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Youbet.com 10-K 2009 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the fiscal year ended December 31, 2008
Commission file number: 0-26015
YOUBET.COM, INC.
(Exact name of registrant as specified in its charter)
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
(§229.405 of this chapter) is not contained herein, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. 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.
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 of the registrant as
of the last business day of the registrant’s most recently completed second fiscal quarter (June
30, 2008) was approximately $38.1 million based on the closing sale price of $1.27 as reported on
the NASDAQ Capital Market on June 30, 2008.
As of December 31, 2008, there were 41,463,470 shares of common stock, $.001 par value per share,
outstanding (net of treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2009 Annual Meeting of Stockholders are
incorporated by reference in Part III of this report.
YOUBET.COM, INC.
INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2007
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Preliminary Notes
This annual report on Form 10-K is for the year ended December 31, 2008. This annual report
modifies and supersedes documents filed prior to this annual report. The Securities and Exchange
Commission, or 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. In addition, information that we file with the SEC in
the future will automatically update and supersede information contained in this annual report.
Industry and market data used throughout this annual 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 annual report on Form 10-K contains forward-looking statements which include, but are not
limited to, statements concerning expectations as to our revenues, expenses, and net income, our
growth strategies and plans, our assessment of strategic alternatives for United Tote, including a
possible sale, as to which there can be no assurance of success, the timely development and market
acceptance of our products and technologies, 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, the adoption of future industry standards, expectations as to our
financing and liquidity requirements and arrangements, the need for additional capital, and other
matters that are not historical facts. 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 performance and are subject to risks, uncertainties, and
assumptions that are difficult to predict. Therefore, actual results could differ materially and
adversely from those results expressed in any forward-looking statements, as a result of various
factors, some of which are listed under Item 1A “Risk Factors” of this report. 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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PART I.
ITEM 1. BUSINESS
Business 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. Youbet Express is
a leading online advance deposit wagering (“ADW”) company focused on horse racing primarily in the
United States.
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 commingled with the host track betting pools.
We 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 the wager (handle) processed through
Youbet Express.
We acquired United Tote Company in February 2006. United Tote is a leading supplier of totalizator
systems (equipment and technology that processes wagers and payouts). United Tote supplies
pari-mutuel tote services to approximately 100 racing facilities in North America and additional
facilities in a number of foreign markets. As a result of this acquisition, we now operate two
business segments for financial accounting purposes, ADW and totalizator systems. For more
information, see Note 15 “Segment Reporting” in our consolidated financial statements at the end of
this report.
We were incorporated in Delaware on November 13, 1995. Our executive offices are located at 2600
West Olive Avenue, 5th floor, Burbank, Ca. 91505 and our telephone number is (818)
668-2100. Our website address is www.youbet.com.
Industry Overview
According to The Jockey Club, which is the breed registry for all thoroughbred horses in North
America, total U.S. handle on thoroughbred racing, the most popular type of horse racing, was
estimated at approximately $13.6 billion in 2008, of which 89% represented wagers made away from
the host track, such as at OTBs, at other tracks, or via Internet and telephone wagering. We
believe that the ADW segment has outpaced overall pari-mutuel industry growth in recent years and
that the largest volume of ADW wagers in the U.S. were processed through entities licensed as
multi-jurisdictional ADW wagering hubs.
In 2000, the United States Congress amended the Interstate Horseracing Act of 1978 to clarify the
legality of wagering across state lines via telephone or other electronic media and the commingling of
pari-mutuel wagering pools.
In the fourth quarter of 2006, Congress passed the Unlawful Internet Gambling Enforcement Act of
2006, which includes certain racing protective provisions by maintaining the status-quo with
respect to wagering activities covered under the Interstate Horseracing Act of 1978, as amended.
This Act prohibits the acceptance of credit cards, electronic funds transfers, checks, or the
proceeds of other financial transactions by persons engaged in unlawful betting or wagering
businesses; however, the Act specifically excludes from the definition of unlawful Internet
gambling “any activity that is allowed under the Interstate Horseracing Act of 1978”. On November
12, 2008, the Department of Treasury and Federal Reserve Board jointly published the final rule
(the “UIGEA Rule”) implementing the Unlawful Internet Gambling Enforcement Act of 2006.
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Competitive Advantages
We are a leading ADW company focused on horse racing primarily in the U.S. and have processed over
$2.1 billion in wagers from January 1, 2004 to December 31, 2008. We believe we have the following
competitive advantages:
Extensive customer database and strong analytical capability
We utilize sophisticated data mining software, which generates detailed customer segmentation
analyses based on variables such as wagering propensities and preferences. With this information,
we are able to personalize our product offerings through targeted special offers, contests and
promotions tailored to specific customer segments. This information also helps us maximize revenue
yield by allowing us to target promotions and incentives to wagers on tracks that generate greater
revenue yield to us.
Highly scalable infrastructure
Our highly scalable technological infrastructure and automated online and telephonic wagering
platform provide us with significant operating leverage. We typically operate at less than 33% of
system capacity. This built-in excess capacity enables us to easily process significantly greater
wagering volume at a low incremental cost. Additionally, we continuously build automation into our
core online and interactive voice recognition wagering platform in order to minimize our
incremental staffing requirements. With this operating leverage, we are well-positioned to
capitalize on handle growth to increase earnings.
Growth Strategies
We aim to maintain our strong position in the ADW segment and build upon the strength of our brand.
We have adopted the following key growth strategies to achieve these objectives:
Continue to develop high-quality wagering products
We intend to continue to develop industry-leading technology and to expand the diversity and
breadth of our product offerings and services. We believe this will translate into a more enjoyable
customer experience, and as a result, we believe our customers will place a greater portion of
their wagering dollars through us.
Seek additional content
We intend to continue to seek access to additional domestic content for our customers to view and
to wager on. We also hope to enter into additional content agreements with international racing
and gaming entities, which will provide our customers with a more diverse array of content to view
and to wager on. In 2008, we derived less than 5% of our handle from races outside of the U.S. and
Canada.
Expand geographic presence
We intend to seek opportunities in the U.S. and abroad to leverage our highly scalable online and
telephone wagering platforms and to diversify our customer base, revenue streams and content. We
hope to increase our penetration of the international market by entering into content and
technology agreements with international racing and gaming entities that will enable us to expand
our customer base internationally.
Expansion into new gaming opportunities
International jurisdictions permit a broader array of wagering activities than the U.S., including
fixed-odds sports betting. We believe that, with modifications, our robust operating platform can
be adapted to facilitate such international opportunities.
Leverage our flexible wagering platform to provide online solutions for track operators and other
gaming companies
Only a limited number of track operators currently operate a website that accepts ADW wagers. If
track operators or other gaming companies decide to enter the online ADW segment, our experience
and technological leadership make us highly qualified to assist in building and supporting such
websites. In addition, with our technologically advanced, highly scalable and flexible online
platform and our excess capacity, we are well-positioned to provide the technological
infrastructure for the online initiatives of track operators or other gaming companies.
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Revenue Sources
For each pari-mutuel wager placed by our customers, we receive a commission calculated as a
percentage of the wager. In the aggregate, these commissions represented approximately 76% of our
total revenue for 2008. We generate additional revenue primarily from processing fees, monthly
subscription fees and the sale of handicapping information.
United Tote revenue is derived from contractual arrangements for the supply, installation,
operation, servicing and maintenance of totalizator systems at pari-mutuel facilities, including
horse and dog racing tracks. This revenue is supplemented by sales and licensing of supplies,
software and equipment used by the facilities.
Marketing
Using a variety of media channels, consisting primarily of online marketing and search engine
optimization, supported by tactical print and radio advertising and complimented by brand placement
through our track partners, media and promotions channels, we focus our integrated marketing
efforts on targeted marketing to horse racing enthusiasts. An integrated marketing approach allows
us to cycle a series of targeted messages and promotions centered on key product features,
differentiators, benefits, key content, online tournaments and contests, and event-specific
promotions. A complimentary strategy, implemented in 2008, includes design and content
modifications to the Youbet.com website aimed at increasing its prominence in natural search
results in order to drive new customers to the website.
Our marketing campaigns and customer retention strategies are supported with customer research and
analysis and are intended to satisfy the needs of existing customers and drive new customers to
Youbet ExpressSM. We frequently initiate communication with our customers via phone,
email and online channels. One-to-one messaging through the Youbet ExpressSM platform
allows us to tailor dynamic personalized messages and offers to our members based on their wagering
propensity, preferences and frequency of visitation.
Acquisitions and Dispositions
Acquisition of United Tote
In February 2006, we completed the acquisition of United Tote for $31.9 million plus the assumption
of approximately $14.7 million of United Tote debt (primarily related to the financing of equipment
that had been placed with United Tote’s track customers). We financed the acquisition by delivering
to UT Group, LLC, United Tote’s former owner, approximately $9.7 million in cash, an aggregate of
$10.2 million in unsecured promissory notes and 2,181,818 shares of Youbet common stock, valued at
$5.50 per share.
The Youbet shares issued to UT Group 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, we delivered notice
exercising our 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, and we paid UT Group the aggregate make-whole payment of $4.5 million.
For more information regarding the promissory notes issued to UT Group, see Item 7 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital
Resources.”
We have streamlined the operations of United Tote and, as previously announced, we are continuing
to evaluate strategic alternatives for this segment of our business, including a possible sale.
Disposition of Bruen Productions
In October 2006, Youbet acquired privately-held Bruen Productions International, Inc. We funded the
acquisition with common stock held in treasury, payable in four installments over three years, and
the assumption of approximately $0.2 million of debt. Youbet delivered 13,953 shares of common
stock in October 2006 as the first installment. As of December 31, 2007, we sold Bruen Productions
back to the original owner in exchange for return of the delivered shares, termination of future
stock obligations and cash. The decision to sell the Bruen Productions was reached after management
concluded that Bruen Productions was not a core business for Youbet, and that the sale would free
up management resources to focus on our ADW platform and totalizator services. For more information
regarding the sale of Bruen Productions, see Note 17 “Discontinued Operations” in our consolidated
financial statements at the end of this report.
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Shutdown of IRG
As further described in Item 3 “Legal Proceedings,” the International Racing Group (“IRG”) business
was adversely impacted by a severe reduction in wagering activity following the commencement of an
investigation involving the IRG business by the U.S. Attorney’s Office in Las Vegas, Nevada.
Accordingly, on February 15, 2008, we stopped taking wagers and ceased all other operations
associated with its business. In connection with the IRG shutdown, we surrendered IRG’s license
with the Oregon Racing Commission (“ORC”). For more information regarding the discontinued
operations of IRG, see Note 17 “Discontinued Operations” in our consolidated financial statements
at the end of this report.
Research and Development
Expenses
During 2008, 2007 and 2006, we spent approximately $4.5 million, $4.4 million and $4.1 million,
respectively, on research and development activities, including capitalized expenses of $1.1
million, $0.5 million and $1.1 million in 2008, 2007 and 2006, respectively.
