Form 10KSB for INTERACTIVE MOTORSPORTS & ENTERTAINMENT CORP
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15-Apr-2004
Annual Report
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of the consolidated results of operations and financial condition of the Company. The terms "Company", "we", "our" or "us" are used in this discussion to refer to Interactive Motorsports and Entertainment Corp. along with Interactive Motorsports and Entertainment Corp.'s wholly owned subsidiary, Perfect Line, Inc., on a consolidated basis, except where the context clearly indicates otherwise. The discussion and information that follows concerns the Registrant as it exists today, as of this filing, including the predecessor of the Company's operations, Perfect Line, LLC. This discussion and analysis does not relate to the operations of Pacific International Holding, Inc. which had limited operations prior to the merger with the Company on August 2, 2002.
Overview
The Company has not generated a profit nor has it generated sufficient cash flow since inception to fund operations. Since inception on May 31, 2001 and through December 31, 2003, the Company has accumulated aggregate losses totaling
$(6,434,655), which includes the net loss of $(3,525,581) for the twelve months ended December 31, 2003, the net loss of $(2,189,220) for the twelve months ended December 31, 2002 and the net loss of $(719,854) for the period from inception to December 31, 2001.
The Company has funded its retained losses through the initial investment of $650,000 in May 2001, $400,000 of capital contributed in February 2002, approximately $2.6 million received in August 2002 from the sale of Preferred Stock, $700,000 borrowed in March 2003, $352,000 received in the form of deposits for the future purchase by third parties of racecar simulators, and $1,212,619 by delaying payments to its vendors. The Company is presently in the process of soliciting additional debt and/or equity financing to fund current operating deficits and the Company's growth plan. See further discussion under "Liquidity and Capital Resources" and "Risk Factors" below.
During the twelve months ended December 31, 2003, the Company had total revenues of $7,552,978 compared to $9,636,278 for the twelve months ended December 31, 2002. The 21.6% decrease in revenue is due to: a) the closing of two racing centers (Arbor Place and Crossgates Mall); b) conversion of RiverTown Mall to a revenue share location; c) the weakness of the economy and the war in Iraq; and d) the company's lack of capital to purchase merchandise inventory at levels great enough to adequately stock its stores and to properly advertise and promote the racing centers.
Review of Consolidated Financial Position
Cash and Cash Equivalents: The Company had $249,005 in cash and cash equivalents as of December 31, 2003 compared with $582,905 at December 31, 2002, a decrease of $333,900. This decrease in cash for the year ended December 31, 2003 relates principally to the net loss of ($3,525,581).
Trade Accounts Receivable: These are primarily credit card receivables and the lower balance of $39,459 at December 31, 2003 versus $86,734 at December 31, 2002 is due to the lower volume of business transacted in the final days of December 2003 versus December 2002.
Merchandise Inventory: At December 31, 2003, merchandise inventory decreased by $112,584 from December 31, 2002 due primarily to the company's lack of capital to purchase all the inventory desired..
Accounts Receivable from Related Parties: One hundred thousand dollars of the balance at December 31, 2003 was a receivable from Perfect Line Investments, LLC, a related party. This receivable was fully reserved at December 31, 2002 as its collection is deemed unlikely.
Accounts Payable: Due to the inability of the company's cash flow to fund operations, the company has relied to a great extent on the credit offered by vendors to finance its losses from operations. This resulted in an increase in the Accounts Payable balance of $1,212,619 as compared to the balance at December 31, 2002.
Line of Credit and Notes Payable: Both the revolving line of credit and the bank term loan were repaid in full in August 2002 using the proceeds from the May 10, 2002 private placement of preferred stock. Other than the Secured Bridge Notes issued in March 2003 as further discussed in Note 5 to the Consolidated Financial Statements, the Company does not currently have a revolving credit facility in place, although it continues to be in discussions with potential lenders.
