charged to operations in 1997, and the remaining $7,272 will be charged to
operations in 1998 through 2001.
During the year ended December 31, 1997, Company had no audit or nominating
committees, or committees performing similar functions. The Compensation
Committee, which administers the Company's stock option plans, consists of David
M. Marshall and Russell M. Fine. Mr. Marshall and Mr. Fine are ineligible to
receive awards under the Company's stock option plans.
Employment Agreements:
David M. Marshall and Russell M. Fine each have employment agreements with the
Company providing for terms of four years commencing December 6, 1995. The
employment agreements provide for annual compensation of $130,000 and $120,000,
respectively, a car allowance of $500 per month, and other usual and customary
benefits. In addition, each person is entitled to such bonuses as may be
declared from time to time by the Company's Board of Directors.
In the event of a change in control of the Company, as defined below, Mr.
Marshall and Mr. Fine each have the right, but not the obligation, to consider
such event to be a termination of his employment agreement. In the event of a
change in control of the Company, Mr. Marshall and Mr. Fine are entitled to
receive the remaining compensation provided for under their employment
agreements, without reduction for any amounts that they may earning in any
capacity after the date of termination. Pursuant to the employment agreements,
a change in control is defined as (i) any sale of all or substantially all of
the assets of the Company; (ii) any stock sale, merger or other business
combination in which the members of the management of the Company (a) no longer
are affiliates of the surviving entity, (b) no longer are in control of the
surviving entity, or (c) no longer own in excess of 20% of the outstanding
common stock of such surviving entity.
Stock Option Plans:
In November 1995, the Company's Board of Directors approved the 1995 Stock
Option Plan and the 1995 Stock Option Plan for Non-Employee Directors
(collectively, the "1995 Plans"). The 1995 Plans provide for the granting of
awards of incentive stock options, non-qualified stock options, and stock
appreciation rights. The aggregate number of shares of common stock available
for issuance under the 1995 Plans is 15% of the total number of shares of common
stock outstanding, allocated 13.5% to the 1995 Stock Option Plan and 1.5% to the
1995 Stock Option Plan for Non-Employee Directors. The options generally vest
in four equal annual installments, and have a term of ten years.
The 1995 Plans provide for the granting of incentive stock options ("Incentive
Stock Options") within the meaning of Section 422A of the Internal Revenue Code
of 1986, as amended (the "Code") and non-qualified stock options. Non-qualified
stock options may be granted to
22
<PAGE>
employees, directors and consultants of the Company, while Incentive Stock
Options may be granted only to employees. The 1995 Plans are currently
administered by the Compensation Committee of the Board of Directors, which
determines the terms and conditions of the options granted under the 1995 Plans,
including the exercise price, number of shares subject to option and the
exercisability thereof.
The exercise price of all Incentive Stock Options granted under the 1995 Plans
must be at least equal to the fair market value of the common stock of the
Company on the date of grant, and must be 110% of fair market value when granted
to a 10% or more shareholder. The exercise price of all non-qualified stock
options granted under the 1995 Plans shall be not less than 85% of the fair
market value of the common stock. The term of all options granted under the
1995 Plans may not exceed ten years, except the term of incentive options
granted to a 10% or more shareholder may not exceed five years. The 1995 Plans
may be amended or terminated by the Board of Directors, but no such action may
be taken which would materially increase the aggregate number of shares as to
which options may be granted, materially increase the benefits accruing to the
optionees, or materially modify the requirements as to eligibility for
participation under the 1995 Plans.
The 1995 Plans provides the Board of Directors or the Compensation Committee
with the discretion to determine when options granted thereunder shall become
exercisable and the vesting period of such options. Upon termination of a
participant's employment or consulting relationship with the Company, all
unvested options terminate and are no longer exercisable. Vested non-qualified
options remain exercisable for a period not to exceed three months following the
termination date.
During the year ended December 31, 1997, the Company granted options to
officers of the Company's subsidiary as follows:
<TABLE>
<CAPTION>
% of Options
Number of Granted to Total Exercise
Recipient Options Granted Options Granted Price
- --------- --------------- ---------------- ---------
<S> <C> <C> <C>
Steven A. Molnar 20,000 8.1% $3.00
Katherine I. Wilkins 13,200 5.3 3.00
</TABLE>
23
<PAGE>
A summary of stock options issued to officers of the Company's subsidiary
under the 1995 Plans as of December 31, 1997 is summarized below. No options
were exercised during 1995, 1996 or 1997.
<TABLE>
<CAPTION>
Number of Value of
Shares of Unexercised
Common Stock in-the-Money
Underlying Options at
Stock Options Weighted Fiscal Year-End(1)
--------------- Exercise ----------------
Recipient Unvested Vested Price Unvested Vested
- --------- ------- ------ ----- ------- ------
<S> <C> <C> <C> <C> <C>
Ronald W. Luniewski 50,000 50,000 $2.50 $100,000 $100,000
Steven A. Molnar 40,000 60,000 2.60 70,000 120,000
Katherine Wilkins 28,050 15,150 2.65 53,325 26,475
------- ------- ------- -------
Total 118,050 125,150 2.57 $223,325 $246,475
------- ------- -------- --------
------- ------- -------- --------
</TABLE>
(1) The dollar values are calculated by determining the difference between the
weighted exercise price of the options and the market price for the common
stock of $4.50 on December 31, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
As used in this section, the term beneficial ownership with respect to a
security is defined by Rule 13d-3 under the Securities Exchange Act of 1934, as
amended, as consisting of sole or shared voting power (including the power to
vote or direct the vote) and/or sole or shared investment power (including the
power to dispose of or direct the disposition of) with respect to the security
through any contract, arrangement, understanding, relationship or otherwise,
subject to community property laws where applicable.
As of March 31, 1998, the Company had a total of 9,603,994 shares of common
stock issued and outstanding. All common share amounts reflect the 1 for 1.5
reverse stock split effected in December 1995. There are no other classes of
equity securities currently outstanding.
The following table sets forth, as of March 31, 1998: (a) the names and
addresses of each beneficial owner of more than five (5%) of the Company's
common stock known to the Company, the number of shares of common stock
beneficially owned by each such person, and the percent of the Company's common
stock so owned; and (b) the number of shares of common stock beneficially owned,
and the percentage of the Company's common stock so owned, by each director, and
by all directors and officers of the Company as a group. Each person has sole
voting and investment power with respect to the shares of common stock, except
as
24
<PAGE>
otherwise indicated. Beneficial ownership consists of a direct interest in the
shares of common stock, except as otherwise indicated.
<TABLE>
<CAPTION>
Percent
of
Amount and Shares
Nature of of
Name and Address of Beneficial Common
Beneficial Owner Ownership Stock
- ------------------- ---------- -----
<S> <C> <C>
David M. Marshall (12) 2,139,375 (1) 22.3%
Russell M. Fine (12) 2,107,375 21.9%
Trafina Privatbank 1,200,000 (2) 12.0%
Rennweg 50 CH-4020
Basel, Switzerland
Marmara Shipping and Trading, Inc. 615,000 (3) 6.3%
50 Upper Brook Street
London W141PG
United Kingdom
Sid Marshall 616,001 (4) 6.2%
11770-M Pacific Coast Highway
Malibu, California 90265
Marshall Gift Trust 612,250 (5) 6.3%
1700 Bank of America Plaza
300 South Fourth Street
Las Vegas, Nevada 89101
Jess Rifkind (12) 30,000 (6) .3%
Ronald W. Luniewski (12) 50,000 (7) .5%
Steven A. Molnar (12) 60,000 (8) .6%
Katherine I. Wilkins (12) 115,150 (9) 1.2%
Jeffrey D. Franklin (12) 50,040 (10) .5%
Robert N. Weingarten (12) - -
All Directors and
Officers as a Group (8 persons) 4,451,940 (11) 45.5%
</TABLE>
- --------------------
(1) Excludes shares of common stock and common stock purchase warrants owned
by Sid Marshall and the Marshall Gift Trust. David M. Marshall is the
son of Sid Marshall and a beneficiary of the Marshall Gift Trust.