New Products
We have made important investments in product development areas focused on meeting our customers’
needs. A number of these improvements were released in the fourth quarter of 2008 rolling into 2009. These
developments include “experience” related modification such as enhancing the video streaming
quality with higher resolution and speed, through implementation of Flash video. This improvement
will allow our customers who use Apple’s Mac products to enjoy our streaming service for the first
time. We have created other key wagering and analytic tools including “myROI”, a “return on
investment” tool to help customers identify and reproduce their greatest areas of success.
Additionally, we have launched tools to enhance the wagering experience, leveraging conditional
logic and key improvements to our Wager Queue Pro offerings. We have also developed a number of key
new promotional capabilities to improve trial and conversion as well as rebuilding and revising our
referral program offering, which provides incentives for our customers to invite their friends to
join the Youbet.com family.
In 2008, we began providing a co-branded product for a group of four racetracks in Illinois, which
provides for the sharing of the revenue from wagers placed by Illinois customers and sharing the
expenses for providing the co-branded product. The co-branded offering provides virtual off-track
betting systems and services to customers, including, but not limited to, information regarding
horse races enabling customers to transmit wagering instructions on horse races via a Website.
This is accomplished through the creation of dynamic pages with a specific URL address to enable
visitors and customers to use the service.
Competition
Web-based interactive gaming and wagering is a new and rapidly changing marketplace. We anticipate
competition will become more intense as many web-based ventures focus on the gaming industry.
Management believes that we are well-positioned to compete with these entities, as well as other
established gaming companies seeking to enter the interactive, pari-mutuel gaming market.
Our primary competitors in the domestic interactive pari-mutuel wagering market include ODS
Technologies, L.P. and ODS Properties, Inc., collectively doing business as TV Games Network
(“TVG”), Churchill Downs Technology Initiatives Company, doing business as TwinSpires
(“Twinspires”), and XpressBet, Inc. (“XpressBet”).
TVG currently accepts wagers from customers in 15 states. TVG is a 24-hour national horse racing
channel broadcast over cable and satellite. In January 2009, Betfair Group Ltd., a gaming company
based in the United Kingdom (“Betfair”), purchased TVG from Macrovision Solutions Corporation.
Twinspires is an ADW platform owned by Churchill Downs Incorporated (“Churchill Downs”). Aside
from its namesake track, where the Kentucky Derby is held, Churchill Downs also owns and operates
Arlington Park, Calder Race Course and Fair Grounds Race Course.
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XpressBet is an ADW platform owned by Magna Entertainment Corp. (“Magna”). Magna owns and operates
horse racetracks throughout North America, including Santa Anita Park, Gulfstream Park, Golden Gate
Fields and Pimlico Race Course, where The Preakness Stakes is held. Magna also owns AmTote
International, Inc., which is a provider of totalizator services.
In March 2007, Magna and Churchill Downs announced that they had formed a joint venture called
TrackNet Media Group LLC (“TrackNet”) through which the companies’ horse racing content would be
available to each other’s various distribution platforms, including XpressBet and Twinspires, as
well as third parties, including racetracks, casinos and other ADW providers. TrackNet also
purchases horse racing content to make available through its partners’ respective distribution
platforms. Magna and Churchill Downs also jointly own Horse Racing Television.
Other competitors include Elite Turf Club, Racing & Gaming Services, Premier Turf Club, The Racing
Channel, doing business as Oneclickbetting.com, Lien Games, and AmWest Entertainment.
We believe potential new domestic and international competitors looking to enter the interactive
wagering marketplace may include large established interactive and online software companies, media
companies and gaming companies. Our business strategies may be influenced by the timing of a
competitor’s product releases and the similarity of such products to our products. Additional
competition may result in significant pressure on our pricing and profit margins.
United Tote competes primarily on the basis of the design, performance, reliability and pricing of
our products as well as contract services provided. To effectively compete, we expect to make
continued investments in product development and/or acquisitions of technology. Our two principal
competitors in this business segment are AmTote International, Inc. (owned by Magna) and Scientific
Games Corporation. Our competition outside of North America is more fragmented, with competition
also being provided by several international and regional companies.
Government Regulation and Legislation
Current licensing
In June 2008, the Oregon Racing Commission (“ORC”) approved Youbet’s application to renew for one
year our multi-jurisdictional simulcast and interactive wagering totalizator hub license to accept
and place online and telephone horse racing pari-mutuel wagers. Also, in June 2008, the Washington
Horse Racing Commission approved Youbet’s application to renew for one-year our ADW license to
accept and place online and telephone horse racing and pari-mutuel wagers.
In November 2008, the Idaho State Racing Commission approved Youbet’s application to renew for one
year our multi-jurisdictional simulcast and interactive wagering totalizator hub license to accept
and place online and telephone horse racing and pari-mutuel wagers.
In December 2008, the California Horse Racing Board renewed our in-state and out-of-state ADW
licenses through the end of 2009. Also, in December 2008, the Virginia Racing Commission approved
Youbet’s application to renew for our license to accept and place online and telephone horse racing
pari-mutuel wagers through the end of 2009.
We intend to apply for renewal of each of the licenses described above and, at this time, we have
no reason to believe that these licenses will not be renewed.
Other government regulation and licensing
Gaming activities are subject to extensive statutory and regulatory control by federal, state and
foreign agencies and could be significantly affected by any changes in the political climate and
changes to economic and regulatory policies. These changes may impact our operations in a
materially adverse way. Our facilities are used by customers to place wagers and we receive
commissions derived from such wagers; therefore various statutes and regulations could have a
direct and material impact on our business and on the public demand for our products and services.
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For a description of pertinent federal legislation, see “Industry Overview.”
From time to time, we receive correspondence from various governmental agencies inquiring into the
legality of our activities. We believe that our activities conform to those federal and state laws
and regulations applicable to our activities. However, we face the risk of either civil or criminal
proceedings brought by governmental or private litigants who disagree with our interpretation of
the applicable laws and therefore, we are at risk of losing such lawsuits or actions and may be
subject to significant damages or civil or criminal penalties.
A number of states have enacted, considered or are considering interactive and Internet gaming
legislation and regulations which may inhibit our ability to do business in such states or reduce the profitability
of doing business in such states, and anti-gaming conclusions and recommendations of other
governmental or quasi- governmental bodies could form the basis for new laws, regulations and
enforcement policies that could have a material adverse impact on our business.
Any expansion into international markets may subject us to additional regulation in those countries
into which we expand.
Seasonality and Backlog
Our business segments are subject to seasonal fluctuations in demand associated with racing
schedules. The first and fourth quarters of the calendar year traditionally comprise the weakest
seasons for our pari-mutual wagering business. As a result of inclement weather during the winter
months, a number of racetracks do not operate and those that do operate often experience missed
racing days. This adversely affects the amounts wagered and the corresponding service revenues. Due
to the services we provide, we do not experience a material backlog in sales orders or the
fulfillment of client services.
Employees
As of December 31, 2008, we had a total of 326 employees, all of whom were full-time employees. We
have never had a work stoppage. Fifteen of our United Tote employees as of December 31, 2008, were
represented by a labor union. We consider our relations with our employees and the union that
represents some of our employees to be good.
Available Information
Our internet website address is http://www.youbet.com. We make available, free of charge through
our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the
Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such documents
are electronically filed with, or otherwise furnished to, the SEC.
ITEM 1A. RISK FACTORS
The risks and uncertainties described below may not be the only risks we face. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial also may impair our
business operations or financial results. If any of the following risks occur, our business,
prospects, financial condition, operating results and cash flows could be adversely affected in
amounts that could be material.
Risks Related to Our Business
If it is determined that our business practices violate state gaming laws or regulations, we could
be subject to claims for damages, fines or other penalties and may be prohibited from accepting
pari-mutuel wagers from these states in the future.
We currently have licenses in the states of California, Idaho, Oregon, Virginia and Washington to
operate an ADW multi-jurisdictional wagering hub and/or to accept wagers from residents of such
states. We also accept pari-mutuel wagers from subscribers in other states where, we believe,
accepting such wagers is permitted pursuant to the Interstate Horseracing Act of 1978, as amended,
state laws, and certain other laws and legal principles, including those contained in the U.S.
Constitution. However, state attorneys general and gaming regulators may interpret state gaming
laws, the federal statutes and constitutional principles and doctrines in a narrower manner than we
do. If a federal or state court were to adopt such a narrow interpretation of these laws, we may
face criminal or civil damages, fines or other penalties and may be prohibited from accepting
pari-mutuel wagers in one or more states in the future, which may adversely affect our business and
results of operations.
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In addition, if any proceedings were brought by governmental or private litigants who disagree with
our interpretation of the applicable laws, the adverse publicity and cost of such litigation and
diversion of management’s focus and time away from our business operations may have a materially
adverse effect on our financial condition and results of operations. From time to time, we have
received correspondence from various state governmental agencies inquiring into the legality of our
business activities and, in certain circumstances, alleging our non-compliance with state gaming
laws. To date, we have responded in a timely manner to all of these inquiries outlining our legal
position, which we believe permits our business operations in such states. We cannot assure you
that any of these state governmental agencies agree with our legal position or that proceedings
intended to prohibit or restrict our business will not be brought against us by one or more of
these state governmental agencies in the future.
Furthermore, a number of states have considered, enacted or are considering interactive and
Internet gaming legislation and regulations which may inhibit our ability to do business in such
states or reduce the profitability of doing business in such states, and anti-gaming conclusions
and recommendations of other governmental or quasi-governmental bodies could form the basis for new
laws, regulations and enforcement policies that could have a material adverse impact on our
business. The extensive regulation by both state and federal authorities of gaming activities also
can be significantly affected by changes in the political climate and changes in economic and
regulatory policies. Such effects could be materially adverse to us.
Laws and regulations proposed by Congress and various state legislatures or federal or state
authorities that are directly applicable to online and Internet gambling could have a material
adverse effect on our business.
The
Unlawful Internet Gambling Enforcement Act of 2006, (the “UIGEA”), was signed into law on
October 13, 2006. On November 12, 2008, the Department of Treasury and Federal Reserve Board
jointly published the final rule (the “UIGEA Rule”) implementing the UIGEA.
The UIGEA includes certain racing protective provisions by maintaining the status quo with respect
to wagering activities under the Interstate Horseracing Act of 1978, as amended. Certain versions
of this legislation and other bills introduced in prior years have not included exemptions
applicable to our business, and we cannot be certain legislation will not be introduced in the
future that could threaten to materially and adversely affect our business.
A number of states have enacted, considered or are considering interactive and Internet gaming
legislation and regulations which may or may not be worded so as to permit our business to continue
in such states; and anti-gaming conclusions and recommendations of other governmental or
quasi-governmental bodies could form the basis for new laws, regulations, or enforcement policies
that could have a material adverse effect on our business. International expansion of our business
could result in our business being subject to laws and regulations of additional foreign
jurisdictions, and changes in such laws and regulations or enforcement policies could have a
material adverse effect on our business.
If credit card companies, banks or third party processing companies, as a policy, refuse to process
account wagering transactions as a result of perceived legal uncertainty surrounding online live
event wagering, our business and results of operations could be adversely affected.