Other Liabilities: Accrued payroll and payroll taxes, sales taxes payable, unearned revenue, and other accrued expenses fluctuate with the volume of business, timing of payments, and the day of the week on which the period ends. At December 31, 2003, the payroll accrual was a week and a half payroll. Gift certificates at December 31, 2003 decreased by $28,529 compared to December 2002. This decrease can be attributed at least in substantial part to decreased consumer spending during the 2003 holiday season. Accrued expenses are higher at December 31, 2003 due primarily to accrual of licensing fees to NASCAR of $80,000 and the accrual of approximately $431,700 for gas and electric utilities, and rent due landlords at the various store locations
Review of Consolidated Results of Operations
Sales for the twelve months ended December 31, 2003 were $2,083,300 lower than for the 12 month period ending December 31, 2002 due primarily to deterioration in the economy, decreases in consumer spending, the war in Iraq and the limited
amount of available merchandise inventory resulting from the Company's limited financial situation. Additionally, the company closed its Albany, New York and one of its Atlanta, Georgia locations, and converted its Grand Rapids store to a revenue share store. On a weighted average basis, 11.2 stores were open in the twelve months ended December 31, 2003 versus 11.4 stores open in the twelve months ended December 31, 2002. During 2003, the Company experienced a continuing decline in the average sales per week per company store on a comparable basis from $13,588 for the period from inception to December 31, 2002 to an average of $11,115 for the year ended December 31, 2003. We believe this decrease is primarily attributable to deterioration in the economy, decreases in consumer spending, the war in Iraq, a lack of marketing expenditures, and the lack of sufficient quantities of merchandise inventory to maximize the opportunity the retail component of the stores provides.
Operating expenses for the year ended December 31, 2003 were approximately 140% of net sales and approximately 122% in 2002. Although overall expenses in terms of dollars declined 9.8% in 2003 as compared to the same period ending December 31, 2002, the extent of the decline was not as great as the 21.6% decline in revenue. Expenses that increased in 2003 included costs related to employment, benefits, maintenance and depreciation. Licensing fees to NASCAR, teams and tracks also increased..
Qualitative and Quantitative Disclosures of Market Risk
The fair value of the assets and liabilities comprising the Company's condensed consolidated balance sheet are not subject to an inordinate amount of market risk. The term market risk refers to the risk of loss arising from adverse changes in interest rates and other relevant market rates and prices. The Company's primary assets are the racing simulators and the software that runs them. As such, the Company does not believe it has any significant exposure to market risk, as defined.
Critical Accounting Policies
The Company's critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the Notes to Consolidated Financial Statements for the year ended December 31, 2003 included in Item 7 in this Form 10-KSB. The Company has consistently applied these policies in the year ended December 31, 2003. Management does not believe that operations to date have involved uncertainty of accounting treatment, subjective judgment, or estimates, to any significant degree.
Internal Controls
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, management has reviewed the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) as of a date within 90 days prior to this annual report (the "Evaluation Date"). Management believes that such disclosure controls and procedures as of the Evaluation Date were adequate to ensure that employees and others with material information relating to the Company make that information known to management. To management's knowledge, there were no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the Evaluation Date.
Liquidity and Capital Resources
The primary source of funds available to the Company are receipts from customers for simulator and merchandise sales, proceeds from equity offerings including the $2,610,050 received in August 2002, loans from related parties including net proceeds of $687,500 received in March, 2003, credit extended by vendors, and possible future financings.
As of the filing of this Form 10-KSB, the net proceeds of $687,500 from the Secured Bridge Notes and warrants financing received in March 2003 has been depleted and the Company believes the projected level of cash receipts from simulator and merchandise sales may not be sufficient to fund the daily operations of the business through 2004. A difficult consumer and retail environment and the lack of merchandise in the stores have created further challenges at increasing the sales volume in 2004. However, management believes that under the recently announced conversion of seven owned and operated racing centers to revenue share locations, and based upon the guaranteed minimum payments within the Checker Flag agreement as described herein, and the Company's current financial projections, management expects the Company to show a positive EBITDA soon after the landlords approval of the conversions. While
the landlords have not formally agreed to the conversions to revenue and assumption of the lease obligations, the Company is aware of no reasons why they will not do so.
