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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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 No. 0-1607
MID-STATE RACEWAY, INC.
- --------------------------------------------------------------------------------
(Exact name of Registrants as specified in their respective charters)
New York 15-0555258
- --------------------------------------------- ---------------------------------
(State or Other Jurisdiction of Incorporation (IRS Employer Identification No.)
or Organization)
PO Box 860, Vernon, New York 13476
- --------------------------------------------- ---------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (315) 829-2201
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[ ] YES [X] NO
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
[ ] YES [X] NO
The aggregate market value of the voting stock held by non-affiliates
of the Company as of January 10, 2004 is not determinable due to limited
trading.
Indicate the number of shares outstanding of each of the Company's
classes of common stock, as of January 10, 2004: 892,766 shares
Securities registered pursuant to Section 12(b) of the Act: none
Securities registered pursuant to Section 12(g) of the Act: common
stock, $0.10 par value
TABLE OF CONTENTS
PAGE
----
PART I.
Item 1. Business................................................................................ 3
Item 2. Properties.............................................................................. 3
Item 3. Legal Proceedings....................................................................... 4
Item 4. Submission of Matters to a Vote of Security Holders..................................... 5
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................... 5
Item 6. Selected Consolidated Financial Data.................................................... 6
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................... 7
Item 7A. Qualitative and Quantitative Disclosures about Market Risk.............................. 13
Item 8. Financial Statements and Supplementary Data............................................. 13
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure....... 13
PART III.
Item 10. Directors and Executive Officers of the Registrant...................................... 14
Item 11. Executive Compensation.................................................................. 16
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 16
Item 13. Certain Relationships and Related Transactions.......................................... 17
Item 14. Controls and Procedures................................................................. 18
PART IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 19
Signatures
Certifications
2
Mid-State Raceway, Inc. has not filed its Form 10-Q's and Form 10-K's since its
June 30, 2000 quarterly filing. With this 2002 10-K, we are concurrently filing
the delinquent reports for all periods through December 2002.
PART I.
ITEM 1. BUSINESS
(a) Mid-State Raceway, Inc., ("MSR" or the "Company"), owns and operates a
harness horse race track (the "Track" or "Vernon Downs") known as Vernon Downs,
situated in Vernon, New York. MSR is licensed under and subject to the
regulations of the Pari-Mutual Revenue Law and supervision of the New York State
Racing and Wagering Board to conduct live harness racing at its track and to and
from simulcast racing from other tracks. Such licenses are subject to annual
renewal.
Mid-State Development Corporation ("MSD"), formerly known as Mid-Year Sales,
Inc., is a wholly owned subsidiary of the Company. Prior to 1999, MSD was an
inactive corporation. Beginning in October 1999, MSD commenced operating food
and beverage concessions at the Track owned by the Company. In January 2000, MSD
began operating special events (concerts, snowmobile racing, motorcycle racing,
etc.) at Vernon Downs. In June of 2000, MSD began operating a hotel situated on
property owned by MSR and adjacent to the Track (the "Hotel").
Vernon Hospitality, Inc. (formed in June 2000) and Vernon Productions, Inc.
(formed in July 2000) are inactive wholly-owned subsidiaries of MSR.
(b) The Company was engaged in one business segment during 2002. In 2003
the Company (i) filed its application to be licensed as a video gaming agent so
as to install and operate video lottery terminals (VLTs) at its facility in
Vernon Downs, (ii) substantially constructed a 35,000 square foot "Racino" and
(iii) commenced to hire and train a staff to operate the Racino. It is
anticipated that operations at the VLT facility will commence shortly after the
first quarter of 2004.
(c) Generally, the Company is not in competition with other harness racing
tracks in New York State for patrons. Saratoga race track, a thoroughbred race
track, which conducts a day-time racing meet, is located about 110 miles from
Vernon, New York, and competes to some extent for the Vernon Downs customers
primarily on weekend dates. Saratoga race track is expected to have its VLT
operations open in early first quarter 2004. However, their VLT operations are
not expected to have a significant impact on VLT revenues of Mid-State Raceway,
which is due to open shortly thereafter.
Increased off-track wagering on thoroughbred and harness racing due to a live
television signal being sent into OTB shops in Central New York, the New York
State Lottery and the Oneida Indian Nation's Turning Stone Casino, approximately
7 miles away in Verona, New York, all continue to affect Vernon's on-track daily
averages of handle and attendance.
3
Competition for good horses with the resultant attractive racing programs, has
increased in recent years, particularly from the metropolitan New York and New
Jersey area. This has adversely affected both the number and quality of horses
racing at Vernon Downs.
The Company employed a total of 392 full-time equivalent employees during the
calendar year 2002.
ITEM 2. PROPERTIES.
The Track is located in Vernon, Oneida County, New York. Since the opening of
the plant and related facilities in 1953, the Company has maintained a policy of
continuously improving and modernizing its facilities.
The grandstand and clubhouse at the Track can accommodate approximately 14,000
patrons, which includes seating for 2,000 in the Grandstand and 1,700 in the
Clubhouse. There are parking facilities for approximately 5,900 automobiles.
In June of 2000, the Company completed construction of an expanded 7/8 mile oval
stone dust track which is comparable with tracks located in major metropolitan
areas. Previously the track was a 3/4 mile oval stone dust track with a 1/4 mile
chute and a passing lane running from the last turn to the finish line. The
chute and passing lane have been eliminated. The track is illuminated by a
metal-halide and quartz lighting system. Most races are for a distance of one
mile. The stables accommodate approximately 1,000 horses and are located
adjacent to three exercise tracks and the main track.
ITEM 3. LEGAL PROCEEDINGS
(a) When MSR purchased Gwen Bennett's stock in Comfort Associates, Inc.
("CAI") on May 19, 2000, it agreed to indemnify her for any liability she may
have had with respect to the Comfort Inn franchise agreement for the hotel.
Following the purchase, MSR terminated the franchise agreement and Gwen Bennett
was sued by Choice Hotels International for damages of approximately $557,000.
She has answered the Complaint in such action claiming, among other things, that
the signature on the franchise agreement was not hers. She has notified MSR of
the claim and has requested indemnification if the suit is successful. While the
outcome is not presently determinable, MSR believes that Mrs. Bennett did not
sign the agreement and accordingly believes it is more likely than not the
lawsuit against her will not be successful.
(b) In 2001, the New York State Legislature approved VLT legislation to
allow for the installation and operation of VLTs at New York State harness race
tracks. MSR is currently working with the New York State Lottery Commission on
implementation of the activities allowed by the VLT legislation. MSR has been
initially authorized to install 1,087 and up to 2,500, based on activity
performance, VLTs on its Track premises.
As a result of this legislation, MSR was named as a defendant in two separate
lawsuits challenging the legality of the legislation and the operation of VLTs
at harness race tracks. The outcome of these lawsuits is not presently
determinable.
4
(c) In July 2002, MSR (along with certain MSR directors, Shawn A. Scott,
Vernon, LLC, and All Capital, LLC) was named as a defendant in a lawsuit filed
by a group of private purchasers. The lawsuit alleges bad faith and breach of
contract against MSR and seeks not less than $30 million in damages from the
Raceway plus interest. The lawsuit also alleges fraud by certain MSR directors
and seeks damages from those defendants to be determined at trial plus legal
fees. In addition, the lawsuit alleges tortuous interference with contract by
certain MSR directors, Shawn A. Scott, Vernon, LLC, and All Capital, LLC and
seeks $30 million in damages from those defendants plus interest. The agreement
upon which the action is based contains a provision for the payment of a
$130,000 "break up fee" which has been recorded in the financial statements.
This action was dismissed for failure of prosecution by the plaintiff but was
subsequently reinstituted and is presently pending. The Company has notified its
insurance carrier of the commencement and pendency of the subject action. The
outcome of this lawsuit is not presently determinable and, as such, no provision
for any unfavorable outcome that may arise from this litigation has been
included in the financial statements.
(d) On December 3, 2002, MSR was served with a summons and complaint from
both its former President (John Signorelli) and a current Board member and then
member of the Board's Audit Committee (Dominic Giambona) seeking, inter alia,
(i) monetary damages in the amount of $10 million and/or the issuance of
warrants to acquire up to 175,000 shares with a strike price of $10 per share
that would enable the plaintiffs to acquire such additional common stock upon
payment of $1.75 million; such warrants allegedly to have anti-dilution and
percentage maintenance protection for their combined interests of 39.9%; (ii)
the issuance of 21,600 additional shares of common stock; the issuance of
additional warrants with a strike price of $5 per share to enable each of them
to maintain his present 17.19% interest in the future; and (iii) other
declaratory, equitable, and monetary relief. Such shares and warrants have not
been issued and the issuance of these shares and warrants has not been approved
by the shareholders. The Company believes that it has valid defenses to the
lawsuit, has asserted counterclaims against the plaintiffs based on various
breaches of conduct and duties and intends to seek dismissal of the case.
(e) On November 19, 2003 John Signorelli, a former officer of the Company
and two other stockholders (one of whom owns 200 recently acquired shares of
Common Stock) commenced an action in U.S. District Court for the Southern
District of New York against the Company, certain of its directors and others
seeking damages for alleged fraud, violations of fiduciary duties and "looting".
The Company believes that it has valid defenses to this action and intends to
vigorously defend it. The Company filed a motion to dismiss on December 30,
2003. A hearing of the Company's motion, scheduled for January 22, 2004, was
adjourned to February 12, 2004 to be heard before Judge Miriam Cedarbaum in New
York City.
(f) MSR is a defendant in several litigation matters involving its
operations. Management believes that liabilities resulting from these lawsuits,
if any, will be immaterial or covered by insurance policies.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
5
No items to report.
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
(a) Price Range of Stock
MSR's common stock trades on the over-the counter bulletin board market under
the symbol "MRWY.OB". The stock is not listed or reported by any stock market
exchange or by NASDAQ.
The following table shows the high and low bid prices for the quarters indicated
for the Company's common stock in the over-the-counter bulletin board market for
the calendar quarters
indicated. The prices are based upon reported quotes only, as the stock is not
listed or reported by the NASDAQ. The quotations may not necessarily represent
actual transactions and do not necessarily reflect retail mark-up, markdown or
commission.
Quarter Ended High Bid Low Bid
-------- --------
March 31, 2001 6.75 6.75
June 30, 2001 2.50 2.50
September 30, 2001 5.00 5.00
December 31, 2001 3.50 3.50
March 31, 2002 9.00 8.00
June 30, 2002 8.00 8.00
September 30, 2002 8.00 8.00
December 31, 2002 8.00 8.00
(b) At November 24, 2003, there were 499 holders of record of the Company's
common stock as reported by the Registrar and Transfer Company. As of January
10, 2004, there were 500 holders of record of the Company's common stock.
(c) There were no dividends paid during the years ended December 31, 2002
and 2001.
There are no restrictions on the payment of dividends on the Company's common
stock. Future payment of dividends will be within the discretion of the
Company's Board of Directors and will depend on earnings, capital requirements
and the operating and financial condition of the Company.
ITEM 6. SELECTED FINANCIAL DATA
6
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
OPERATING RESULTS
Number of racing days 84 84 93 114 122
OPERATING REVENUES:
Net Pari-mutuel commissions and breakage $ 5,301,079 $ 5,504,645 $ 4,996,851 $ 5,439,471 $ 5,940,500
Room rental revenue 2,110,754 1,882,666 1,410,333 - -
Admissions 48,599 47,110 69,270 68,843 70,925
Food, beverage and concessions 951,809 817,166 848,237 195,038 193,057
Other revenues 269,984 255,846 284,494 250,195 197,434
------------ ------------ ------------ ------------ ------------
Total operating revenues 8,682,225 8,507,433 7,609,185 5,953,547 6,401,916
------------ ------------ ------------ ------------ ------------
OPERATING EXPENSES 11,511,312 10,531,514 8,882,553 7,453,820 7,222,285
------------ ------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (2,829,087) (2,024,081) (1,273,368) (1,500,273) (820,369)
------------ ------------ ------------ ------------ ------------
Other income (loss) (2,138,937) (235,354) (577,592) 135,059 933,811
------------ ------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (4,969,224) (2,262,191) (1,474,868) (1,368,967) 113,038
------------ ------------ ------------ ------------ ------------
EXTRAORDINARY ITEM - GAIN ON EXTINGUISHMENT
OF DEFERRED RETIREMENT BENEFIT LIABILITY,
NET OF DEFERRED INCOME TAXES - - 593,261 - -
------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (4,969,224) $ (2,262,191) $ (881,607) $ (1,368,967) $ 113,038
============ ============ ============ ============ ============
Per share of common stock - basic and diluted
Net (loss) income before extraordinary item $ (11.22) $ (5.11) $ (3.33) $ (4.89) $ 0.45
Extraordinary item - - $ 1.34 - -
Net (loss) income $ (11.22) $ (5.11) $ (1.99) $ (4.89) $ 0.45
Cash dividends per share - - - - -
FINANCIAL CONDITION
Total Assets $ 8,627,436 $ 6,166,181 $ 6,993,375 $ 4,386,727 $ 3,189,768
Total Liabilities $ 15,791,532 $ 8,361,053 $ 6,917,030 $ 3,477,595 $ 2,750,675
Total Shareholders' Equity $ (7,164,096) $ (2,194,872) $ 76,345 $ 909,132 $ 439,093
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 AS COMPARED TO DECEMBER 31, 2001
7
During the year ended December 31, 2002 operating revenues increased by $174,792
or 2.0% when compared to operating revenues for the year ended December 31, 2001
of $8,507,433.
