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Youbet.com 10-K 2008
Filed by Bowne Pure Compliance
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 1)
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-26015
YOUBET.COM, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   95-4627253
(State of incorporation)   (I.R.S. employer identification no.)
     
5901 De Soto Ave., Woodland Hills, California 91367   91367
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code: (818) 668-2100
Securities registered under Section 12(b) of the Act:
Common Stock, par value $.001 per share
Securities registered under Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the voting common equity held by non-affiliates (assuming that the registrant’s affiliates are its officers and directors) of the registrant as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2007) was approximately $89.8 million based on the closing sale price of $2.44 as reported on the NASDAQ Capital Market on June 30, 2007.
As of December 31, 2007, there were 42,562,805 shares of common stock, $.001 par value per share, outstanding.
 
 

 

 


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Explanatory Note
We are filing this Amendment No. 1 to our annual report on Form 10-K for the year ended December 31, 2007, originally filed with the Securities and Exchange Commission, or the SEC, on March 31, 2008, to restate our consolidated financial statements for the year and our selected unaudited quarterly results of operations for the quarter ended December 31, 2007. See Note 2 to our consolidated financial statements contained at the end of this report for more information regarding the restatement.
This Form 10-K/A also includes Items 6, 7 and 8 of Part II, Item 9A of Part III and Item 15 of Part IV. These Items have been updated to give effect to the subject matter of the restatement. In accordance with Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the complete text of each amended Item is set forth in this report, even though much of the disclosure in the restated Items has not changed.

 

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YOUBET.COM, INC.
INDEX TO FORM 10-K/A
FOR THE YEAR ENDED DECEMBER 31, 2007
         
    Page  
 
       
PART II
       
 
       
    1  
 
       
    3  
 
       
    13  
 
       
    13  
 
       
       
 
       
    14  
 
       
    17  
 
       
 Exhibit 23.1
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
Preliminary Notes
This Form 10-K/A is for the year ended December 31, 2007. This amended report modifies and, with respect to those Items contained in this amendment, supersedes our original annual report. The SEC allows us to “incorporate by reference” information that we file with them, which means that we can disclose important information to you by referring you directly to those documents. Information incorporated by reference (such as exhibits to this annual report) is considered to be part of this annual report.
Industry and market data used in this amended report is based on independent industry and government publications, reports by market research firms and other published independent sources. Some data is also based on our good faith estimates, which are derived from our review of internal surveys and independent sources. Although we believe these sources are reliable, we have not independently verified the information from these third-party sources and cannot guarantee their accuracy or completeness.
Cautionary Statement
This amended annual report on Form 10-K/A contains forward-looking statements which include, but are not limited to, statements that relate to the possibility of identifying claims to reduce the earn-out payment owed to the former owners of IRG, statements concerning anticipated results from operations, the competitive nature of and anticipated growth in our markets, our ability to achieve further cost reductions, the status of evolving technologies and their growth potential, and the need for additional capital. These forward-looking statements are based on our current expectations, estimates, and projections about our industry, management’s beliefs, and certain assumptions made by it. Words such as “anticipates”, “appears”, “expects”, “intends”, “plans”, “believes, “seeks”, “estimates”, “may”, “will” and variations of these words or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These statements, which are included in accordance with the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended, are not guarantees of future results and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual results and outcomes could differ materially and adversely from those results and outcomes expressed in any forward-looking statements, as a result of various factors, some of which are listed under Item 1A “Risk Factors” of our original annual report for the year ended December 31, 2007. Readers are cautioned not to place undue reliance on forward-looking statements, which are based only upon information available as of the date of this report. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

 

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing at the end of this report.
                                         
    Years ended December 31,  
    Restated                          
    2007(1)     2006(2)     2005(3)     2004     2003  
    (in thousands, except per share data)  
 
                                       
Statement of Income Data
                                       
Revenues
  $ 138,193     $ 136,400     $ 88,837     $ 65,249     $ 54,147  
 
                                       
Operating costs (4)
    163,604       137,724       85,000       63,868       58,150  
 
                             
 
                                       
Income (loss) from continuing operations before income tax (benefit)
    (25,411 )     (1,324 )     3,837       1,381       (4,003 )
Income tax (benefit)
    2,083       734       (1,854 )     (3,250 )      
 
                             
Income (loss) from continuing operations
    (27,494 )     (2,058 )     5,691       4,631       (4,003 )
Income (loss) from discontinued operations (5)
    (924 )     27                    
 
                             
Net income (loss)
  $ (28,418 )   $ (2,031 )   $ 5,691     $ 4,631     $ (4,003 )
 
                             
 
                                       
Earnings (loss) per share:
                                       
Basic
                                       
Income (loss) from continuing operations
  $ (0.66 )   $ (0.06 )   $ 0.18     $ 0.16     $ (0.15 )
Income (loss) from discontinued operations
    (0.02 )     0.00                    
Net income (loss)
    (0.68 )     (0.06 )     0.18       0.16       (0.15 )
Diluted
                                       
Income (loss) from continuing operations
  $ (0.66 )   $ (0.06 )   $ 0.16     $ 0.14     $ (0.15 )
Income (loss) from discontinued operations
    (0.02 )     0.00                    
Net income (loss)
    (0.68 )     (0.06 )     0.16       0.14       (0.15 )
 
                                       
Selected Balance Sheet Data
                                       
Cash and cash equivalents
  $ 6,551     $ 21,051     $ 16,686     $ 13,287     $ 8,274  
Working capital (deficit)
    (14,300 )     5,019       12,015       8,876       2,372  
Total assets
    65,050       105,605       40,829       25,442       18,852  
Current portion of long-term debt
    10,390       8,311       620       391        
Long-term debt, net of current portion
    4,767       12,054       178       158        
Stockholders’ equity
    19,981       52,774       22,884       14,098       7,730  
     
(1)  
See Note 2 to our consolidated financial statement contained at the end of this report for more information regarding the restatement. In September and December of 2007, we recognized impairments of goodwill and intangible assets. See Note 17 to our consolidated financial statements at the end of this report. Further, on October 2007, $1.5 million in cash held by our International Racing Group subsidiaries (collectively, “IRG”) was seized by U.S. government related to the investigation of certain customers who are alleged to have used telephone rebate wagering services in an illegal manner. As of December 31, 2007, we had fully provided for this seized amount.
 
(2)  
In February 2006, we acquired United Tote, and in October 2006, we acquired Bruen Productions. See Note 15 to our consolidated financial statements at the end of this report.
 
(3)  
In June 2005, we acquired IRG. See Note 15 to our consolidated financial statements at the end of this report.
 
(4)  
An arbitration award related to an audit of amounts paid to TVG under our license agreement with TVG for the period April 2002 through March 2005 and associated legal fees totaled $2.7 million in 2006.
 
(5)  
In December 2007, we sold Bruen Productions. See Note 18 to our consolidated financial statements at the end of this report.

 

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Selected Unaudited Quarterly Results of Operations
In the opinion of management, the accompanying unaudited quarterly financial information presented below includes all adjustments which management considers necessary to present fairly the results of its operations for the periods presented below in conformity with accounting principles generally accepted in the United States of America. This quarterly financial information has been prepared consistently with the accounting policies described in the accompanying audited consolidated financial statements for the year ended December 31, 2007. The results of operations for the periods presented below are not necessarily indicative of the results of operations to be expected in the future.
                                                                 
    Fiscal quarters ended  
    2007     2006  
                            Restated                          
    Mar. 31     Jun. 30     Sep. 30     Dec. 31(2)     Mar. 31(3)     Jun. 30     Sep. 30     Dec. 31(4)  
    (in thousands, except per share data)  
Revenues
  $ 34,822     $ 37,256     $ 38,036     $ 28,079     $ 27,756     $ 39,590     $ 37,050     $ 32,005  
 
                                               
Costs and expenses
                                                               
Track fees
    14,625       13,664       13,138       8,683       11,578       14,783       14,171       11,865  
Licensing fees
    2,823       5,617       6,991       4,379       3,104       6,176       6,043       6,644  
Network operations
    1,298       1,384       1,154       1,340       1,283       1,517       1,335       1,213  
Contract costs
    3,763       4,305       4,258       4,259       1,934       3,858       4,150       3,606  
Cost of equipment sales
    88       121       189       31       90       444       58       84  
 
                                               
 
    22,597       25,091       25,730       18,692       17,989       26,778       25,757       23,412  
 
                                               
Gross profit
    12,225       12,165       12,306       9,387       9,767       12,812       11,293       8,593  
 
                                               
 
                                                               
Operating expenses
                                                               
General and administrative
    5,257       4,677       4,930       10,530       4,417       5,574       6,192       7,426  
Sales and marketing
    2,509       3,982       2,409       2,639       2,071       2,482       2,399       2,511  
Research and development
    927       919       1,024       1,400       766       908       813       723  
Depreciation and amortization including intangibles
    1,875       2,427       3,196       2,872       1,140       1,730       2,204       1,749  
Goodwill and intangible impairment writedown
                      18,923                          
 
                                               
 
    10,568       12,005       11,559       36,364       8,394       10,694       11,608       12,409  
 
                                               
Income (loss) from continuing operations
    1,657       160       747       (26,977 )     1,373       2,118       (315 )     (3,816 )
Interest expense
    (257 )     (377 )     (222 )     (295 )     (31 )     (404 )     (413 )     (561 )
Other income (expense)
    10       9       27       107       102       493       161       (32 )
 
                                               
Income (loss) from continuing operations before income tax (benefit)
    1,410       (208 )     552       (27,165 )     1,444       2,207       (567 )     (4,409 )
Income tax (benefit)
    (230 )     (18 )     (59 )     2,390       95       12       (127 )     754  
 
                                               
Income from continuing operations
    1,640       (190 )     611       (29,555 )     1,349       2,195       (440 )     (5,163 )
Income (loss) from discontinued operations (1)(5)
    (54 )     (167 )     (544 )     (159 )                       27  
 
                                               
Net income (loss)
  $ 1,586     $ (357 )   $ 67     $ (29,714 )   $ 1,349     $ 2,195     $ (440 )   $ (5,136 )
 
                                               
Net income per common share, diluted
                                                               
Income (loss) from continuing operations
  $ 0.04     $ (0.00 )   $ 0.01     $ (0.71 )   $ 0.04     $ 0.06     $ (0.01 )   $ (0.14 )
Income (loss) from discontinued operations
                (0.01 )                             (0.00 )
Net income (loss) per common share
    0.04       (0.00 )     0.00       (0.71 )     0.04       0.06       (0.01 )     (0.14 )
     
(1)  
We recognized impairment of goodwill in Bruen Productions in the third quarter of 2007.
 
(2)  
See Note 2 to our consolidated financial statement contained at the end of this report for more information regarding the restatement. In October 2007, $1.5 million held in IRG bank accounts was seized by U.S. government as part of its investigation of certain individuals who may have used telephone rebate wagering services in an illegal manner. As of December 31, 2007, we had fully reserved for this seized amount.
 
(3)  
United Tote was acquired in February 2006.
 
(4)  
Bruen Productions was acquired in October 2006. An arbitration award related to an audit of amounts paid to TVG under our license agreement with TVG for the period April 2002 through March 2005 and associated legal fees totaled $2.7 million in 2006.
 
(5)  
In December 2007, we sold Bruen Productions. See Note 18 to our consolidated financial statements at the end of this report.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a diversified provider of technology and pari-mutuel horse racing content for consumers through Internet and telephone platforms and a leading supplier of totalizator systems, terminals and other pari-mutuel wagering services and systems to the pari-mutuel industry.
To date, we have focused on the United States pari-mutuel horse race wagering market through our main product, Youbet ExpressSM, which features online wagering, simulcast viewing, and in-depth, up-to-the-minute information on horse racing. Our customers receive interactive, real-time audio/video broadcasts, access to a comprehensive database of handicapping information, and, in most states, the ability to wager on a wide selection of horse races in the United States. We are working to expand the Youbet.ExpressSM brand, its products, and its services throughout the United States and in select international markets.
Based on information compiled by The Jockey Club, over 88% of pari-mutuel wagers, or handle, on thoroughbred racing in the United States were placed at locations away from the host track. We believe the shift toward off-track wagering has been driven by the betting public’s desire for convenience and access to a broader range of content. Our website, www.youbet.com, enables our customers to securely wager on horse races at over 150 racetracks worldwide from the convenience of their homes or other locations. Our customers receive the same odds and expected payouts they would receive if they were wagering directly at the host track and their wagers are placed directly into the track betting pools.
We strive to appeal to both new and experienced handicappers by providing a user-friendly “one-stop-shop” experience. To place a wager, customers open an account and deposit funds with us via several convenient options, including our ExpressCash system, which links our customers’ wagering accounts directly to their personal checking accounts. To enable our customers to make informed wagers, we provide 24-hour access to up-to-the minute track information, real-time odds and value-added handicapping products, such as Turfday Super Stats, a comprehensive database of racing statistics and a grading system to assess trainers, jockeys and horses. Our customers can view high-quality, live audio/video broadcasts of races as well as replays of a horse’s past races. Our convenient automated services are complemented by our player service agents, who are available 15 hours a day, seven days a week to provide technical support and address any wagering or funding questions.
Our content partners provide us the same live satellite feeds that they normally broadcast at the track and to off-track betting facilities (“OTBs”). As a result, our partners have the opportunity to increase the total handle wagered on their racing signal, which we believe leads to higher revenues for the host track and a higher quality of racing through larger purses for the horse owners. In return, we receive a commission, or a percentage of their wager (handle), from the race tracks.
Our acquisition of United Tote Company in February 2006 diversified our product offerings and furthered our efforts to be the pari-mutuel industry’s leading end-to-end technology provider. United Tote is a leading supplier of totalizator systems (equipment and technology that processes wagers and payouts) and processes more than $7 billion in handle annually on a global basis, approximately 90% of which is North American pari-mutuel handle. United Tote supplies pari-mutuel tote services to approximately 100 racing facilities in North America and additional facilities in the Philippines and other foreign markets.
We have two reportable segments for accounting purposes. Our ADW segment consists of our core Youbet Express operations, as well as IRG which closed as of February 15, 2008, and Bruen Productions which we sold in December 2007. For information on IRG and Bruen Productions, see Note 18 “Discontinued Operations” and Note 19 “Subsequent Events”, respectively, in our consolidated financial statements at the end of this report. United Tote operations constitute a separate totalizator segment. For information regarding results for each segment, see Note 16 “Segment Reporting” in our consolidated financial statements at the end of this report.

 

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2007 Restatement
Subsequent to the filing of our original annual report on Form 10-K, management identified an error in its calculation of the final earn-out potentially payable to the former owners of IRG, and for accounting purposes, this resulted in an understatement of the potential earn-out payment of approximately $1.1 million that had been included in accrued expenses in our December 31, 2007 balance sheet and a corresponding understatement of net loss for the year ended December 31, 2007. The actual earn-out payment, if any, is subject to any claims that may be determined prior to the date such payment is due on August 31, 2008. The aggregate value of any such claims cannot be determined or reasonably estimated at this time, but since they are in the nature of contingent assets, they will not be given accounting recognition until the contingency is resolved. Accordingly, we have restated our consolidated financial statements for the year ended December 31, 2007, for the full amount of the liability, without any income tax effect. See Note 2 to our consolidated financial statement contained at the end of this report for more information regarding the restatement.
Results of Operations for 2007 Compared to 2006
Revenues
Total revenues increased $1.8 million, or 1.3%, for 2007 compared to 2006. ADW segment revenue increased $0.5 million, or 0.4%, and totalizator segment revenues increased $1.3 million largely due to including full year results for United Tote (acquired in mid-February 2006) in 2007. The increase in our ADW segment reflects a $5.9 million, or 6.4%, increase in Youbet Express revenues, offset by a $5.5 million, or 25%, decrease in IRG revenues. Following the commencement of the investigation involving IRG’s business by the U.S Attorney’s Office in Las Vegas, Nevada, the IRG business was adversely impacted by a reduction of its player base and wagering handle, eventually resulting in our decision to shut down IRG’s operations in February 2008.
Total wagering handle for 2007 was $716.0 million, a decrease of $47.0 million, or 6.2%, with Youbet Express and IRG experiencing an increase (decrease) of 4.4% and (22.6%), respectively, when compared to 2006. We believe the increase in the Youbet Express handle was driven primarily by an increase in our marketing activity, including player award programs offered in 2007.
Youbet Express and IRG’s total blended yield (defined as commission revenue less track and licensing fees as a percentage of handle) was 5.6% in 2007, up from 4.7% in the prior year, reflecting our efforts to increase handle on higher yielding tracks and the significant revenue decline in the lower-yielding IRG handle. In 2007, we generated a 7.2% yield on Youbet Express handle and a 2.4% yield on IRG handle, compared to 6.1% and 2.4%, respectively, in the 2006 period. We believe that yield is a useful measure to evaluate operating results and profitability. Yield, however, should not be considered an alternative to operating income or net income as indicators of Youbet’s financial performance and may not be comparable to similarly titled measures used by other companies.
Revenue generated by our United Tote operations in 2007 included contract revenue associated with the service of totalizator systems of $23.3 million and equipment sales of $0.9 million, an increase of $1.7 million and a decrease of $0.4 million, respectively, compared to 2006.
Operational Expenses
Track Fees: Track fees primarily consist of amounts paid and payable to various tracks. Track fees decreased $2.3 million, or 4.4%, in 2007 compared to 2006. The decrease is consistent with decreased handle and relates primarily to a $3.8 million reduction of track fees associated with IRG’s operations.
Licensing Fees: Licensing fees represent amounts paid and payable under our license and content agreement with TVG. For 2007, these fees decreased $2.2 million, or 9.8%, compared to 2006, primarily due to changes in track mix and the decline in wagering handle at IRG.
Network Operations: Network operations expense decreased $0.2 million, or 3.2%, for 2007 compared to 2006, primarily due to reduced handle associated with the operations of IRG and improved cost control.
Contract Costs: Contract costs are from United Tote’s operations and represent those costs associated with earning totalizator servicing contract revenue at tracks. Contract costs increased $3.0 million, or 22.4%, for the year ended December 31, 2007 compared to 2006 largely because of the mid-February 2006 acquisition of our United Tote subsidiary, increased data communication costs of $0.5 million, professional fees for internal control over financial reporting compliance of $0.1 million and payroll related costs.