Management is seeking additional sources of short-term funds to continue operations until additional long-term equity and/or debt financing can be established.
Currently, the Company is exploring both equity and collateralized debt financing with several sources and is in various stages of discussion with each. While the Company believes that at least one of these financing efforts will occur, there are no assurances. Management believes that some combination of simulator sales (from existing inventory of owned and unencumbered simulators), equity financing and/or collateralized debt financing will generate enough capital to sustain the business until permanent financing can be obtained, although there can be no assurances.
Since inception, the Company's short-term and long-term plans have included raising a level of investment adequate to accomplish the objectives of the business. The required level of financing has not yet been achieved. Absent additional funding, the Company believes it may not have sufficient resources to satisfy cash requirements for the next twelve months or even the remainder of 2004. The Company's ability to raise the necessary financing will depend on many factors, including the economic and market conditions prevailing at the time financing is sought. Management believes that the investment climate since the Company commenced operations has generally been unfavorable, particularly to newer enterprises, which has hindered the Company in obtaining its financing goals. Nonetheless, management believes that the recently announced conversion of seven of its owed and operated racing centers to revenue share locations, combined with some combination of simulator sales (from existing inventory of owned and unencumbered simulators), the increased revenues from the recently signed third party revenue share agreements, and even a minimum level of equity financing and/or collateralized debt financing will allow the Company to achieve positive EBITA and monthly profitability. While management has pursued financing for some time, it has encountered difficulties in raising the financing, and there can be no assurance that additional financing will be available or, if available, that it will be on terms acceptable to the Company.
During the year ended December 31, 2003, the operating activities of the Company used net cash of $858,169 compared to net cash used of $1,524,364 for the comparable period in 2002. The majority of the decrease in cash used in operations was due to an increase in net operating loss before taxes of approximately $1,336,361 offset by the $1,212,619 increase in accounts payable, the $352,692 increase in deposits from customers who have contracted to purchase simulators, and an increase in depreciation and other non-cash expenses of $284,298.
During the year ended December 31, 2003, the Company used $221,481 of net cash in investing activities compared with $143,510 of net cash used in investing activities during the comparable period in 2002. In 2003, the net cash used relates primarily to the capitalization of internally developed software for the new Indianapolis Motor Speedway racetrack and other enhancements to the Company's proprietary racing simulation software.
The Company intends to use the debt and equity markets to raise sufficient capital to fund its operating deficits while it refines its business model and technology and then markets the new offering to customers. All of the $745,750 cash provided through financing activities during the year ended December 31, 2003 represents the receipt of proceeds from the issuance of the Secured Bridge Notes and warrants in March 2003, along with a promissory note in August 2003. The Secured Bridge Notes matured at December 31, 2003, but all except $50,000 of the note holders have entered into extension agreements pursuant to which the maturity of the notes is extended to April 30, 2004.
As of December 31, 2003, the Company had cash and cash equivalents totaling $249,005 compared to $582,905 at December 31, 2002. Current assets totaled $381,335 at December 31,2003 compared to $860,804 on December 31, 2002. Current liabilities totaled $3,654,089 on December 31,2003 compared with $1,286,533 on December 31, 2002. As such, these amounts represent an overall decrease in working capital of $2,847,025 from December 31, 2002.
Inflation
We do not expect the impact of inflation on our operations to be significant.
