UNITED STATES

**SECURITIES AND EXCHANGE COMMISSION**

Washington, D. C. 20549 

 

**FORM 10-KSB/A**

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE

SECURITIES EXCHANGE ACT OF 1934 

 

For the fiscal year ended

December 31, 2005

 

*Commission File Number:  000-30771*

 

**INTERACTIVE MOTORSPORTS AND**

**ENTERTAINMENT CORP.**

f.k.a. Pacific International Holding, Inc.

 (Exact name of registrant as specified in charter) 

 

Indiana

(State or other jurisdiction of incorporation or organization) 

 

35-2205637

(I.R.S. Employer I.D. No.) 

 

5624 West 73rd Street, Indianapolis, Indiana 46278

(Address of principal executive offices)

 

(317) 295-3500

(Registrant’s telephone number, including area code)

 

Indicate by checkmark whether the Issuer: (1) filed all reports required to be filed by section 13 or 15 (d) of the Exchange Act during the past 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. (1) Yes x No [] (2) Yes x No []

 

Issuer’s Revenues for its most recent fiscal year: $4,838,988 

 

As of March 22, 2006, the aggregate market value of the voting stock held by non-affiliates of the Issuer, 44,220,406 shares, was $1,768,816. The market value of Common Stock of the Issuer, par value $0.0001 per share, was computed by reference to the average of the closing bid and asked prices of one share on such date which was $0.04. 

 

The number of shares of the issuer’s Common Stock, par value $0.0001 issued and outstanding as of March 22, 2006, was 93,769,177.

 

Exhibit Index located on Page 59

 

1

**INDEX TO ANNUAL REPORT ON FORM 10-KSB**

 

 

PAGE

NUMBER

SECTION

 

| NOTE ON FORWARD-LOOKING INFORMATION | 3 |
|-------------------------------------|---|

| BASIS OF PRESENTATION | 4 |
|-----------------------|---|

 

 

**PART I**

 

| ITEM 1. | Description of Business | 5 |
|---------|-------------------------|---|

| ITEM 2. | Description of Properties | 11 |
|---------|---------------------------|----|

| ITEM 3. | Legal Proceedings | 11 |
|---------|-------------------|----|

| ITEM 4. | Submission of Matters to a Vote of Security Holders | 11 |
|---------|-----------------------------------------------------|----|

 

 

**PART II**

 

| ITEM 5. | Market for Common Equity and Related Stockholder Matters | 12 |
|---------|----------------------------------------------------------|----|

| ITEM 6. | Management’s Discussion and Analysis of Financial Conditions and Results of Operations | 14 |
|---------|---------------------------------------------------------------------------------------------|----|

| ITEM 7. | Financial Statements and Notes to Financial Statements |
|---------|--------------------------------------------------------|

|   | Report of Independent Registered Public Accounting Firm | 24 |
|--------|---------------------------------------------------------|----|

|   | Consolidated Balance Sheet at December 31, 2005 | 25 |
|--------|-------------------------------------------------|----|

|   | Consolidated Statements of Operations for the Years Ended |
|--------|-----------------------------------------------------------|

|   | December 31, 2005 and December 31, 2004 | 27 |
|--------|-----------------------------------------|----|

|   | Consolidated Statements of Changes in Shareholders’ Equity |
|--------|-----------------------------------------------------------------|

|   | for the Years Ended December 31, 2005 and December 31, 2004 | 28 |
|--------|-------------------------------------------------------------|----|

|   | Consolidated Statements of Cash Flows for the Year Ended |
|--------|----------------------------------------------------------|

|   | December 31, 2005 and December 31, 2004 | 29 |
|--------|-----------------------------------------|----|

|   | Notes to Consolidated Financial Statements | 31 |
|--------|--------------------------------------------|----|

| ITEM 8. | Changes In and Disagreements With Accountants on Accounting and Financial Disclosure | 49 |
|---------|--------------------------------------------------------------------------------------|----|

| ITEM 8A. | Controls and Procedures | 50 |
|----------|-------------------------|----|

 

 

**PART III**

 

| ITEM 9. | Directors, Executive Officers, Promoters and Control Persons | 50 |
|---------|--------------------------------------------------------------|----|

| ITEM 10. | Executive Compensation | 52 |
|----------|------------------------|----|

| ITEM 11. | Security Ownership of Certain Beneficial Owners and Management | 53 |
|----------|----------------------------------------------------------------|----|

| ITEM 12. | Certain Relationships and Related Transactions | 54 |
|----------|------------------------------------------------|----|

| ITEM 13. | Exhibits and Reports on Form 8-K | 55 |
|----------|----------------------------------|----|

| ITEM 14. | Principal Accountant Fees and Services | 56 |
|----------|----------------------------------------|----|

 

| SIGNATURES | 58 |
|------------|----|

 

| EXHIBITS INDEX | 59 |
|----------------|----|

 

 

2

 

**NOTE ON FORWARD-LOOKING INFORMATION**

 

This Form 10-KSB/A and other statements issued or made from time to time by the Company or its representatives contain statements, which may constitute “forward-looking statements” within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995, 15 U.S.C.A Sections 77z-2 and 78u-5. Those statements include statements regarding the intent, belief, or current expectations of the Company and members of its management team as well as the assumptions on which such statements are based. All statements, trend analyses, and other information contained in this report relative to markets for the Company’s products and/or trends in the Company’s operations or financial results, as well as other statements which include words such as “anticipate(s),” “could,” “feel(s),”“believes,” “plan,” “estimate(s),” “expect(s),” “should,” “intend(s),” “will,” and other similar expressions, constitute forward-looking statements and are subject to known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things: (i) general economic conditions that may impact the disposable income and spending habits of consumers; (ii) the availability of alternative entertainment for consumers; (iii) the ability of the Company to obtain additional capital; (iv) the receipt of a going concern opinion from the Company’s independent public accountants; and (v) the ability of the Company to control costs and execute its business plan.

 

The reader is cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth herein. The Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. 

 

 

3

 

**BASIS OF PRESENTATION**

 

Effective August 2, 2002, Pacific International Holding, Inc., a Utah corporation (“PIH”), which was originally organized in 1986, changed its state of domicile and name by merging with and into Interactive Motorsports and Entertainment Corp. (the surviving entity), an Indiana corporation (the “Company”), pursuant to an Agreement and Plan of Reorganization. Per the merger agreement, each share of PIH common stock outstanding immediately prior to the effective date of the merger was cancelled and converted into four shares of Interactive Motorsports and Entertainment Corp. common stock. Although it had been in a variety of businesses for over 15 years, at the time of the merger, PIH had limited operations.

 

Subsequent to the merger and effective as of the same date, the Company acquired pursuant to a Plan and Agreement of Exchange all of the issued and outstanding shares of common stock and preferred stock of Perfect Line, Inc., an Indiana corporation (“Perfect Line”), from the Perfect Line shareholders in exchange on a “share-for-share” basis for shares of the Company’s common stock and preferred stock. As a result of the share exchange, the Perfect Line shareholders held as of August 2, 2002 Company shares representing approximately eighty-two percent (82%) of the Company’s capital stock. Also effective as of August 2, 2002, the members of the Board of Directors of Perfect Line were elected to replace the members of the Company’s Board of Directors and the executive officers of Perfect Line became the executive officers of the Company. 