 

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Equipment Costs: These costs relate to United Tote’s operations and represent those costs associated with earning equipment sales revenue. Equipment costs for 2007 declined $0.2 million or 36.3%, when compared with 2006, due to the decline in equipment sales.
Research and Development: Research and development expense increased $1.1 million or 33.0% for 2007, compared to 2006. The 2007 increase is primarily due to a full year’s research and development expense at United Tote, which was acquired in February 2006, reduced capitalization of research and development costs due to a fewer number of projects and the write-off of costs associated with several work-in-progress projects, including $0.3 million relating to a player activity tracking/accounting system for our IRG operations. We will continue to invest in the development of our network infrastructure and to support continued technology upgrades, which may increase our research and development expenses in the future.
Sales and Marketing: Sales and marketing expense increased $2.1 million, or 21.9%, for the year ended December 31, 2007 compared to the same period of 2006 largely due to increased marketing expenditures in the second and third quarters of 2007. This increase was primarily at Youbet Express and resulted from increased business development efforts and marketing programs, including expanded print and television advertising and race track promotional expenses, targeted at reducing the impact of the loss of TrackNet content.
General and Administrative: General and administrative expense increased $1.8 million, or 7.6%, for the year ended December 31, 2007 compared to the same period of 2006. While reductions in payroll and incentive compensation, and consulting costs as well as the nonrecurring legal expenses associated with a prior-year arbitration with TVG and bank debt refinancing accounted for approximately $0.8 million of expenses in 2006 that were not incurred in 2007. These reductions were offset by the full year impact of the 2006 acquisition of United Tote; a $0.8 million and $0.6 million increase to IRG’s and United Tote’s bad debt reserves; and a $1.5 million reserve established as a result of the U.S. Attorney’s seizing IRG funds from its Nevada’s bank accounts in October 2007. Approximately $1.0 million in legal expense was incurred in the fourth quarter relating to the IRG investigation. Additionally, in connection with restructuring the company’s cost structure and shutting down the IRG business, the company recorded severance/termination charges of $0.5 million and $2.0 million for IRG and Youbet Express, respectively, in the fourth quarter of 2007.
General and administrative expense, as a percentage of total revenues, increased to 18.3% for the year 2007 from 17.3% in the same period of 2006.
Depreciation and Amortization: Depreciation and amortization increased $3.5 million compared to the year ended December 31, 2006. This increase was primarily due to the impact of 2007 capital spending, a full years’ depreciation expense and intangible amortization expense at United Tote, which was acquired in the middle of the first quarter of 2006, the final purchase price allocation for that company, completed at year-end 2006 and the amortization of $0.5 million of capitalized software development costs associated with our King Contest product in the third quarter of 2007.
Impairment Write downs: As a result of substantially reduced business levels following the commencement in October 2007 of the U.S. government investigation involving the IRG business, we concluded that the intangible assets associated with the IRG business (attributable to customer lists and a non-competition agreement, as well as amounts accrued with respect to a potential earn-out payment based on IRG’s historic performance and due August 31, 2008) were impaired. In light of the future outlook for the IRG business under the continuing investigation, we recorded an impairment charge for the intangibles associated with the IRG business of $11 million, consisting of $6.7 million in the unamortized balance of prior earn-out payments and $4.3 million of an unpaid earn-out potentially payable August 31, 2008, although the precise payment, if any, is subject to reduction for any claims that may be determined prior to the date such payment is due. Management is in the process of determining what claims are available to reduce the final earn-out payment and intends to vigorously pursue any and all appropriate claims. The nature and value of any such claims cannot be determined or reasonably estimated at this time, which are to be regarded as contingent assets and, therefore, will not be recorded until the contingencies are resolved. In connection with our exploration of strategic alternatives for United Tote and the preparation of our 2007 financial statements, we re-evaluated the goodwill related to United Tote. As part of this evaluation, we compared the current estimated fair value to the carrying value of goodwill, and on March 25, 2008, we concluded that United Tote goodwill was impaired as of December 31, 2007. The total amount of this non-cash impairment charge was $8.0 million.
Interest Expense: Interest expense decreased to $1.8 million in 2007 compared to $2.0 million in the same period of 2006. The decrease is primarily due the paydown of the Company’s bank debt. Interest expense is related to our credit facility and, to a lesser extent, the unsecured promissory notes issued in connection with our February 2006 acquisition of United Tote and capitalized leases.
Other Income: Other income decreased $0.6 million compared to 2006 primarily due to an early termination fee received by United Tote in the second quarter of 2006.

 

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Income Taxes: Income taxes were negatively impacted by several permanent and non-permanent book/tax differences such as amortization of intangibles, asset impairments, stock based compensation and depreciation. Additionally, the company increased its valuation allowance relating to deferred tax assets for net operating loss carryforwards by $2.9 million. According to Statement of Financial Accounting Standards Board Statement (“SFAS”) No. 109, Accounting for Income Taxes, a deferred tax asset should be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. All available evidence, both positive and negative, must be considered in determining the need for a valuation allowance. For 2007, positive evidence considered included future revenue and expenses, reversals of book to tax temporary differences, and the implementation of and/or ability to employ various tax planning strategies. Negative evidence included book and tax losses generated in prior periods, and the inability to achieve forecasted results for those periods. The company concluded that a valuation allowance was warranted against a portion of its net operating loss carry forwards. On January 1, 2007, we adopted Financial Accounting Standards Board Interpretation (“FIN”) 48, Accounting for Uncertainty in Income Taxes, which had no effect on our financial statements or related disclosures.
Discontinued Operations: Effective December 31, 2007, we sold Bruen Productions back to the original owner (David Bruen). For the year ended December 31, 2007, Bruen generated a loss of $0.9 million, which includes a $0.4 million third quarter charge for the impairment of goodwill. For more information regarding the sale of Bruen Productions, see Item 1 “Business — Acquisitions and Dispositions”.
Results of Operations for 2006 Compared to 2005
Revenues
Total revenues increased $47.8 million or 54% for 2006, compared to 2005. This increase is primarily attributable to several factors: the acquisition of United Tote in February 2006 and Bruen Productions in October 2006, which contributed $22.8 million and $0.3 million in revenue, respectively; the first full year of IRG’s operations (acquired in June 2005 and discussed in the next two paragraphs), which contributed $15.3 million in revenue; and $9.4 million from continued growth in our Youbet Express operations for reasons also discussed in the next two paragraphs.
Handle for the year ended December 31, 2006 was $763.0 million, an increase of 61.5% from the prior year. This increase was due to $222.0 million of additional IRG handle included in the total for the year 2006, coupled with a $68.5 million increase in Youbet’s handle. In addition to IRG operations being included for a full year for the first time, we believe these increases in handle were driven primarily by an increase in our marketing activity, including player award programs offered in 2006.
In addition, blended yield, commission revenue less track and licensing fees, as a percentage of handle was 4.7% during 2006, compared to 5.9% during 2005 reflecting the impact of the lower-yielding IRG handle. We generated a 6.1% yield on Youbet handle and a 2.4% yield on IRG handle. The 4.7% yield is a decline from the 2005 yield of 5.9% due to a change in year-over-year track mix, coupled with IRG handle representing a larger share of our total overall handle. We believe that yield is a useful measure to evaluate operating results and profitability. Yield, however, should not be considered an alternative to operating income or net income as indicators of Youbet’s financial performance and may not be comparable to similarly titled measures used by other companies.
Revenue generated by our United Tote operations in 2006 included contract revenue associated with the service of totalizator systems of $21.6 million and equipment sales of $1.3 million.
Operating Expenses
Track Fees: Track fees increased 37%, or $14.2 million, for 2006 compared to 2005. The increase was primarily due to $10.8 million of track fees associated with IRG’s first full year of operations, which we acquired in June 2005. The remaining increase was primarily related to Youbet’s increase in handle and revenues discussed above.
Licensing Fees: For 2006, these fees increased 12.4%, or $2.5 million, compared to 2005, primarily due to the payment of a net contract arbitration award of $1.1 million to TVG and increased wagering on horse races at TVG tracks.
Contract Costs: Contract costs for 2006 are from United Tote’s operations and represent those costs associated with earning totalizator servicing contract revenue at tracks. Youbet did not have these costs prior to the United Tote acquisition in February 2006.

 

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Equipment Costs: Equipment costs for 2006 are also from United Tote’s operations and represent those costs associated with earning equipment sales revenue. Youbet did not have these sales or costs prior to the United Tote acquisition.
Network Operations: Network operations expenses increased 8.9%, or $0.4 million, for 2006 compared to 2005, consisting primarily of network operations expenses related to handle associated with the operations of IRG, which was acquired in June 2005.
Research and Development: Research and development expense increased 103%, or $1.6 million, for 2006 compared to 2005, primarily consisting of $1.6 million of such expense for United Tote that we did not have in 2005.
Sales and Marketing: Sales and marketing expense increased 49%, or $3.1 million, for 2006 compared to 2005 due, in part, to $0.8 million of additional IRG player services expenses and $0.8 million of United Tote expenses that we did not have in 2005. The remaining increase was primarily due to increased international and domestic business development efforts and increased marketing programs, including expenses associated with our arrangements with CBS SportsLine.com and ESPN.com.
General and Administrative: General and administrative expense increased 73%, or $10.1 million, for 2006 compared to 2005. The increase includes $0.6 million and $2.3 million associated with the operations of IRG (acquired in June 2005) and United Tote (acquired in February 2006), respectively. Additional one-time 2006 charges relating to legal fees of $1.6 million associated with the TVG arbitration, bank refinancing costs of $0.2 million, tax penalties of $0.4 million and business taxes of $0.7 million were incurred in 2006. The balance of the increase was due to increased transaction processing fees related to the increased transaction volume, increased fully burdened salaries, and consulting expenses. For 2006 and 2005, general and administrative expense as a percent of net revenues was 17.4% and 15.5%, respectively. Excluding the one-time charges described above, our general administrative expense as a percent of revenue would have declined for 2006 as compared to 2005 to 15.4%.
Depreciation and Amortization: Depreciation and amortization increased $5.2 million for 2006 compared to 2005. The increase includes $4.3 million of depreciation and amortization related to United Tote that we did not have last year. This was coupled with $0.5 million of amortization related to intangible assets acquired in the IRG acquisition.
Interest Expense: Interest expense increased to $1.9 million during 2006 compared to 2005, primarily consisting of $1.3 million related to our credit facility and $0.5 million of interest expense related to the three unsecured promissory notes issued in connection with our acquisition of United Tote.
Other Income: During 2006, a competitor paid United Tote $0.4 million as a fee to terminate early their totalizator services agreement with United Tote.
Liquidity and Capital Resources
During 2007, we funded our operations primarily with net cash provided by operating activities.
As of December 31, 2007, we had negative net working capital of $14.3 million, compared to positive net working capital of $5.0 million (including the current portion of our deferred tax asset of $2.5 million) at December 31, 2006. During the fourth quarter of 2006, we raised net proceeds of approximately $18.5 million in a registered direct offering. As of December 31, 2007, we had $6.6 million in cash and cash equivalents and $8.6 million in restricted cash.
Our principal ongoing cash requirements consist of payroll and benefits, business insurance, real estate and equipment leases, legal fees, data center operations, telecommunications and debt service. In addition, the former owners of IRG are entitled to a potential final earn-out payment based on IRG’s performance. As of December 31, 2007, we had accrued approximately $4.3 million, payable on or about August 31, 2008. The payment is subject to reduction for any claims that we may assert prior to the date such payment is due. The value of such possible claims cannot be reasonably estimated at this time, are to be regarded as contingent assets and therefore, will not be recorded until the contingencies are resolved. Management believes that its on-going efforts to contain costs and operate efficiently, combined with the growth in handle and yield improvement at Youbet Express, generates sufficient cash flow to adequately support its operations. We believe that our cash flow from operations and our unrestricted cash and cash equivalents are sufficient to fund our working capital and capital expenditure requirements for at least the next 12 months. However, we may from time to time seek additional capital to fund our operations and to reduce our liabilities in response to changes in the business environment. To raise capital, we may seek to sell additional equity securities, issue debt or convertible securities or seek to obtain credit facilities through financial institutions or other resources.

 

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We have an effective shelf registration statement under which we may from time to time issue and offer debentures, notes, bonds, and other evidence of indebtedness, and forward contracts in respect of any such indebtedness, shares of preferred stock, shares of common stock, warrants, stock purchase contracts, stock purchase units, and stock purchase rights for an original maximum aggregate offering amount of approximately $30 million, or up to approximately $36 million if we utilized our shelf for one offering. Unless otherwise described in future prospectus supplements, we intend to use the net proceeds from the sale of securities registered under this universal shelf registration statement for general corporate purposes, which may include additions to working capital, the repayment or redemption of existing indebtedness and the financing of capital expenditures and future acquisitions. The sale of additional equity or convertible securities would result in additional dilution to our stockholders.
The Youbet shares issued to UT Group (the former owners of United Tote) were subject to a “make-whole” provision pursuant to which we agreed to pay to UT Group a one-time cash payment equal to the amount by which $5.50 exceeds the average trading price of our common stock for the five trading-day period ending on February 9, 2007, multiplied by the number of shares delivered by us and then held by UT Group. In addition, we were entitled to cause UT Group to sell some or all of the Youbet shares on or before February 9, 2007, if the trading price was below $5.50 per share, provided that we paid to UT Group the make-whole amount within ten trading days of the sale. On January 23, 2007, Youbet delivered notice exercising its right to force the sale of UT Group’s 2,181,818 shares of Youbet common stock. On January 24, 2007, all 2,181,818 shares were sold for $3.45 per share, which sale closed on January 29, 2007. Youbet paid UT Group the aggregate make-whole payment of $4.5 million in January 2007 with a portion of the proceeds from the December 2006 registered direct offering.
Cash Flows for 2007 Compared to 2006
Net cash provided by operating activities was $2.0 million for 2007, compared to net cash provided by operating activities of $9.4 million for 2006. The year-over-year decrease of $7.4 million was primarily due to a relatively modest sales volume increase of 1.3%, coupled with a $4.0 million shift of operating cash to restricted cash to be in compliance with Oregon Racing Commission (the “ORC”) requirements and decreases of $1.2 million and $3.7 million in accrued expenses and trade payables (track related), respectively, due to the timing of obligation requirements, attributable to the 34% decline in wagering handle experienced in the fourth quarter of 2007 versus 2006. Also, in connection with IRG, we established a $1.5 million reserve for the IRG funds seized by the U.S. government and incurred $1.0 million in legal fees in connection with the U.S. government investigation. Additionally, Youbet and IRG incurred $2.0 million and $0.5 million related to termination and severance costs in 2007, respectively. These decreases were partially offset by the collection of receivables.
Net cash used in investing activities for 2007 was $9.9 million, compared to net cash used in investing activities of $18.0 million for 2006. The year-over-year decrease of $8.1 million was primarily due to the net cash paid out in 2006 in connection with the United Tote ($10.1 million) and Bruen Productions ($0.1 million) acquisitions, an earn-out payment to the former owners of IRG ($1.9 million) and increased purchases of property and equipment ($6.2 million) versus 2007 activity consisting of a $4.5 million make-whole payment made in the first quarter to the former owners of United Tote, a $3.1 million earn-out payment to the former owners of IRG and general capital spending of $2.5 million.
Net cash provided (used) by financing activities was ($6.3 million) and $13.1 million for 2007 and 2006, respectively. The year-over-year decrease of $19.4 million was primarily due to proceeds generated from a registered direct offering occurring in the fourth quarter of 2006 ($18.9 million) and the exercise of stock options and warrants, partially offset by the repayment of long-term debt in 2006. The proceeds from the direct registered public offering were used in 2007 to pay off debt ($7.9 million), repurchase Youbet stock ($1.0 million) and working capital requirements. Additional cash proceeds were obtained in 2007 through a sale/leaseback of totalizator equipment and short-term borrowings of $1.1 million and $1.3 million, respectively.
In accordance with the agreements that we entered into in connection with our acquisition of IRG in 2005, we were required to pay the sellers annual earn-out payments over the three-year period following June 2, 2005, based on IRG’s future performance. In 2006 and 2007, earn-out payments of $2.3 million and $3.1 million, respectively, were paid. As of December 31, 2007, we had accrued approximately $4.3 million for an earn-out potentially payable on or about August 31, 2008. The 2008 payment is subject to reduction for any claims that may be determined prior to the date such payment is due which Youbet may assert in order to reduce the obligation to make the potential earn-out payment. The value of such possible claims cannot be reasonably estimated at this time, are to be regarded as contingent assets and, therefore ,will not be recorded until the contingencies are resolved.
Cash Flows for 2006 Compared to 2005
Net cash provided by operating activities was $9.4 million for 2006, compared to net cash provided by operating activities of $5.8 million for 2005. The year-over-year increase of $3.4 million was primarily due to increased sales volume and customer deposits, coupled with increased leverage of our liabilities, such as increases in accrued expenses and trade payables, track related. These increases were partially offset by increases in receivables and restricted cash attributable to our acquisition of United Tote.