Although net wagering and simulcast revenue was down to $5,301,079 in 2002 from
$5,504,645 in 2001, a decline of $203,566 or 3.7%, this was offset by increases
in room revenue of $228,088 or 12.0%, and increased food and beverage concession
revenue of $134,643 or 16.5%.
The decline in wagering and simulcast revenue is attributed to general economic
conditions. The increase in hotel revenue and food and beverage concession
revenue is due to increased utilization of those facilities by patrons.
Operating expenses for the year ended December 31, 2002 were $11,511,312 versus
$10,531,514 for the year ended December 31, 2001, an increase of $979,798 or
9.3%.
The major increase in operating expenses was the increase in purses from
$1,896,896 in 2001 to $2,620,736 in 2002. This increase of $723,840 is due, in
part, to the recording of under funded prior year purses of $553,000 as an
expense in 2002 as further explained in Note 16 of the notes to the Consolidated
Financial Statements.
Other operating expenses consisted of 1) payroll costs, which were relatively
unchanged from the 2002 amount of $2,699,502 versus $2,746,811 in 2001, due to
better utilization of personnel and lower head count; 2) utilities, which
declined $37,406 from $844,217 in 2001 to $806,811 in 2002 due to a milder
winter in 2002; 3) simulcast expenses, which decreased from $1,316,512 in 2001
to $1,212,902 in 2002 due to the decline in simulcast wagering noted above; and
4) increased outside services and rentals of $334,276 from $1,549,770 in 2001 to
$1,884,046 in 2002 due to increased legal and consulting fees in connection with
the project to install video lottery terminals.
The loss from operations was $2,829,087 in 2002 versus a loss of $2,024,081 in
2001 or an increase in the loss by $805,006 mainly due to the increased
operating expenses discussed above.
Total interest expense and financing costs were $2,351,491 in 2002 versus
$632,224 in 2001. The increased costs in 2002 are a direct result of numerous
refinancings in 2002 which resulted in higher effective interest rates and fees
associated with the refinancing as discussed in Note 7 of the Notes to the
Consolidated Financial Statements.
Overall the net loss for 2002 was $4,969,224 versus a loss of $2,262,191 or an
increase in the loss of $2,707,033. The increase is a result of increased
operating expenses and interest and financing charges in 2002 when compared to
2001.
STATISTICAL COMPARISON:
12 MONTHS ENDED DECEMBER 31, 2002 VS 12 MONTHS ENDED DECEMBER 31, 2001
8
TWELVE MONTHS ENDED
DECEMBER 31, INCREASE
2002 2001 (DECREASE)
------------ ------------ ------------
GROSS HANDLE:
Live Harness $ 4,682,919 $ 4,331,615 $ 351,304
OTB & ITW 9,312,174 9,349,900 (37,726)
Thoroughbred Simulcast 6,481,972 7,458,801 (976,829)
Harness Simulcast 9,608,447 9,976,806 (368,359)
------------ ------------ ------------
30,085,512 31,117,122 (1,031,610)
DAILY AVERAGE:
Live Harness Handle $ 55,749 $ 51,567 $ 4,182
OTB & ITW Handle 110,859 111,308 (449)
Attendance (85,362 in 2002
and 72,548 in 2001) 1,016 864 (152)
LIVE RACING DAYS 84 84 0
YEAR ENDED DECEMBER 31, 2001 AS COMPARED TO DECEMBER 31, 2000
During the year ended December 31, 2001 the Company incurred a loss from
operations of $2,024,081 versus a loss of $1,273,368 for the year ended December
31, 2000.
The increased loss from operations was a result of increased operating expenses
of $8,882,553 in 2000 versus $10,531,514 in 2001. These expense increases were
mainly related to increased payroll and benefits ($647,596), utilities
($101,730), simulcast expenses ($376,052) and food and beverage costs
($159,781). These costs increased in 2001 even though racing days decreased from
93 in 2000 to 84 in 2001 because 2001 includes the expenses of operating the
hotel, acquired in June of 2000 as well as increased simulcast expenses due to
increasing the number of simulcast events.
Operating revenue did increase from $7,609,185 in 2000 to $8,507,433 in 2001.
But the increase was not sufficient to offset the increased expenses that were
incurred in 2001 as discussed above. Operating revenue increases included an
increase of $507,794 in wagering revenue even with a decrease in racing days
previously mentioned because of the $663,656 increase in simulcasting revenue in
2001. The remaining revenue increase in 2001 was a $472,333 increase in room
rental revenue due to operating the hotel for all of 2001 compared to seven
months in 2000.
Other losses in 2001 decreased by $342,238 in 2001 to $235,354 mainly as a
result of special events income of $249,062 in 2001 versus a loss of $411,008 in
2000 which was offset by an increase in interest expense in 2001 of $301,186 to
$632,224 versus $331,035 in 2000. The increase in special events income was due
to the Company acting as a venue rather than a promoter of special events in
2001 and the increase in interest expense represents increased borrowings in
2001 to fund the operating loss previously discussed.
Income tax expense in 2001 was minimal due to the losses incurred in 2001 and
was $376,092 in 2000 due to the extraordinary gain recognized in 2000 due to the
extinguishment of the deferred retirement benefit liability in 2000.
Net loss for 2001 was $2,262,191 versus a loss of $881,607 in 2000. The
difference results from the extraordinary gain of $593,261 recognized in 2000
and the increased loss from operations of $2,024,081 in 2001 versus $1,273,368
in 2000, or a difference of $750,713.
9
STATISTICAL COMPARISON:
12 MONTHS ENDED DECEMBER 31, 2001 VS 12 MONTHS ENDED DECEMBER 31, 2000
TWELVE MONTHS ENDED
DECEMBER 31, INCREASE
2001 2000 (DECREASE)
----------- ----------- -----------
GROSS HANDLE:
Live Harness $ 4,331,615 $ 4,650,566 $ (318,951)
OTB & ITW 9,349,900 8,952,350 397,550
Thoroughbred Simulcast 7,458,801 4,510,304 2,948,497
Harness Simulcast 9,976,806 9,220,939 755,867
----------- ----------- -----------
31,117,122 27,334,159 3,782,963
DAILY AVERAGE:
Live Harness Handle $ 51,567 $ 50,006 $ 1,561
OTB & ITW Handle 111,308 96,262 15,047
Attendance (72,548 in 2001
and 95,407 in 2000) 864 1,026 (162)
LIVE RACING DAYS 84 93 (9)
SUBSEQUENT EVENTS
2003 LOAN AGREEMENTS AND OTHER FINANCING
$18,000,000 Loan Agreement
On January 29, 2003, MSR and MSD entered into an $18,000,000 Loan Agreement with
All Capital, LLC. This loan agreement was secured by a first mortgage on MSR and
MSD land, buildings, and improvements and was also secured by the personal
property of MSR and MSD. The $18,000,000 proceeds of this loan were applied to
the extent of (a) $11,903,831 to refinance and consolidate the $15,000,000 loan,
and (b) $3,689,169 for payment of loan commitment fees, a fund of one year
interest reserve, and for payment of the costs associated with the loan. The
remaining proceeds of the loan in the amount of $2,407,000 were to be disbursed
for working capital and in connection with and for the partial funding of
construction of facilities were to be utilized for the installation and
operation of video lottery terminals. The loan boar interest at the rate of 12%
per annum and was to mature on July 31, 2004. The loan could be extended by MSR
for up to four successive quarters, until July 30, 2005, subject to the payment
of applicable extension fees. The loan agreement required MSR to create an
interest reserve account to hold the amount necessary to fund the payment of
interest over the initial one year term of the loan. The interest reserve was
funded by a portion of the loan proceeds and a credit for the unused balance of
interest reserve maintained for the $15,000,000 loan. The loan agreement also
required MSR to pay a commitment and loan fee equal to 8% of the loan; which fee
was paid by MSR out of a portion of the loan proceeds. Additionally, in the
event of VLT installation at MSR, the loan agreement required the Company to pay
All Capital, LLC the greater of 2% gross or 6% net VLT revenues earned by MSR
through the term of the loan in exchange for management services subject to the
terms of a separate management agreement between All Capital, LLC and MSR. This
management contract was never entered into between All Capital, LLC and MSR
because the loan was repaid prior to the installation of VLTs at MSR.
10
$23,000,000 Loan Agreement
On June 30, 2003, the MSR and MSD (collectively the "Borrower") entered into a
Loan Agreement (the "Loan Agreement") with Vestin Mortgage, Inc. (a Nevada
corporation) pursuant to which Vestin Mortgage, Inc. ("Vestin") agreed to lend
to the Borrower up to $23,000,000 (the "Vestin Loan"). The Vestin Loan was
evidenced by a Consolidated Secured Promissory Note (the "note") in the original
principal amount of $23,000,000 and was secured by (a) a first mortgage
encumbering all of the real property and improvements thereon owned by the
Borrowers and (b) a first priority security interest in all of the personal
property of the Borrower. Additionally, the owner of All Capital, LLC had agreed
to guarantee the payment of all interest (other than default interest) and
principal payments due under the note until such time as video lottery terminals
("VLTs") are installed and operating at Vernon Downs Racetrack. Neither All
Capital LLC nor its owner received any compensation in connection with the
issuance of such guaranty. The loan boar interest at the rate of 11% per annum
and was to mature on June 30, 2005. Additionally, Vestin had the right to
designate three members to the Board of Directors of the applicant (none have
been as of the date hereof exercised by Vestin).
On June 30, 2003, Vestin advanced $20,300,000 pursuant to the terms of the Loan
Agreement and the note. Such proceeds were applied as follows: (a) $15,834,485
to All Capital, LLC ("All Capital") in satisfaction of the Borrowers obligation
to All Capital pursuant to a certain $18,000,000 Consolidated Secured Promissory
Note dated January 29, 2003 (which promissory note was assigned to Vestin); (b)
$1,686,667 to fund the interest reserve; (c) $1,840,000 to the payment of loan
commitment fees; (d) $150,000 to the payment of closing costs, and (e) $788,848
to working capital of the applicant. An additional $2,700,000 of loan proceeds
were approved to be subsequently drawn down by the Borrower in connection with
the construction of a facility to house the VLTs.
By agreement dated June 30, 2003, Vestin sold a $3,000,000 junior participation
in the Vestin Loan and the proceeds thereof, (the "Junior Participation"), to
All Capital LLC. Payments of interest and principal on or with respect to the
Junior Participation were junior and subordinate to the payment of Vestin of
interest and principal on or with respect to Vestin's retained senior
participation (the "Senior Participation") in and to the Vestin Loan, the note
and the loan documents evidencing and/or securing the Vestin Loan and the note.
During November 2003 Vestin repurchased the Junior Participation from All
Capital LLC.
During November 2003, the Vestin Loan Agreement was modified to increase the
maximum amount thereof to $26,000,000; and in connection with such modification
the Company was required to pay loan commitment fees of $300,000 to Vestin and a
loan broker. All of the remaining terms of the loan were unchanged.
V.I.P. Structures, Inc. Deferment
V.I.P. Structures, Inc. ("VIP"), the design/builder of the Company's VLT
Facility, has agreed to defer payment of $800,000 of the construction costs
until November 2004; and in connection therewith All Capital LLC has issued a
limited guarantee of $500,000 of such obligation to VIP. The Company has agreed
to indemnify All Capital LLC for any liability under such guaranty. All Capital
LLC received no compensation in connection with the issuance of such guaranty.
11
$250,000 Sunset Management LLC Loan
During November 2003, Sunset Management LLC loaned to the Company, on an
unsecured basis, the sum of $250,000 at the rate of 25% per annum. This bridge
loan was promptly repaid by the Company and the interest expense with respect
thereto was less than $4,000.
2003 RACING AND SIMULCAST LICENSES
In December 2002, the New York State Racing and Wagering Board (the "Board")
denied MSR's application for 2003 racing and simulcast licenses. The Board's
determination with respect to MSR's 2003 licenses was stayed by court order.
2003 license negotiations between MSR and the Board continued through the first
quarter of 2003. In April 2003, MSR and the Board entered into a stipulation and
settlement (the "SS Agreement") which effectively granted MSR conditional racing
and simulcast licenses for the 2003 racing season. The SS Agreement requires
that MSR and an associate of MSR's then major creditor complete new applications
in a timely period and that the associate be subject to a background
investigation by the Board. The SS Agreement further provided for a $25,000 fine
(of which $15,000 was abated) for conduct committed by prior management in
violation of the Board's rules and regulations.
Concurrent with the SS Agreement, MSR and the associate entered into a separate
agreement whereby the associate (who otherwise had no obligation to do so)
agreed to file such application and cooperate with the Board's investigation.
MSR agreed to reimburse the associate for all reasonable costs associated with
complying with the Board's investigation. Further, as additional consideration,
MSR agreed to pay an incentive fee of $280,000 to the associate over a 28 month
period commencing May 2003. Also, in April 2003, in connection with the
agreement, MSR granted the associate a warrant to purchase 23,800 shares of MSR
common stock at a price of $8.58 per share. The warrant expires on April 8,
2008.
From the proceeds of the increase in the Vestin Loan from $23,000,000 to
$26,000,000, the Company paid in full (a) all sums due pursuant to the SS
Agreement and (b) the Sunset Management LLC $250,000 loan.
LIQUIDITY AND CAPITAL RESOURCES
Due to the loss from operations in 2002, cash of $2,409,020 was used in
operations. This deficit was financed through additional borrowings of
$2,872,005 net of repayments on capital leases of $124,993.