 

As Perfect Line had revenues, operations, and business activity, for financial reporting purposes, Perfect Line is considered the acquirer, and therefore the predecessor, and the Company is considered the acquiree for accounting and reporting purposes. Due to the fact that the merger is being treated as a reverse acquisition, the equity of the Company has been recapitalized for financial reporting purposes. The operations of Interactive Motorsports and Entertainment Corp. have been included in consolidation from August 2, 2002 until December 31, 2005.

 

All information in this Form 10-KSB/A is presented from the perspective of Interactive Motorsports and Entertainment Corp. and its subsidiary Perfect Line and not from the perspective of PIH.

 

 

 

4

 

**PART I**

 

**ITEM 1. DESCRIPTION OF BUSINESS** 

 

**Overview**

 

Interactive Motorsports and Entertainment Corp. (“IMTS” or the “Company”), an Indiana corporation, through its wholly owned subsidiary, Perfect Line, Inc., is a world leader in race simulation.  The Company is in the business of manufacturing and then selling, revenue sharing or leasing race car simulators to contracted parties in malls, amusement parks, family entertainment centers, casinos and auto malls and mobile fan interactive experiences. Under licenses from America’s fastest growing sport, NASCAR, simulator customers experience driving in a NASCAR race car that simulates the motion, sights and sounds of an actual NASCAR event.  The Company owns and operates NASCAR Silicon Motor Speedway racing centers at the Mall of America in Minneapolis, MN, and at Universal CityWalk in Hollywood, CA, where racing on 12 simulators and NASCAR merchandise are sold at each site.

 

The Company currently has two versions of race car simulators, the SMS and the Reactor, and in marketing these two products it leverages its strategic relationships and proprietary assets, which include (a) sophisticated racing simulation technology (including 2 patents), (b) an exclusive licensing agreement with NASCAR, and (c) license agreements with other racing entities including race tracks, race teams, and race sponsors to offer a unique and affordable race simulation experience. 

 

For the year ended December 31, 2005, the Company’s racing centers, leased and revenue share simulators and sold simulators generated revenue of approximately $5.414 million. Management has transitioned the Company’s business model from an owned and operated, mall-based racing center concept to a simulator purchase, revenue share or leasing business, with the owner of the purchased simulators required to enter into an ongoing license and maintenance agreement.  The Company now offers two simulator products, both using the proprietary software and motion platform, but each offering different features and different price points.  The Company plans to offer territories for operators of its new Reactor Mobile Experience (48 foot trailer with 4 Reactors installed).

 

Major Agreements:  During 2005, the Company entered into lease and revenue share agreements as well as entered into transactions for the sale of the original (“SMS”) simulators and the new Reactor and Reactor Mobile Experience simulators.  On December 31, the Company entered into an asset purchase agreement and long term note agreement with Checker Flag Lightning whereby the 28 simulators within three Mills Corporation mall stores were sold in exchange for the Mills releasing Perfect Line of all past, current and future obligations 

 

 

5

Perfect Line’s race simulators, including those owned by Race Car Simulation Corp., are currently featured in the following locations.  

 

**Locations**

 

***Company Owned (24 Simulators):***

 

| ***Location*****              | ***Market*****  | ***Sq. Ft.***** | ***Simulators***** |
|-------------------------------|-----------------|-----------------|--------------------|
| ***1)***   Mall of America    | Minneapolis, MN | 5,899           | 12 SMS             |
| ***2)***   Universal CityWalk | Los Angeles, CA | 5,000           | 12 SMS             |

 

 

***Revenue Share (72 Simulators):***

 

| ***Location*****                        | ***Market*****    | ***Sq. Ft.***** | ***Simulators***** |
|-----------------------------------------|-------------------|-----------------|--------------------|
| ***1)***   Mall of Georgia              | Atlanta, GA       | 5,895           | 8 SMS              |
| ***2)***   Riverchase Galleria          | Birmingham, AL    | 6,188           | 8 SMS              |
| ***3)***  Jordan Creek Town Ctr         | Des Moines, IA    | 4,000           | 8 SMS              |
| ***4)***   NASCAR SpeedPark             | Sevierville, TN   | 1,584           | 6 SMS#             |
| ***5)***  NASCAR SpeedPark              | St. Louis, MO     | 1,496           | 6 SMS#             |
| ***6)***  NASCAR SpeedPark              | Toronto, Canada   | 1,500           | 6 SMS#             |
| ***7)***  NASCAR SpeedPark              | Myrtle Beach, SC  | 1,600           | 6 SMS#             |
| ***8)***  Playcenter (b)                | Sao Paulo, Brazil | 1,000           | 4 SMS*             |
| ***9)***  Burdick Driver’s Village | Syracuse, NY      | 3,472           | 8 SMS#             |
| ***10)*** Bass Pro Outdoor              | Harrisburg, PA    | 500             | 2 SMS              |
| ***11)*** Bass Pro Outdoor              | Clarksville, IN   | 750             | 3 SMS              |
| ***12)*** University Mall               | Burlington, VT    | 3,700           | 5 SMS              |
| ***13)*** Bass Pro Outdoor (a)          | Springfield, MO   | 500             | 2 SMS              |

 

 

|   | a. | Scheduled to open Q2 |
|--------|----|----------------------|

|   | b. | Scheduled to open TBD |
|--------|----|-----------------------|

 

***Mobile Units (16 Simulators):***

 

| ***1)***   Nextel Mobile Experience    | 2004-06 NASCAR Nextel Cup series events | 6 SMS# |
|----------------------------------------|-----------------------------------------|--------|
| ***2)***   Perfect Line/NTI Experience | Mobile Experience                       | 2 SMS  |
| ***3)***   Nextel Mini Experiences     | Nextel regional marketing               | 6 SMS# |
| ***4)***  DaimlerChrysler              | European Auto Shows                     | 2 SMS  |

 

 

 

6

***Sales of Simulators (74 Simulators):***

 

| ***Buyer*****                   | ***Market*****             | ***Simulators***** |
|---------------------------------|----------------------------|--------------------|
| ***1)***   Roltex               | Moscow, Russian Federation | 8 SMS*             |
| ***2)***   Tonne Mgmt.          | Wisconsin Dells, WI        | 4 SMS*             |
| ***3)***   Ft. Gordon           | Ft. Gordon, GA             | 2 SMS              |
| ***4)***   I-Vision Tech.       | Abu Dhabi, UAE             | 4 SMS              |
| ***5)***   I-Vision Tech.       | Abu Dhabi, UAE             | 2 SMS              |
| ***6)***  Fun City              | Burlington, IA             | 1 SMS*             |
| ***7)***  DaimlerChrysler       | US Auto Shows in 2006      | 2 SMS*             |
| ***8)***  NASCAR SpeedPark      | Concord, NC                | 4 Reactors*        |
| ***9)***  Opry Mills            | Nashville, TN              | 10 SMS             |
| ***10)*** Gurnee Mills          | Chicago, IL                | 6 SMS              |
| ***11)*** Concord Mills         | Charlotte, NC              | 12 SMS             |
| ***12)*** H&H Motorsports   | Boone, NC                  | 4 Reactors         |
| ***13)*** Gate A Sports         | Cleveland, OH              | 5 SMS              |
| ***14)*** Skycoaster of Florida | Kissimmee, FL              | 6 SMS              |
| ***15)*** Vacationland F.E.     | Brainerd, MN               | 4 SMS*             |

 

 

# Denotes assets sold to Race Car Simulation Corporation with no current revenue stream to Company

* Denotes that simulators are not yet installed

 

The balance of the 192 SMS simulators built since inception are at the Company’s warehouse or Elan Motorsports Technologies where they are built.