 

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Net cash used in investing activities for the year ended December 31, 2006 was $18.0 million, compared to net cash used in investing activities of $3.9 million for 2005. The year-over-year increase of $14.1 million was primarily due to the net cash paid in connection with the United Tote acquisition, the IRG earn-out, the Bruen Productions acquisition and increased purchases of property and equipment.
Net cash provided by financing activities was $13.1 million and $1.5 million for 2006 and 2005, respectively. The year-over-year increase of $11.6 million was primarily due to proceeds generated from a registered direct offering that closed in the fourth quarter of 2006 and the exercise of stock options and warrants, partially offset by the repayment of long-term debt in 2006. The proceeds from the direct offering were used to pay off debt and supplement working capital.
In 2006, we paid $0.3 million in capital lease obligations from capital lease arrangements that we entered into in 2006 totaling $0.5 million, and $0.3 million in capital lease obligations will become due within the next 12 months. Also, during 2006, we paid $0.6 million in operating lease obligations from various operating lease arrangements, and $0.8 million in operating lease obligations will become due within the next 12 months.
Off Balance Sheet Arrangements
We have a standby letter of credit outstanding that is collateralized by a restricted cash account in connection with the lease of our executive and operating offices in Woodland Hills, California. This letter of credit includes automatic renewals on the anniversary date of the lease origination, and permits annual automatic reductions of approximately $0.1 million. As of December 31, 2007, the letter of credit obligation and corresponding cash collateral balance was $0.3 million.
At December 31, 2007, we had outstanding various other irrevocable standby letters of credit issued to the benefit of the California Horse Racing Board, ORC and Washington Horse Racing Commission totaling $1.1 million. These letters of credit include automatic renewals on their anniversary dates.
Contractual Obligations, Contingent Liabilities and Commitments
We have contractual obligations and commitments primarily with regard to facilities leases and employment contracts. The following table aggregates our expected contractual obligations as of December 31, 2007:
                                                 
    Payments Due by Period  
                                  2012 and        
Contractual Obligations   2008     2009     2010     2011     Beyond     Total  
    (in thousands)  
Gary W. Sproule (1)
  $ 344     $ 344     $ 344                     $ 1,032  
James A. Burk
    300       175                               475  
Capital leases and other financed arrangements
    690       309                               999  
Operating equipment leases
    868       449                               1,317  
Operating facility leases
    1,264       1,186       282       102       484       3,318  
Minimum totalizator related guarantees
    600       500                               1,100  
IRG earn-out payments (2)
    4,293                                       4,293  
Bank debt (3)
    6,500       4,458                               10,958  
Notes payable (4)
    3,200                                       3,200  
Other
    450       97       72                       619  
 
                                   
 
                                               
Total
  $ 18,509     $ 7,518     $ 698     $ 102     $ 484     $ 27,311  
 
                                   

 

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(1)  
Mr. Sproule resigned in April 2008, and under his employment agreement he is entitled to receive severance of approximately $0.9 million in the aggregate.
 
(2)  
The final IRG earn-out obligation reflects our current calculation of the amount potentially payable, with no effect to a possible reduction for any claims we may assert against the seller. See Note 2 “Restatement” and Note 19 “Subsequent Events” in our consolidated financial statements at the end of this report for more information.
 
(3)  
Consists of the aggregate principal payments under a term loan from 2008 to 2009 and aggregate final monthly payments of $4.4 million under the term loan in 2009. The revolving credit facility, as amended, currently provides for borrowings of up to $1.0 million. See “—Credit Facility” for more information. The amounts reported in the table do not include interest payments because the interest rate under the credit agreement is variable and cannot be accurately calculated.
 
(4)  
See “—Youbet Promissory Notes” for more information.
In 2007, we entered into capital and operating lease arrangements for networking equipment, computer equipment and software totaling $1.8 million, of which $0.9 million will become due within the next 12 months.
All accounts payable and accrued expenses presented in the consolidated financial statements are excluded from this table.
Youbet Promissory Notes
On February 10, 2006, we issued three promissory notes with an aggregate principal amount of $10.2 million in connection with the acquisition of United Tote. For information regarding this acquisition, see Note 10 “Debt” and Note 15 “Acquisitions” in our consolidated financial statements at the end of this report.
The first promissory note had a principal amount of $5.2 million, matured on February 9, 2007, and bore interest at 5.02% per annum, which interest was payable on a quarterly basis beginning May 31, 2006. The terms of this promissory note required that we promptly prepay this obligation if we receive any “excess capital”, and our December 2006 registered direct offering created “excess capital”. In accordance with the terms of the first promissory note, we prepaid the $5.2 million note, including interest, from the proceeds of our registered direct offering in December 2006.
The second promissory note had a principal amount of $1.8 million and bore interest at 5.02%. The terms of the $1.8 million note provide that we are not required to make a mandatory “excess capital” prepayment under the $1.8 million note until the $5.2 million note has been paid in full, but no earlier than March 12, 2007. We prepaid the $1.8 million principal amount, including accrued interest of $0.1 million, on March 12, 2007 with a portion of the proceeds of our December 2006 registered direct offering.
The third promissory note has a principal amount of $3.2 million, bears interest at 5.02%, and is currently due, but is subject to rights of indemnification and offset. The terms of the $3.2 million note provide that: (i) we are not required to make a mandatory “excess capital” prepayment under the $3.2 million note until both the $5.2 million note and the $1.8 million note have been paid in full, but no earlier than June 11, 2007; and (ii) we may set off from the amount we owe under this note any loss suffered by us for which we are entitled to indemnification under the United Tote stock purchase agreement. We have four outstanding indemnification claims regarding a United Tote employee lawsuit, a Canadian tax issue, an Internal Revenue Service tax issue, and a Pennsylvania tax issue. As such, payments may be subject to appeal and/or subject to escrow pending resolution. Accrued interest on the $3.2 million note at December 31, 2007 was approximately $0.3 million.
The remaining promissory note cannot be transferred without our consent. Also, this promissory note contains customary events of default and provides that, upon the occurrence of certain events of default, we will be required to pay default interest of 11.02% per annum until the event of default is cured or until the note is paid in full. We are not in default under the remaining outstanding promissory note.
Credit Facility
Our credit facility currently consists of a revolving line of credit and a $15.0 million term loan. At December 31, 2007, $10.9 million was owed on the term loan and we had no outstanding borrowings under the revolving credit facility.

 

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Proceeds from the term loan were drawn in July 2006 in order to repay the former United Tote credit facility. The principal of the term loan is to be repaid in monthly installments of $0.25 million. In addition, we made a $1.0 million principal payment in March 2008, and we have agreed to make two additional $1.0 million principal payments on July 1, 2008 and September 1, 2008, respectively, and one $0.5 million principal payment on December 1, 2008. These payments are in addition to the regularly scheduled payments, and they will be applied to such regularly scheduled payments in the inverse order of their maturity. The lending commitments under the credit facility are scheduled to terminate on January 31, 2009.
Borrowings under the credit agreement, as amended, will bear interest at the prime rate announced by Wells Fargo Bank, National Association at its principal office in San Francisco, California plus 1.50% per annum. At December 31, 2007, the interest rate on our credit facility was 8.75% per annum.
The credit agreement provides for mandatory prepayment upon the occurrence of certain specified events. The credit facility is secured by certain of our assets and certain of our subsidiaries are guarantors of our obligations under the credit facility. We are subject to customary covenants for financings of this type, including restrictions on our ability to incur indebtedness, make investments, pay dividends, repurchase shares or make capital expenditures. The amended credit agreement also contains certain financial covenants, including (i) a requirement to achieve certain specified EBITDA thresholds, (ii) a requirement to achieve a specified free cash flow (as defined in the credit agreement) threshold, (iii) a requirement to maintain a specified leverage ratio, and (iv) limitations on capital expenditures.
As of December 31, 2007, we were not in compliance with certain financial covenants under the credit agreement and the lender has waived our defaults and agreed to amend certain terms of the credit agreement. For a description of this amendment, see Note 19 “Subsequent Events” in our consolidated financial statements at the end of this report.
Critical Accounting Estimates and Policies
Critical accounting policies are those that are important to the portrayal of our financial condition and results, and which require management to make difficult, subjective or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We have made critical estimates in the following areas. We also believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenues
We record commission revenues and the related track and market access fees as operating expenses when wagers are settled, typically the same day as the wager. Other sources of revenue, such as tote services, are recorded when earned. Incentives offered to customers for them to wager on tracks that generate the greatest margins are deducted from gross revenues as are the volume discounts offered by IRG.
Pari-mutuel racetrack operators typically retain a portion of all wagers as their commission prior to distributing payoffs to the winners. In accordance with our agreements with TVG, Magna and various independent racetracks, we receive a fee from each racetrack for wagers delivered to their respective pari-mutuel pools. In the aggregate, these fees, coupled with tote service revenue, represent our primary revenue stream. We expect the majority of its future revenue to be in the form of fees from pari-mutuel wagering and tote service revenue. We generate additional revenue from processing fees, monthly subscription fees and the sale of handicapping information.
Allowance for doubtful accounts
We are required to make judgments, based on historical experience and future expectations, as to the collectibility of accounts receivable. The allowances for doubtful accounts represent allowances for trade accounts receivable that are estimated to be partially or entirely uncollectible. These allowances are used to reduce gross trade receivables to their estimated net realizable value. We record these allowances as a charge to general and administrative expenses based on estimates related to the following factors:
   
customer specific allowance;
 
   
amounts based upon an aging schedule; and
 
   
an estimated amount, based on our historical experience, for issues not yet identified.

 

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Inventory obsolescence
We regularly review inventory quantities on hand and record provisions for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements.
Valuation of long-lived and intangible assets
Long-lived assets, consist primarily of property, plant and equipment, goodwill and intangibles.
Long-lived assets, including goodwill, are reviewed for impairment whenever events or changes in circumstances have indicated that their carrying amounts may be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to its fair value in a current transaction between willing parties, other than in a forced liquidation sale. Recorded fair value was estimated by independent appraisals and other valuation techniques.
Factors we consider important which could trigger an impairment review include the following:
   
Significant underperformance relative to expected historical or projected future operating results;
 
   
Significant changes in the manner of our use of the acquired assets or the strategy of our overall business;
 
   
Significant negative industry or economic trends;
 
   
Significant decline in our stock price for a sustained period; and
 
   
Our market capitalization relative to net book value.
If we determine that the carrying value of long-lived assets and related goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we would measure any impairment based on comparing the carrying amount of the asset to its fair value in a current transaction between willing parties or, in the absence of such measurement, on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Any amount of impairment so determined would be written off as a non-cash charge to the income statement, together with an equal reduction of the related asset.
Intangibles, such as licenses and patents are stated at cost and are amortized over their estimated economic life or agreement term, whichever is shorter.
Internally developed software
The capitalization of software development costs under the provisions of Statement of Position 98-1, or SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use requires judgment in determining when a project has reached and concluded the development stage and the period over which the Company expects to benefit from the use of that software. We amortize capitalized software development costs using the straight-line method over the expected useful life of the product, generally between two and four years. We regularly review the carrying value and amortization lives of capitalized software development costs, and we recognize a non-cash charge if the estimated value benefit related to the asset falls below the unamortized cost.
Indemnification agreements
Under our bylaws and certain consulting and employment agreements, we have agreed to indemnify our officers, directors and other service providers. The term of the indemnification period is for the individual’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, Youbet has a director and officer liability insurance policy that limits its exposure and enables it to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal, and we had no liabilities under these agreements as of December 31, 2007.

 

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We enter into indemnification provisions under our agreements with other companies in the ordinary course of business. Under these provisions, we generally indemnify the indemnified party for losses suffered or incurred by the indemnified party as a result of our activities. These indemnification provisions generally survive termination of the underlying agreement. We have not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements.
We believe the estimated fair value of these agreements is minimal. Accordingly, we had no liabilities for these agreements recorded under FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others - an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34 as of December 31, 2006 and 2007.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value and establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FAS 115. SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value in situations when they are not required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 157 and SFAS 159 became effective for us on January 1, 2008. The adoption of SFAS No. 157 or SFAS No. 159 did not have a material impact on our financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations, (SFAS 141R). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations we engage in will be recorded and disclosed following existing GAAP until January 1, 2009. We expect SFAS 141R will have an impact on our consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate after the effective date.
In December 2007, the FASB also issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-An Amendment of ARB No. 51. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2007, and earlier adoption is prohibited. Since we do not now have and do not contemplate acquiring any interests in subsidiaries or variable interest entities with noncontrolling interests, we currently expect that SFAS No. 160 will not have an impact on our future financial position, results of operations or operating cash flows.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements for Youbet.com, Inc. are included at the end of this report beginning on page F-1.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Controls and Procedures. As of December 31, 2007, after considering the internal control implications, if any, that gave rise to the need for the restatement, our management, including the Interim Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“the Exchange Act”). These disclosure controls and procedures are designed to ensure that material information we must disclose in this report is recorded, processed, summarized and filed or submitted on a timely basis and that such information is accumulated and communicated to management, including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure. For the reasons discussed in Management’s Report on Internal Control Over Financial Reporting (“Management’s Report”), which appears at the beginning of our consolidated financial statements located elsewhere in this report, management, including the Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, concluded that our disclosure controls and procedures were effective as of December 31, 2007.

 

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Changes in Internal Control Over Financial Reporting. Other than the changes described under “Changes in Internal Control over Financial Reporting” in Management’s Report, no change in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) occurred during the quarter ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting. Management’s report and the report of our independent registered public accounting firm on our internal control over financial reporting are included with our consolidated financial statements at the end of this report under the captions, “Management’s Report on Internal Control Over Financial Reporting” and “Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting” and are incorporated herein by reference.
PART IV.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
  (a)  
The following documents are filed as part of this report:
  (1)  
The consolidated financial statements of Youbet.com, Inc. which are listed on the Index to consolidated financial statements appearing on page F-1 of this report.
 
  (2)  
Schedule II — Valuation and Qualifying Accounts. All other schedules are omitted because they are not applicable, not required or the information is included elsewhere in the consolidated financial statements or notes thereto.
 
  (3)  
List of Exhibits:
  2.1  
Stock Purchase Agreement, dated as of November 30, 2005, by and among Youbet.com, Inc., UT Gaming, Inc., UT Group, LLC, and United Tote Company (incorporated by reference to Exhibit 2.1 to Youbet’s Current Report on Form 8-K dated November 30, 2005 and filed December 5, 2005).
 
  2.2  
First Amendment to Stock Purchase Agreement, dated as of December 22, 2005, by and among Youbet.com, Inc., UT Gaming, Inc., UT Group, LLC, and United Tote Company (incorporated by reference to Exhibit 2.2 to Youbet’s Current Report on Form 8-K dated and filed December 22, 2005).
 
  2.3  
Second Amendment to Stock Purchase Agreement, dated as of January 26, 2006, by and among Youbet.com, Inc., UT Gaming, Inc., UT Group, LLC, and United Tote Company (incorporated by reference to Exhibit 2.3 to Youbet’s Current Report on Form 8-K dated and filed January 26, 2006).
 
  2.4  
Third Amendment to Stock Purchase Agreement, dated as of February 10, 2006, by and among Youbet.com, Inc., UT Gaming, Inc., UT Group, LLC, and United Tote Company (incorporated by reference to Exhibit 2.4 to Youbet’s Current Report on Form 8-K dated February 10, 2006 and filed February 13, 2006).
 
  3.1  
Certificate of Incorporation of Youbet.com, Inc., as amended (incorporated by reference to Exhibit 3.1 to Youbet’s Form 10-QSB for the quarter ended September 30, 2003).
 
  3.2  
Amended and Restated Bylaws of Youbet.com, Inc. (incorporated by reference to Exhibit 3.1 to Youbet’s Current Report on Form 8-K dated April 16, 2007 and filed April 20, 2007).
 
  4.1  
Registration Rights Agreement by and among Youbet.com, Inc. (formerly You Bet International, Inc.) and the other parties listed therein dated June 29, 1998 (incorporated by reference to Exhibit 99.5 to Youbet’s Current Report on Form 8-K dated June 29, 1998 and filed July 14, 1998).
 
  4.2  
Warrant to purchase Youbet common stock issued to Robert M. Fell dated June 29, 1998 (incorporated by reference to Exhibit 99.3 to Youbet’s Current Report on Form 8-K dated June 29, 1998 and filed July 14, 1998).
 