Risk Factors
The Company is subject to certain risk factors due to the organization and structure of the business, the industry in which we compete and the nature of our operations. These risk factors include the following:
Operating History, Operating Losses, and Accumulated Deficit
Perfect Line was formed in June 2001 for the purpose of acquiring certain of the assets of SEI, a bankrupt corporation, and modifying and improving the business model under which SEI operated, as more fully described under Overview above. While the concept is a modification and improvement upon the prior model, the modified business model was only in place for less than two full years, but also proved to be unprofitable. It is for that reason, among others, that the Company has determined to move to the revenue share model, although that business model has yet to be tested. Perfect Line has a limited operating history and is subject to numerous risks, expenses, problems, and difficulties typically encountered in establishing any business. For the 5 months ended December 31, 2001, Perfect Line had sales of $3,533,402, and a loss of $(719,854). For the year ended December 31, 2002, Perfect Line generated net sales of $9,636,278, resulting in a net loss of $(2,189,220) As of December 31, 2003 and for the twelve months then ended, Perfect Line had net sales of $7,557,978 generating a net loss of $(3,525,581). This resulted in an accumulated deficit of $(6,434,655) as of December 31, 2003 for the Company. Management believes the Company can become profitable in the future, based upon revenues generated from owned and operated racing centers, revenue share locations, mobile leases and equipment sales. There can be no assurance that the Company will be profitable for fiscal 2004 or thereafter or that the Company's cash flow will allow it to continue operations.
Dependence on Discretionary Consumer Spending and Competition
Much of the revenue anticipated by the Company will be the result of discretionary spending by consumers. If the current downturn in the economy continues for an extended time or worsens, either overall or in the locations in which Company racing centers and revenue share sites are located, the amount of discretionary spending may be reduced which would have a negative effect on the Company results from operations and its financial position. In addition, if the popularity of NASCAR diminishes, it is likely that the Company will experience a similar reduction in simulator usage and merchandise sales that will have a negative impact on the Company and its future.
There is considerable competition for consumer entertainment dollars. The Company feels its patented technology, high-traffic, premium locations, licenses with NASCAR and various teams, drivers, and tracks combined with the NASCAR retail store-within-a-store concept create significant points of difference between its competitors and NSMS. However, there can be no assurance that these factors will be sufficient to assure successful product development into the marketplace.
Significant Capital Requirements and Need for Additional Financing
The Company's capital requirements have been and will continue to be significant. The Company is dependent upon the proceeds of additional equity and debt offerings in order to fund its continued growth and related working capital requirements. The Company anticipates, based upon its currently proposed plans and assumptions relating to its operations, that the net financing proceeds received to date by the Company will only provide a portion of the funds necessary in connection with the implementation and continuation of its long term business plans. Ongoing operations, marketing and new product development will require capital resources greater than the resources currently available to the Company. To the extent that the Company's operations do not generate sufficient working capital for its long-term business plans, the Company will need to obtain additional outside financing. There can be no assurance that additional financial resources necessary to permit the Company to implement or continue its programs will be available. See "Liquidity and Capital Resources" for further discussion of capital requirements.
Currently, the Company is exploring collateralized debt financing with several sources and is in various stages of discussion with each. While the Company believes that at least one of these financing efforts will occur, there are no assurances.
Dependence on Updated Technology and Licenses/Leases
The Company will likely have a need to routinely update and upgrade its simulation technology. If the Company is not able to retain appropriate personnel with the skills and ability to maintain its simulators, it will likely have a material adverse effect on the Company. The Company will also need to routinely upgrade the appearance of the simulators to closely approximate that
of the then current NASCAR sponsors. This updating may involve significant time and expense and, in certain instances, require additional license agreements from new teams and/or sponsors. The Company will also need to renew existing licensing agreements with NASCAR teams and/or drivers. The Company currently has executed either contracts or term sheets with fourteen teams and/or drivers. The Company has established licensing relationships with a significant number of racetracks at which NASCAR events are held. The Company has license agreements with International Speedway Corp (ISC), Speedway Motorsports International (SMI) and the Indianapolis Motor Speedway (IMS), and has incorporated to date six NASCAR tracks into its proprietary software. The Company has the rights to many more prominent NASCAR tracks, and plans to add tracks to its software once funded. The Company has entered into an exclusive location based entertainment license agreement with NASCAR to utilize its logo. The license agreement permits the continued use of the NASCAR logo in the Las Vegas NASCAR Cafe and the Daytona USA simulator and provides that it is not a breach of the exclusivity clause for those two venues to continue to use their current simulator experiences. The license requires the Company to utilize its best efforts to maintain a minimum of eight entertainment stores. The Company's confidential licensing agreement with NASCAR required an annual royalty payment in 2002 and quarterly royalty payments commencing in 2003 through 2009 based on simulator, merchandise, food, beverage, sponsor, and remote site revenues at varying percentages. The licensing agreement is subject to renewal on December 31, 2009.