Credit card companies, banks and third party processing companies may in the future become hesitant
to process deposits, fees and online transactions by our customers as a result of perceived legal
uncertainty, including perceived uncertainty under the UIEGA and the UIGEA Rule, which prohibit the
acceptance of credit cards, electronic funds transfers, checks, or the proceeds of other financial
transactions by persons engaged in unlawful betting or wagering businesses, even though the UIEGA
contains a specific exemption for activities that are permitted under the Interstate Horseracing
Act of 1978. The refusal by credit card companies, banks and third party processing companies to
process such transactions would limit the methods of payment available to our subscribers, reducing
the convenience of our services, and may make competitive
services more attractive. This may adversely affect our business.
If the federal government or state governments impose taxes on wagers or increase fees on wagers,
our business could be adversely affected.
If one or more governmental authorities successfully assert that we should collect taxes on wagers,
it could adversely affect our business. We do not currently collect taxes on wagers. However, one
or more local, state or foreign jurisdictions may seek to tax Internet wagering when a subscriber
is physically within their jurisdiction at the time the wager is placed. Such taxes, if imposed,
could have a material adverse effect on our business. We currently pay all applicable fees on
wagers in accordance with the applicable rules and regulations of the jurisdictions where we are
licensed and regulated. If the regulatory authorities in such jurisdictions increase the fees
required to be paid on wagers, it would have a material adverse effect on our business.
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If any of our significant license and content agreements is terminated or is not renewed, our
business and results of operations may be adversely affected.
TVG has formed purported exclusive relationships with a number of major U.S. horse racetracks. In
May 2001, we entered into a license and content agreement with TVG. Pursuant to this agreement, we
have a non-exclusive license to access the simulcast audio, video and data content, as well as the
wagering pools, of certain racing content at these racetracks. If our agreement with TVG is
terminated or if such relationships between TVG and such racetracks are terminated or not renewed,
and if, following any such termination or non-renewal, we are not able to license such content
directly from the track operators, our business and results of operations may be adversely
affected. We also have content agreements with TrackNet, NYRA and Hollywood Park which allow us to
access the video and data content, as well as the wagering pools, of certain racing content
controlled by them or their affiliates. If any of these content agreements are terminated or we
are not able to renew such agreements, our business and results of operations may be adversely
affected.
We face strong competition, and we expect competition to increase.
TVG, which operates an ADW website and the Television Games Network, is a direct competitor in the
interactive, pari-mutuel wagering market. The Television Games Network is a 24-hour national racing
channel for distribution over cable, Dish Network and DIRECTV®, along with an in-home
pari-mutuel wagering system that requires a dedicated television set-top box. TVG currently
operates in 15 states. Expansion by TVG into states where TVG does not currently operate would
increase competition for us.
In January 2009, Betfair completed its purchase of TVG. Changes by Betfair in the operation of TVG,
including investment of significant resources into the operation of TVG or expansion into states
where TVG currently does not operate, would increase competition for us.
Magna and its affiliated ADW website XpressBet, and Churchill Downs and its affiliated ADW website
Twinspires.com, are also direct competitors in the domestic interactive, pari-mutuel wagering
market. In March 2007, Magna and Churchill Downs announced that they had formed a joint venture
called TrackNet through which the companies’ horse racing content would be available to each
other’s various distribution platforms, including XpressBet and Twinspires, and to third parties,
including racetracks, casinos and other ADW providers. Magna and Churchill Downs also jointly own
Horse Racing Television. For more information about TrackNet, see Item 1. “Business—Competition”.
Other competitors include Elite Turf Club, Racing & Gaming Services, Premier Turf Club, The Racing
Channel, doing business as Oneclickbetting.com, Lien Games, and AmWest Entertainment. We expect to
compete with these entities, as well as new companies which may enter the interactive, pari-mutuel
gaming market. It is possible that our current and potential competitors may have greater resources
than us.
The refusal by horsemen’s groups to approve content agreements could have a material adverse effect
on our business.
In 2008, the Thoroughbred Horsemen’s Group (“THG”), a collection of horsemen’s groups from several
states, refused to approve agreements for the distribution of certain content by ADW operators
pursuant to the Interstate Horseracing Act of 1978. It is possible that the THG, other collections
of horsemen groups, or individual horsemen groups, could refuse to approve such agreements in the
future and such refusal may limit the content we could provide to our customers and therefore have
a material adverse affect on our business.
Our inability to retain our relationships with our content providers would have a material adverse
effect on our business.
We depend upon a limited number of suppliers for the majority of our premier content, and the
cancellation or non-renewal of our license agreements with any one of those suppliers, such as
TrackNet, NYRA, Del Mar or Hollywood Park, would have a material adverse effect on our business.
Our inability to retain our core customer base or our failure to attract new customers would have a
material adverse effect on our business.
Our data mining software generates detailed customer segmentation analyses based on variables such
as wagering propensities and preferences, which allows us to personalize our product offerings
through targeted special offers tailored to specific customer segments. We believe that these
techniques help us to retain our best customers. In addition, our marketing relationships with the
Daily Racing Form and others help us attract new customers. If we are unable to retain our core
customer base through robust content offerings and other popular features, if we lose customers to
our competitors, or if we fail to attract new customers, our businesses would fail to grow or would
be adversely affected.
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Current economic climate may adversely impact customers wager frequency and amounts.
The continuing credit crisis, increasing unemployment and the stock market declines may impact our
customers’ ability to wager with the same frequency and maintain their wagering level profiles. A
significant loss of customers or a considerable decline in wagering would adversely affect our
business and results of operations. In addition, the current economic climate could adversely
impact wagering levels and profitability at racetracks from which we carry racing content, which
may cause certain racetracks to cancel races or cease operations and therefore reduce the content
we could provide to our customers. A reduction in the content we provide to our customers could
reduce our revenue and have an adverse impact on our profitability.
System failures or damage from earthquakes, fires, floods, power loss, telecommunications failures,
break-ins or other unforeseen events could harm our business.
Our business depends upon our communications hardware and our computer hardware. Currently, our
hardware is stored in two different locations. Our web services and internet connection hardware
are located in a Tier IV co-location facility in Miami, Florida. Our AV distribution systems are
stored at a co-location facility in Denver, Colorado. We have built certain redundancies into our
systems to avoid downtime in the event of outages, system failures or damage; however, we do not
have duplicate geographic locations for our site of operations. Thus, our systems remain vulnerable
to damage or interruption from floods, fires, power loss, telecommunication failures, terrorist
attacks, hardware or software error, computer viruses, computer denial-of-service attacks and
similar events. Despite any precautions we may take, the occurrence of a natural disaster or other
unanticipated problems could result in lengthy interruptions in our services. Any unscheduled
interruption in the availability of our website and our services results in an immediate, and
possibly substantial, loss of revenue. Frequent or persistent interruptions in our services could
cause current or potential users to believe that our systems are unreliable, leading them to switch
to our competitors or to avoid our site, and could permanently harm our reputation and brand. These
interruptions also increase the burden on our engineering staff, which, in turn, could delay our
introduction of new features and services on our website. We have property and business
interruption insurance covering damage or interruption of our systems. However,
this insurance might not be sufficient to compensate us for all losses that may occur.
We may not be able to respond to rapid technological changes in a timely manner or without service
interruptions, which may cause customer dissatisfaction.
The gaming sector is characterized by the rapid development of new technologies and continuous
introduction of new products. Our main technological advantage versus potential competitors is our
software lead-time in the market and our experience in operating an Internet-based wagering
network. However, we may not be able to maintain our competitive technological position against
current and potential competitors, especially those with greater financial resources. Our success
depends upon new product development and technological advancements, including the development of
new wagering platforms. While we expend a significant amount of resources on research and
development and product enhancement, we may not be able to continue to improve and market our
existing products or technologies or develop and market new products in a timely manner. Further
technological developments may cause our products or technologies to become obsolete or
noncompetitive.
If we were to lose the services of key personnel, we may not be able to execute our business
strategy.
Our future success depends in a large part upon the continued service of key members of our senior
management team. They are critical to our overall management, as well as the development of our
technology, culture and strategic direction. Our future success depends on our ability to identify,
attract, hire, train, retain and motivate highly skilled technical, managerial, marketing,
finance/accounting and customer service personnel. Competition for such personnel is intense, and
we may not be able to retain and attract such employees.
Our operating results fluctuate seasonally and may be adversely impacted by a reduction in live
racing dates as a result of regulatory factors.
We experience significant fluctuations in quarterly operating results as a result of the
seasonality associated with the racing schedules. Generally, revenue is greater in the second and
third quarters of the calendar year. We carry a limited number of live racing dates and the number
of live racing dates varies somewhat from year to year. The allocation of live racing dates in most
of the jurisdictions is subject to regulatory approval from year to year and, in any given year,
there may not be the same or more racing dates than in prior years. A significant decrease in the
number of live racing dates would reduce our revenue and cause our businesses to suffer.
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If the horse racing tracks that we carry experience unfavorable weather, it may cause races to be
cancelled which would reduce our revenue and have an adverse impact on our profitability.
Because horse racing is conducted outdoors, unfavorable weather conditions, including extremely
high or low temperatures, excessive precipitation, storms or hurricanes, may cause races to be
cancelled. Because a substantial portion of our operating expenses are fixed, a reduction in the
number of races held or in the number of horses racing due to unfavorable weather would reduce our
revenue and have an adverse impact on our profitability.
A horse racing industry controversy could cause a decline in bettor confidence and result in
changes to legislation, regulation or industry practices, which could materially reduce the amount
wagered on horse racing and increase our costs, and therefore, adversely affect our revenue and
operating results.
A horse racing industry controversy could cause a decline in bettor confidence and result in
changes to legislation, regulation or industry practices. For example, on October 26, 2002, in
connection with the Breeders’ Cup World Thoroughbred Championships held at Arlington Park in
Chicago, Illinois, only one person placed winning bets on the Pick 6, a bet to pick the winning
horse in six consecutive races. The bettor purchased all six winning tickets, valued at more than
$2.5 million, through an off-track betting telephone
system. Payment of the winnings was withheld when an examination of the winning bets revealed an
unusual betting pattern. Scientific Games Corporation, the parent company of Autotote Systems,
Inc., later announced that it had fired an employee who had allegedly accessed the totalizator
system operated by Autotote Systems, altered the winning Pick 6 tickets, and erased the record of
his access. The Federal Bureau of Investigation conducted an investigation, and three individuals
pled guilty in federal court to conspiring to commit fraud and money laundering. Industry
controversy, like the Pick 6 matter, could result in a perceived lack of integrity or security, a
decline in bettor confidence, and could lead to a decline in the amount wagered on horse racing.
Any such controversy could lead to changes in legislation, regulation or industry practices, which
could result in a material reduction in the amount wagered on horse racing and in the revenue and
earnings of companies in the horse racing industry, including us.
The inability of our systems and controls to handle online security risks would have a material
adverse effect on our business.
We use packet filters, fire walls and proxy servers which are all designed to control and filter
the data allowed to enter our data centers. However, advances in computer capabilities, new
discoveries in the field of cryptography or other events or developments may make it easier for
someone to compromise or breach the technology we use to protect our subscribers’ transaction data.