  4.3  
Registration Rights Agreement, dated as of June 1, 2005, by and among Youbet.com, Inc., and Louis J. Tavano, James Scott and Richard M. Tavano (incorporated by reference to Youbet’s Form 10-Q for the quarter ended June 30, 2005).

 

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  4.4  
Stockholder Rights Agreement, dated as of February 10, 2006, by and between Youbet.com, Inc. and UT Group, LLC (incorporated by reference to Exhibit 4.1 to Youbet’s Current Report on Form 8-K dated February 10, 2006 and filed February 13, 2006).
 
  4.5  
Amendment No. 1, dated as of May 3, 2006, to Stockholder Rights Agreement, dated as of February 10, 2006, by and between Youbet.com, Inc. and UT Group LLC (incorporated by reference to Exhibit 4.2 to Youbet’s Current Report on Form 8-K dated May 3, 2006 and filed May 4, 2006).
 
  4.6  
Waiver Letter, dated as of April 11, 2006, by and among Youbet.com, Inc., UT Gaming, Inc., UT Group LLC, and United Tote Company (incorporated by reference to Exhibit 4.5 to Youbet’s Registration Statement on Form S-3 (File No. 333-133478) filed April 21, 2006).
 
  4.8  
Forced Sale Notice dated January 23, 2007 (incorporated by reference to Exhibit 10.1 to Youbet’s Current Report on Form 8-K dated January 23, 2007 and filed January 25, 2007).
 
  10.1  
Youbet.com, Inc. Equity Incentive Plan (incorporated by reference to Exhibit 10.2 to Youbet’s Registration Statement on Form S-3, SEC File No. 333-126131).*
 
  10.2  
Form of Incentive Stock Option Agreement (incorporated by reference to Youbet’s Form 10-Q for the quarter ended June 30, 2005).*
 
  10.3  
Form of Non-Employee Director Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.7 to Youbet’s Form 10-Q for the quarter ended June 30, 2007).*
 
  10.4  
Form of lease agreement for the Woodland Hills Facility dated March 11, 2000 (incorporated by reference to Exhibit 10.26 to Youbet’s Form 10-K for the year ended December 31, 2000).
 
  10.5  
Amendment, dated as of September 8, 2003, to lease agreement for the Woodland Hills Facility dated March 11, 2000 (incorporated by reference to Exhibit 10.6 to Youbet’s Form 10-KSB for the year ended December 31, 2003).
 
  10.6  
License and Content Agreement, dated as of May 18, 2001, by and among ODS Technologies, L.P., ODS Properties, Inc. and Youbet.com, Inc. (incorporated by reference to Exhibit 10.27 to Youbet’s Form 10-Q for the quarter ended June 30, 2001).
 
  10.7  
Amendment to License and Content Agreement dated as of June 6, 2007, by and among ODS Technologies, L.P., ODS Properties, Inc. and Youbet.com, Inc. (incorporated by reference to Exhibit 10.2 to Youbet’s Current Report on Form 8-K dated June 6, 2007 and filed June 12, 2007).
 
  10.8  
Employment Agreement, dated as of June 16, 2003, by and between Youbet.com, Inc. and Charles F. Champion (incorporated by reference to Exhibit 10.25 to Youbet’s Form 10-KSB for the year ended December 31, 2003).*
 
  10.9  
First Amendment, dated as of August 1, 2005, to Employment Agreement, dated as of June 16, 2003, by and between Youbet.com, Inc. and Charles F. Champion (incorporated by reference to Exhibit 10.2 to Youbet’s Form 10-Q for the quarter ended September 30, 2005).*
 
  10.10  
Second Amendment, dated as of December 31, 2005, to Employment Agreement, dated as of June 16, 2003, by and between Youbet.com, Inc. and Charles F. Champion (incorporated by reference to Exhibit 10.9 to Youbet’s Form 10-K for the fiscal year ended December 31, 2005).*
 
  10.11  
Separation Agreement and Mutual Release of Claims, dated as of November 29, 2007, between Youbet.com, Inc. and Charles F. Champion (incorporated by reference to Exhibit 10.1 to Youbet’s Current Report on Form 8-K dated November 28, 2007 and filed November 30, 2007).*
 
  10.12  
Employment Agreement, dated as of January 1, 2004, by and between Youbet.com, Inc. and Gary W. Sproule (incorporated by reference to Exhibit 10.2 to Youbet’s Form 10-Q for the quarter ended June 30, 2004).*
 
  10.13  
First Amendment, dated as of August 1, 2005, to Employment Agreement, dated as of January 1, 2004, by and between Youbet.com, Inc. and Gary W. Sproule (incorporated by reference to Exhibit 10.4 to Youbet’s Form 10-Q for the quarter ended September 30, 2005).*
 
  10.14  
Employment Agreement, dated as of July 20, 2004 by and between Youbet.com, Inc. and Scott A. Solomon, as amended as of July 20, 2004 and supplemented as of January 25, 2006 (incorporated by reference to Exhibit 10.2 to Youbet’s Form 10-Q for the quarter ended September 30, 2006).*

 

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  10.15  
Youbet.com, Inc. Offer Letter to Michael D. Nelson, dated December 12, 2006 and accepted December 13, 2006 (incorporated by reference to Exhibit 99.2 to Youbet’s Current Report on Form 8-K dated December 13, 2006 and filed January 8, 2007).*
 
  10.16  
Employment Agreement, dated as of July 9, 2007, by and between Youbet.com, Inc. and James A. Burk (incorporated by reference to Exhibit 10.1 to Youbet’s Current Report on Form 8-K dated July 9, 2007 and filed July 11, 2007).*
 
  10.17  
Promissory Notes issued by Youbet.com, Inc. in favor of UT Group, LLC (incorporated by reference to Exhibit 10.4 to Youbet’s Current Report on Form 8-K dated February 10, 2006 and filed February 13, 2006).
 
  10.18  
Credit Agreement dated as of July 27, 2006, by and among Youbet.com, Inc. and United Tote Company, as borrowers, the lenders signatory thereto, as lenders, and Wells Fargo Foothill, Inc., as arranger and administrative agent (incorporated by reference to Exhibit 10.1 to Youbet’s Current Report on Form 8-K dated July 27, 2006 and filed July 28, 2006).
 
  10.19  
First Amendment to Credit Agreement and Waiver, dated as of March 14, 2007, by and among Youbet.com, Inc. and United Tote Company, as borrowers, and Wells Fargo Foothill, Inc., as arranger and agent (incorporated by reference to Exhibit 10.16 to Youbet’s Annual Report on Form 10-K for the year ended December 31, 2006).
 
  10.20  
Consent to Stock Repurchase, dated as of April 10, 2007, by and between Youbet.com, Inc., as administrative borrower, and Wells Fargo Foothill, Inc., as administrative agent (incorporated by reference to Exhibit 10.3 to Youbet’s Current Report on Form 8-K dated April 10, 2007 and filed April 11, 2007).
 
  10.21  
Waiver of Default Side Letter Agreement, dated as of October 30, 2007, by and among Youbet.com, Inc. and United Tote Company, Inc., as borrowers, and Wells Fargo Foothill, Inc., as administrative agent (incorporated by reference to Exhibit 10.5 to Youbet’s Current Report on Form 8-K dated October 30, 2007 and filed November 5, 2007).
 
  10.22  
Consent Letter, dated as of February 13, 2008, by and among Youbet.com, Inc. and United Tote Company, Inc., as borrowers, and Wells Fargo Foothill, Inc., as agent and as lender (incorporated by reference to Youbet’s Current Report on Form 8-K dated February 7, 2008 and filed February 13, 2008).
 
  10.23  
Second Amendment to Credit Agreement and Acknowledgement of Guarantors, dated as of March 25, 2008, by and among Youbet.com, Inc. and United Tote Company, Inc., as borrowers, and Wells Fargo Foothill, Inc., as arranger and agent, and acknowledged by IRG US Holdings Corp., IRG Services, Inc. and UT Gaming, Inc., as guarantors (incorporated by reference to Exhibit 10.23 to Youbet’s Annual Report on Form 10-K for the year ended December 31, 2007).
 
  23.1  
Consent of Piercy Bowler Taylor & Kern.
 
  24.1  
Power of Attorney (set forth on the signature page of this report).
 
  31.1  
Certification of President and Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
 
  31.2  
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
 
  32.1  
Certifications Pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.
 
     
*  
Management contract or compensatory plan.

 

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SIGNATURES
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.
         
  YOUBET.COM, INC.
 
 
July 31, 2008  By:   /s/ Michael Brodsky    
    Michael Brodsky   
    President and Chief Executive Officer   
Power of Attorney
Youbet.com, Inc. a Delaware corporation, and each person whose signature appears below, constitutes and appoints Michael Brodsky and James A. Burk, and either of them, with full power to act without the other, such person’s true and lawful attorneys-in-fact, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign this annual report on Form 10-K/A and any and all further amendments to such annual report on Form 10-K/A and other documents in connection therewith, and to file the same, and all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact, and each of them, full power and authority to do and perform each and every act and thing necessary or desirable to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, thereby ratifying and confirming all that said attorneys-in-fact, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of Youbet.com, Inc. and in the capacities and on the dates indicated.
             
Signature   Title   Date
 
/s/ Michael Brodsky
 
Michael Brodsky
  President and Chief Executive Officer
(Principal Executive Officer)
  July 31, 2008
 
           
/s/ James A. Burk
 
James A. Burk
  Chief Financial Officer
(Principal Financial Officer)
  July 31, 2008
 
           
/s/ Michael D. Nelson
 
Michael D. Nelson
  Corporate Controller
(Principal Accounting Officer)
  July 31, 2008
 
           
/s/ Gary Adelson
 
Gary Adelson
  Director    July 31, 2008
 
           
/s/ Michael D. Sands
 
Michael D. Sands
  Director    July 31, 2008
 
           
/s/ Jay Pritzker
 
Jay Pritzker
  Director    July 31, 2008
 
           
/s/ James Edgar
 
James Edgar
  Director    July 31, 2008
 
           
/s/ F. Jack Liebau
 
F. Jack Liebau
  Director    July 31, 2008
 
           
/s/ Michael Soenen
 
Michael Soenen
  Director    July 31, 2008
 
           
/s/ Raymond Anderson
 
Raymond Anderson
  Director    July 31, 2008

 

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Index to Consolidated Financial Statements
         
    Page  
 
       
    F-1  
 
       
    F-3  
 
       
    F-4  
 
       
Consolidated financial statements:
       
 
       
    F-5  
 
       
    F-6  
 
       
    F-7  
 
       
    F-8  
 
       
    F-9  
 
       

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Youbet.com, Inc. (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment or breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override.
Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements, as was the case with the miscalculation corrected in this report. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has re-assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, after considering the internal control implications, if any, that gave rise to the need for the restatement. In making this re-assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control-Integrated Framework”.
In 2007, the Company undertook remediation efforts with respect to internal control over financial reporting surrounding the: (i) pervasive control deficiencies across key COSO components including information technology general controls (ITGC) and information technology (IT) application controls, and (ii) control deficiencies across key business processes at all operating units. Most of these deficiencies consisted of an insufficient or ineffective control environment, lack of segregation of duties, insufficient documentation of key business process policies and procedures, insufficient IT security, insufficient staffing and training among accounting personnel, incomplete and untimely reconciliations related to financial reporting and insufficient managerial oversight, review and approval processes over financial reporting. Management devoted substantial resources to remediate these deficiencies and, in consideration of such remediation, have concluded that the Company’s internal control over financial reporting was effective as of December 31, 2007. Management also, considered and re-assessed its procedures used to calculate the potential earn-out accrual for the fourth quarter 2007, including review by outside counsel that drafted the IRG acquisition agreement for the Company.
Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007 has been audited by Piercy Bowler, Taylor & Kern, as stated in their report which appears on page F-3 of this Form 10-K under the heading, Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting.
Changes in Internal Control over Financial Reporting
As disclosed in the Company’s 2006 Annual Report on Form 10-K, and in its Quarterly Reports on Form 10-Q for each of the first three quarters of 2007, the Company reported a material weakness in its internal control over financial reporting related to the: (i) pervasive control deficiencies across key COSO components including ITGC and IT application controls, and (ii) control deficiencies across key business processes at all operating units. A material weakness is a deficiency, or a combination of deficiencies, in internal controls over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis.

 

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As of December 31, 2007, the Company had remediated the previously reported material weakness in its internal control over financial reporting related to the (i) pervasive control deficiencies across key COSO components including ITGC and IT application controls, and (ii) control deficiencies across key business processes at all operating units. The following remedial actions have been undertaken:
   
With the establishment of the Company’s Compliance Department in March 2007 and help of external advisors (other than the Company’s independent registered public accounting firm), standard controls were enhanced for pervasive control deficiencies over ITGC, which included increasing access security over critical computer applications, eliminating incompatible functions and improving segregation of duties, documentation of various IT policies, processes and procedures and identification and implementation of ITGC key controls.
   
Organizational structure changes were made to enhance efficiency and segregation of duties controls for business processes. A new Chief Accounting Officer and Chief Financial Officer were hired in January 2007 and July 2007, respectively, with appropriate backgrounds and experience for a public company. Management review and approval controls were put in place prior to posting transactions into the financial reporting system. Monitoring entity level controls were implemented to improve the company’s control environment.
   
In the fourth quarter of 2007, the Company made further enhancements to its internal controls over financial reporting, including: review and approve procedures for completeness and accuracy over United Tote’s interface billing; fixed asset transfer review and approval between United Tote locations to monitor and improve equipment tracking and verification for appropriateness of transfers; and computer application access controls were implemented according to job function and responsibilities.
In the third and fourth quarters of 2007, and in the initial part of the first quarter of 2008, the Company also undertook and completed, as appropriate, its testing to validate compliance with the enhanced policies, procedures and controls. The Company has undertaken this testing over these three periods so as to be able to demonstrate operating effectiveness over a period of time that is sufficient to support its conclusion. In reviewing the results from this testing, management has concluded that the internal controls related to the completeness and accuracy of the Company’s financial reporting have been significantly improved and that the above referenced material weakness in internal control over financial reporting had been remediated as of December 31, 2007.
     
/s/ Michael Brodsky
  /s/ James A. Burk
 
   
Michael Brodsky
  James A. Burk
President and Chief Executive Officer
  Chief Financial Officer

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors
Youbet.com, Inc.
Woodland Hills, California
We have audited the internal control over financial reporting of Youbet.com, Inc. and Subsidiaries (the Company) as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Youbet.com, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Youbet.com, Inc. and Subsidiaries as of and for the year ended December 31, 2007 (as restated), and our report dated March 28, 2008, except for the matters discussed in Note 2 to the consolidated financial statements, as to which the date is July 28, 2008, expressed an unqualified opinion thereon.
PIERCY BOWLER TAYLOR & KERN

/s/ Piercy, Bowler, Taylor & Kern
Certified Public Accountants
Las Vegas, Nevada
March 28, 2008, except for the effects of the matters discussed in Note 2 to the consolidated financial statements, as to which the date is July 28, 2008.

 

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Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENTS
Board of Directors
Youbet.com, Inc.
Woodland Hills, California
We have audited the accompanying consolidated balance sheets of Youbet.com, Inc. and Subsidiaries (the Company) as of December 31, 2007 (as restated) and 2006, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years ended December 31, 2007 (as restated), 2006 and 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position Youbet.com, Inc. and Subsidiaries as of December 31, 2007 (as restated) and 2006, and the results of its operations and its cash flows for each of the three years ended December 31, 2007 (as restated), 2006 and 2005, in conformity with accounting principles generally accepted in the United States.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 28, 2008, except for the effects of the matters discussed in Note 2 to the consolidated financial statements, as to which the date is July 28, 2008, expressed an unqualified opinion thereon.
PIERCY BOWLER TAYLOR & KERN

/s/ Piercy, Bowler, Taylor & Kern
Certified Public Accountants
Las Vegas, Nevada
March 28, 2008, except for the matters discussed in Note 2 to the consolidated financial statements, as to which the date is July 28, 2008.

 

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Table of Contents

Youbet.com, Inc. and Subsidiaries
Consolidated Balance Sheets
As of December 31, 2007 and 2006
                 
    Restated        
(in thousands, except share amounts)   2007     2006  
ASSETS
               
Current assets
               
Cash and cash equivalents
  $ 6,551     $ 21,051  
Current portion of restricted cash
    8,635       4,862  
Accounts receivable, net of allowance for doubtful collection of $3,406 and $1,813
    7,314       13,287  
Inventories
    2,085       2,587  
Current portion of deferred tax asset
          2,367  
Prepaid expenses and other current assets
    1,417       1,072  
 
           
 
    26,002       45,226  
Property and equipment, net of accumulated depreciation and amortization of $21,638 and $13,787
    24,664       30,110  
Intangibles and assets other than goodwill
    6,505       13,369  
Goodwill
    6,859       15,243  
Other assets
    1,020       1,657  
 
           
 
  $ 65,050     $ 105,605  
 
           
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities
               
Current portion of long-term debt
  $ 10,390     $ 8,311  
Trade payables
    10,028       13,759  
Accrued expenses
    11,346       9,489  
Customer deposits
    8,326       8,441  
Deferred revenues
    212       207  
 
           
 
    40,302       40,207  
Long-term debt, net of current portion
    4,767       12,054  
Deferred tax liability
          570  
 
           
 
    45,069       52,831  
 
           
Stockholders’ equity
               
Preferred stock, $0.001 par value, authorized 1,000,000 shares, none outstanding
               
Common stock, $0.001 par value, authorized 100,000,000 shares, 42,562,805 and 42,118,446 shares issued and outstanding
    43       42  
Additional paid-in-capital
    134,286       137,597  
Deficit
    (111,973 )     (83,555 )
Accumulated other comprehensive loss
    (56 )     (10 )
Less treasury stock, 1,043,781 shares and 443,062 shares at cost
    (2,319 )     (1,300 )
 
           
 
    19,981       52,774  
 
           
 
  $ 65,050     $ 105,605  
 
           
See notes to consolidated financial statements.

