FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2006
-------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
----------------------- -------------------------
Commission file number 0-9624
----------------------------------------------------------
International Thoroughbred Breeders, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 22-2332039
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Suite 1300, 1105 N. Market Street, Wilmington, Delaware 19899-8985
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(302) 427-7599
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
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 last 90 days.
Yes X No
----- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.)
Yes No X
----- ----
Indicate by check as to whether the registrant is a shell company (as
defined in Exchange Act Rule 12b-2).
Yes No X
----- ----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the close of the latest practicable date.
Class Outstanding at August 19, 2006
- ----------------------------- ------------------------------
Common Stock, $2.00 par value 11,367,487 Shares
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
FORM 10-Q
QUARTERLY REPORT
for the Six Months ended June 30, 2006
(Unaudited)
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets
as of June 30, 2006 and December 31, 2005.............1-2
Consolidated Statements of Operations
for the Three and Six Months ended
June 30, 2006 and 2005................................3
Consolidated Statement of Stockholders' Equity
for the Six Months ended June 30, 2006................4
Consolidated Statements of Cash Flows
for the Six Months ended
June 30, 2006 and 2005................................5
Notes to Consolidated Financial Statements..............................6-28
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......29-45
Item 3. Quantitative and Qualitative Disclosures
About Market Risk......................................46
Item 4. Controls and Procedures...............................46
PART II. OTHER INFORMATION
Item 1A. Risk Factors .........................................47
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds........................................47
Item 3. Defaults Upon Senior Securities........................47
Item 6. Exhibits ..............................................47
SIGNATURES ......................................................48
CERTIFICATIONS..........................................................49
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2006 AND DECEMBER 31, 2005
ASSETS
June 30,
2006 December 31,
(UNAUDITED) 2005
------------- -------------
CURRENT ASSETS:
Cash and Cash Equivalents $ 1,095,285 $ 1,846,239
Accounts Receivable 249,490 218,087
Prepaid Expenses 2,054,116 1,697,034
Other Current Assets 187,719 524,200
Assets of Discontinued Operations 1,597 401,672
------------- -------------
TOTAL CURRENT ASSETS 3,588,207 4,687,232
------------- -------------
VESSELS & EQUIPMENT
Vessel - Palm Beach Princess -
under Capital Lease 17,500,000 17,500,000
Equipment 3,878,904 3,334,079
Leasehold Improvements 918,999 988,625
Vessel - Big Easy - under Capital
Lease - Not in Service 20,305,348 20,305,348
Vessel Not Placed in Service -
Royal Star 3,054,735 3,007,216
------------- -------------
45,657,986 45,135,268
LESS: Accumulated Depreciation
and Amortization 5,534,137 4,024,434
------------- -------------
TOTAL VESSELS & EQUIPMENT - NET 40,123,849 41,110,834
------------- -------------
OTHER ASSETS:
Notes Receivable 14,278,651 14,278,651
Vessel Deposits - Related Parties 9,733,027 9,726,377
Deposits and Other Assets -
Related Parties 4,587,077 4,541,125
Deposits and Other Assets -
Non-Related Parties 1,359,350 1,734,756
Spare Parts Inventory 1,008,026 1,032,603
------------- -------------
TOTAL OTHER ASSETS 30,966,131 31,313,512
------------- -------------
TOTAL ASSETS $ 74,678,187 $ 77,111,578
============= =============
See Notes to Consolidated Financial Statements.
1
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2006 AND DECEMBER 31, 2005
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30,
2006 December 31,
(UNAUDITED) 2005
------------- -------------
CURRENT LIABILITIES:
Accounts Payable $ 6,151,322 $ 7,310,569
Accrued Expenses 4,604,753 4,519,508
Accrued Expenses Bareboat Charter -
Related Party 1,235,995 129,425
Short-Term Debt 4,488,615 4,133,997
Vessel Equipment Lease Payable - PDS 1,254,766 -
Vessel Capital Lease Payable -
Current Portion 30,112,846 26,255,439
Deferred Interest - Short-Term 523,161 510,423
Short-Term Debt - Related Parties 382,864 531,353
Liabilities of Discontinued Operations 410,600 405,802
------------- -------------
TOTAL CURRENT LIABILITIES 49,164,922 43,796,516
------------- -------------
LONG-TERM LIABILITIES:
Vessel Capital Lease Payable - Long Term
Portion - Related Party 3,500,000 3,500,000
Long-Term Debt - Net of Current Portion 51,007 93,108
Deferred Interest - Long-Term 978,033 1,239,609
Long-Term Advances From Related Parties 543,407 653,571
------------- -------------
TOTAL LONG-TERM LIABILITIES 5,072,447 5,486,288
------------- -------------
DEFERRED INCOME 1,523,557 1,559,388
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY:
Series A Preferred Stock, $100 Par Value,
Authorized 500,000 Shares, 362,844
Issued and Outstanding 36,284,375 36,284,375
Series B Convertible Preferred Stock, $10
Par Value, Authorized 500,000 Shares,
500,000 Issued and Outstanding 5,000,000 5,000,000
Common Stock, $2 Par Value, Authorized
25,000,000 Shares, 12,282,564,
Issued and Outstanding 24,565,125 24,565,125
Capital in Excess of Par 23,535,680 22,462,582
(Deficit) (subsequent to June 30, 1993,
date of quasi-reorganization) (70,010,381) (61,585,158)
------------- -------------
19,374,799 26,726,924
LESS:
Treasury Stock, 915,077 Shares (457,538) (457,538)
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 18,917,261 26,269,386
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 74,678,187 $ 77,111,578
============= =============
See Notes to Consolidated Financial Statements.
2
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- -----------------------------
2006 2005 2006 2005
------------ ------------ ------------- -------------
OPERATING REVENUES:
Gaming $ 7,283,863 $ 7,213,088 $ 15,137,188 $ 15,702,668
Fare 651,513 754,524 1,612,529 1,830,848
On Board 435,108 513,814 863,141 1,113,278
Other 57,472 117,520 208,695 233,138
------------ ------------ ------------- -------------
NET OPERATING REVENUES 8,427,956 8,598,946 17,821,553 18,879,932
------------ ------------ ------------- -------------
OPERATING COSTS AND EXPENSES:
Gaming 2,765,623 2,291,658 5,973,541 4,884,559
Fare 676,040 1,117,214 1,471,012 2,364,511
On Board 213,234 248,762 455,684 535,594
Maritime & Legal Expenses 2,300,639 1,715,709 5,060,998 3,528,794
General & Administrative Expenses 1,100,795 1,216,442 1,956,407 1,523,400
General & Administrative Expenses - Parent 686,279 547,305 1,274,071 967,501
Ship Development Costs - Big Easy - 3,273,382 - 4,382,692
Ship Development Costs - Royal Star 512,944 165,503 898,900 177,839
Development Costs - Other 210,980 109,682 304,127 235,178
Equine Costs - 212,155 - 447,989
Depreciation & Amortization 625,061 472,911 1,680,479 1,029,406
Loss on Impairment of Assets - 50,000 400,000 150,000
------------ ------------ ------------- -------------
TOTAL OPERATING COSTS AND EXPENSES 9,091,595 11,420,723 19,475,219 20,227,463
------------ ------------ ------------- -------------
OPERATING (LOSS) (663,639) (2,821,777) (1,653,666) (1,347,531)
------------ ------------ ------------- -------------
OTHER INCOME (EXPENSE):
Interest and Financing Expenses (2,744,390) (646,598) (4,728,830) (1,130,324)
Interest and Financing Expenses - Related Party (565,111) (302,462) (1,116,076) (917,862)
Cost of Warrants Granted for Financing (579,798) - (1,073,098) -
Interest Income 2,149 7,750 2,798 13,454
Interest Income Related Parties 71,865 73,656 143,650 146,949
------------ ------------ ------------- -------------
TOTAL OTHER INCOME (EXPENSE) (3,815,285) (867,654) (6,771,556) (1,887,783)
------------ ------------ ------------- -------------
INCOME (LOSS) BEFORE TAX PROVISION (4,478,924) (3,689,431) (8,425,222) (3,235,314)
Income Tax Expense (Benefit) - 90,000 - 90,000
------------ ------------ ------------- -------------
NET (LOSS) $(4,478,924) $(3,779,431) $ (8,425,222) $ (3,325,314)
============ ============ ============= =============
NET BASIC AND DILUTED (LOSS) PER COMMON SHARE $ (0.39) $ (0.37) $ (0.74) $ (0.32)
============ ============ ============= =============
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING - Basic & Diluted 11,367,487 10,303,942 11,367,487 10,303,942
============ ============ ============= =============
See Notes to Consolidated Financial Statements.
3
INTERNATIONAL THOROUGHBRED BREEDERS, INC
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2006
Series A Series B Convertible
Preferred Preferred Common
---------------------- ----------------------- -------------------------
Number of Number of Number of
Shares Amount Shares Amount Shares Amount
------- ------------ ------- ----------- ---------- ------------
BALANCE - DECEMBER 31, 2005 362,844 $ 36,284,375 500,000 $ 5,000,000 12,282,564 $ 24,565,125
Warants Issued as Compensation - - - - - -
Net(Loss for the Six Months Ended June 30, 2006 - - - - - -
------- ------------ ------- ----------- ---------- ------------
BALANCE - JUNE 30, 2006 362,844 $ 36,284,375 500,000 $ 5,000,000 12,282,564 $ 24,565,125
======= ============ ======= =========== ========== ============
Capital Treasury
in Excess Stock
of Par (Deficit) At Cost Total
------------ ------------- ---------- -------------
BALANCE - DECEMBER 31, 2005 $ 22,462,582 $ (61,585,158) $ (457,538) $ 26,269,386
Warants Issued as Compensation 1,073,098 - - 1,073,098
Net(Loss for the Six Months Ended June 30, 2006 - (8,425,233) - (8,425,233
------------ ------------- ---------- -------------
BALANCE - JUNE 30, 2006 $ 23,535,680 $ (70,010,391) $ (457,538) $ 18,917,251
============ ============= ========== =============
See Notes to Consolidated Financial Statements.
4
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
Six Months Ended
June 30,
--------------------------
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
(LOSS) BEFORE DISCONTINUED OPERATIONS $ (8,425,223) $ (3,325,314)
Adjustments to reconcile income (loss)
to net cash (used in) provided by operating
activities:
Depreciation and Amortization 1,680,479 1,029,406
Expense of Warrants Granted 1,073,098 -
Interest Added to Capital Lease Debt - PDS 3,857,405 -
Impairment of Assets 400,000 150,000
(Decrease) in Deferred Income (35,831) (35,594)
Changes in Operating Assets and Liabilities -
(Increase) Decrease in Accounts Receivable (31,403) (1,282,769)
(Increase) Decrease in Other Assets 336,481 (239,756)
(Increase) in Prepaid Expenses (321,742) (256,622)
Increase in Accounts Payable and
Accrued Expenses 1,287,335 3,567,444
------------ ------------
CASH (USED IN) OPERATING ACTIVITIES BEFORE
DISCONTINUED OPERATIONS (179,401) (393,205)
CASH PROVIDED BY DISCONTINUED OPERATING ACTIVITIES 4,800 85,402
------------ ------------
NET CASH (USED IN) OPERATING ACTIVITIES (174,601) (307,803)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase and Improvements of Big Easy -
Related Party - (7,315,923)
Purchase and Improvements of Royal Star - (564,229)
Purchase Options in Big Easy - Related Party - (2,973,575)
Note Receivable Collected - Related Party - 2,600,749
Advances - Related Party - (2,246,355)
Livestock Expenditures - (328,247)
Capital Expenditures (598,358) (128,675)
(Increase) Decrease in Other Investment Activity 435,082 226,363
------------ ------------
NET CASH (USED IN) INVESTING ACTIVITIES (163,276) (10,729,892)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Funds Received from PDS Notes & Other Lenders - 10,829,417
Proceeds from Related Party Loans - 2,651,558
Financing Costs - (1,120,240)
Principal Payment on Stock Purchase Note - (1,241,669)
Advances (Paid) Received (to) From Related Parties 63,254 180,107
Principal Payments on Short Term Notes (391,056) (190,002)
Principal Payments on Long Term Notes (85,686) (574,387)
Decrease in Balances Due to/from
Discontinued Subsidiaries 4,875 61,802
------------ ------------
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
BEFORE DISCONTINUED FINANCING ACTIVITIES (408,613) 10,596,586
CASH (USED IN) DISCONTINUED FINANCING ACTIVITIES (4,875) (85,477)
------------ ------------
NET CASH (USED IN) PROVIDED BY
FINANCING ACTIVITIES (413,488) 10,511,109
------------ ------------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS (751,365) (526,586)
LESS CASH AND CASH EQUIVALENTS FROM
DISCONTINUED OPERATIONS 411 75
CASH AND CASH EQUIVALENTS AT BEGINNING
OF THE PERIOD 1,846,239 1,640,895
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 1,095,285 $ 1,114,384
============ ============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 114,921 $ 4,940,781
Income Taxes $ 78,130 $ -
Supplemental Schedule of Non-Cash Investing and Financing Activities:
During the Six Months ended June 30, 2006, the PDS interest
expense for the period in the amount of $3,857,405 was added to
the short term principal balance of the respective leases.
See Notes to Consolidated Financial Statements.
5
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared
assuming International Thoroughbred Breeders, Inc. and subsidiaries
(collectively, the "Company") will continue as a going concern.
The Company has recorded recurring losses from operations of $6.8 million,
$1.9 million, $12.2 million and $8.4 million during the fiscal years ended June
30, 2004 and 2005, for the six months ended December 31, 2005, and for the six
months ended June 30, 2006, respectively. These losses and the lack of working
capital have caused us to be unable to comply with certain of our debt covenants
and the Company has been unable to make its required debt service payments since
December, 2005. On March 22 , 2006 we entered into a Forbearance Agreement with
our lender, PDS Gaming Corporation ("PDS") which waived prior defaults and
permitted us to defer making payment on our debt and certain equipment leases
until May 31, 2006. On July 14, 2006, we entered into a First Amended and
Restated Forbearance Agreement (the "New Agreement") which is effective from
June 1, 2006 until August 29, 2006. The New Agreement defers payment of monthly
principal and interest payments under our loan agreement and monthly rental
payments under our equipment leases which otherwise would become due during the
forbearance periods. We have agreed to retain a financial advisor to analyze and
pursue strategic alternatives. The New Agreement requires us to sell one or more
assets with closing date(s) targeted to occur no later than August 29, 2006, or
otherwise refinance, and pay in full our obligations to PDS by the end of the
forbearance period, August 29, 2006. Based upon the Company's historical
operating performance we do not believe we will be able to bring ourselves into
compliance with either the payment requirements or the EBITDA covenants. The
uncertainty about the Company's ability to generate adequate cash from the sale
of assets and cash flow from operations to service its debt and meet its debt
covenants raises doubt about the Company's ability to continue as a going
concern.
The Company has taken various steps intended to reduce its losses and to
increase its liquidity. As discussed in Note 13, the Company suspended the
operation of the Big Easy. We will continue to incur expenses to maintain the
vessel in wet storage; however, those amounts will be substantially less than
when we were preparing the vessel for service and while operating the vessel.
The Company is seeking refinancing, has liquidated its equine holdings and
may be forced to sell other Company assets. We are also exploring opportunities
to profitably deploy the Big Easy or sell this vessel. Absent asset sales,
refinancing or the profitable deployment of the Big Easy, we will not be able to
make our debt service payments beginning on September 1, 2006. No assurances can
be given that the Company will be successful in these endeavors prior to
September 1, 2006 or thereafter.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) Nature of Operations - International Thoroughbred Breeders, Inc., a
Delaware corporation ("ITB" and together with its subsidiaries, the "Company"),
was incorporated on October 31, 1980. Its principal operating subsidiary, ITG
Vegas, Inc. ("ITG Vegas") is currently engaged in an entertainment cruise and
casino ship business under a bareboat charter of the vessel M/V Palm Beach
Princess (the "Palm Beach Princess"). The Palm Beach Princess performs fourteen
cruises weekly from the Port of Palm Beach, Florida, that is, a daytime and an
evening cruise each day. Each cruise is of five to six hours duration. During
each cruise, the Palm Beach Princess offers a range of amenities and services to
her passengers, including a full casino, sit-down buffet dining, live musical
shows, bars and lounges, swimming pool and sundecks. The casino occupies
approximately 15,000 square feet aboard the ship and is equipped with
approximately 425 slot machines, 29 table games, including blackjack, craps and
roulette, 7 poker tables, and a sports wagering book.
Using the funding provided by the PDS Transactions (see Note 4) and working
capital, our subsidiary, ITG Palm Beach, LLC, began making alterations,
retrofits and improvements to a second vessel, the Big Easy, to prepare it for
use as a casino cruise ship. After numerous delays caused by start up problems
and hurricane Wilma, we began limited regular
6
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
passenger service also from the Port of Palm Beach, Florida on November 12,
2005. On February 1, 2006 we indefinitely suspended operations of the Big Easy
after two and one half months of operations because the Coast Guard removed the
vessel's Certificate of Inspection until the installation of an insulating
bulkhead was completed. The February 1, 2006 Coast Guard decision was the latest
in a series of unforeseen business circumstances which limited management's
ability to introduce the Big Easy to the market and necessitated the suspension
of Big Easy commercial cruise operations indefinitely due to disappointing
operating results.
(B) Principles of Consolidation - The accounts of all subsidiaries are
included in the consolidated financial statements. All significant intercompany
accounts and transactions have been eliminated in consolidation.
(C) Classifications - Certain prior years' amounts have been reclassified
to conform with the current years' presentation.