The Company had a deficit in working capital of $50,144 at December 31, 2002
compared with a deficit in working capital of $2,350,310 at December 31, 2001.
The decrease in the deficit was due to the refinancing in 2002 which included
$1,821,727 of prepaid interest which is classified as a current asset at
December 31, 2002.
As of September 2003, the Company had a working capital deficit of $1,351,757,
and $2,700,000 in available financing from existing loan agreements to fund the
VLT construction. Losses for the nine month period ended September 30, 2003
approximated $5,500,000 and net cash used in operating activities for the period
approximated $6,800,000. Management expects
12
to require approximately $500,000 per month to cover expected net operating
losses on average until the estimated April 1, 2004 opening date of the VLT
facility. Subsequent to September 30, 2003, the Company secured an additional
$3,000,000 through an amendment to the Vestin loan. Additionally, the Company
received $900,000 in proceeds from the issuance of stock as a result of
exercised warrants. Based on the above, which is prepared by management and
unaudited, management expects to have funds sufficient to operate the Company
through the anticipated April VLT opening date.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141, Business Combinations (SFAS 141),
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142), and Statement of Financial Accounting Standards
No. 143, Accounting for Asset Retirement Obligations (SFAS 143). In August 2001,
FASB issued Statement of Financial Accounting Standards No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets (SFAS 144).
SFAS 141 addresses financial accounting and reporting for business combinations
and requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. Additionally, SFAS 141 further
clarifies the criteria to recognize intangible assets separately from goodwill.
SFAS 142, effective October 1, 2001, provides that goodwill and certain
indefinite lived intangible assets will no longer be amortized but will be
reviewed at least annually for impairment and written down and charged to income
when their recorded value exceeds their estimated fair value. Separable
intangible assets that do not have an indefinite life will continue to be
amortized over their useful lives. SFAS 143, effective in 2003, requires
recording of the fair value of liabilities associated with the retirement of
long-lived assets in the period in which they are incurred. SFAS 144, effective
in 2002, provides new guidance on the recognition of impairment losses on
long-lived assets to be held and used or to be disposed of and also broadens the
definition of what constitutes a discontinued operation and how the results of a
discontinued operation are to be measured and presented.
The adoptions of SFAS 141, SFAS 142, SFAS 143 and SFAS 144 have not had a
material impact on the consolidated results of operations or financial position
of the Company.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Company presently does not hold any derivative financial instruments that
would subject it to market risk inherent in derivative financial instruments.
A significant portion of the Company's long-term debt, as refinanced throughout
2002 and in 2003, bears interest at a fixed rate of 12%. The fixed interest rate
limits the amount of exposure that the Company has to change in interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the report of the
independent accountants are submitted under item 15 of this report.
13
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
On December 15, 2003, Mid-State Raceway, Inc. received notice that Urbach Kahn &
Werlin LLP, Certified Public Accountants (UK&W), the firm of independent
accountants previously engaged as the principal accountants to audit the
Company's financial statements, resigned. The resignation was unilateral and was
communicated in a letter to the Company dated December 11, 2003 citing
delinquent SEC filings as the reason. The resignation was not requested or
prompted by the Company.
UK&W's reports on the Company's financial statements for the past two years
contained no adverse opinion or disclaimer of opinion, nor were they qualified
or modified as to uncertainty, audit scope, or accounting principles. During the
Company's two most recent fiscal years and the subsequent interim period up to
the date of the resignation, there were no disagreements with UK&W of the
character described in paragraph (a)(1)(iv) of Regulation S-K, Item 304, and
there were no reportable events of the character described in paragraph
(a)(1)(v) of Regulation S-K, Item 304.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and officers of the Company as of January 10, 2004 are as follows:
Common Shares
Beneficially
Became Owned as of
Name Age Director December 1, 2003 Percent
---- --- -------- ---------------- -------
* Paul V. Noyes 72 1998 - -
* Dominic A. Giambona 64 1999 68,833 .71%
** Edward A. Kiley 62 1999 250 ***
Deborah Bishop 53 2002 - -
*,** Jerry D. Mottern 45 2002 - -
Joan Rae Parker 65 2002 - -
*,** Victoria Ann Scott 61 2002 450,000 50.41%
* John Stone 47 2002 - -
Jack D. Dallas 64 - - -
David E. Wilson 67 - - -
Rose H. Frawert 39 - - -
All officers and directors
as a group 519,083 58.12%
* Member of Executive Committee
** Member of Audit Committee
*** Less than one percent
14
DEBORAH BISHOP (age 53) was appointed to the Board of Directors in 2002 and
serves as the Assistant Secretary. She is a proven professional in the field of
corporate administration. Ms. Bishop recently was associated with Delta Downs
thoroughbred racing in Vinton, Louisiana and subsequently Vernon Downs in an
administrative capacity.
JACK D. DALLAS (age 63) is Mid-State Raceway's Vice President of Hospitality and
Resort Operations. Mr. Dallas has an extensive background in hospitality and
gaming, having directed the truck stop gaming operations in Louisiana for Delta
Downs. He also has worked as the general manager or head of operations for
numerous hotels, including the Disneyland Hotel, the Royal Lahaina Resort,
Radisson Hotel at Fisherman's Wharf and several others.
DOMINIC A. GIAMBONA (age 65) was Chairman of the Board from September 8, 2000
through September 26, 2001 and has served as a Director since September 1999.
Mr. Giambona is a private investor and business consultant. Born and raised in
Rome, New York, Mr. Giambona now resides in Jupiter, Florida. He is a graduate
of Syracuse University and has more than 40 years experience with building
construction, facilities management, development and marketing.
EDWARD A. KILEY (age 61) has served as a Director since June 1999 and is
currently the Secretary of the Company. He is a 1964 graduate of Brown
University and Dean's List and Cum Laude graduate of the Syracuse University
School of Law. A member of the New York, Florida and United States Supreme court
bars before retiring from the practice of law in 1995, he is currently employed
as a financial planner. He is the eldest son of Vernon Downs founder William F.
Kiley.
JERRY D. MOTTERN (age 45) was appointed to the Board of Directors in 2002. He is
in the practice of Public Accounting as a sole practitioner based in Twin Falls,
Idaho. Previously, Mr. Mottern was an associate of McMullen, McPhee and Company,
CPA's and Cooper Norman and Company. Mr. Mottern practices principally in the
area of taxation. He received his Bachelor of Science from the University of
Idaho in 1980 and is a member of the American Institute of Certified Public
Accountants.
PAUL V. NOYES (age 73) has served as a Director since August 1998. He is an
attorney with an office in Sherrill, New York. Mr. Noyes, a former shareholder
of Mid-State Raceway, Inc. (1968-2003), is a graduate of Hamilton College and
Cornell University Law School.
HOOLAE PAOA (age 53) is the Chairman of the Board, President and CEO of
Mid-State Raceway, Inc. His background is primarily in hospitality and facility
development, including hotels, restaurants, retail centers, golf courses,
racetracks and casinos. Mr. Paoa was recently responsible for the operations,
expansion and ultimate sale of Delta Downs Racetrack and Casino. Born and raised
in Hawaii, Mr. Paoa currently resides in Vernon, New York. The New York Racing
and Wagering Board refused to renew Mr. Paoa's individual license to participate
in New York racing on December 12, 2003. Dave Wilson is the acting president
during Mr. Paoa's appeal process.
JOAN RAE PARKER (age 65) was appointed to the Board of Directors in 2002. She
recently retired from a career in the field of corporate administration with
Bridge Capital, LLC. Ms. Parker attended the University of Idaho and currently
resides in Henderson, Nevada.
15
VICTORIA ANN SCOTT (age 61) has served on the Board of Directors since 2002. Her
extensive experience in the gaming industry includes the responsibility of
building, licensing and managing video poker lounges in Louisiana. She holds two
gaming device owner licenses and four video poker type V licenses. Effective
November 13, 2003, Ms. Scott acquired and exercised warrants to purchase 450,000
shares of Common Stock (previously issued to All Capital LLC); and in connection
therewith paid the Company $900,000 for such shares.
JOHN STONE (age 46) was appointed to the Board of Directors in 2002. He has an
extensive background and is currently involved in property management in the
private sector. Mr. Stone received a Bachelor of Science degree from DeVry
Institute of Technology.
DAVID E. WILSON (age 67) is the Vice President of Racing and Facilities and
acting Chief Operating Officer for Mid-State Raceway, Inc. Mr. Wilson has over
45 years of experience in the racing industry, including stints at many
prestigious tracks, as well as the Daily Racing Form. Most recently, he was the
Vice President of Racing and the General Manager of Delta Downs in Louisiana. He
also serves as Vice President for the Lea Downs Racetrack and Casino in Hobbs,
New Mexico.
ROSE FRAWERT (age 39) was appointed Treasurer and Chief Financial Officer of the
Company of November 14, 2003 replacing James R. Wise who had served in such
capacities since October 1997. Ms. Frawert joins Mid-State Raceway after most
recently serving as Casino Controller for the Reno Hilton, a Park Place
Entertainment business. Prior experience includes serving as assistant Corporate
Controller for Phoenix Leisure, Inc., a gaming development and management
company, and with Caesars World Inc. where she advanced through the company's
financial structure. Ms. Frawert holds a bachelors degree in accounting and is a
Certified Public Accountant.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth summary information concerning compensation paid
or accrued by the Company for services rendered during the last three fiscal
years by the named Executive Officers.
Consulting
Name and Principal Position Salary Bonus Fees
--------------------------- -------- ----- ----------
Justice M. Cheney
President and Chief Executive Officer
January 1, 2000 to October 28, 2000 $ 50,769 - -
May 26, 2001 to December 31, 2001 39,118 - -
January 1, 2002 to July 13, 2002 31,934 - -
July, 14, 2002 to December 31, 2002 - - $ 19,250
John J. Signorelli
President and Chief Executive Officer
January 1, 2000 to December 31, 2000 - - $ 75,000
16
November 26, 2000 to December 31, 2000 $ 6,000 -
January 1, 2001 to April 21, 2001 37,049 - -
Andy Goodell
President and Chief Executive Officer
July 1, 2002 to December 28, 2002 $ 50,356 - -
No other executive officer received an annual salary and bonus in excess of
$100,000 during the fiscal years ended December 31, 2000, 2001 and 2002. Dominic
A. Giambona received consulting fees of $60,900 during 2000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
At the close of business on December 1, 2003, the Company had outstanding
892,776 shares of common stock. No person or group is known by the Company to
beneficially own more than 5% of the Company's common stock except as set forth
in the following table.
Amount of
Name and Address Beneficial Percent
Of Beneficial Officer Ownership Class
- ------------------------------- -------------- --------
Richard C. Breeden, Trustee 38,000 shares 4.25%
Bennett Management &
Development Corp.
Two Clinton Square
Syracuse, NY 13202
Richard C. Breeden, Trustee 126,657 shares 14.18%
The Bennett Funding Group, Inc.
And Neil H. Ackerman, Trustee
NW Investors II
555 Fifth Ave.
New York, NY 10017
Dominic A. Giambona 68,833 shares 7.71%
249 Barbados Drive
Jupiter, FL 33458
John J. Signorelli 68,833 shares 7.71%
25 Mandia Lane
PO Box 386
Goldens Bridge, NY 10526
Victoria Scott 450,000 shares 50.40%
7000 Beach Plaza, Suite 702
St. Petersburg Beach, FL 33706
17
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
At December 31, 2001 the Company had outstanding borrowings of $1,650,000 with
interest at 12% to a lender who was also a board member. Interest expense
incurred related to this loan was $181,000 in 2001. In March 2001, to extend the
due date of these loans to May 2002, the lender was granted a warrant to
purchase 10,000 shares of stock at a price of $10 per share. This loan was
repaid in April 2002 in connection with a refinancing of substantially all of
the Company's debt with All Capital LLC.
The Company had outstanding at December 31, 2001 $166,500 of debt with two board
members, one of whom was an officer. The debt bears interest at 12%. Interest
expense related to this loan approximated $20,000 in 2001. The amount
outstanding was repaid in April 2002 with the refinancing discussed above.
At December 31, 2001, the Company had a $300,000 loan outstanding due to a board
member. The debt bears interest at 13%. Interest expense related to this loan
approximated $42,250 in 2001. In March 2001 in consideration for amendments to
this loan agreement, the lender was granted a warrant to purchase 2,700 shares
of stock at a price of $10 per share. This loan was repaid in April 2002 with
the refinancing discussed above.
On January 11, 2001, the Board of Directors of the Company authorized the
issuance of a total of 24,840 shares of common stock to four individual
shareholders (three of whom were board members and two of whom were officers) in
an effort to prevent the dilution of such shareholders' ownership interest in
the Company, which includes 21,600 shares that are subject to pending
litigation. These anti-dilution shares of common stock were never issued. Due to
the fact that these shares were authorized without consideration on the part of
the shareholders, legal counsel for the Company has advised that any such
issuance would not be valid. Further, since the stock certificates were not
issued to the shareholders for the shares in question, legal counsel believes
that the Company does not need to take any action to rescind the authorization
for the issuance of such shares. On December 17, 2001 the Board of Directors
clarified the minutes of the January 11, 2001 meeting to state the 24,840 shares
of common stock will be issued for past services. However, issuance of the stock
is subject to approval by the shareholders, by Board resolution.
See elsewhere herein information with respect to the following transactions:
(I) In March 2002 the Company entered into a Financing Agreement with
Vernon, LLC, a company controlled by a shareholder.