 

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Youbet.com, Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31, 2007, 2006 and 2005
                         
(in thousands, except share and per share amounts)   Restated
2007
    2006     2005  
 
Revenues
                       
Commissions
  $ 110,315     $ 109,900     $ 85,555  
Contract revenues
    23,316       21,568          
Equipment sales
    877       1,295          
Other
    3,685       3,637       3,282  
 
                 
 
    138,193       136,400       88,837  
 
                 
Costs and expenses
                       
Track fees
    50,110       52,397       38,038  
Licensing fees
    19,810       21,967       19,541  
Network operations
    5,176       5,348       4,910  
Contract costs
    16,585       13,548          
Cost of equipment sales
    429       674          
 
                 
 
    92,110       93,934       62,489  
 
                 
Gross profit
    46,083       42,466       26,348  
 
                 
 
                       
Operating expenses
                       
General and administrative
    25,394       23,610       13,734  
Sales and marketing
    11,539       9,463       6,359  
Research and development
    4,270       3,211       1,579  
Depreciation and amortization
    10,370       6,823       1,591  
Impairment write downs
    18,923                  
 
                 
 
    70,496       43,107       23,263  
 
                 
Income (loss) from continuing operations
    (24,413 )     (641 )     3,085  
Interest income
    644       547       581  
Interest expense
    (1,795 )     (1,955 )     (81 )
Other
    153       725       252  
 
                 
Income (loss) from continuing operations before income tax (benefit)
    (25,411 )     (1,324 )     3,837  
 
Income tax (benefit)
    2,083       734       (1,854 )
 
                 
Income (loss) from continuing operations
    (27,494 )     (2,058 )     5,691  
Discontinued operations
                       
Income (loss) from discontinued operations, without tax effect
    (924 )     27          
 
                 
Net income (loss)
  $ (28,418 )   $ (2,031 )   $ 5,691  
 
                 
 
                       
Basic income (loss) per share
                       
Income (loss) from continuing operations
  $ (0.66 )   $ (0.06 )   $ 0.18  
Income (loss) from discontinued operations
    (0.02 )                
 
                 
Net income (loss)
    (0.68 )     (0.06 )     0.18  
 
                 
Diluted income (loss) per share
                       
Income (loss) from continuing operations
  $ (0.66 )   $ (0.06 )   $ 0.16  
Income (loss) from discontinued operations
    (0.02 )                
 
                 
Net income (loss)
    (0.68 )     (0.06 )     0.16  
 
                 
Weighted average shares outstanding
                       
Basic
    41,796,218       35,141,027       32,078,957  
Diluted
    41,796,218       35,141,027       34,643,677  
See notes to consolidated financial statements.

 

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Youbet.com, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2007 (Restated), 2006 and 2005
                                                         
                            Accumulated                      
                    Additional     Other                      
    Common Stock     Paid-In     Comprehensive             Treasury        
    Shares     Dollars     Capital     Loss     Deficit     Stock     Total  
                            (in thousands)                          
 
                                                       
Balances at January 1, 2005
    30,980     $ 31     $ 103,111             $ (87,215 )   $ (1,829 )   $ 14,098  
Warrants exercised
    179               114                               114  
Stock options exercised
    2,293       2       2,123                               2,125  
Treasury stock re-issuance
                    512                       488       1,000  
Stock based compensation
                    (144 )                             (144 )
Net income
                                    5,691               5,691  
 
                                         
Balances at December 31, 2005
    33,452       33       105,716             (81,524 )     (1,341 )     22,884  
Warrants exercised
    25               12                               12  
Stock options exercised
    260       1       255                               256  
Treasury stock re-issuance
                    13                       41       54  
Equity sale
    6,200       6       18,947                               18,953  
Stock issued in connection with acquisition of United Tote
    2,182       2       11,998                               12,000  
Cumulative translation adjustment
                            (10 )                     (10 )
Stock based compensation
                    656                               656  
Net loss
                                    (2,031 )             (2,031 )
 
                                         
Balances at December 31, 2006
    42,119       42       137,597       (10 )     (83,555 )     (1,300 )     52,774  
Stock options exercised
    444       1       352                               353  
Payment to former owners of United Tote under “make-whole” provision
                    (4,473 )                             (4,473 )
Other
                    (88 )                             (88 )
Purchase of treasury stock
                                            (1,019 )     (1,019 )
Cumulative translation adjustment
                            (46 )                     (46 )
Stock based compensation
                    898                               898  
Net loss
                                    (28,418 )             (28,418 )
 
                                         
Balances at December 31, 2007
    42,563     $ 43     $ 134,286     $ (56 )   $ (111,973 )   $ (2,319 )   $ 19,981  
 
                                         
See notes to consolidated financial statements.

 

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Youbet.com, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2007, 2006, and 2005
                         
    Restated              
    2007     2006     2005  
    (in thousands)  
Operating activities
                       
Net income (loss)
  $ (28,418 )   $ (2,031 )   $ 5,691  
Income (loss) from discontinued operations
    (924 )     27          
 
                 
Income (loss) from continuing operations
    (27,494 )     (2,058 )     5,691  
 
                 
Adjustments to reconcile net income (loss) to net cash provided by operating activities
                       
Depreciation and amortization of property
    8,431       5,333       1,252  
Amortization of intangibles
    1,939       1,491       339  
Goodwill and intangibles impairment
    18,923                  
Stock-based compensation
    898       656       (144 )
Provision for doubtful accounts receivables
    3,509       173       132  
Provision for inventory obsolesence
    (353 )                
Other
    (59 )                
Increase in operating (assets) and liabilities
                       
Restricted cash, Players Trust SM
    (3,863 )     (443 )     (994 )
Accounts receivable
    2,306       (7,471 )     (78 )
Inventory
    855       (610 )      
Prepaid expenses
    (341 )     710       (371 )
Deferred tax asset
    1,797       (231 )     (1,854 )
Other assets
    510       768       (1,013 )
Trade payables
    (3,738 )     4,275       802  
Accrued expenses
    (1,187 )     4,036       1,115  
Customer deposits
    (115 )     2,536       943  
Deferred revenues
    5       (313 )     9  
Deferred tax liability
    (1 )     570          
 
                 
Net cash provided by operating activities
    2,022       9,422       5,829  
 
                 
Investing activities
                       
Purchase of property and equipment
    (2,504 )     (6,206 )     (1,414 )
Proceeds from sale of property and equipment
    59       576       3  
Cash paid for United Tote acquisition, net of $159 cash acquired in 2006
    (4,473 )     (10,191 )        
Cash paid for Bruen Productions International, Inc., net of $6 cash acquired
            (111 )        
Cash paid for IRG acquisition, net of $535 cash acquired
                    (1,579 )
Cash paid for IRG acquisition earn-out
    (3,106 )     (1,929 )        
Investments in intangibles and other
            (1,177 )     (35 )
Increase in restricted cash (other than Players Trust SM)
            (258 )     (1,000 )
Decrease in restricted cash (other than Players Trust SM)
    90       1,132       113  
Other
            166          
 
                 
Net cash used in investing activities
    (9,934 )     (17,998 )     (3,912 )
 
                 
Financing activities
                       
Proceeds from issuance of common stock
          18,953          
Proceeds from exercise of stock options and warrants
    353       268       2,239  
Purchase of treasury stock
    (1,019 )                
Proceeds from sale-leaseback transaction
    1,065                  
Proceeds from debt
    4,409       3,769          
Repayment of debt
    (11,045 )     (9,840 )     (758 )
Other
    (88 )                
 
                 
Net cash provided by financing activities
    (6,325 )     13,150       1,481  
 
                 
Net cash used in discontinued operations
                       
Net cash used in operating activities
    (217 )     (198 )        
Foreign currency translation adjustments
    (46 )     (10 )        
 
                 
Net increase/ (decrease) in cash and cash equivalents
    (14,500 )     4,366       3,398  
Cash and cash equivalents at the beginning of period
    21,051       16,685       13,287  
 
                 
Cash and cash equivalents at the end of period
  $ 6,551     $ 21,051     $ 16,685  
 
                 
 
                       
Supplemental disclosure of cash flow information:
                       
Cash paid for interest
  $ 1,322     $ 15     $ 60  
Cash paid for income taxes
    381       195       64  
Non-cash investing and financing activities:
                       
Re-issuance of 166,668 shares of treasury stock in IRG acquisition
                    1,000  
Accrued IRG acquisition earn-out payment
  $ 5,998     $ 2,676     $ 1,048  
Re-issuance of 13,953 shares of treasury stock for Bruen Productions
            54          
Seller financing of United Tote acquisition
            12,000          
Equipment acquired with capital lease and other financing arrangements
    1,428       469       1,007  
See notes to consolidated financial statements

 

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Youbet.com and Subsidiaries
Notes to Consolidated Financial Statements
Note 1: THE COMPANY
Youbet.com, Inc. and its consolidated subsidiaries (the Company) is a licensed, multi-jurisdictional facilitator of online pari-mutuel horse race wagering and a leading supplier of tote equipment and services to the racing industry. Through its main product, Youbet ExpressSM, Youbet offers its customers interactive, real-time audio/video broadcasts, access to a comprehensive database of handicapping information, and, in most states, the ability to wager on a wide selection of horse races in the United States, Canada, the United Kingdom, Australia, South Africa and Hong Kong. Youbet is working to expand its brand, products and services throughout the United States and in select international markets.
In 2006, Youbet expanded its product and service offering through the acquisition of United Tote Company and United Tote Canada (collectively with U.T. Gaming, Inc., referred to as United Tote). United Tote is a leading supplier of totalizator systems (a system that process wagers and payouts).
As of December 31, 2007, the Company had negative net working capital of $14.3 million. Principal ongoing cash requirements consist of payroll and benefits, business insurance, real estate and equipment leases, legal fees, data center operations, telecommunications and debt service. In addition, the former owners of the Company’s International Racing Group subsidiaries (collectively, “IRG”) are entitled to a potential final earn-out payment based on IRG’s performance. As discussed in Note 2, as of December 31, 2007, the Company accrued approximately $4.3 million, potentially payable on or about August 31, 2008. The precise payment is subject to reduction for the value, if any, of claims that may arise prior to the date such payment is due.
Management believes that its on-going efforts to contain costs and operate efficiently, combined with the growth in handle and yield improvement at Youbet Express, generates sufficient cash flow to adequately support its operations. Management believes that cash flows from operations and unrestricted cash and cash equivalents are sufficient to fund working capital and capital expenditure requirements for at least the next 12 months. However, the Company may from time to time seek additional capital to fund operations and reduce liabilities in response to changes in the business environment. To raise capital, the Company may seek to sell additional equity securities, issue debt or convertible securities or seek to obtain credit facilities through financial institutions or other resources. The Company has an effective shelf registration statement under which the Company may from time to time issue and offer debentures, notes, bonds, and other evidence of indebtedness, and forward contracts in respect of any such indebtedness, shares of preferred stock, shares of common stock, warrants, stock purchase contracts, stock purchase units, and stock purchase rights for an original maximum aggregate offering amount of approximately $30 million, or up to approximately $36 million if the Company utilized the shelf for one offering. Unless otherwise described in future prospectus supplements, the Company intends to use the net proceeds from the sale of securities registered under this universal shelf registration statement for general corporate purposes, which may include additions to working capital, the repayment or redemption of existing indebtedness and the financing of capital expenditures and future acquisitions. The sale of additional equity or convertible securities would result in additional dilution to the Company’s stockholders.
Note 2: RESTATEMENT
As previously disclosed, in October 2007, a search warrant was served on the Company at its headquarters in Woodland Hills, California, by federal agents, accompanied by agents of the Nevada Gaming Control Board, for various records including, among other things, business records of IRG related to the wagering activities of certain customers. The Company was advised that the U.S. Attorney’s Office is investigating a potentially wide net of activities of certain individuals who may have used telephone rebate wagering services, including those offered by IRG, in an allegedly illegal manner. In addition, the Oregon Racing Commission (ORC) issued a notice to commence proceedings seeking suspension of IRG’s license based upon alleged noncompliance with ORC requirements. In February 2008, in light of the future outlook for the IRG business, IRG stopped taking wagers and began the unwind of its business in an orderly fashion. The Company also entered into an a stipulation with the ORC, pursuant to which IRG and the ORC agreed that IRG would voluntarily surrender the license issued by the ORC, IRG would not re-apply for a hub license in Oregon, and the ORC would deem the allegations in their notice to be resolved and not pursue them. In March 2008, the Company entered into agreements with the U.S. Attorney’s Office in Las Vegas, pursuant to which the U.S. Attorney’s Office agreed not to pursue any charges against Youbet or IRG in exchange for our continued cooperation with the government’s ongoing investigation. Accordingly, in the fourth quarter of 2007, the Company recorded an impairment charge for the intangibles associated with the IRG business. The original impairment charge included amounts estimated and accrued for a final earn-out payment potentially payable to the former owners of IRG.

 

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Based on a miscalculation at the time the Company prepared its 2007 financial statements, the Company originally accrued $3.2 million for the final earn-out payment due August 31, 2008, although the precise payment, if any, is subject to reduction for any claims that may be determined prior to the date such payment is due. Management is in the process of determining what claims are available to reduce the final earn-out payment and intends to vigorously pursue any and all appropriate claims. The value of any such claims cannot be determined or reasonably estimated at this time, but they are in the nature of contingent assets and, therefore, will not be recoreded until the contingency is resolved.
Subsequent to the filing of the Company’s original annual report on Form 10-K, management identified the error in its calculation of the final earn-out potentially payable to the former owners of IRG, and the unpaid earn-out is currently believed to be $4.3 million, subject to any claims, as discussed above, that may be determined prior to the date such payment is due. Accordingly, this restatement increased the potential earn-out accrual by $1.1 million, which resulted in an equal increase to the impairment charge recorded in the fourth quarter of 2007 for intangible assets associated with IRG (Note 17). The restatement resulted in recording no related income tax benefit due to the tax position of the Company.
On July 3, 2008, upon the recommendation of management, the audit committee of the Company’s board of directors authorized the restatement of the previously-issued financial statements as of and for the year ended December 31, 2007 to correct the calculation error. The effect of the restatement on the consolidated balance sheet at December 31, 2007 and the consolidated statement of operations, consolidated statement of stockholders’ equity and consolidated statement of cash flows for the year ended December 31, 2007 is presented in the following tables.
                 
    December 31, 2007  
    As Originally Filed     Restated  
    (in thousands, other than per share amounts)  
 
               
Consolidated Balance Sheet
               
Liabilities and stockholders’ equity:
               
Accrued expenses
  $ 10,302     $ 11,346  
Current liabilities
    39,258       40,302  
Total liabilities
    44,025       45,069  
Deficit
    (110,929 )     (111,973 )
Total stockholders’ equity
    21,025       19,981  
 
               
Consolidated Statement of Operations
               
Operating expenses:
               
Impairment writedowns
    17,879       18,923  
Total operating expenses
    69,452       70,496  
 
               
Loss from continuing operations before interest income (expense) and other
    (23,369 )     (24,413 )
Loss from continuing operations before income tax benefit
    (24,367 )     (25,411 )
Loss from continuing operations
    (26,450 )     (27,494 )
Net loss
    (27,374 )     (28,418 )
 
               
Basic loss per share
               
Loss from continuing operations
    (0.63 )     (0.66 )
Net loss
    (0.65 )     (0.68 )
 
               
Consolidated Statement of Stockholders’ Equity
               
Net loss
    (27,374 )     (28,418 )
Balances as of December 31, 2007
    (110,929 )     (111,973 )
 
               
Consolidated Statement of Cash Flows
               
Net loss
    (27,374 )     (28,418 )
Loss from continuing operations before income tax benefit
    (26,450 )     (27,494 )
Goodwill and intangibles impairment
    17,879       18,923  
 
               
Non-cash and investing activities
               
Accrued IRG acquisition earn-out payment
    4,954       5,998  

 

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    December 31, 2007  
    As Originally Filed     Restated  
    (in thousands, other than per share amounts)  
Selected Unaudited Quarterly Results of Operations — Fourth Quarter
               
Goodwill and intangible impairment writedown
  $ 17,879     $ 18,923  
Total operating expenses
    35,320       36,364  
 
               
Loss from continuing operations before interest income (expense) and other
    (25,933 )     (26,977 )
Loss from continuing operations before income tax benefit
    (26,121 )     (27,165 )
Loss from continuing operations
    (28,511 )     (29,555 )
Net income (loss)
    (28,670 )     (29,714 )
 
               
Basic loss per share
               
Loss from continuing operations
    (0.68 )     (0.71 )
Net loss
    (0.68 )     (0.71 )
Note 3: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of consolidation
The consolidated financial statements include the accounts of Youbet and its wholly-owned subsidiaries (inclusive of IRG), United Tote and Bruen Productions International, Inc. (Bruen). All inter-company accounts and transactions have been eliminated in consolidation.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of 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.
Revenue recognition
Through Youbet and IRG, the Company earns and records commissions on wagers placed with tracks for customers as revenue and the related track and market area access fees as operating expenses when the wagers are settled, typically the same day as the wager. Other sources of revenue, including membership and information fees, are relatively insignificant. Prepayments of such fees are treated as deferred revenue and later recognized over the duration of the subscription. Incentives offered to customers to encourage wagering on events at tracks that generate higher margins are charged immediately to operations as reductions in commissions earned.
Youbet launched a player rewards program during the second quarter of 2006 called Youbet Advantage. Participating members earn points based on the amount they wager, and they can redeem their points for merchandise, travel rewards, and wager credits. Youbet’s Player Advantage incentives and IRG’s volume discounts are both recorded as a reduction of commission revenue when the points are issued or discounts are earned.
The majority of United Tote’s revenues are derived from service contracts principally for the installation and operation of pari-mutuel wagering networks. Services provided via these networks include accepting wagers, performing odds and payout calculations and calculating ticket payouts. United Tote charges the track for these services either by transaction count or by dollar volume in accordance with the related service contract. In some instances, United Tote incurs significant costs relating to these contracts before the systems become operational. United Tote is also required to provide various levels of routine operational support and software maintenance throughout the life of the contract, which is expensed as incurred. Revenue from the sale of pari-mutuel gaming systems equipment and related parts is recognized upon delivery and customer acceptance.

