ITEM 1: BUSINESS
THE COMPANY
You Bet International, Inc. (the "Registrant" and together with its consolidated subsidiaries, the "Company"), is a provider of entertainment technology and services. The Company believes that the proliferation of multimedia personal computers (PCs), the advancement of technologies for data compression and the production of sophisticated interactive software have spurred a demand in the market for interactive entertainment products. The Company plans to focus on services that require access to live events and databases interactively. The Company's principal executive offices are located at 1950 Sawtelle Boulevard, Suite 180, Los Angeles, CA 90025, and its telephone number at that address is 310-444-3300.
RECENT DEVELOPMENTS
1. Liquidity Problems As of April 6, 1997, the Company had cash and cash equivalents of approximately $270,000 and short term obligations of approximately $2,636,000. The short term payables include $975,000 in bridge notes (See 1996 offerings) which may be converted into common stock at the note holders option. Accordingly, the Company is experiencing certain liquidity problems that are expected to continue until the Company completes some form of additional financing. The Company has commenced discussions with a number of investment banking, venture capital and other financial enterprises regarding obtaining additional financing. The Company believes that its current resources will enable it to operate at current expenditure levels through June, 1997. If a financing is not completed at that date, the Company will have to significantly curtail its planned testing of You Bet, the Company's first product, which is contemplated for May 1997, and other planned expansion activities. In any event, it is not likely that the Company will be able to finance its contemplated operations beyond the next six months with out obtaining significant financing, at which time the Company may be forced to cease all ongoing development and marketing operations. No assurance can be given that the Company will be able to find such financing, that such financing, if available, will be on terms acceptable to the Company. See "Management's Discussion and Analysis and Results of Operations-Liquidity and Capital Resources".
2. Introduction of First Product
In January 1997, after completing the construction of the first product and software and installing necessary processes and procedures to administer the product, the Company entered Alpha testing. The Company also scheduled approvals with the New York Racing and Wagering Board and the New York State Tax Department. These approvals are necessary for the product certification.
The Company anticipates entering the limited release of approximately 400 users in the second quarter of 1997. During the limited release, the entire service functionality will be operational to test and validate the system with live bets. Consumers will not be charged for on-line time or for information purchases during the limited release. Based on testing throughout the limited release, the Company will schedule a national roll-out where it will begin to charge subscription fees, on-line time and information purchases. This is anticipated for the third quarter of 1997.
THE COMPANY'S INITIAL SERVICE
The Company's first application - The You Bet! Racing Network (YBRN) - will enable subscribers to gather a substantial amount of information on horse racing events, witness the events live, and transmit wagering data on the events to licensed account wagering entities, by accessing the Company's private computer network. The proprietary software developed by the Company gives the experienced handicapper and novice an all inclusive package, through a computer based network for the horse racing experience which include: (FLP)
o Real time audio and video feeds from multiple tracks
o Immediate transmission of wagering information from a PC to a licensed account wagering facility
o Complete historical and race day information
o Live odds and results
o Convenient account management
(1)
- ----------------- (1) Forward Looking Statements. The symbols "FLS" and "FLP" refer to a "forward looking statement" or "forward looking paragraph". The information contained herein is subject to various risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated in such forward looking statements or paragraphs. Included among the important risks, uncertainties and other factors are those hereinafter discussed.
The business of the Company is dependent upon successful deployment of the Company's initial product You Bet! 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 product, the Company will be subject to other related risks, such as delays (or failures) in transmission of data, under-capacity and 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.
Secondly, the Company will be largely dependent upon negotiating agreements with third parties, including various track and information providers. Those third parties will have different business objectives than those of the Company. Unless the Company and such third parties are able to compromise their respective objectives in a manner that is mutually acceptable, agreements and arrangements will not be consummated.
Assuming the Company's product can be developed as anticipated, the Company will need additional capital to market the product. The Company's need for additional capital will be dependent
The Company developed The You Bet! Racing Network to satisfy a perceived market need in the horseracing industry because of the following:
o The market is substantial - $14.7 billion domestically and $100 billion internationally.
o The wagering trend is to off track sources such as the YBRN. Wagering on domestic horse racing wagering, has continued to grow principally because of the explosive growth from off-track sources. From 1993 to 1995, the estimated percentage of off-track betting has grown from 44.7% to 68.3% of all domestic wagers placed ($10 billion in 1995).
o Horse racing wagering data is currently being transmitted from interstate account holders to account wagering entities from five states via telephone lines. Those entities use that information to place wagers from the account holders' balance into the wager pools of the host tracks. The current systems in place do not enable account holders to experience the race or interactively access data or the account wagering facility from one source. (See Business Guide - Government Regulation; Legality)
o The Company's experience in horse racing (See Company History).
The Company believes that its You Bet! Racing Network will be well received in the horse racing industry: (FLP)
o The fan has a more convenient way to experience horse races.
o The licensed account wagering facility will benefit from more account holders and activity. They will also benefit from streamlining the transmission of the wagering process.
- ------------------ 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 unavailability of additional funds when needed could have a material adverse affect on the Company. The availability of debt and or equity financing, as well as financing from joint venture sources, is affected by, among other things, world wide 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.
Finally, the Company's software will be affected by the changing and dynamic nature involving 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 which 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 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 affect on the Company's ability to effectively deploy its products and compete in the marketplace.
o The host tracks (tracks where the races are run) receive increased wagering activity as a result of their races reaching fans from outside their geographic area.
o The horse racing industry benefits from increased access and promotion of their sport.
o State governments will receive increased tax revenues through increased purses.
The Company believes that the convenience and availability of off-track sources has had a major impact on the industry. The ability to transmit wagering data to licensed wagering facilities by using a customer's personal computer from home, office or elsewhere would extend this trend and accelerate the industry's growth. The Company intends to enter this market with its computer network service and derive revenue from subscription fees, on-line time charges, data delivery charges, and fees from the account wagering facility for the transmission of the wagering data (FLP)
STAGE OF DEVELOPMENT
The Company has entered into an agreement with the New York Racing Association to introduce a limited release of its proprietary service beginning in May, 1997. The Company expects the limited release will be in effect until July 1997 when a national release of the service is planned (FLP).
STRATEGIC PARTNERSHIPS
Account Wagering Entity
The New York Racing Association operates three of the top six race tracks in the United States, offers full-cards simulcasting to "witness" the event, and already has an established, legal interstate telephone account wagering system.
Data Provider
The Company has entered into a five-year agreement with Equibase, of the premier horse racing data providers to receive a copy of the official thoroughbred database. This agreement will enable the Company to provide customers, via their PC, with remote access to critical racing information and statistics including handicapping information, last minute odds, jockey substitution, weather conditions and live audio/video of the races. (FLP)
Private Network Provider
The Company has also entered into a partnership with a major data network provider, which will allow bettors using the Company's private network to transmit confidently wagering data at the last minute with more efficiency than the current phone wagering process where last minute bets are subject to operator error or busy signals. Wagering results will also be transmitted through the system and the licensed wagering facility automatically debiting or crediting the bettor's pre-established, existing account based upon the success of the wager.
COMPETITIVE ADVANTAGES & BARRIERS TO ENTRY
Proprietary Technologies
The Company has developed a number of proprietary software technologies that provide key competitive advantages and barriers to entry including, but not limited to:
(i) A national multicast network allowing for reliable and economical delivery of audio, video, and information updates to a virtually unlimited audience. (FLP)
(ii) Open architecture capable of providing multi-currency and multi-lingual games including horse racing and other high-level participation games (i.e. use with international sporting events). (FLP)
(iii) A distributed high speed transaction platform capable of handling the extreme peak loads of interactive wagering. (FLP)
(iv) Proprietary security technologies and techniques. (FLP)
Totalisator System
The totalisator system consists of a complex computer software and hardware that calculates wagering odds, facilities infield scorebroads 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 (with PC Totes see Company History) in all aspects of developing, deploying, and running totalisator systems provides a key competitive advantage and barrier to entry (FLP).