(D) Revenue Recognition - Casino revenue consists of gaming winnings net of
losses. Net income is the difference between wagers placed and winning payout to
patrons and is recorded at the time wagers are made. The vast majority of the
wagers are in the form of cash; although, to a limited extent, we do grant
credit to our customers. Fare revenues consist of admissions to our vessel and
are recognized as earned. On board revenues consist primarily of ancillary
activities aboard the vessel such as the sale of food and beverages, cabin
rental, gift shop, spa activities and skeet shooting. These revenues are
recognized on the date they are earned.
(E) Accounting Periods - The subsidiaries which operate the Palm Beach
Princess and operated the Big Easy until February 1,2006 end their quarterly
accounting periods on the last Sunday of each quarter. These end of the week cut
offs create more comparability of the Company's quarterly operations, by
generally having an equal number of weeks (13) and week-end days in each
quarter. During the quarter ended June 30, 2006, these accounting periods ended
on July 2, 2006 as compared to July 3, 2005 in the quarter ended June 30, 2005.
Since our accounting periods consist of a 4-4-5 week quarter, from time to time
an additional week is included in the first period to adjust our period ends to
more closely match a calendar year end. For example, the period ended March 31,
2005 contained 14 weeks compared to the 13 weeks of the period ended March 31,
2006.
(F) Spare Parts Inventory - Spare parts inventory consists of operating
supplies, maintenance materials and spare parts. The inventories are carried at
cost. It is necessary that these parts be readily available so that the daily
cruise operations are not cancelled due to mechanical failures. The inventory
was purchased from Palm Beach Maritime Corporation ("PBMC") at a time when we
were operating the Palm Beach Princess under a bare boat charter with PBMC. PBMC
is owned by Mr. Francis W. Murray. Fair value of this inventory was determined
by actual invoice prices and estimates made by the Palm Beach Princess
engineers.
(G) Deferred Financing Costs - Deferred financing costs that are incurred
by the Company in connection with the issuance of Debt are deferred and
amortized to interest expense over the life of the underlying indebtedness using
the straight-line method.
(H) Depreciation and Amortization - Depreciation of property and equipment
were computed by the straight- line method at rates adequate to allocate their
cost or adjusted fair value in accordance with U. S. generally accepted
accounting principles over the estimated remaining useful lives of the
respective assets. Amortization expense includes the write off of major vessel
repairs and maintenance work completed at dry dock period. These expenses are
written off during a two year period following the dry dock period. For the
three months ended June 30, 2006 and 2005, the amortized expense was $84,635 and
$43,373, respectively and $169,270 and $90,082, respectively for the six month
comparable periods.
7
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
As a result of the PDS transactions (see Footnote 4) we are leasing the
vessel M/V Palm Beach Princess and the Big Easy under capital lease
arrangements. The Company began depreciating the M/V Palm Beach Princess during
our previous fiscal year end of June 30, 2005 and began depreciating the Big
Easy when it was placed in service on October 18, 2005. As a result of the Big
Easy being removed from service during the quarter ended March 31, 2006 and the
unlikelihood that the vessel will be returned to service in the immediate
future, we discontinued depreciating the vessel. Financing fees in connection
with the PDS financings, are being amortized over the life of the loans. For the
three months ended June 30, 2006 and 2005, the amortized expense associated with
these finance costs was $132,573 and $46,336, respectively and $228,479 and
$120,044, respectively for the six month comparable periods.
Long-lived assets and certain identifiable intangibles held and used by the
Company are reviewed for impairment whenever events or changes in circumstances
warrant such a review. The carrying value of a long-lived or amortizable
intangible asset is considered impaired when the anticipated undiscounted cash
flow from such asset is separately identifiable and is less than its carrying
value. In that event, a loss is recognized based on the amount by which the
carrying value exceeds the fair value of the asset. Losses on long-lived assets
to be disposed of are determined in a similar manner, except that fair values
are reduced for the cost of disposition. Beginning with fiscal years starting
after December 15, 2001, SFAS 142 requires an annual impairment review based on
fair value for all intangible assets with indefinite lives.
(I) Net Assets of Discontinued Operations - At June 30, 2006 and December
31, 2005, the remaining net assets and liabilities of Garden State Park and
Freehold Raceway were classified as "Assets of Discontinued Operations." and
"Liabilities of Discontinued Operations."
(J) Recent Accounting Pronouncements
In July 2002, the FASB issued SFAS No. 148, "Accounting for Costs
Associated with Exit or Disposal Activities". This statement requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Management recognized the costs incurred associated with the suspension of the
Big Easy operations on February 1, 2006 in our quarter ended March 31, 2006 and
future carrying costs will be recognized as incurred.
In December, 2004, the FASB issued Statement No. 123 (revised 2004),
"Stock-Based Payment" (SFAS 123R). This statement replaces SFAS 123, "Accounting
for Stock-Based Compensation", and supersedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25). SFAS 123R is now effective for public
companies for the first interim or annual reporting period of the registrant's
first fiscal year beginning on or after June 15, 2005. In accordance with the
new rule, the Company will begin to expense the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award, effective July 1, 2005. Until July 1, 2005 the Company
accounted for stock option grants using the intrinsic-value method in accordance
with APB 25. Under the intrinsic-value method, because the exercise price of the
stock options granted was equal to or greater than the market price of the
underlying stock on the date of the grant, no compensation expense was
recognized. No options were granted during the six month period ended June 30,
2006.
(K) Income Taxes - The Company has adopted the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS
109"). SFAS 109 requires a company to recognize deferred tax liabilities and
assets for the expected future tax consequences of events that have been
recognized in its financial statements or tax returns. Under this method,
deferred tax liabilities and assets are determined based on the difference
between the financial statement carrying amounts and tax basis of assets and
liabilities. Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment. The Company has provided
a valuation reserve against the full amount of the net operating loss benefit
because in the opinion of management based upon the earning history of the
Company, it is more likely than not that the benefits will not be realized.
8
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(L) Cash and Cash Equivalents - The Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
(M) Concentrations of Credit Risk - Financial instruments which potentially
subject the Company to concentrations of credit risk are cash and cash
equivalents. The Company places its cash investments with high credit quality
financial institutions and currently invests primarily in U.S. government
obligations that have maturities of less than 3 months. The amount on deposit in
any one institution that exceeds federally insured limits is subject to credit
risk.
(N) Use Of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
(O) Deferred Income - The gain from the sale of our Garden State Park
property on November 28, 2000 in the amount of $1,439,951 has been deferred
until such time as the note receivable on the sale has been collected. In
connection with the PDS Transaction we have deferred the gain on the
sale/leaseback of equipment of $101,522 over the term of the equipment lease.
(P) Net Income per Common Share - Basic earnings per share is computed as
net income available to common shareholders divided by the weighted average
number of common shares outstanding during the quarter. When applicable, diluted
earnings per share reflects the potential dilution that could occur from common
shares issuable through stock options and warrants utilizing the treasury stock
method. Diluted earnings per share is calculated by using the weighted average
number of common shares outstanding adjusted to include the potentially dilutive
effect of these occurrences.
(Q) Goodwill - Through the purchase of Leo Equity, we purchased the assets
and operations of GMO Travel which was a 100% owned subsidiary of Leo Equity.
GMO Travel provides reservations and travel services for our Palm Beach Princess
subsidiary and other non-ship related travel activities. Travel services for the
Palm Beach Princess include reservations and travel services for its numerous
foreign employees and our customers, some of which rely on air travel to reach
our location. The goodwill recorded in the amount of $193,946 represents the
fair value of GMO Travel based on its discounted cash flows and the synergies
and cost savings gained by the Palm Beach Princess. The Company accounts for
goodwill in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets". In accordance with SFAS No.
142, amortization of goodwill is not required. Goodwill is tested at least
annually for impairment by comparing the fair value of the recorded assets to
their carrying amount. If the carrying amount of the goodwill exceeds its fair
value, an impairment loss is recognized.
(3) SERIES B PREFERRED STOCK
On July 13, 2005 the Company began accepting subscriptions for the purchase
of shares of the Company's Series B Convertible Preferred Stock, par value
$10.00 per share (the "Series B Preferred Stock"). The subscriptions for Series
B Preferred Stock were received by the Company as part of a private offering of
500,000 shares of its Series B Preferred Stock, at a subscription price of
$15.00 per share. As of December 28, 2005 the Company had accepted subscriptions
for the purchase of 295,033 shares of Series B Preferred Stock and had received
approximately $4 million in net cash proceeds. On December 29, 2005 our
Chairman, Francis W. Murray, purchased all of the remaining Series B Preferred
Stock which had not previously been sold in the private offering, amounting to
204,966 shares of Series B Preferred Stock, on the same terms as the private
offering. We sold the Series B Preferred Stock to Mr. Murray in payment of
$3,074,500 of debt which the Company had owed to Mr. Murray. This amount has not
been included in the net cash proceeds amount of $4 million as indicated above.
Subscribers also received warrants for the purchase of 1.2 shares of the
Company's common stock for each share
9
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
of Series B Preferred Stock purchased (an aggregate of 600,000 shares of the
Company's common stock based on purchases of all 500,000 shares of the Series B
Preferred Stock). The exercise price under each such warrant is $3.25 per common
share, and the warrants issued to purchasers of the Series B Preferred Stock are
exercisable for a term of three (3) years beginning one year after issuance.
The Series B Preferred Stock will automatically be converted into common
stock upon the effective date of a Registration Statement covering the common
shares issuable upon conversion which was filed with the Securities and Exchange
Commission on December 30, 2005. The initial conversion price is $2.00 per share
of common stock, declining by $.02 for each full calendar quarter elapsing from
July 1, 2005 to the date on which the conversion shall occur. Upon conversion,
each share of Series B Preferred Stock will be converted into a number of shares
of common stock determined by dividing the subscription price, $15.00 per share,
by the conversion price then in effect. The Company will need to file an Amended
Form S-1 in the near future and if the registration statement becomes effective
during the quarter ended December 31, 2006, the conversion price will be $1.90
and the outstanding Series B Preferred Stock will be convertible into 3,947,368
shares of additional new common shares.
During the quarter our net loss was increased by a non-cash expense of
$163,712 as the result of the accounting for the sale of Series B convertible
preferred stock. This non-cash item, known as a "Beneficial Conversion Feature",
is the result of the application of the Emerging Issues Task Force's (EITF)
Issues 98-5 and 00-27. The beneficial conversion feature was calculated as the
difference between the effective conversion price and the fair value of the
common stock, multiplied by the estimated number of common shares into which the
security is convertible. The number of common shares the Preferred Stock is
convertible into has been increased during the current quarter, assuming a
delayed conversion before December 31, 2006, at a price of $1.90 per share. Upon
conversion, each share of Series B Preferred Stock will be converted into a
number of shares of common stock determined by dividing the subscription price
of $15 per share by the conversion price then in effect. If these shares are
issued before December 31, 2006 a total of 3,947,368 shares of Common Stock
would be issued upon conversion of all the Series B Preferred Stock, which
represents an additional 197,368 shares above the original number had the price
been $2. The value assigned to the beneficial conversion feature on the
Preferred Stock was credited to paid in capital and charged to earnings as
interest expense.
Pursuant to the Subscription Agreement, the Company also agreed to increase
the size of its Board of Directors from four to seven members, and to fill two
of those vacancies with one person to be designated by MBC Global, LLC, an
Illinois limited liability company which has served as a financial advisor to
the Company, and a second person to be designated by another group of purchasers
of the Series B Preferred Stock.
The majority of the net proceeds of the sale of Series B Preferred Stock
was used for working capital of the subsidiary companies which operate the Big
Easy and the Palm Beach Princess, and a portion of the proceeds was used for the
Parent Company operating expenses.
(4) PDS TRANSACTIONS
Since July 2004, ITB and several of its subsidiaries, along with Palm Beach
Maritime Corporation ("PBMC") and Palm Beach Empress, Inc. ("PBE"), companies
owned or controlled by Francis W. Murray, completed several financial and lease
transactions with PDS Gaming Corporation ("PDS"), a publicly held company
located in Las Vegas, along with several of its affiliated companies. On July 7,
2004, January 5, 2005 and April 5, 2005 we closed on various transactions with
PDS. On June 30, 2005 the Company and several of its subsidiaries, along with
companies controlled by Francis W. Murray, borrowed $29,313,889 to refinance the
approximately $27 million in existing PDS debts, with approximately $2.3 million
of add-on financing being provided. We have been operating under the vessel and
equipment leases and financing arrangements consummated on at various times
since July 7, 2004. Below is a summary of those transactions.
10
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(A) On July 7, 2004 PBMC and its affiliate company, PBE, the Company and
our subsidiaries ITG Vegas and ITG Palm Beach, LLC closed on a $23 million
transaction with PDS. The transactions were structured as a sale/leaseback by
PBMC and PBE, although, as to $20 million of the $23 million total, it was
effectively equivalent to a secured loan against the Palm Beach Princess and the
Big Easy vessels. Of the $23 million, $14 million was advanced to PBMC by an
affiliate of PDS as purchase price in purchasing the Palm Beach Princess. The
PDS affiliate leased and chartered the Palm Beach Princess back to PBMC and PBE,
which then subchartered the vessel to our subsidiary, ITG Vegas, Inc. Another $6
million of the $23 million was advanced for the benefit of PBMC and PBE for the
purchase and retrofitting of the vessel Big Easy, which vessel PDS (through an
affiliate) leased and chartered to PBMC and PBE, who, in turn, subchartered the
Big Easy vessel to ITG Vegas, Inc. and a new wholly-owned subsidiary of ITG
Vegas, ITG Palm Beach, LLC ("ITG Palm Beach"). The remaining $3 million of
funding from PDS is for ITG Vegas and ITG Palm Beach's lease of gaming equipment
for use on the Palm Beach Princess and Big Easy vessels.
All of the outstanding capital stock of PBMC is owned by Francis W. Murray,
our Chairman and Chief Executive Officer. PBMC owns 50% of the outstanding
capital stock of PBE. The remaining 50% of the outstanding capital stock of PBE
is owned by Raymond Parello and has been pledged to us to secure certain debts
owed to us as described below under "Prior Operations - Sale of Las Vegas Note."
Sale-Leaseback of the Princess. Prior to the closing of the PDS Transaction
(the "Closing"), the Palm Beach Princess was owned by PBMC. PBMC was indebted
under the Ship Mortgage Obligation in a principal amount of $12,000,000 plus
accrued interest, the Brennan Trustee was the holder of the Ship Mortgage
Obligation, and our subsidiary, ITG Vegas, had agreed to purchase the Ship
Mortgage Obligation for a purchase price of $13,750,000 (the "Purchase
Obligation") in order to obtain rights to operate the vessel under a bareboat
charter. In addition, we were indebted to the Brennan Trustee in connection with
our repurchase of 3,678,145 shares of our common stock (the "ITB Obligation").
As of Closing of the first PDS transaction on July 7, 2004, the aggregate
outstanding amount of the Purchase Obligation and ITB Obligation was
$7,916,451.71, for all of which PBMC, ITG Vegas and ITB were jointly and
severally liable. At the Closing, Cruise Holdings I, LLC ("Cruise I"), a
subsidiary of PDS Gaming Corporation ("PDS"), purchased the Palm Beach Princess
from PBMC for $14,000,000, $7,916,451.71 of which was paid by PBMC directly to
the Brennan Trustee to satisfy the Purchase Obligation and the ITB Obligation.
Also at July 7, 2004, Cruise I entered into a Bareboat Charter and Option
to Purchase (the "Princess Charter") and a Master Lease Agreement (together with
Lease Schedule No. 1 thereto, the "Princess Master Lease") to charter and lease
the Palm Beach Princess to PBMC and PBE for a period of five years. The charter
hire/rent payable by PBMC and PBE was $178,500 per month for the first 12 months
and $391,762.80 for the remaining term.
The Princess Charter included an option for PBMC to purchase the Palm Beach
Princess at the end of the term and is structured such that the monthly charter
hire payments under the Princess Charter would reduce the purchase price for the
Palm Beach Princess to zero in five years and title would automatically pass to
PBMC at the end of the term of the Princess Charter.
PBMC and PBE entered into a Sub-Bareboat Charter to charter the Palm Beach
Princess to ITG Vegas and ITG Palm Beach for the same five year period. The
charter hire payable by ITG Vegas and ITG Palm Beach to PBMC and PBE under the
Princess Sub-Charter was $50,000 per month ($600,000 per year) plus one percent
(1%) of the gross operating revenues of the Palm Beach Princess. Under the
Princess Sub-Charter, PBMC granted to ITG Vegas and ITG Palm Beach an option to
purchase PBMC's right to acquire the Palm Beach Princess at the end of the term,
for an exercise price equal to the appraised value of the Palm Beach Princess,
$17,500,000, to which certain amounts, including principal payments made by ITG
Vegas on the PDS lease of the Palm Beach Princess were to be credited against
the purchase price.
Acquisition of the Big Easy. On March 1, 2004, PBE entered into an
agreement to purchase the Big Easy from Empress Joliet Corporation at a purchase
price of $3,800,000. At Closing, PBE assigned to Cruise Holdings II, LLC
11
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
("Cruise II"), a subsidiary of PDS and affiliate of Cruise I, all of its rights,
title and interest in and to the Big Easy Sale Agreement, and the sum of
$6,000,000 was deposited in a blocked account to be used to pay costs of the
alterations, retrofit and improvements of the Big Easy. Such deposit was funded
to the extent of $2,880,652 by ITG Vegas.
Also at Closing, Cruise II entered into a Bareboat Charter and Option to
Purchase (the "Big Easy Charter") and a Master Lease Agreement to charter and
lease the Big Easy to PBMC and PBE for a period of five years. The charter hire
was $82,695 for the first 12 months and $171,702.54 for the remaining term.
The Big Easy Charter included an option for PBE to purchase the Big Easy at
the end of the term and was structured the same as the Princess Charter in that
the monthly payments of charter hire under the Big Easy Charter would reduce the
purchase price for the Big Easy to zero and title would automatically pass to
PBE.