 

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Sales and similar revenue-based taxes collected from customers are excluded from revenue but rather are recorded as a liability payable to the appropriate taxing authority and included in accrued expenses.
Cash equivalents and restricted cash
Cash equivalents consist of highly liquid investments with maturities of three months or less at the date of purchase. For purposes of the financial statements, restricted cash (Note 4), current and non-current, is excluded from cash and cash equivalents.
Accounts receivable and allowance for doubtful accounts
Accounts receivable are carried, net of an appropriate allowance, at their estimated collectible value. Since customer credit is generally extended on a short-term basis, trade receivables do not bear interest. Accounts for which no payments have been received for two consecutive months are considered delinquent, and customary collection efforts are initiated.
The Company recognizes an allowance for doubtful accounts (Note 5) to reduce accounts receivable to an estimated net realizable value. The allowance for an estimated collection losses on its accounts receivable is established based on historic loss experience, the individual tracks and players, the relative strength of the Company’s legal position, the related cost of any proceedings, and general economic conditions.
The Company manages its concentrations of credit risk by evaluating the creditworthiness of tracks and players before extending credit. The maximum losses that the Company would incur if a track or player failed to pay would be limited to the amount due after the related allowances provided.
Fair value of financial instruments
The carrying value of financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses, approximate fair value due to the short maturities of these financial instruments. In evaluating the fair value of other financial instruments, consisting of long-term receivables and debt, the Company generally uses third-party market quotes. The estimated fair value of long-term receivables and debt approximates their carrying value.
Foreign currency
The functional currency of United Tote Canada is Canadian dollars. The Company translates assets and liabilities at exchange rates in effect at the balance sheet date and income and expense accounts at average exchange rates during the year.
Inventories
Inventories consist of totalizator equipment and components to build totalizator equipment. Inventories are stated at the lower of cost (using the first-in, first-out method) or market value. The Company regularly reviews inventory quantities on hand and records an allowance for estimated excess and obsolete inventory based primarily on the Company’s forecast of product demand and production requirements.
Property and equipment
Property and equipment is carried at cost less accumulated depreciation and amortization. Depreciation of property and equipment, which includes equipment under capital leases, is provided on the straight-line method over estimated useful lives, generally ranging from three to five years. Leasehold improvements are amortized over the estimated economic life or the term of the lease, including lease renewal option periods, if intended to be exercised, whichever is shorter. The majority of United Tote’s equipment is in place at various pari-mutuel gaming sites located throughout North America.
Also included in property and equipment is internally developed software. Internally used software, whether purchased or developed, is capitalized and amortized using the straight-line method over an estimated useful life of two to four years in accordance with American Institute of Certified Public Accountants Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.

 

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Goodwill
The Company evaluates its goodwill on an annual basis and if events and circumstances, significant decreases in the market value of an asset, a change in operating model or strategy and competitive forces indicate that the carrying amount of an asset may not be recoverable. If the expected undiscounted future cash flow attributable to the asset is less than the carrying amount of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded. Fair value is determined based on the present value of estimated future cash flows using a market discount rate commensurate with the risk involved, quoted market prices or appraised values, depending on the nature of the assets.
Income taxes
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes.
In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN No. 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 was effective for fiscal years beginning after December 15, 2006.
The Company adopted the provisions of FIN 48 on January 1, 2007. The adoption of FIN 48 had no effect on the Company’s reported deficit as of December 31, 2006, its net loss or net loss per share for 2007 or on its reported deferred net tax assets from net operating loss carryforwards or the related valuation allowance (Note 11).
The Company will recognize interest and penalties related to unrecognized tax benefits within the income tax expense (benefit) line in its consolidated statement of operations. As of December 31, 2007, the Company had not recognized liabilities for penalty and interest as the Company does not have liability for unrecognized tax benefits.
Legal defense costs
Estimated legal defense costs are not accrued. Rather, such costs are expensed when services are provided.
Accounting for stock-based compensation
Prior to January 1, 2006, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the Company measured compensation costs in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), but provided pro forma disclosures of net income and earnings per share using the fair value method defined by SFAS No. 123. Under APB 25, compensation expense was recognized over the vesting period based on the difference, if any, on the date of grant between the deemed fair value for accounting purposes of the Company’s stock and the exercise price on the date of grant. The Company accounted for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services.

 

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Had the Company determined compensation cost based on the fair value of its stock options at the grant date, as set forth under SFAS No. 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below:
         
    Year Ended December 31,  
    2005  
    (in thousands)  
Net income:
       
As reported
  $ 5,691  
Add: stock-based employee compensation expense included in reported loss
    (144 )
Deduct: total stock-based employee compensation expense determined under fair value based method for all awards
    (1,735 )
 
     
Pro forma income
  $ 3,812  
 
     
 
       
Earnings per share:
       
As reported:
       
Basic
  $ 0.18  
Diluted
  $ 0.16  
Pro forma:
       
Basic
  $ 0.12  
Diluted
  $ 0.11  
The fair value for these options was estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2005: expected volatility of 40.1% and a risk-free interest rate of 7.3%. A dividend yield of zero and expected life of 8.6 years was assumed for 2005. All options granted in 2005 were intended to be issued at fair market price.
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment, (SFAS No. 123R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. The consolidated financial statements as of and for the year ended December 31, 2006 reflect the input of SFAS No. 123R. In accordance with the modified prospective transition method, consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123R. Stock-based compensation expense related to employee or director stock options recognized for the years ended December 31, 2007 and 2006 were $0.9 million and $0.7 million, respectively.
Stock-based compensation expense recognized for the year ended December 31, 2007 and 2006, included compensation expense for the share-based payment awards granted subsequent to January 1, 2006. For stock-based awards issued to employees and directors, stock-based compensation is attributed to expense using the straight-line single option method, which is consistent with how the prior-priced pro forma was presentation. As stock-based compensation expense recognized for 2007 and 2006 are based on awards expected to vest, SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For the year ended December 31, 2007 and 2006, expected forfeitures are immaterial and, therefore, the Company is recognizing forfeitures as they occur. In the pro-forma information provided under SFAS No. 123 for the periods prior to fiscal 2006, the Company also accounted for forfeitures as they occurred.
The Company’s determination of fair value of share-based payment awards to employees and directors on the date of grant under SFAS 123R also uses the Black-Scholes option pricing model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the expected volatility over the expected term of the awards, and actual and projected employee stock options exercise behaviors. The Company estimates expected volatility using historical data.
The fair value of each option was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
                         
    Year Ended December 31,  
    2007     2006     2005  
Risk-free interest rate
    3.7 %     4.7 %     7.3 %
Expected term (years)
    7       7       8.6  
Volatility
    38.1 %     30.2 %     40.1 %
Expected annual dividend
    0       0       0  

 

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Discontinued Operations
The Company presents the results of operations, financial position and cash flows of operations that met the criteria for “held for sale accounting” as discontinued operations if such operations meet the required conditions. At the time an operation qualifies for held for sale accounting, the operation is evaluated to determine whether or not the carrying value exceeds its fair value less costs to sell. Any loss resulting from carrying value exceeding fair value less cost to sell is recorded in the period the operation meets held for sale accounting. Management judgment is required to (1) assess the criteria required to meet held for sale accounting, and (2) estimate fair value. Changes to fair value could result in an increase or decrease to previously recorded losses.
Earnings or net income (loss) per share
Basic earnings (loss) per share are calculated based on the weighted average number of shares of common stock outstanding during the reporting period. Diluted earnings per share are calculated giving effect to all potentially dilutive common shares, assuming such shares were outstanding during the reporting period. In instances where the Company incurs a loss, however, diluting the earnings would not be applicable as the effect will be anti-dilutive.
The following is a reconciliation of the numerators and denominators of the net income (loss) per share computations for the periods presented:
                         
            Weighted Average     Per  
    Net Income (Loss)     Shares     Share  
    (numerator)     (denominator)     Amount  
    (in thousands except share amounts)  
2007
                       
Loss per share, basic
  $ (28,418 )     41,796     $ (.68 )
(714 potentially dilutive securities were omitted from the calculation since the effect of including them would have been anti-dilutive)
                       
 
                       
2006
                       
Loss per share, basic and diluted
  $ (2,031 )     35,141     $ (0.06 )
(3,750 potentially dilutive securities were omitted from the calculation since the effect of including them would have been anti-dilutive)
                       
 
                       
2005
                       
Earnings per share, basic
  $ 5,691       32,079     $ 0.18  
Effect of dilutive securities
          2,565        
Earnings per share, basic and diluted
    5,691       34,644       0.16  
Note 4: RESTRICTED CASH
Facilities lease: As required by a lease agreement (Note 12), the Company provided a standby letter of credit in favor of the landlord secured by restricted cash deposits in like amount through 2010. The restricted cash requirement ($275,000 and $382,000 at December 31, 2007 and 2006, respectively) decreases $107,000 per year for the first five years of the lease and $98,000 thereafter. The portion of the restricted deposit that is allowed to be released in the subsequent year is reported as a current asset in the accompanying financial statements.
Players TrustSM: As of December 31, 2007 and 2006, customer deposits maintained in Players TrustSM totaled $8.5 million and $4.5 million, respectively, all of which was included in restricted cash in current assets.
Oregon Racing Commission: During 2006, IRG placed a $250,000 letter of credit with the ORC to secure customer deposits on hand. As of December 31, 2007, the letter of credit was secured by restricted cash of $258,000.

 

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Note 5: RECEIVABLES
Accounts receivable consisted of the following as of the balance sheet dates presented:
                 
    December 31,     December 31,  
    2007     2006  
    (in thousands)  
Track receivables, net of allowance for doubtful collection of $1,180 and $1,294
  $ 6,784     $ 11,218  
Player receivables, net of allowance of for doubtful collection of $759 and $0
    60       1,249  
Other, net of allowance for doubtful collection of $1,467 and $519
    470       820  
 
           
 
  $ 7,314     $ 13,287  
 
           
On October 4, 2007, a search warrant issued by the U.S. District Court for the Central District of California was served on our company headquarters in Woodland Hills, California, by special agents for U.S. Immigration and Customs Enforcement, an agency under the U.S. Department of Homeland Security, for various records including, among other things, business records of our IRG business related to the wagering activities of certain customers. The investigation is being run by the U.S. Attorney’s Office in Las Vegas, Nevada.
As part of its investigation, and without prior notice to Youbet or IRG, the government seized funds in three IRG bank accounts in Nevada, totaling $1.5 million. This amount is included in other receivables and the entire $1.5 million has been reserved. (See Note 19)
Note 6: INVENTORIES
Inventories are stated at the lower of cost (using the first-in, first-out method) or market value.
                 
    December 31,     December 31,  
    2007     2006  
    (in thousands)  
Totalizator components
  $ 1,477     $ 2,094  
Ticket stock
    608       493  
 
           
 
  $ 2,085     $ 2,587  
 
           
Note 7: PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of :
                 
    December 31,     December 31,  
    2007     2006  
    (in thousands)  
Computer equipment owned
  $ 14,520     $ 13,963  
Computer equipment under capital lease (Note 10)
    1,605       176  
Pari-mutuel equipment
    21,966       21,668  
Software
    4,347       4,385  
Office furniture, fixtures and equipment
    663       575  
Leasehold improvements
    3,201       3,130  
 
           
 
    46,302       43,897  
Less: accumulated depreciation and amortization
    (21,638 )     (13,787 )
 
           
 
  $ 24,664     $ 30,110  
 
           
Depreciation and amortization are recorded over the estimated lives of the following types of property and equipment: computer equipment (3 to 5 years), software (2 to 10 years), furniture and fixtures (5 years) and leasehold improvements (3 to 5 years, limited to the lease term).

 

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Note 8: INTANGIBLES, OTHER THAN GOODWILL
Intangibles, other than goodwill, are presented net of accumulated amortization of $3.8 million and $1.8 million at December 31, 2007 and 2006, respectively.
                 
    December 31,     December 31,  
    2007     2006  
    (in thousands)  
Intangibles
  $ 10,274     $ 15,198  
Less:
    (3,769 )     (1,829 )
 
           
 
  $ 6,505     $ 13,369  
 
           
Amortizable intangibles consist of customer listings, non-competition agreements, trademarks, trade names, technology and game content derived through acquisition of IRG and United Tote. Amortization expense in 2007 and 2006 for these intangibles was $1.9 million and $1.5 million, respectively. Estimated future amortization of intangibles for each of the next five years is $0.7 million, $0.7 million, $0.7 million, $0.6 million, and $0.6 million, respectively. See Note 19, Subsequent Events.
Note 9: ACCRUED EXPENSES
Accrued expenses consisted of the following as of the balance sheet dates presented:
                 
    December 31,     December 31,  
    2007     2006  
    (in thousands)  
Legal fees
  $ 298     $ 432  
Employee compensation, related taxes and other benefits
    2,853       1,985  
IRG accrued purchase payments
    4,293       1,401  
TVG arbitration award
    0       1,249  
Accrued interest and taxes
    2,074       1,440  
Other
    1,828       2,982  
 
           
 
  $ 11,346     $ 9,489  
 
           
Note 10: DEBT
Debt consisted of the following as of the balance sheet dates presented:
                 
    December 31,     December 31,  
    2007     2006  
    (in thousands)  
Capital lease obligations and other financing arrangements
  $ 999     $ 359  
Promissory notes
    3,200       5,000  
Bank revolving line of credit
    0       990  
Bank term loan
    10,958       14,007  
Note payable
    0       9  
 
           
 
    15,157       20,365  
Current portion of long-term debt
    10,390       8,311  
 
           
Long-term debt, less current maturities
  $ 4,767     $ 12,054  
 
           
In February 2006, the Company completed its acquisition of all of the outstanding stock of United Tote for consideration valued at $31.9 million plus the assumption of approximately $14.7 million of debt (primarily related to the financing of equipment placed with United Tote’s track customers). As part of this purchase, the Company issued three unsecured promissory notes to United Tote’s former owners aggregating $10.2 million in principal amount, with each promissory note bearing interest at a fixed rate of 5.02% per annum and with their principal amounts due in full at their respective maturity dates. The Company repaid a $5.2 million principal amount promissory note in December 2006 and a $1.8 million principal amount promissory note in March 2007. The remaining $3.2 million principal amount promissory note is currently due but is subject to rights of indemnification and offset. The Company has four outstanding claims for indemnification against the former owners of United Tote and will not pay the net balance due until those matters are resolved.