(2) Includes 400,000 shares of common stock subject to currently exercisable
Series A common stock purchase warrants.
25
<PAGE>
(3) Includes 205,000 shares of common stock subject to currently exercisable
Series A common stock purchase warrants.
(4) Includes 412,000 shares of common stock subject to currently exercisable
common stock purchase warrants as follows: Series C - 320,000; Series D
- 92,000. Does not include shares of common stock and common stock
purchase warrants owned by the Marshall Gift Trust, of which Sid
Marshall is the trustee. Sid Marshall is the father of David M.
Marshall.
(5) Includes 141,333 shares of common stock subject to currently exercisable
common stock purchase warrants as follows: Series C - 80,000; Series D
- 61,333.
(6) Includes 10,000 shares of common stock subject to currently exercisable
stock option.
(7) Consists solely of 50,000 shares of common stock subject to currently
exercisable stock option.
(8) Consists solely of 60,000 shares of common stock subject to currently
exercisable stock option.
(9) Consists of 15,150 shares of common stock subject to currently
exercisable stock option and 100,000 shares subject to currently
exercisable stock purchase warrant.
(10) Consists solely of 50,040 shares of common stock subject to currently
exercisable stock option.
(11) Consists of 185,190 shares of common stock subject to currently
exercisable stock options and 100,000 shares subject to currently
exercisable common stock purchase warrant.
(12) The address for such individuals is c/o You Bet International, Inc.,
1950 Sawtelle Boulevard, Suite 180, Los Angeles, California 90025.
Divestment Shares:
In conjunction with the December 1995 reverse merger, a total of 5,800,000
shares of common stock were issued, including 5,710,000 shares of common stock
to David M. Marshall and Russell M. Fine, their nominees and Sid Marshall, the
father of David M. Marshall. In conjunction with the contemporaneous 1995
private placement offering, 2,500,000 of the 5,710,000 shares were subject to
forfeiture under certain conditions if the Company did not achieve certain
customer subscription levels within a specified timeframe through December 5,
1999 (the "Divestment Shares"). The Company's original short-term goal,
established in 1995, was to maximize customer subscription levels. However, as
a result of a change in the Company's marketing strategy during 1997, the
Company has decided to de-emphasize its original short-term goal in order to
focus on certain long-term goals. The Company's revised marketing strategy is
focused on building a brand name and becoming a market leader, acquiring and
retaining a large and loyal customer base, and maximizing long-term
profitability.
26
<PAGE>
Accordingly, effective December 31, 1997, the Board of Directors authorized the
release of the forfeiture restrictions on the 2,500,000 shares of common stock
in exchange for the return of 750,000 shares to the Company.
The release from the possibility of forfeiture with respect to the Divestment
Shares is recorded for accounting purposes as the payment of compensation to the
recipients when the possibility of forfeiture terminates, and results in a
charge to operations in an amount equal to the fair market value of the
Divestment Shares retained at the time such forfeiture possibility terminates.
Accordingly, the Company recognized a charge to operations, with a corresponding
credit to additional paid-in capital, of $7,875,000 at December 31, 1997,
reflecting the release from the possibility of forfeiture on the remaining
1,750,000 shares at the fair market value of $4.50 per share.
Changes in Control:
The Company is unaware of any contract or other arrangement, the operation of
which may at a subsequent date result in a change in control of the Company.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In conjunction with the closing of the reverse merger and private placement
offering in 1995, bridge loans payable aggregating $250,000 were exchanged for
10 units of common stock and Series A common stock purchase warrants, and
advances aggregating $345,000, including $100,000 from a related party, were
exchanged for 13.8 units of common stock and Series A common stock purchase
warrants. As a result of the issuance of 23.8 units, the Company issued an
aggregate of 238,000 shares of common stock and 119,000 Series A common stock
purchase warrants, including 40,000 shares and 20,000 Series A common stock
purchase warrants to a related party.
In conjunction with the closing of the private placement offering, bridge loans
payable aggregating $1,679,000, representing a principal balance of $1,460,000
and accrued interest of $219,000, were exchanged for 89.55 units of common stock
and Series D common stock purchase warrants. Included in the $1,679,000 was
$632,500, representing a principal balance of $550,000 and accrued interest of
$82,500, from related parties. As a result of the issuance of 89.55 units in
1997, the Company issued 895,468 shares of common stock and 447,734 Series D
common stock purchase warrants, including 337,335 shares of common stock and
168,667 Series D common stock purchase warrants to related parties.
As part of the consideration for making the bridge loans, the Company agreed at
the time the bridge loans were funded to give the bridge investors the option to
convert their bridge loans, including accrued interest, into the subsequent
private placement securities at the lesser of $25,000 per unit or 75% of the
private placement offering price. Accordingly, the Company recognized a charge
to operations, with a corresponding credit to additional paid-in capital,
representing the aggregate discount of $559,667, including $210,834 allocable to
related parties. As a result, bridge investors exchanged their bridge
27
<PAGE>
loans for units offered in the private placement at the rate of $18,750 per
unit, equivalent to a 25% discount from the $25,000 private placement price.
The Company issued a warrant to an executive to purchase 100,000 shares of
common stock at an exercise price of $3.00, exercisable through October 31,
1998, partially in exchange for an accrued but unpaid bonus. Aggregate fair
value was $210,000, which was charged to operations in 1997.
The Company issued an aggregate of 1,114,217 Series C common stock purchase
warrants to various parties as financing costs. The Series C common stock
purchase warrants are exercisable at $2.50 per share through December 31, 2002.
Employees deferring a portion of their compensation received 5,717 warrants,
vendors deferring amounts due them received 142,500 warrants, individuals
providing short-term unsecured advances to the Company received 262,000 warrants
(including 236,000 warrants to related parties), and bridge investors received
704,000 warrants (including 220,000 warrants to related parties). Aggregate
fair market value of the warrants was $3,656,202 (including $1,504,580 allocable
to related parties), all of which was charged to operations in 1997.
Jess Rifkind, the non-employee member of the Board of Directors, is paid a
consulting fee of $2,400 per month.
PART IV.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
- ------ -----------------------
<S> <C>
2.1 Acquisition Agreement between PC Totes, Inc. and Embassy
Acquisition, Inc. dated as of December 6, 1995 (1)
3.1 Restated Articles of Incorporation (1)
3.2 By-Laws of the Company (1)
10.1 Employment Agreement between the Company and David M. Marshall
dated as of December 6, 1995 (2)
10.2 Employment Agreement between the Company and Russell M. Fine
dated as of December 6, 1995 (2)
10.3 Lease between the Company and Storage Tek (2)
10.4 1995 Stock Option Plan (2)
10.5 1995 Stock Option Plan for Non-Employee Directors (2)
</TABLE>
28
<PAGE>
21.1 Subsidiaries of the Company (2)
27 Financial data schedule (electronic filing only)
- ---------------------
(1) Previously filed as an exhibit to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1995, and incorporated herein
by reference.
(2) Previously filed as an exhibit to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1996, and incorporated herein
by reference.
(b) Reports on Form 8-K: During the fourth quarter of the fiscal year ended
December 31, 1997, the Company filed a Current Report on Form 8-K dated
November 3, 1997, and subsequently amended by a Current Report on Form
8-K dated November 17, 1997, to report the resignation of the Company's
independent accountants on November 3, 1997 (Item 4).
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
YOU BET INTERNATIONAL, INC.