MARKETING AND SALES
It is management's belief that the introduction, availability and ease of use of its computer network service will create a meaningful opportunity to attract a significant portion of the existing horse racing market and to reach out to many new potential customers. Initially, the Company intends to target U.S. handicappers who already use a computer for racing information. The Company believes this market segment alone is sufficient to generate positive cash flow. Moreover, the Company intends to develop vigorously the use of its computer network service in international markets as well by utilizing the Company's favorable affiliations with individuals and organizations familiar with such markets.(FLP)
The You Bet! Racing Network (YBRN) has two principal target markets: existing handicappers and individuals with access to a personal computer and modem. The
Company's marketing to existing handicappers is expected to focus on YBRN providing convenient, current and more detailed information than that available from traditional sources. The other target market is those individuals who otherwise have access to PC/Modems but have not previously exhibited a substantial interest in racing. The Company will attempt to interest PC users on the basis of the intellectual and financial challenge of either simulated betting or actual betting. Both of these groups consists of large populations of individuals with generally high levels of discretionary income, and the former group has evidenced serious interest in wagering and gaming. (FLP)
Although these groups can be reached through traditional print and broadcast means, the Company plans to employ a strategy that leverages the low cost and wide reach of on-line services and the Internet. The Company plans to allow free access to YBRN software on-line for download.(FLP)
COMPANY HISTORY
On December 6, 1995, the Company (which concurrently changed its name to You Bet International, Inc. and which was formerly known as Continental Embassy Acquisition, Inc. ("CEA")) completed the acquisition (the "Acquisition") of You Bet! Inc. ("YBI", which was formerly known as PC Totes, Inc.) a privately held Delaware corporation. The Acquisition was completed concurrently with the closing of a private placement of securities of YBI.
Upon the consummation of the Acquisition, the shareholders of MiddleWare Telecom Corporation, a California corporation ("MTC"), who were also the principal shareholders of YBI, contributed the stock of MTC to YBI without additional consideration.
At the time of the Acquisition, YBI had been offering (and the Company, as successor, continued to offer) securities in private placements to accredited investors and in offshore transactions to persons who were not U.S. persons. Gross proceeds to the Company from the combined offering, which continued into 1996, were approximately $4.8 million, including approximately $650,000 which was in the form of the cancellation of certain indebtedness. The remaining proceeds have been used by the Company for expenses related to the merger with a public company and the costs of the private placement, product development and other general corporate purposes.
YBI has over eight years of experience developing computer-based wagering systems. In 1987, YBI developed a personal computer ("PC") 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 system is currently in use at several racetracks in the Far East. Through the implementation of this horse and dog racing pari-mutuel wagering system, YBI was one of the first companies worldwide to employ PC based technology in a real-time, transaction processing environment.
COMPETITION
Numerous Internet and other interactive gaming ventures have been announced over the past several months. The Company expects to compete with these entities, as well as other established gaming companies which may engage in computer-based gaming activities. Competition on the Internet with companies providing entertainment activities, as well as competition with interactive gaming, is and is expected to continue to be intense. (FLS) The Company's competitors range from small companies with limited resources to large companies with greater financial, technical and marketing resources than those of the Company. The Company considers its principal competitors in the interactive pari-mutuel gaming market to be ODS and IWN, among others.
o ODS is developing an in-home pari-mutuel wagering system that requires an ODS television set-top box and interactive technology. The system is currently being tested in Kentucky.
o IWN is a division of NTN Communication, a publicly traded company that provides interactive trivia entertainment in sports bars, hotels, and other hospitality environments. IWN has announced that it will release an in-home pari-mutuel wagering system based on PCs in 1996. Until recently, YBI was the technology development partner of IWN, providing all technical expertise and manpower. IWN and YBI signed a Separation and Settlement agreement, providing IWN with what management believes is an early and incomplete version of the PC client software. IWN has no rights or access to YBI's interactive host technology. In addition, YBI retained all personnel involved in the development of the interactive wagering products and devices and has since gone on to develop the second generation client software.
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. Companies with greater financial resources than the Company may be able to carry larger inventories, undertake more extensive marketing campaigns, invest more in the development of production technology and communication networks, adopt more aggressive pricing policies and make higher offers or guarantees than the Company. In addition, the Company believes that potential new competitors, including large software companies, media companies, and gaming companies, are increasing their focus on the interactive software market and network connectivity. 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. (FLP)
GOVERNMENT REGULATION; LEGALITY
The gaming industry, which is subject to extensive statutory and regulatory control by both state and federal agencies, 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 facilities are used by subscribers to place intrastate or interstate wagers or the Company receives commissions in respect thereof, such 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 products and services.
Currently, all 50 states 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 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 (i) the intrastate or interstate activities the Company proposes or hopes to engage in with respect to actual wagering, or (ii) the type of activities (initially pari-mutuel horse racing) associated therewith. Any change in either the substance or the enforcement of the applicable rules and regulations in these areas could have a material effect on the Company's business and prospects.
The Company has been advised by counsel that it can legally provide the facilities through which subscribers communicate interstate wagers in the five states that allow interstate telephone account wagering (30% of the domestic market) and the other states that allow parimutuel wagering subject to state and local requirements. 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, the Company might be considered to be engaged in the gaming business. The Company will not actually be placing or accepting any wagers. The Company will transmit the wagering data on behalf of the subscriber to the licensed account wagering facilities with which the Company has appropriate contractual relationships. These facilities will take the data to make a wager from the subscriber's account with that facility. The results will be transmitted to the subscriber through the YBRN and the transfer of funds into and out of the subscribers account will be performed by the licensed account wagering facilities. Although the Company intends to obtain indemnification from each such account wagering entities, no assurance can be given that such indemnification will be available or, if obtained, that such provisions will be enforceable or adequate from a financial standpoint.
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) that it is such counsel's opinion that, although not necessarily free from 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, determines with a high degree of confidence that although the matter is not necessarily free from 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 as to which it has not received a legal opinion that the activities are permitted under applicable law, the possibility of violation of applicable law is enhanced. In addition, the uncertain application of existing laws to interactive gaming and the lack of applicable precedents suggest that legal opinions in this field may be qualified on the basis that the matters expressed therein 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 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 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 obtain the approvals necessary to market in such territories.
EMPLOYEES
As of March 31, 1996, the Company engaged thirty-six employees and two consultants. Of the employees, six are administrative or support personnel. The Company believes that its relationship with its employees is good. Additional employees will be hired to help maintain and operate the You Bet Racing Network and to market to the consumer and horse racing industry.
ITEM 2:
ITEM 2: PROPERTIES
In February, 1996, the Company entered into a lease for 7,779 square feet of space in an office building located at 1950 Sawtelle Boulevard in Los Angeles, California, which houses the Company's executive offices. The lease is for a 26 month term, expiring March 31, 1998, with expenses per month of $7,688. The Company prepaid the $193,220 aggregate lease payments. The Company believes that this property is adequate for its present purposes.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
The Company is not party to any legal proceedings.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Pursuant to Section 228 of the General Corporation Law of the State of Delaware, the Company adopted the following resolutions:
The Company had adopted two stock option plans, the 1995 Stock Option Plan (the "Employee Plan") and the 1995 Stock Option Plan for Non-Employee Directors (the "Non-Employee Directors Plan") (the "Employee Plan and the Non-Employee Directors Plans are referred to as the "Plans");
The Company amended such Plans so that (i) the Employee Plan shall relate to the grant of option equaling 13.5% of the Company's outstanding Common Stock and (ii) the Non Employee Directors Plan relates to the grant of options equaling 1.5% of the Company's Common Stock.