 

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In December 2006, the Company entered into a placement agency agreement with ThinkEquity Partners, LLC pursuant to which ThinkEquity Partners agreed to act as the Company’s placement agent in connection with a registered direct offering of 6.2 million shares of Youbet’s common stock at an offering price of $3.25 per share. The registered direct offering closed on December 20, 2006.
In July 2006, the Company entered into a credit agreement pursuant to which the lender agreed to provide the Company with up to $19.0 million in total borrowing capacity. The credit facility consists of a $1.0 million revolving line of credit and a $15.0 million term loan. The revolving line of credit requires monthly interest payments and the outstanding principal, if any, is due at maturity. The principal of the term loan is to be repaid in equal monthly installments ($3.0 million annually) plus interest, and payments commenced on September 1, 2006. At December 31, 2007, the Company owed $10.9 million under the term loan and no amount was outstanding under the revolving credit facility. At December 31, 2007, the interest rate on this facility was 8.75% per annum.
The credit agreement provides for mandatory prepayment upon the occurrence of certain specified events. The credit facility is secured by certain assets of the Company and certain of its subsidiaries are guarantors of the company’s obligations under the credit facility. The credit agreement contains customary covenants for financings of this type, including, but not limited to, restrictions on our ability to incur indebtedness, make investments, pay dividends, repurchase shares or make capital expenditures. The credit agreement also contains certain financial covenants, including (i) a requirement to achieve certain specified EBITDA thresholds, (ii) a requirement to achieve a specified free cash flow (as defined in the credit agreement) threshold, (iii) a requirement to maintain a specified leverage ratio, and (iv) limitations on capital expenditures.
In March 2007, the Company amended certain financial covenants of its credit agreement. In August 2007, the administrative agent for the lenders agreed to waive the Company’s failures to achieve the minimum EBITDA required under the credit agreement, as amended, when measured for the 12-month period ended June 30, 2007, and to maintain the leverage ratio required under the credit agreement, as amended, when measured as of June 30, 2007. As of December 31, 2007, the Company was not in compliance with certain financial covenants leverage ratio required under the credit agreement, as amended. (See Note 19)
In April 2007, United Tote entered into a sale-leaseback transaction with a bank. United Tote sold certain totalizator equipment to the bank for proceeds of $1.1 million and agreed to lease back the equipment for a 24-month period at an implicit interest rate of 8.8%.
Upon the occurrence of certain events of default, the interest rate on outstanding borrowings may be increased by 2.0%, obligations under the credit agreement may be accelerated and the lending commitments terminated.
The Company has financed the purchase of certain equipment through the issuance of bank debt, promissory notes and under capital leasing arrangements. The debt bears interest at rates ranging from 5.0% to LIBOR plus 3.25%. Such obligations are payable in monthly installments through May 2019.
Annual maturities for debt, including capital lease obligations as of December 31, 2007, are as follows:
         
Year   (in thousands)  
2008
  $ 10,390  
2009
    4,767  
 
     
 
  $ 15,157  
 
     
Capital leases
The Company has capital lease arrangements for networking equipment, computer equipment and software. Future obligations under these non-cancelable capital leases are as follows:
         
Year   (in thousands)  
2008
  $ 771  
2009
    320  
 
     
Total obligation
    1,091  
Less: interest portion
    92  
 
     
Total principal
  $ 999  
 
     

 

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Note 11: INCOME TAXES
Income tax expense (benefit) consists of the following:
                         
    2007     2006     2005  
    (in thousands)  
Current
                       
Federal
  $       $ 76     $ 107  
State
    4       18       34  
Foreign
    282       307          
 
                 
 
    286       401       141  
 
                 
Deferred
                       
Federal
    (600 )     (244 )     1,334  
State
    (735 )     577       388  
Change in valuation allowance
    3,132               (3,717 )
 
                 
 
    1,797       333       (1,995 )
 
                 
 
  $ 2,083     $ 734     $ (1,854 )
 
                 
Income taxes from continuing operations for 2007, 2006 and 2005 differ from “expected” income taxes for those years computed by applying the U.S. federal statutory rate of 34% to income (loss) before taxes for those years as follows:
                         
    2007     2006     2005  
    (in thousands)  
Tax expense (benefit) at U.S. statutory rate
  $ (8,640 )   $ (441 )   $ 1,371  
State tax (benefit) net of federal benefit
    353       (76 )     235  
Foreign taxes
    30                  
Amortization / impairment of intangibles
    6,762       323          
Stock based compensation
    305       261          
Jurisdictional penalties
            254          
Other permanent differences
    197       86       231  
Net change in valuation allowance
    2,960               (3,717 )
Expiration of California net operating loss carryforward
            405          
Other, net
    116       (78 )     26  
 
                 
 
 
  $ 2,083     $ 734     $ (1,854 )
 
                 
The Company does not provide for deferred taxes on the excess of the financial reporting over the tax basis in our investments in the foreign subsidiaries that are essentially permanent in duration. The determination of the additional deferred taxes that have not been provided is not practicable.

 

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The Company’s net deferred tax assets at December 31 consisted of the following:
                         
    2007     2006     2005  
    (in thousands)  
Deferred tax assets
                       
Net operating loss carryforwards
  $ 23,142     $ 21,848     $ 20,334  
Tax credit carryforwards
    226       226       178  
Depreciation
                    292  
Amortization of intangibles
                    630  
Accrued expenses
    234       1,272       449  
Accounts receivable allowance
    1,361       399          
Other
    121       4       55  
 
                 
 
    25,084       23,749       21,938  
 
                 
 
                       
Deferred tax liabilities
                       
Depreciation
    (3,573 )     (3,210 )        
Intangibles
    (1,717 )     (2,082 )        
Inventory
            (31 )        
 
                   
 
    (5,290 )     (5,323 )        
 
                   
 
                       
Net deferred tax assets
    19,794       18,426       21,938  
 
Valuation allowance
    (19,794 )     (16,629 )     (16,629 )
 
                 
 
                       
 
  $ 0     $ 1,797     $ 5,309  
 
                 
The Company has tax credit carryforwards totaling $226,000. In addition, the Company has federal and state net operating loss carryforwards in the amount of $61.8 million and $18.2 million, substantially all of which are also available for state income tax purposes, at December 31, 2007, which are expected to begin expiring in 2012 and 2013, respectively.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the amount and timing of scheduled reversals of deferred tax liabilities and projected future taxable income over the periods for which the deferred tax assets are deductible. Although the management believes the Company will be profitable in the foreseeable future, based upon the Company’s history of continuing operating losses, realization of its deferred tax assets does not meet the more likely than not criteria under SFAS No. 109 and, accordingly, a valuation allowance for the entire deferred tax asset amount has been recorded.
Due to the change of ownership provisions of the Tax Reform Act of 1986, utilization of a portion of our net operating loss and tax credit carryfowards may be limited in future periods. Further, a portion of the carryfowards may expire before being applied to reduce future income tax liabilities.
The Company expects resolution of unrecognized tax benefits, if created, would occur while the full valuation allowance of deferred tax assets is maintained, therefore, the Company does not expect to have any unrecognized tax benefits that, if recognized, that would affect the effective tax rate.
The Company will recognize interest and penalty related to unrecognized tax benefits and penalties as income tax expense. As of December 31, 2007, the Company has not recognized liabilities for penalty and interest as the Company does not have liability for unrecognized tax benefits.
The Company is subject to taxation in the U.S. and various states and in Canada. The company’s tax years for 2004, 2005 and 2006 are subject to examination by the taxing authorities. With few exceptions, the Company is no longer subject to U.S. federal, state, local or foreign examinations by taxing authorities for years before 2004.

 

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Note 12: COMMITMENTS
Operating leases
The Company leases office and production facilities in California, Oregon, Kentucky, Curacao and Canada under various operating leases. Approximate minimum rental payments under these non-cancelable operating leases as of December 31, 2007 are as follows:
         
Year   (in thousands)  
2008
  $ 1,264  
2009
    1,186  
2010
    282  
2011
    102  
2012
    484  
 
     
 
  $ 3,318  
 
     
Total rental expense was approximately $1.7 million, $1.3 million, and $1.0 million for 2007, 2006 and 2005, respectively.
Employment Commitments
Agreement with Gary W. Sproule - Effective January 1, 2004, Mr. Sproule entered into an employment agreement with the Company. Mr. Sproule’s employment agreement, as amended, will terminate two years after either the Company or Mr. Sproule provide notice to the other of their intention to terminate the agreement. Under his employment agreement, Mr. Sproule’s annual salary was $300,000 during the first year, $325,000 during the second year and will be $325,000 during each subsequent year. Upon execution of the employment agreement, Mr. Sproule received 300,000 stock options at an exercise price of $2.49, all of which immediately vested. In addition, Mr. Sproule is eligible to receive an annual bonus to be determined by the board of directors in its discretion and based on attaining certain profitability goals. Mr. Sproule also receives a $750 per month car allowance and reimbursement for personal financial consulting services up to $10,000. On November 28, 2007, Gary W. Sproule was appointed as interim president and chief executive officer effective as of the departure of Mr. Charles Champion on December 11, 2007. Mr Sproule resigned and left the Company in April 2008.
Agreement with James A. Burk - Effective July 9, 2007, Mr. Burk entered into a two year employment agreement. Under his employment agreement, Mr. Burk’s annual salary is $300,000 during the first year and may increase in succeeding years based on his and the Company’s performance. Upon execution of the employment agreement, Mr. Burk received 150,000 stock options at an exercise price of $2.35. The stock options are ten year options and shall vest ratably over four years. In addition, Mr. Burk is eligible to receive an annual bonus to be determined by the board of directors in its discretion and based on attaining mutually agreed upon business objectives and certain profitability goals.
As of December 31, 2007, the aggregate minimum future compensation for executives, except if terminated for cause and exclusive of annual bonuses and/or incentives, if any, is $0.6 million, $0.5 million and $0.3 million annually for 2008, 2009 and 2010, respectively.
Employee Benefit Plan - The Company sponsors two defined contribution 401(k) plans. The plans provide for voluntary contributions by eligible employees and matching contributions by the Company of 100% of the first 6% of the employee’s pre-tax contributions. Matching contributions made by the Company included in general and administrative expenses were $0.5 million, $0.4 million and $0.4 million for 2007, 2006 and 2005, respectively, excluding nominal administrative costs assumed by the Company.
Note 13: CONTINGENCIES
On September 19, 2007, Colonial Downs, L.P. and the Virginia Horsemen’s Benevolent and Protective Association filed lawsuit against the Company in the U.S. District Court for the Eastern District of Virginia. The complaint alleges that the Companies operating as an ADW provider in the Commonwealth of Virginia and seeks a declaration of the rights and obligations of the parties under the Virginia Horse Racing and Pari-Mutuel Wagering Act. The complaint also seeks injunctive relief enjoining the Company from conducting ADW operations in Virginia until the Company contracts with the plaintiffs and obtains a license under the Virginia statute and regulations. See Note 19, Subsequent Events.
A search warrant was served on the Company on October 4, 2007 at its headquarters in Woodland Hills, California, by federal agents, accompanied by agents of the Nevada Gaming Control Board, for various records including, among other things, business records of IRG related to the wagering activities of certain customers. The investigation is being conducted by the U.S. Attorney’s Office in Las Vegas, Nevada. The Company has been advised that the U.S. Attorney’s Office is investigating a potentially wide net of activities of certain individuals who may have used telephone rebate wagering services, including those offered by IRG, in an allegedly illegal manner. In connection with its investigation, the U.S. government, on October 11, 2007, took possession of $1.5 million held in IRG bank accounts by way of civil asset forfeiture. The Company is cooperating with authorities and has pledged its ongoing assistance in their investigation. See Note 19, Subsequent Events.

 

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Other
From time to time the Company may be a party to proceedings that are ordinary and incidental to the Company’s business. Management is unable to estimate any minimum losses from any of these legal proceedings. Accordingly, no losses have been accrued.
Note 14: STOCKHOLDERS’ EQUITY
Youbet has issued various warrants and stock options for services rendered and to be rendered, and to obtain financing.
Information with respect to common stock purchase warrants issued is summarized as follows:
                 
            Weighted  
            Average  
    Warrants     Exercise Price  
Balance, January 1, 2005
    351,363     $ 0.80  
Warrants issued
           
Warrants expired and terminated
    (137,108 )     0.81  
Warrants exercised
    (179,255 )     0.64  
 
           
Balance, December 31, 2005
    35,000     $ 1.58  
Warrants issued
           
Warrants expired
    (10,000 )      
Warrants exercised
    (25,000 )     0.50  
 
           
Balance, December 31, 2006
        $  
 
           
Warrants exercisable at December 31, 2006 and 2007
        $  
 
           
In June 2005, the Company’s stockholders approved the Youbet.com, Inc. Equity Incentive Plan (the Equity Incentive Plan), which constitutes an amendment, restatement and continuation of the Company’s 1998 Stock Option Plan. As of December 31, 2007, there were outstanding options for 4,717,411 shares of common stock issued under the Equity Incentive Plan, out of a total approved pool of 11,750,000 shares.
During 2007, the Company granted various stock options to officers, other employees and directors, under the Equity Incentive Plan as follows:
1)  
Stock options were granted to the then executive officers of the Company to purchase a total of 180,000 shares of common stock at exercise prices ranging from $2.35 to $2.72, the fair market values at the dates of grant. These options vest ratably over four years and are exercisable for ten years.
 
2)  
Stock options were granted to other employees of the Company to purchase a total of 360,000 shares of common stock at exercise prices ranging from $2.72 to $3.69, the fair market values at the dates of grant. These options vest ratably over four years and are exercisable for ten years.
 
3)  
Stock options were granted to directors of the Company to purchase a total of 185,500 shares of common stock at an exercise price of $2.72, the fair market value at the date of grant. These options vest ratably over twelve months and are exercisable for ten years.

 

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During 2006, the Company granted various stock options to officers, other employees and directors, under the Equity Incentive Plan as follows:
1)  
Stock options were granted to the then executive officers of the Company to purchase a total of 225,000 shares of common stock at an exercise price of $3.67, the fair market value at the date of grant. These options vest ratably over four years and are exercisable for ten years.
 
2)  
Stock options were granted to other employees of the Company to purchase a total of 678,814 shares of common stock at exercise prices ranging from $3.33 to $5.08, the fair market values at the dates of grant. These options vest ratably over four years and are exercisable for ten years.
 
3)  
Stock options were granted to directors of the Company to purchase a total of 90,000 shares of common stock at exercise prices ranging from $3.69 to $5.08, the fair market values at the dates of grant. These options vest ratably over twelve months and are exercisable for ten years.
During 2005, the Company granted various stock options to officers, other employees and directors, under the Equity Incentive Plan as follows:
1)  
No stock options were granted to executive officers of the Company during 2005.
 
2)  
Stock options were granted to other employees of the Company to purchase a total of 695,600 shares of common stock at exercise prices ranging from $4.38 to $6.19, the fair market values at the dates of grant. These options vest ratably between two and four years and are exercisable for ten years.
 
3)  
Stock options were granted to directors of the Company to purchase a total of 110,000 shares of common stock at exercise prices ranging from $4.73 to $5.99, the fair market values at the dates of grant. These options vest ratably over twelve months and are exercisable for ten years.
Under all plans, the stock option price per share for options granted is generally based on the market price of the Company’s common stock on the date of grant and no option can be exercised later than ten years from the date it was granted. The stock options generally vest over four years.
At December 31, 2007, there were options outstanding to acquire 4,717,411 shares at an average exercise price of $2.70 per share. The estimated fair value of all awards granted during the year ended December 31, 2007 was $1.0 million.
The following table summarizes the status of these plans as of December 31, 2007:
         
    Equity Incentive Plan  
Options originally available
    11,750,000  
Stock options outstanding
    4,717,411  
Options available for grant
    1,653,350  
Transactions involving stock options are summarized as follows:
                 
    Number of     Weighted Average  
    Shares     Exercise Price  
Balance at January 1, 2005
    6,154,325     $ 1.52  
Granted
    805,600       4.46  
Exercised
    (2,292,786 )     0.93  
Cancelled
    (191,350 )     3.34  
Options forfeited
    (81,417 )     2.63  
 
             
Balance at December 31, 2005
    4,394,372     $ 2.30  
Granted
    993,717       3.95  
Exercised
    (259,819 )     1.00  
Cancelled
    (222,611 )     4.43  
 
             
Balance at December 31, 2006
    4,905,659     $ 2.61  
Granted
    725,500       2.86  
Exercised
    (444,359 )     0.79  
Cancelled
    (469,389 )     3.81  
 
             
Balance at December 31, 2007
    4,717,411     $ 2.38  
 
             

 

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As of December 31, 2007, the total compensation costs related to non-vested awards yet to be expensed was approximately $2.1 million to be amortized over the next four years.
The weighted average exercise prices for options granted and exercisable and the weighted average remaining contractual life for options outstanding as of December 31, 2006 and 2007 were as follows:
                                 
                    Weighted        
                    Average        
                    Remaining        
    Number of     Weighted Average     Contractual        
    Shares     Exercise Price     Life (Years)     Intrinsic Value  
As of December 31, 2006
                               
Employees — Outstanding
    4,905,659     $ 2.61       6.06     $ 12,795,124  
Employees — Expected to Vest
    1,265,539       4.03       9.03       5,096,442  
Employees — Exercisable
    3,640,120       2.11       5.02       7,698,683  
 
                               
As of December 31, 2007
                               
Employees — Outstanding
    4,717,411     $ 2.70       6.03     $ 12,737,009  
Employees — Expected to Vest
    1,308,616       3.55       8.87       4,645,587  
Employees — Exercisable
    3,408,795       2.37       4.95       8,078,844  
Additional information with respect to outstanding options as of December 31, 2007 is a follows:
                                                 
Options Outstanding     Options Exercisable  
                    Weighted                        
Options         Number     Average                     Weighted  
Exercise         of     Remaining     Weighted Average     Number of     Average  
Price Range         Shares     Contractual Life     Exercise Price     Shares     Exercise Price  
$ 0.49-$0.99    
 