If such a breach of security were to occur, it could cause interruptions in service and loss of
data or cessation in service to our subscribers. This may also allow someone to introduce a “virus”
or other harmful component to Youbet causing an interruption or malfunction.
To the extent our activities involve the storage and transmission of information such as credit
card numbers, security breaches could damage our reputation and expose us to a risk of loss or
litigation and possible liability, as well as costs of complying with laws governing disclosure and
remediation following such breaches. Our insurance policies might not be sufficient to reimburse us
for losses caused by such security breaches.
The U.S. government’s investigation into the wagering activities of certain IRG customers may
adversely affect our financial condition and results of operations.
The U.S. government’s investigation into the wagering activities of certain IRG customers resulted
in the seizure of approximately $1.5 million held in IRG bank accounts on October 11, 2007, among
other things. On March 14, 2008, we entered into agreements with the U.S. Attorney’s Office in Las
Vegas. Pursuant to one agreement, 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. In separate agreements, we agreed to forfeit approximately $1.5 million previously
seized by the government as part of its investigation.
While these agreements resolve the matter for Youbet, the U.S. government’s ongoing investigation
creates other ancillary risks. Our continued cooperation with the U.S. government’s investigation
may continue to divert management’s attention from managing our day-to-day operations and expenses
arising from cooperating and responding to the U.S. government’s investigation may be significant.
In addition, current and former employees, officers and directors may seek indemnification,
advancement or reimbursement of expenses from us, including attorneys’ fees, with respect to
current or future proceedings related to this matter. These events could adversely affect our
financial condition, results of operations and the price of our common stock.
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Our credit facility imposes significant restrictions on us.
Our credit facility, which consists of a $5.0 million revolving line of credit and a $10.0 million
term loan and matures on November 30, 2010, contains customary covenants under the loan and
security agreement, including restrictions on our ability to incur indebtedness, make investments,
pay dividends or engage in mergers and acquisitions. The loan and security agreement also contains
certain financial covenants, including (i) a requirement to maintain a specified debt service
coverage ratio, (ii) a requirement to maintain a leverage ratio not to exceed 2:1, (iii) a
requirement to maintain a certain specified adjusted EBITDA and (iv) limitations
on capital expenditures. Our indebtedness under the loan and security agreement is guaranteed by UT
Gaming, Inc., the direct parent of United Tote Company, and secured by substantially all of our
assets, including our intellectual property, and UT Gaming’s equity in United Tote Company. The
covenants contained in the loan and security agreement may limit our ability to expand, pursue our
business strategies and obtain additional funds. Our ability to meet the financial covenants in the
loan and security agreement may be adversely affected by deterioration in business conditions or
our results of operations, adverse regulatory developments and other events beyond our control. As
of December 31, 2008, we were in compliance with financial covenants under the loan and security
agreement. Failure to comply with these covenants may result in the occurrence of an event of
default. Upon the occurrence of an event of default, the lender may terminate our credit facility
and demand immediate payment of all amounts borrowed by us, which would have adverse consequences
on our business and results of operations and may adversely affect the trading price of our common
stock.
Risks Related to United Tote
United Tote‘s totalizator business depends on its relationships with its track and other partners
for a substantial portion of its revenue. The loss of all or a portion of these relationships could
result in the failure to realize the expected level of revenue from United Tote‘s totalizator
business.
United Tote has contracts to provide totalizator services to more than 100 tracks and other
facilities that accept pari-mutuel wagers, such as off-track betting parlors, casinos, and jai alai
frontons. As a result, the success of United Tote depends, in part, on our ability to maintain
successful relationships with United Tote’s contract partners. Should these contract partners
discontinue purchasing totalizator services from United Tote, we will fail to realize our expected
level of revenue from United Tote’s totalizator business.
United Tote‘s totalizator business depends on the total amount of wagers placed with its track
partners.
Many of United Tote’s contracts provide that it will receive a percentage of the pari-mutuel wagers
for which it provides totalizator services. As the amount of pari-mutuel wagering increase, United
Tote’s revenue increases. Accordingly, a decrease in wagers placed at one or more of United Tote’s
contract partners could cause a decline in United Tote’s revenue and, in turn, our consolidated
revenue as the owner of United Tote. Further, any material reduction by any one of United Tote’s
contract partners in its level of commitment of resources, funding, personnel, and interest in
continued development of horse racing or other wagering-based businesses could cause a decline in
wagering and United Tote’s and our consolidated revenue.
United Tote‘s totalizator business depends upon leading with and responding to technological
changes.
United Tote’s success depends upon new product development and technological advancements,
including the development of more advanced wagering terminals. While United Tote devotes resources
to research and development and product enhancement, it may not be able to continue to improve and
market existing products or technologies or successfully develop and market new products in a
timely manner. Further technological developments by competitors may cause United Tote products or
technologies to become obsolete or noncompetitive.
Technological or human errors could have a material adverse effect on United Tote’s totalizator
business
Errors by United Tote technology or personnel may subject United Tote to liabilities, including
financial penalties under its totalizator service contracts, which could have a material adverse
effect on United Tote’s business.
Current economic conditions may lead to a cessation or reduction of operations by United Tote’s
contract partners that could have a material adverse effect on United
Tote’s totalizator business.
The continuing credit crisis, increasing unemployment and the stock market declines may impact the
ability of United Tote’s contract partners to continue operations at current levels. A cessation
or reduction of operations by United Tote’s contract partners
could cause them to discontinue or limit the totalizator services
they purchase from United Tote, which could adversely affect our business
and results of operations.
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Risks Related to Ownership of Our Common Stock
If we fail to continue to meet all applicable Nasdaq Capital Market requirements and Nasdaq
determines to delist our common stock, the delisting could adversely affect the market liquidity of
our common stock, impair the value of your investment and harm our business.
Our common stock is listed on the Nasdaq Capital Market. In order to maintain that listing, we must
satisfy minimum financial and other requirements. One such requirement is a $1.00 per share minimum
bid price. For example, in March 2008, our common stock did not meet the $1.00 per share minimum
bid price requirement for 30 consecutive business days, and on March 31, 2008, Nasdaq delivered a
notice regarding our noncompliance with their continued listing requirements. The share price
subsequently increased above $1.00 for the minimum time period specified by Nasdaq and the
situation was cured. If, in the future, our share price drops below the minimum bid price
requirement for the applicable period prescribed by Nasdaq, our common stock would be delisted if
we are unable to demonstrate compliance within the applicable grace period. On October 16, 2008,
the Nasdaq temporarily suspended the $1.00 minimum bid price requirement until January 16, 2009 and
has now extended the temporary suspension until April 20, 2009.
In such a scenario, we may seek stockholder approval to affect a reverse stock split to cause an
increase in the trading price of our common stock to a level above the minimum bid price
requirement. However, a reverse stock split may not prevent the common stock from dropping back
down towards the Nasdaq minimum per share price requirement or below the required level. It is also
possible that we would otherwise fail to satisfy another Nasdaq requirement for continued listing
of our common stock.
If we fail to meet all applicable Nasdaq Capital Market requirements in the future and Nasdaq
determines to delist our common stock, the delisting could adversely affect the market liquidity of
our common stock, adversely affect our ability to obtain financing for the continuation of our
operations and harm our business. This delisting could also impair the value of your investment.
The share price of our common stock may be volatile and can decline further.
The trading price of our common stock has been volatile and is likely to continue to be volatile.
Our stock price could be subject to wide fluctuations in response to a variety of issues, including
broad market factors that may have a material adverse impact on our stock price, regardless of
actual performance. These factors include the following:
If our quarterly results are below the expectations of securities market analysts and investors,
the price of our common stock may decline further.
Many factors, including those described in this report, can affect our business, financial
condition and results of operations, which makes the prediction of our financial results difficult.
These factors include:
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If our quarterly operating results fall below the expectations of securities market analysts and
investors due to these or other risks, securities analysts may downgrade our common stock and some
of our stockholders may sell their shares, which could adversely affect the trading prices of our
common stock.
We have the ability to issue additional equity securities, which would lead to further dilution of
our issued and outstanding common stock.
The issuance of additional equity securities or securities convertible into equity securities would
result in dilution of then-existing stockholders’ equity interests in us. We 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, 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. Our Board of Directors has the authority to issue, without vote or action of
stockholders, up to 1,000,000 shares of preferred stock in one or more series, and has the ability
to fix the rights, preferences, privileges and restrictions of any such series. Any such series of
preferred stock could contain dividend rights, conversion rights, voting rights, terms of
redemption, redemption prices, liquidation preferences or other rights superior to the rights of
holders of our common stock. If we issue convertible preferred stock, a subsequent conversion may
dilute the current common stockholders’ interest. Our Board of Directors has no present intention
of issuing any such preferred stock, but reserves the right to do so in the future.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
As of December 31, 2008, Youbet owned no real property. Youbet currently leases its facilities for
administrative, service and/or sales activities. The terms of the leases for our leased facilities
expire at various dates from June 2009 to December 2016. The following table sets forth the
location, business segment, approximate square footage and purpose of our properties as of December
31, 2008:
Youbet believes that its facilities are adequate for its current and anticipated future levels of
operations.
ITEM 3. LEGAL PROCEEDINGS
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. We were 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 approximately
$1.5 million held in IRG bank accounts by way of civil asset forfeiture.
Following the seizure of the IRG accounts, ORC issued a notice to commence proceedings seeking
suspension of IRG’s license based upon IRG’s alleged noncompliance with ORC requirements. IRG
contested the ORC’s complaint and requested a hearing. Prior to the scheduling of a hearing date,
we shut down IRG operations and entered into a Stipulated Order of License Surrender 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.
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On March 14, 2008, we entered into agreements with the U.S. Attorney’s Office in Las Vegas.
Pursuant to one agreement, 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. In separate agreements, we agreed to forfeit approximately $1.5 million previously
seized by the government as part of its investigation.
We also are party to various legal proceedings that are ordinary and incidental to our business. We
do not expect that any of these currently pending legal proceedings will have a material adverse
impact on our consolidated financial position, consolidated results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II.
ITEM 5. MARKET FOR REGISTRANT‘S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES
Market Information
Our common stock currently trades on the Nasdaq Capital Market under the symbol “UBET”. The
following table sets forth, for the periods indicated, the high and low closing price per share for
our common stock.
On December 31, 2008, the closing sale price per share of our common stock as reported on the
Nasdaq Capital Market was $0.85 per share. As of December 31, 2008, we had 305 stockholders of
record.