---------------------------
(Registrant)
Date: April 14, 1998
In accordance with the Exchange Act, this report has been signed by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Date: April 14, 1998 By: /s/ David M. Marshall
--------------------------
David M. Marshall
President and Chief
Operating Officer
29
<PAGE>
Date: April 14, 1998 By: /s/ Russell M. Fine
--------------------------
Russell M. Fine
Executive Vice President
and Chief Technology
Officer
Date: April 14, 1998 By: /s/ Jess Rifkind
--------------------------
Jess Rifkind
Director
Date: April 14, 1998 By: /s/ Robert N. Weingarten
--------------------------
Robert N. Weingarten
Chief Financial Officer
30
<PAGE>
You Bet International, Inc.
Index to Consolidated Financial Statements
Consolidated Financial Statements
for the Years Ended December 31,
1996 and 1997, and 1995 to Date:
Reports of Independent Certified
Public Accountants:
BDO Seidman, LLP
Weinbaum & Yalamanchi
Consolidated Balance Sheets -
December 31, 1996 and 1997
Consolidated Statements of
Operations - Years Ended
December 31, 1996 and 1997,
and 1995 to Date
Consolidated Statements of
Stockholders' Equity
(Deficiency) - Years Ended
December 31, 1995, 1996 and
1997
Consolidated Statements of
Cash Flows - Years Ended
December 31, 1996 and 1997,
and 1995 to Date
Notes to Consolidated
Financial Statements - Years
Ended December 31, 1996 and
1997, and 1995 to Date
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders
You Bet International, Inc.
Los Angeles, California
We have audited the accompanying consolidated balance sheet of You Bet
International, Inc. and subsidiaries (a development stage company) as of
December 31, 1997, and the related consolidated statements of operations,
stockholders' equity (deficiency) and cash flows for the year then ended. We
have also audited the consolidated statements of operations and cash flows for
the period from inception of development stage (January 1, 1995) through
December 31, 1997 (Note 1), except that we did not audit these financial
statements for the period from inception of development stage (January 1, 1995)
to December 31, 1996 (Note 1); those statements were audited by other auditors.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit. Our opinion, insofar as it relates to the amounts for the period
from inception of development stage (January 1, 1995) to December 31, 1996, is
based solely on the reports of the other auditors.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial
statements. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, based on our audit and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of You Bet International, Inc. (a
development stage company) and subsidiaries as of December 31, 1997, and the
results of their operations and their cash flows for the year then ended and the
period from inception of development stage (January 1, 1995) to December 31,
1997, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to
the consolidated financial statements, the Company's recurring losses from
operations, current liquidity problems, including a negative working capital of
$2,739,184, and other factors raise substantial doubt about its ability to
continue as a going concern. Management's plans concerning these matters are
also described in Note 1. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
BDO SEIDMAN, LLP
Los Angeles, California
March 26, 1998, except
for Note 11, which is
April 9, 1998
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders of
You Bet International, Inc.
(a development stage company)
Los Angeles, California
We audited You Bet International, Inc.'s (You Bet) accompanying December 31,
1996 consolidated balance sheet and its related consolidated statements of
operations, stockholders' (deficiency) and cash flows for the year then ended.
These financial statements are the responsibility of You Bet's management. Our
responsibility is to express an opinion on the financial statements based on our
audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant management estimates,
as well as evaluating the overall presentation of the financial statements. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, You Bet's financial position, results of
operations and cash flows as of December 31, 1996 and for the year then ended in
conformity with generally accepted accounting principles.
You Bet's financial statements were prepared assuming that it will continue as a
going concern. As discussed in financial statement Note 1, You Bet's continuing
operating losses and liquidity problems raise substantial doubt about its
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The financial statements include no
adjustments that might result from resolving this uncertainty.
WEINBAUM & YALAMANCHI
Los Angeles, California
April 10, 1998
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Balance Sheets - Assets
December 31, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
ASSETS (Notes 4 and 11)
Current assets:
Cash $ 87,318 $ 52,895
Receivables 7,508 6,158
Prepaid expenses 143,238 49,315
Other current assets 5,996 4,288
---------- ----------
Total current assets 244,060 112,656
---------- ----------
Property and equipment (Note 3) 1,128,055 1,260,411
Less: Accumulated depreciation
and amortization (115,242) (423,177)
---------- ----------
Property and equipment, net 1,012,813 837,234
---------- ----------
Deposits 53,963 53,963
---------- ----------
Total assets $1,310,836 $1,003,853
---------- ----------
---------- ----------
</TABLE>
(continued)
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Balance Sheets - Liabilities and Stockholders' Deficiency
(continued)
December 31, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable $ 827,599 $ 910,278
Accrued compensation and related items 191,925 503,467
Accrued interest payable 1,250 116,892
Other accrued expenses 264,311 341,108
Advances and bridge loans payable
(Note 4) -
Related parties 200,000 390,000
Unrelated parties 300,000
State income taxes payable (Note 8) 4,420 6,400
Current portion of capitalized
lease obligations (Note 6) 129,432 283,695
----------- ------------
Total current liabilities 1,618,937 2,851,840
Capitalized lease obligations,
less current portion (Note 6) 97,598
----------- ------------
Total liabilities 1,716,535 2,851,840
----------- ------------
Commitments and contingencies
(Notes 6 and 7)
Stockholders' deficiency (Note 5):
Preferred stock, $.001 par value;
authorized - 1,000,000 shares;
issued and outstanding - none
Common stock, $.001 par value;
authorized - 50,000,000 shares;
issued and outstanding and
issuable - 8,283,333 shares and
9,603,994 shares at December 31,
1996 and 1997, respectively 8,283 9,604
Additional paid-in capital 4,410,661 23,413,989
Accumulated deficit during
development stage (4,547,556) (23,964,394)
----------- ------------
Total stockholders' deficiency (128,612) (540,801)
Less: Deferred compensation (277,087) (1,307,186)
----------- ------------
Net stockholders' deficiency (405,699) (1,847,987)
----------- ------------
Total liabilities and
stockholders' deficiency $ 1,310,836 $ 1,003,853
----------- ------------
----------- ------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Statements of Operations
Years Ended December 31, 1996 and 1997, and 1995 to Date
<TABLE>
<CAPTION>
1996 1997 1995 to Date
---- ---- ------------
(Note 1)
<S> <C> <C> <C>
Costs and expenses:
Research and development
and network operations $ 1,610,604 $ 1,919,062 $ 3,847,733
Sales and marketing 663,572 710,532 1,374,104
General and administrative 1,441,439 1,804,176 3,438,960
Depreciation and amortization 122,673 307,935 433,464
Amortization of deferred
compensation (Note 5) 102,263 167,965 308,703
Fair value of warrants and
stock options issued for
services rendered (Note 5) 2,008,217 2,008,217
Release of forfeiture
restrictions on common
stock owned by officers/
major stockholders (Note 5) 7,875,000 7,875,000
----------- ------------ ------------
Total costs and expenses 3,940,551 14,792,887 19,286,181
----------- ------------ ------------
Other income (expense):
Interest expense (15,154) (390,471) (439,158)
Discount on conversion of
bridge loans, accounts
payable and employee
deferred salaries into
common stock and warrants
(Note 5) (573,348) (573,348)
Fair value of warrants issued
financing costs (Note 5) (3,656,202) (3,656,202)
Interest income 78,000 1,145 93,347
Consulting revenues 7,725 5,400 164,602
Other 9,875 (831) 29,044
----------- ------------ ------------
Total other income (expense) 80,446 (4,614,307) (4,381,715)