PBMC and PBE also entered into a Sub-Bareboat Charter to charter the Big
Easy to ITG Vegas and ITG Palm Beach for a five year period. The charter hire
payable by ITG Vegas and ITG Palm Beach under the Big Easy Sub-Charter was
$100,000 per month ($1.2 million per year) plus one percent (1%) of the gross
operating revenues of the Big Easy. Under the Big Easy Sub-Charter, PBE granted
to ITG Vegas and ITG Palm Beach an option to purchase PBE's right to acquire the
Big Easy at the end of the term, for an exercise price equal to the appraised
value of the Big Easy, to be determined following commencement of operations of
the Big Easy, to which certain amounts were to be credited.
Lease of Gaming Equipment. At Closing, ITG Vegas and ITG Palm Beach entered
into a Master Lease, together with three Lease Schedules (the "Gaming Equipment
Lease"), to lease certain new and used gaming equipment from PDS for use on the
two vessels. A portion of the equipment was previously owned and used by ITG
Vegas on the Princess and was sold to PDS at Closing, for $500,000 and then
leased back pursuant to a Gaming Master Lease. Each Schedule of the Gaming
Equipment Lease had a term of three years. Aggregate rent during fiscal 2005 for
all gaming equipment was approximately $1.4 million per year under this
agreement. ITG Vegas and ITG Palm Beach have an option to purchase the leased
equipment at the end of the term for a purchase price equal to the fair market
value of the equipment at such time.
(B) On January 5, 2005, Royal Star Entertainment, LLC ("RSE"), a
wholly-owned indirect subsidiary of ITB, borrowed $2,850,000 from PDS. The Loan
was evidenced by the Note and was to be repaid on January 17, 2006. Interest on
the Loan was payable monthly at a rate of 10% per annum. At closing, RSE paid a
closing fee to the lender in an amount equal to $78,375 or 2.75% of the
principal amount of the Note. The proceeds of the loan were used to make
improvements to the vessels Royal Star and Big Easy. Also at the closing, RSE
entered into an equipment lease with PDS providing for the lease by RSE of slot
machines to be located on the vessel Royal Star. The term of the Lease was three
years, with rental payments of $11,879 per month for the first four months and
$95,351.73 for the next thirty-two months. RSE paid a closing fee of $57,020.74,
and a security deposit in the amount of $95,351.73.
(C) On April 5, 2005, ITB and certain of its subsidiaries, together with
PBMC, PBE, Francis W. Murray and Francis X. Murray, executed and delivered as
joint and several co-borrowers, a promissory note payable to PDS in the amount
of $4,350,000. The note evidenced a loan made by PDS to the Company, the
proceeds of which were placed in escrow in order to obtain the release of the
vessel the Big Easy from dry dock. The $4.35 million note bore interest at 20%
per annum, until June 30, 2005 when it was refinanced. As further consideration
to PDS, ITG Vegas, Inc. and ITG Palm Beach, LLC entered into a three-year lease
of an additional $1.5 million of gaming equipment. Rental payments under such
lease were $50,000 per month for 36 months.
(D) On June 30, 2005, the Company, together with its subsidiaries, ITG
Vegas, Inc. ("ITGV"), ITG Palm Beach, LLC ("ITGPB"), International Thoroughbred
Gaming Development Corporation ("ITGDC") and Riviera Beach Entertainment, LLC
("RBE") and Royal Star Entertainment, LLC ("RSE"), entered into a Loan and
Security Agreement with PDS as lender, pursuant to which ITGV, ITGDC, RBE, RSE
and ITGPB (collectively, the "Borrowers"), borrowed
12
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
$29,313,889 to refinance the approximately $27 million in existing debts
(whether in the form of loans, ship leases or ship charters) to PDS, with
approximately $2.3 million of add-on financing being provided. The maturity of
all of the new indebtedness will be July 1, 2009. Our overall annual interest
rate on the new PDS loan is 17% until ITG Vegas' EBITDA exceeds $17 million on
an annualized basis, at which time the interest rate will be 15.5%. Funding was
completed on July 18, 2005 following the satisfaction of certain conditions,
including the execution, delivery and recording of ship mortgages and all other
closing documents.
In accounting for the add-on financing, we applied guidance as set forth in
EITF 96-19, "Debtor's Accounting for a Modification of Exchange of Debt
Instruments". We believe this add-on financing was a modification of the
existing debt rather than an extinguishment of the old debt. The present value
of the cash flows required to fund the new debt has not increased by more than
10%. Therefore, in accordance with EITF 96-19 the new debt has been treated as
an exchange or modification of the debt. We did not write off any deferred
financing costs which were on the books at that time.
Equipment leases taken during our fiscal year ended June 30, 2005 will
remain the same and the terms of the equipment leases and the loans, taken in
January and April will be extended until July 1, 2009.
Effective August 1, 2005 monthly interest and principal payments were due
in the amount of approximately $1,100,000 during the first 2 years, with the
remaining monthly payments decreasing slightly. The terms of the new loan
require the Company to maintain an EBITDA of $7.5 million for the nine months
ending October 2, 2005, $10.5 million for the twelve months ending January 1,
2006, increasing to $12 million for the twelve months ending October 1, 2006. If
these levels are not maintained or if we should not be in compliance with other
various loan covenants we will be in default of the loan.
Under the Loan and Security Agreement signed on June 30, 2005 with PDS,
upstream payments by the Borrowers to the Company were limited to $150,000 per
month plus amounts of ITG Vegas' income tax savings attributed to inclusion in
the Parent Company tax return.
As a condition to entering into the PDS Transaction, PDS required the
Company, International Thoroughbred Gaming Development Corporation ("ITGDC"),
PBMC and PBE to guaranty performance of certain of the PDS Transactions. The
Company, ITGDC and PBMC and PBE entered into a Guaranty Agreement and Pledge
Agreements guaranteeing the obligations of the borrowers.
The PDS indebtedness is secured by mortgages on the Royal Star, the Big
Easy and the Palm Beach Princess, an assignment of our promissory note dated
November 29, 2000 payable by Realen-Turnberry/Cherry Hill, LLC in the principal
amount of $10 million, an assignment of our promissory note, dated May 1, 2002,
payable by OC Realty in the principal amount of $2,021,176, and stock in certain
of our subsidiaries.
In connection with this refinancing, PBMC, an affiliate 100% owned by our
Chairman and CEO, Francis W. Murray, acquired all of the membership interests of
Cruise Holdings I, the owner of the casino cruise ship Palm Beach Princess, and
PBE, an affiliate 50% owned by Mr. Murray, acquired all of the membership
interests of Cruise Holdings II, the owner of the casino cruise ship the Big
Easy. As a result, the Bareboat Charters between PBMC and Cruise I, and PBE and
Cruise II, respectively, terminated, and, in place of the sub-Bareboat Charters
by ITGV and ITGPB, these subsidiaries charter the vessels from Cruise I and
Cruise II under substantially the same economic terms as had applied under their
previous sub-Bareboat Charters in effect on July 7, 2004.
(E) Placement Fee Agreement
On September 1, 2005 the Company entered into a Placement Fee Agreement
with PDS Gaming Corporation. In consideration of PDS providing $29.3 million in
funding and lease agreements to the Company during our prior fiscal year
13
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ended June 30, 2005, ITB agreed to pay a Placement fee of $750,000 for such
funding. The agreement was verbally agreed to between the parties during the
period of our negotiations with PDS Gaming, which resulted in the additional
loan proceeds given to the Company in the amount of $2,158,166 and a potential
agreement wherein PDS would loan an additional $3.2 million in the fall of 2005,
which loan was never completed. ITB has made a deposit of $50,000 and the
balance was to be paid monthly beginning March 1, 2006 with monthly payments of
$58,333, without interest, until February 1, 2007. The Placement Fee Agreement
also permitted the Company to cancel an equipment lease it had signed with PDS
on April 5, 2005. The original amount of the equipment lease was $1.5 million.
Under the Placement Fee Agreement, the Company was permitted to cancel the lease
after paying the $250,000 rental for the period to the date of cancellation, the
equipment was returned to PDS and the Placement Fee Agreement was put in place
of the equipment lease. Subsequently, on December 29, 2005 PDS Gaming agreed to
accept the Company's common stock, valued at $2 per share, in full payment of
the placement fee.
(F) Deferral of Principal Payments on PDS Financing
The Loan and Security Agreement signed on June 30, 2005 permitted the
Company to defer the principal portion of its scheduled payments of up to $3
million, providing the Company meets certain conditions. In order to conserve
working capital the Company began deferring principal payments of approximately
$450,000 on September 1, 2005 through December 1, 2005. This action was
necessary due to the continued delays in receiving the necessary approvals to
begin operating the Big Easy and the Company's current negative working capital
position.
(G) December 2005 Transactions
In December 2005, the Company borrowed from and issued a note payable in
the amount of $535,744 to PDS Gaming in order to cover our required debt service
interest payment on December 10, 2005. See Note 10.
(H) On October 30, 2005, we breached our loan agreements because we did not
meet the minimum EBITDA covenants and beginning January 10, 2006 through March ,
we were in default of our loan agreements for not making the principal and
interest payments due under the vessel leases for the three month period. As a
result, the interest rate on the loans increased an additional 2.5% or to 19.5%
retroactive to November 1, 2005. With the additional interest rate, interest
payments due on the leases is approximately $600,000 per month.
(I) Forbearance Agreement
On March 22, 2006, International Thoroughbred Breeders Inc, together with
certain of its subsidiaries (the Company) and certain companies owned or
controlled by Francis W. Murray, our CEO, (all being the same companies which
entered into the Loan and Security Agreement with PDS Gaming Corporation and
certain of its subsidiaries on June 30, 2005) entered into a Forbearance
Agreement effective March 22, 2006 with PDS Gaming Corporation. Under the
Agreement the Lender agreed not to enforce its rights and remedies against the
Borrower's due to their being in default on several loan covenants and payment
obligations. The Agreement permitted the Company to defer the payments on our
loan and equipment lease payments until June 1, 2006. A fee of $165,796 was
charged by the lender for the Forbearance Agreement. This fee has been added to
the outstanding lease balances in addition to costs and expenses of
approximately $150,000.
Under the Agreement, upstream payments to the parent company were permitted
in the approximate amount of $19,000 per week. The lender permitted the upstream
of funds to continue despite our not making a required May 1, 2006 payment.
We have also agreed to deliver the Second Cherry Hill Note to the lender as
additional collateral. This note has a face value of approximately $35 million
but is recorded on our books for $4.3 million.
14
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
During the forbearance period the Company was to use its best efforts to
sell or refinance the Big Easy Vessel and reduce the loan balance with the
proceeds from such a transaction. However, we were unsuccessful in our efforts.
In accordance with Emerging Issues Task Force (EITF) 86-30, "Classification
of Obligations When a Violation is Waived by the Creditor," we have classified
the long-term portion of vessel leases and the Royal Star note payable due to
PDS Gaming as current liabilities on the balance sheets because the Forbearance
Agreements signed were only effective through the periods ending May 31, 2006
and August 29, 2006, respectively.
(J) First Amended and Restated Forbearance Agreement
On July 14, 2006, International Thoroughbred Breeders, Inc. and certain of
its subsidiaries (collectively, the "Company") and certain other companies owned
or controlled by Francis W. Murray, our CEO (all being the same companies which
are parties to the Loan and Security Agreement dated as of June 30, 2005, with
PDS Gaming Corporation and being hereinafter collectively called the "Credit
Parties"), entered into a First Amended and Restated Forbearance Agreement (the
"New Agreement"). The New Agreement, which was effective June 1, 2006, amends
and restates the original Forbearance Agreement among the same parties dated
March 22, 2006, which had expired on May 31, 2006. Under the New Agreement, PDS
Gaming Corporation ("PDS") agreed, as lender and as lessor, that, as long as no
additional defaults occur under the New Agreement or under our loan and security
agreements or equipment leases with PDS, it will forbear, for a period expiring
August 29, 2006, from accelerating payment and enforcing its rights and remedies
against the Credit Parties due to the specified payment defaults and covenant
defaults presently existing on our part under our loan documents and equipment
leases. Notwithstanding expiration of the original Forbearance Agreement, PDS
has not accelerated payment of the balance of our indebtedness.
Also under the New Agreement, PDS deferred payment of monthly principal and
interest payments under our loan agreement and monthly rental payments under our
equipment leases which otherwise would become due during the forbearance period
ending August 29, 2006. In consideration of PDS' agreements in the New
Agreement, we agreed to pay a forbearance fee of $173,687 to PDS at maturity.
The Company also agreed to pay, as damages to PDS on account of default
interest that it in turn is required to pay to its financier, additional
interest at a rate of 2-1/2% per annum above the interest rate already being
charged to us on our principal and delinquent interest payments under our loan
agreement with PDS. Therefore, the effective rate of interest we are required to
pay on the unpaid principal balance plus delinquent interest payments which are
being capitalized totaling $33,238,091 as of June 30, 2006 is approximately 22%
per annum. As of June 30, 2006, the amount of such additional interest which we
agreed to pay to PDS is $526,565.
Under the New Agreement, the Credit Parties have agreed to retain a
financial advisor to analyze and pursue strategic alternatives, including the
sale of assets, and to retain a broker in connection with such asset sales, in
order to reduce indebtedness. The New Agreement requires the Credit Parties to
sell one or more assets with closing date(s) targeted to occur no later than
August 29, 2006, or otherwise refinance, and pay in full our obligations to PDS
by the end of the forbearance period, August 29, 2006.
Also pursuant to the New Agreement, the EBIDTA requirements applicable to
the Company will be waived for the 12 month periods ending July 2, July 30 and
August 27, 2006. All disbursements by our operating subsidiary, ITG Vegas, Inc.,
will require written approval by an assigned Crisis Manager, and disbursements
may only be made in accordance with an approved budget as submitted by the
Company and approved by PDS.
After expiration of the forbearance period on August 29, 2006, we do expect
to be able to make our monthly loan and lease payments unless, as a result of
closing an Alternative Transaction, our outstanding loan and lease payments are
substantially reduced. We also do not expect that we will be able to consummate
the sale of any of our vessels, the Original
15
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Cherry Hill Note or our operating business before the expiration of the
forbearance period on August 29, 2006 and will seek to negotiate a further
amendment to the forbearance agreement giving us additional time to consummate
any such transactions based on circumstance existing on August 29, 2006. No
assurance can be given that PDS will be willing to grant any further extension
of time or otherwise agree to forbear from exercising rights or remedies it may
have due to our defaults.
(5) DESCRIPTION OF LEASING ARRANGEMENTS
As mentioned in the footnote 4 above, the Company and several of its
subsidiaries have entered into charter transactions for two vessels and lease
transactions for equipment placed on three vessels.
The charter for the Palm Beach Princess, which is currently in service, has
been accounted for as a capital lease. Principal payments on the Palm Beach
Princess portion of the loan ($14 million) will reduce the capital lease
purchase liability and the interest portion of each monthly payment will be
expensed. Depreciation expense will be recorded for the Palm Beach Princess
using an estimated useful life of 20 years. Charter hire fees of $50,000 per
month plus 1% of gross revenues of the Palm Beach Princess have been accounted
for as additional interest payments on the capital lease and will be expensed as
incurred. The lease for the gaming equipment currently aboard the vessels and
the lease for new gaming equipment will be accounted for as an operating lease.
The transaction described in Note 4 also included the charter of the Big
Easy and a lease for gaming equipment aboard that vessel. As a result of the
June 30, 2005 PDS transaction, we have accounted for the Big Easy charter as a
capital lease. Principal payments on the Big Easy portion of the PDS loan of
$12.6 million will reduce the capital lease purchase liability and the interest
portion of each monthly payment will be expensed. The transaction described in
note 4 also permits the Company to purchase the Big Easy for the appraised value
of the vessel which shall be determined upon the refitting and refurbishing of
the vessel. The Company has determined the value of the Big Easy by capitalizing
the total of: 1) the costs it had incurred for improvements it had made to the
Big Easy; and 2) all payments required under the PDS Gaming loans.
The transaction described in Note 4(B) included a lease for gaming
equipment aboard the vessel, Royal Star. The gaming equipment lease will be
accounted for as an operating lease.
Vessels, plant and equipment at June 30, 2006 include the following amounts
for capitalized leases:
Vessel, Palm Beach Princess $ 17,500,000
Vessel, Big Easy 20,305,348
-----------
Less: allowance for depreciation (1,098,577)
-----------
Capital Leases $ 36,706,771
===========
The following is a schedule by years of future minimum lease payments under
capital leases together with the present value of the net minimum lease payments
as of June 30, 2006:
Period ending June 30, 2006
Total minimum lease payments $ 41,089,334
---------------
$ 41,089,334
Less: amount representing interest (10,976,488)
---------------
Present value of net minimum lease payment $ 30,112,846
===============
16
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following is a schedule of capital lease at June 30, 2006:
June 30, 2006
---------------------------------------
Vessel Short-Term Long-Term Total
- ----------------------------------- ----------- ----------- -----------
Palm Beach Princess $ 15,736,187 $ - $ 15,736,187
Big Easy 14,376,659 - 14,376,659
Royal Star 3,093,925 - 3,093,925
----------- ----------- -----------
Amount due to PDS for vessels 33,206,771 - 33,206,771
Less: Royal Star Note shown in
Notes Payable (See Note 10) (3,093,925) - (3,093,925)
Fair Market Valuation -
Palm Beach Princess - 3,500,000 3,500,000
----------- ----------- -----------
Total Short and Long Term Vessel
Leases Payable $ 30,112,846 $ 3,500,000 $ 33,612,846
=========== =========== ===========
(6) NOTES RECEIVABLE
(A) Original Cherry Hill Note
A portion of the proceeds from the sale on November 30, 2000 of our Garden
State Park property in Cherry Hill, New Jersey, to Realen-Turnberry/Cherry Hill,
LLC ("Realen") was paid in the form of a promissory note in the face amount of
$10 million (the "Note.") Under the Note, the interest rate will be adjusted
from time to time since the interest actually payable will be dependent upon,
and payable solely out of, the buyer's net cash flow available for distribution
to its equity owners ("Distributable Cash"). After the buyer's equity investors
have received aggregate distributions equal to their capital contributions plus
an agreed upon return on their invested capital, the next $10 million of
Distributable Cash will be paid to us. We will thereafter receive payments under
the Note equal to 33 1/3% of all Distributable Cash until the maturity date,
which occurs on the 15th anniversary of the issuance of the Note. We may convert
the promissory note, at our option, into a 33 1/3% equity interest in Realen
during the six month period prior to the 15th anniversary of the issuance of the
Note. If not then converted, the Note will be payable at maturity on said 15th
anniversary in an amount equal to (i) the difference, if any, between $10
million and total payments previously made to us under the Note and (ii) 33 1/3%
of any excess of the fair market value of Realen's assets over the sum of its
liabilities (other than the Note) and any unreturned equity investment of its
owners.