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Purchases of Equity Securities by Youbet
In March 2007, our board of directors authorized a $10.0 million repurchase of up to two million
shares of our common stock. Share repurchases are administered by a special committee of directors and must be
made on or before March 31, 2009, but may not be made at any time we are in default under the terms
of our credit agreement. Since the inception of this repurchase program through the end of 2007,
we repurchased 586,766 shares of our common stock at a weighted average price of $1.71 per share
for an aggregate purchase price of approximately $1.0 million. We used cash on hand and cash
provided by operating activities to fund these share repurchases. We did not repurchase any shares
of our common stock during 2008 pursuant to this repurchase program.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information about securities authorized for issuance under our equity
compensation plans as of December 31, 2008:
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Comparison of Cumulative Total Returns
The chart below compares the performance of Youbet’s common stock with the performance of the
Nasdaq Composite and a peer group index by measuring the changes in common stock prices from
December 31, 2003 through December 31, 2008. Pursuant to the SEC’s rules, we created peer group
indexes with which to compare our own stock performance since a relevant published industry or
line-of-business index does not exist. We have selected a grouping of companies that have lines of
business similar to our own. All of the companies included in the peer group index are also engaged
in other businesses in which Youbet does not participate. The common stocks of the following
companies have been included in the Peer Group Indexes: Peer Group (1) — Churchill Downs, Inc. and
Magna Entertainment Corp. Previously included Gemstar-TV Guide International, Inc. was removed due
to its acquisition by Macrovision. Peer Group (2) — Churchill Downs, Inc., Magna Entertainment
Corp and Scientific Games Corp. The chart assumes $100 was invested on December 31, 2003 in
Youbet’s common stock and in each of the foregoing indices. The stock performance shown on the
graph below is not necessarily indicative of future price performance.
Dividends
We have never declared or paid any dividends on our common stock. We intend to retain any future
earnings primarily for use in the operation and expansion of our business. Consequently, we do not
anticipate paying any cash dividends on our common stock to our stockholders for the foreseeable
future. Our ability to pay dividends is restricted by the loan and security agreement relating to
our credit facility. Our ability to declare or pay dividends in the future may be dependent upon
our financial condition, results of operations, capital requirements, terms of any debt instruments
or preferred stock then outstanding and such other factors as our board of directors may deem
relevant at the time.
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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 elsewhere in 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, 2008. The results of operations
for the periods presented below are not necessarily indicative of the results of operations to be
expected in the future.
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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 89% of pari-mutuel wagers, or handle, on
thoroughbred racing in the United States were placed at locations away from the host track during
2008. 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 commingled with the
host track betting pools.
We 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 the wagers (handle) processed by Youbet Express.
We acquired United Tote Company in February 2006. 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 a number of foreign markets.
We have two reportable segments for accounting purposes. Our ADW segment consists of our core
Youbet Express operations. Our ADW segment also included IRG until it closed as of February 15,
2008, and Bruen Productions, which we sold in December 31, 2007, the results of both of which are
accounted for as discontinued operations. For information on IRG and Bruen Productions, see Note 14
“Discontinued Operations” 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 15 “Segment Reporting” in our consolidated financial statements at the
end of this report.
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Results of Operations for 2008 Compared to 2007
Revenues
Total revenues decreased $13.5 million, or 11%, for 2008 when compared with 2007. ADW segment
revenue, which consists primarily of commissions on wagers placed by our customers, decreased
approximately $11.8 million, or 12%, compared to 2007 resulting primarily from a 9% decline in
handle, as discussed below, as well as higher customer incentives and rebates, which amounted to
$2.5 million and represented a 45% increase in such incentives and rebates compared with the prior
year. Totalizator segment revenues decreased $1.7 million, or 6%, when compared to 2007.
Total handle for 2008 was $438.3 million, a decrease of $46.0 million, or 9%, compared to 2007
primarily due to the loss of certain track content and changes in jurisdictions where we accept
wagers.
Youbet Express yield, defined as commission revenue less track and licensing fees (each calculated
in accordance with generally accepted accounting principles), increased 70 basis points to 7.9% in
2008 versus 7.2% in 2007. The yield improvement reflects the impact of changes in track mix
favoring tracks with higher yields, the loss of lower yielding TrackNet content and a reduction in
lower yielding TVG content in 2008. We believe that yield is a useful measure to evaluate our
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 2008 included contract revenue associated with
the service of totalizator systems of $22.1 million and equipment sales of $1.1 million,
representing a decrease of $1.9 million and an increase of $0.3 million, respectively, compared to
2007. Service revenue declined as a result of track closures and reduced racing days due to
inclement weather and track maintenance.
Costs and Expenses
Track fees: Track fees, which primarily consist of host and market access fees paid and payable to
various tracks remained flat in 2008 when compared to 2007. The year-over-year decrease in track
fees attributable to reduced handle was offset by source market fee settlement accruals and higher
host fees paid to the NYRA tracks. In the beginning of 2008, these NYRA tracks were no longer TVG
exclusive.
Licensing fees: Licensing fees, which represent amounts paid and payable under our licensing
agreement with TVG, decreased $10.7 million, or 54%, in 2008 compared to 2007, primarily due to
decreased wagering on horse races at TVG tracks and the fact that, in 2007, certain California
racetracks and, beginning in 2008, NYRA racetracks were no longer TVG exclusive and, therefore,
became subject to lower licensing fees.
Network operations: Network operations expense, which consists of costs for salaries, data center
management, telecommunications and various totalizator fees, declined $0.6 million or 14% in 2008
when compared to 2007. This decrease was primarily attributable to lower data communication, AV
fees and totalizator fees, partially offset by higher outside service expenses related to the
relocation of our servers to a more secure facility in the latter part of 2007.
Contract costs: Contract costs, which represent costs of United Tote associated with providing
totalizator services at racetracks, decreased $1.8 million, or 11%, in 2008 compared to 2007,
largely due to lower compensation costs resulting from the restructuring initiated during the
second half of 2007. In addition, lower repair and maintenance costs, professional fees and data
communication expenses were partially offset by higher equipment rental and outside labor expense.
Equipment Costs: Equipment costs, which costs of United Tote associated with earning equipment
sales revenue, increased 9% in 2008, when compared with 2007, due to a modest increase in equipment
sales.
Operating Expenses
Research and development: Research and development expense decreased $0.5 million, or 13%, in 2008
compared with 2007 primarily due to labor cost savings and higher capitalization of internally
developed software. We continue to invest in the development of our network infrastructure and to
support continued technology upgrades as necessary, which may increase our research and development
expenses in the future.
Sales and marketing: Sales and marketing expense decreased $4.7 million, or 47%, in 2008 compared
to 2007. This decrease was primarily all in the Youbet Express business and resulted from a
management priority to reduce and more appropriately target marketing efforts to specific
initiatives including online customer acquisition, conversion and retention.
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General and administrative: General and administrative expense decreased $3.4 million, or 16%, in
2008 compared to 2007. The decrease in these expenses results primarily from reduced personnel and
recruiting expenses, accounting fees and expenses related to improving and testing our internal
control over financial reporting, as well as other cost reduction initiatives that commenced in the
fourth quarter of 2007 and the of recording severance/termination charges of $2.0 million in the
fourth quarter of 2007. These reductions were partially offset by a $0.7 million severance payment
to our former interim chief executive officer accrued in the second quarter of 2008 and higher
non-cash compensation expense in 2008 compared with 2007.
Depreciation and amortization: Depreciation and amortization decreased $1.0 million, or 11%,
compared to 2007, primarily due to the amortization of $0.5 million of capitalized software
development costs associated with our King Contest product in 2007 and continued aging of assets.
Impairment Write downs: In connection with our exploration of strategic alternatives for United
Tote, 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 and recorded a non-cash impairment charge of $8.0
million as of December 31, 2007. In February, 2009, we concluded that the carrying value of United
Tote was further impaired as of December 31, 2008. The total amount of this additional non-cash
impairment charge was $11.2 million, which included a $6.9 million impairment of goodwill, and
write downs in computer equipment and intangible assets of $3.1 million and $1.2 million,
respectively.
Interest expense (income): Interest expense of $1.2 million in 2008, decreased $0.6 million
compared to $1.8 million in 2007. This decrease is primarily due to lower debt levels during 2008
and lower interest rates Interest income was $0.4 million lower than 2007, primarily due to lower
investment yields in 2008 compared with 2007.
Other income: Other income remained flat when compared to the twelve months ended December 31,
2007.
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, in the third quarter of 2008, the State of California suspended the use
of net operating loss carry forwards, resulting in additional tax of $0.4 million being recognized
in 2008. In 2007, the company increased its valuation allowance relating to deferred tax assets
for net operating loss carry forwards 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 2008, positive evidence we
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 its net operating loss carry forwards.
Discontinued Operations: Effective February 15, 2008, we ceased operations at IRG and, accordingly,
have accounted for such operations retroactively as discontinued operations. For the year ended
December 31, 2008, IRG generated income of $1.4 million resulting from a negotiated earn-out
settlement, reducing the earn-out accrual as of December 31, 2007, by $2.2 million. For the year
ended December 31, 2007, IRG sustained a net loss of $13.3 million, including an impairment charge
for the intangibles associated with the IRG business of $10.9 million. Additionally, effective
December 31, 2007, we sold Bruen Productions back to the original owner and we have accounted for
Bruen’s operations as discontinued operations. 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.
Results of Operations for 2007 Compared to 2006
Revenues
Total revenues increased $7.9 million, or 7%, for 2007 compared to 2006. ADW segment revenue
increased $5.9 million, or 6%, and totalizator segment revenues increased $2.0 million largely due
to including full year results for United Tote (acquired in mid-February 2006) in 2007.
Total
wagering handle for 2007 was $484.2 million, an increase of $20.5 million, or 4% 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.
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Youbet Express yield (defined as commission revenue less track and licensing fees as a percentage
of handle) was 7.2% in 2007, up from 6.1% in the prior year, reflecting our efforts to increase
handle on higher yielding tracks. 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 $23.0 million and equipment sales of $0.9 million, an
increase of $1.4 million and a decrease of $0.4 million, respectively, compared to 2006.
Costs and Expenses
Track Fees: Track fees increased $1.6 million, or 4%, in 2007 compared to 2006. The increase is
consistent with increased handle.
Licensing Fees: For 2007, Licensing fees decreased $2.2 million, or 9.8%, compared to 2006,
primarily due to changes in track mix and in 2007 certain California racetracks were no longer TVG
exclusive and therefore, became subject to lower licensing fees.
Network Operations: Network operations expense increased $0.6 million, or 16%, for 2007 compared to
2006, primarily due to increased tote fees and communication costs associated with the increase in
handle.
Contract Costs: Contract costs increased $3.0 million, or 22%, 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.
Equipment Costs: Equipment costs for 2007 declined $0.2 million or 36%, when compared with 2006,
due to the decline in equipment sales.
Operating Expenses
Research and Development: Research and development expense increased $0.9 million or 31% 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. We 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 27%, 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 $1.6 million, or 7%, 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 $0.6 million increase
United Tote’s bad debt reserve. Additionally, in connection with restructuring our cost structure,
we recorded severance/termination charges of $2.0 million in the fourth quarter of 2007.
Depreciation and Amortization: Depreciation and amortization increased $3.1 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: In connection with our exploration of strategic alternatives for United
Tote, 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.
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Interest Expense: Interest expense decreased to $1.8 million in 2007 compared to $2.0 million in
2006. The decrease is primarily due the pay down of our 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 increased $0.1 million compared to 2006 primarily due to an early
termination fee received by United Tote in the second quarter of 2006.
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, we increased our valuation allowance relating to deferred tax assets
for net operating loss carry forwards 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 we 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. We concluded
that a valuation allowance was warranted against a portion of our net operating loss carry
forwards. On January 1, 2007, we adopted Financial Accounting Standards Board Interpretation No.