(II) In April 2002 the Company entered into an $8,500,000 Loan Agreement
with All Capital, LLC, a Company affiliated with Vernon, LLC.
(III) On July 16, 2002 the Company borrowed $1,000,000 from All Capital LLC.
(IV) On August 28, 2002, the Company entered into a $15,000,000 Loan
Agreement with All Capital, LLC replacing the three above loans (I, II, III).
18
(V) On January 29, 2003, the Company entered into an $18,000,000 Loan
Agreement with All Capital LLC.
In 2002, 2001, and 2000, MSR paid approximately $59,000, $131,000, and $232,000,
respectively, to related parties for consulting services, lodging, and interest,
including amounts attributable to long-term debt (Note 7).
In December 2002, in order to induce the NYS Racing and Wagering Board (the
"Board') to issue a license to its President and CEO, the Company advanced
approximately $67,000 in the form of a security deposit to a third party for the
benefit of its President and CEO. Upon the satisfaction by the President and CEO
of the provisions of a certain undertaking given to the Board, the advance will
be returned to MSR. Should the advance be applied to the benefit of the
President and CEO it will, at that time, be treated as additional compensation.
A Company owned by MSR's President and CEO has a consulting agreement with MSR
to provide VLT consulting services to MSR in exchange for monthly payments of
$6,500 through March 2004.
ITEM 14. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures.
Within the 90 days before the date of this Form 10-K, we evaluated the
effectiveness of the design and operation of our "disclosure controls and
procedures". Mid-State Raceway, Inc. and Subsidiary conducted this evaluation
under the supervision and with the participation of management, including our
Chief Executive Officer and Chief Financial Officer.
(i) Definition of Disclosure Controls and Procedures.
Disclosure controls and procedures are controls and other procedures that are
designed with the objective of ensuring that information required to be
disclosed in our periodic reports filed under the Exchange Act, such as this
report, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. As defined by the SEC, such disclosure
controls and procedures are also designed with the objective of ensuring that
such information is accumulated and communicated to our management, including
the Chief Executive Officer and Chief Financial Officer, in such a manner as to
allow timely disclosure decisions.
(ii) Limitations on the Effectiveness of Disclosure Controls and Procedures and
Internal Controls.
The Company recognizes that a system of disclosure controls and procedures (as
well as a system of internal controls), no matter how well conceived and
operated, cannot provide absolute assurance that the objectives of the system
are met. Further, the design of such a system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented in a number of ways. Because of the inherent limitations in a
cost-effective control system, system failures may occur and not be detected.
19
(iii) Conclusions with Respect to Our Evaluation of Disclosure Controls and
Procedures.
Subject to the limitations described above and not withstanding the delinquency
of this report, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures going forward are
effective in timely alerting them to material information relating to Mid-State
Raceway, Inc. and subsidiary required to be included in The Company's periodic
SEC filings.
(b) Changes in Internal Controls.
There have been no significant changes in The Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements
(1) Reports of Independent Auditors
Consolidated Balance Sheets at December 31, 2002 and 2001
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Changes in Shareholders' Equity for
the years ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
All other schedules are omitted because they are not required, are
inapplicable or the information is otherwise shown in the financial statements
or notes thereto.
(b) Reports on Form 8-K filed during the last quarter of 2002
None
(c) Exhibits:
4.1 Loan Agreements 4.2 Vestin Amendment
10.1 Horseman's Agreement
10.21 VIP Finance 10.22 VIP Indemnification
10.23 VIP Guarantee
16.1 Change in Accountants 16.2 Engagement Letter
21.1 Subsidiaries of the Registrant
(d)
Exhibit 31.1 Certification of Chief Executive Officer
Exhibit 31.2 Certification of Principal Financial and Accounting Officer
Exhibit 32.1 Sarbanes-Oxley Chief Executive Officer
Exhibit 32.2 Sarbanes-Oxley Principal Financial and Accounting Officer
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
MID-STATE RACEWAY, INC.
(Registrant)
BY: /S/ HOOLAE PAOA
-----------------------------
Hoolae Paoa
Chief Executive Officer
JANUARY 10, 2004
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities indicated on the 10th day of January 2004.
/S/ HOOLAE PAOA
Hoolae Paoa
President, Chief Executive Officer, and Chairman of the Board
/S/ ROSE H. FRAWERT
Rose H. Frawert
Principal Financial and Accounting Officer
/S/ DAVE WILSON
Dave Wilson
Acting Chief Operating Officer
/S/ ANDREW EDWARD KILEY
Andrew Edward Kiley
Secretary and Director
/S/ VICTORIA SCOTT
Victoria Scott
Director
/S/ JERRY MOTTERN
Jerry Mottern
Director
/S/ DEBBIE BISHOP
Debbie Bishop
Director
/S/ JOHN STONE
John Stone
Director
/S/ JOAN PARKER
Joan Parker
Director
21
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders
Mid-State Raceway, Inc.
We have audited the accompanying consolidated balance sheets of Mid-State
Raceway, Inc. and Subsidiary as of December 31, 2002 and 2001, and the related
consolidated statements of operations, changes in shareholders' equity
(deficit), and cash flows for each of the three years in the period ended
December 31, 2002. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As explained further in Notes 19 and 20 to the financial statements, subsequent
to December 31, 2002, the Company refinanced substantially all of its debt and
was granted a temporary racing and simulcasting license for 2003. In addition,
as explained in Note 21 to the financial statements, the Company has applied for
licensure to operate a video lottery terminal project and for its 2004 racing
and simulcasting license. There can be no assurances, however, that the VLT
project will be successfully implemented, that revenue projections of such will
be met, and the 2004 racing and simulcasting license will be granted.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Mid-State Raceway,
Inc. and Subsidiary as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
/s/ Urbach Kahn & Werlin LLP
----------------------------
Albany, New York
March 21, 2003, except for the second paragraph of
Note 19 and Note 20 for which the dates are August 27,
2003 and the eighth paragraph of Note 19 and Note 20
for which the dates are January 9, 2004
22
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 2001
------------ ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 89,907 $ 41,287
Restricted cash 253,794 192,903
Other receivables, net of allowance for doubtful accounts of
$10,000 in 2002 and 2001 401,135 242,527
Prepaid expenses (principally interest in 2002) 1,821,727 118,937
------------ ------------
Total current assets 2,566,563 595,654
------------ ------------
PROPERTY, BUILDINGS AND EQUIPMENT
Land, buildings and equipment 17,778,070 17,439,753
Other properties 121,671 121,671
------------ ------------
17,899,741 17,561,424
Less accumulated depreciation 12,412,951 11,990,897
------------ ------------
5,486,790 5,570,527
------------ ------------
OTHER ASSETS 574,083 -
------------ ------------
$ 8,627,436 $ 6,166,181
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Lines of credit $ - $ 674,678
Current portion of long term debt 113,569 96,110
Accounts payable and accrued expenses 1,638,161 1,767,782
Uncashed winning tickets 66,333 63,736
Purse funds payable 495,000 -
Deposits and other current liabilities 196,110 138,391
Retention for capital improvements 27,534 45,267
Deferred grant revenue 80,000 160,000
------------ ------------
Total current liabilities 2,616,707 2,945,964
------------ ------------
LONG-TERM DEBT, net of current portion 13,174,825 5,415,089
------------ ------------
CONTINGENCIES (Notes 13, 14, 15, 17, 18 and 19)
------------ ------------
SHAREHOLDERS' EQUITY
Common stock, par value $.10 per share;
authorized 10,000,000 shares; issued and
outstanding 442,766 shares in 2002 and 2001 44,277 44,277
Additional paid-in capital 2,084,909 2,084,909
Accumulated deficit (9,293,282) (4,324,058)
------------ ------------
Total shareholders' deficit (7,164,096) (2,194,872)
------------ ------------
$ 8,627,436 $ 6,166,181
============ ============
See Notes to Consolidated Financial Statements.
23
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000
(84 RACING DAYS) (84 RACING DAYS) (93 RACING DAYS)
--------------- --------------- ---------------
Operating revenues:
Net pari-mutuel commissions and breakage from wagering:
Vernon Downs Harness $ 921,853 $ 837,718 $ 896,222
Off-track betting (OTB) and inter-track wagering (ITW) 1,370,520 1,433,419 1,530,777
Simulcasting 3,008,706 3,233,508 2,569,852
--------------- --------------- ---------------
5,301,079 5,504,645 4,996,851
Room rental revenue 2,110,754 1,882,666 1,410,333
Admissions 48,599 47,110 69,270
Food, beverage, and concessions 951,809 817,166 848,237
Other revenues 269,984 255,846 284,494
--------------- --------------- ---------------
Total operating revenues 8,682,225 8,507,433 7,609,185
--------------- --------------- ---------------
Operating expenses:
Purses 2,620,736 1,896,896 1,796,874
Payroll 2,699,502 2,746,811 2,355,818
Taxes, other than income 631,961 559,410 302,807
Outside services and rentals 1,884,046 1,549,770 1,339,756
Utilities 806,811 844,217 742,487
Simulcasting expenses 1,212,902 1,316,512 940,460
Food and beverage costs 484,735 471,765 311,984
Depreciation 422,054 445,357 356,774
Bad debts (recovery) 740 4,897 (101,637)
Other expenses 747,825 695,879 837,230
--------------- --------------- ---------------
Total operating expenses 11,511,312 10,531,514 8,882,553
--------------- --------------- ---------------
Loss from operations (2,829,087) (2,024,081) (1,273,368)
--------------- --------------- ---------------
Other income (loss):
Special events income (loss), net 78,455 249,062 (411,008)
Commissions for capital improvements 70,853 46,668 101,960
Aid from state and local governments 80,000 80,550 36,248
Loss on sale of other assets - (2,892) -
Investment (expense) income (16,754) 23,482 26,243
Interest expense (1,374,385) (632,224) (331,035)
Financing costs (977,106) - -
--------------- --------------- ---------------
Total other income (loss) (2,138,937) (235,354) (577,592)
--------------- --------------- ---------------
Loss before (provision) benefit for federal and state
income taxes and extraordinary item (4,968,024) (2,259,435) (1,850,960)
--------------- --------------- ---------------
(Provision) benefit for federal and state income taxes:
Currently payable (1,200) (2,756) (708)
Deferred benefit - - 376,800
--------------- --------------- ---------------
Total (provision) benefit for federal and state income taxes (1,200) (2,756) 376,092
--------------- --------------- ---------------
Loss before extraordinary item (4,969,224) (2,262,191) (1,474,868)
--------------- --------------- ---------------
Extraordinary item - gain on extinguishment of deferred retirement
benefit liability, net of deferred income taxes of $376,800 (Note 17) - - 593,261
--------------- --------------- ---------------
Net loss $ (4,969,224) $ (2,262,191) $ (881,607)
=============== =============== ===============
(Loss) income per common share - based on weighted
average shares outstanding
Loss before extraordinary item $ (11.22) $ (5.11) $ (3.33)
Extraordinary item $ - $ - $ 1.34
Loss after extraordinary item $ (11.22) $ (5.11) $ (1.99)
=============== =============== ===============
See Notes to Consolidated Financial Statements.
24
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
Accumulated
Common Stock Additional Other
------------------- Paid-in Accumulated Comprehensive
Shares Amount Capital Deficit Income Total
-------- --------- ----------- ------------ ------------- -----------
Balances at January 1, 2000 438,386 $ 43,839 $ 2,041,547 $ (1,180,260) $ 4,006 $ 909,132
-----------
Comprehensive loss
Net loss for the year (881,607) - (881,607)
Unrealized gain on securities available for sale - 5,020 5,020
------------ ------------- -----------
Total comprehensive loss (881,607) 5,020 (876,587)
Issuance of common stock for settlement of lawsuit 4,380 438 43,362 - - 43,800
-------- --------- ----------- ------------ ------------- -----------
Balances at December 31, 2000 442,766 44,277 2,084,909 (2,061,867) 9,026 76,345
-----------
Comprehensive loss
Net loss for the year (2,262,191) - (2,262,191)
Unrealized loss on securities available for sale - (9,026) (9,026)
------------ ------------- -----------
Total comprehensive loss (2,262,191) (9,026) (2,271,217)
-------- --------- ----------- ------------ ------------- -----------
Balances at December 31, 2001 442,766 44,277 2,084,909 (4,324,058) - (2,194,872)
Comprehensive loss
Net loss for the year (4,969,224) - (4,969,224)
------------ ------------- -----------
Total comprehensive loss (4,969,224) - (4,969,224)
-------- --------- ----------- ------------ ------------- -----------
Balances at December 31, 2002 442,766 $ 44,277 $ 2,084,909 $ (9,293,282) $ - $(7,164,096)
======== ========= =========== ============ ============= ===========
See Notes to Consolidated Financial Statements.