 

**Pricing**

 

In a typical racing center, an individual race typically costs $8.50-$9.00 and quantity discounts are offered with purchases of multiple races. Customers pay an average of $25 per hour to use a simulator during leagues and competitions. Depending on the program or package, the targeted yield for group sales averages between $300 and $800 per hour for the use of the entire racing center.  Prices of merchandise range from $16 for a hat up to $200 for high-end leather jackets.  Prices for the die-cast and collectable cars range between $15 and $65.  The Company’s owned locations provide the only means to generate revenues from merchandise sales.  The Company does not receive any payments from the revenue share sites for merchandise sales.

 

In revenue share locations, the revenue share partner provides the space and the labor, and the Company provides the simulators and the license to use the software that operates the simulators.  The revenue share split varies, but is usually in the range of 60-65% to revenue share partner, and 35-40% to Company.  The Company typically requires a minimum guarantee per simulator of $20,000-$25,000 per year for the SMS simulator, and lower minimums are expected for the new Reactor simulators.

 

Lease agreements are typically one year flat fees, and the pricing depends upon the number of uses per year.  

 

Pricing for the sale of simulators varies between the age and usage of the simulators.  A new SMS sold domestically is priced at $95,000, and refurbished SMS simulators sold domestically range from $65,000-$80,000.  International sales can be 20-30% higher due to the added work that is required for use in other markets.

 

 

7

**History**

 

NSMS racing centers were originally owned and developed by Silicon Entertainment, Inc. (“SEI”).  SEI opened its first site in August 1997 at the Mall of America in Bloomington, Minnesota, the largest mall in the United States.  SEI raised large sums of initial capital, of which, according to SEI internal documents, approximately $6.5 million was utilized to create its proprietary software technology and approximately $25 million was utilized to produce approximately 170 SMS simulators and complete the build-out of 15 stores in high traffic malls. SEI was unable to secure additional long term financing to support its capital expansion, and was liquidated through Chapter 7 bankruptcy in April 2001. Perfect Line’s assets were primarily acquired from creditors of SEI. As a result of SEI’s bankruptcy, Perfect Line was able to purchase the assets of SEI at a price substantially below SEI’s cost. 

 

Perfect Line, LLC, a predecessor to Perfect Line, Inc., initially tested the mall-based business model by re-opening 12 of the SEI racing centers, which utilized 136 of the SMS simulators, between July 2001 and August 2002.  The Company then warehoused 32 SMS simulators for future deployment and 2 SMS simulators were used for research and development purposes at the Company’s technology center in Santa Clara, California. The proprietary technology includes two U.S. Patents, which combine to create what management believes to be one of the world’s most realistic simulations of the sights, sounds and motions experienced by driving in an actual NASCAR race. The patented motion-based platform that the racecar simulator is mounted on is among the other assets that were acquired and licensed as part of the SEI asset purchase.

 

In August 2002, Perfect Line became a wholly owned subsidiary of IMTS, through an exchange of shares that resulted in Perfect Line shareholders owning approximately 82% of IMTS equity.  Simultaneous with this event, approximately $2.6 million in private equity financing was made available to Perfect Line.  Approximately one-half of the funding was used to retire the Company’s bank note and the balance was used for working capital.  

 

In July of 2003, management began the process of revising the Company’s business model, changing the focus from the inherited Company owned and operated mall-based racing centers to revenue share, lease and purchased simulators for mall merchandise retailers, family entertainment centers, amusement parks, casinos, auto malls, etc. and mobile lease programs such as the Nextel Experience and the DaimlerChrysler auto show exhibits.  After testing the assignment of one mall lease to Checker Flag Lightning (“CFL”) of Granville, Michigan in November of 2003, the Company assigned an additional six (6) mall leases to CFL in March of 2004.  The business model change resulted in the Company’s first quarterly operating profit for the quarter ending September 30, 2004, and first quarterly net profit for the quarter ended December 31, 2004.  

 

While the Company was beginning to earn profits by late 2004, management decided it was necessary to generate cash to reduce debt and secure growth capital   As a result, on December 31, 2004 and on March 31 and April 15, 2005, the Company entered into three  Asset Purchase Agreements pursuant to which it sold a total of forty-four (44) of its existing race car simulators in revenue producing sites to Race Car Simulation Corporation (“RCSC”), a wholly owned subsidiary of Dolphin Direct Equity Partners, LP (“Dolphin”) for an aggregate purchase price of $2,856,600.  While these transactions reduced debt and allowed the Company to begin building new simulators, it also reduced cash flow by approximately $1,000,000 on an annual basis until the Company could activate another 44 simulators into the market on a revenue share basis.  This, coupled with the fact that Checker Flag Lightningstopped paying on its revenue share agreements (approximately $1,000,000 annually) created cash flow issues for the Company during 2005.  The sale of SMS simulators during this period helped to offset the cash flow problem.

 

 

8

**The Company’s Current Operations, Recent Developments and Plan for the Future**

 

The Company’s goal is to be the world leader in experiential simulation. The Company is initially leveraging its internationally unique, proprietary race car simulation technology with domestic focus on the NASCAR experience. The Company believes that this can be done profitably through a combination of owned and operated racing centers, third party revenue share locations (family entertainment centers, amusement parks, casinos, auto malls, etc.), mobile unit sales and  leases and the domestic and international sales of its race simulator products.  

 

NASCAR racing is currently the #1 spectator sport in America. The Company has an exclusive license agreement with NASCAR for location-based entertainment, which includes the right to use the NASCAR name within the Silicon Motor Speedway logo, on racing center signage, within collateral sales materials, on the NSMS web site, and within the NSMS racing simulator software. The Company has also secured licenses with many popular racetracks in the United States, and the cars driven by many of the race fans’ favorite Nextel Cup teams and drivers, ranging from established stars such as Dale Earnhardt, Jr., Tony Stewart and Jeff Gordon, to rising stars like Kasey Kahne and Jimmie Johnson. These licensing agreements and the use of NASCAR related identities and marks provide immediate name recognition, credibility, and authenticity to the experience.

 

The Company has integrated these license agreements with sophisticated proprietary racing simulator technology to create one of the world’s leading race car simulations.  Simulator races take place on famous NASCAR Nextel Cup racetracks such as Daytona International Speedway, Indianapolis Motor Speedway, Lowe’s (Charlotte) Motor Speedway, Atlanta Motor Speedway, Bristol Motor Speedway, and Richmond International Raceway.