(“FIN”) 48, Accounting for Uncertainty in Income Taxes, which had no effect on our financial
statements or related disclosures.
Discontinued Operations: Effective February 15, 2008, we ceased operations at IRG and,
accordingly, have accounted for such operations retroactively as discontinued operations. For the
year ended December 31, 2007, IRG sustained a net loss of $13.3 million, including an impairment
charge for the intangibles associated with the IRG business of $11 million, and for the year ended
December 31, 2006, IRG had a net loss of $3.4 million. Additionally, effective December 31, 2007,
we sold Bruen Productions back to the original owner and we have accounted for Bruen’s operations
as discontinued operations. For the year ended December 31, 2007, Bruen sustained a net loss of
$0.9 million, which includes a $0.4 million third quarter charge for the impairment of goodwill and
for the year ended December 31, 2006, Bruen generated net income of $0.03 million.
Liquidity and Capital Resources
During 2008, we funded our operations primarily with net cash provided by operating activities.
As of December 31, 2008, we had negative net working capital of $0.8 million, compared to negative
net working capital of $14.3 million at December 31, 2007. In December 2008, we entered into a new
credit agreement with National City Bank, which provides us with up to $15.0 million in total
borrowing capacity. The credit facility consists of a $5.0 million revolving line of credit and a
$10.0 million term loan. Proceeds of $4.6 million from the term loan under new credit facility
were used to repay principal and interest in full amounts owed to Wells Fargo Foothill, Inc., our
prior lender, as well as fees and expenses associated with the refinancing. The remaining proceeds
will be used for general corporate purposes. On December 31, 2008, a principal repayment of $1.25
million was made on the term loan. No amounts have been borrowed under the revolving and letter of
credit facility. The terms of the new credit facility are more fully described below under “Credit
Facility.”
As of December 31, 2008, we had $16.5 million in cash and cash equivalents and $4.7 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.
The United States is currently experiencing a recession accompanied by, among other things, reduced
credit availability and highly curtailed gaming and other recreational activities. The effects and
duration of these developments and related risks and uncertainties on our future operations and cash flows cannot be estimated by management at this time, however, such effects may
be significant.
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Nevertheless management presently believes that our borrowing capacity, as well as on-going efforts
to contain costs and operate efficiently, and growth in handle and yield improvement at Youbet
Express will generate 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. We have an effective shelf
registration statement under which we may from time to time issue 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. 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.
Cash Flows for 2008 Compared to 2007
Net cash provided by operating activities was $15.0 million for 2008, compared to net cash used by
operating activities of $0.6 million for 2007. The year-over-year increase of $15.6 million was
primarily due to improved earnings resulting from increase revenues from our ADW segment, reduced
expenses, favorable working capital fluctuations and a non-recurring payment of a $1.2 million
arbitration award to TVG in the first quarter of 2007
Net cash used in investing activities for 2008 was $1.4 million, compared to net cash used in
investing activities of $7.1 million for 2007. The year-over-year decrease of $5.7 million was
primarily due to the net cash paid out in 2007 in connection with the United Tote ($4.5 million)
acquisition and decreased purchases of property and equipment ($1.1 million).
Net cash used in financing activities was $3.3 million and $6.3 million for 2008 and 2007,
respectively. The year-over-year decrease of $3.0 million was primarily due the refinancing of our
term loan and pay down of debt. In December 2008, we entered into a new credit facility, the terms
of which are described below under “Credit Facility.” Proceeds of $4.6 million from the term loan
under the new credit facility were used to repay principal and interest in full amounts owed to the
prior lender, as well as fees and expenses associated with the refinancing. Total repayment of
debt in 2008 was $14.0 million, which included a $1.25 million repayment on the new term loan
versus repayment of $11.0 million of debt in 2007.
Cash Flows for 2007 Compared to 2006
Net cash used in operating activities was $0.6 million for 2007, compared to net cash provided by
operating activities of $6.9 million for 2006. The year-over-year decrease of $7.5 million was
primarily due to reduced profitability, coupled with decreases of $3.8 million and $6.7 million in
accounts payable and accrued expenses, respectively, due to the timing of obligation requirements,
attributable a decline in wagering handle experienced in the fourth quarter of 2007 versus 2006.
Additionally, we 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 $7.1 million, compared to net cash used in
investing activities of $15.9 million for 2006. The year-over-year decrease of $8.8 million was
primarily due to the net cash paid out in 2006 in connection with the United Tote ($10.1 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,
and general capital spending of $2.5 million.
Net cash provided by (used in) 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.
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Credit Facility
Our
credit facility currently consists of a $5.0 million revolving line of credit and a $10.0 million
term loan. At December 31, 2008, $8.8 million was owed on the term loan and we had no outstanding
borrowings under the revolving credit facility.
On December 3, 2008, we entered into a loan and security agreement with National City Bank. The
loan and security agreement with National City Bank provides for a $10.0 million term loan, and a
$5.0 million revolving line of credit and letter of credit facility. In no event, however, may the
aggregate principal amount borrowed by us under the loan and security agreement exceed a borrowing
base determined by the amount of our available cash plus a percentage, differing in each case, of
the value of certain of our eligible accounts, inventory and equipment, subject to additional
reserves established by National City Bank at its discretion. In connection with closing the loan
and security agreement, we paid National City Bank a fee of $225,000.
On December 3, 2008, we borrowed the full $10.0 million under the term loan. We used $4.6 million
to repay principal and interest in full amounts owed to Wells Fargo Foothill, Inc., as well as fees
and expenses associated with the refinancing, and the remaining proceeds will be used for general
corporate purposes. We have not borrowed any amounts under the revolving and letter of credit
facility.
Any indebtedness under the term loan and the revolving credit facility bears interest at a variable
rate equal to either, at our discretion, prime plus 200 to 250 basis points or LIBOR plus 325 to
375 basis points. The applicable basis point margin is determined by our leverage ratio as at the
most recently delivered calculation thereof pursuant to provisions of the loan and security
agreement. Any interest accruing on the basis of the prime rate is due and payable on the first
business day of each month. Any interest accruing on the basis of LIBOR is due and payable on the
date upon which such LIBOR loan ends as determined by us. LIBOR loans may have a one, two or three
month term.
The outstanding principal amount under the term loan is due and payable on the last day of each
quarter beginning on December 31, 2008 in installments of $1.25 million. The term loan and the
revolving credit facility each mature on November 30, 2010. The loan and security agreement
provides for mandatory prepayment in the event of certain asset sales and recovery events;
provided, that, so long as an event of default has not occurred, a mandatory prepayment of the net
proceeds is not required, subject to certain thresholds or amounts as more fully described in the
loan and security agreement. Our indebtedness under the loan and security agreement is guaranteed
by UT Gaming, Inc., the direct parent of United Tote Company, and secured by substantially all of
our assets, including our intellectual property, and UT Gaming’s equity in United Tote Company.
We are subject to customary covenants under the loan and security agreement, including restrictions
on our ability to incur indebtedness, make investments, pay dividends or engage in mergers and
acquisitions. The loan and security agreement also contains certain financial covenants, including
(i) a requirement to maintain a specified debt service coverage ratio, (ii) a requirement to
maintain a leverage ratio not to exceed 2:1, (iii) a requirement to maintain a certain specified
adjusted EBITDA and (iv) limitations on capital expenditures.
As of December 31, 2008, we were in compliance with financial covenants under the loan and security
agreement.
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 Item 1 “Business-Acquisitions and Dispositions”.
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.
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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, 2008 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.
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, 2008, the
letter of credit obligation and corresponding cash collateral balance was $0.2 million.
At December 31, 2008, 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 $0.7 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, 2008:
All accounts payable and accrued expenses presented in the consolidated financial statements are
excluded from the above table.
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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 other volume
related incentives offered.
We retain a portion of all wagers as commissions prior to distributing payoffs to the winners. In
the aggregate, these commissions, coupled with tote service revenue, represent our primary revenue stream. We
expect the majority of our future revenue to be in the form of commissions and 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 collectability 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:
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 not 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
is estimated by using independent appraisals or other valuation techniques.
Factors we consider important which could trigger an impairment review include the following:
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If we determine that the carrying value of long-lived assets and related goodwill may not be
recoverable t, 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.
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,
2007 and 2008.
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. SFAS No. 157 became effective for us
only for financial assets and liabilities on January 1, 2008. SFAS 157 becomes effective for
nonfinancial assets January 1, 2009. Since we carry no nonfinancial assets on an estimated fair
value basis of accounting, the adoption of SFAS No. 157 for nonfinancial assets will not have an
effect on our financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141R,”Business Combinations.” SFAS No. 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 No. 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 No. 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, none of which are presently
expected.
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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 (including a consolidatable
variable interest entity) and 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 160 will not have an impact on our future financial position, results of
operations or operating cash flows except if we dispose of a subsidiary (see Note 16 to our
consolidated financial statements) before its effective date.
In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging
Activities — an amendment of FASB Statement No. 133”. SFAS No. 161 expands the disclosure
requirements in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
regarding an entity’s derivative instruments and hedging activities. SFAS No. 161 will be effective
for the Company’s fiscal year and interim periods beginning January 1, 2009. We do not expect that
SFAS No. 161 will have an impact on the Company’s future financial condition, results of operations
or cash flows.
In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, “Determination of the Useful
Lives of Intangible Assets”, which amends the factors that should be considered in developing
renewal or extension assumptions used to determine the useful life of an intangible asset. This
interpretation will be effective for financial statements issued for fiscal years beginning after
December 15, 2008 and interim periods within those years. We are still assessing the potential
impact of adoption.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Investments
Our exposure to market risk and related changes in interest rates may impact our investment
portfolio. As of December 31, 2008, our portfolio of investments included $16.5 million of cash and
cash equivalents and $4.7 million of restricted cash. Our portfolio of cash and cash equivalents
consists of highly liquid investments with maturities of three months or less at the date of
purchase. The average yield on our investments in 2008 was approximately 2.5%. Due to the
conservative nature of our investment portfolio, we believe that a sudden 1% change in interest
rates would not have a material effect on the value of the portfolio. The impact on our future
interest income will depend largely on the gross amount of our investment portfolio. We do not
expect our operating results or cash flows to be affected to any significant degree by a sudden
change in market interest rates.
Debt
We had aggregate debt of $12.7 million outstanding at December 31, 2008 under a term loan,
promissory note and capital lease obligations. The following table shows the breakdown of our
fixed-rate and variable-rate debt at December 31, 2008:
The weighted average interest rate paid during 2008 on outstanding indebtedness was 5.9%. For
variable-rate debt outstanding at December 31, 2008, a 0.25% increase in interest rates would
increase annual interest expense by approximately $22,000. Amounts outstanding under the revolving
credit facility provides for interest at the banks’ prime rate plus a base rate margin. Our market risk exposure with respect to
financial instruments changes in relation to the prime rate.
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 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. As of December 31, 2008, our management,
including the Chief Executive Officer, Chief Operating 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 Operating Officer, Chief Financial Officer and Chief Accounting Officer,
as appropriate, to allow timely decisions regarding required disclosure. Based on that evaluation, management, including the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer
and Chief Accounting Officer, concluded that our disclosure controls and procedures were effective
as of December 31, 2008.