    870,000       4.42     $ 0.53       870,000     $ 0.53  
$ 1.00-$1.99    
 
    100,500       0.25       1.77       100,500       1.77  
$ 2.00-$4.99    
 
    3,612,697       6.53       3.15       2,353,505       2.97  
$ 5.00-$6.19    
 
    134,214       7.41       5.30       84,790       5.32  
The Company has elected to adopt the detailed method provided in SFAS No. 123R for calculating the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS No. 123R.
Note 15: ACQUISITIONS
United Tote
In February 2006, the Company completed its acquisition of 100% of the outstanding common stock of United Tote Company for $31.9 million plus the assumption of approximately $14.7 million of United Tote secured debt (primarily related to the financing of equipment that is placed with United Tote’s track customers), which the Company agreed to guarantee. The acquisition provided increased diversification of the Company’s customer base and product offering, as well as furthered the Company’s efforts to be the pari-mutuel industry’s leading end-to-end technology provider. The Company financed the acquisition by delivering to United Tote’s former owner the following consideration:
 
Approximately $9.7 million in cash;
 
 
$5.2 million one-year, unsecured promissory note;

 

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$3.2 million two-year, unsecured promissory note;
 
 
$1.8 million two-year, unsecured promissory note; and
 
 
2,181,818 shares of the Company’s common stock, valued at $5.50 per share.
Each promissory note bore interest at a fixed rate of 5.02% per annum, and the principal amounts are due in full at their respective maturity dates (subject to partial or full prepayment under certain circumstances). The Company has repaid in full the $5.2 million and $1.8 million promissory notes in accordance with their respective terms. The $3.2 million promissory note remains outstanding and subject to rights of indemnification, offset and subordination. For more information regarding these promissory notes and United Tote’s debt (which the Company guaranteed in connection with the acquisition), see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations, Contingent Liabilities and Commitments.”
The Company also agreed to a “make-whole” provision pursuant to which the Company agreed to pay to UT Group a one-time cash payment equal to the amount by which $5.50 exceeds the average trading price of the Company common stock for the five trading-day period ending on February 9, 2007, multiplied by the number of shares delivered by us and then held by UT Group. In addition, the Company was entitled to cause UT Group to sell some or all of the the Company shares on or before February 9, 2007, if the trading price was below $5.50 per share, provided that the Company paid to UT Group the make-whole amount within ten trading days of the sale. On January 23, 2007, the Company delivered notice exercising its right to force the sale of UT Group’s 2,181,818 shares of the Company common stock. On January 24, 2007, all 2,181,818 shares were sold for $3.45 per share, which sale closed on January 29, 2007. The Company paid UT Group the aggregate make-whole payment of $4.5 million in January 2007.
The purchase price allocation resulted in approximately $7.9 million of identifiable intangible assets related to trademarks, trade names, game content and technology. A summary of the purchase price allocation through December 31, 2006 is as follows:
         
    (in thousands)  
Purchase price allocation
       
Purchase price paid at closing
  $ 31,947  
Legal and other closing costs
    604  
 
     
 
  $ 32,551  
 
     
 
       
Cash
  $ 160  
Accounts receivable
    3,317  
Note receivable
    258  
Inventory
    1,978  
Other current assets
    1,419  
Property and equipment, net
    20,950  
Intangibles related to trademarks, trade names, technology and game content
    7,874  
Goodwill
    14,859  
Other assets
    295  
 
     
Total assets
    51,110  
 
     
 
       
Accounts payable
    1,470  
Accrued liabilities
    1,845  
Deferred revenue
    399  
Debt
    14,845  
 
     
Total liabilities
    18,559  
 
     
Total allocated purchase price
  $ 32,551  
 
     

 

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The excess purchase price paid at closing over the fair value of the net assets of the acquired company was allocated to various intangibles (including trademarks, trade names, software, game content and technology) and goodwill based upon relative market values. Intangibles are amortized on a straight-line basis over the estimated useful lives of the various components, ranging from 5 to 15 years.
Bruen Productions International, Inc.
On October 9, 2006, the Company acquired 100% of the outstanding shares of common stock of privately-held Bruen Productions. Youbet financed the acquisition with the issuance of $162 in common stock held in treasury, payable in four installments over the next three years and the assumption of approximately $174 of debt. Youbet issued 13,953 shares in October 2006 as the first installment. (See Note 14)
The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of the Bruen Productions International, Inc. acquisition. The purchase price allocation resulted in approximately $384 of identifiable intangible assets related to goodwill which was written off in the third quarter of 2007.
         
    (in thousands)  
Purchase price allocation
       
Purchase price paid at closing
  $ 220  
Legal and other closing costs
    68  
 
     
 
  $ 288  
 
     
 
       
Cash
  $ 6  
Accounts receivable
    69  
Other current assets
    13  
Property and equipment, net
    22  
Goodwill
    384  
 
     
Total assets
    494  
 
     
 
       
Accounts payable
    17  
Accrued liabilities and other
    65  
Loans payable
    124  
 
     
Total liabilities
    206  
 
     
Total allocated purchase price
  $ 288  
 
     
Pro Forma Impact of Acquisitions
The following unaudited pro forma financial information for 2006 and 2005 presents the consolidated operations of the Company as if all the forgoing acquisitions had been made on January 1, 2004, after giving effect to certain pro forma adjustments as of the respective acquisition dates. The unaudited pro forma financial information should not be used to project the Company’s results of operations for any future period:
                 
    2006     2005  
Revenue
  $ 136,682     $ 119,419  
Net income (loss)
    (2,031 )     6,002  
Earnings (loss) per share
               
- Basic
    (0.06 )     0.19  
- Diluted
    (0.06 )     0.17  

 

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Note 16: SEGMENT REPORTING
As a result of the acquisition of United Tote, the Company began operating as two reportable segments beginning in 2006, each of which the Company operates and manages as a strategic business unit. The Company’s ADW segment consists of the combined operations of Youbet Express, IRG and Bruen Productions, and the Company’s totalizator segment consists of the operations of United Tote.
The reporting segments follow the same accounting policies used for the Company’s consolidated financial statements and are described in the summary of significant accounting policies. Company management evaluates a segment’s performance based upon its individual financial results of operations. Sales to customers located outside the United States primarily relate to totalizator services and are immaterial.
Information for the Company’s ADW segment for 2005 and 2004, which was the only segment in those years, is presented for comparative purposes.
                         
    (in thousands)  
Revenue   2007     2006     2005  
ADW segment
  $ 114,000     $ 113,552     $ 88,837  
Totalizator segment
    26,093       23,885          
Intercompany eliminations
    (1,900 )     (1,037 )        
 
                 
 
  $ 138,193     $ 136,400     $ 88,837  
 
                 
                         
Revenue by Geographic Area   2007     2006     2005  
United States
  $ 135,924     $ 134,308     $ 88,837  
International
    2,269       2,092          
 
                 
 
  $ 138,193     $ 136,400     $ 88,837  
 
                 
                         
Reconciliation of income (loss) before income taxes   2007     2006     2005  
Income (loss) from operations
                       
- ADW segment
  $ (12,452 )   $ (1,300 )   $ 3,085  
- Totalizator segment
    (11,961 )     659          
 
                 
 
    (24,413 )     (641 )     3,085  
 
                       
Interest income
    644       547       581  
Interest expense
    (1,795 )     (1,955 )     (81 )
Other
    153       725       252  
 
                 
Income (loss) before income taxes from continuing operations
    (25,411 )     (1,324 )     3,837  
Income (loss) before income taxes from discontinued operations
    (924 )     27          
 
                 
Income (loss) before income taxes
  $ (26,335 )   $ (1,297 )   $ 3,837  
 
                 
                         
Capital Spending   2007     2006     2005  
ADW segment
  $ 287     $ 2,305     $ 2,422  
Totalizator segment
    2,217       4,431          
 
                 
 
  $ 2,504     $ 6,736     $ 2,422  
 
                 

 

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Depreciation and Amortization   2007     2006     2005  
ADW segment
  $ 3,864     $ 2,527     $ 1,591  
Totalizator segment
    6,506       4,296          
 
                 
 
  $ 10,370     $ 6,823     $ 1,591  
 
                 
                 
Total Assets   2007     2006  
ADW segment
  $ 23,617     $ 50,280  
Totalizator segment
    41,433       55,325  
 
           
 
  $ 65,050     $ 105,605  
 
           
Note 17: IMPAIRMENT OF INTANGIBLES AND GOODWILL
Intangibles and goodwill are reviewed for impairment annually during the third quarter or when circumstances exist which indicate a possible impairment has occurred. The fair value of the reporting unit associated with the intangibles and goodwill is typically estimated using the expected present value of future cash flows. If expected future cash flows are less than the carrying value of an asset, an impairment charge is taken to reduce the value on the Company’s balance sheet to fair value. The following table shows the Company’s intangible assets and goodwill activity for the period ended December 31, 2007.
                                 
    Intangibles     Goodwill  
    Advance             Advance        
    deposit             deposit        
    wagering     Totalizator     wagering     Totalizator  
    segment     segment     segment     segment  
    (in thousands)  
Balance as of January 1, 2007
  $ 6,123     $ 7,246     $ 384     $ 14,859  
Additions
    5,998                    
Amortization
    (1,198 )     (741 )            
Impairment losses
    (10,923 )           (384 )     (8,000 )
 
                       
Balance as of December 31, 2007
  $     $ 6,505     $ 0     $ 6,859  
 
                       
In connection with our exploration of strategic alternatives for United Tote, the Company re-evaluated the goodwill related to United Tote. As part of this evaluation, the Company compared the current estimated fair value to the carrying value of goodwill, and on March 25, 2008, concluded that United Tote goodwill was impaired as of December 31, 2007. The total amount of this non-cash impairment charge was $8.0 million.
As previously discussed, IRG had $7.0 million in intangible assets and had a single player that accounted for over 50% of IRG’s wagering handle during the first nine months of 2007 and the federal government seized $1.5 million from IRG’s three bank accounts. Additionally, IRG had lost or been denied content. After adjusting assumptions for current facts and circumstances, management determined that an impairment of IRG intangible assets was not required in the third quarter.
The Company continued to monitor the results of IRG, and attempted to forecast future results. Due to the loss of content and the reduced player base, wagering handle was not expected to recover.
In view of these facts, the Company performed a follow-up impairment test as of December 31, 2007 to ascertain the need for an impairment adjustment of the intangibles associated with IRG. The intangibles reviewed include those relating to acquired customer lists and a non-compete agreement. These intangibles have increased in amount since the acquisition of IRG due to the annual earn-outs paid to the prior owners due the achievement of certain performance criteria as indicated in the purchase agreement and total approximately $6.7 million (net of amortization). As of December 31, 2007, an additional $4.3 million (as restated) was accrued and is due to be paid as of August 31, 2008. Based on these events, the cash flow forecast for IRG was revised downward resulting in an impairment of the intangibles associated with IRG in the fourth quarter of 2007. The precise payment, however, is subject to reduction for any claims that the Company may assert prior to the date such payment is due. The value of such possible claims cannot be reasonably estimated at this time, are to be regarded as contingent assets and, therefore ,will not be recorded until the contingencies are resolved.

 

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Note 18: DISCONTINUED OPERATIONS
Effective December 31, 2007, the Company sold Bruen Productions back to the original owner (David Bruen).
The aggregate sell price was $202,500, comprised of the following:
   
repurchase by the Company from the buyer of 13,953 shares of the Company’s common stock with a value as of the closing date of $17,022 (13,953 shares@ $1.22/sh);
 
   
an amount of $108,000 was attributed to the buyer cancelling all rights of the buyer to receive any shares of the Company’s common stock pursuant to the original purchase agreement; and
 
   
payment in cash of $77,478.
The results of Bruen Productions have been treated as discontinued operations in these financial statements and are as follows:
                 
    2007     2006  
    (in thousands)  
Sales
  $ 772     $ 282  
Cost of services
    408       72  
 
           
 
    364       210  
Operating expenses (1)
    1,288       183  
 
           
Net income (loss)
  $ (924 )   $ 27  
 
           
     
(1)  
Included in operating expense is $354,000 write off of goodwill.
The sale of Bruen Productions resulted in a nominal gain.
Note 19: SUBSEQUENT EVENTS
A search warrant was served on the Company on October 4, 2007 at its headquarters in Woodland Hills, California, by federal agents, accompanied by agents of the Nevada Gaming Control Board, for various records including, among other things, business records of our IRG business related to the wagering activities of certain customers. The investigation is being conducted by the U.S. Attorney’s Office in Las Vegas, Nevada. On March 14, 2008, the Company entered into two separate agreements with the U.S. Attorney’s Office in Las Vegas. Pursuant to the first agreement, the U.S. Attorney’s Office agreed not to pursue any charges against Youbet or IRG in exchange for the company’s continued cooperation with the government’s ongoing investigation. In a separate agreement, the company agreed to forfeit approximately $1.5 million previously seized by the government as part of its investigation.
Given the severe and adverse downturn in the IRG business since October 2007, the Company made the decision that effective February 15, 2008, IRG would stop taking wagers and cease all other operations associated with IRG and unwind the business in an orderly and businesslike fashion. In connection with the shutdown of the IRG business, the Company recorded a charge of approximately $0.5 million for severance costs associated with exiting the IRG business. In addition, the IRG business will incur other shutdown costs estimated to range from $0.2 million to $0.3 million to cover lease obligations, outside services, asset disposals and other miscellaneous costs. In addition, the Company expects to incur ongoing costs associated with its continued cooperation with, and eventual resolution of, the ongoing government investigation, although the precise amount or timing cannot be predicted at this time and such costs are not related to the Company’s decision to shutdown the IRG business.
The Company recently reached an agreement in principle with Colonial Downs, L.P., the Virginia Horsemen’s Benevolent and Protective Association, the Virginia Racing Commission (VRC), and the Commonwealth of Virginia. Terms of the settlement are expected to include mutual releases by the parties of all claims and dismissal of the litigation. As part of the agreement, the Company promptly will refresh its application for an ADW license from the VRC, and the settlement and dismissal of the litigation is conditioned upon the issuance of an ADW license by the VRC. Also as part of the agreement, the Company expects to pay source market fees on handle from Virginia residents effective as of January 1, 2008, and continuing for a period of three years. In 2008, the Company also expects to pay additional fees of $150,000 spread over four calendar quarters.

 

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On March 28, 2008, the Company entered into a second amendment to credit agreement with Wells Fargo Foothill, Inc., the administrative agent under our credit facility (Wells Fargo Foothill). Wells Fargo Foothill agreed to waive the Company’s defaults as of December 31, 2007 under the credit facility resulting from the Company’s failure to comply with certain financial covenants as of and for the year ended December 31, 2007. In addition, the Company agreed to amend the terms of the credit facility in order to, among other things:
   
change the maturity date to January 31, 2009;
   
eliminate the Company’s option to have our interest rate determined by reference to LIBOR;
   
provide for additional payments on principal of $1.0 million each on the date of the amendment, July 1, 2008 and September 1, 2008, respectively, and of $0.5 million on December 1, 2008;
   
set the prime rate margin at 1.50%;
   
modify the definition of EBITDA and the adjustments to EBITDA for purposes of the credit facility; and
   
amend the minimum EBITDA level and leverage ratio the Company is required to maintain.
In consideration of this amendment, the Company paid Wells Fargo Foothill an amendment fee of $50,000.
In connection with the Company’s decision to exit the IRG business, Wells Fargo Foothill, agreed that the Company could fund legal fees associated with the ongoing government investigation up to $0.5 million, if necessary. This consent letter also contains customary representations by the Company and a provision reducing the Company’s ability to draw on a revolving line of credit under the credit facility from $4.0 million to $1.0 million, which amount can be increased or decreased in Wells Fargo Foothill sole discretion. At December 31, 2007, there were no amounts outstanding under the revolving line of credit.

 

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SCHEDULE II
YOUBET.COM, INC.
VALUATION AND QUALIFYING ACCOUNTS
                                         
            Additions                
    Balance at     Charged     Charged             Balance at  
    beginning     to cost and     to other             end of  
Description   of period     expenses     accounts     Deductions     Period  
    (in thousands)  
Fiscal 2007
                                       
Allowance for doubtful accounts receivable
  $ 1,813     $ 3,002     $ (7 )   $ (1,402 )   $ 3,406  
 
                                       
Allowance for doubtful notes receivable
  $ 76               (76 )           $    
Deferred tax asset valuation allowance
  $ 16,629     $ 3,165     $       $       $ 19,794  
 
                                       
Fiscal 2006
                                       
Allowance for doubtful accounts receivable
  $ 346     $ 173     $ 1,294     $       $ 1,813  
 
                                       
Allowance for doubtful notes receivable
  $               $ 76             $ 76  
 
                                       
Deferred tax asset valuation allowance
  $ 16,629     $       $       $       $ 16,629  
 
                                       
Fiscal 2005
                                       
Allowance for doubtful accounts receivable
  $ 526     $       $       $ (180 )   $ 346  
Deferred tax asset valuation allowance
  $ 20,346     $ (3,717 )   $       $       $ 16,629  

 

 


Table of Contents

EXHIBIT INDEX
         
Exhibit    
Number   Description
       
 
  23.1    
Consent of Piercy Bowler Taylor & Kern.
       
 
  24.1    
Power of Attorney (set forth on the signature page of this report).
       
 
  31.1    
Certification of President and Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
       
 
  31.2    
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
       
 
  32.1    
Certifications Pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.

 

 

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