 

The Company first tested the revenue share business model with the Burroughs and Chapin Company of Myrtle Beach, South Carolina, by installing 6 simulators at their Smokey Mountain NASCAR SpeedPark in April of 2003  Revenue share locations provide the Company the opportunity to install simulators in existing or planned entertainment venues and share proportionately in the sales generated with owner-operators. The Company provides the simulators at cost (expected to be financed through a third party leasing firm, although no agreements have been reached) and the host organization (owner-operator) provides the space, required site build-out, and day-to-day operations staffing. Minimum revenues are typically guaranteed to the Company within the revenue share agreements.

 

At the 2004 Daytona 500, Nextel debuted The Nextel Experience, a mobile fan interactive experience that features six of the Company’s race simulators.  The Nextel Experience continues to have a prominent location at each of the NASCAR Nextel Cup events.  Nextel is also leasing an additional three mini mobile experiences that they use for promotional events around the country, each featuring two of the Company’s simulators. The Company also has sold and leased simulators to DaimlerChrysler for their domestic and international trade show exhibits, and the Dodge division takes 2 of the Companies simulators to selected NASCAR events.

 

 

9

In November of 2005, the Company introduced a prototype of the new Reactor simulator at the International Association of Amusement Parks and Attractions (IAAPA) convention in Atlanta.  The Reactor features a smaller footprint (5 feet wide and 7.5 feet long) allowing for more simulators per square foot and thus greater throughput per hour.  The Reactor is also on casters and collapses to a 3 foot wide unit so that it can be rolled into conference rooms, retail locations, race suites, trade shows, etc.  Using the same software and game experience as in the SMS simulators, the Company reduced the size of the patented motion platform for the Reactor and reduced the number of projectors from three to two.  The Reactor can be plugged into standard 110 power, and does not require 3 phase power as does the SMS.  Both the lease price and purchase price of the Reactor are substantially lower than the SMS.  Managementbelieves that the combination of greater mobility, portability and lower price points will broaden the market for simulator purchases and leases, although there can be no assurances.  

 

In February of 2006, the first Reactor Mobile Experience was introduced at Daytona Beach, Florida surrounding the Daytona 500 events.  Four Reactor simulators were installed into a 48 foot Featherlite car trailer that can be towed by a 2-ton pickup truck.   Under a newly developed License, Maintenance and Operating (“LMO”) agreement, management is now seeking operators for Reactor Mobile Experiences within specific territories around the country. Under terms of the LMO agreement, the Company administers the event contracts, and pays the operator a percentage of the revenues from event bookings and sponsorships associated with the events.  Management believes that taking this relatively low cost experience to large crowds (sporting events, trade shows, festivals, etc.) and to corporate retail sites (big box retailers, restaurants, auto dealers, etc.)  is an attractive business model for futuregrowth, although there can be no assurance. 

 

At December 31, 2005, the Company had built 21 new SMS simulators, and an additional 30 SMS simulators had been refurbished at Elan.  Subsequent to December 31, 2005, the Company has built or is in the process of building 8 Reactor simulators, 4 of which have been installed in a Reactor Mobile Experience.  

 

The Company has made several technological improvements to the simulation in recent years, resulting in an enhanced racing experience.  Two popular racetracks, Bristol and Indianapolis, were introduced to the simulation experience late in 2002 and early in 2003.  *MySpeedway* was introduced in 2003 on IMTS’s website (www.smsonline.com) that allows customers to find their recent lap times, and analyze their results to improve their performance by comparing their times to those of other racers throughout the country.  Car parameters were also introduced in 2003 allowing racers to set up their cars to their personal preferences. Adjustable parameters include traction control, anti-lock brakes, spoiler angle, steering ratio, front anti-roll bar, engine, transmission gearing, and rear end ratio.  The operating systemhas been updated to a Linux platform, and beginning in 2006 is available as an upgrade to race simulator operators.  The new operating system is incorporated in the new Reactor simulators, and will be incorporated into all future SMS simulators.  The new platform allows for each simulator to operate on one computer as compared to six, and allows for improved graphics and game features as they are introduced in the future.  New and improved projector technology has also been designed into all future SMS and Reactor simulators.

 

Management is currently discussing with potential customers the opportunity to expand its patented motion platform to full size passenger vehicles, and creating customized experiences for each vehicle.  This opportunity will likely begin with trade show experiences, and then grow to local markets from there, although there can be no assurance.   

 

 

10

**ITEM 2. DESCRIPTION OF PROPERTIES**

 

The Company is headquartered at 5624 West 73rd Street in Indianapolis, Indiana where the Company leases approximately 4,800 square feet. The facility consists primarily of office and storage areas and is leased from an unrelated third party. The headquarters’ lease expires September 14, 2006. The Company also maintains an engineering office at 2065 Martin Avenue in Santa Clara, California where it leases approximately 1,800 square feet of office space. The engineering office is currently a month-to-month lease.****In addition, the Company has a warehouse in Concord, North Carolina that is also currently on a month-to-month lease.****The Company believes its headquarters and engineering space is adequate for the present time and is reviewing options for relocating or extending its leases at these locations.

 

The two NASCAR Silicon Motor Speedway racing centers owned and operated by the Company are: 

 

|  

**Location** |  

**Market**      | **Square****Footage** |
|----------------------|-------------------------|-----------------------|
|                 |                    |                  |
| Mall of America      | Minneapolis, Minnesota  | 5,899                 |
| Universal CityWalk   | Los Angeles, California | 5,067                 |
|                 |                    |                  |

 

 

**ITEM 3. LEGAL PROCEEDINGS** 

 

From time to time, the Company may be party to various legal actions and complaints arising in the ordinary course of business.  While waiting for a response to a payment plan proposed by Perfect Line to the Mall of America landlord (MOAC Mall Holdings, LLC), Perfect Line received an eviction summons from the landlord on February 16, 2006.  Perfect Line has since contacted the landlord and the parties have agreed to terms for a stipulation agreement whereby Perfect Line will sign a promissory note totaling $294,642 payable in five (5) quarterly installments, the first of which has already been paid.  The agreement and note are being drafted and are expected to be signed by the end of March, 2006.  As of the filing of this Annual Report on Form 10-KSB, the Company is not aware of any other material legal actions directed against the Company.  

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS** 

 

None, not applicable.

 

 

 

11

 

**PART II**

 

**ITEM 5. MARKET FOR COMMON EQUITY; RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES**

 

**Dividend Policy**

 

To date, the Company has not paid dividends on its common stock. The payment of dividends, if any, is within the discretion of the Board and will depend upon the Company’s earnings, capital requirements and financial condition, and other relevant factors. The Board does not intend to declare any dividends in the foreseeable future.

 

**Holders of Record**

 

As of March 22, 2006 there were approximately 296 holders of record of our Common Stock consisting of 93,769,177 shares issued and outstanding. The number of holders of record was calculated by reference to reports from the Company’s stock transfer agent.