Changes in Internal Control Over Financial Reporting. 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, 2008 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” and are incorporated herein by reference.
ITEM 9B. OTHER INFORMATION
United Tote Goodwill Impairment
In connection with our exploration of strategic alternatives for United Tote, 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 in February 2009, we concluded that United Tote
goodwill was impaired as of December 31, 2008. The total amount of this non-cash impairment charge
was $11.2 million, which includes the elimination of $6.9 million in goodwill and write downs in
capitalized software and intangible assets of $3.1 million and $1.2 million, respectively, and is
included in our consolidated financial statements at the end of this report.
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Option Grants and Cash Bonuses for Certain Officers and Directors
On March 4, 2009, the compensation committee of our board of directors approved cash bonus
compensation and grants of options to purchase shares of our common stock for certain of our employees and directors, including the
bonus payments and options grants set forth in the table below for the following director and
executive officers:
The exercise price for each of the above options is $1.26 per share, which represents the closing
price of our common stock on March 4, 2009, the grant date. Each of the above options will vest
ratably in four equal installments over a four year period on the anniversary of the grant date,
beginning on March 2010, and are exercisable until March 3, 2019.
Departure of James A. Burk
On
March 5, 2009, we entered into a severance and general release
agreement with James A. Burk, under which we agreed with Mr. Burk
that he will step down as Chief Financial Officer of Youbet,
effective March 31, 2009. The severance and general release
agreement, in pertinent part, modifies the severance payable to Mr.
Burk under his employment agreement with us and provides that Mr.
Burk will be paid a lump sum severance payment of $180,000, which
payment is in lieu of severance payments contemplated under his
employment agreement, and a lump sum bonus of $120,000. The severance
and general release agreement also contains a release of claims on
behalf of Mr. Burk.
The
foregoing description of the separation and general release agreement
with Mr. Burk is qualified in its entirety by reference to the full
text of the separation and general release agreement, a copy of which
is filed as Exhibit 10.15 and is incorporated herein by reference.
Adoption of Form Indemnification Agreement for Directors
On March 4, 2009, our board of directors approved a form of indemnification agreement between us
and each of our directors. The purpose of the indemnification agreement is to provide specific
contractual assurance with respect to indemnification and expense advancement rights extended to
such directors under our Amended and Restated Bylaws in order to attract highly qualified
individuals to serve as directors or in other capacities. The form of indemnification agreement
provides assurance that no future amendment to or revocation of our Amended and Restated Bylaws
will adversely affect any contractual right of a director or certain other individuals with respect
to indemnification and expense advancement.
The foregoing description of the form of indemnification agreement is qualified in its entirety by
reference to the full text of the form of indemnification agreement, a copy of which is filed as
Exhibit 10.16 and is incorporated herein by reference.
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PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information called for by Item 10 of Form 10-K will be set forth in our proxy statement for our
annual meeting of stockholders (the Proxy Statement) and is incorporated herein by reference.
Code of Ethics
Youbet has a code of business conduct and ethics, referred to as the Youbet.com Code of Conduct
(the “Code”), which is applicable to our Chief Executive Officer, Chief Operating Officer, Chief
Financial Officer and all other employees. Among other provisions, the Code sets forth standards
for honest and ethical conduct, full and fair disclosure in public filings and stockholder
communications, compliance with laws, rules and regulations, reporting of code violations and
accountability for adherence to the Code. The text of the Code has been posted on our website
(http://www.youbet.com/aboutyoubet/investors/code_of_conduct/). A copy of the Code can be obtained
free-of-charge upon written request to:
Corporate Secretary
Youbet.com, Inc. 2600 West Olive Avenue, 5th floor Burbank, CA. 91505 If we make any amendment to, or grant any waivers of, a provision of the Code that applies to our
principal executive officer or principal financial officer and that requires disclosure under
applicable SEC rules, we intend to disclose such amendment or waiver and the reasons for the
amendment or waiver on our website.
Material Changes to the Procedures By Which a Stockholder May Recommend Nominees for Election to
the Board of Directors
None.
ITEM 11. EXECUTIVE COMPENSATION
Information called for by Item 11 of Form 10-K will be set forth in the Proxy Statement and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
Information called for by Item 12 of Form 10-K will be set forth in the Proxy Statement and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information called for by Item 13 of Form 10-K will be set forth in the Proxy Statement and is
incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANTS’ FEES AND SERVICES
Information called for by Item 14 of Form 10-K will be set forth in the Proxy Statement and is
incorporated herein by reference.
PART IV.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
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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.
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, as 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 and any and all amendments to such annual
report on Form 10-K 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.
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Index to Consolidated Financial Statements
F-1
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company’s management is responsible for establishing and maintaining adequate internal control
over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934,
as amended). 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:
Management, including the Company’s Chief Executive Officer and Chief Financial Officer, does not
expect that the Company’s internal controls will prevent or detect all errors and all fraud. A
control system, no matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of internal controls can provide absolute assurance that all control
issues and instances of fraud, if any, have been detected. Also, any evaluation of the
effectiveness of controls in future periods are subject to the risk that those internal controls
may become inadequate because of changes in business conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management conducted an evaluation of the effectiveness of the Company’s internal control over
financial reporting based on the criteria set forth in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this
evaluation, management has concluded that the Company’s internal control over financial reporting
was effective as of December 31, 2008.
The Company’s independent registered public accounting firm, Piercy, Bowler, Taylor & Kern,
Certified Public Accountants, has issued an audit report on the Company’s internal control over
financial reporting. Their report on the audit of internal control over financial reporting is
included in their report on the audit of our consolidated financial statements, which appears on
page F-3 of this Form 10-K.
F-2
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Youbet.com, Inc. Burbank, California We have audited the accompanying consolidated balance sheets of Youbet.com, Inc. and Subsidiaries
(the Company) as of December 31, 2008 and 2007, and the related consolidated statements of
operations, stockholders’ equity and cash flows for each of the three years ended December 31,
2008, 2007 and 2006. Our audits included the financial statement schedule of Valuation and
Qualifying Accounts included in Item 15(a)(2). We have also audited the Company’s internal control
over financial reporting as of December 31, 2008, based on criteria established in Internal Control
— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company’s management is responsible for these financial statements and
financial statement schedule, 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 these financial statements and financial statement
schedule and an opinion on the company’s internal control over financial reporting 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 and
whether effective internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting, assessing risk that a
material weakness exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also include performing such other
procedures as we considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
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, the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company as of December 31, 2008 and
2007, and the consolidated results of its operations and cash flows for each of the three years
ended December 31, 2008, 2007 and 2006, in conformity with accounting principles generally accepted
in the United States. Also in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control — Integrated Framework issued by the COSO.
PIERCY BOWLER TAYLOR & KERN
/s/ Piercy, Bowler, Taylor & Kern
Certified Public Accountants
Las Vegas, Nevada March 6, 2009
F-3
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YOUBET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 2008 and 2007
(in thousands, except share amounts)
See notes to consolidated financial statements
F-4
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YOUBET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2008, 2007 and 2006
(in thousands, except per share amounts)
See notes to consolidated financial statements
F-5
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YOUBET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY
Years Ended December 31, 2008, 2007 and 2006
See notes to consolidated financial statements
F-6
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YOUBET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See notes to consolidated financial statements
F-7
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Youbet.com and Subsidiaries
Notes to Consolidated Financial Statements
Note 1: THE COMPANY
Youbet.com, Inc. (Youbet) and its consolidated subsidiaries (collectively, 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 and South Africa. 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).
Note 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of consolidation
The consolidated financial statements include the accounts of Youbet and its wholly-owned
subsidiaries (inclusive of Youbet Services Corporation, International Racing Group (consisting of
IRG U.S. Holdings Corp, IRG Holdings Curacao, N.V., International Racing Group, N.V. and IRG
Services (collectively, IRG), United Tote and Bruen Productions International, Inc. from October 9,
2006 until it was sold effective December 31, 2007 (Bruen)). The operations of IRG were shut down
effective February 15, 2008. Both IRG and Bruen are retroactively reported as discounted
operations (Note 14). 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 other
volume incentives are 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.
F-8
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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 3), current
and non-current, is excluded from cash and cash equivalents.
Accounts receivable and allowance for doubtful accounts
Accounts receivable are uncollateralized and 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 normally bear interest. Accounts for which no payments have been received
for two consecutive months are considered delinquent, and customary collection efforts are
initiated.
The allowance for doubtful accounts (Note 4) 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 components to build totalizator equipment and ticket paper
stock. 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 (Note 16) and if events and circumstances
(such as, 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. The estimated fair value is determined using inputs from
among the three levels of the fair value hierarchy set forth in the Financial Accounting Standards
Board Statement No. 157, Fair Value Measurements, as follows: Level 1 inputs — Unadjusted quoted
prices in active markets for identical assets or liabilities, which prices are available at the
measurement date. Level 2 inputs — Include quoted prices for similar assets and liabilities in
active markets, quoted prices for identical or similar assets and liabilities in markets that are
not active, inputs other than quoted prices that are observable for the asset or liability (i.e.,
interest rates, yield curves, etc.) and inputs that are derived principally from or corroborated by
observable market data by correlation or other means (market corroborated inputs). Level 3 inputs
— Unobservable inputs that reflect management’s estimates about the assumptions that market
participants would use in pricing the asset or liability. Management develops these inputs based
on the best available information available, including internally-developed data. In estimated the
fair value, the Company utilizes valuation techniques that maximize the use of observable inputs
and minimize the use of unobservable inputs to the extent possible.
Income taxes
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.
Effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards
Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an
Interpretation of FASB Statement No. 109” (“FIN 48”). Based on management’s evaluation, the Company
concluded that there were no significant uncertain tax positions requiring recognition in its
financial statements or related disclosures. Accordingly, no adjustments to recorded tax
liabilities or accumulated deficit were required, and there was no effect on 2007 operations as a
result of adopting FIN 48. As of December 31, 2008 the Company had not recognized liabilities for
penalty and interest as the Company does not have liability for unrecognized tax benefits.
The Company will recognize interest and penalties related to income tax matters as part of income
tax expense (benefit) in its consolidated statements of operations.
Legal defense costs
Estimated legal defense costs are not accrued. Rather, such costs are accrued and expensed when
services are provided.
Stock-based compensation
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment, (SFAS No.
123R) using the modified prospective transition method, for accounting for all stock-based
compensation. Stock-based compensation expense related to employee and director stock options
recognized for the years ended December 31, 2008, 2007 and 2006 was $1.4 million, $0.9 million and
$0.7 million, respectively.
Under the fair value recognition provisions of SFAS No. 123(R), stock-based compensation cost is
measured at the grant date based on the value of the award and is recognized on a straight-line
basis as expense over the vesting period. Under SFAS No. 123R, the Company is required to use
judgment in estimating the amount of stock-based awards that are expected to be forfeited. If
actual forfeitures differ significantly from the original estimate, stock-based compensation
expense and the results of operations could be materially impacted. Expected forfeitures are
immaterial and, therefore, the Company is recognizing forfeitures as they occur.