There were 5,007,950 (60.4%) votes cast in favor of these resolutions.
PART II
ITEM 5:
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
a. Stock: The Company's Common Stock has been traded on the electronic bulletin board under the symbol "UBET". The following table sets forth for the periods shown, the high and low bid prices as reported by NASDAQ. The bid prices reflect interdealer prices without retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions. Prior to the Acquisition, the Company's stock traded irregularly. Since the Acquisition, the limited number of shares of free trading stock may have impacted the market for the Company's shares.
On April 6, 1997 the closing bid price for the Common Stock was $3.00 and the closing asked price was $3.50 per share. The approximate number of holders of record of Common Stock on that date was 206.
The Company has never paid a dividend on its Common Stock and presently intends to retain all earnings for use in its business.
b. Warrants: Registrant issued and sold 970,000 Series A Warrants, and 517,188 Series B Warrants (collectively, the "Warrants") in connection with the Acquisition and the concurrent and subsequent placement by the Company of its securities to accredited and offshore investors. Each of the Series A and Series B Warrants is exercisable for one share of Common Stock. There is currently no public market for the Warrants. The Series A Warrants are exercisable for shares of Common Stock at a price of $5.25 per share, and expire on the earlier of (a) two years from the later of (i) the date of issuance of the last Series A Warrant to be issued or (ii) the date of effectiveness of a registration statement under the Securities Act covering the issuance and sale of the shares of Common Stock upon issuable exercise of such Warrants or resale of such shares by the holder, which period shall be extended day-for-day for any time that a prospectus meeting the requirements of the Securities Act is not available, or (b) the date specified in a notice of redemption from the Registrant (subject to the prior right of the holder to exercise the Warrants for at least 30 trading days following the date of such notice), which notice can only be given if the closing price of the Common Stock for the twenty consecutive trading days preceding such notice exceeds $7.50 per share and a current prospectus covering the underlying shares is then available and the Company has a good faith belief that it will remain available during said period of at least 30 trading days. A Series A Warrant may not be exercised during the first year following issuance, and the Company may not call the Series A Warrants for redemption during the 15 months immediately following the initial issuance of Series A Warrants or while any Series A Warrant may not be exercised. The Series B Warrants are substantially similar to the Series A Warrants, except that (i) the Series B Warrants are exercisable for shares of Common Stock at a price of $3.125 per share; (ii) the Series B Warrants expire three years after they are first issued, and (iii) the Company may not call the Series B Warrants for redemption.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
Selected historical financial data presented below as of and for the three years ended December 31, 1996 have been derived from the audited consolidated financial statements of the Company. The following financial information should be read in conjunction with Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and the Consolidated Financial Statements of the Company and the notes thereto, included in Item 8.
SUMMARY OF SELECTED FINANCIAL DATA (in thousands except per share)
YEAR ENDED DECEMBER 31,
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Registrant has for the past year, used its resources to focus on developing its product software, computer network service and establishing alliances inside of horse racing. The Company's computer network service is ready for deployment, key partnerships have been established and the product is scheduled for beta testing in May 1997. However the Company is currently experiencing cash flow difficulties, which has impacted the ability of the Company to implement its business plan.
In September 1996, the Company announced its intention to seek, on a best efforts basis, up to $4,500,000 through a private placement of Regulation D Units, to "accredited investors", as defined in Rule 501 of Regulation D, and the concurrent offering of the Regulation S Units to persons other than "U.S. persons", as defined in Regulation S promulgated under the Securities Act of 1933, as amended (the "Securities Act"). Each Regulation S Unit and Regulation D Unit were priced at $22,500 per share and were to consist of 5,000 shares of the Company's common stock.
The Company, having been unable to complete the above described placement, that it was terminated the Offering around December 5, 1996. Since that time, the Company has been offering to accredited investors (the "Bridge Offering") certain Bridge Units, each such Bridge Unit consisting of $50,000 principal amount of 15% Secured Convertible Notes (the "15% Notes"or "Bridge Notes") and 20,000 Common Stock Purchase Warrants (the "Warrants"). As of April 6, the Company has been able to effectuate the sale of $975,000 principal amount of Bridge Units. (see Liquidity and Capital Resource section).
Management believes that the historical financial information relating to the Company is not indicative of the operations of the Company in the future for the following reasons:
o In 1994 and 1995, the Company has pursued most of its ongoing business activity through consulting projects relating to on-line marketing and wagering. It is not anticipated that consulting assignments will be sought or significant consulting revenue will be received in the current year or subsequent periods.
o In mid-1995 and fiscal year 1996 the Company focused exclusively on the research and development of The You Bet! Racing Network and the recruitment of key employees.
o It is anticipated that future years (1997 and beyond) that costs associated with providing the service will be much more significant with relation to development costs (FLS).
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995.
Revenues decreased $144,000 from $152,000 in 1995 to $8,000 in 1996 as a result of the cessation of consulting business in 1995 and the focus on the development of The You Bet! Racing Network.
Expenses increased $3,378,000 to $3,931,000 in 1996 from $553,000 in 1995 as the Company continued its development efforts on the product and the virtual private network, recruited and hired the management, horse racing, and technical teams, and attracted strategic partners. The components of the increase in expenses were payroll and consulting expense of $1,898,000 as the management, horse racing, and technical teams were hired, other product and network development costs of $311,000, marketing costs of $228,000 to promote the product and the Company, and increased general and administrative costs of $941,000 associated with the increased number of employees and legal, accounting and other expenses related to failed September 1996 private placement offering.
Interest income increased $64,000 from $14,000 in 1995 to $78,000 in 1996 primarily from the short-term deployment of funds raised from the Company's private placement in late 1995.
Interest expense decreased $19,000 to $15,000 in 1996 from $34,000 in 1995, primarily resulting from a decrease in short-term borrowings.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994.
Revenues declined $36,000 to $152,000 in 1995 from $186,000 for 1994 as a result of the cessation of consulting business in the fourth quarter of 1995 in connection with the Company's decision to focus exclusively on the research and development of The You Bet! Racing Network. During 1995, the Company signed a termination agreement with its principal consulting customer.
Operating expenses increased $444,000 to $553,000 in 1995 from $109,000 in 1994 because of costs incurred in developing The You Bet! Racing Network. The components of the increase were payroll and consulting expense of $279,000 as more programmers and development personnel were added, other development costs of $69,000, marketing costs of $68,000 to promote the product and the Company, and increased general and administrative costs of $28,000 associated with the increased number of employees.
Interest income of approximately $14,000 was earned in 1995, primarily from the short term deployment of funds raised from the Company's private placement in late 1995. The Company did not earn any interest income in 1994.
Interest expense increased approximately $10,000 to $34,000 in 1995 from $24,000 in 1994, primarily resulting from an increase in short-term borrowings.
LIQUIDITY AND CAPITAL RESOURCES
Current Cash Position
The Company is currently experiencing certain liquidity problems that are expected to continue until the Company completes some form of long term financing. In response to this situation, the Company has reduced the number of its employees, agreed to defer compensation to certain of its senior officers, and otherwise reduced operating and capital expenditures. The Company has $270,000 in cash and cash equivalents and $2,636,000 of short-term payables as of April 6, 1997. The short term payables include $975,000 in bridge notes (See 1996 offerings) which may be converted into common stock at the note holders option.