----------- ------------ ------------
Loss before provision for
state income and franchise
taxes (3,860,105) (19,407,194) (23,667,896)
Provision for state income
and franchise taxes (Note 8) 4,629 9,644 16,673
----------- ------------ ------------
Net loss $(3,864,734) $(19,416,838) $(23,684,569)
----------- ------------ ------------
----------- ------------ ------------
Net loss per common share $(0.67) $(3.06)
----------- ------------
----------- ------------
Weighted average number of
common shares outstanding 5,730,333 6,355,352
----------- ------------
----------- ------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Statement of Stockholders' Equity (Deficiency)
Years Ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
Common Stock Additional
----------------- Paid-in Accumulated Deferred
Shares Amount Capital Deficit Compensation Total
------ ------ ------- ------- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Balance,
January
1, 1995 343,333 $ 343 $ 21,657 $ (279,825) $ $ (257,825)
Issuance of
shares in
reverse
merger 5,800,000 5,800 (522,796) (516,996)
Shares
issued in
private
placement 1,490,000 1,490 3,723,510 3,725,000
Costs of
private
placement (575,860) (575,860)
Shares
issued as
underwriters
compensation 200,000 200 499,800 500,000
Shares
issued in
exchange
for debt 238,000 238 594,762 595,000
Stock options
issued for
services 289,575 (289,575)
Amortization
of deferred
compensation 38,475 38,475
Net loss for
the year (402,997) (402,997)
--------- ----- ---------- ---------- --------- ----------
Balance,
December
31, 1995 8,071,333 8,071 4,030,648 (682,822) (251,100) 3,104,797
</TABLE>
(continued)
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Statement of Stockholders' Equity (Deficiency) (continued)
Years Ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
Common Stock Additional
----------------- Paid-in Accumulated Deferred
Shares Amount Capital Deficit Compensation Total
------ ------ ------- ------- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Shares issued
in private
placement 212,000 212 529,788 530,000
Costs of
private
placement (278,025) (278,025)
Stock options
issued for
services
rendered 128,250 (128,250)
Amortization
of deferred
compensation 102,263 102,263
Net loss for
the year (3,864,734) (3,864,734)
--------- ----- ---------- ---------- --------- ----------
Balance,
December
31, 1996 8,283,333 8,283 4,410,661 (4,547,556) (277,087) (405,699)
Shares issued
as payment
for amounts
due to
vendors and
employees 27,433 28 61,410 61,438
Shares issued
in private
placement 897,760 898 2,243,502 2,244,400
Costs of
private
placement (291,020) (291,020)
Shares issued
to bridge
loan
investors
for
conversion
into
common
stock and
warrants 895,468 895 1,678,105 1,679,000
</TABLE>
(continued)
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Statement of Stockholders' Equity (Deficiency) (continued)
Years Ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
Common Stock Additional
----------------- Paid-in Accumulated Deferred
Shares Amount Capital Deficit Compensation Total
------ ------ ------- ------- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Shares
returned to
Company for
cancellation
by officers/
major
stockholders (750,000) (750) 750
Release of
forfeiture
restrictions
on common
stock owned
by officers/
major
stockholders 7,875,000 7,875,000
Discount on
conversion
of bridge
loans,
accounts
payable and
employee
deferred
salaries into
common
stock and
warrants 573,348 573,348
Shares issued
as finders
fees for
capital
raising
transactions 250,000 250 (250)
Amortization
of deferred
compensation 167,965 167,965
Fair value of
stock options
and warrants
issued 6,862,483 (1,198,064) 5,664,419
Net loss for
the year (19,416,838) (19,416,838)
--------- ------ ----------- ------------ ----------- ------------
Balance,
December
31, 1997 9,603,994 $9,604 $23,413,989 $(23,964,394) $(1,307,186) $ (1,847,987)
--------- ------ ----------- ------------ ----------- ------------
--------- ------ ----------- ------------ ----------- ------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Statements of Cash Flows
Years Ended December 31, 1996 and 1997, and 1995 to Date
<TABLE>
<CAPTION>
1996 1997 1995 to Date
---- ---- ------------
<S> <C> <C> <C>
Increase (Decrease) in Cash (Note 1)
Cash flows from operating
activities:
Net loss $(3,864,734) $(19,416,838) $(23,684,569)
Adjustments to reconcile
net loss to net cash
provided by (used in)
operating activities:
Depreciation and
amortization 122,673 307,935 433,464
Amortization of deferred
compensation 102,263 167,965 308,703
Reduction of loan from
settlement agreement (20,000)
Accounts payable and
accrued liabilities
settled through the
issuance of common
stock and warrants 280,438 280,438
Fair value of warrants
and stock options issued 5,664,419 5,664,419
Discount on conversion
of bridge loans, accounts
payable and employee
deferred salaries into
common stock and warrants 573,348 573,348
Release of forfeiture
restrictions on common
stock owned by officers/
major stockholders 7,875,000 7,875,000
Changes in operating
assets and liabilities:
(Increase) decrease in -
Receivables 28,100 1,350 23,842
Prepaid expenses (143,238) 93,923 (49,315)
Other current assets (632) 1,708 (4,288)
Deposits (53,963) (53,963)
Increase (decrease) in -
Accounts payable 568,385 82,679 910,278
Accrued compensation
and related items 146,712 311,542 490,061
Accrued interest payable 1,250 115,642 99,813
Other accrued expenses 258,901 76,797 341,108
State income taxes payable 2,020 1,980 5,600
----------- ------------ ------------
Net cash used in operating
activities (2,832,263) (3,862,112) (6,806,061)
----------- ------------ ------------
</TABLE>
(continued)
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Statements of Cash Flows (continued)
Years Ended December 31, 1996 and 1997, and 1995 to Date
<TABLE>
<CAPTION>
1996 1997 1995 to Date
---- ---- ------------
<S> <C> <C> <C>
Increase (Decrease) in Cash (Note 1)
Cash flows from investing
activities:
Purchases of property
and equipment (790,152) (132,356) (1,003,518)
----------- ---------- -----------
Net cash used in investing
activities (790,152) (132,356) (1,003,518)
----------- ---------- -----------
Cash flows from financing
activities:
Proceeds from lease
financing 150,261 150,261
Proceeds from sale of
securities, net of
offering costs 251,975 1,953,380 5,354,495
Proceeds from advances
and bridge loans -
Related parties 200,000 844,000 1,329,987
Unrelated parties 1,315,000 1,315,000
Repayments of advances -
Related parties (104,000) (104,000)
Unrelated parties (105,000) (105,000)
Payments on capitalized
lease obligations (40,150) (93,596) (133,746)
----------- ---------- -----------
Net cash provided by
financing activities 411,825 3,960,045 7,806,997
----------- ---------- -----------
Cash and cash equivalents:
Net decrease (3,210,590) (34,423) (2,582)
At beginning of period 3,297,908 87,318 55,477
----------- ---------- -----------
At end of period $ 87,318 $ 52,895 $ 52,895
----------- ---------- -----------
----------- ---------- -----------
Supplemental disclosure of
cash flow information:
Cash paid for -
Interest $ 12,627 $ 27,364 $ 90,603
State income taxes 1,756 6,443 8,999
</TABLE>
(continued)
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Consolidated Statements of Cash Flows (continued)
Years Ended December 31, 1996 and 1997, and 1995 to Date
<TABLE>
<CAPTION>
1996 1997 1995 to Date
---- ---- ------------
<S> <C> <C> <C>
(Note 1)
Non-cash investing and
financing activities:
Equipment acquired under
capital leases $ 267,180 $ $ 267,180
Reduction of loan from
settlement agreement 20,000
Additions to deferred
compensation 128,250 417,825
Advances and bridge loans,
including accrued
interest, converted
into common stock and
warrants -
Related parties 632,500 732,500
Unrelated parties 1,046,500 1,541,500
Conversion of accounts
payable and accrued
compensation into
common stock 61,438 61,438
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
You Bet International, Inc. and Subsidiaries
(a Development Stage Company)
Notes to Consolidated Financial Statements
Years Ended December 31, 1996 and 1997, and 1995 to Date
1. Organization and Basis of Presentation
Principles of Consolidation -
The consolidated financial statements include the accounts of You Bet
International, Inc., a Delaware corporation, its wholly-owned subsidiary, You
Bet!, Inc., a Delaware corporation, and Middleware Telecom Corporation, a
California corporation and a wholly-owned subsidiary of You Bet!, Inc.