 

**Share Price History**

 

The Company’s common stock (the “Common Stock”) has traded on the over-the-counter market in what is commonly referred to as the “OTC Bulletin Board” or the “OTCBB” under the trading symbol “IMTS” since August 14, 2002. The following table sets forth the high and low bid prices of the Common Stock for the periods indicated. The price information contained in the table was obtained from the OTCBB web site and other sources we consider reliable. Note that such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and the quotations may not necessarily represent actual transactions. 

 

|               | **Common Stock Price** |
|--------------------|------------------------|
| **Quarter Ended**  | **High**               | **Low** | **Close** |
|               |                   |   |   |
| March 31, 2004     | .24                    | .09 | .10 |
| June 30, 2004      | .14                    | .05 | .07 |
| September 30, 2004 | .07                    | .04 | .05 |
| December 31, 2004  | .09                    | .05 | .07 |
| March 31, 2005     | .12                    | .05 | .06 |
| June 30, 2005      | .09                    | .06 | .07 |
| September 30, 2005 | .07                    | .03 | .04 |
| December 31, 2005  | .04                    | .02 | .02 |

 

 

 

12

**Issuance of Securities**

 

In connection with the Company’s merger with and into PIH on August 2, 2002, a total of 11,300,000 shares of Interactive Motorsports and Entertainment Corp. common stock were issued to shareholders of PIH in exchange for their shares of common stock of that company. 

 

On August 2, 2002, 4,745,456 shares of the Company’s Preferred Stock were issued for cash consideration of $2,610,050.  The Convertible Preferred Stock was all converted to common stock, with 2,472,728 shares of Convertible Preferred Stock converted to 12,724,183 shares of common stock in 2003, and 2,272,728 shares of Convertible Preferred Stock were converted to 11,363,640 shares of common stock in 2004.

 

In 2003, a total of 140,000 shares of common stock were issued under a Form S-8 filed on February 13, 2003 for consulting services. 

 

On March 7, 2003, the Company entered into a short term financial agreement whereby the Company borrowed $700,000 for working capital purposes.  The Agreement also involved the issuance of warrants for 2,941,176 common shares.  The warrants had a strike price of $0.17, and expired on June 30, 2004.  

 

In 2004, a total of 935,726 shares of common stock were issued per the terms of the 2003 Bridge Notes.

 

In 2004, a total of 260,000 shares of common stock were issued for services rendered.

 

In 2004, a total of 842,361 shares of common stock were issued for payment of prior year accruals under the 2003 Bridge Notes.

 

Between February and June, 2004, the Company sold a series of notes collectively referred to as the 2004 Note and Option Purchase Agreement in the total amount of $750,000.  The Agreement also involved the issuance of options for approximately 6,904,395 common shares.  The options had a strike price equal to the closing price of IMTS stock on the date the note was purchased, which ranged from $.08 to $.21 per share.  2,804,395 of the options expired on March 1, 2005, and 4,100,000 options were exercised for repayment of the note per the terms of the 2004 Note and Option Purchase Agreement.

 

On December 31, 2004, the Company entered into an Asset Purchase Agreement pursuant to which it sold thirty-four (34) of its existing race car simulators to Race Car Simulation Corporation (“RCS”), a wholly owned subsidiary of Dolphin Direct Equity Partners, LP (“Dolphin”).  The Sale is accounted for as a borrowing in accordance with the guidance provided in paragraphs 21-22 of SFAS 13.  The transaction also included the sale of warrants to Dolphin for the purchase of 5,161,500 shares of common stock.  The warrants have a strike price of $.10 per share, and expire on 12/31/2009.  The transaction also required the payment of $84,000 and the issuance of warrants for 150,000 shares of common stock to Northeast Securities for their services in the transaction.   The warrants also have a strike price of $.10 per share, and expire on 12/31/2009.  At December 31, 2005, none of these warrantshad been exercised.

 

 

13

On March 31, 2005, the Company entered into an Asset Purchase Agreement pursuant to which it sold four (4) of its existing race car simulators to Race Car Simulation Corporation (“RCS”), a wholly owned subsidiary of Dolphin Direct Equity Partners, LP (“Dolphin”).  The Sale is accounted for as a borrowing in accordance with the guidance provided in paragraphs 21-22 of SFAS 13.  The transaction also included the sale of warrants to Dolphin for the purchase of 1,080,000 shares of common stock.  The warrants have a strike price of $.10 per share, and expire on 3/31/2010.  At December 31, 2005, none of these warrants had been exercised.

 

On April 15, 2005, the Company entered into an Asset Purchase Agreement pursuant to which it sold six (6) of its existing race car simulators to Race Car Simulation Corporation (“RCS”), a wholly owned subsidiary of Dolphin Direct Equity Partners, LP (“Dolphin”).  The Sale is accounted for as a borrowing in accordance with the guidance provided in paragraphs 21-22 of SFAS 13.  The transaction also included the sale of warrants to Dolphin for the purchase of 900,000 shares of common stock.  The warrants have a strike price of $.10 per share, and expire on 4/15/2010.  At December 31, 2005, none of these warrants had been exercised.

 

In 2005, a total of 953,267 shares of common stock were issued per the terms of the 2003 Bridge Notes.

 

In 2005, a total of 1,000,000 shares of common stock were issued for services rendered.

 

In 2005, a total of 4,100,000 shares of common stock were issued upon conversion of 2004 Note and Option Purchase Agreement.

 

**ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** 

 

The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of the consolidated results of operations and financial condition of the Company. The terms “Company”, “we”, “our” or “us” are used in this discussion to refer to Interactive Motorsports and Entertainment Corp. along with Interactive Motorsports and Entertainment Corp.’s wholly owned subsidiary, Perfect Line, Inc., on a consolidated basis, except where the context clearly indicates otherwise. The discussion and information that follows concerns the Registrant as it exists today, as of this filing, including the predecessor of the Company’s operations, Perfect Line, LLC. This discussion and analysis does not relate to the operations of Pacific International Holding, Inc. which had limited operations prior to the merger with the Company onAugust 2, 2002.

 

**Overview**

 

The Company generated its first quarterly operating profit in the third quarter of 2004, and its first quarterly net profit in the fourth quarter of 2005.  Since inception on May 31, 2001 and through December 31, 2005, the Company has accumulated aggregate losses totaling $(8,765,148), which includes the net loss of $(1,095,074) for the twelve months ended December 31, 2005, the net loss of $(1,235,419) for the twelve months ended December 31, 2004, and the net loss of $(6,434,655) for the period from inception to December 31, 2003. 

 

 

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The Company has funded its retained losses through the initial investment of $650,000 in May 2001, $400,000 of capital contributed in February 2002, approximately $2.6 million received in August 2002 from the sale of Preferred Stock, $700,000 borrowed in March 2003, $604,000 in net proceeds borrowed between February 2004 and June 2004, $1.257 million received in the form of deposits for the placement of race car simulators in revenue share locations, or for the future purchase by third parties of racecar simulators, and $769,147 by delaying payments to its vendors.  See further discussion under “Liquidity and Capital Resources” and “Risk Factors” below.