The Company is dependent upon the proceeds of long term financing (see 1997 offering) for the continuation of its current testing and marketing efforts relating to The You Bet! Racing Network (YBRN) software and for the continuation and expansion of the Company's development activities and planned marketing expenditures. If adequate funds are not available to satisfy short-term or long-term requirements, management will be required to consider a variety of other options including seeking joint venture partners, selling or licensing all or a portion of its proprietary technology, curtailing product development and delaying the roll-out of its first product, as well as other cost cutting actions, including suspending all or a portion of its activities.
The Company expects that the cash on hand coupled with the cash to be raised from the new private placement (see 1997 offering), assuming it will be successful, will be sufficient for operating expenses and capital expenditures through at least June 1998. No assurance can be given that the Company will be successful in raising additional funds. If the Company is not successful in raising this additional financing, management will be required to consider a variety of other options including seeking joint venture partners, selling or licensing all or a portion of its proprietary technology, curtailing product development and delaying the roll-out of its first product, as well as other cost cutting actions, including suspending all or a portion of its activities. (FLS)
The Company's need for capital (beyond that contemplated in the anticipated private placement) during the next year or more will vary based upon a number of factors, including the rate at which demand for products expands, the level of sales and marketing activities for its products, and the level of effort needed to develop and commercialize additional applications. In addition, the Company's business plans may change or unforeseen events may occur which require the Company to raise additional funds. Additional funds may not
be available on terms acceptable to the Company when the Company needs such funds. The unavailability of additional funds when needed could have a material adverse effect on the Company. (FLP)
1996 Offerings
In September 1996, the Company announced its intention to seek, on a best efforts basis, up to $4,500,000 through a private placement of Regulation D Units, to "accredited investors", as defined in Rule 501 of Regulation D, and the concurrent offering of the Regulation S Units to persons other than "U.S. persons", as defined in Regulation S promulgated under the Securities Act of 1933, as amended (the "Securities Act"). Each Regulation S Unit and Regulation D Unit were priced at $22,500 per share and were to consist of 5,000 shares of the Company's common stock. The Company having been unable to complete the above described placement, terminated the Offering in December 1996.
Since that time, the Company has been offering to accredited investors (the "Bridge Offering") certain Bridge Units, each such Bridge Unit consisting of $50,000 principal amount of 15% Secured Convertible Notes (the "15% Notes"or "Bridge Notes") and 20,000 Common Stock Purchase Warrants (the "Warrants"). No minimum subscription is required and the Company intends to accept any qualified subscriptions. The principal amount of, and interest on, the 15% Notes shall be due and payable on the earlier to occur of (i) a public or private financing raising in excess of $5,000,000 of net cash proceeds to the Company (ii) the first anniversary of the Initial Closing Date, and shall be secured by substantially all of the assets of the Company. Each Warrant (the "Bridge Warrants") entitles the holder thereof to acquire one share (each such share, a "Warrant Share") of Common Stock at the exercise price per share of $2.50 during the period commencing two business days following the effective date (the "Effective Date") of the registration statement relating to a sale of the Company's securities.
The Company has been able to continue operations on a limited basis by deferring salaries, delaying payable payments and funding from the bridge facility. To date, the Company has been able to effectuate the sale of $975,000 principal amount of Bridge Units.
1997 Offering
On March 17, 1997 the Company initiated a private placement where the Company is seeking to raise up to $10,000,000 in gross proceeds before deduction of expected placement fees and expenses, through a private placement of Units to persons who are not U.S. persons, as defined in Regulation S, in offshore transactions, as defined in Regulation S (the "Offering").
Concurrently, the Company is also seeking to offer in the United States identical Units as is offered for this Offering for the same Unit price of $25,000 per Unit, each Unit consisting of 10,000 Shares of the Company's $.001 par Common Stock and 5,000 callable Series D Warrants, each Warrant allowing its holder to purchase a Share of Common Stock for $5.25 per Share for a period of up to two years from the date of issue (the "Domestic Offering"). The
concurrent Domestic Offering in the United States will only be to accredited investors as defined in Rule 501 of Regulation D promulgated under the Securities Act. In no event, however, will the aggregate amount of subscriptions for this Offering and for the Domestic Offering be accepted for an amount in excess of the maximum $10,000,000 (4,000,000 Shares of Common Stock and 2,000,000 Series D Warrants) amount of this Offering (without regard for the Over-Allotment option).
The Company intends to have an initial closing ("Initial Closing") of this Offering under this Private Placement Memorandum when an aggregate of at least 240 Units have been subscribed for at an aggregate price of at least $6,000,000. See "Description of Securities" herein for a more detailed description of the Shares and Warrants included in the Units. After such Initial Closing, the Offering may continue with the intent of raising up to an aggregate of $10,000,000 from the sale of up to an aggregate of 400 Units, not including any Over-Allotment amount, from either the Domestic Offering and/or this Offering.
The net proceeds available for use by the Company from the sale of the Units being offered hereby will vary depending on the number of Units sold. If only the minimum aggregate number of Units is sold, the net cash proceeds to the Company are estimated to be $5,275,000 after deducting the placement fee and expenses estimated at an aggregate of $725,0000. If the maximum aggregate number of Units is sold, the net cash proceeds to the Company are estimated to be $9,100,000 after deducting the placement fee and expenses estimated at an aggregate of $900,000. The net proceeds are expected to be used for the final stage development of the You Bet! Racing Network software; Private Network installation, expansion and usage; marketing activities such as service launch, customer acquisition, website creation and maintenance, and promotional programs for frequent users, repay short-term loans; certification for the product software and service; new accounting and management software; and for general corporate purposes.
The private placement documents requires David Marshall to transfer the present job functions of the Company's CEO and President positions when a suitable candidate with appropriate experience can be recruited. (See Item 10 - Management)
1996 Use of Cash
During the year ended December 31, 1996, the Company's cash position decreased $3.2 million to $87,000 compared to $3.3 million at December 31, 1995. In December 1995, the Company closed a portion of a private offering, issuing 1,290,000 shares and warrants to purchase an additional 645,000 shares of Common Stock at an exercise price of $5.25 and receiving net proceeds of approximately $3.0 million after payments of commissions and other offering expenses. The private placement offering generated an additional $950,000 after commissions and expenses in 1996 from the issuance of 650,000 additional shares and warrants to purchase 325,000 additional shares of Common Stock. Substantially all of the Company's then existing indebtedness (aggregating $650,000) was retired.
Net cash used by operating activities totaled $2,843,000 during 1996, which was used for continued development efforts on the product and the virtual private network, recruitment
and employment of the management, horse racing, and technical teams, costs incurred to attract strategic partners. In addition, the Company incurred increased legal, accounting and other expenses related to failed September 1996 private placement offering.
Cash flows used in investing activities totaled $780,000 for capital expenditures principally for the test and production environment and the virtual private network.
The Company has entered into a capital lease that provides for a $100,000 sale and leaseback of equipment previously purchased by the Company and a $150,000 line for new equipment purchases in the third quarter 1996. The lease terms are 30 month, 20% security deposit of which 1/3 is returned after each year with an effective interest rate of approximately 15% per annum.
The Company also entered into a capital lease that provides a $160,000 line for new equipment purchases in the first quarter 1997. The lease terms are 36 month, with no security deposits and an effective interest rate of approximately 15% per annum.
ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Index to Financial Statements of the Company is included in Item 14.