Dependence on Small Number of Key Management Personnel
We do not have employment agreements with any of our employees. Our future success depends, in part, on the continued service of our key executive, management, and technical personnel. If key officers or employees are unable or unwilling to continue in their present positions, our business and our ability to raise capital could be harmed.
Our business is especially dependent upon the continued services of our Chairman and Chief Executive Officer, William R. Donaldson. Should we lose the services of Mr. Donaldson, our operations will be negatively impacted. The loss of the services of Mr. Donaldson would have a material adverse effect upon our business.
Officers and Directors Have Limited Liability and Indemnification Rights
Our officers and directors are required to exercise good faith and high integrity in the management of our affairs. Our certificate of incorporation and bylaws, however, provide, that the officers and directors shall have no liability to the stockholders for losses sustained or liabilities incurred which arise from any transaction in their respective managerial capacities unless they violated their duty of loyalty, did not act in good faith, engaged in intentional misconduct or knowingly violated the law, approved an improper dividend or stock repurchase, or derived an improper benefit from the transaction. Our certificate of incorporation and bylaws also provide for us to indemnify our officers and directors against any losses or liabilities they may incur as a result of the manner in which they operate our business or conduct our internal affairs, provided that the officers and directors reasonably believe such actions to be in, or not opposed to, our best interests, and their conduct does not constitute gross negligence, misconduct or breach of fiduciary obligations.
Market and Capital Risks
Future issuance of Common Stock of the Company may lead to dilution in the value of our common stock, a reduction in shareholder voting power, and allow a change in control.
Stock issuances may result in reduction of market price of our outstanding shares of common stock. If we issue any additional shares of common or preferred stock, proportionate ownership of our common stock and voting power will be reduced. Further, any new issuance of common or preferred shares may prevent a change in our control or management.
Issuance of our preferred stock could depress the market value of current shareholders. We have 10,000,000 authorized shares of convertible preferred stock that may be issued by action of our Board of Directors. Our Board of Directors may designate voting control, liquidation, dividend and other preferred rights to preferred stock holders. Our Board of Directors' authority to issue preferred stock without shareholder consent may have a depressive effect on the market value of our common stock. The issuance of preferred stock, under various circumstances, could have the effect of delaying or preventing a change in our control or other take-over attempt and could adversely affect the rights of holders of our shares of common stock.
High-Risk Investment and Restrictions on Marketability
Our common stock has traded on the Over-the Counter Bulletin Board since August 2002. The bid price of our common stock has been less than $5.00 during this period. As such, we are subject to the penny stock rules adopted by the Securities and Exchange Commission that require brokers to provide extensive disclosure to its customers prior to executing trades in penny stocks. These disclosure requirements may cause a reduction in the trading activity of our common stock.
Broker-dealer practices in connection with transactions in penny stocks are regulated by certain penny stock rules adopted by the Securities and Exchange Commission. Penny stocks generally are equity securities with a price of less than $5.00. Penny stock rules require a broker dealer prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer's account. In addition, the penny stock rules generally require that prior to a transaction in a penny stock, the broker-dealer makes a special written determination that the penny stock is a suitable investment for the purchaser and receives the purchaser's written agreement to the transaction.
Because we are subject to the penny stock rules our shareholders may find it difficult to sell their shares. |