 

During the twelve months ended December 31, 2005, the Company had total revenues of $4,838,988 compared to $5,769,104 for the twelve months ended December 31, 2004.  The 16 % decrease in revenue is due primarily to the final implementation of the Company’s revised business model during 2005.  All but two of the Company store locations at December 31, 2005 had been converted to Checker Flag Lightning, Inc. revenue share locations, or closed as part of the Company’s ongoing strategy of extricating itself from long-term leases.  Revenue share and leasing revenue was primarily impacted by the sale of 44 revenue producing simulators at the end of 2004 and early 2005.  Revenue was further impacted by the non-payment of revenue share income by the Checker Flag organization.  This resulted in the Company experiencing cash flow shortages sufficient to hamper its ability to replenish its stock ofmerchandise inventory and also to replace the simulators sold, and the associated revenue, with new revenue producing simulators in new locations.

 

**Review of Consolidated Financial Position**

 

**Cash and Cash Equivalents**: The Company had $353,180 in cash as of December 31, 2005 compared with $1,334,673 at December 31, 2004, a decrease of $981,493.  This decrease in cash for the year ended December 31, 2005 relates principally to the December 31, 2004, and March and April 2005 sale of a total of 44 simulators and its associated reduction of $1,000,000 in annual revenue share and lease payments.  Also impacting cash was the net repayment of $431,500 in loans, the default of Checker Flag Lightning in the payment of its revenue share payments, and the $389,384 of investment in new revenue share locations.

 

**Trade Accounts Receivable**: The balance at December 31, 2004 of $428,726 decreased by $216,570 in 2005 to  $212,156.  Trade accounts receivable is primarily revenue share and credit card receivables.  The decrease is attributable to the reserve the Company established due to the default of Checker Flag Lightning in the payment of its revenue share payments.

 

**Inventory:** At December 31, 2005, inventory of $208,453 consisted of merchandise inventory of $7,763 and simulator inventory of $200,690.  In addition, the inventory has a very conservative $5,000 reserve against it.  Merchandise inventory decreased by $19,536 from December 31, 2004 due primarily to the conversion of company store sites to revenue share sites, thus reducing the outlets from which the Company sells merchandise from nine to two.  Merchandise inventory was also the victim of priorities as the Company sought to make maximum use of its tight cash flow by deploying all available cash toward new revenue share and sales opportunities.  At December 31, 2005 simulator inventory available for placement in new revenue share sites, or available for sale, totaled three new simulators and nine refurbished simulators resulting from our agreement with Elan Motorsports Technologies.

 

 

15

**Accounts Payable:**The balance of accounts payable of $925,761 at December 31, 2005 represents an increase of  $506,946 from the balance at December 31, 2004 of $418,815.  This increase is primarily attributable to the cash flow shortfalls the Company experienced resulting in the Company’s reliance on trade credit to help fund its operations.  

 

**Accrued Liabilities:**The balance at December 31, 2004 of $1,158,929 decreased by $779,109 in 2005 to $379,820 due primarily to sale of simulators located in the Mills Corporation malls to Checker Flag Lightning.  The sale eradicated $571,000 of back rent due the Mills Corporation.  Also driving the decrease was the reduction of accruals for warranty expenses on sold simulators, as the one year warranty on a number of sold simulators either expired. or reduced to a sharing of warranty related expenses., 

 

**Notes Payable:** On March 7, 2003, the Company entered into a short term financial agreement (the Secured Bridge Notes) whereby the Company borrowed $700,000 for working capital purposes.  The Agreement also involved the issuance of warrants for 2,941,176 common shares.  The warrants had a strike price of $0.17, and expired on June 30, 2004.  

 

Two of the four Secured Bridge Notes continue to maintain a balance totaling $650,000, of which a net $100,000 in new funds were advance in 2005.  One of the four Secured Bridge Notes dated March, 2003 was paid in full in 2004, and another of the notes, along with an additional Company obligation, was transferred to a third party controlled by a major Company shareholder and rolled into the 2004 Note and Option Purchase Agreement described below.

 

Between February and June, 2004, the Company sold a series of notes collectively referred to as the 2004 Note and Option Purchase Agreement in the total amount of $750,000.  These notes generated $604,000 in cash, while $146,000 of the notes were the result of a transfer to a third party controlled by a major Company shareholder of a prior company obligation under the Secured Bridge Notes described above.  The Agreement also involved the issuance of options for approximately 6,904,395 common shares.  The options had a strike price equal to the closing price of IMTS stock on the date the note was purchased, which ranged from $.08 to $.21 per share.  2,804,395 of the options expired on March 1, 2005, while the remaining 4,100,000 options were exercised for repayment of the Note per the terms of the 2004 Note and Option Purchase Agreement.

 

On December 31, 2004, March 31, 2005 and April 15, 2005, the Company entered into an Asset Purchase Agreement pursuant to which it sold forty-four (44) of its existing race car simulators to Race Car Simulation Corporation (“RCS”), a wholly owned subsidiary of Dolphin Direct Equity Partners, LP (“Dolphin”).  The Sale is accounted for as a borrowing in accordance with the guidance provided in paragraphs 21-22 of SFAS 13.  The transaction also required the payment of $105,000 and the issuance of warrants for 5,161,500 shares of common stock to Northeast Securities for their services in the transaction.  The warrants have a strike price of $.10 per share, and expire on 04/30/2010.  Using the Black Schoales valuation model, the Company determined the value of these warrants to be $287,308, $47,123 and $39,269, respectively, assuming a risk-free interest rate of 3.95% over a period of fiveyears.  The warrants also have a strike price of $.10 per share, and expire on 04/30/2010.  At December 31, 2005, none of these warrants had been exercised.

 

**Other Liabilities:**Accrued payroll and payroll taxes, sales taxes payable, unearned revenue, and other accrued expenses fluctuate with the volume of business, timing of payments, and the day of the week on which the period ends. At December 31, 2005, the payroll accrual was approximately two weeks payroll. Gift certificates at December 31, 2005 decreased by $20,264 compared to December 2004. This decrease can be attributed to the reduction in the number of company locations from which gift certificates are sold and redeemed.  

 

 

16

**Review of Consolidated Results of Operations**

 

Sales for the twelve months ended December 31, 2005 were $930,116 lower than for the 12 month period ending December 31, 2004 due primarily to the final implementation of the Company’s revised business model during 2005.  All but two of the Company store locations at December 31, 2003 have been converted to Checker Flag Lightning, Inc. revenue share locations, or closed as part of the Company’s ongoing strategy of extricating itself from long-term leases.  Revenue share and leasing revenue was primarily impacted by the sale of 34 revenue producing simulators at the end of 2004.  Revenue was further impacted by the non-payment of revenue share income by the Checker Flag organization,  This resulted in the Company experiencing cash flow shortages sufficient to hampered its ability to replenish its stock of merchandise inventory, and also impacted the Company’s ability to replace the simulatorssold, and the associated revenue, with new revenue producing simulators in new locations.  

 

The resultant reduction in revenue from store sites and revenue share locations was offset in part by sales of simulators to third party operators.  During 2005, the company recorded the sale or partial sale of 45 simulators in 6 transactions totaling approximately $1.5 million, as compared to the approximately $1.4 million generated by the sale of 38 simulators in 2 transactions in 2004.