Fair value and the collectability of this note was determined by financial
statements and financial projections by the developer of the property. Now that
a portion of the mixed use project is opened, we believe that the future
projections of cash flow previously obtained from the project, along with
historical financial statements provided by the developer and prices obtained on
the re-sale of portions of the property give us a basis on which to develop
assumptions which continue to indicate a fair value based on discounted cash
flows in excess of the carrying value.
(B) Second Cherry Hill Note
A portion of the proceeds from the sale of the non-operating former El
Rancho Hotel and Casino in Las Vegas to Turnberry/Las Vegas Boulevard, LLC
("Turnberry") on May 22, 2000 was used by us to purchase a promissory note of
the buyer in the face amount of $23,000,000 (the "Las Vegas Note"). On June 16,
2004, the Company sold the Las Vegas Note to Cherry Hill at El Rancho LP (the
"Buyer"), a limited partnership which is affiliated with the maker of the Las
Vegas Note.
In exchange for the Las Vegas Note, the Company received cash payments from
the Buyer of $2.8 million,
17
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
a non-recourse loan from Turnberry Development, LLC, an affiliate of the Buyer,
in the amount of $5 million and a promissory note issued by Soffer/Cherry Hill
Partners, L.P. ("Cherry Hill Partners"), another affiliate of the Buyer, in the
principal amount of $35,842,027 (the "Second Cherry Hill Note"). The principal
amount of the Second Cherry Hill Note equaled the unpaid principal plus all
accrued and unpaid interest (at 22%) under the Las Vegas Note, less the $2.8
million in purchase price payments and $5 million non-recourse loan paid to the
Company.
The Company is not liable for repayment of the principal of the $5 million
loan, however, the Company is obligated to pay interest and fees on such loan
aggregating $600,000 per year ($50,000 per month) for five (5) years. Due to our
negative cash position, we have not made the $50,000 per month payment since
January 2005.
The Second Cherry Hill Note received by the Company matures in 2015 and is
similar to the Las Vegas Note which was sold, in that it generally is payable
prior to maturity only from distributable cash of the maker. The maker under the
Second Cherry Hill Note is one of the principal partners in the entity which
purchased the Garden State Park real property from a Company subsidiary in
November of 2000, and such obligor will only have funds with which to pay the
Second Cherry Hill Note out of its profits from the development of Garden State
Park. The development of Garden State Park, located in Cherry Hill, New Jersey,
was delayed as a result of community opposition to certain elements of the
development plan, and, while the Company believes that the development plan is
now moving forward, the timing and amount of profits there remain uncertain. The
Company already holds a promissory note in the face amount of $10 million,
received from the purchaser of Garden State Park in connection with the sale of
such real property, which the Company expects will be fully paid in time. While
the Company expects that $10,000,000 note to be fully paid, it was not
optimistic that this Second Cherry Hill Note will be fully paid, and
accordingly, during the fiscal years ended June 30, 2004 and 2005 the Company
wrote down the Second Cherry Hill Note on its books to $4,278,651.
The Second Cherry Hill Note is secured by a pledge of stock owned by
Raymond Parello, an affiliate of the Buyer, in Palm Beach Empress, Inc.,
representing fifty percent (50%) of the stock in that company. Palm Beach
Empress, Inc. is the entity formed to acquire the Big Easy, the second vessel
which is chartered to a subsidiary of the Company. The other fifty percent (50%)
of the stock in Palm Beach Empress, Inc. is owned by PBMC, a corporation owned
by Francis W. Murray, the Company's Chief Executive Officer.
Mr. Parello will have the right to acquire the Second Cherry Hill Note from
the Company in exchange for his stock in Palm Beach Empress, Inc. Such "put"
option held by Mr. Parello (giving him the right to put his stock in Palm Beach
Empress, Inc. to the Company in exchange for the Cherry Hill Note) will
effectively limit the value to the Company of the Second Cherry Hill Note to the
value of Mr. Parello's one-half interest in Palm Beach Empress, Inc. Mr.
Parello's put right will be exercisable upon the later to occur of (1) payment
by or for the account of Cherry Hill Partners of $483,205.48 under the Second
Cherry Hill Note, and (2) repayment of the entire principal balance of the
non-recourse loan received by our Orion subsidiary in the principal amount of $5
million, referred to above (upon which repayment the Company's obligation to pay
interest and fees of $600,000 per year on such loan would end). Such put option
is set forth in the Shareholders' Agreement among Palm Beach Empress, Inc.,
Raymond Parello and PBMC, to which our Orion subsidiary has joined solely for
the purpose of confirming its agreement (as holder of the Second Cherry Hill
Note) to the put option.
In the event Mr. Parello receives any dividends or other distributions on
or proceeds from any sale of his shares in Palm Beach Empress, Inc., the same
will be applied as a mandatory prepayment of the Second Cherry Hill Note.
Fair value and the collectability of the Second Cherry Hill Note was
determined by 1) assessing the present value of the Big Easy vessel, since 50%
of the stock in the company which owns it (PBE) is pledged as security of this
note; 2) and the present value of a $483,000 payment due us from the sale of the
El Rancho property. When the
18
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
fair value of this note was originally computed we assumed 50% of the value of
the Big Easy to be $5,000,000, based upon the estimated value of the Big Easy at
the time.
(7) DEPOSITS AND OTHER ASSETS - NON RELATED PARTIES
The following items are classified as deposits and other assets -
non-related parties:
June 30, 2006 December 31, 2005
------------- -----------------
Long-Term Prepaid Loan Costs - Net of
amortization in the amount of ($819,796)
and ($362,424), respectively $ 989,944 $ 1,411,976
Port Lease Rights 250,000 250,000
Other Misc. Assets 154,746 72,780
---------- ----------------
Total $ 1,394,690 $ 1,734,756
========== ================
(8) VESSEL DEPOSITS AND DEPOSITS AND OTHER ASSETS - RELATED PARTIES
(A) Vessel Deposits - Related Parties
Beginning on July 7, 2004, we entered into Sub-Bareboat Charters of the
vessels Palm Beach Princess and Big Easy with entities (Palm Beach Maritime
Corporation and Palm Beach Empress, Inc.) owned or controlled by our Chairman,
Francis W. Murray. Pursuant to our June 30, 2005 refinancing and restructuring
of the PDS transactions, we now charter the vessels, Palm Beach Princess and Big
Easy directly from Cruise Holdings I and Cruise Holdings II, respectively, which
companies are owned by Palm Beach Maritime Corporation and Palm Beach Empress,
Inc. Pursuant to the new charters, we pay Cruise Holdings I and Cruise Holdings
II, as owners of the vessels, charter fees of $50,000 per month for the Palm
Beach Princess and $100,000 per month for the Big Easy, plus 1% of our gross
revenues from operation of those vessels. We have the right to purchase either
or both vessels, at our option, for $17.5 million in the case of the Palm Beach
Princess (representing its appraised value at the time of $17.5 million) and for
fair market value (to be determined by appraisal) in the case of the Big Easy.
Once we pay off the loans against the Palm Beach Princess and Big Easy, we will
be entitled to substantial credits against the purchase prices of the vessels: a
$14 million credit in the case of the Palm Beach Princess and a $6 million
credit in the case of the Big Easy, representing the original principal amounts
of the July 2004 sale - leaseback transactions involving those vessels; as well
as credits for our investment in the net Ship Mortgage Obligation of
approximately $7.2 million which can be applied to the purchase price of either
vessel; and a credit for the portions of the costs of refurbishing and
retrofitting the Big Easy in excess of $6 million which we paid, amounting to
approximately $14 million, that can be applied to the purchase price of the Big
Easy. We have not paid the bareboat charter fees on either the Palm Beach
Princess or the Big Easy since December 2005. The outstanding balance due at
June 30, 2006 is $1,235,995 which is classified as current on our balance sheet.
19
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(B) Deposits and Other Assets - Related Parties:
June 30, December 31,
2006 2005
----------- ------------
Loans to the Ft Lauderdale
Project (OC Realty, LLC) $ 2,769,989 $ 2,769,989
Accrued Interest on Loans to the
Ft. Lauderdale Project (OC Realty, LLC) 1,623,142 1,577,190
Goodwill on Purchase of GMO Travel 193,946 193,946
----------- ------------
Total Deposits and Other Assets - Related Parties $ 4,587,077 $ 4,541,125
=========== ============
(9) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
(A) The following table represents the aging of accounts payable as of
June 30, 2006 and December 31, 2005.
Over
Total Current 31-60 Days 61-90 Days 91 Days
---------- ------- ---------- ---------- ----------
June 30, 2006 $ 6,151,322 $ 367,667 $ 1,176,382 $ 611,727 $ 3,995,546
December 31, 2005 $ 7,310,568 $ 599,387 $ 1,216,245 $ 1,244,204 $ 4,250,732
(B) Accrued expenses consisted of the following as of June 30, 2006 and
December 31, 2005
June 30, 2006 December 31, 2005
------------- -----------------
Trade Payables $ 1,790,113 $ 1,544,211
Payroll and Related Obligations 1,364,363 1,819,604
Interest 947,255 725,272
Various State Taxes 163,717 91,016
Prior State Tax Audit 339,405 339,405
------------ -----------------
Total $ 4,604,853 $ 4,519,508
============ =================
20
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(10) NOTES AND MORTGAGES PAYABLE
Notes and Mortgages Payable are summarized below. The capital lease
transactions with PDS other than the Royal Star loan are carried under lease
liabilities (See Note 4).
June 30, 2006 December 31, 2005
Interest % ------------------------ ----------------------
Per Annum Current Long-Term Current Long-Term
---------- ---------- ---------- ---------- ---------
International Thoroughbred
Breeders,Inc.:
PDS Gaming (A) 20% $ 541,102 $ -0- $ 541,102 $ -0-
Francis X. Murray (B) 8% 382,864 -0- 459,164 -0-
William H. Warner (B) 12% 37,000 -0- 37,000 -0-
MBC Global (C) 9% 200,000 -0- 200,000 -0-
Westminister Investments (C) 9% 150,000 -0- 150,000 -0-
Ryan Moore Trust (C) 9% 25,000 -0- 25,000 -0-
James B. Moore Trust (C) 9% 25,000 -0- 25,000 -0-
Other Various 25,000 -0- 36,595 -0-
ITG Vegas, Inc.:
PDS Gaming (D) 22.5% 3,125,250 -0- 2,733,838 -0-
Maritime Services, Corp. 9% -0- -0- 166,156 -0-
International Game Technology (E) 8% 345,253 28,349 221,297 59,568
Others Various 52,010 22,658 35,009 33,540
Garden State Park:
Service America Corporation (F) 6% 160,000 -0- 160,000 -0-
---------- ---------- ---------- ---------
Totals $ 5,068,479 $ 51,007 $ 4,790,161 $ 93,108
Net Liabilities of
Discontinued Operations -
Long Term (160,000) -0- (160,000) -0-
Related Party Notes (419,864) -0- (496,164) -0-
---------- ---------- ---------- ---------
Totals $ 4,488,615 $ 51,007 $ 4,133,997 $ 93,108
========== ========== ========== =========
(A) On December 9, 2005, the Company executed and delivered a promissory
note in the original principal amount of $541,102 to PDS Gaming. The proceeds of
the note were used to make several December 9, 2005 interest payments due on the
PDS Transactions. The interest rate is 20% until such time as the annualized
EBITDA for the various vessels operated by the Company reach $20 million at
which time the interest rate will be reduced to 15%
(B) On March 1, 2003, we issued a promissory note for a line of credit
bearing interest at 8% to Francis X. Murray. The outstanding balance on the line
of credit note at December 31, 2005 was $459,164 and accrued interest was
$29,052. On September 19, 2005 Mr. Murray lent an additional $300,000 to the
Parent Company. At June 30, 2006 the outstanding balance on the line of credit
was $382,864 and accrued interest was $41,962. In fiscal 2003 and fiscal 2005,
we issued promissory notes for $24,000 and $13,000 respectively, bearing
interest at 12% to
21
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
William H. Warner, Secretary of the Company. The outstanding balance is due on
demand. The proceeds from both notes were used for working capital.
(C) On November 9, 2005, we borrowed $400,000 from four (4) private parties
and agreed to issue our promissory notes evidencing the loans. In consideration
of the loans we also agreed to issue 3-year warrants to purchase 100,000 shares,
in the aggregate of our common stock, exercisable at $2.50 per share. The loans,
bearing interest at 9% per year, and the principal were due on December 9, 2005.
The terms of the note required the Company to issue penalty warrants on December
9, 2005 to purchase 100,000 shares of our common stock at an exercise price of
$2.50 per share. If the notes are not paid by the 9th day of each month
thereafter, we are required to issue additional penalty warrants to purchase
200,000 shares of common stock at the lesser of $2.50 per share or the then
current market price per share for each month beginning January 9, 2006 until
these notes are paid. Proceeds of the loans were used to pay interest then due
on our secured indebtedness for borrowed money to PDS Gaming Corporation.
(D) On January 5, 2005, the Company and its subsidiary, Royal Star
Entertainment, LLC ("RSE"), executed and delivered a promissory note in the
original principal amount of $2,850,000 (the "Note"). The Note is secured by
RSE's Preferred Ship Mortgage. The lender and holder of the Note and Mortgage is
Cruise Holdings IV, LLC, an affiliate of PDS Gaming Corporation. At closing, RSE
paid a closing fee to the lender in an amount equal to $78,375 or 2.75% of the
principal amount of the Note. The proceeds of the Loan were used to make
improvements to the vessel Royal Star or to the vessel Big Easy. The Note was
originally due on January 17, 2006, however, the PDS re-financing completed on
June 30, 2005 extended the terms of this note to July 1, 2009. The interest rate
is 20% until such time as the annualized EBITDA for the various vessels operated
by the Company reach $17 million at which time the interest rate will be reduced
to 15%. We are currently paying a default interest rate of 22.5%
(E) On December 22, 2003, ITG Vegas, Inc. issued a twenty-four month
promissory note in the amount of $231,716 bearing interest at 8.5% to
International Game Technology for the purchase of gaming equipment. A payment of
$30,000 was paid on delivery of the equipment and 24 consecutive monthly
installments of $10,532.85 were to be paid on the balance. In March 2005, ITG
Vegas, Inc. issued an additional thirty month promissory note in the amount of
$387,463 bearing interest at 8.15% to International Game Technology for the
purchase of fully reconditioned gaming equipment. Thirty consecutive monthly
installments of $14,319.49 were to be paid on the balance. At June 30, 2006, the
principal balance on the two notes to International Game Technology was $373,602
of which $345,253 was classified as short term and the balance of $28,349 was
classified as long term. At June 30, 2006 the balance on the notes includes past
due payments. The Company is negotiating new terms under these notes and if
unsuccessful the creditor may seek to enforce payment of the notes.
(F) In connection with the January 28, 1999 lease transactions for the
Garden State Park facility, the Company purchased a liquor license located at
Garden State Park owned by an unaffiliated third party, Service America
Corporation (the "Holder"), for $500,000 financed by a five (5) year promissory
note at a 6% interest rate. Yearly principal payments of $80,000 plus interest
were due on December 28, 2002 and December 28, 2003 and have not been paid. The
Company has been unsuccessful in negotiating new terms under this note and the
creditor may seek to enforce payment of the note. In additional to the principal
amount due of $160,000 the accrued but unpaid interest is approximately $39,600
as of June 30, 2006.
22
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(11) VESSELS AND EQUIPMENT
Vessels owned and/or leased and equipment consist of the following:
Depreciation is being computed over the estimated remaining useful lives using
the straight-line method.
Estimated
Useful Lives June 30, December 31,
in Years 2006 2005
- -------------------------------------- ------------ ------------ ------------
Leased Vessel - Palm Beach Princess 20 $ 17,500,000 $ 17,500,000
Leased Vessel - Big Easy Not in Service 20 20,305,348 20,305,348
Vessel Not Placed in Service -
Royal Star N/A 3,054,735 3,007,216
Equipment 5-15 3,878,904 3,334,079
Leasehold Improvements 15-40 918,999 988,625
------------ ------------
45,657,986 45,135,268
Less Accumulated Depreciation
and Amortization (5,534,137) (4,024,434)
------------ ------------
$ 40,123,849 $ 41,110,834
============ ============
(12) RELATED PARTY DEBT
The following schedule represents related party debt (See Note 17 - Related
Party Transactions):
June 30, 2006 December 31, 2005
----------------------- ------------------------
Short-Term Long-Term Short-Term Long-Term
---------- --------- ---------- ---------
Accrued Wages due to and Advances from
Francis W. Murray $ 382,864 $ - $ 531,353 $ -
Advances from Palm Beach Maritime Corp.
(Francis W. Murray ownership) - 543,407 - 653,571
---------- --------- ---------- ---------
Total Debt - Related Parties $ 382,864 $ 543,407 $ 531,353 $ 653,571
========== ========= ========== =========
(13) COMMITMENTS AND CONTINGENCIES
See Note 4 for additional commitments and contingencies with respect to the
PDS Transactions.