The Company’s determination of fair value of share-based payment awards to employees and directors
on the date of grant under SFAS 123R 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 term of the awards, and actual and projected employee stock options exercise
behaviors. The Company estimates expected volatility using historical data.
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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:
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 would 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:
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Note 3: RESTRICTED CASH
Facilities lease: As required by a lease agreement (Note 11), 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 ($168,000 and $275,000 at December 31, 2008 and 2007, respectively)
decreases $107,000 per year for the first five years of the lease and $98,000 thereafter until
expiration. 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, the remainder is
included in other assets.
Players TrustSM: As of December 31, 2008 and 2007, customer deposits maintained in
Players TrustSM totaled $4.6 million and $8.6 million, respectively, all of which is
reported as restricted cash in current assets pursuant to our licensing agreements.
Note 4: RECEIVABLES
Accounts receivable consisted of the following as of the balance sheet dates presented:
Note 5: INVENTORIES
Inventories are stated at the lower of cost (using the first-in, first-out method) or market value.
Note 6: PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of the balance sheet dates presented:
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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). In
connection with our exploration of strategic alternatives for United Tote, the Company re-evaluated
the carrying value of United Tote. As part of this evaluation, the Company compared the current
estimated fair value to its carrying value and in February 2009,
concluded that the United
Tote carrying value was impaired as of December 31, 2008 by $11.2 million. Goodwill of $6.9 million
was eliminated and based upon the carrying values of property and equipment and intangible assets
as of December 31, 2008, the Company reduced the carrying value of property and equipment and
intangible assets $3.1 million and $1.2 million respectively.
Note 7: INTANGIBLES, OTHER THAN GOODWILL
Intangibles, other than goodwill, consisted of the following as of the balance sheet dates
presented:
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 2008 and 2007 for these intangibles was $0.7 million and $1.9 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 footnote 6 above for
explanation of the $1.2 million reduction in the carrying value of intangibles as of December 31,
2008.
Note 8: ACCRUED EXPENSES
Accrued expenses consisted of the following as of the balance sheet dates presented:
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Note 9: DEBT
Debt consisted of the following as of the balance sheet dates presented:
In February 2006, the Company completed its acquisition of all of the outstanding stock of United
Tote (Note 16) 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.
In December 2008, the Company entered into a new credit agreement pursuant to which the lender
agreed to provide the Company with up to $15.0 million in total borrowing capacity. The credit
facility consists of a $5.0 million revolving line of credit and a $10.0 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
($1.25 million quarterly) plus interest, and payments commenced on December 31, 2008. At December
31, 2008, the Company owed $8.8 million under the term loan and no amount was outstanding under the
revolving credit facility. At December 31, 2008, the interest rate on this facility was 5.75% per
annum.
Proceeds of $4.6 million from the new credit agreement were used to repay principal and interest in
full amounts owed to the prior lender, as well as fees and expenses associated with the
refinancing. The remaining proceeds will be used for general corporate purposes. No amounts have
been borrowed under the revolving and letter of credit facility.
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 under the loan and security agreement, including
restrictions on our ability to incur indebtedness, make investments, pay dividends or engage in
mergers and acquisitions. The loan and security agreement also contains certain financial
covenants, including (i) a requirement to maintain a specified debt service coverage ratio, (ii)
a requirement to maintain a leverage ratio not to exceed 2:1, (iii) a requirement to maintain a
certain specified adjusted EBITDA and (iv) limitations on capital expenditures.
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%.
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 10.4%. Such obligations are payable in monthly installments through May 2010.
Annual maturities for debt, including capital lease obligations as of December 31, 2008, are as
follows:
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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:
Note 10: INCOME TAXES
Income tax expense from continuing operations consists of the following:
Income taxes from continuing operations for 2008, 2007 and 2006 differ from “expected” income taxes
for those years computed by applying the U.S. federal statutory rate of 34% to loss before taxes
for those years as follows:
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.
Except
for 2007, income (loss) from discontinued operations principally
consists of transactions with no tax effect.
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The Company’s net deferred tax assets at December 31 consist of the following:
The Company has federal and state net operating loss carry forwards in the amount of $59,066,000
and $60,588,000, respectively at December 31, 2008, which are expected to begin expiring in 2012
and 2013, respectively. Due to the change of ownership provisions of the Tax Reform Act of 1986
(Internal Revenue Code Section 382), utilization of a portion of our net operating loss and tax
credit carry forwards may be limited in future periods. Further, a portion of the carry forwards
may expire before being applied to reduce future income tax liabilities. In addition, on September
30, 2008, the State of California suspended the ability of corporations to offset taxable income
with net operating loss carry forwards for the tax years 2008 and 2009. The Company has tax credit
carry forwards totaling $342,000.
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.
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes, on January 1, 2007. The Company did not recognize any additional liability for
unrecognized tax benefit as a result of the implementation. As of December 31, 2007, the Company
did not increase or decrease liability for unrecognized tax benefit related to tax positions in
prior period nor did the company increase its liability for any tax positions in the current year.
Furthermore, there were no adjustments to the liability or lapse of statute of limitation or
settlements with taxing authorities.
The Company expects resolution of any 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, 2008, 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 US and various states and Canada. The Company’s tax
years for 2005, 2006, and 2007 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 2005. The Company’s federal return was selected for
examination by the Internal Revenue Service (IRS) for prior tax year ended December 31, 2006. As
of December, 2008, the IRS has not proposed any significant adjustments to the Company’s tax
positions. Additionally, the Canadian Revenue Agency is currently auditing United Tote’s Canadian
subsidiary’s operations for the tax years 2002, 2003 and 2004. The outcome of these audits is
uncertain; however, management believes there is no material tax liability exposure to the Company
at this time.
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Note 11: COMMITMENTS
Operating leases
The Company leases office and production facilities in California, Oregon, Kentucky and Canada
under various operating leases. Approximate minimum rental payments under these non-cancelable
operating leases as of December 31, 2008 are as follows:
Total rental expense was approximately $1.3 million, $1.7 million, and $1.3 million for 2008, 2007
and 2006, respectively.
Employment Commitments
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. On March 5, 2009, we entered into a severance and general release agreement with James A. Burk, under
which we agreed with Mr. Burk that he will step down as Chief
Financial Officer of Youbet, effective as of March 31, 2009. The
severance and general release agreement, in pertinent part, modifies
the severance payable to Mr. Burk under his employment agreement
with us and provides that Mr. Burk will be paid a lump sum severance
payment of $180,000, which payment is in lieu of severance payments
contemplated under his employment agreement, and a lump sum bonus of
$120,000. The severance and general release agreement also contains a
release of claims on behalf of Mr. Burk.
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 depending on the respective plan. Matching contributions made by the Company included in
general and administrative expenses were $0.5 million, $0.5 million and $0.4 million for 2008, 2007
and 2006, respectively, excluding nominal administrative costs assumed by the Company.
Note 12: CONTINGENCIES
The Company is 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.
The United States is currently experiencing a recession accompanied by, among other things, reduced
credit availability and highly curtailed gaming and other recreational activities. The effects and
duration of these developments and related risks and uncertainties on the Company’s future
operations and cash flows cannot be estimated at this time buy may likely be significant.
The Company often carries cash on deposit with financial institutions substantially in excess of
federally-insured limits, and the risk of losses related to such concentrations may be increasing
as a result of recent economic developments. The extent of a future loss as a result of uninsured
deposits in the event of a future failure of a bank or other financial institutions, if any, is not
subject to estimation at this time.
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Note 13: STOCKHOLDERS’ EQUITY
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, 2008, there were outstanding options for
5,559,173 shares of common stock issued under the Equity Incentive Plan, out of a total approved
pool of 13,750,000 shares.
During 2008, the Company granted various stock options to officers, other employees and directors,
under the Equity Incentive Plan as follows:
During 2007, the Company granted various stock options to officers, other employees and directors,
under the Equity Incentive Plan as follows:
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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:
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, 2008, there were options outstanding to acquire 5,559,173 shares at an average
exercise price of $1.99 per share. The estimated fair value of all awards granted during the year
ended December 31, 2008 was $1.7 million.
The following table summarizes the status of these plans as of December 31, 2008:
As of December 31, 2008, the total compensation costs related to non-vested awards yet to be
expensed was approximately $2.2 million to be amortized over the next four years.
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The weighted average exercise prices for options granted and exercisable and the weighted average
remaining contractual life for options outstanding as of December 31, 2007 and 2008 were as
follows:
Additional information with respect to outstanding options as of December 31, 2008 is a follows:
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 14: DISCONTINUED OPERATIONS
Effective December 31, 2007, the Company sold Bruen back to the original owner. The results of
Bruen Productions have been treated as discontinued operations in these financial statements and
are as follows:
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Effective February 15, 2008, the Company ceased operations at IRG in an orderly and businesslike
fashion and, accordingly, has accounted for such operations retroactively as discontinued. The
following results of IRG also have been treated as discontinued operations in these financial
statements and are as follows:
Note 15: SEGMENT REPORTING
The Company operates as two reportable segments. The Company’s advance deposit wagering (ADW)
segment consists of the operations of Youbet Express and Youbet Services Corporation and its
totalizator services segment consists of the operations of United Tote (Note 16). Bruen and IRG
were previously reported as part of the advance deposit wagering segment, but are now reported
retroactively as discontinued operations (Note 14); therefore, the amounts reported below for the
advanced deposit wagering segment have been adjusted to exclude Bruen and IRG.
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. Stated in thousands.
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Note 16: 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 expected future cash flows. If the present value of expected future cash
flows is 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, 2008 and 2007.
In connection with our evaluation of strategic alternatives for United Tote, the Company
re-evaluated the goodwill related to United Tote as of December 31, 2007. The Company determined
that the carrying value of the net assets of United Tote, including goodwill, exceeded its
estimated fair value and concluded goodwill was impaired as of December 31, 2007 by $8.0 million.
As the Company is continuing its evaluation of strategic alternatives for United Tote, including a
possible sale, combined with the decline in live track wagering and the deterioration in the
economic environment, the Company again re-evaluated the carrying value of United Tote as of
December 31, 2008 using valuations by interested third parties and discounted cash flow analyses
(referred to Level 3 inputs) and concluded that the carrying value of net assets of United Tote
exceeded the estimated fair value as of December 31, 2008 by $11.2 million. The Company eliminated
the remaining $6.9 million of goodwill and reduced the carrying
value of computer equipment and intangible assets by $3.1 million and $1.2 million respectively.
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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 $4.4 million was earned and was 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.
During the fourth quarter of 2008, the Company settled with the former owners of IRG, agreeing to
pay $2,252,000 in cash in settlement of all existing disputes and claims, including all claims
under the stock purchase agreement and the management agreement. Under the settlement agreement,
the former owners relinquished their rights to 55,554 shares of Youbet’s common stock acquired by
them in connection with their sale of the IRG business pursuant to the stock purchase agreement.
As a result of this settlement, the Company reduced the amortization and depreciation of IRG by
$2.2 million, representing the difference between the accrued earn-out payment and the amount of
the settlement.
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SCHEDULE II
YOUBET.COM, INC. VALUATION AND QUALIFYING ACCOUNTS
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