 

Operating expenses for the year ended December 31, 2005 declined by approximately 21% from the period ending December 31, 2004.  These expenses represented approximately 101% of net sales and approximately 108% for the comparable period in 2004.  Final implementation of the Company’s revised business model resulted in a reduction in operating expenses of approximately $1.3 million, with reductions occurring primarily in payroll of $0.9 million  and occupancy costs of $0.4 million. as the Company either converted company owned stores to revenue share locations, or closed locations with sub-par performance. 

 

Additionally, interest expense increased by approximately $101,410 as the Company paid off the 2004 notes in the first quarter of 2005.  Additionally, most of the values of the warrants associated with the 2004 notes were amortized in 2004, thus increasing interest expense in that year.

 

EBITDA of $(122,124) for the period ending December 31, 2005 decreased as compared to EBITDA of $(386,567) for the period ending December 31, 2004.  This decline in performance is directly attributable to the size of the loss generated by the Company in 2005 as compared to 2004.

 

**Qualitative and Quantitative Disclosures of Market Risk**

 

The fair value of the assets and liabilities comprising the Company’s condensed consolidated balance sheet are not subject to an inordinate amount of market risk. The term market risk refers to the risk of loss arising from adverse changes in interest rates and other relevant market rates and prices. The Company’s primary assets are the racing simulators and the software that runs them. As such, the Company does not believe it has any significant exposure to market risk, as defined. 

 

 

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**Critical Accounting Policies**

 

The Company’s critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the Notes to Consolidated Financial Statements for the year ended December 31, 2005 included in Item **7** in this Form 10-KSB/A. The Company has consistently applied these policies in the year ended December 31, 2005. Management does not believe that operations to date have involved uncertainty of accounting treatment, subjective judgment, or estimates, to any significant degree.

 

**Internal Controls**

 

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, management has reviewed the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) as of a date within 90 days prior to this annual report (the “Evaluation Date”). Management believes that such disclosure controls and procedures as of the Evaluation Date were adequate to ensure that employees and others with material information relating to the Company make that information known to management. To management’s knowledge, there were no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the Evaluation Date. 

 

**Liquidity and Capital Resources**

 

The various sources of funds available to the Company are receipts from revenue share sites, payments on leased simulators, receipts collected on the sale of simulator assets, deposits collected on future sales or revenue share sites, and from customers in our company owned stores for simulator rides and merchandise sales, proceeds from equity offerings including the $2,610,050 received in August 2002, loans from related parties including net proceeds of $687,500 received in March, 2003, and net proceeds received between February 2004 and June 2004 totaling $604,000, $122,500 in loan proceeds form the sale of the 2005 Notes between October and November, 2005, credit extended by vendors, and possible future financings. 

 

In July of 2003, management revised the Company’s business model, changing the focus from Company owned and operated mall-based racing centers to revenue share racing centers (mall merchandise retailers, family entertainment centers, amusement parks, casinos, auto malls, etc.) and mobile lease programs such as the Nextel Experience, and simulator purchases.  Without the burden of occupancy costs and labor costs, the Company realized its  first quarterly operating profit for the quarter ending September 30, 2004, and its first quarterly net profit for the quarter ended December 31, 2004.  

 

On December 31, 2004, and again on March 31 and April 15, 2005, the Company entered into an Asset Purchase Agreements pursuant to which it sold a total of forty-four (44) of its race car simulators to Race Car Simulation Corporation (“RCSC”), a wholly owned subsidiary of Dolphin Direct Equity Partners, LP (“Dolphin”) for an aggregate purchase price of $2,856,600. The Sale is accounted for as a borrowing in accordance with the guidance provided in paragraphs 21-22 of SFAS 13.  

 

 

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During the year ended December 31, 2005, the operating activities of the Company used net cash of $991,750 compared to net used of $724,053 for the comparable period in 2004. The drivers for the $267,697 reduction in cash generated from operations can be attributed to the decline in profitability, the decline in simulator deposits as the Company completed the installation of simulators sold, the increase in the reserve established for receivables due from Checker Flag Lightning, and the decrease in accrued expenses as the Company resolved its indebtedness associated with the Mills Corporation mall sites.  These requirements for cash were offset by increases in accounts payable of $533,510, and decreases in inventory related to the production and delivery of new race car simulators of approximately $51,000.

 

During the year ended December 31, 2005, the Company used $821,980 of net cash in investing activities compared with $190,793 of net cash used in investing activities during the comparable period in 2004. In both years, the net cash used relates primarily to the capitalization of the costs associated with the installation of simulators in new revenue share locations, and the costs of components for simulators currently in production.

 

During the year ended December 31, 2005, the Company generated $832,237 of cash from financing activities compared with $2,000,514 of cash generated during the comparable period in 2004.  The Company was able to secure additional financing from the sale of $122,500 in new notes, and from the net $100,000 increase in the financing under of the Secured Bridge Notes dated March, 2003.  This was offset by the decrease of $660,000 of the $750,000 in notes sold in 2004.

 

Between October and November, 2005, the Company sold a series of notes collectively referred to as the 2005 Note and Option Purchase Agreement in the total amount of $122,500.

 

As of December 31, 2005, the Company had cash and cash equivalents totaling $353,180 compared to $1,334,673 at December 31, 2004. Current assets totaled $868,703 at December 31, 2005 compared to $2,058,820 on December 31, 2004. Current liabilities totaled $3,874,458 on December 31, 2005 compared with $5,786,193 on December 31, 2004. As such, these amounts represent an overall increase in working capital of $721,618 from December 31, 2004. 

 

**Inflation**

 

We do not expect the impact of inflation on our operations to be significant. 

 

 

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**Risk Factors**

 

The Company is subject to certain risk factors due to the organization and structure of the business, the industry in which we compete and the nature of our operations. These risk factors include the following: 

 

**Operating History, Operating Losses, and Accumulated Deficit**

 

Perfect Line, LLC was formed in June 2001 for the purpose of acquiring certain of the assets of SEI, a bankrupt corporation, and modifying and improving the business model under which SEI operated, as more fully described under Overview above. While the concept is a modification and improvement upon the prior model, the modified business model was only in place for less than two full years, but also proved to be unprofitable.  It is for that reason, among others, that the Company designed and implemented a revised business model focusing on revenue share locations and to a lesser extent, sales of the race car simulators.  Perfect Line has a limited operating history and is subject to numerous risks, expenses, problems, and difficulties typically encountered in establishing any business. For the 5 months ended December 31, 2001, Perfect Line had sales of $3,533,402, and a loss of $(719,854).  For the yearended December 31, 2002, Perfect Line generated net sales of $9,636,278, resulting in a net loss of $(2,189,220).  For the year ended December 31, 2003, Perfect Line had net sales of $7,557,978 generating a net loss of $(3,525,581). For the year ended December 31, 2004, Perfect Line had net sales of $5,769,104 generating a loss of $(1,235,419).  For the year ended December 31, 2005, the Company had net sales of $4,838,988 generating a loss of $(1,095,074).  This overall financial performance resulted in an accumulated deficit of $(8,765,148) as of December 31, 2005 for the Company.  Management believes the addition of simulators to its two owned and operated sites, upcoming sales and licensing revenues from the new Reactor and Reactor Mobile Experience, and upcoming new sales and installations in revenue share and lease sites, will return the Company to profitability in the future, although there can be no assurance.  