See Notes 12 and 17 for additional commitments and contingencies of the
Company and transactions with related parties.
See Note 18 with respect to events and developments after June 30, 2006.
On February 1, 2006 we indefinitely suspended operations of the vessel the
"Big Easy" until further notice and released the Big Easy employees. The Company
has requested an extension from the United States Coast Guard to complete the
installation of bulkhead insulation on-board the vessel because the contractor
doing the work was unavailable until mid-February 2006. However, the Coast Guard
denied the request. As a result the Coast Guard has removed the vessel's
Certificate of Inspection until the installation is completed. This work has
been substantially completed.
23
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The vessel passed Coast Guard approval to operate on October 11, 2005, but
because of the continuing effects of hurricane Wilma, inclement weather and
rough seas, mechanical problems and our inability to meet the minimum employee
counts per Coast Guard regulations, we did not begin operations until mid
November. On February 1, 2006 we indefinitely suspended operations of the Big
Easy after two and one half months of operations. On that date the Coast Guard
had denied our request for an extension to complete certain work and the Coast
Guard rescinded our Certificate of Inspection until the work was completed. The
Coast Guard's decision, coupled with an inadequate number of on-board personnel
due to the Coast Guard administrative delays in licensing our personnel, was the
latest in a series of unforeseen business circumstances which had limited
management's ability to introduce the Big Easy to the market and necessitated
the suspension of Big Easy commercial cruise operations indefinitely. We intend
to explore all of our options including changing the Big Easy from a U.S. to a
foreign flag vessel which would require less administrative dependency on the
U.S. Coast Guard. Relocation of the Big Easy to a new domestic or foreign port
is being explored.
Our vessels are subject to the provisions of the International Convention
on Safety of Life at Sea as Amended ("SOLAS 74"), which was adopted in 1974 by
the International Maritime Organization, a specialized agency of the United
Nations that is responsible for measures to improve the safety and security of
international shipping, and to prevent marine pollution from ships. SOLAS 74 is
the current basic safety standard for all ships engaged in international
service. The Convention was substantially amended in 1992 and 2000 in order to
upgrade and improve shipboard fire safety standards. The Amendments are
applicable to all passenger ships engaged in international service, including
retroactively those ships such as the Palm Beach Princess that were built prior
to 1980. Under the terms of the Amendments, full compliance by older ships with
SOLAS 74 standards is to be phased in and implemented over the years and
completed no later than October 1, 2010. The Palm Beach Princess, in compliance
with the SOLAS 74 requirements to date, has previously completed substantial
upgrading and installation of fire sprinkler and smoke detection systems and
other fire safety construction standards. By 2010 the ship must comply with the
final phase of the implementation of the SOLAS 74 Amendments, most notably being
requirements that no combustible material be used in ships' structures and that
certain other interior structure and space standards be met. The precise nature
and scope of necessary work will be determined in conjunction with the ship's
classification society, Det norske Veritas. To accomplish such work may entail
substantial cost in order to remove all wood and other combustible materials now
used in the structure of the Palm Beach Princess, to refit the ship with
non-combustible materials, and otherwise to upgrade interior structure and
spaces. We have not yet obtained an estimate of such cost. The Bareboat Charter
and Option to Purchase Agreement for the Palm Beach Princess permits us to
purchase the vessel for $17.5 million at the end of the charter period on July
1, 2009. We will be allowed credits for the payments made on the PDS lease of
$14 million, provided such payments are made, and credits of up to $7.2 million
against the purchase of the Palm Beach Princess. (However, use of the $7.2
million as a credit toward the Palm Beach Princess purchase would decrease the
credits allowed for the purchase of the Big Easy since the $7.2 million credit
can be used for the purchase of either vessel) (See Note 4A) We will need to
make a determination if it will be economically feasible to purchase the Palm
Beach Princess at the end of the charter period considering the costs which may
be involved in readying the vessel for "SOLAS" requirements.
With the sale of our Freehold Raceway property on January 28, 1999 we
assumed full responsibility for the costs associated with the clean up of
petroleum and related contamination caused by the leakage of an underground
storage tank which was removed in 1990, prior to our purchase of Freehold
Raceway. In February 2000 the N.J. Department of Environmental Protection
approved our remedial investigation workplan ("RIW"). Under the RIW numerous
test wells were drilled and the soil tested and monitored to determine the
extent and direction of the flow of underground hazardous material and reports
and conclusions of the tests were prepared for the State of New Jersey. However,
prior to obtaining a remedial action workplan from the State of New Jersey, the
work was stopped due to a lack of funds resulting from the institution of
proceedings by our subsidiary, ITGV, under Chapter 11 of the bankruptcy code. At
this time we are unable to predict the effects
24
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
that such delay may cause, but it is likely that some retesting of the wells may
be necessary. Prior to the delays it was estimated that the cost to remediate
the site would be approximately $750,000. However, we now estimate that the
total cost of clean up to be approximately $830,000 including costs we have
already spent according to the environmental consulting firm handling this
matter. These costs include drilling of test wells and monitoring, lab testing,
engineering and administrative reports, equipment and remediation of the site
through a "pump and treat" plan. The Company has made payments of approximately
$617,000 during prior fiscal years 2000, 2001 and 2002. As of June 30, 2006 we
have accrued $211,000 for the additional work. It is estimated that completion
of the site clean up will take approximately 18 months from the time the work is
reinstated. The Company will not receive any insurance reimbursement for our
costs of this remediation project.
The following table summarizes commitments on non-cancelable contracts and
leases as of June 30, 2006.
Twelve Month Period Ended June 30,
--------------------------------------------------- There-
2007 2008 2009 2010 after Total
----------- ---------- ---------- --------- -------- -----------
Capital Leases:
P.B. Princess - Principal & Interest $ 21,080,158 $ - $ - $ - $ - $ 21,080,158
Bare Boat Charter - Related Party 960,000 960,000 960,000 80,000 - 2,960,000
Big Easy - Principal & Interest 20,325,907 - - - - 20,325,907
Bare Boat Charter - Related Party 1,200,000 1,200,000 1,200,000 100,000 - 3,700,000
Notes and Mortgages:
Principal & Interest 6,094,364 192,235 3,965 - - 6,290,564
Interest Only 173,135 173,135
Deferred Interest Payments 600,000 600,000 450,000 - - 1,650,000
Operating Leases:
Casino Equipment 3,201,719 572,110 681,820 - - 4,455,649
Administrative & Office 995,863 120,503 2,028 2,873 - 1,121,267
Purchase Obligations 345,890 45,056 10,592 - - 401,538
----------- ---------- ---------- --------- -------- -----------
Total $ 54,977,036 $ 3,689,904 $ 3,308,405 $ 182,873 $ 0 $ 62,158,218
=========== ========== ========== ========= ======== ===========
(14) LEGAL PROCEEDINGS
LIQUOR LICENSE
In connection with the January 28, 1999 sale and lease transactions for the
Garden State Park facility, we purchased a liquor license owned by an
unaffiliated third party, Service America Corporation, for $500,000 financed by
a five (5) year promissory note at a 6% interest rate. At December 31, 2002, the
unpaid principal balance was $160,000. Yearly principal payments of $80,000 plus
interest were due on December 28, 2002 and December 28, 2003 and have not been
paid. The Company entered into a sale and lease agreement for the lease of our
premises from Jan. 28, 1999 to May 29, 2001 and the sale of a 10 acre portion to
be used as an OTB facility. Under the terms of our sale and lease agreement the
lessee/buyer purchased the liquor license for $100,000 and was obligated to
return it to us in exchange for a refund of the $100,000 payment if, at the
expiration of the lease, June 27, 2002, it did not have a use for the liquor
license at the OTB facility. During the three year period Jan. 28, 1999 to Jan.
28, 2002 no OTB facility was built and we believe the lessee/buyer did not have
a use for the liquor license at that property. By the terms of the contract it
was the Company's position that we had the right to re-acquire the liquor
license for $100,000 and exercised such right, however
25
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
the lessee/buyer refused to perform. On January 18, 2006 the Company filed a
Complaint in Camden County Superior Court of NJ, Chancery Division, (Civil
Action No. C-7-06) against the defendants to protect our interests in the
license. In May 2006 the judge ruled against us in a bench ruling. The Company
is appealing this matter. The carrying value of the liquor license was $400,000
and as of March 31, 2006 we expensed off the $400,000 as a result of the court's
ruling.
We are a defendant in various lawsuits incidental to the ordinary course of
business. It is not possible to determine with any precision the probable
outcome or the amount of liability, if any, under these lawsuits; however, in
the opinion of the Company and its counsel, the disposition of these lawsuits
will not have a material adverse effect on our financial position, results of
operations, or cash flows.
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS
As of June 30, 2006, in assessing the fair value of financial instruments,
the Company has used a variety of methods and assumptions, which were based on
estimates of market conditions and loan risks existing at that time. For certain
instruments, including cash and cash equivalents, investments, non-trade
accounts receivable and loans, and short-term debt, it was estimated that the
carrying amount approximated fair value for the majority of these instruments
because of their short-term maturity. The carrying amounts of long term debt
approximate fair value since the Company's interest rates approximate current
interest rates. On our original Cherry Hill note receivable in the amount of $10
million, we have elected to defer the gain on the sale and the interest to be
accrued until such time that collectability can be determined. On our second
Cherry Hill note receivable we recorded a $10.5 million impairment loss during
the fiscal year ended June 30, 2004 and 2005 to reflect the estimated current
market value of this note. (See Note 6-B)
(16) OPTIONS AND WARRANTS
A. STOCK BASED COMPENSATION
In June 2005, the Company's Board of Directors adopted and approved the
2005 Stock Option and Award Plan (the "2005 Plan"). The 2005 Plan would permit
the grant of options to purchase up to 1,300,000 shares of Common Stock at a
price per share no less than 100% of the fair market value of the Common Stock
on the date an option is granted with respect to incentive stock options only.
The price would be no less than 110% of fair market value in the case of an
incentive stock option granted to any individual who owns more than 10% of the
total combined voting power of all classes of outstanding stock. Due to the
Company's continuing cash shortages we did not have the funds available to
conduct a stockholder meeting before June 30, 2006 and therefore the 2005 Stock
Option and Award Plan expired along with the options that were granted under
that plan. No expense has been recognized for the 300,000 options which were
issued on June 27, 2005 and expired on June 27, 2006.
26
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
B. ISSUANCE OF ADDITIONAL WARRANTS
In connection with our borrowing of $400,000 on November 9, 2005 we agreed
to issue additional penalty warrants, exercisable for a period of three years,
if the loan was not paid by January 9, 2006; we agreed to issue 200,000 warrants
each month at a price of the lower of $2.50, or the market value on the day of
issue in each month for each additional month until the loan is paid. The
following table summarizes our stock prices for each month that warrants were
issued.
Date of Issue Price
---------------- -------
January 9, 2006 $2.45
February 9, 2006 $1.50
March 9, 2006 $1.25
April 7, 2006 $0.75
May 9, 2006 $0.80
June 9, 2006 $0.55
During the quarter ended June 30, 2006, we recognized a non-cash expense for the
600,000 warrants issued in the amount of $579,800. During the six months ended
June 30, 2006, we recognized a non-cash expense for the 1,200,000 warrants
issued in the amount of $1,073,098. As of August 21, 2006, the loan has not been
paid.
The fair value of the warrants was estimated on the date of each grant
using the Black-Scholes model utilizing the assumptions shown in the following
table:
Three Months Ended Six Months Ended
June 30, 2006 June 30, 2006
------------------- ----------------
Expected volatility 20% to 140% 20% to 445%
Risk-free interest rate 4.7% 4.7%
Expected term 3 Years 3 Years
In determining expected volatility, we based the assumptions using a
ceiling of the higher prices quoted for our stock over the last year. Our stock
is traded on the "Pink Sheets" of the over-the-counter market and our stock
prices and number of shares traded have historically been very erratic.
(17) RELATED PARTY TRANSACTIONS
See Footnote 4 for related party transactions regarding the PDS
Transaction.
During the third quarter of Fiscal 2001, we invested in two projects in
which our Chairman, President and Chief Executive Officer, Francis W. Murray,
also has a pecuniary interest. In connection with one such project, the Board of
Directors approved advances, as loans, of up to $1.5 million to a limited
partnership in which Francis W. Murray owned, at that time, an 80% equity
interest and owned the general partner, the proceeds of which were to be used to
pay costs and expenses for development of a golf course in Southern California.
In Fiscal 2003, the limited partnership's indebtedness to us, including
principal of $735,584 and accrued interest, in the amount of $193,957 was
assumed by OC Realty, LLC, a Florida limited liability company which is owned by
Francis W. Murray and which owns the second real estate project (Ocean Club)
described below. Such indebtedness was due December 31, 2004, but was extended
by the Board of Directors to December 31, 2007, and bears an interest rate of 6%
and is now scheduled to be paid upon the completion of the Ocean Club. These
balances are shown in the "Deposits and Other Assets - Related Parties" section
of the Balance Sheet (See Footnote 8 (B)).
27
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In the second project, Mr. Murray (through OC Realty) is participating in
the development of an oceanfront parcel of land, located in Fort Lauderdale,
Florida, which has received all governmental entitlements from the City of Fort
Lauderdale and the State of Florida to develop a 14-story building to include a
5-story parking garage, approximately 6,000 square feet of commercial space and
a residential 9-story tower. As of December 31, 2005, we had lent $2,034,405 in
total to the project and we have accrued interest in the amount of $1,429,185 on
the loan. These balances are shown in the "Deposits and Other Assets - Related
Parties" section of the Balance Sheet (see Footnote 8 (B)). These loans bear
interest at 12% and will be repayable out of OC Realty's share of proceeds,
after payment of bank debts, generated by the sale of condominiums. We will also
have the right to receive, as participation interest, from available cash flow
of OC Realty, if the project is successful, a priority return of our investment
and a priority profits interest for up to three times our investment. Repayment
of these loans and our participation interest will be subject to repayment of,
first, bank debt of approximately $14 million (at present) and, second,
construction financing expected to amount to $25 to $30 million and third, any
capital invested by and fees payable to joint venture partners including OC
Realty. OC Realty's share of proceeds thereafter will range from 22.5% to 45%.
We have assessed the collectability of the advances made to OC Realty based on
comparable sales of like units in the marketplace which suggest demand for
prospective sales of the project's condominium units will be adequate to meet
its obligations and provide sufficient return to OC Realty with which to pay OC
Realty's debt to us.
Beginning on July 7, 2004, we entered into Sub-Bareboat Charters of the
vessels Palm Beach Princess and Big Easy with entities (Palm Beach Maritime
Corporation and Palm Beach Empress, Inc.) owned or controlled by our Chairman,
Francis W. Murray. Pursuant to our June 30, 2005 refinancing and restructuring
of the PDS transactions, we now charter the vessels, Palm Beach Princess and Big
Easy directly from Cruise Holdings I and Cruise Holdings II, respectively, which
companies are owned by Palm Beach Maritime Corporation and Palm Beach Empress,
Inc. Pursuant to the new charters, we pay Cruise Holdings I and Cruise Holdings
II, as owners of the vessels, charter fees of $50,000 per month for the Palm
Beach Princess and $100,000 per month for the Big Easy, plus 1% of our gross
revenues from operation of those vessels. We have the right to purchase either
or both vessels, at our option, for $17.5 million in the case of the Palm Beach
Princess (representing its appraised value at the time of $17.5 million and for
fair market value (to be determined by appraisal) in the case of the Big Easy.
Once we pay off the loans against the Palm Beach Princess and Big Easy, we will
be entitled to substantial credits against the purchase prices of the vessels: a
$14 million credit in the case of the Palm Beach Princess and a $6 million
credit in the case of the Big Easy, representing the original principal amounts
of the July 2004 sale - leaseback transactions involving those vessels, as well
as credits for our investment in the net Ship Mortgage Obligation of
approximately $7.2 million which can be applied to the purchase price of either
vessel, and a credit for the portions of the costs of refurbishing and
retrofitting the Big Easy in excess of $6 million which we paid, amounting to
approximately $14 million, that can be applied to the purchase price of the Big
Easy.
(18) SUBSEQUENT EVENTS
(A) First Amended and Restated Forbearance Agreement with PDS Gaming
Corporation. See Note 4-J
(B) Issuance of additional Warrants. See Note 16-B
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS
Forward-Looking Statements
We have made forward-looking statements in this Form 10-Q, including the
information concerning possible or assumed future results of our operations and
those preceded by, followed by or that include words such as "anticipates,"
"believes," "expects," "intends," or similar expressions. For those statements,
we claim the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995. You should
understand that the following important factors, in addition to those discussed
elsewhere in this document, particularly under "Risk Factors", could affect our
future results and could cause those results to differ materially from those
expressed in our forward-looking statements:
o general economic and business conditions affecting the tourism
business in Florida;
o increased competition from new and existing forms of gaming;
o our ability to reposition the Big Easy in a timely and cost
effective manner in the future, or as an alternative, sub lease
the vessel to other parties;
o changes in laws regulating the gaming industry;
o the timing of the installation of slot machines in Broward
County's three race tracks and one jai- alai facility as a result
of a referendum approved on March 8, 2005. Broward County is
contiguous to Palm Beach County where we conduct operations;
o fluctuations in quarterly operating results as a result of
seasonal and weather considerations; and
o events directly or indirectly relating to our business causing
our stock price to be volatile.
Overview
We lease through a bareboat charter and operate, through our wholly owned
subsidiary, ITG Vegas, Inc. ("ITGV"), the gaming vessel, M/V Palm Beach
Princess. The M/V Palm Beach Princess sails twice daily from the Port of Palm
Beach, Florida. Once beyond the state's territorial water limits the vessel
engages in a casino gaming business. The business of operating the cruise vessel
includes a variety of shipboard activities, such as dining, music, casino gaming
and other entertainment.