(collectively, the "Company"). All intercompany accounts and transactions have
been eliminated in consolidation.
Business -
Since mid-1995, the Company has been engaged in developing PC-based proprietary
communications software technology to be utilized by consumers for online
entertainment purposes. The Company's first service to be offered to consumers
is The You Bet Racing Network, a horse racing network to be broadcast over the
Company's secure private network.
Development Stage -
As of December 31, 1997, the Company is considered to be a development stage
entity, as it had not realized any revenues from planned principal operations.
During 1995, the Company shifted its business strategy by de-emphasizing
consulting services and software licensing, as a result of which the Company
became a development stage company. Accordingly, the Company has provided
cumulative consolidated statements of operations, consolidated statements of
stockholders' equity (deficiency) and consolidated statements of cash flows for
the period from January 1, 1995 through December 31, 1997.
Organization -
Continental Embassy Acquisition, Inc. ("CEA") was organized in the State of
Utah in 1987 for the purpose of raising capital and acquiring a suitable
business opportunity through a merger with, or acquisition of, a private
business enterprise seeking to obtain the perceived benefits of being a
publicly-owned company. On December 6, 1995, CEA acquired 100% of the
outstanding capital stock of You Bet!, Inc., a Delaware corporation, in
exchange for the issuance of 5,800,000 shares of common stock, including
5,710,000 shares of common stock to two officers/major stockholders of the
Company (who were the founders of the Company's predecessor entity), their
nominees and a stockholder related to one of the officers. In conjunction
with the contemporaneous private placement of the Company's securities as
described at Note 5, 2,500,000 of the 5,710,000 shares were deemed subject to
forfeiture by the holders under certain conditions, also as described at Note
5. Concurrent with this
<PAGE>
transaction, CEA reincorporated in the State of Delaware and changed its name
to You Bet International, Inc., and the management of You Bet!, Inc. became
the management of You Bet International, Inc. For accounting purposes, the
acquisition of You Bet!, Inc. by You Bet International, Inc. has been treated
as a reverse acquisition of You Bet!, Inc. with You Bet!, Inc. considered the
acquiror. The operating results reflected in the accompanying financial
statements, where 1995 to Date amounts are presented, do not include CEA's
operating activities prior to the You Bet!, Inc. acquisition, as the amounts
are not significant.
Concurrent with this transaction, 100% of the capital stock of Middleware
Telecom Corporation was contributed by its stockholders, who were substantially
the same as the stockholders of You Bet!, Inc., to You Bet!, Inc. for no
additional consideration. The historical financial information presented
includes the combined financial statements of You Bet!, Inc. and Middleware
Telecom Corporation due to the common control, management and operations of the
companies. All intercompany transactions have been eliminated in consolidation.
Concurrent with this transaction, the Company also effected a 1 for 1.5 reverse
stock split of its common stock in December 1995. All references to shares and
per share amounts have been retroactively restated to reflect this reverse stock
split.
Going Concern -
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The Company has had recurring losses and has experienced
significant continuing liquidity problems since late 1996 that are expected to
continue until the Company is able to complete a long-term debt or equity
financing of substantial size and/or until significant operating revenues are
generated on an ongoing basis. The Company had a negative working capital of
$2,739,184 as of December 31, 1997. As a result, the Company's independent
certified public accountants have expressed substantial doubt about the
Company's ability to continue as a going concern.
In order to conserve working capital, the Company has reduced the number of
its employees, deferred compensation to certain of its senior officers and
other employees, deferred or delayed the payment of accounts payable, capital
lease obligations and bridge loans payable, and reduced operating expenses
and capital expenditures. As a result, the Company is in arrears with
respect to its payment obligations to certain lessors, creditors and a bridge
noteholder.
During 1997, the Company relied on the proceeds from short-term loans, primarily
from related parties, bridge loans from both related and unrelated parties, and
the private placement of its common stock and warrants, which aggregated
approximately $3,900,000, to fund its operating requirements. During the period
from January 1, 1998 through April 9, 1998, the Company received $1,520,000 of
bridge financing, $420,000 from the exercise of stock purchase warrants,
and $200,000 from related party advances to partially fund its estimated 1998
cash
<PAGE>
requirements of $7,000,000, which includes estimated discretionary costs
related to marketing and promotion activities of $2,000,000, research and
development activities of $800,000 and estimated capital expenditures of
$2,000,000. The Company is also exploring various other options to raise
additional operating capital during 1998.
The Company is dependent on the proceeds from the previously described financing
efforts for the continuation of its current testing and marketing efforts
related to The You Bet Racing Network, as well as for the continuation and
expansion of the Company's development activities and planned marketing efforts.
The Company expects that its cash on hand, combined with the funds that the
Company expects to raise from new debt and equity financings during the
remainder of 1998, will be sufficient to fund operating and capital expenditures
at least through December 1998. However, there can be no assurances that the
Company will be able to complete such financings on a timely basis and/or under
acceptable terms and conditions. To the extent that adequate working capital is
not available to fund the Company's operations, management will consider a
variety of alternatives, including seeking a joint venture partner, selling or
licensing its proprietary software technology, curtailing product development,
delaying the introduction, marketing and expansion of The You Bet Racing
Network, and reducing or suspending operations.
The Company's need for financing during 1998 and beyond will vary based upon a
number of factors, some of which are outside the control of the Company. These
factors include the scope of the Company's development and marketing efforts,
consumer reaction/acceptance and the development of operating revenues, the time
and cost to develop and commercialize additional applications, competition from
similar wagering systems and from competing interactive gaming/leisure time
systems and activities, and potential political and legal issues. In addition,
the Company's business plans may change based on changes in technology, new
developments in the marketplace or unforeseen events which could require the
Company to raise additional funds. The unavailability of additional funds under
acceptable terms and conditions when needed could have a material adverse effect
on the Company.
The consolidated financial statements do not include any adjustments that might
result from the outcome of these uncertainties.
2. Summary of Significant Accounting Policies
Software Development Costs -
Under the criteria set forth in Statement of Financial Accounting Standards No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed", capitalization of software development costs begins upon
the establishment of technological feasibility for the product and ceases when
the product is ready for sale or use. The establishment of technological
feasibility and the ongoing assessment of the recoverability of these costs
requires an evaluation by management with respect to certain external factors,
including, but not limited to, anticipated future gross product revenues,
estimated economic life, and changes in software and hardware technology. After
considering the above factors, the Company has
<PAGE>
determined that software development costs to date should properly be charged to
operations as research and development costs. Subsequent to year end,
management believes technological feasibility of the Company's proprietary
software technology had been established.
Property and Equipment -
Property and equipment are stated at cost. Equipment and furniture are
depreciated using the straight-line method over their estimated use life of
three to five years. Leasehold improvements are amortized over the term of the
lease.
Property and equipment are reviewed for impairment whenever events or
circumstances indicate that the asset's undiscounted expected cash flows are not
sufficient to recover its carrying amount. The Company measures impairment loss
by comparing the fair value of the asset to its carrying amount. Fair value of
an asset is calculated as the present value of expected future cash flows.
Impairment losses, if any, are recorded currently.
Income Taxes -
The Company accounts for income taxes utilizing the asset and liability
approach, which requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of temporary differences between the
basis of assets and liabilities for financial reporting purposes and tax
purposes.
Loss Per Share -
During 1997, the Company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share" (SFAS 128), which requires the presentation of basic
and diluted earnings per share. Basic earnings per share are calculated by
dividing net income (loss) by the weighted average number of common shares
outstanding during the period. Diluted earnings per share are calculated by
dividing net income (loss) by the basic shares and all dilutive securities,
including stock options, warrants and convertible notes, but does not include
the impact of potential common shares which would be antidilutive. These
dilutive securities were anti-dilutive in 1996 and 1997. No prior year earnings
per share amounts have been restated as a result of SFAS 128.