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
At a board meeting on January 15, 1996 the Board of Directors of the Company (the "Board") authorized the Company's executive officers to engage new auditors for the fiscal year ended December 31, 1995. As of February 28, 1996 the Company engaged the accounting firm of Deloitte & Touche LLP as independent accountants for the Company for the fiscal year ended December 31, 1995. The firm of Robinson, Hill & Co. (sometimes referred to herein as "Prior Firm") was replaced because the Prior Firm was located in Salt Lake City and the Company has moved its offices to Los Angeles, California after its December 6, 1995 Acquisition of YBI. The Board's decision to retain Deloitte & Touche LLP was based primarily on its national reputation, partner availability and familiarity with the Company's general business in the computer software industry. During the fiscal year ended December 31, 1994 and the interim period beginning January 1, 1995 through February 28, 1996 there were no disagreements with the Prior Firm on matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure.
PART III
ITEM 10:
ITEM 10: DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT; COMPLIANCE WITH 16(A) OF THE EXCHANGE ACT
DAVID MARSHALL, CEO AND PRESIDENT
Marshall was the CEO and co-founder of PC-Totes, Inc. (PC-Totes) and MiddleWare Telecom Corporation (MTC), both of which now comprise You Bet!, Inc. In 1987, PC-Totes developed the world's first fault tolerant, PC based computer totalisator system that is now used to operate wagering at horse and dog racing tracks in Thailand, Malaysia, Guam and other countries in the Pacific Rim. Presently, while Marshall intends to remain an active officer of the Company, he also intends to transfer the present job functions of the
Company's CEO and President positions when a suitable candidate with appropriate experience can be recruited. When such replacement occurs, Marshall intends to focus his efforts on strategic matters and pursuing appropriate joint ventures.
RUSSELL FINE, EXECUTIVE VICE-PRESIDENT AND CHIEF TECHNOLOGY OFFICER
Fine was the Chief Technology Officer and co-founder of MiddleWare Telecom Corporation (MTC) and Vice-President of Research and Development at PC-Totes Inc. (PC-Totes). Fine has been instrumental in ensuring the exceptional success of these companies within the interactive system development industry. For example, at PC-Totes, he spearheaded the innovative design and overall development of one of the world's high-speed, fault tolerant, real-time transaction processing systems to use PC technology. Similarly, while at MTC, Fine designed and managed the development of interactive wagering software, including the development of real-time metering and billing systems, data translation software and multimedia CD-ROM content development.
RON LUNIEWSKI, CHIEF OPERATIONS OFFICER
Luniewski comes to You Bet! from EDS where he has more than 11 years of experience directing large software development efforts. Most recently, Luniewski was VP of GM Marketing & Advertising, and was responsible for providing information technology and consulting services to his GM clients. This included the development and implementation of the largest integrated Internet project in the world.
BARRY PETERS, CHIEF FINANCIAL OFFICER
Peters is a senior financial executive with experience in start-ups, interactive service companies, and large multinational corporations. Peters was previously employed as Chief Financial Officer/Senior Vice President of Interactive Cable Systems (ICS Communications). He was a founding member of ICS's executive team. At ICS, he started a company that pioneered providing cable television, telephone and security services to apartment building residents. The Company's market capitalization grew from $4 to $250 million, and revenue from $1 million to $20 million in less than two years. Previously, Peters started his interactive career at Spectradyne where he was Financial Director of field operations, responsible for 400 employees. Prior to Spectradyne, Peters was responsible for reviews of United Technologies international joint ventures - specifically in the Pacific Rim
STEVE MOLNAR, EXECUTIVE VICE-PRESIDENT, RACING
Molnar held the positions of Director of Marketing, and then President and Chief Operations Officer of McKinnie Systems. Under his leadership, McKinnie Systems implemented a nationwide licensing system based on Smart Card technology. The company also became the number one computer software supplier to racetracks throughout North America.
JEFF FRANKLIN, EXECUTIVE DIRECTOR/RACING PRODUCT DEVELOPMENT
Previously in his role as jockey agent, Franklin has represented such icons as Gary Stevens, Patrick Valenzuela and Jose Santos, winning more than fifteen riding titles throughout the country. In addition, he helped build and develop some of racing's most successful stables. Brookside Farms (owned by Allen E. Paulson) received the prestigious Eclipse Award as the country's leading breeder during Jeff Franklin's term as racing manager.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
The Summary Compensation Table below includes, for each fiscal year ended December 31, 1996 and 1995 individual compensation for services to the Company and its subsidiaries of the President and Executive Vice President (the "Named Officers").
SUMMARY COMPENSATION TABLE
OPTION GRANTS IN LAST FISCAL YEAR
SHOWN BELOW IS INFORMATION ON GRANTS OF STOCK OPTIONS PURSUANT TO THE 1995 STOCK OPTION PLAN DURING THE FISCAL YEAR ENDED DECEMBER 31, 1996 TO THE OFFICERS WHICH ARE LISTED IN THE SUMMARY COMPENSATION TABLE ABOVE.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZED VALUE AT ASSIGNED ANNUAL RATES OF STOCK PRICE
DIRECTOR COMPENSATION
Directors holding salaried positions with the Company do not receive compensation for their services as directors. It is the intention of the Company that each non-employee director will receive options to purchase 5,000 shares per year, retroactive to each year of service rendered by such director. See "Item 13 - Certain Transactions" for a discussion of consulting fees paid to Jess Rifkind, a director of the Company.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company does not currently have a compensation committee. The Board of Directors has designated David Marshall and Russell Fine to serve as the members of the Stock Option Committee for purposes of administering the 1995 Employee Stock Option Plan, including designating participants and the amounts of the awards thereto. Messrs. Marshall and Fine are ineligible to receive awards under this Plan. The compensation paid to Messrs. Marshall and Fine was approved by Mr. Rifkind, the sole outside director.
EMPLOYMENT AGREEMENTS AND STOCK OPTIONS
Employment Agreements:
Messrs. Marshall and Fine are parties to employment agreements providing for terms of four years commencing as of December 6, 1995. The 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 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 of Control" (as defined below) of the Company, each of Mr. Marshall and Mr. Fine shall have the right, but not the obligation, to consider such event to be a termination of his employment agreement. In such event, neither Mr. Marshall nor Mr. Fine shall have a duty, either express or implied, to mitigate any damages under his agreement, and the Company shall remain liable for all compensation (whether salary, bonus or other benefits) provided for under the terms of the agreements. Moreover, any compensation earned by either Messrs. Marshall or Fine in any capacity after the date of such termination will not reduce or mitigate the amounts payable by the Company under the applicable agreement. For purposes of their employment agreements, "Change of Control" shall mean (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 stock of such surviving entity.
Option Plans
In August 1996, the Company's Board of Directors approved, and recommended for adoption by the shareholders, an amendment to the You Bet 1995 Stock Option Plan (the "Employee Plan") and the 1995 Stock Option Plan for Non-Employee Directors (the "Non-Employee Directors Plan" and together with the Employee Plan, the "1995 Plans"). The number of shares available to the employee plan was formerly limited to 12% of the aggregate amount of shares of Common Stock of the Company then outstanding and the director plan was formerly limited to 3% of the aggregate amount of shares of Common Stock of the Company then outstanding. These percentages were adjusted to relect 13.5% for the employees and 1.5% for the directors.
As of April 6, 1997, options to purchase 1,022,614 shares of Common Stock were outstanding under the 1995 Plans, of which 176,735 are vested. The options vest ratably over four years. Common Stock purchased upon the exercise of such options are subject to restrictions which prohibit the resale of such Shares for a 24 month period commencing from the issuance of the options.
The following summary is qualified in its entirety by reference to the full text of the 1995 Plans. Unless otherwise indicated, the summary is applicable to each plan.
The 1995 Plans. The 1995 Plans provide for the granting of awards of incentive stock options ("ISOs") within the meaning of Section 422 of the Code, Nonqualified stock options ("NSOs"), and stock appreciation rights ("SARs") (awards of ISOs, NSOs, and SARs sometimes hereinafter collectively referred to herein as "Awards"). 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 issued and outstanding from time to time.