We also lease through a bareboat charter the gaming vessel, Big Easy and
during the six month period ended June 30, 2006 operated the vessel for one
month, through our wholly owned subsidiary, ITG Palm Beach, LLC ("ITGBP"). After
retrofitting and refurbishing the Big Easy, this vessel was initially placed
into service on October 18, 2005, also from the Port of Palm Beach Florida,
although we did not commence regular (although limited) operations until
November 12, 2005. The Big Easy did not meet our expectations and due to the
operating losses and the removal of the vessel's Certificate of Inspection by
the U.S. Coast Guard, on February 1, 2006 we indefinitely suspended operations
of the Big Easy and have placed the vessel in wet dock storage.
During the course of retrofitting and getting the Big Easy operational, we
were required to raise the significant funding needed to accomplish the goal of
making this vessel comply with U.S. Coast Guard regulations and placing this
vessel into service. We entered into various debt service agreements throughout
Fiscal 2005, primarily with PDS Gaming ("PDS"), which at June 30, 2005 amounted
to approximately $33.8 million which balance includes accrued but unpaid
interest. The loans are secured by mortgages on the Palm Beach Princess and the
Big Easy as well as virtually all of the assets of ITGV and its subsidiaries,
including the vessel Royal Star in addition to pledges of our stock in ITGV and
its subsidiaries, and collateral assignments of certain promissory notes payable
to us. We, along with Palm Beach Maritime Corporation ("PBMC") and Palm Beach
Empress, Inc. ("PBE"), companies affiliated with our Chairman, Francis W.
Murray, have guaranteed the loans.
29
ITGV charters the M/V Palm Beach Princess from Cruise Holdings I, LLC, a
company owned by PBMC, for a five year period ending July 2009. The charter
provides for the payment to Cruise Holdings I, LLC of $50,000 per month plus 1%
of the gross operating revenues of the M/V Palm Beach Princess. Under the
charter, ITG Vegas has the option to purchase the M/V Palm Beach Princess at the
end of the term, for an exercise price equal to the appraised value of the M/V
Palm Beach Princess, $17,500,000, to which certain amounts are to be credited
against the purchase price.
ITGPB charters the Big Easy from Cruise Holdings II, LLC, a company owned
by PBE, for a five year period ending July 2009. The charter provides for
payments to Cruise Holdings II, LLC of $100,000 per month plus 1% of the gross
operating revenues of the Big Easy. Under the Big Easy charter, PBE granted
ITGPB an option to purchase the Big Easy at the end of the term, for an exercise
price equal to the appraised value of the Big Easy, which is yet to be
determined following the retrofitting and refurbishment of the Big Easy, to
which certain amounts are to be credited against the purchase price. The Big
Easy is currently in wet dock storage following a brief period of operations as
deiscribed below in Liquidity and Capital Resources.
We continue to explore other gaming opportunities, both domestically and
internationally. During our 2004 fiscal year we purchased a third vessel, the
M/V Royal Star. The Royal Star is currently in wet dock storage and we are
limited by our negative cash position to make any further improvements on the
vessel. In the past we have explored possible locations from which to
potentially operate the vessel, however additional financing is necessary before
we move forward with the extensive improvements and outfitting needed before
being placed in service.
Liquidity and Capital Resources
Our cash flow from operations is primarily dependent upon the cash flows
from ITG Vegas, which operates the vessel, M/V Palm Beach Princess. During the
six months ended June 30, 2006, the Palm Beach Princess operations generated
approximately $3.9 million of cash (which amount was only achieved by the
deferral of $2 million of interest payments due) which was insufficient for our
consolidated needs, thus we had to rely on other adjustments in our operations
to meet our cash requirements.
ITG Vegas' cash flow from operations is seasonal. The period from January 1
to June 30 has been a period of increased activity and revenues. The period July
1 to December 31 is a seasonably slow period for vessel operations and a period
during which we have suffered from hurricanes interrupting our business.
Therefore, we normally schedule dry dock or wet dock vessel work during this
period, which further negatively effects our operations during this six month
period. Many of ITG Vegas' operating costs, including leasing and charter fees,
fuel costs and wages, are fixed and cannot be reduced when passenger counts
decrease.
During the past few fiscal quarters, we extended the terms of our payables
and as a result, our accounts payable and accrued expenses exceeded our cash by
approximately $12 million as of June 30, 2006. We continued to defer payments on
vessel and equipment leases, on notes payable and charter hire fees and continue
to defer the salary of our Chairman.
Our cash flows were negatively impacted by the delay in putting the Big
Easy in full service, caused by delays in obtaining certification for passenger
operations pursuant to the United States Coast Guard's Alternative Compliance
Program. The costs associated with refurbishing and retrofitting the Big Easy
for placing it in service increased substantially due to upgrades to the vessel,
expansion of our Mardi Gras- theme build out, and improvements required by the
Coast Guard, further depleting our working capital from our original estimate
and required us to borrow additional funds which increased our interest expense.
These borrowings will continue to adversely affect our cash flows in the future.
More than 150 crew members and other employees were hired and trained during
this period and employees who normally worked exclusively for the Palm Beach
Princess spent time completing assignments for the Big Easy, putting a severe
drain on our operational efforts and our cash flow during this period.
On November 12, 2005 we placed the Big Easy vessel into limited scheduled
service from the Port of Palm Beach, Florida. The vessel received Coast Guard
approval to operate on October 11, 2005 but because of
30
the continuing effects of hurricane Wilma, inclement weather and rough seas,
mechanical problems and our inability to meet the minimum employee counts per
Coast Guard regulations, we did not begin regular, limited operations until mid
November. The Big Easy did not meet our expectations and with its poor
performance together with continuing Coast Guard licensing difficulties we were
forced to remove the Big Easy from service on February 1, 2006 in order to
conserve working capital.
During the six months ended June 30, 2006, the operating loss for the Big
Easy for January 2006 and the carrying costs for the remaining five months were
$3.55 million before interest expense. We expect that future carrying costs
during the wet dock storage will be approximately $325,000 per month before
interest expense.
During our 2004 fiscal year, we purchased a third vessel, the Royal Star.
We anticipate that the vessel will need extensive improvements and outfitting
costing between $5 and $6 million before being placed in service as a gaming
vessel. The vessel had been placed in wet storage and delays in commencing the
Royal Star operations have and will continue to adversely affect our cash flows
because of the continuing costs of carrying the vessel. During the six months
ending June 30, 2006, carrying costs for the Royal Star vessel and the gaming
equipment leases were approximately $900,000 before interest expense.
Our debt to PDS Gaming for the vessel leases was $29.3 million on June 30,
2005, with interest rates ranging from approximately 15.3% to 20%. We have not
made the required interest and principal payments since December 1, 2005 and the
PDS loan balances are approximately $33.8 million as of June 30, 2006 due to the
accrued interest accumulating at an interest default rate of an additional 2.5%
and fees for the Forbearance Agreements. We borrowed and additional $535,744 to
make the December 2005 interest payment. We did not make the required debt
service payments or the equipment lease payments to PDS from January through
June 2006. On June 1, 2006 we entered into the First Amended and Restated
Forbearance Agreement with PDS which will defer any payments due them until
August 29, 2006.
The new agreement requires us to sell the Big Easy vessel, the Royal Star
vessel and the $10 million Original Cherry Hill Note with a closing date
targeted to occur no later than August 29, 2006. While proceeding toward sales
of such assets, we also are required to retain a financial adviser to sell the
Palm Beach Princess vessel and our casino cruise business operating that vessel,
or otherwise refinance and pay in full our obligations to PDS, by the end of the
forbearance period, August 29, 2006. In that regard, (a) we were required to
provide to PDS, on or before July 28, 2006, an offering memorandum prepared by a
financial adviser and designed to seek the sale or refinancing of the Palm Beach
Princess assets and business; (b) not later than August 2, 2006 we were to
deliver the offering memorandum and all other relevant information to at least
15 third party lenders or third party purchasers identified by us as being
reasonably likely lenders or purchaser; and (c) no later than August 14, 2006,
we were required to have a written term sheet from a third party lender or
purchaser for the sale or refinancing of the Palm Beach Princess assets and
business. We do not believe that such time schedule is realistic and we are not
able to meet such time deadlines. Notwithstanding such provisions and others
which we may not be able to comply with under the terms of the new agreement, we
agreed to enter into the new agreement and make additional payments to PDS of a
forbearance fee of $173,687 and an additional 2.5% per annum default interest,
under duress, since we were faced with PDS' threats of imminent foreclosure on
substantially all of our assets.
Under the new agreement, PDS may elect to extend the deadlines provided in
such agreement for the sale of collateral after its due consideration of, among
other things, (a) purchase offers received from the third parties with respect
to the sale of the Big Easy, Royal Star or Cherry Hill Note, (b) the range of
values proposed by brokers and financial advisers, (c) the timing of such sales,
and (d) the net cash proceeds realizable from any alternative transaction to be
paid in reduction of our obligations to PDS.
After expiration of the forbearance period on August 29, 2006, we do expect
to be able to make our monthly loan and lease payments unless, as a result of
closing an Alternative Transaction, our outstanding loan and lease payments are
substantially reduced. We also do not expect that we will be able to consummate
the sale of any of our vessels, the Original Cherry Hill Note or our operating
business before the expiration of the forbearance period on August 29, 2006 and
will seek to negotiate a further amendment to the forbearance agreement giving
us additional time to consummate any such transactions based on circumstance
existing on
31
August 29, 2006. No assurance can be given that PDS will be willing to grant any
further extension of time or otherwise agree to forbear from exercising rights
or remedies it may have due to our defaults.
Additionally the EBITDA requirements applicable to the Company will be
waived for the 12 month periods ending July 2, July 30, August 27, 2006 and
disbursements by our operating subsidiary, ITG Vegas, Inc., will require written
approval by an assigned crisis manager, and disbursements may only be made in
accordance with an approved budget as submitted by the us and approved by PDS.
The Company is seeking refinancing, has liquidated its equine holdings and
may be forced to sell other Company assets. We are also exploring opportunities
to profitably deploy the Big Easy or the sale of this vessel. Absent asset
sales, refinancing or the profitable deployment of the Big Easy, we will not be
able to make the debt service payments beginning on September 1, 2006. No
assurances can be given that the Company will be successful in these endeavors
prior to September 1, 2006 or thereafter.
Our working capital as of June 30, 2006 was a negative ($45.6 million). Our
cash flow and negative working capital circumstances worsened during the six
months ended June 30, 2006 due in part to:
o classifying all the debt due to our primary lender as current
debt,
o operating losses suffered by the Big Easy from January 1st to
January 31st due to her limited sailing schedule in which
scheduled cruises were cancelled due to Coast Guard restrictions,
mechanical problems, high seas, or scheduling conflicts with the
Palm Beach Princess.
o costs to carry the Big Easy after the vessel was taken out of
service on February 1, 2006,
o costs to carry the Royal Star,
o expenses paid for costs of the Holding Company and other
developmental costs and
o a decrease in the net income before depreciation and taxes of the
Palm Beach Princess of approximately $1.34 million as compared to
the corresponding six month period of last year.
The following table summarizes commitments on non-cancelable contracts and
leases as of June 30, 2006.
Twelve Month Period Ended June 30,
--------------------------------------------------- There-
2007 2008 2009 2010 after Total
----------- ---------- ---------- --------- -------- -----------
Capital Leases:
P.B. Princess - Principal & Interest $ 21,080,158 $ - $ - $ - $ - $ 21,080,158
Bare Boat Charter - Related Party 960,000 960,000 960,000 80,000 - 2,960,000
Big Easy - Principal & Interest 20,325,907 - - - - 20,325,907
Bare Boat Charter - Related Party 1,200,000 1,200,000 1,200,000 100,000 - 3,700,000
Notes and Mortgages:
Principal & Interest 6,094,364 192,235 3,965 - - 6,290,564
Interest Only 173,135 173,135
Deferred Interest Payments 600,000 600,000 450,000 - - 1,650,000
Operating Leases:
Casino Equipment 3,201,719 572,110 681,820 - - 4,455,649
Administrative & Office 995,863 120,503 2,028 2,873 - 1,121,267
Purchase Obligations 345,890 45,056 10,592 - - 401,538
----------- ---------- ---------- --------- -------- -----------
Total $ 54,977,036 $ 3,689,904 $ 3,308,405 $ 182,873 $ 0 $ 62,158,218
=========== ========== ========== ========= ======== ===========
32
Outlook
Based on our historical level of operations of the Palm Beach Princess we
believe that cash generated from operations will not be adequate to meet our
anticipated loan payment requirements and our other working capital needs. The
Big Easy began limited regular passenger service in November 2005, however
operations were suspended on February 1, 2006. While we have substantially
reduced the operating losses for the Big Easy effective February 1, 2006 with
its suspension of service, we will continue to incur costs while the vessel is
held in wet storage along with the Royal Star.
We will need additional funds to meet our working capital deficiency, debt
service needs and operating losses. However we have no present commitments to
obtain such necessary funds. The failure to obtain such funds on a timely basis
may require us to curtail operations or sell assets such as the Royal Star, the
Big Easy or our Note Receivable on the Cherry Hill Property or even our Palm
Beach Princess business. The sale of assets with insufficient proceeds to pay
related debt may lead to default in our debt service payments, which could lead
to foreclosures on the leased vessels.
No assurances can be given that our business will generate sufficient cash
flow from operations or that future borrowings will be available to enable us to
service our lease/purchase and loan payments or to make anticipated capital
expenditures. Our future operating performance and our ability to make payments
under our leases and other debts will be subject to future economic conditions
and to financial, business, weather, seasonality of our business, and other
factors, many of which are beyond our control.
Critical Accounting Policies and Estimates
Financial Reporting Release No. 60 requires companies to include a
discussion of critical accounting policies or methods and estimates used in the
preparation of financial statements. We prepare our Consolidated Financial
Statements in conformity with accounting principles generally accepted in the
United States. Certain of our accounting policies, including the estimated lives
assigned to our assets, asset impairment, and the calculation of our income tax
liabilities, require that we apply significant judgment in defining the
appropriate assumptions for calculating financial estimates. By their nature,
these judgments are subject to an inherent degree of uncertainty. Our trends in
the industry and information available from other outside sources, are used as
appropriate. There can be no assurance that actual results will not differ from
our estimates. Note 2 to the Consolidated Financial Statements describes the
significant accounting policies we have selected for use in the preparation of
our financial statements and related disclosures. We believe the following to be
the most critical accounting estimates and assumptions affecting our reported
amounts and related disclosures.
Notes Receivable
Statement of Financial Accounting Standards No. 114, "Accounting by
Creditors for Impairment of a Loan" as amended, requires management judgments
regarding the future collectability of notes receivable and the underlying fair
market value of collateral. As a result of the sale of the Garden State Park
Racetrack property in Cherry Hill NJ, and the sale of the non-operating former
El Rancho Hotel and Casino in Las Vegas, NV, portions of the proceeds from each
sale were paid in the form of promissory notes. During the fiscal year ended
June 30, 2004 we sold the note receivable we held on the Las Vegas, NV property
for cash and other future benefits including a second note payable solely from
profits of the Cherry Hill, NJ property (Second Cherry Hill Note). We had
previously received a note receivable from the sale of the Garden State Park
property in the amount of $10 million (original Cherry Hill Note) and together,
these notes are classified on the Balance Sheet as Long Term Notes Receivables
in the amount of $14,278,651 as of June 30 2006 and December 31, 2005. Estimates
are required to be used by management to assess the recoverability of our notes
receivable. We regularly review our receivables to determine if there has been
any decline in value. These reviews require management judgments that often
include estimating the outcome of future events and determining whether factors
exist that indicate impairment has occurred. We evaluate financial balance
sheets, earnings and cash forecasts of the Cherry Hill developer. Our returns on
the Cherry Hill Notes are subject to debt incurred by the property and the
developer's capital contributions that precede the debt owed to us. Our returns
are also subject to factors affecting the profitability and saleability of the
project. Our assumptions, estimates and evaluations
33
are subject to the availability of reliable data and the uncertainty of
predictions concerning future events. Accordingly, estimates of recoverable
amounts and future cash flows are subjective and may not ultimately be achieved.
Should the underlying circumstances change, the estimated recoverable amounts
and future cash flows could change by a material amount.
When making our impairment review for the year ended June 30, 2004 for the
Note Receivable on the Las Vegas property we determined that after this note was
transferred to the Cherry Hill property (the Second Cherry Hill Note) a portion
of it should be impaired by $12,786,589 (or a net of $10,000,000 when offset by
$2,786,589 of deferred gain on the sale of the Las Vegas property) based on the
collectability of the note since we already held a note in the amount of
$10,000,000 on that same property. Additionally during the year ended June 30,
2005 an additional impairment charge of $500,000 was recorded on the Second
Cherry Hill Note because projected future events did not materialize.
Valuation of Vessels and Vessel Deposits - Related Parties
We charter vessels, the Palm Beach Princess and the Big Easy, directly from
companies owned or controlled by our Chairman and CEO. The charter and PDS
Gaming loan agreement for the Palm Beach Princess has been accounted for as a
capital lease. In accordance with our lease and purchase agreement for the Palm
Beach Princess we have the right to purchase the vessel for $17,500,000 at the
end of the lease term, and up to $14 million of principal payments to be made by
us and allocable to the Palm Beach Princess debt will be credited toward the
purchase price. The carrying value of the Palm Beach Princess of $17,500,000 is
less than the fair value appraisal on the vessel. The charter and PDS Gaming
loan agreement for the Big Easy has also been accounted for as a capital lease.
In accordance with our lease and purchase agreement for the Big Easy we have the
right to purchase the Big Easy for the appraised value of the vessel which would
be determined upon the refitting and refurbishing of the vessel. The Company has
determined the capital lease value of the Big Easy by capitalizing the total of:
1) the costs it had incurred for improvements it had made to the Big Easy; and
2) all payments required under the PDS Gaming loans.