For the year ended December 31, 1997, potential dilutive securities
representing 1,121,433 outstanding stock options, 3,810,275 outstanding
common stock purchase warrants, and 345,000 convertible notes (and accrued
interest), are not included in the earnings per share calculation since their
effect would be antidilutive.
During the years ended December 31, 1996 and 1997, 2,500,000 shares of common
stock issued and outstanding to two officers/major stockholders and a
stockholder related to one of the officers were subject to forfeiture under
certain specified conditions as described at Note 5, and were excluded from the
calculation of net loss per share in 1996. The forfeiture provisions were
released effective December 31, 1997 pursuant to the transaction described at
Note 5.
Stock-Based Compensation -
<PAGE>
During 1996, the Company adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation", which establishes a fair value
method of accounting for stock-based compensation plans. The provisions of this
statement allow companies to either expense the estimated fair value of stock
options or to continue to follow the intrinsic value method set forth in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", but to disclose the pro forma effect on net income (loss) and net
income (loss) per share had the fair value of the stock options been expensed.
The Company has elected to continue to account for stock-based compensation
plans utilizing the intrinsic value method. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the fair market price of the
Company's stock at the date of grant above the amount an employee must pay to
acquire the stock.
In accordance with this statement, the Company has provided footnote disclosure
with respect to stock-based employee compensation. The cost of stock-based
employee compensation is measured at the grant date based on the value of the
award and is recognized over the service period. The value of the stock-based
award is determined using a pricing model whereby compensation cost is the
excess of the fair value of the award as determined by the pricing model at
grant date or other measurement date above the amount an employee must pay to
acquire the stock.
Use of Estimates -
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Reclassifications -
Certain prior period amounts have been reclassified to conform to the current
year presentation.
Fair Value of Financial Instruments -
The carrying value of the Company's financial instruments, consisting primarily
of accounts payable, notes payable and capitalized lease obligations,
approximates fair value due to the immediate or short-term maturity of these
financial instruments.
Recent Accounting Pronouncements -
In February 1997, the Financial Accounting Standards Board issued Statement No.
129, "Disclosure of Information about Capital Structure", which is effective for
financial statements issued for fiscal years ending after December 15, 1997.
The new standard reinstates various securities disclosure requirements
previously in effect under Accounting Principles Board Opinion No. 15, which has
been superseded
<PAGE>
by this statement. Adoption of this statement did not have an impact on the
Company's current disclosures and presentation.
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
"Reporting Comprehensive Income", which is effective for financial statements
issued for fiscal years beginning after December 15, 1997. This statement
establishes standards for the reporting and display of comprehensive income and
its components in a full set of general purpose financial statements.
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income refers to revenues, expenses, gains and losses that
under generally accepted accounting principles are included in comprehensive
income but are excluded from net income. Adoption of this statement is not
expected to have an impact on the Company's current disclosures and
presentation.
In June 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which is
effective for financial statements issued for fiscal years beginning after
December 15, 1997. This statement requires that public companies report certain
information about their major customers, operating segments, products and
services, and the geographic areas in which they operate. Adoption of this
statement is not expected to have an impact on the Company's current disclosures
and presentation.
3. Property and Equipment
Property and equipment consisted of the following at December 31, 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Computer equipment $ 636,872 $ 602,449
Office furniture and equipment 161,575 176,987
Leasehold improvements 62,428 63,534
Assets under capital leases (Note 6) 267,180 417,441
---------- ----------
1,128,055 1,260,411
Less: Accumulated depreciation
and amortization (115,242) (423,177)
---------- ----------
$1,012,813 $ 837,234
---------- ----------
---------- ----------
</TABLE>
At December 31, 1996 and 1997, depreciation and amortization included $17,812
and $131,352, respectively, related to assets under capital leases.
Advances and Bridge Loans Payable
Advances and bridge loans consisted of the following at December 31, 1996 and
1997:
<PAGE>
<TABLE>
<CAPTION>
Related Unrelated
Parties Parties
------- -------
<S> <C> <C>
Advances
- --------
Balance, December 31, 1995 $ $
Balance, December 31, 1996
Add: New loans 594,000 105,000
Less: Repayments (104,000) (105,000)
Converted into 1997
bridge financing (100,000)
--------- ----------
Balance, December 31, 1997 $ 390,000 $
--------- ----------
--------- ----------
Bridge Loans Payable
- --------------------
Balance, December 31, 1995 $ $
Add: New loans 200,000
--------- ----------
Balance, December 31, 1996 200,000
Add: New loans 250,000 1,210,000
Converted from advances 100,000
Less: Converted into common
stock and warrants (550,000) (910,000)
--------- ----------
Balance, December 31, 1997 $ $ 300,000
--------- ----------
--------- ----------
</TABLE>
Interest expense with respect to bridge loans payable aggregated $264,000 during
1997, including $82,500 to related parties. Additional financing cost was also
incurred during 1997 as a result of the issuance of an aggregate of 966,000
Series C common stock purchase warrants to the parties that provided unsecured
advances during 1997 and to the participants in the 1997 bridge financing,
including 456,000 warrants to related parties. As a result, the Company
recorded a charge to operations of $2,949,420 in 1997, including $1,504,580
allocable to related parties, as more fully described at Note 5.
Except for one bridge note payable of $50,000 which is currently due and
payable, the due date of the bridge loans has been extended to December 1998.
The bridge note investors are given the option to convert their bridge loans,
including accrued interest, into the lesser of units, which include 10,000
shares of common stock and 5,000 Series D warrants, at the rate of $18,750
per unit, or 75% of the next private placement offering price of an offering
over $5,000,000.
The bridge notes are secured by substantially all the assets of the Company.
Upon a successful public offering or private placement of $5,000,000 or more,
the Company must repay all outstanding bridge loans and accrued interest.
5. Stockholders' Equity (Deficiency)
<PAGE>
Issuance of Common Stock and Warrants -
Concurrent with the completion of the reverse merger discussed in Note 1, the
Company completed a private placement offering of securities to investors.
The Company sold 140 units at $25,000 per unit. Each unit consisted of
10,000 shares of common stock and 5,000 Series A common stock purchase
warrants exercisable at $5.25 per share and expiring two years from the date
on which a registration statement registering the warrants is declared
effective. Total offering costs of $575,860 were charged against the gross
proceeds of $3,725,000, resulting in net proceeds of $3,149,140. As a result
of the sale of 149 units under this private placement offering in 1995, the
Company issued a total of 1,490,000 shares of common stock and 745,000 Series
A common stock purchase warrants.
The Company issued 200,000 shares of common stock and Series B common stock
purchase warrants representing the right to purchase 417,188 shares of common
stock as commission to the placement agent of the private placement offering,
which were valued at $500,000. The Series B common stock purchase warrants
are exercisable at $3.12 and expire on December 6, 1998.
In conjunction with the closing of the reverse merger and private placement
offering in 1995, bridge loans payable aggregating $250,000 were exchanged for
10 units of common stock and Series A common stock purchase warrants, and
advances aggregating $345,000, including $100,000 from a related party, were
exchanged for 13.8 units of common stock and Series A common stock purchase
warrants. As a result of the issuance of 23.8 units, the Company issued an
aggregate of 238,000 shares of common stock and 119,000 Series A common stock
purchase warrants, including 40,000 shares and 20,000 Series A common stock
purchase warrants to a related party.
During 1996, the Company sold an additional 21.2 units as part of the private
placement offering commenced during 1995. Total offering costs of $278,025
were charged against the gross proceeds of $530,000, resulting in net
proceeds of $251,975. As a result of the sale of 21.2 units under this
private placement offering in 1996, the Company issued a total of 212,000
shares of common stock and 106,000 Series A common stock purchase warrants.