25
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
For the Year For the Year For the Year
Ended Ended Ended
December 31, December 31, December 31,
2002 2001 2000
(84 Racing Days) (84 Racing Days) (93 Racing Days)
---------------- ---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (4,969,224) $ (2,262,191) $ (881,607)
Adjustments to reconcile net loss to net cash used in
operating activities:
Gain on extinguishment of deferred benefit liability - - (593,261)
Deferred tax benefit - - (376,800)
Depreciation 422,054 445,357 356,774
Amortization of prepaid financing costs 2,091,243 - -
Change in allowance for doubtful accounts - - (102,000)
Realized (gain) loss on investments - (28,227) 17,917
Imputed interest expense - 263,105 128,947
Loss on sale/disposal of equipment - 2,892 -
Changes in:
Restricted cash (60,891) (65,335) 30,341
Accounts and grants receivable (158,608) 68,845 364,243
Prepaid interest and other (61,556) 45,492 (3,165)
Other assets - 8,904 20,361
Accounts payable (129,621) 32,355 224,336
Uncashed winning tickets and other current
liabilities 60,316 119,206 19,529
Purse funds payable 495,000 - -
Deferred revenue (80,000) 160,000 -
Retention for capital improvements (17,733) 5,375 (44,380)
---------------- ---------------- ----------------
Net cash used in operating activities (2,409,020) (1,204,222) (838,765)
---------------- ---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities and sales of available-for-sale
investment securities - 520,676 168,160
Purchase of available-for-sale investment securities - - (487,427)
Proceeds from sale of equipment - 12,700 -
Purchase of properties and equipment (289,372) (182,603) (658,394)
---------------- ---------------- ----------------
Net cash provided by (used in) investing activities (289,372) 350,773 (977,661)
---------------- ---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from debt, net of issuance costs 2,872,005 1,141,000 897,333
Principal payments on line of credit and other debt - (313,655) -
Principal payments on capital leases (124,993) (78,789) (48,256)
---------------- ---------------- ----------------
Net cash provided by financing activities 2,747,012 748,556 849,077
---------------- ---------------- ----------------
Net increase (decrease) in cash and cash equivalents 48,620 (104,893) (967,349)
Cash and cash equivalents at beginning of year 41,287 146,180 1,113,529
---------------- ---------------- ----------------
Cash and cash equivalents at end of year $ 89,907 $ 41,287 $ 146,180
================ ================ ================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 290,148 $ 351,228 $ 176,656
Income taxes $ 1,200 $ 2,756 $ 696
================ ================ ================
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Acquisition of hotel building and equipment:
Debt incurred $ - $ - $ 2,421,155
Accounts payable and other liabilities assumed $ - $ - $ 345,856
Principal payments on debt through proceeds from
refinancing the existing debt $ 15,816,178 $ - $ -
Payments on prepaid financing costs through proceeds from
refinancing the existing debt $ 4,306,560 $ - $ -
Capital leases $ 48,915 $ 16,261 $ 508,776
Accounts payable incurred for property and equipment $ - $ 99,165 $ -
================ ================ ================
See Notes to Consolidated Financial Statements.
26
NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS:
Mid-State Raceway, Inc. ("MSR") operates a harness racing track in
Vernon, New York, known as Vernon Downs. MSR is licensed by the New
York State Racing and Wagering Board to conduct live harness racing at
its track and to simulcast racing from other tracks. Such licenses are
subject to annual renewal. MSR was granted a conditional license for
2003 in May 2003 (see Note 20).
Mid-State Development Corporation ("MSD") is a wholly owned subsidiary
of MSR. MSD operates concessions at the harness racing track owned by
MSR, and, beginning in June of 2000, operates a hotel adjacent to the
track owned by MSR (see Note 13).
MSR and MSD sustained significant operating losses for each of the
three years in the period ended December 31, 2002, resulting in a
shareholder deficit of approximately $7.2 million as of December 31,
2002. Management's plans with respect to this deficit financial
position are described in Note 21.
PRINCIPLES OF CONSOLIDATION:
The accompanying consolidated financial statements include the accounts
of MSR and MSD (collectively referred to as the Company). All
significant intercompany accounts and transactions have been eliminated
in the consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
CASH EQUIVALENTS:
For purposes of reporting cash flow, cash and cash equivalents include
money market accounts and any highly liquid debt instruments purchased
with a maturity of three months or less.
PROPERTY, BUILDINGS AND EQUIPMENT:
Property, buildings and equipment are carried at cost less accumulated
depreciation computed by the straight-line and accelerated methods.
The estimated useful life to the various classes of assets on which
current provisions were based are as follows:
Land improvements 5 to 20 years
Buildings and improvements 10 to 40 years
Other structures 15 to 31 1/2 years
Equipment 3 to 20 years
LOSS (GAIN) PER COMMON SHARE:
Loss per share of common stock has been calculated based on the
weighted average shares outstanding during each year. The weighted
average number of common shares outstanding was 442,766, 442,766, and
442,382 for the years December 31, 2002, 2001 and 2000, respectively.
Outstanding authorized stock warrants (see Note 12) totaled
27
1,897,700 and 197,700 at December 31, 2002 and 2001, respectively. All
such warrants were excluded from all loss per share calculations
because their effect was anti-dilutive.
ADVERTISING:
MSR follows the policy of charging the costs of advertising to expense
as incurred. Advertising expense was $136,106, $77,160, and $80,710,
for the years ended December 31, 2002, 2001 and 2000, respectively.
INCOME TAXES:
The Company recognizes deferred income taxes for the tax consequences
in future years of differences between the tax bases of assets and
liabilities and their financial reporting amounts at each year-end
based on enacted tax laws and statutory tax rates applicable to the
periods in which the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred
tax assets to the amount expected to be realized. Income tax expense is
the tax payable for the period and the change during the period in
deferred tax assets and liabilities.
REVENUE RECOGNITION:
MSR recognizes revenue for commissions from wagering, corporate
sponsors, and admissions when the related racing event is run. Revenue
from hotel and other services are recognized at the time the related
service is performed. Commissions for capital improvements are
recognized when the related qualifying expenditures are incurred.
Investment income is recognized on the accrual basis.
PURSE EXPENSE RECOGNITION:
Similar to its policy of recognizing revenue for commissions from
wagering, through 2001, MSR recognized purse expenses associated with
live racing when the related racing event was conducted. As explained
in Note 16, purse expense for 2002 includes amounts attributable to
underfunded purse carryovers from prior years, based on a contractual
arrangement.
ASSET IMPAIRMENT ASSESSMENTS:
The Company reviews long-lived assets for impairment whenever events or
circumstances indicate that the carrying value of such assets may not
be fully recoverable. An impairment is recognized to the extent that
the sum of undiscounted estimated future cash flows expected to result
from use of the assets is less than the carrying value. No impairment
has been recognized through December 31, 2002.
OTHER ASSETS:
Other assets consist principally of finance fees paid in connection
with the August 2002 financing arrangement. Commitment loan fees and
closing costs on this financing (approximately $848,000) are amortized
on the straight-line method over one year, the original term of the
loan.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141, Business
Combinations (SFAS 141), Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets (SFAS 142), and Statement
of Financial Accounting Standards No. 143, Accounting for
28
Asset Retirement Obligations (SFAS 143). In August 2001, FASB issued
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets (SFAS 144).
SFAS 141 addresses financial accounting and reporting for business
combinations and requires that the purchase method of accounting be
used for all business combinations initiated after June 30, 2001.
Additionally, SFAS 141 further clarifies the criteria to recognize
intangible assets separately from goodwill. SFAS 142, effective October
1, 2001, provides that goodwill and certain indefinite lived intangible
assets will no longer be amortized but will be reviewed at least
annually for impairment and written down and charged to income when
their recorded value exceeds their estimated fair value. Separable
intangible assets that do not have an indefinite life will continue to
be amortized over their useful lives. SFAS 143, effective in 2003,
requires recording of the fair value of liabilities associated with the
retirement of long-lived assets in the period in which they are
incurred. SFAS 144, effective in 2002, provides new guidance on the
recognition of impairment losses on long-lived assets to be held and
used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a
discontinued operation are to be measured and presented.
The adoptions of SFAS 141, SFAS 142, SFAS 143 and SFAS 144 have not had
a material impact on the consolidated results of operations or
financial position of the Company.
RECLASSIFICATIONS:
Certain balances in the 2000 and 2001 financial statements have been
reclassified for comparative purposes.
NOTE 2. RESTRICTED CASH
Cash is restricted for the following purposes at December 31:
2002 2001
--------- ---------
Purses $ 60,266 $ 12,217
Capital improvements 30,958 45,267
Uncashed winning tickets 66,333 63,736
Account wagering 96,237 71,683
--------- ---------
$ 253,794 $ 192,903
========= =========
NOTE 3. OTHER RECEIVABLES
Other receivables consist of the following at December 31:
29
2002 2001
--------- ---------
Shift adjustments $ 108,920 $ 3,545
Commissions 78,084 75,983
Hotel related 113,655 122,225
Other 110,476 50,774
Total 411,135 252,527
Less allowance for doubtful accounts 10,000 10,000
--------- ---------
Other receivables, net $ 401,135 $ 242,527
========= =========
NOTE 4. PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment consist of the following at December
31:
2002 2001
----------- ------------
Land, buildings and equipment:
Land $ 77,802 $ 77,802
Land improvements 1,932,192 1,817,481
Buildings and improvements 10,689,479 10,632,810
Equipment 4,940,783 4,797,494
Construction in progress 137,814 114,166
----------- ------------
17,778,070 17,439,753
Other properties:
Land 121,671 121,671
----------- ------------
17,899,741 17,561,424
Less accumulated depreciation 12,412,951 11,990,897
----------- ------------
$ 5,486,790 $ 5,570,527
=========== ============
NOTE 5. REAL ESTATE TAXES PAYABLE
In May 1998, Oneida County and MSR entered into an agreement whereby MSR would
make 36 monthly installments of $6,000, commencing May 29, 1998, to
satisfy its liability to Oneida County for nonpayment of 1997 property
taxes totaling $216,000. As MSR did not make all of the required
payments on a timely basis, Oneida County recorded a deed in 2001
transferring MSR's title to parcels to the Oneida County Board of
Legislators. MSR satisfied all amounts due pursuant to the 1997
property taxes in 2002.
At December 31, 2002, MSR owes approximately $545,000 relating to delinquent
property and school taxes for 2002 and prior periods. In January 2003,
the Company paid approximately $236,000 to Oneida County to satisfy
2003 property taxes and relevied 2002 school taxes. Additionally, as
part of a delinquent tax payment agreement with Oneida County, the
Company is required to pay the County $10,000 per month for ten months
(March 2003 - December 2003) and $16,974 per month for 24 months
(January 2004 - December 2005) to satisfy the delinquent tax liability.
Unpaid real estate taxes at December 31, 2002 and 2001 are included in accounts
payable and accrued expenses.
NOTE 6. LINES OF CREDIT
Lines of credit at December 31 are as follows:
30
2002 2001
---- --------
$351,000 revolving line of credit with an investment company, with interest at
3.15% over the 30-day commercial paper rate (4.9% at December 31, 2001). The
outstanding balance was repaid in January 2002. The agreement was terminated
in 2001. $ - $ 33,678
$700,000 line of credit agreement with prospective purchasers of MSR (see Note
15), with interest at 10%, scheduled to mature on March 15, 2002. Borrowings
under this line were repaid in full by MSR in April 2002 in connection with the
2002 financing and loan agreements (see Note 7). The agreement was effectively
cancelled upon the repayment. - 641,000
---- --------
$ - $674,678
==== ========
NOTE 7. LONG-TERM DEBT
Long-term debt is comprised as follows at December 31:
2002 2001
------------ ----------
(A) Note payable, All Capital, LLC $ 12,966,500 $ -
(B) through (F) Notes payable and other obligations repaid in 2002 - 5,113,257
(G) Capital lease obligations 321,894 397,942
------------ ----------
13,288,394 5,511,199
Current portion 113,569 96,110
------------ ----------
Long-term debt, net $ 13,174,825 $5,415,089
============ ==========
A description of significant long-term obligations at December 31, 2002 and 2001
is as follows:
Note Payable, All Capital, LLC
(A) In March 2002, MSR entered into a financing agreement with
Vernon, LLC (an unaffiliated company). Under the terms of the
financing agreement, MSR sold a $400,000 secured convertible
promissory note to Vernon, LLC that was scheduled to mature in
December 2003 with interest originally at 10% (amended to 15%
in April 2002). The financing agreement required MSR to create
an interest reserve account to hold the first year of interest
on the note. The agreement also required MSR to pay a
commitment and loan fee equal to 5% of the total note. Both
the fee and the first year interest reserve were funded by MSR
utilizing a portion of the note proceeds. The note was
initially convertible, at the option of Vernon, LLC, at any
time after August 1, 2002, into 40,000 shares of MSR common
stock at the rate of $10 per share and subject to certain
anti-dilution provisions outlined in the financing agreement.
The note was secured by a mortgage and security interest on
MSR property and was subordinate to the mortgages described in
(B) through (E). Additionally, the financing agreement
included a provision for tag along warrants. This provision
required MSR to distribute to note holders, who elected not to
convert the principal amount of the note into common stock,
warrants to purchase shares of common stock for a period of
three years. The financing agreement also granted Vernon, LLC
the right of first refusal with respect to any subsequent debt
and/or equity financings undertaken by MSR prior to December
31, 2003 and allowed Vernon, LLC to appoint up to two
Directors on MSR's Board. The financing agreement also
provided that if the exclusive option agreement (Note 15) was
approved by the shareholders that the note would be
immediately repaid and the number of shares issuable upon
conversion of the note (or the tag along warrants) would be
reduced to 10,000 shares.