Purpose. The purpose of the 1995 Plans is to provide key employees, officers (other than Messrs. Marshall and Fine) and directors with an additional incentive to promote the success of the Company's business and to encourage employees to remain in the employ of the Company.
Administration -- Employee Plan. The Employee Plan is administered by a committee (the Employee Plan Committee"), which consists of at least two directors of the Company appointed by the Board. The members of the Employee Plan Committee are not eligible to receive Options except pursuant to a formula contained in the Non-Employee Directors Plan and must be "disinterested persons" as defined in Rule 16b-3(d)(3) promulgated under the Securities Exchange Act of 1934, as amended (the "1934 Act"). The aggregate number of shares of Stock that may be granted to non-employee members of the Board pursuant to the Plan may not exceed 13.5% of the aggregate amount of shares of Common Stock of the Company then outstanding.
Administration -- Non-Employee Directors Plan. The Plan is administered by a committee (the "Non-Employee Plan Committee") of not less than two persons, appointed by the Board and serving at the pleasure of the Board. However, the Non-Employee Plan Committee has no discretion as to the issuance of Options under this Plan. Directors initially will receive options to purchase 10,000 shares when first elected to the Board. On the day after (i) the 1996 annual stockholders' meeting of the Company and on the day after each annual stockholders' meeting of the Company thereafter during the term of the Plan or (ii) if there shall be no annual meeting during the preceding thirteen months, on June 30 of such year, each non-employee member of the Board shall be granted a Non-Qualified Stock Option to purchase 5,000 shares of Common Stock. The option price per share of Common Stock purchasable under such Stock Options shall be 100% of the fair market value on the date of grant. Such options shall be exercisable immediately on the date of grant by payment in full of the purchase price in cash. The aggregate number of shares of Stock that may be granted to non-employee members of the Board pursuant to the Plan may not exceed 1.5% of the aggregate amount of shares of Common Stock of the Company then outstanding.
Incentive Stock Options. The Employee Plan authorizes the Employee Plan Committee to grant ISOs to any key employee of the Company or any affiliate of the Company and to determine the terms and conditions of each grant, including without limitation, the number of shares subject to each ISO. The ISO exercise price would also be determined by the Committee and would not be less than the fair market value of the Common Stock on the date of grant. The exercise price would not be less than 110% of such fair market value and the exercise period would not exceed five years if the recipient of such ISO was the holder of more than 10% of the Company's outstanding voting securities.
Nonqualified Stock Options. The Employee Plan provides that the Employee Plan Committee has the authority to grant NSOs to any key employee of the Company or its affiliates. The Committee is authorized to grant NSOs to any qualified participant and to determine the terms and conditions of each such grant, including the number of shares subject to each NSO, the option period and the option exercise price. The exercise price for
NSOs would not be less than the fair market value of the shares subject to the NSO on the date of grant.
The Manner of Exercise. The exercise price for options granted under the 1995 Plans may be paid in cash or shares of Common Stock, including shares of Common Stock which the Plan participants received upon the exercise of one or more options provided that, with respect to the exercise of ISOs, such shares, if acquired through the exercise of an option, have been held by such participant for a period not shorter than the later of two years from the date the option was granted and one year after the shares of Common Stock were acquired by the participant through the exercise of options.
The option exercise price may also be paid by the participant's delivery of an election directing the Company to withhold shares of Common Stock from the Common Stock otherwise due upon exercise of the option.
Vesting. Unless the Employee Plan Committee establishes a different vesting schedule at the time of grant, awards under the Employee Plan will vest ratably over 4 years.
Nontransferability. Awards are not transferable other than by will or the laws of descent and distribution. During a participant's lifetime, his options may be exercised only by the participant.
Discretionary Awards. It is not possible to state the amount of discretionary awards that will be received by any of the participants under the Employee Plan since the grant of awards are within the discretion of the Committee.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of Common Stock as of April 6, 1997. The table shows the beneficial ownership of each person known to the Company who beneficially own more than 5% of the shares of the Company's Common Stock, each current director, and all directors and officers as a group. Except as otherwise indicated, the Company believes that the beneficial owners of the Common Stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable.
(1) Includes 1,156,250 Divestment Shares (as hereinafter defined) for each of Messrs. D. Marshall and R. Fine. If the Divestment Shares are all forfeited, Messrs. D. Marshall and Fine would own 16.42% and 16.22% respectively.
(2) Includes 187,500 Divestment Shares for the Marshall Gift Trust. If the Divestment Shares are all forfeited, Marshall Gift Trust would own 2.91%.
(3) Does not include Shares held by the Marshall Gift Trust, of which Mr. Sid Marshall is co-trustee. See Note 2 and related information.
(4) The options held by Messrs. Luniewski and Peters are not exercisable during 1996.
(5) Includes currently exercisable options to acquire 10,000 shares at $ 2.50 a share, as well as 10,000 shares owned by Mr. Rifkind and 10,000 shares owned by his wife.
(6) Based upon 8,283,333 shares of Common Stock, which were outstanding as of July 26, 1996.
* The address for Messrs. D. Marshall, R. Fine, Luniewski and Peters is c/o the Company, 1950 Sawtelle Boulevard, Suite 180, Los Angeles, California 90025. The address for Trafina Privatbank is Rennweg 50 CH-4020 Basel, Switzerland. The address for Sid Marshall and the Marshall Gift Trust is 11770-M Pacific Coast Highway, Malibu, CA. 90265. The address for Jess Rifkind is 5227 Bianca Avenue, Encino, California 91316.
** Less than 1%
DIVESTMENT SHARES
Upon completion of the Offerings, David Marshall and Russell Fine, who are respectively the President and Executive Vice President of the Company, own, in the aggregate 5,007,950 shares of the Company's common stock. Of this amount, 2,312,500 shares of Company Common Stock owned by such shareholders, plus 187,500 shares of Common Stock owned by Marshall Gift Trust (collectively, the "Divestment Shares") are subject to forfeiture and cancellation by the Company if certain conditions are not satisfied. Forfeiture of the Divestment Shares will occur if either the Company does not achieve the subscription levels indicated below or the market price of the Company's Common Stock does not exceed $5.25 per share. The possibility of forfeiture will terminate, regardless of the share price or the level of subscriptions, upon a sale of substantially all of the assets of the Company, or upon a merger or other business combination involving the Company, provided either (i) such transaction has been approved by holders of a majority of the outstanding shares of the Company which are not owned by beneficial holders of Divestment Shares and their affiliates or (ii) the consideration to be received by the holders of Company Common Stock shall be in the form of cash or marketable securities (valued as of the date of the shareholder vote with respect thereto) having a value of not less than $7.50 per share of Common Stock.
Divestment Shares will no longer be subject to the risk of forfeiture according to the following schedule, assuming the market price condition is satisfied:
Forfeiture Schedule
2,500,000 shares subject to forfeiture Based on subscribers
The termination of the possibility of forfeiture with respect to the Divestment Shares will be deemed to be the payment of compensation to the recipients and will result in a charge to the earnings of the Company in the year or years the possibility of forfeiture terminates, in an amount equal to the fair market value of the Divestment Shares at the time such possibility terminates. This charge to earnings, if required, could have a substantial negative impact on the earnings of the Company in the year or years in which the compensation
expense is recognized and could adversely affect the Company's qualifications for listing on various securities exchanges. In no event, however, may the possibility of forfeiture terminate unless the then current trading price for the Company's common stock exceeds $5.25 per share, provided that the market price condition may be satisfied within six months after the expiration of the time frame indicated above with respect to the relevant subscription level. The market price requirement for the Divestment Shares will be satisfied when the closing price for Common Stock on the principal national securities exchange on which it is then listed, or if not so listed, the mean between the highest closing bid and lowest closing asked prices, exceeds $5.25 for twenty consecutive trading days after the relevant subscriber level is achieved and maintained.