The Company has credits in the amount of $9,726,377 which are available to
use against the purchase costs for the vessels. See footnote 8 to our financial
statements with respect to the credits which are available against the purchase
costs of the vessels. Should the Company elect not to purchase one or either
vessel at the end of the lease, the Company could lose some or all of the value
of the credits unless other terms are negotiated with the owner of the vessels.
Results of Operations for the Three Months Ended June 30, 2006 and 2005
The following are the most important factors and trends that affect our
operating performance and the comparability of historical results, both
currently and in the future:
We are currently dependent upon operating revenues from the Palm Beach
Princess to pay the wet dock storage, interest, debt service and equipment lease
costs of the Big Easy and the Royal Star and the administrative costs of the
Parent Company. Big Easy operational losses and carrying costs have adversely
affected our cash position. We could face significant challenges in managing and
integrating the combined operations of the Big Easy and the M/V Palm Beach
Princess should we relocate the Big Easy to a different port or reinstate its
operation in Palm Beach. Any future integration of the Big Easy operation will
require dedication of management resources that may temporarily divert attention
from our day-to-day business.
We have approximately $33.8 million of indebtedness outstanding to PDS for
vessel leases and loans taken to pay interest as of June 30, 2006. We have been
unable to make the required monthly debt service payments required under the PDS
loans since November 2005 and in December 2005 borrowed additional funds in
order to make interest payments due under the debt agreement. We have extended
payment terms of our accounts payable in order to conserve working capital. This
action could jeopardize the relationships with our vendors and we may be forced
to find alternative sources for some of our suppliers and professional advisors,
further disrupting our operations. We will incur additional indebtedness in the
future for accrued but unpaid interest on the PDS debt. Our level of
indebtedness will have several significant negative effects on our future
34
operations, including the following:
o we will be required to use the majority of our cash flow from
operations for the payment of any principal or interest due on
our outstanding indebtedness or may need additional working
capital in addition to our cash flow for payment of principal and
interest due;
o our outstanding indebtedness and leverage will increase the
impact of negative changes in general economic and industry
conditions, as well as competitive pressures; and
o the level of our outstanding debt may effect our ability to
obtain additional financing for working capital, capital
expenditures or general corporate purposes.
If we cannot generate sufficient cash flow from operations in the future to
service our debt, we may, among other things be forced to:
o seek additional financing in the debt or equity markets further
diluting our current shareholders;
o refinance or restructure all or a portion of our indebtedness; or
o sell selected assets or our operating business.
These measures might not be sufficient to enable us to service our
indebtedness. In addition, any financing, refinancing or sale of assets might
not be available on economically favorable terms.
On March 8, 2005 the citizens of Broward County approved a referendum that
will amend Florida's constitution to permit slot machines at pari-mutuel
facilities in Broward County. Currently there are three race tracks and one
jai-alai facility in the County. Broward County is contiguous to Palm Beach
County in which we conduct operations. In a special session in early December
2005, the Florida legislature passed legislation which would permit 1,500 slot
machines at each of the four (4) pari-mutuel facilities in Broward County.
Neither the timing of the installation of the slot machines, nor the impact to
our Company, can be predicted at this time. Over the past few years, there has
been an attempt to legalize gaming throughout the State of Florida. It is likely
that the gaming industry will continue to pursue legalization of gaming in
Florida, and we believe that the legalization of gaming in Florida could have a
material adverse impact on our operations.
35
Consolidated
The table below separately identifies and compares the revenues, expenses
and net income before taxes of our vessels and other operating subsidiary
companies as shown on the Consolidated Statement of Operations for the three
months ended June 30, 2006 as compared to the three months ended June 30, 2005.
Three Months Ended Three Months Ended
June 30, 2006 June 30, 2005
------------------------------------------------ --------------------------------------------------
Holding Co Holding Co
Palm Beach Big & Palm Beach Big &
Princess Easy Other Subs Total Princess Easy Other Subs Total
----------- ----------- ----------- ----------- ----------- ----------- ------------ ------------
Operating Revenues:
Gaming $ 7,283,863 $ - $ - $ 7,283,863 $ 7,213,088 $ - $ - $ 7,213,088
Fare 651,513 - - 651,513 754,524 - - 754,524
On Board 435,108 - - 435,108 513,814 - - 513,814
Other - - 57,472 57,472 - - 117,520 117,520
----------- ----------- ----------- ----------- ------------ ----------- ------------ ------------
Total 8,370,484 0 57,472 8,427,956 8,481,426 0 117,520 8,598,946
----------- ----------- ----------- ----------- ------------ ----------- ------------ ------------
Operating Costs and
Expenses:
Gaming 2,406,679 358,944 - 2,765,623 2,291,658 - - 2,291,658
Fare 586,280 9,919 79,841 676,040 1,014,790 - 102,424 1,117,214
On Board 201,401 11,833 213,234 248,762 - - 248,762
Maritime & Legal 1,977,572 323,067 - 2,300,639 1,715,709 - - 1,715,709
G & A Expenses 1,032,808 253,674 500,592 1,787,074 1,070,893 - 692,854 1,763,747
Development Costs - - 210,980 210,980 - 3,273,382 109,682 3,383,064
Royal Star - - 512,944 512,944 - - 165,503 165,503
Equine - - - - - - 212,155 212,155
Impairment of Assets - - - - - - 50,000 50,000
Dep & Amort 622,585 - 2,476 625,061 468,638 - 4,273 472,911
----------- ----------- ----------- ----------- ------------ ----------- ------------ ------------
Total 6,827,325 957,437 1,306,833 9,091,595 6,810,450 3,273,382 1,336,891 11,420,723
----------- ----------- ----------- ----------- ------------ ----------- ------------ ------------
Operating Income (Loss) 1,543,159 (957,437) (1,249,361) (663,639) 1,670,976 (3,273,382) (1,219,371) (2,821,777)
Other Income (Expense):
Interest &
Financing Expenses (1,189,904) (1,277,840) (276,646) (2,744,390) (419,099) - (227,499) (646,598
Interest & Financing
Expenses - RP (265,111) (300,000) - (565,111) (286,485) - (15,977) (302,462
Warrant Expense - - (579,798) (579,798) - - - -
Interest Income 2,149 - - 2,149 - - 7,750 7,750
Interest Income - RP 64,540 - 7,325 71,865 66,329 - 7,327 73,656
----------- ----------- ----------- ----------- ------------ ----------- ------------ ------------
Total (1,388,326) (1,577,840) (849,119) (3,815,285) (639,255) 0 (228,399) (867,654)
----------- ----------- ----------- ----------- ------------ ----------- ------------ ------------
Income (Loss) Before
Income Tax $ 154,833 $(2,535,277)$(2,098,480)$(4,478,924)$ 1,031,721 $(3,273,382)$ (1,447,770)$ (3,689,431)
=========== =========== =========== =========== ============ =========== ============ ============
36
Revenues decreased slightly by $171,000 primarily as a result of the
revenues generated by the Palm Beach Princess decreasing by $111,000.
Operating expenses decreased approximately $2.6 million, or 23%, from
$11,420,721 in the three months ended June 30, 2005 to $8,827,232 in the three
months ended June 30, 2006 primarily the result of:
o a decrease in the development costs of the Big Easy of $3,237,382
offset by carrying costs in the amount of $957,434 incurred while the
vessel is in wet dock;
o a decrease in the Parent Company administrative expense of $192,262;
o a decrease in operating expenses for the Palm Beach Princess of
$137,072 offset by an increase in depreciation of $153,947;
o a decrease in equine operating costs of $212,155 because the Company
terminated its equine operations on December 31, 2005;
o a decrease in other development costs of $101,298 since the Company
was forced to reduce its costs in search for new gaming opportunities;
offset by,
o an increase in the carrying costs for our Royal Star vessel of
$347,441, which vessel has been in wet dock storage since its
purchase. The increase was primarily caused by the payments we are
making on the gaming equipment placed aboard the vessel in January
2005 whereas last year the payments on the equipment were interest
only and classified as an interest expense;
o an impairment of a note receivable in the amount of $50,000 during the
comparative quarter last year.
The Operating (loss) for the three months ended June 30, 2006 was
($663,639) as compared to an operating loss of ($2,821,777) for the comparative
period of last year.
Other expenses increased by approximately $3 million as a result of an
increase in the interest and financing expense due to: 1) the higher debt levels
on the vessel leases; 2) higher interest rates as a result of the penalty
interest incurred on the $30 million loan from PDS; 3) a $173,687 forbearance
fee; and 4)an increase in the costs of warrants granted for financing in the
amount of $579,798.
The Net (Loss) for the three months ended June 30, 2006 was ($4,478,924) or
($0.39) per share as compared to a net loss of ($3,689,431) or ($.37) per share
for the three months ended June 30, 2005.
For the three months ending June 30, 2006 the (loss) before interest,
taxes, depreciation and amortization and an impairment loss, (Adjusted EBITDA)
was ($38,578) as compared to Adjusted EBITDA loss of ($2,478,865) for the
corresponding period. The change in the Adjusted EBITDA (loss) of $2.4 million
was primarily due to the losses sustained by the Big Easy decreasing by $2.3
million before interest expense. See the reconciliation of Adjusted EBITDA to
net income for the three month periods ended June 30th below.
Reconciliation of Non-GAAP Measures to GAAP
Adjusted EBITDA or earnings before interest, taxes, depreciation and
amortization and unusual items is not a measure of performance or liquidity
calculated in accordance with generally accepted accounting principles. EBITDA
information is presented as a supplemental disclosure because management
believes that it is a widely used measure of such performance in the gaming
industry. In addition, management uses Adjusted EBITDA as the primary measure of
the operating performance of its operations, including the evaluation of
operating personnel. Adjusted EBITDA should not be construed as an alternative
to operating income, as an indicator of the Company's operating performance, or
as an alternative to cash flows from operating activities, as a measure of
liquidity, or as any other measure of performance determined in accordance with
generally
37
accepted accounting principles. The Company has significant uses of cash flows,
including capital expenditures, interest payments, taxes, lease and debt
principal repayments, which are not reflected in Adjusted EBITDA. It should also
be noted that other gaming companies that report EBITDA information may
calculate EBITDA in a different manner than the Company. A reconciliation of the
Company's Adjusted EBITDA and unusual items to net income (GAAP), is shown
below.
Reconciliation of Adjusted EBITDA to Net Income (GAAP)
Three Months Ended June 30,
------------------------------
2006 2005
-------------- ------------
Total Adjusted EBITDA $ (38,578) $ (2,478,865)
Depreciation & Amortization (625,061) (472,911)
Interest & Financing Expenses (3,889,302) (949,058)
Interest Income 74,017 81,404
Tax Benefit (Expense) on Income - 90,000
Net Income (Loss) before Unusual Items (4,478,924) (3,729,430)
Impairment Loss - (50,000)
-------------- ------------
Net Income (Loss) $ (4,478,924) $ (3,779,430)
============== ============
Vessel Operations
Palm Beach Princess
During the current period net operating revenue from vessel operations was
$8,370,484 as compared to $8,481,428. The decrease in revenue of $111,000 during
the comparable quarters is due to a decrease in the passenger counts from 70,213
in 2005 to 63,406 or 10% for the three months ended June 30, 2006. We attributed
this drop in passenger counts primarily to a decrease in the amounts spent for
marketing and advertising during the three month period due to a decrease in
cash available. During the quarter we spent $428,510 less or 42% less on
marketing and advertising then during the corresponding period in the prior six
month period. The drop in passenger counts was partially offset by an increase
in the revenue per passenger from $120.80 to $132.01 during the current period.
Casino operating expenses which also includes food, beverage and
entertainment increased $115,022 from $2,291,657 or 31.8% of casino revenue in
2005 to $2,406,679 or 33% of casino revenue in 2006 primarily the result of
dividing costs, many of which are fixed by their nature, over reduced revenues.
During the three months ended June 30, 2005, a portion of the employee
costs normally incurred by the Palm Beach Princess for operational and
administrative salary expenses were allocated to the Big Easy start up
operation. These allocations were made to more accurately reflect the cost of
preparing the Big Easy for use as a casino gaming vessel. Approximately $296,900
of salaries allocated to the Big Easy were expensed as operating costs during
the three months ended June 30, 2005 and $37,300 of salaries which were
capitalized as part of the vessel costs during the three months ended June 30,
2005 where as during the three months ended June 30, 2006, there was no
allocation of employee cost made to the Big Easy Operation. This allocation
should be taken into consideration when comparing operating results from year to
year for the Palm Beach Princess.
Maritime and legal expenses increased approximately $262,000 or 27% due to
an increase in fuel costs of approximately $100,000 and an increase in medical
insurance expense of approximately $100,000 as a result of a self insured
medical claims during the comparable three month periods.
Administrative expenses decreased $263,527. During the quarter ended June
30, 2005 we wrote off an amount of $322,000 for payments we made on behalf of
the day cruise casino operating companies for lobby efforts concerning slot
machines to be placed at racetracks in Miami-Dade and Broward counties.
38
Finance expenses increased $855,615 as a result of the higher interest rate
due to default interest being charged and a forbearance fee recorded during the
quarter. Depreciation and amortization increased $153,947 from $468,638 for the
three months ended June 30 2005 to $622,585 for the three months ended June 30,
2006 as a result of the increase in the amortization expense of the dry dock
expenditures made in October 2005.
The income before income tax expense for the three months ended June 30,
2006 was $273,729 as compared to income before income tax of $1,031,722 in the
comparable three month period of 2005.
The Palm Beach Princess performs fourteen cruises weekly, that is, a
daytime and an evening cruise each day. Each cruise is of five to six hours
duration. During each cruise, the Palm Beach Princess offers a range of
amenities and services to her passengers, including a full casino, sit-down
buffet dining, live musical shows, discotheque, bars and lounges, swimming pool
and sundecks. The casino occupies 15,000 square feet aboard the ship and is
equipped with approximately 425 slot machines, all major table games (blackjack,
dice, roulette and poker), and a sports wagering book.
The following is a comparative summary of income and expenses of the Palm
Beach Princess operation for the 13 weeks ended July 2, 2006 and for the 13
weeks ended July 3, 2005:
Three Months Ended
July 2, July 3,
Description 2006 2005 Change
- --------------------------------- ----------- ----------- ----------
Passenger Count 63,406 70,213 (6,807)
Number of Cruises 177 175 2
Average Number of
Passengers per Cruise 358 401 (43)
Net Revenue per Passenger $ 132.01 $ 120.80 $ 11.21
Revenue:
Gaming $ 7,283,863 $ 7,213,088 $ 70,775
Fare 1,794,255 1,946,858 (152,603)
On Board 903,562 1,025,473 (121,911)
Less: Promotional Allowances
Fare (1,142,742) (1,192,333) 49,591
On Board (468,454) (511,658) 43,204
----------- ----------- ----------
Net Operating Revenue 8,370,484 8,481,428 (110,944)
----------- ----------- ----------
Expenses:
Gaming 2,406,679 2,291,657 115,022
Fare 586,280 1,014,790 (428,510)
On Board 201,401 248,762 (47,361)
Maritime and Legal Expenses 1,977,572 1,715,709 261,863
Administrative 701,759 965,286 (263,527)
Finance Expenses - Net 1,600,479 744,864 855,615
Depreciation and Amortization 622,585 468,638 153,947
Total Expenses 8,096,755 7,449,706 647,049
----------- ----------- ----------
Income Before Income
Tax Expense $ 273,729 $ 1,031,722 $ (757,993)
=========== =========== ==========
Big Easy
The United States Coast Guard issued the Big Easy her Certificate of
Inspection on October 11, 2005, following an extensive and unexpected delay in
receiving such certification. The vessel's first official cruise to
international waters was October 18, 2005. Due to the approaching Hurricane
Wilma, the vessel was ordered out of the Port for safe haven following her
afternoon cruise on October 19, 2005. Hurricane Wilma struck Florida on October
24, 2005. Due to the damages caused by Hurricane Wilma and vessel schedule
conflicts, the Big Easy was unable to sail commercially until November 6, 2005.
The unexpected delay in receiving the
39
vessels' Certificate of Inspection, and the subsequent delays, damage and
inconveniences caused by Hurricane Wilma immediately following the maiden voyage
had a compounding adverse effect on the Company's ability to retain personnel.
As a result, the Company experienced greater than normal attrition of Big Easy
personnel, particularly those who carried Coast Guard-issued Merchant Marine
cards (i.e. also known as z-cards). These are issued by the Coast Guard and
serve as required documentation for those working on US flagged vessels to fill
Coast Guard mandated muster station requirements). As the number of Merchant
Marine card personnel became increasingly inadequate, it became increasingly
difficult for management to meet muster station requirements, often forcing the
cancellation of many sailings, particularly in December and January. The Coast
Guard stopped issuing Merchant Marine cards suddenly and unexpectedly sometime
in October, 2005. Adverse sea conditions in November and December were generally
unfavorable for commercial sailing and were a contributing factor to several
missed sailings. As a result of these numerous challenges the vessel was able to
make only nineteen sailings in November; twenty-four sailings in December and
eight sailings in January. On January 31, 2006 the Coast Guard denied the
Company's request to provide an extension to complete certain mandated work and
removed the vessels' Certificate of Inspection. On January 31, 2006,
approximately one hundred Coast Guard Merchant Marine card applications relating
to the Big Easy remained unprocessed by the Coast Guard for twelve weeks or
longer.
We were having challenges attracting customers to the Big Easy, given her
inconsistent schedule of sailings. The initial delay in receiving a Certificate
of Inspection and subsequent inconsistencies in scheduling caused significant
negative cash flow and made advertising and promotional efforts difficult from
both a financial and practical planning perspective. The lack of a consistent
commercial service schedule caused insignificant customer support resulting in
negative results. On February 1, 2006 we suspended operations indefinitely.