In late March and early April of 2002, MSR and MSD entered into a
$8,500,000 loan agreement with All Capital, LLC, a company
affiliated with Vernon, LLC. The loan agreement was funded in
two installments and was secured by a first mortgage on MSR
and MSD land, buildings and improvements. The initial funding
provided $3,695,000 in funds to MSR to satisfy the $2,816,000
obligation to the bankruptcy trustee described in (F). The
second funding provided $4,805,000 in funds to MSR to repay
the first mortgage obligation described in (B) and the second
mortgage obligations described in (C), (D), and (E). The loan
agreement was scheduled to mature in March 2003 with interest
payable at 15%. The loan agreement provided MSR with the
option to extend the loan for up to four successive quarters
with a final maturity of March 31, 2004.
31
The loan agreement required MSR to create an interest reserve account
to hold the first year of interest on the loan. The interest
reserve was completely funded by a portion of the loan
proceeds. The loan agreement also required MSR to pay a
commitment and loan fee equal to 5% of the total loan. The
commitment and loan fee was paid by MSR using a portion of the
loan proceeds. On April 1, 2002, in connection with the loan
agreement, MSR issued a warrant to purchase 500,000 shares of
common stock at a rate of $2 per share to All Capital, LLC,
exercisable subsequent to August 1, 2002. In accordance with
the anti-dilution and other provisions of the $400,000 secured
convertible promissory note referred to above, the number of
shares which were issuable to Vernon, LLC upon conversion of
the $400,000 note was increased to 200,000 and the exercise
price upon conversion was reduced to $2 per share.
In the event that an exclusive option agreement (Note 15) was approved
by the shareholders (a) the $8,500,000 would be immediately
repayable (b) the warrant issued to All Capital, LLC would not
thereafter be exercisable, and (c) the number of shares
issuable upon conversion of the $400,000 secured convertible
note described above (or the tag along warrants) would be
reduced to 50,000 shares.
(A) CONTINUED All Capital, LLC was also granted the right in the
loan agreement to designate four members to the Board of
Directors of MSR. Consistent with a ruling of the New York
State Racing and Wagering Board, MSR, Vernon, LLC and All
Capital, LLC (and the latter's principal) executed an
undertaking not to place nominees on the Board of Directors or
participate in the management of MSR until the nominees and
the principal of All Capital, LLC were licensed. On July 2,
2002, the nominees and principal were licensed and were
subsequently seated as participating members of the Board of
Directors of MSR.
On July 16, 2002, MSR and MSD entered into a $1,000,000 Interim Loan
Agreement with All Capital, LLC. The loan agreement was funded
in one installment and was secured by a mortgage on MSR and
MSD land, buildings and improvements. Proceeds of this loan
were applied to the extent of $350,000 to the establishment of
a purse escrow account required by the New York State Racing
and Wagering Board as a condition to the maintenance of the
live racing and simulcast licenses; and as to the remainder,
to the short-term obligations and working capital requirements
of the Company. The loan bore interest at the rate of 15% per
annum and was scheduled to mature on July 15, 2003. The loan
agreement required MSR to create an interest reserve account
to hold the amount necessary to fund the payment of interest
over the term of the loan. The interest reserve was completely
funded by a portion of the loan proceeds. The loan agreement
also required MSR to pay a commitment and loan fee equal to 5%
of the loan; which fee was paid by MSR out of a portion of the
loan proceeds. On July 16, 2002 in connection with the loan
agreement, MSR issued a warrant to All Capital, LLC to
purchase 100,000 shares of common stock at the rate of $2.00
per share exercisable subsequent to August 1, 2002. The
issuance of this warrant did not trigger any of the
"anti-dilution" provisions of either the $400,000 Secured
Convertible Promissory Note or the warrant to purchase 500,000
shares of common stock previously granted to All Capital, LLC
in connection with the $8,500,000 loan. In the event the
exclusive option agreement (Note 15) was approved by the
shareholders the warrant to purchase 100,000 shares would not
thereafter be exercisable.
On August 28, 2002, MSR and MSD entered into a $15,000,000 Loan
Agreement with All Capital, LLC. The loan agreement was funded
in multiple installments and is secured by a first mortgage on
MSR and MSD land, buildings and improvements. The $12,500,000
proceeds of the first installment of this loan were applied to
the extent of (a) $9,900,000 to refinance and consolidate the
$400,000, $8,500,000 and $1,000,000 loans described above, and
(b) $2,600,000 for working capital and payment of the costs
associated with the loan. The remaining proceeds of the loan
in the amount of $2,500,000 were to be disbursed in connection
with and for the construction of facilities to be utilized for
the installation and operation of video lottery terminals. The
loan bore interest at the rate of 15% per annum and was
scheduled to mature on August 28, 2003. The loan agreement
required MSR to create an interest reserve account to hold the
amount necessary to fund the payment of interest over the
initial one year term of the loan. The interest reserve was
funded by a portion of the loan proceeds and a credit for the
unused balances of interest reserves maintained for the
$8,500,000 and $1,000,000 loans. The loan agreement also
required MSR to pay a commitment and loan fee equal to 5% of
the loan; which fee was paid by MSR out of a portion of the
loan proceeds. On August 28, 2002 in connection with the loan
agreement, MSR issued a warrant to All Capital, LLC to
purchase 900,000 shares of common stock at the rate of $2.00
per share. The issuance of this warrant did not trigger any of
the "anti-dilution" provisions of either the $400,000 Secured
Convertible Promissory Note or warrants to purchase 500,000
and 100,000 shares of common stock, respectively, previously
granted to All Capital, LLC described above. In the event the
exclusive option agreement (Note 15) was approved by the
shareholders the warrant to purchase 900,000 shares would not
thereafter be exercisable. Also, in connection with the
consolidation of four loans described above into one
$15,000,000 loan, the "tag along" warrant provisions of the
$400,000 Secured Convertible Promissory Note were triggered; a
"tag along" warrant to purchase 200,000 shares of common stock
at $2.00 was issued to All Capital, LLC and the conversion
rights to purchase a similar number of shares at a similar
price per share were terminated. Both prior to and after the
termination of such conversion rights and the issuance of the
"tag along warrant" All Capital, LLC had the right, upon
exercise of warrants and/or the conversion rights in the
$400,000 note to acquire 1,700,000 shares of common stock at
the rate of $2.00 per share. Under the terms of the loan
agreement, All Capital, LLC retained the right to designate
six members of the Board of Directors of MSR (and the right of
Vernon, LLC, an affiliate of All Capital, LLC to designate two
members
32
was terminated). The loan was in default at December 31, 2002
since the Company did not have a 2003 racing license at
December 31, 2002. The initial application for a 2003 racing
license was denied on December 23, 2002. A conditional 2003
racing license was subsequently granted to the Company in
April 2003.
Substantially all long-term debt at December 31, 2001 was classified as
long-term due to the August 2002 refinancing noted above.
As discussed in Note 19, in January and June 2003, the Company
refinanced substantially all of its debt (excluding capital
lease obligations). As a result of the refinancings, all debt
at December 31, 2002 is classified as long-term, excluding the
current portion of capital lease obligations.
Notes Payable and Other Obligations Repaid in 2002
(B) In May 1998, MSR obtained a $1,000,000 loan from a private
lender, who was also a board member. The loan was
collateralized by a first mortgage on MSR's racing plant,
buildings and improvements. In March 2000, MSR obtained an
additional loan from this private lender to finance the
purchase of equipment and food service inventory, valued at
$66,450. This additional loan was added to the $1,000,000
first mortgage. Additionally, $83,500 of the loan described in
(C) below came from this lender and was added to the first
mortgage agreement in 2000. The loans bore interest at 12% and
required monthly interest-only payments. No principal payments
were required until the final due date. This loan was
originally due May 15, 2001. In March 2001, the due date was
extended to May 15, 2002 in exchange for granting the private
lender a warrant to purchase 10,000 shares of MSR common stock
at $10 per share with an expiration date in March 2005. During
2001, MSR obtained an additional $500,000 loan from this
private lender. This amount was also added to the first
mortgage.
(C) In August 1999, MSR obtained $250,000 in loans from three
board members, one of whom was an officer. $83,500 of this
$250,000 loan came from the lender referred to in (B) above.
The loans bore interest at 12%, and were originally secured by
a second mortgage on MSR's racing plant, buildings, and
improvements. In 2000, $83,500 of the original $250,000 was
added to the first mortgage described in (B) above. The
remaining $166,500 remained secured by a junior mortgage and
was due in May 2001.
(D) In September 2000, MSR obtained a $300,000 loan from
another private lender, who was also a board member. The loan
was secured by a junior mortgage on MSR's racing plant,
buildings and improvements. The loan bore interest at 13% and
repayment was due in September 2001. No principal payments
were required until the final due date. In consideration for
making this loan to MSR, the lender was granted a warrant to
purchase 2,500 shares of MSR common stock at $10 per share
with an expiration date in August 2004. Additionally, in March
2001, in consideration for certain amendments made to this
loan, MSR granted this lender a warrant to purchase 2,700
shares of MSR common stock at $10 per share with an expiration
date in March 2005.
(E) In December 2000, MSR obtained a $250,000 loan from private
lenders, with interest originally at 6%, to be paid in the
form of MSR common stock. The note was secured by certain MSR
and subsidiary assets, including machinery, equipment, and
receivables. The note was originally scheduled to mature in
February 2001. In May 2001, the note was amended due to the
fact that MSR was in default under note terms. The amendment
extended the due date until August 15, 2001 and required the
payment of all accrued but unpaid interest on the note. In
September 2001, in connection with an irrevocable purchase
option agreement whereby MSR granted the lenders of this note
an option to purchase MSR (see Note 15), the note maturity was
extended to March 15, 2002, the expiration date of the
purchase option agreement. Additionally, the interest rate was
increased to 10% and the note was added to the junior
mortgages previously mentioned in (C) and (D), above.
(F) Liability approximating $2,750,000 at December 31, 2001
representing the present value of an obligation payable to a
third-party bankruptcy trustee in relation to a settlement
agreement between the trustee and MSR for the purchase of a
hotel located on MSR's land adjacent to its harness racing
track (see Note 13). The initial April 2000 settlement
agreement was amended in July 2001 and was formally approved
by the bankruptcy court in August 2001. The approved agreement
called for MSR to pay $2,816,000 to the bankruptcy trustee by
February 18, 2002 for the purchase of the hotel. For financial
reporting purposes, the $2,816,000 was discounted using an
incremental borrowing rate of 10% and the present value
discount is being treated as imputed interest.
The debt obligations described in (B), (C), (D), (E), and (F) above,
including all accrued interest thereon, were repaid in full in
March and April 2002, in connection with the 2002 financing
and loan agreements, as described in (A).
33
(G) Various capital leases for equipment with monthly payments
ranging from $95 to $2,168 including imputed interest from
6.9% to 24.5%. These leases mature at various dates through
2006.
At December 31, 2002, the cost of equipment acquired through capital
lease obligations totaled $583,197 and is included in land,
building, and equipment on the balance sheet. Accumulated
depreciation related to these assets totaled $242,233 at
December 31, 2002.
The following is a schedule by years of the future minimum lease
payments under capital leases, together with the present value
of the net minimum lease payments, as of December 31, 2002:
YEAR ENDING DECEMBER 31 AMOUNT
----------------------- ---------
2003 $ 137,759
2004 133,202
2005 68,053
2006 16,026
2007 11,042
---------
Total minimum lease payments 366,082
Less amount representing interest 44,188
---------
Present value of net minimum lease payments 321,894
Current maturities 113,569
---------
Capital lease obligation, net of current maturities $ 208,325
=========
NOTE 8. SUMMARIZED QUARTERLY DATA (UNAUDITED)
Following is a summary of the quarterly results of operations for years
ended December 31, 2001 and 2002:
FISCAL QUARTER
----------------------------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
2001
Net revenues $1,650,390 $ 2,217,027 $ 2,836,607 $ 1,795,341
Income from operations 26,052 (521,091) (469,915) (1,059,127)
Net income (29,390) (674,375) (413,677) (1,144,749)
Net income per share $ (0.07) $ (1.52) $ (0.93) $ (2.59)
2002
Net revenues $1,619,960 $ 2,407,606 $ 2,763,367 $ 1,891,292
Income from operations 125,122 (538,822) (553,248) (1,862,139)
Net income 7,047 (1,008,092) (1,519,700) (2,448,479)
Net income per share $ 0.02 $ (2.28) $ (3.43) $ (5.53)
NOTE 9. DEFERRED GRANT REVENUE
During 2001, MSR received $240,000 from Oneida County to mitigate costs
associated with live racing. The agreement required MSR to
continue live racing for a period of at least three years,
beginning in 2001. If at any time during the three year period
MSR
34
discontinues live racing, or breaches any other portion of the
agreement, a pro-rata share of the funds will be payable to
Oneida County. Approximately $80,000 was earned pursuant to
this grant during each of the years ending December 31, 2002
and 2001.
NOTE 10. INCOME TAXES
Net deferred tax assets are provided for the temporary differences bet
ween the tax bases of assets and liabilities and their
financial reporting amounts. The temporary differences that
give rise to a significant portion of the deferred tax
liability and deferred tax asset and their approximate tax
effect are as follows. The net deferred tax asset at December
31, 2002 and 2001 has been offset by an equivalent valuation
allowance because of uncertainty concerning MSR's ability to
utilize net operating loss carryforwards in future years.