During November 1997, the Company reduced the exercise price of the Series A
common stock purchase warrants from $5.25 to $2.50 per share.
During November 1997, the Company completed a private placement offering of
securities to investors. The Company sold 89.78 units at $25,000 per unit.
Each unit consisted of 10,000 shares of common stock and 5,000 Series D common
stock purchase warrants exercisable at $5.25 and expiring November 1999. Total
offering costs of $291,020 were charged against the gross proceeds of
$2,244,400, resulting in net proceeds of $1,953,380. As a result of the sale of
89.78 units under this private placement in 1997, the Company issued a total of
897,760 shares of common stock and 448,880 Series D common stock purchase
warrants.
In conjunction with the closing of the private placement offering, bridge loans
payable aggregating $1,679,000, representing a principal
<PAGE>
balance of $1,460,000 and accrued interest of $219,000, were exchanged for 89.55
units of common stock and Series D common stock purchase warrants. Included in
the $1,679,000 was $632,500, representing a principal balance of $550,000 and
accrued interest of $82,500, from related parties. As a result of the issuance
of 89.55 units in 1997, the Company issued 895,468 shares of common stock and
447,734 Series D common stock purchase warrants, including 337,335 shares of
common stock and 168,667 Series D common stock purchase warrants to related
parties.
As part of the consideration for making the bridge loans, the Company agreed at
the time the bridge loans were funded to give the bridge investors the option to
convert their bridge loans, including accrued interest, into the subsequent
private placement securities at the lesser of $25,000 per unit or 75% of the
private placement offering price. Accordingly, the Company recognized a charge
to operations, with a corresponding credit to additional paid-in capital,
representing the aggregate discount of $559,667, including $210,834 allocable to
related parties. As a result, bridge investors exchanged their bridge loans for
units offered in the private placement at the rate of $18,750 per unit,
equivalent to a 25% discount from the $25,000 private placement price.
In conjunction with the 1997 private placement offering, the Company issued
690,275 Series E common stock purchase warrants to finders exercisable at $3.125
per share through November 2000. The Series E common stock purchase warrants
had an aggregate fair value of $1,891,354.
During 1997, amounts due to vendors aggregating $40,000 and deferred employee
compensation aggregating $21,438 were exchanged for 2.74 units of common stock
and Series D common stock purchase warrants. As a result of the issuance of
2.74 units, the Company issued 27,433 shares of common stock and 13,717 Series D
common stock purchase warrants. The employees exchanged their deferred
compensation for common stock and warrants at the same rate as did the bridge
investors, and the vendors received a premium to exchange their debt for common
stock and warrants. As a result, the Company also recognized a charge to
operations, with a corresponding credit to additional paid-in capital, for
$13,681.
Divestment Shares -
In conjunction with the December 1995 reverse merger, a total of 5,800,000
shares of common stock were issued, including 5,710,000 shares of common stock
to two officers/major stockholders of the Company (who were also the founders of
the Company's predecessor entity), their nominees and a stockholder related to
one of the officers. In conjunction with the contemporaneous 1995 private
placement offering, 2,500,000 of the 5,710,000 shares were subject to forfeiture
under certain conditions if the Company did not achieve certain customer
subscription levels within a specified timeframe through December 5, 1999 (the
"Divestment Shares"). The Company's original short-term goal, established in
1995, was to maximize customer subscription levels. However, as a result of a
change in the Company's marketing strategy during 1997, the Company has decided
to de-emphasize its original short-term goal in order to focus on certain
long-term
<PAGE>
goals. The Company's revised marketing strategy is focused on building a brand
name and becoming a market leader, acquiring and retaining a large and loyal
customer base, and maximizing long-term profitability. Accordingly, effective
December 31, 1997, the Board of Directors authorized the release of the
forfeiture restrictions on the 2,500,000 shares of common stock in exchange for
the return of 750,000 shares to the Company.
The release from the possibility of forfeiture with respect to the Divestment
Shares is recorded for accounting purposes as the payment of compensation to the
recipients when the possibility of forfeiture terminates, and results in a
charge to operations in an amount equal to the fair market value of the
Divestment Shares retained at the time such forfeiture possibility terminates.
Accordingly, the Company recognized a charge to operations, with a corresponding
credit to additional paid-in capital, of $7,875,000 at December 31, 1997,
reflecting the release from the possibility of forfeiture on the remaining
1,750,000 shares at the fair market value of $4.50 per share.
Stock Options and Warrants -
The Company issued various stock options and warrants during 1997 in non-capital
raising transactions for services rendered and to be rendered, and as financing
costs. The Company accounts for stock options and warrants granted to
non-employees in accordance with Statement of Financial Accounting Standards No.
123, which requires non-cash compensation expense be recognized over the
expected period of benefit. The Company has calculated the fair value of such
warrants and stock options according to the Black-Scholes pricing model
utilizing the following weighted average assumptions: risk free interest rate -
6.75%; dividend yield - 0%; expected volatility - 83.4%; expected life - 5
years. The resulting amount has been recorded as a charge to deferred
compensation, with a corresponding credit to additional paid-in capital.
Deferred compensation is being amortized on the straight-line basis over the
period in which the Company expects to receive benefit.
The Company issued a warrant to an officer of a subsidiary to purchase
100,000 shares of common stock at an exercise price of $3.00, exercisable
through October 31, 1998, partially in exchange for an accrued but unpaid
bonus. Aggregate fair value was $210,000, which was charged to operations in
1997.
The Company issued various stock options and warrants to certain consultants to
purchase an aggregate of 394,000 shares of common stock at exercise prices
ranging from $2.50 to $3.12 and exercisable for periods ranging from one to five
years. Aggregate fair value was $720,680, of which $359,421 was charged to
operations in 1997, and the remaining $361,259 will be charged to operations in
1998 and 1999.
Pursuant to a letter of intent dated May 11, 1997 and a final agreement
entered into December 19, 1997, the Company issued a financial and marketing
consulting firm warrants to purchase 1,000,000 shares of common stock
exercisable for a period of 5.5 years, 500,000 of which are exercisable at
$3.125 per share and 500,000 of which are exercisable at $5.25 per share, for
services rendered and to be rendered for the two year period commencing May
11, 1997. In addition, the Company issued a
<PAGE>
bonus to such firm during December 1997 in the form of additional 500,000
warrants exercisable for a period of 5 years, 250,000 of which are
exercisable at $3.125 per share and 250,000 of which are exercisable at $5.25
per share. Aggregate fair value of the 1,000,000 warrants was $1,218,000, of
which $389,084 was charged to operations in 1997, and the remaining $828,916
will be charged to operations through 1999. Aggregate fair market value of
the 500,000 warrants issued as a bonus was $1,037,750, all of which was
charged to operations in 1997.
The Company issued an aggregate of 1,114,217 Series C common stock purchase
warrants to various parties as financing costs. The Series C common stock
purchase warrants are exercisable at $2.50 per share through December 31, 2002.
Employees deferring a portion of their compensation received 5,717 warrants,
vendors deferring amounts due them received 142,500 warrants, individuals
providing short-term unsecured advances to the Company received 262,000 warrants
(including 236,000 warrants to related parties), and bridge investors received
704,000 warrants (including 220,000 warrants to related parties). Aggregate
fair market value of the warrants was $3,656,202 (including $1,504,580 allocable
to related parties), all of which was charged to operations in 1997.