The effect of the charge to earnings associated with the termination of the possibility of forfeiture with respect to the Divestment Shares could place the Company in a net loss position for the relevant year. Moreover, there is no assurance that the operations of the Company will be profitable either in the year or years in which possibility of forfeiture of the Divestment Shares terminates or in any prior or subsequent periods. The management of the Company may have the discretion to accelerate or defer or otherwise influence certain transactions that could affect the number of subscribers. For purposes of the foregoing, a person utilizing the Company's products will be considered a "subscriber" only if such person is paying for such subscription at bona fide commercial rates approved by a majority of the Company's independent directors.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Jess Rifkind, who is a non-employee director, receives $2,400 per month from the Company as consulting fees.
See "Item- 12: Security Ownership of Certain Beneficial Owners and Management" for a discussion of the Divestment Shares currently owed by Messrs. Marshall and Fine.
PART IV
ITEM 14:
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this annual report:
1. FINANCIAL STATEMENT SCHEDULES:
NONE REQUIRED.
2. FINANCIAL STATEMENTS:
THE FINANCIAL STATEMENTS LISTED IN THE ACCOMPANYING INDEX TO FINANCIAL STATEMENTS ARE FILED AS PART OF THIS ANNUAL REPORT.
3. EXHIBITS:
THE EXHIBITS LISTED BELOW ARE FILED AS A PART OF THIS ANNUAL REPORT.
2.1 ACQUISITION AGREEMENT, DATED AS OF DECEMBER 6, 1995 BETWEEN THE COMPANY AND CEA ACQUISITION CORP. (1)
3.1 RESTATED ARTICLES OF INCORPORATION. (1)
3.2 BY-LAWS OF THE COMPANY. (1)
4.1 FORM OF SERIES A WARRANT AGREEMENT DATED AS OF DECEMBER 6, 1995 BETWEEN THE COMPANY AND U.S. STOCK OF TRANSFER CORP.(2)
10.1 EMPLOYMENT AGREEMENT, DATED AS OF DECEMBER 6, 1995, BETWEEN THE COMPANY AND DAVID MARSHALL. (2)
10.2 EMPLOYMENT AGREEMENT BETWEEN THE COMPANY AND RUSSELL FINE, DATED AS OF DECEMBER 6, 1995. (2)
10.3 LEASE BETWEEN THE COMPANY AND STORAGE TEK. (2)
10.4 1995 EMPLOYEES STOCK OPTION PLAN (2)
10.5 1995 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN (2)
21.1 LIST OF SUBSIDIARIES OF REGISTRANT (2)
(1) FILED AS EXHIBIT 1 TO FORM 10K, FILED AS OF JULY 26, 1996.
(2) INCLUDED HEREWITH.
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED IN THE CITY OF LOS ANGELES, STATE OF CALIFORNIA, ON THE 15TH day of April, 1997.
YOU BET INTERNATIONAL, INC. BY:___S/___________________
DAVID MARSHALL CHAIRMAN OF THE BOARD, PRESIDENT, AND CHIEF EXECUTIVE OFFICER
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of You Bet International, Inc. Los Angeles, California:
We have audited the accompanying consolidated balance sheets of You Bet International, Inc. and subsidiary (the "Company") as of December 31, 1996 and 1995 and the related consolidated statements of operations, shareholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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 financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of You Bet International, Inc. and subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 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 and current 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 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Los Angeles, California April 4, 1997
YOU BET INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995
See independent auditors' report and notes to consolidated financial statements.
YOU BET INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
See independent auditors' report and notes to consolidated financial statements.
YOU BET INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
See independent auditors' report and notes to consolidated financial statements.
YOU BET INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
See independent auditors' report and notes to consolidated financial statements.
YOU BET INTERNATIONAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (SEE INDEPENDENT AUDITORS' REPORT)
1. BUSINESS AND PRINCIPLES OF CONSOLIDATION
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of You Bet International, Inc., its wholly owned subsidiary, You Bet!, Inc. and Middleware Telecom, Inc., a wholly owned subsidiary of You Bet!, Inc. (collectively, the "Company"). All significant intercompany transactions have been eliminated in consolidation.
BUSINESS - The Company is an online communications company located in Los Angeles, California, that is developing interactive software and services for consumer use to be provided over its secure private network.
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 is currently experiencing certain liquidity problems that are expected to continue until the Company completes some form of long-term financing. In response to this situation, the Company has reduced the number of its employees, agreed to defer compensation to certain of its senior officers, and otherwise reduced operating and capital expenditures.
The Company is dependent upon the proceeds of long-term financing (see Note 10) for the continuation of its current testing and marketing efforts relating to The You Bet! Racing Network software and for the continuation and expansion of the Company's development activities and planned marketing expenditures. If adequate funds are not available to satisfy short-term or long-term requirements, management will be required to consider a variety of other options, including seeking joint venture partners, selling or licensing all or a portion of its proprietary technology, curtailing product development and delaying the roll-out of its first product, as well as other cost-cutting actions, including suspending all or a portion of its activities.
The Company expects that the cash on hand coupled with the cash to be raised from the new private placement (see Note 10), assuming it will be successful, will be sufficient for operating expenses and capital expenditures through at least June 1998. No assurance can be given that the Company will be successful in raising additional funds.
The Company's need for capital (beyond that contemplated in the anticipated private placement) during the next year or more will vary based upon a number of factors, including the rate at which demand for products expands, the level of sales and marketing activities for its products, and the level of effort needed to develop and commercialize additional applications. In addition, the Company's business plans may change or unforeseen events may occur which require the Company to raise additional funds. Additional funds may not be available on terms acceptable to the Company when the Company needs such funds. The unavailability of additional funds 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.
ACQUISITION - Continental Embassy Acquisition, Inc. ("CEA") was organized in the state of Utah in 1987 for the purpose of raising capital and acquiring any suitable assets, properties and businesses by means of completing a merger with, or acquisition of, any privately held business enterprises seeking to obtain the perceived advantages of being a publicly owned company. On December 6, 1995, CEA reorganized in the state of Delaware, renamed itself You Bet International, Inc. and completed the acquisition of the Delaware corporation, You Bet!, Inc. (the "Acquisition"). The Acquisition was completed through the issuance of 5,800,000 shares of CEA common stock in exchange for all of the outstanding shares of You Bet!, Inc. Concurrent with the Acquisition, CEA changed its name to You Bet International, Inc., and the management of You Bet!, Inc. became the management of the consolidated Company. The Acquisition has been reflected for accounting purposes as the acquisition of You Bet International, Inc. by You Bet!, Inc. (a reverse acquisition). The operating results reflected in the accompanying consolidated financial statements do not include CEA's operating activities prior to the Acquisition, as the amounts are not significant.
Concurrent with the Acquisition, the shareholders of Middleware Telecom, Inc. ("Middleware"), which are substantially the same as the shareholders of You Bet!, Inc., contributed their shares of Middleware to You Bet!, Inc. for no consideration. The historical financial information presented includes the combined financial statements of You Bet!, Inc. and Middleware due to the common control, management and operations of the companies. All intercompany transactions have been eliminated in the combination.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS - The Company considers all investments with original purchased maturities of three months or less to be cash equivalents.