DECEMBER 31
2002 2001
------------------------- -------------------------
TEMPORARY TEMPORARY
DIFFERENCE TAX EFFECT DIFFERENCE TAX EFFECT
----------- ----------- ----------- -----------
Net operating loss carryforwards $12,178,000 $ 4,141,000 $ 7,217,000 $ 2,454,000
Other 8,000 3,000 10,000 4,000
----------- ----------- ----------- -----------
12,186,000 4,144,000 7,227,000 2,458,000
Less valuation allowance - (4,144,000) - (2,458,000)
----------- ----------- ----------- -----------
$12,186,000 $ - $ 7,227,000 $ -
=========== =========== =========== ===========
The net operating loss carryforwards will expire at various dates from
December 31, 2009 through December 31, 2022. Utilization of
the net operating loss carryforwards may be limited due to the
ownership change provisions as enacted by the Tax Reform Act
of 1986 and subsequent legislation.
A reconciliation of the provision (benefit) for income taxes to the
statutory amount is as follows:
FOR THE YEAR ENDED DECEMBER 31
2002 2001 2000
------------------------- -------------------- -----------------
AMOUNT % AMOUNT % AMOUNT %
------------------------- -------------------- -----------------
Statutory federal income tax (benefit) $(1,687,000) (34.0) $(769,000) (34.0) $(629,000) (34.0)
Variances from statutory rate:
Add state income tax, net of federal
income tax benefit 1,200 0.1 2,756 0.1 708 0.1
Increase (decrease) in valuation allowance 1,687,000 34.0 743,200 32.9 255,400 13.6
Other - - 25,800 1.1 (3,200) (0.1)
----------- ---- --------- ---- --------- -----
Provision (benefit) for income taxes $ 1,200 0.1 $ 2,756 0.1 $(376,092) (20.4)
=========== ==== ========= ==== ========= =====
NOTE 11. LEASES
The Raceway leases equipment, including pari-mutuel totalisator
equipment and services, under numerous operating lease
agreements. Total lease rental expense for the years ended
December 31, 2002, 2001, and 2000 amounted to $337,545,
$400,227, and $432,220 of which $275,000, $265,000, and
$275,400 was paid on the totalisator contract for the
respective years.
35
The totalisator operating lease agreement expires in 2004. Under the
agreement, MSR is charged a flat fee for the equipment and
services plus an additional amount that is dependent upon
wager volume. Future minimum rental charges under operating
lease agreements are as follows as of December 31, 2002:
TOTALISATOR
EQUIPMENT
---------
2003 $ 285,000
2004 295,000
---------
$ 580,000
=========
NOTE 12. INVESTMENT INCOME
Investment income (loss) consisted of the following for the years ended December
31:
2002 2001 2000
---- ---- ----
Interest and dividends $ 6,150 $ 33,299 $ 30,772
Other (22,904) (9,817) (4,529)
--------- -------- --------
$ (16,754) $ 23,482 $ 26,243
========= ======== ========
NOTE 13. PRIVATE PLACEMENT AND COMMON STOCK WARRANTS
During 1999, MSR privately placed 150,000 shares of common stock, for the
aggregate amount of $1,500,000 computed at the rate of $10 per share.
In connection with such private placement, MSR, in November 1999
executed and delivered a common stock warrant ("PP Warrant") to two
individuals who were officers and directors of MSR. The PP Warrant
entitled the holders to purchase not less than 150,000 nor more than
175,000 shares of common stock at the rate of $10 per share at any time
prior to November 15, 2000. The PP Warrant was not exercised and
expired in accordance with its terms on November 15, 2000. On November
14, 2000, the Board of Directors authorized the issuance: (i) to each
of the holders of the PP Warrant, a common stock warrant to purchase up
to 87,500 shares of common stock at the rate of $10 per share at any
time prior to November 14, 2004; and (ii) to another member of the
Board of Directors a common stock warrant to purchase up to 7,500
shares of common stock at the rate of $10 per share at any time prior
to November 14, 2004. Stockholder consent with respect to these three
common stock warrants has not been secured. As discussed in Note 7(D),
in September 2000, MSR granted another board member a common stock
warrant to purchase up to 2,500 shares of common stock at the rate of
$10 per share at any time prior to August 31, 2004. Additionally,
during March 2001, as discussed in Notes 7(B) and 7(D), the Board of
Directors authorized the issuance to two members of the Board of
Directors common stock warrants to purchase 10,000 and 2,700 shares of
common stock, respectively, at the rate of $10 per share at any time
prior to March 19, 2005. All of the resolutions with respect to the six
warrants described above were silent as to "anti-dilution" protection,
and MSR has neither executed nor delivered any of such common stock
warrants.
36
As described in Note 7(A), in connection with various 2002 loan transactions,
the Company granted warrants to purchase a total of 1,700,000 shares of
MSR common stock at $2 per share to the creditors associated with the
2002 loan transactions.
A summary of common stock warrants authorized by the Board of Directors as of
December 31, 2002 is as follows:
NUMBER OF EXERCISE AUTHORIZED
STOCK PRICE EXPIRATION
ISSUE DATE WARRANTS PER SHARE DATE
---------- -------- --------- ----
November 14, 2000 182,500 $ 10 November 14, 2004
September 1, 2000 2,500 $ 10 August 31, 2004
March 19, 2001 10,000 $ 10 March 19, 2005
March 19, 2001 2,700 $ 10 March 19, 2005
April 1, 2002 500,000 $ 2 March 31, 2007
July 16, 2002 100,000 $ 2 July 31, 2007
August 28, 2002 1,100,000 $ 2 August 31, 2007
========= ======= =================
Substantially all of the November 14, 2000 warrants are subject to litigation as
described in Note 19. No value has been ascribed to the warrant
issuances.
NOTE 14. HOTEL ACQUISITION
During fiscal year 1994, MSR, as lessor, entered into a lease agreement with
Comfort Associates, Inc. ("CAI"), a company affiliated with MSR's
former majority shareholder. MSR, as lessor, leased, for an initial
period of twenty years, a certain portion of their property for the
purpose of permitting CAI, as lessee, to construct, own, and operate a
hotel. Construction of the hotel by CAI was completed in October 1994.
Anytime during the lease or any renewal period of the lease, MSR could
have elected to terminate the lease and assume all of CAI's duties,
obligations, rights, and responsibilities under the lease for a nominal
amount. Lease payments during the initial twenty year period were
$10,000 per year. In May 2000, the lease was terminated, and MSR
purchased all of the issued and outstanding shares of stock of CAI for
$5,510, plus an additional $48,000 acquisition fee.
An investigation conducted by the bankruptcy trustee of the bankrupt companies
affiliated with MSR's former majority shareholder revealed that the
aforementioned hotel constructed, owned, and operated by CAI was built
by funds fraudulently transferred from the bankrupt companies
affiliated with MSR's former majority shareholder. The trustee
subsequently filed suit against CAI for any and all ownership interests
in the hotel.
Pursuant to an original April 11, 2000 settlement agreement between the trustee
and MSR that was later amended on July 30, 2001 and formally approved
by the bankruptcy court in August 2001, MSR turned over the issued and
outstanding stock of CAI to the trustee and acquired the hotel from the
trustee. The agreement called for MSR to pay the trustee $2,816,000
(the fair market value of the hotel less $184,000 in unpaid real estate
taxes) by February 18, 2002 (see Note 7(F)). It was also the
responsibility of MSR to pay the $184,000 of unpaid real estate taxes
on the hotel (see Note 5).
37
The purchase method of accounting was used to account for the May 2000 hotel
acquisition, and the purchase price was allocated as follows:
Property and equipment $ 2,611,000
Current assets 89,000
Liabilities assumed (345,000)
Debt incurred (2,355,000)
-----------
$ -
===========
The accompanying financial statements include the operations of the hotel,
beginning in June 2000.
When MSR purchased the issued and outstanding stock of CAI in May 2000, it
agreed to personally indemnify CAI's former sole stockholder for any
liability that stockholder may have had with respect to a franchise
agreement for the hotel. Subsequent to the stock transaction in May
2000, the stockholder was sued by the franchisor for damages
approximating $560,000. The stockholder answered the complaint,
notified MSR of the claim, and requested indemnification if the suit is
successful. Although MSR believes that the lawsuit will most likely not
be successful, the ultimate outcome is not presently determinable.
Consequently, no provision for a possible unfavorable outcome is
included in these financial statements.
During 2000, the aforementioned bankruptcy trustee questioned payments of
approximately $136,000 made by CAI to MSR, while MSR was operating the
hotel from May 20, 2000 to June 22, 2000 for rent, water, and sewer
charges. In September 2000, MSR provided financial information to the
trustee relating to these expenses. While MSR believes the matter to be
resolved, the trustee has not yet indicated that the matter is closed.
MSR operates pari-mutuel wagering on the hotel premises. Net pari-mutuel
commissions and breakage from wagering on these premises approximated
$447,000 for the year ended December 31, 2002; $497,000 for the year
ended December 31, 2001, and $481,000 for the year ended December 31,
2000.
NOTE 15. OTHER RELATED PARTY TRANSACTIONS
In 2002, 2001, and 2000, MSR paid approximately $59,000, $131,000, and $232,000,
respectively, to related parties for consulting services, lodging, and
interest, including amounts attributable to long-term debt (Note 7).
In December 2002, in order to induce the NYS Racing and Wagering Board (the
"Board') to issue a license to its President and CEO, the Company
advanced approximately $67,000 in the form of a security deposit to a
third party for the benefit of its President and CEO. Upon the
satisfaction by the President and CEO of the provisions of a certain
undertaking given to the Board, the advance will be returned to MSR.
Should the advance be applied to the benefit of the President and CEO
it will, at that time, be treated as additional compensation.
A Company owned by MSR's President and CEO has a consulting agreement with MSR
to provide VLT consulting services to MSR in exchange for monthly
payments of $6,500 through March 2004.
38
NOTE 16. PURCHASE OPTION AGREEMENT
On September 12, 2001, MSR's Board of Directors authorized its President and
Chief Executive Officer to execute an exclusive option agreement for
the sale of MSR to a group of private purchasers. This group of
purchasers includes one of the private lenders described in Note 7(E).
The exclusive option agreement was formally executed on September 15,
2001 and granted the purchasers an exclusive irrevocable option to
acquire MSR (or its assets) for $9,077,350 at any time prior to March
15, 2002. If exercised, the exclusive option agreement called for the
purchasers to pay off all MSR debt and payables and pay $1,400,000 to
existing MSR shareholders. The $1,400,000 payment to the shareholders
was subject to adjustment based upon the debt outstanding at the
exercise closing date. Accordingly, the $1,400,000 could increase or
decrease as a result of this adjustment. The option agreement was
subject to the approval of MSR's shareholders holding at least 66 2/3%
of the outstanding common stock and the New York State Racing and
Wagering Board.
In 2002, MSR's Board of Director's authorized the extension of the exclusive
option agreement until MSR shareholders have voted on the agreement. A
MSR shareholder vote on this agreement was not scheduled, since as of
March 15, 2002 (a) the debt and payables of MSR were in excess of
$9,077,350 and consequently the shareholders of MSR would have received
no payment in connection with the exercise of the exclusive option
agreement and would not, in all likelihood, have approved of the
transaction, and (b) as the holders of more than 33 1/3% of the issued
and outstanding common stock had indicated their unwillingness to
approve the exclusive option agreement, it was unlikely that
shareholder approval of the exclusive option agreement could be
secured.
If the exclusive option agreement is not approved by MSR's shareholders, MSR may
be required to pay the purchasers a one-time payment of $130,000.
Additionally, if the exclusive option agreement is not approved by
MSR's shareholders or not exercised by the purchasers, the agreement
requires that the loan described in Note 7(E) be repaid along with all
accrued interest thereon. As indicated in Note 7, the full amount of
such loan, and all accrued interest, was repaid in April 2002.
Concurrent with the execution of the exclusive option agreement, the purchasers
provided a $700,000 working capital line of credit to MSR with interest
at 10%, secured by a second mortgage on MSR's buildings and
improvements, due March 15, 2002 (see Note 6).
The full balance drawn by MSR under this line of credit ($700,000) was repaid in
April 2002 in connection with the 2002 financing and loan arrangements
described in Note 7(A). In June 2002, management notified the group of
purchasers that the aforementioned exclusive purchase option agreement
was terminated and of no further force and effect. As a result of the
termination of the option agreement by MSR, the aforementioned $130,000
termination has been recorded as a liability in the December 31, 2002
and 2001 balance sheets (see also Note 17).
NOTE 17. PURSE FUND AGREEMENT
MSR annually enters into agreements with the Harness Horse Association of
Central New York (the "Association") to establish purse funding levels
for harness meetings at MSR. In November 2001, MSR and the Association
entered into an agreement that established MSR's 2002 purse funding at
approximately $2,650,000, including approximately $553,000 in
underfunded purses
39
carried forward from years prior to 2002. Actual purses and fees paid
by MSR in 2002 approximated $2,155,000.
In April 2003, MSR and the Association entered into an agreement that
established MSR's 2003 purse funding based upon a formula defined in
the agreement plus underfunded purses from years prior to 2003 and net
horsemen statutory VLT revenues. As a condition of the agreement, MSR
established a "Designated Account" to provide for the payment and
liquidation of previously unpaid prior purses in the approximate amount
of $495,000. Unfunded prior purses were recorded as purse expenses in
2002.
NOTE 18. COMMITMENTS AND CONTINGENCIES
LETTER OF CREDIT
At December 31, 2002, the Company had a $100,000 letter of credit related to a
pari-mutuel surety bond.