During the three month period ended June 30, 2006 the Big Easy sustained a
loss before interest expense of approximately $957,000. The majority of these
costs consist of the continuing expenses to keep the ship at wet dock and the
casino equipment leases. Gaming expenses consist of gaming equipment lease
expense in the amount of approximately $300,000 and an additional $59,000 for
miscellaneous expense in connection with the termination of services. Maritime
and legal expense to keep the vessel at dry dock were $322,000. Fare and on-
board expenses of $21,751 consist of various expenses incurred as a result of
the termination of the vessel operations. General and administrative expenses of
$253,673 consist of $187.500 for the deployment of the vessel to its current
location in St. Petersburg, Florida and approximately $35,000 for the
exploration of a new location for the vessel and approximately $30,000 for
miscellaneous administrative expenses during the dry dock period. Interest,
financing expense and the bare boat charter fees during the quarter were $1.8
million resulting in a net (loss) of ($2,535,277) for the three months ended
June 30, 2006 as compared to ($3,273,382) during the comparable six month period
when all of the Big Easy costs were charged to development costs.
40
Results of Operations for the Six Months Ended June 30, 2006 and 2005
Consolidated
The table below separately identifies and compares the revenues, expenses
and net income before taxes of our vessels and other operating subsidiary
companies as shown on the Consolidated Statement of Operations for the six
months ended June 30, 2006 as compared to the six months ended June 30, 2005.
Six Months Ended Six Months Ended
June 30, 2006 June 30, 2005
-----------------------------------------------------------------------------------------------------------
Holding Co Holding Co
Palm Beach Big & Palm Beach Big &
Princess Easy Other Subs Total Princess Easy Other Subs Total
------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
Operating Revenues:
Gaming $ 15,074,450 $ 62,738 $ - $ 15,137,188 $ 15,702,668 $ - $ - $15,702,668
Fare 1,606,196 6,333 - 1,612,529 1,830,848 - - 1,830,848
On Board 853,722 9,419 - 863,141 1,113,278 - - 1,113,278
Other - - 208,694 208,694 - - 233,138 233,138
------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
Total 17,534,368 78,490 208,694 17,821,552 18,646,794 - 233,138 18,879,932
------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
Operating Costs and
Expenses:
Gaming 4,745,356 1,228,185 - 5,973,541 4,884,559 - - 4,884,559
Fare 1,185,473 96,723 188,816 1,471,012 2,160,152 - 204,359 2,364,511
On Board 422,135 33,549 - 455,684 535,594 - - 535,594
Maritime & Legal 3,781,011 1,279,987 - 5,060,998 3,528,794 - - 3,528,794
G & A Expenses 1,547,789 583,955 1,098,734 3,230,478 1,516,131 - 974,770 2,490,901
Development Costs - - 304,127 304,127 - 4,382,692 235,178 4,617,870
Royal Star - - 898,900 898,900 - - 177,839 177,839
Equine - - - - - - 447,989 447,989
Impairment of Assets - - 400,000 400,000 - - 150,000 150,000
Dep & Amort 1,264,020 411,104 5,355 1,680,479 1,020,860 - 8,546 1,029,406
------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
Total 12,945,784 3,633,503 2,895,932 19,475,219 13,646,090 4,382,692 2,198,681 20,227,463
------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
Operating Income
(Loss) 4,588,584 (3,555,013) (2,687,238) (1,653,667) 5,000,704 (4,382,692) (1,965,543) (1,347,531)
Other Income (Expense):
Interest &
Financing Expenses (2,030,540) (2,173,497) (524,793) (4,728,830) (900,160) - (230,163) (1,130,323)
Interest & Financing
Expenses - RP (506,571) (600,000) (9,505) (1,116,076) (486,485) (415,400) (15,977) (917,862)
Warrant Expense - - (1,073,098) (1,073,098) - - - -
Interest Income 2,798 - - 2,798 15,233 - - 15,233
Interest Income - RP 124,498 - 19,152 143,650 130,726 - 14,440 145,166
------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
Total (2,409,815) (2,773,497) (1,588,244) (6,771,556) (1,240,686) (415,400) (231,700) (1,887,786)
------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
Income (Loss) Before
Income Tax $ 2,178,769 $ (6,328,510)$ (4,275,482) $ (8,425,223) $ 3,760,018 $(4,798,092) $ (2,197,243) $(3,235,317)
============ ============ ============ ============ ============ ============ ============ ===========
Since our accounting periods consist of a 4-4-5 week quarter, from time to
time an additional week is included in the first period to adjust our period
ends to more closely match a calender year end. For example, the three month
period ended March 31, 2005 contained 14 weeks compared to the 13 weeks of the
three month period ended March 31, 2006. As a result, the six months ended June
30, 2006 had 26 weeks as compared to 27 weeks in the same six month period ended
June 30, 2005
41
Revenues decreased $1,058,380 primarily as a result of the net effect of
the revenues generated by the Palm Beach Princess decreasing by approximately
$1.1 million, offset in part by the Big Easy revenues generated during the month
of January 2006.
Operating expenses decreased approximately $.752 million, or 4%, from
$20,227,463 in the six months ended June 30, 2005 to $19,475,219 in the six
months ended June 30, 2006 primarily the result of:
o a decrease in the operating and carrying costs for the Big Easy of
approximately $750,000 for the six months as compared to the previous
six month period when we incurred start-up costs of $4.4 million;
o a decrease in operating expenses for the Palm Beach Princess of
approximately $700,000;
o a decrease in equine operating costs of $447,989 because the Company
terminated its equine operations on December 31, 2005; and
o an increase in the carrying costs for our Royal Star vessel of
$721,061, which vessel has been in wet dock storage since its
purchase. The increase was primarily caused by the payments we are
making on the gaming equipment placed aboard the vessel in January
2005 whereas last year the payments on the equipment were interest
only and classified as an interest expense;
o an increase in the Parent Company administrative expense of
approximately $124,000;
o the impairment of the liquor license in the amount of $400,000 as
compared to an impairment of a note receivable in the amount of
$150,000 during the comparative six month period.
The Operating (loss) for the six months ended June 30, 2006 was
($1,653,667) as compared to an operating (loss) of ($1,347,531) for the
comparative six month period ended June 30, 2005.
Other expenses increased by approximately $4.9 million as a result of an
increase in the interest and financing expense due to: 1) the higher debt levels
on the vessel leases; 2) higher interest rates as a result of the penalty
interest incurred on the $30 million loan from PDS; 3) forbearance fees; 4)
interest for the Big Easy being capitalized until March 31, 2005 during its
reconstruction period which is reflected in the six month period ended June 30,
2005; and 5) an increase in the costs of warrants granted for financing in the
amount of approximately $1.1 million.
The Net (Loss) for the six months ended June 30, 2006 was ($8,425,223) or
($0.74) per share as compared to a net (loss) of ($3,325,314) or ($.32) per
share for the six months ended June 30, 2005.
For the six months ending June 30, 2006 the income before interest, taxes,
depreciation and amortization and an impairment loss, (Adjusted EBITDA) was
$426,812 as compared to Adjusted EBITDA of a negative ($348,125) for the
corresponding six month period.
Reconciliation of Non-GAAP Measures to GAAP
Adjusted EBITDA or earnings before interest, taxes, depreciation and
amortization and unusual items is not a measure of performance or liquidity
calculated in accordance with generally accepted accounting principles. EBITDA
information is presented as a supplemental disclosure because management
believes that it is a widely used measure of such performance in the gaming
industry. In addition, management uses Adjusted EBITDA as the primary measure of
the operating performance of its operations, including the evaluation of
operating personnel. Adjusted EBITDA should not be construed as an alternative
to operating income, as an indicator of the Company's operating performance, or
as an alternative to cash flows from operating activities,
42
as a measure of liquidity, or as any other measure of performance determined in
accordance with generally accepted accounting principles. The Company has
significant uses of cash flows, including capital expenditures, interest
payments, taxes, lease and debt principal repayments, which are not reflected in
Adjusted EBITDA. It should also be noted that other gaming companies that report
EBITDA information may calculate EBITDA in a different manner than the Company.
A reconciliation of the Company's Adjusted EBITDA and unusual items to net
income (GAAP), is shown below.
Reconciliation of Adjusted EBITDA to Net Income (GAAP)
Six Months Ended June 30,
------------------------------
2006 2005
-------------- ------------
Total Adjusted EBITDA $ 426,812 $ (348,125)
Depreciation & Amortization (1,680,479) (1,029,406)
Interest & Financing Expenses (6,918,004) (2,048,182)
Interest Income 146,448 160,399
Tax Benefit (Expense) on Income - 90,000
-------------- ------------
Net Income (Loss) before Unusual Items (8,025,223) (3,175,314)
Impairment Loss (400,000) (150,000)
-------------- ------------
Net Income (Loss) $ (8,425,223) $ (3,325,314)
============== ============
Vessel Operations
Palm Beach Princess
During the current period net operating revenue from vessel operations was
$17,534,368 as compared to $18,646,794. The decrease in revenue of $1.1 million
during the comparable quarters is due to comparing the 26 weeks of operations
during 2006 to 27 weeks of operations during 2005. The operating subsidiary
which operates the Palm Beach Princess ends its quarterly accounting period on
the last Sunday of each quarter. These end of the week cut offs normally create
more comparability of the Company's quarterly operations by generally having an
equal number of weeks (13) and weekend days in each quarter. Periodically, this
system necessitates a 14 week quarter. The March 31, 2005 quarter was such a
quarter, therefore, the number of cruises, revenues and expenses reported for
the first Fiscal quarter of last year included one additional week of operations
as compared to the first quarter of 2006. The average revenue per week during
the six months ended June 30, 2006 was $674,400 compared to $690,622 for the
comparable six month period ended June 30, 2005. This was a result of a decrease
in the number of passenger per week of 5.4%, partially offset by an increase in
the revenue per passenger of $119.25 to $123.07.
Casino operating expenses which also includes food, beverage and
entertainment decreased $139,203 from $4,884,559 or 31.1% of casino revenue in
the six month period ended June 30, 2005 to $4,745,356 or 31.5% of casino
revenue in the six month period ended June 30, 2006 primarily the result of
dividing costs, many of which are fixed by their nature, over reduced revenues.
During the month of January 2006, a portion of the employee costs normally
incurred by the Palm Beach Princess for operational and administrative salary
expenses were allocated to the Big Easy operation. These allocations were made
to more accurately reflect the cost of the Big Easy used as a casino gaming
vessel. Approximately $161,465 of salaries allocated to the Big Easy were
expensed as operating costs during the six months ended June 30, 2006 as
compared to approximately $295,000 of salary costs that were expensed and
$60,000 of salaries which were capitalized as part of the vessel costs during
the six months ended June 30, 2005. This allocation should be taken into
consideration when comparing operating results from year to year for the Palm
Beach Princess.
43
Sales, marketing and advertising expenses decreased $974,679 or 45%. The
amounts incurred for marketing and advertising decreased because the Company did
not have sufficient funds to spend due to our negative cash position. On Board
expenses decreased by $113,459 as a result of fewer cruises during the current
six month period.
Maritime, legal and administrative expenses increased $527,762 which
reflects in part the decrease in the allocation of salaries to the Big Easy
since the allocation was only done for one month in the current year.
Finance expenses increased $925,241 as a result of the higher interest rate
due to default interest being charged and a forbearance fee recorded during the
quarter. Depreciation and amortization increased $243,160 as a result of
amortizing the dry dock expenses incurred in October of 2005.
The income before income tax expense for the six months ended June 30, 2006
was $2,178,769 as compared to income before income tax of $3,760,017 in the
comparable six month period ended June 30, 2005.
The Palm Beach Princess performs fourteen cruises weekly, that is, a
daytime and an evening cruise each day. Each cruise is of five to six hours
duration. During each cruise, the Palm Beach Princess offers a range of
amenities and services to her passengers, including a full casino, sit-down
buffet dining, live musical shows, discotheque, bars and lounges, swimming pool
and sundecks. The casino occupies 15,000 square feet aboard the ship and is
equipped with approximately 425 slot machines, all major table games (blackjack,
dice, roulette and poker), and a sports wagering book.
The following is a comparative summary of income and expenses of the Palm Beach
Princess operation for the 26 weeks ended July 2, 2006 and for the 27 weeks
ended July 3, 2005:
Six Months Ended
July 2, July 3,
Description 2006 2005 Change
- --------------------------------- ------------ ----------- -----------
Passenger Count 142,477 156,361 (13,884)
Number of Cruises 350 367 (17)
Average Number of
Passengers per Cruise 407 426 (19)
Net Revenue per Passenger $ 123.07 $ 119.25 $ 3.82
Revenue:
Gaming $ 15,074,450 $ 15,702,668 $ (628,218)
Fare 4,638,017 4,627,835 10,182
On Board 1,452,037 2,176,936 (724,899)
Less: Promotional Allowances
Fare (2,638,235) (2,796,987) 158,752
On Board (991,901) (1,063,658) 71,757
------------ ----------- -----------
Net Operating Revenue 17,534,368 18,646,794 (1,112,426)
------------ ----------- -----------
Expenses:
Gaming 4,745,356 4,884,559 (139,203)
Fare 1,185,473 2,160,152 (974,679)
On Board 422,135 535,594 (113,459)
Maritime and Legal Expenses 3,781,011 3,528,794 252,217
Administrative 1,547,789 1,272,244 275,545
Finance Expenses - Net 2,409,815 1,484,574 925,241
Depreciation and Amortization 1,264,020 1,020,860 243,160
------------ ----------- -----------
Total Expenses 15,355,599 14,886,777 468,822
------------ ----------- -----------
Income Before Income
Tax Expense $ 2,178,769 $ 3,760,017 $ (1,581,248)
============ =========== ===========
44
Big Easy
During the six month period ending June 30, 2006 the Big Easy sustained
losses before interest expense of approximately $3,555,000. This loss consist of
the operational loss for the month of January and the continuing expenses to
keep the ship at wet dock after February 1, 2006 and the casino equipment
leases. Interest, financing expense and the bare boat charter fees during the
six months were $2.8 million resulting in a net (loss) of ($6,328,510) for the
six months ended June 30, 2006 as compared to a net (loss) of ($4,798,092)
during the comparable six month period when the Big Easy costs were charged to
development costs.
Inflation
To date, inflation has not had a material effect on the Company's
operations.
45
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not subject to material interest rate risk, foreign currency
exchange rate risk, commodity price risk or other relevant market rate or price
risks.
ITEM 4. CONTROLS AND PROCEDURES
Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures.
As of the end of the period covered by this report, we completed an
evaluation, under the supervision and with the participation of our management,
including our chief executive officer and chief financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on the foregoing, our chief executive officer and chief
financial officer concluded that the Company's disclosure controls and
procedures were effective.
There have not been any significant changes that occurred during the fiscal
quarter ended June 30, 2006 in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
46
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
Part II
OTHER INFORMATION
ITEM 1A. RISK FACTORS
As disclosed in Part I, Item 1, Footnote 4, the Company has entered into a
First Amended and Restated Forbearance Agreement with its primary lender, PDS
Gaming Corporation, ("PDS") which agreement expires on August 29, 2006. The
agreement which among other things requires that we sell assets or refinance
their indebtedness in full by August 29, 2006 and if not renewed, PDS may
foreclose on its collateral which could put us out of business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
See Part I, Item 1, Note 16 regarding warrants to purchase stock which is
incorporated herein by reference.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Part I, Item 1, Footnote 4 which is incorporated herein by reference.
The Company has failed to made any payments of principal or interest since
January 2006. As of June 30, 2006, the balance of the monthly interest and
principal payments that are in arrears total approximately $7 million dollars.
The Company has also defaulted in the payment of $400,000 of an unsecured
promissory note due December 9, 2005. The note bears interest at 9 % and more
importantly requires the payment of penalty warrants for each month the note
remains outstanding. See Part I, Item 1, Note 16-B, which is herein incorporated
by reference.
ITEM 6. EXHIBITS
Exhibit Description of Exhibit
- ------- ----------------------
31.1 CEO Certification pursuant to rule 13a-14(a) and 15d-14(a) of the
Securities Exchange Act of 1934
31.2 CFO Certification pursuant to rule 13a-14(a) and 15d-14(a) of the
Securities Exchange Act of 1934
32 CEO & CFO Certification pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
47
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements 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.
INTERNATIONAL THOROUGHBRED BREEDERS, INC.
August 21, 2006 /s/Francis W. Murray
----------------------------------------------------
Francis W. Murray, President, Chief Executive Officer and
Chief Financial Officer
48
Exhibit 31.1
CEO CERTIFICATION PURSUANT TO RULE 13A-14 AND 15D-14 OF
THE SECURITIES AND EXCHANGE ACT OF 1934
I, Francis W. Murray, certify that:
1. I have reviewed this quarterly report on Form 10-Q of International
Thoroughbred Breeders;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions);
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: August 21, 2006
/s/Francis W. Murray
----------------------------------------------------
Francis W. Murray, President, Chief Executive Officer and
Chief Financial Officer
49
Exhibit 31.2
CFO CERTIFICATION PURSUANT TO RULE 13A-14 AND 15D-14 OF
THE SECURITIES AND EXCHANGE ACT OF 1934
I, Francis W. Murray, certify that:
1. I have reviewed this quarterly report on Form 10-Q of International
Thoroughbred Breeders;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions);
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: August 21, 2006
/s/Francis W. Murray
----------------------------------------------------
Francis W. Murray, President, Chief Executive Officer and
Chief Financial Officer
50
Exhibit 32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
In connection with the filing of the Quarterly Report on Form 10-Q of
International Thoroughbred Breeders, Inc. (the "Company") for the three and six
months ended June 30, 2006 as filed with the Securities and Exchange Commission
on the date hereof (the "Report"), I, Francis W. Murray, Chief Financial Officer
of the Company, hereby certify pursuant to 18 U.S.C. ss.1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of
my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or
Section 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ Francis W. Murray
- ------------------------
Name: Francis W. Murray
Title: Chief Financial Officer
August 21, 2006
51