Information with respect to common stock purchase warrants and stock options
issued, excluding stock options issued under the 1995 Stock Option Plans as
described below, is summarized as follows:
<TABLE>
<CAPTION>
Weighted
Warrants Exercise Price
-------- --------------
<S> <C> <C>
Warrants/stock options issued 1,281,188 $2.70
---------
Balance, December 31, 1995 1,281,188 2.70
Warrants/stock options issued 106,000 2.50
---------
Balance, December 31, 1996 1,387,188 2.69
Warrants/stock options issued 4,708,823 3.70
---------
Balance, December 31, 1997 6,096,011 $3.47
---------
---------
Warrants/stock options
exercisable (vested)
at December 31, 1997 5,192,869 $3.39
---------
---------
</TABLE>
Stock Option Plans -
In November 1995, the Company's Board of Directors approved the 1995 Stock
Option Plan and the 1995 Stock Option Plan for Non-Employee Directors
(collectively, the "1995 Plans"). The 1995 Plans provide for the granting of
awards of incentive stock options, non-qualified stock options, and stock
appreciation rights. The aggregate number of shares of common stock available
for issuance under the 1995 Plans is 15% of the total number of shares of common
stock outstanding. The options
<PAGE>
generally vest in four equal annual installments, and have a term of ten years.
During 1995 and 1996, deferred compensation of $289,575 and $128,250 was
recorded as a result of the issuance of stock options being granted with
exercise prices less than the current market price, and is being amortized on
the straight-line basis over the vesting period of the stock options. Deferred
compensation charged to operations was $38,475 in 1995, $102,263 in 1996 and
$167,965 in 1997.
During 1997, the Company issued a stock option to the non-employee director
under the 1995 Plans to purchase 5,000 shares of common stock at an exercise
price of $2.75 per share, exercisable for a period of ten years. Aggregate fair
value was $9,083, of which $1,811 was charged to operations in 1997, and the
remaining $7,272 will be charged to operations in 1998 through 2001.
During 1997, the Company issued stock options to certain consultants under the
1995 Plans to purchase an aggregate of 3,773 shares of common stock at exercise
prices ranging from $3.00 to $3.88 and exercisable for a period of ten years.
Aggregate fair value was $10,151, all of which was charged to operations in
1997.
Information with respect to activity under the 1995 Plans is summarized as
follows:
<TABLE>
<CAPTION>
Weighted
Stock Options Exercise Price
------------- --------------
<S> <C> <C>
Options granted 755,000 $2.50
Options terminated (111,500) 2.50
---------
Balance, December 31, 1995 643,500 2.50
Options granted 469,914 2.60
Options terminated (87,050) 2.50
---------
Balance, December 31, 1996 1,026,364 2.55
Options granted 246,735 3.06
Options terminated (151,666) 2.70
---------
Balance, December 31, 1997 1,121,433 $2.64
---------
---------
Options exercisable (vested)
at December 31, 1997 642,858 $2.61
---------
---------
</TABLE>
The Company accounts for stock options issued to officers and employees
under Accounting Principles Board Opinion No. 25, under which no compensation
cost is recognized. Options granted to outside directors are accounted for in
accordance with Statement of Financial Accounting Standards No. 123. If
compensation expense for stock options issued to officers and employees had been
determined based upon the fair value at the grant date consistent with the
methodology prescribed under Statement of Financial Accounting Standards No.
123, the net loss and
<PAGE>
basic loss per share would have been as shown below. The fair value of stock
options granted under the Company's 1995 Plans was estimated on the date of
grant using the Black-Scholes option pricing model using the following weighted
average assumptions:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Expected life in years 5 5
Risk free interest rate 5.7% 6.75%
Dividend yield 0% 0%
Expected volatility 100% 83.4%
</TABLE>
The weighted average fair value at the date of grant for stock options and
warrants granted during 1996 and 1997 was $2.61 per option in 1996 and $2.12 per
option and $2.31 per warrant in 1997.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1997
---- ----
<S> <C> <C>
Net loss
As reported $(3,864,734) $(19,416,838)
Pro forma $(4,138,734) $(20,015,044)
Net loss per share
As reported $(0.67) $(3.06)
Pro forma $(0.72) $(3.15)
</TABLE>
The effect of applying Statement of Financial Accounting Standards No. 123 in
this pro forma disclosure is not necessarily indicative of future results.
No stock options or warrants had been exercised at December 31, 1997.
6. Capital and Operating Leases
During the year ended December 31, 1996, the Company acquired $267,180 of
equipment under capital leases. During the year ended December 31, 1997, the
Company financed $150,261 of equipment through a capital lease transaction. The
capitalized lease obligation of $283,695 at December 31, 1997 (excluding the
interest portion of $45,556), has been classified as a current liability in the
accompanying consolidated financial statements. The Company is in arrears with
respect to certain of its payment obligations to lessors. An
officer/stockholder has guaranteed a portion of these obligations.
The Company leases its executive and operating offices under an operating lease
which expires on March 31, 1998, and which was subsequently extended through
September 30, 1998. Rent expense under this lease was $89,928 and $106,269 for
the years ended December 31, 1996 and 1997, respectively.
<PAGE>
7. Commitments and Contingencies
The Company has entered into employment agreements with its two senior officers
requiring aggregate base annual compensation of $250,000 through December 1999.
The Company entered into a five year license agreement with a service provider
in March 1996 which requires the payment of certain license fees based on usage
levels and product sales, with a minimum monthly payment of $5,000.
The Company entered into a network services agreement with a service provider in
May 1997 which will require a minimum monthly fee of $10,000 beginning in
mid-1998, and increasing to $25,000 per month as the Company's operations
expand.
The Company entered into a five year agreement with a service provider in
September 1997 which requires the payment of certain license fees based on usage
levels and product sales.
From time to time, the Company is involved in litigation arising in the ordinary
course of business. In the opinion of management, the ultimate disposition of
these matters will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
8. Income Taxes
The Company has recorded a provision for current state income taxes in the
accompanying consolidated financial statements. At December 31, 1997, the
Company has available Federal and State net operating loss carryforwards of
approximately $8,825,000 and $8,679,000, respectively, for income tax purposes,
which expire in varying amounts through 2012 for Federal and 2002 for State
purposes.
The net operating loss carryforward generated a deferred tax asset of
approximately $5,124,000 as of December 31, 1997. The deferred tax asset has
not been recognized since it is more likely than not that it will not be
realized. Accordingly, a 100% valuation allowance has been provided.
9. Related Party Transactions
The non-employee member of the Board of Directors is paid a consulting fee of
$2,400 per month.
Additional related party transactions are described at Note 5.
10. Fourth Quarter Transactions and Adjustments
During the fourth quarter of the fiscal year ended December 31, 1997, the
Company recorded adjustments to reflect the fair value of various stock options
and warrants issued for services rendered as a charge to operations; such
amounts aggregated $344,362 for services rendered and
<PAGE>
$1,376,207 for financing costs. The Company recorded a charge to operations of
$7,875,000 to reflect the release of forfeiture provisions on certain shares of
common stock owned by two officers/major stockholders and a stockholder related
to one of the officers. The Company recorded a charge to operations of $573,348
to reflect a discount on conversion of bridge loans, accounts payable and
employee deferred salaries into common stock and warrants. These transactions
are more fully described at Note 5.
11. Subsequent Event
In January 1998, the Company commenced a bridge financing. Each unit consists
of a secured note with interest at 12%, and will be convertible, at the option
of the holder, into a subsequent private placement at the lower of $2.75 per
unit or 80% of the private placement price. The bridge notes are secured by
substantially all the assets of the Company. As of April 9, 1998, the Company
had raised $1,520,000 under this financing.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Audited
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1997, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 52895
<SECURITIES> 0
<RECEIVABLES> 6158
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 112656
<PP&E> 1260411
<DEPRECIATION> 423177
<TOTAL-ASSETS> 1003853
<CURRENT-LIABILITIES> 2851840
<BONDS> 0
0
0
<COMMON> 9604
<OTHER-SE> (1857591)
<TOTAL-LIABILITY-AND-EQUITY> 1003853
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 390471
<INCOME-PRETAX> (19407194)
<INCOME-TAX> 9644
<INCOME-CONTINUING> (19416838)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (19416838)
<EPS-PRIMARY> (3.06)
<EPS-DILUTED> (3.06)
</TABLE>