2002 RACING AND SIMULCAST LICENSES
On April 8, 2002, the New York State Racing and Wagering Board (the Board)
issued MSR a 90-day limited period harness racing license for the 2002
racing season. The license expired on July 6, 2002 and was conditional
upon numerous factors involving the 2002 financing and loan agreements
referred to above. Extension of the 2002 license past the July 6, 2002
expiration date was dependent upon, among other things, the individual
licensability, under Board laws and regulations, of the principals
involved in the 2002 financing and loan agreements (see Note 7(A)). On
July 2, 2002, the Board voted to extend MSR's limited period track and
simulcast license through December 31, 2002. As a condition of the
license extension, MSR was required to create a segregated escrow
account to ensure the payment of purses to horsemen.
VIDEO LOTTERY TERMINAL (VLT) LEGISLATION
In 2001, the New York State Legislature approved VLT legislation to allow for
the installation and operation of VLT's at New York State harness race
tracks. MSR is currently working with the New York State Lottery
Commission on implementation of the activities allowed by the VLT
legislation. MSR has been initially authorized to install 1,000 VLT's
on its premises.
As a result of this legislation, MSR was named as a defendant in two separate
lawsuits challenging the legality of the legislation and the operation
of VLT's at harness race tracks. The outcome of these lawsuits is not
presently determinable.
OTHER
In March 1998, MSR voted to terminate its unfunded deferred compensation plan.
At December 31, 1999, there was a $1,013,861 liability recorded in
MSR's consolidated balance sheet related to this plan. Subsequent to
this termination, a lawsuit was brought against MSR by beneficiaries of
the deferred compensation plan challenging the plan's termination and
seeking damages of
40
$1,200,000. The lawsuit was settled in 2000 with the beneficiaries
receiving 4,380 shares of stock, valued for financial reporting
purposes at $10 per share, in full settlement of their claim. The gain
on this settlement, of approximately $970,000, is recognized as an
extraordinary item in the December 31, 2000 consolidated statement of
operations, net of applicable income taxes of $376,800.
LITIGATION
In July 2002, MSR (along with certain MSR directors, Vernon, LLC, All Capital,
LLC, and its principal) was named as a defendant in a lawsuit filed by
the group of private purchasers referred to in Note 15. The lawsuit
alleges bad faith and breach of contract against MSR and seeks not less
than $30 million in damages from MSR plus interest. The lawsuit also
alleges fraud by certain MSR directors and seeks damages from those
defendants to be determined at trial plus legal fees. In addition, the
lawsuit alleges tortious interference with contract by certain MSR
directors, Vernon, LLC, All Capital, LLC, and its principal and seeks
$30 million in damages from those defendants plus interest. The outcome
of this lawsuit is not presently determinable and, as such, no
provision for any unfavorable outcome that may arise from this
litigation has been included in the financial statements.
On December 3, 2002, MSR was served with a summons and complaint from one former
Board member and a current member of the Board seeking, inter alia,
monetary damages in the amount of $10 million and/or the issuance of
warrants to acquire up to 175,000 shares with a strike price of $10 per
share that would enable the plaintiffs to acquire such additional
common stock upon payment of $1.75 million, such shares allegedly to
have anti-dilution protection for their combined interests of 39.9%
(see Note 12), the issuance of 21,600 additional shares of common stock
(see Note 17, Anti-Dilution Stock), and the issuance of additional
warrants with a strike price of $5.00 per share to enable each of them
to maintain his present 17.19% interest in the future and other
declaratory, equitable, and monetary relief. The issuance of these
shares and warrants have not been approved by the shareholders. The
Company believes that it has valid defenses to the lawsuit, and intends
to seek dismissal of the case. Additionally, MSR has filed
counterclaims against these individuals.
On November 19, 2003 John Signorelli, a former officer of the Company and two
other stockholders (one of whom owns 200 recently acquired shares of
Common Stock) commenced an action in U.S. District Court for the
Southern District of New York against the Company, certain of its
directors and others seeking damages for alleged fraud, violations of
fiduciary duties and "looting". The Company believes that it has valid
defenses to this action and intends to vigorously defend it. The
Company filed a motion to dismiss on December 30, 2003. A hearing of
the Company's motion, scheduled for January 22, 2004, was adjourned to
February 12, 2004 to be heard before Judge Miriam Cedarbaum in New York
City.
MSR is a defendant in various other litigation matters arising from its
operations. No estimate can yet be made of the potential liability or
damages, or the likely outcome of the litigation. Management believes
that liabilities resulting from these lawsuits, if any, will be
immaterial or will be completely covered by insurance policies.
DELINQUENT SECURITIES AND EXCHANGE COMMISSION (SEC) FILINGS
41
MSR is delinquent in filing a number of periodic reports, including annual and
quarterly financial information, required to be filed with the SEC. The
consequences of the Company's failure to file these reports and the
actions, if any, that the SEC might initiate against the Company in
this connection, are not presently determinable.
ANTI-DILUTION STOCK
On January 11, 2001, the Board of Directors of MSR authorized the issuance of a
total of 24,840 shares of common stock to four individual shareholders
(three of whom were board members and two of whom were officers of MSR)
in an effort to prevent the dilution of such shareholders' ownership
interest in MSR, which includes 21,600 shares that are subject to
pending litigation (see Note 17, Litigation). These anti-dilution
shares of common stock were never issued by MSR. Due to the fact that
these shares were authorized without consideration on the part of the
shareholders, legal counsel for MSR has advised that any such issuance
would not be valid. Further, since the stock certificates were not
issued to the shareholders for the shares in question, legal counsel
believes that MSR does not need to take any action to rescind the
authorization for the issuance of such shares. On December 17, 2001 the
Board of Directors clarified the minutes of the January 11, 2001
meeting to state the 24,840 shares of common stock will be issued for
past services to MSR. However, issuance of the stock is subject to
approval by the shareholders, by Board resolution. No amounts have been
recognized in this connection for the years ended December 31, 2002 or
2001.
DELINQUENT REAL ESTATE TAXES
As explained in Note 5, MSR is subject to an agreement covering delinquent real
estate taxes with Oneida County.
NOTE 19. SUBSEQUENT EVENTS
JANUARY 2003 REFINANCING
On January 29, 2003, MSR and MSD entered into a $18,000,000 Loan Agreement with
All Capital, LLC. The loan agreement is secured by a first mortgage on
MSR and MSD land, buildings, and improvements and is also secured by
the personal property of MSR and MSD. The $18,000,000 proceeds of this
loan were applied to the extent of (a) $11,903,831 to refinance and
consolidate the $15,000,000 loan (see Note 7(A)), and (b) $3,689,169
for payment of loan commitment fees, a one year interest reserve, and
payment of the costs associated with the loan. The remaining proceeds
of the loan in the amount of $2,407,000 are to be disbursed for working
capital and in connection with and for the partial funding of
construction of facilities to be utilized for the installation and
operation of video lottery terminals. The loan bears interest at the
rate of 12% per annum and matures on July 31, 2004. The loan can be
extended by MSR for up to four successive quarters, until July 30,
2005, subject to the payment of applicable extension fees. The loan
agreement required MSR to create an interest reserve account to hold
the amount necessary to fund the payment of interest over the initial
one year term of the loan. The interest reserve was funded by a portion
of the loan proceeds and a credit for the unused balances of interest
reserve maintained for the $15,000,000 loan. The loan agreement also
required MSR to pay a commitment and loan fee equal to 8% of the loan;
which fee was paid by MSR out of a
42
potion of the loan proceeds. Additionally, in the event of VLT
installation at MSR, the loan agreement requires the Company to pay All
Capital, LLC the greater of 2% gross or 6% net VLT revenues earned by
MSR through the term of the loan in exchange for management services
subject to the terms of a separate management agreement between All
Capital, LLC and MSR.
JUNE 2003 REFINANCING
On June 30, 2003, the MSR and MSD (collectively the "Borrower") entered into a
Loan Agreement (the "Loan Agreement") with Vestin Mortgage, Inc. (a
Nevada corporation) pursuant to which Vestin Mortgage, Inc. ("Vestin")
agreed to lend to the Borrower up to $23,000,000 (the "Vestin Loan").
The Vestin Loan is evidenced by a Consolidated Secured Promissory Note
(the "note") in the original principal amount of $23,000,000 and is
secured by (a) a first mortgage encumbering all of the real property
and improvements thereon owned by the Borrowers and (b) a first
priority security interest in all of the personal property of the
Borrower. Additionally, the owner of All Capital LLC has agreed to
guarantee the payment of all interest (other than default interest) and
principal payments due under the note until such time as video lottery
terminals ("VLTs") are installed and operating at Vernon Downs
Racetrack.
The primary terms of the Vestin Loan (as set forth in the Loan Agreement and the
note) are as follows:
A. Amount of loan - $23,000,000;
B. Term of loan - 24 months;
C. Maturity date - June 30, 2005;
D. Loan commitment fees - $1,840,000;
E. Interest reserve - $1,686,667; and
F. Additional Vestin rights - the right to designate
three members to the Board of Directors of the
applicant (not as of the date hereof exercised by
Vestin).
On June 30, 2003, Vestin advanced $20,300,000 pursuant to the terms of the Loan
Agreement and the note. Such proceeds were applied as follows: (a)
$15,834,485 to All Capital LLC ("All Capital") in satisfaction of the
Borrowers obligation to All Capital pursuant to a certain $18,000,000
Consolidated Secured Promissory Note dated January 29, 2003 (which
promissory note was assigned to Vestin); (b) $1,686,667 to the interest
reserve; (c) $1,840,000 to the payment of loan commitment fees; (d)
$150,000 to the payment of closing costs, and (e) $788,848 to working
capital of the applicant. An additional $2,700,000 of loan proceeds may
be subsequently drawn down by the Borrower in connection with the
construction of a facility to house the VLTs.
By agreement dated June 30, 2003, Vestin sold a $3,000,000 junior participation
in the Vestin Loan, the note (and the proceeds thereof) and the loan
documents evidencing and/or securing the Vestin Loan and the note (the
"Junior Participation") to All Capital LLC. Payments of interest and
principal on or with respect to the Junior Participation are junior and
subordinate to the payment to Vestin of interest and principal on or
with respect to Vestin's retained senior participation (the "Senior
Participation") in and to the Vestin Loan, the note and the loan
documents evidencing
43
and/or securing the Vestin Loan and the note. By agreement dated June
30, 2003, Vestin sold an undivided interest in its Senior Participation
to Owens Mortgage Investment Fund, a California general partnership
("Owens"); and thereafter, on July 9, 2003, repurchased such undivided
interest from Owens.
NOTE 20. 2003 RACING AND SIMULCAST LICENSES
In December 2002, the New York State Racing and Wagering Board (the Board)
denied MSR's application for 2003 racing and simulcast licenses. The
Board's determination with respect to MSR's 2003 licenses was stayed by
court order. 2003 license negotiations between MSR and the Board
continued through the first quarter of 2003. In April 2003, MSR and the
Board entered into a stipulation and settlement (the Agreement) which
effectively granted MSR conditional racing and simulcast licenses for
the 2003 racing season. The Agreement requires that MSR and an
associate of MSR's major creditor complete new applications for
licenses, that the Board act upon the applications in a timely period
and that the associate be subject to a background investigation by the
Board.
Concurrent with the Agreement, MSR and the associate entered into a separate
agreement whereby the associate agreed to cooperate with the Board's
investigation. MSR agreed to reimburse the associate for all reasonable
costs associated with complying with the Board's investigation. In
addition, as additional consideration, MSR agreed to pay an incentive
fee of $280,000 to the associate over a 28 month period commencing May
2003. Also, in April 2003, in connection with the agreement, MSR
granted the associate a warrant to purchase 23,300 shares of MSR common
stock at a price of $8.58 per share. The warrant expires on April 8,
2008.
NOTE 21. FINANCIAL CONDITION AND MANAGEMENT PLANS
As of September 2003, the Company had a working capital deficit of $1,351,757,
and $2,700,000 in available financing from existing loan agreements to
fund the VLT construction. Losses for the nine month period ended
September 30, 2003 approximated $5,500,000 and net cash used in
operating activities for the period approximated $6,800,000. Management
expects to require approximately $500,000 per month to cover expected
net operating losses on average until the estimated April 1, 2004
opening date of the VLT facility. Subsequent to September 30, 2003, the
Company secured an additional $3,000,000 through an amendment to the
Vestin loan. Additionally, the Company received $900,000 in proceeds
from the issuance of stock as a result of exercised warrants. Based on
the above, which is prepared by management and unaudited, management
expects to have funds sufficient to operate the Company through the
anticipated April VLT opening date.
The Company expects to be profitable when the VLT's are in full operation.
Circumstances that could affect the opening date and the amount of net
revenue that will be ultimately realized from the VLT project include
(i) the timing and number of machines installed, and (ii) approval by
the New York State Lottery of a license for the Company and the
approval by the New York Racing and Wagering board for the track's
racing license.
Although the actual amount of net revenues will ultimately depend on the number
of visitors to the new casino and the amount bet by such visitors, a
preliminary independent study indicates that the Company could receive
over $4.5 million per year in additional income from the VLT project
before the payment of interest, taxes, depreciation, or amortization.
Subsequent to the
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completion of the preliminary study (a) the number of VLT machines was
increased from 650 to 1,000, (b) the daily hours of operation were
increased from 12 to 16 hours and (c) the portion of VLT revenues to be
retained by the Company was increased from 15% to 20 1/4%.
Consequently, it is anticipated that the amount to be received by the
Company will be approximately $7.1 million.
There are no assurances that the VLT project will be successfully implemented or
that revenue projections will be met. Furthermore, the future success
of the Company is dependent on the successful resolution of the various
lawsuits, contingencies and contingent liabilities discussed in Note 19
and filed since then.
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