SOFTWARE DEVELOPMENT COSTS - The Company's initial software development costs have been charged to operations as research prior to the commencement of a working model. Costs incurred subsequent to demonstrating technological feasibility will be capitalized and amortized over the estimated product life.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. Equipment and furniture are depreciated using the straight-line method over their estimated useful life of three to five years. Leasehold improvements are amortized over the term of the lease.
REVENUE RECOGNITION - Revenue is primarily derived from various software consulting agreements and is recognized upon rendering of services.
NET (LOSS) INCOME PER SHARE - Net (loss) income per share is computed using the weighted average common shares outstanding during the year and the dilutive effect of common share equivalents (stock options and warrants). For the years ended December 31, 1996 and 1995 the effect of common share equivalents was antidilutive. There were no common share equivalents in 1994. A total of 2,500,000 shares, which are subject to a divestiture of shares agreement (see Note 6), have been excluded from the earnings per share calculation in 1996 and 1995, as the amounts are antidilutive.
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.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company's financial instruments consist primarily of cash equivalents, accounts payable and capitalized lease obligations. The book values of the cash equivalents and accounts payable are representative of their fair value due to their short-term maturity. The book values of the capitalized lease obligations approximate fair value, as such leases were recently negotiated.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
4. CAPITALIZED LEASE OBLIGATIONS
In 1996, the Company entered into capitalized lease obligations for computer equipment in the amount of $267,000. The leases have been discounted at interest rates implicit in the leases of approximately 16%. At December 31, 1996, the leases mature as follows:
5. BRIDGE LOANS PAYABLE
In December 1996, the Company obtained bridge financing through a private placement in the amount of $200,000 from a shareholder. For each unit of bridge financing sold, the purchaser receives a note in the face amount of $50,000 and 20,000 warrants. The notes bear interest at the rate of 15% per annum, were convertible at the rate of $2.50 per share, and are convertible only if there is a current registration statement in effect for the shares underlying the notes. The notes are secured by substantially all of the assets of the Company and contain restrictive provisions on the Company's ability to pay dividends, change its line of business, enter into a merger or consolidation, or liquidate the business. Accrued interest on these notes at December 31, 1996 totaled $1,000.
The warrants issued in connection with this financing are exercisable at $2.50 per share (see Note 10) and expire five years from the date of grant. In addition, the warrants contain antidilutive provisions. Management believes the value of the warrants issued to be immaterial to the consolidated financial statements. The Company has agreed to register the warrants and conversion shares.
Subsequent to December 31, the Company obtained an additional $775,000 in bridge loans and in connection therewith issued 310,000 warrants.
6. COMMON STOCK
PRIVATE PLACEMENTS - Concurrent with the closing of the Acquisition in 1995 (see Note 1), the Company completed a private placement offering to new investors of 149 units for $25,000 per unit, each consisting of 10,000 shares of common stock, and Series A warrants to purchase 5,000 shares of the Company's common stock. A total of 1,490,000 shares and 745,000 Series A warrants were issued with proceeds totaling $3,730,000. The Series A warrants are exercisable at $5.25 per share and expire on the later of the second anniversary of the date of issuance or two years from the date on which a registration statement registering the warrants is declared effective. Total costs of the offering of $581,000 were charged against the proceeds. Included in cash at December 31, 1995 was $505,000 held in escrow pending the issuance of 200,000 of the total shares sold.
The Company issued 200,000 shares of its common stock and Series B warrants to purchase an additional 417,188 shares as commission to the underwriter of the 1995 offering. The Series B warrants are exercisable at $3.125 and expire December 6, 1998.
In 1996, the Company sold an additional 21 units with proceeds totaling $530,000. A total of 212,000 shares and 106,000 Series A warrants were issued. Offering costs incurred during 1996 of $278,000 were charged against the proceeds.
CONVERSION OF DEBT - Concurrent with the closing of the Acquisition (see Note 2), bridge financing in the amount of $250,000 was exchanged for 10 of the units offered in the private placement and 100,000 Series B warrants exercisable at $3.125 per share, and additional loans in the amount of $345,000 were exchanged for 138,000 shares of common stock.
STOCK OPTIONS 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, nonqualified 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 from time to time. The options vest in four equal installments. A total of 176,735 options have vested at December 31, 1996. Deferred compensation totaling $128,000 in 1996 and $289,000 in 1995 was recorded upon the issuance of the options granted at exercise prices less than current market value of the Company's common stock and is being amortized over the vesting period of the options.
Transactions under the 1995 Plans are as follows:
The weighted average fair values of the stock options during 1996 and 1995 were $2.61 and $2.50, respectively. The Company applies Accounting Principles Board Options No. 25 and related interpretations in accounting for its stock option plans. Accordingly, except as discussed above, no compensation costs have been recognized. Had compensation cost for the Company's Option Plan been determined based on the fair value at the grant dates for awards during 1996 and 1995 consistent with the method of Financial Accounting Standards Board Statement No. 123, the Company's net loss and loss per share for the years ended December 31, 1996 and 1995 would have been increased to the pro forma indicated below:
The fair value of options granted under the Company's 1995 Plans was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used: expected life of five years; risk free interest rate of 5.7%; and expected volatility of 100.0 %.
DIVESTITURE OF SHARES - A total of 2,500,000 of the issued shares of the Company, which are owned by two officers of the Company and a third shareholder, are subject to forfeiture by the shareholders and cancellation by the Company if certain conditions are not satisfied. Forfeiture of such divestment shares will occur if either the Company does not achieve certain subscriber levels or the Company's stock does not exceed $5.25 by certain target dates. These contingent shares are excluded from the calculation of weighted average shares outstanding in the accompanying financial statements and, upon termination of the forfeiture restrictions, will be reflected as compensation expense and the issuance of capital in the period the forfeiture restrictions are terminated.
7. COMMITMENTS
EMPLOYMENT AGREEMENTS - The Company has entered into employment agreements with two of its officers providing for base compensation totaling $250,000 per year through December 1999.
LEASE - Through December 31, 1995, the Company leased office space on a month-to-month basis. In January 1996, the Company entered into a lease for office space which expires in March 1998. The lease agreement required the Company to prepay the entire lease. The prepaid rent is being amortized to rent expense on a straight-line basis over the term of the lease. Rent expense for the years ended December 31, 1996 and 1995 totaled $90,000 and $5,000, respectively.
8. INCOME TAXES
The provision for income taxes consists of the following:
A reconciliation between the statutory federal income tax rate and the effective income tax rate is as follows:
Deferred income taxes are computed annually for differences between the financial statement and income tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. Such deferred income tax asset and liability computations are based on enacted laws and rates applicable to periods in which the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the income tax payable or refundable for the period plus or minus the change during the period in deferred income tax assets and liabilities. Net deferred tax assets, consisting primarily of the net operating loss carryforwards, have been reduced to zero by valuation allowances due to the uncertainty of their recoverability.
9. EXTRAORDINARY ITEM
In May 1995, the Company entered into a settlement with IWN, Inc. ("IWN"). The Company had been performing consulting services for IWN in connection with the joint development of certain interactive wagering software. In connection with this arrangement, the Company was paid $119,000 by IWN in 1994 and was loaned $20,000 by IWN. On May 18, 1995 the Company and IWN entered into a separation and settlement agreement whereby the loan was forgiven.
10. SUBSEQUENT EVENTS
On March 17, 1997 the Company initiated a private placement whereby the Company is seeking to raise up to $10,000,000 in gross proceeds before deduction of expected placement fees and expenses, through a private placement of units. Each unit will cost $25,000 and will consist of 10,000 shares of the Company's common stock and 5,000 callable Series D or Series S warrants, each warrant allowing its holder to purchase a share of common stock for $5.25 per share for a period of up to two years from the date of issue.
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