 

**Dependence on Discretionary Consumer Spending and Competition**

 

Much of the revenue anticipated by the Company will ultimately be the result of discretionary spending by consumers. If the current trepidation in the economy continues for an extended time or worsens, either overall or in the locations in which Company racing centers and revenue share sites are located, the amount of discretionary spending may be reduced which would have a negative effect on the Company results from operations and its financial position. In addition, if the popularity of NASCAR diminishes, it is likely that the Company will experience a similar reduction in simulator usage and merchandise sales that will have a negative impact on the Company and its future.

 

There is considerable competition for consumer entertainment dollars. The Company feels its patented technology, high-traffic, premium locations, licenses with NASCAR and various teams, drivers, and tracks and the ability to take its driving experience to the public through the integration of its new Reactor simulator with a Featherlite trailer, create significant points of difference between its competitors and NSMS. However, there can be no assurance that these factors will be sufficient to assure successful product development into the marketplace. 

 

 

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**Significant Capital Requirements and Need for Additional Financing**

 

The Company has been and continues to build back the approximately $83,000 in monthly revenue share and lease payments that were given up as a result of the asset sale of 44 simulators to Race Car Simulation Corporation in three asset purchases totaling $2,856,600 in December, 2004 and March and April of 2005.  The Company is both using its current inventory of used and new simulators and building new simulators to install simulators within revenue share, lease or purchased racing center sites to meet the installation demand.  At December 31, 2005, the Company had built, or partially built, 192 SMS simulators, of which 98 had been sold or were in the process of being sold, 24 were in company owned and operated sites,  45 were in revenue share or lease sites (includes mobile experiences).  Of the remaining 25  (21 used or refurbished and 4 new) 2 were at corporate offices and 23 were at the Company’swarehouse or at Elan being prepared to install into future asset purchase, revenue share or lease racing center sites.  In addition, the Company had built or were in the process of building 8 Reactor simulators, 4 of which were installed in a new Reactor Mobile Experience in February.  Reactors are typically purchased with advance payments that cover manufacturing costs so that no financing is required by the Company.

 

Going forward, asset purchases (both SMS and Reactor) require an advance that will cover the manufacturing costs, so no financing is required for these installations.  Financing will be required to manufacture the revenue share simulators that will be owed by the Company and installed into a revenue share partner’s site.  The Company seeks financially viable revenue share and lease partners for financing these installations, secured by simulators as collateral and minimum guarantee contracts.

 

Management has been and plans to continue to sell SMS simulators from its inventory base if necessary to cover cash flow needs until cash is built back up from any combination of revenue share, lease or new Reactor  and Reactor Mobile Experiences, although there can be no assurance that the demand will continue, or that the orders will come in a timely manner to meet the Company’s cash needs. 

 

**Dependence on Revenue Share Partners For Timely Payments**

 

The Company relies on the timely payments from its revenue share partners in order to meet operational cash flow needs.  The Company has also made certain guarantees to Race Car Simulation Corporation of minimum levels of revenue share payments from the revenue share partners where the assets were sold to Race Car Simulation Corporation.  At the year ending December 31, 2005, the allowance for bad debt was increased to cover the receivable from Checker Flag Lightning, who was in default on revenue share payments.  The Company continues to review all its options, legal and otherwise, to try to resolve this situation in the most expedited manner possible.  At the time of this filing, no resolution had occurred.

 

 

 

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**Dependence on Updated Technology and Licenses/Leases**

 

The Company will likely have a need to routinely update and upgrade its simulation technology. If the Company is not able to retain appropriate personnel with the skills and ability to maintain its simulators, it will likely have a material adverse effect on the Company. The Company will also need to routinely upgrade the appearance of the simulators to closely approximate that of the then current NASCAR sponsors. This updating may involve significant time and expense and, in certain instances, require additional license agreements from new teams and/or sponsors. The Company will also need to renew existing licensing agreements with NASCAR teams and/or drivers. The Company currently has executed either contracts or term sheets with fourteen teams and/or drivers. The Company has established licensing relationships with a significant number of racetracks at which NASCAR events are held. The Company haslicense agreements with International Speedway Corp (ISC), Speedway Motorsports International (SMI) and the Indianapolis Motor Speedway (IMS), and has incorporated to date six NASCAR tracks into its proprietary software.  The Company has the rights to many more prominent NASCAR tracks, and plans to add tracks to its software once funded.  The Company has entered into an exclusive location based entertainment license agreement with NASCAR to utilize its logo. The license agreement permits the continued use of the NASCAR logo in the Las Vegas NASCAR Cafe and the Daytona USA simulator and provides that it is not a breach of the exclusivity clause for those two venues to continue to use their current simulator experiences. The license requires the Company to utilize its best efforts to maintain a minimum of eight entertainment stores. The Company’s confidential licensing agreement with NASCAR required an annual royalty payment in 2002 and quarterly royalty payments commencing in 2003through 2009 based on simulator, merchandise, food, beverage, sponsor, and remote site revenues at varying percentages. The licensing agreement was amended on December 31, 2004, and the Company was able to reduce its minimum royalty guarantees.  The exclusivity is subject to a minimum guarantee by July of 2007, and the license is up for renewal on December 31, 2009.

 

**Dependence on Small Number of Key Management Personnel**

 

We do not have employment agreements with any of our employees. Our future success depends, in part, on the continued service of our key executive, management, and technical personnel. If key officers or employees are unable or unwilling to continue in their present positions, our business and our ability to raise capital could be harmed. 

 

Our business is especially dependent upon the continued services of our Chairman and Chief Executive Officer, William R. Donaldson. Should we lose the services of Mr. Donaldson, our operations will be negatively impacted. The loss of the services of Mr. Donaldson would have a material adverse effect upon our business. 

 

**Officers and Directors Have Limited Liability and Indemnification Rights**

 

Our officers and directors are required to exercise good faith and high integrity in the management of our affairs. Our certificate of incorporation and bylaws, however, provide, that the officers and directors shall have no liability to the stockholders for losses sustained or liabilities incurred which arise from any transaction in their respective managerial capacities unless they did not act in good faith, engaged in intentional misconduct or knowingly violated the law, approved an improper dividend or stock repurchase, or derived an improper benefit from the transaction. Our certificate of incorporation and bylaws also provide for us to indemnify our officers and directors against any losses or liabilities they may incur as a result of the manner in which they operate our business or conduct our internal affairs, provided that the officers and directors reasonably believe such actions to be in, or notopposed to, our best interests, and their conduct does not constitute gross negligence, misconduct or breach of fiduciary obligations. 

 

 

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**Market and Capital Risks**

 

Future issuance of Common Stock of the Company may lead to dilution in the value of our common stock, a reduction in shareholder voting power, and allow a change in control. 

 

Stock issuances may result in reduction of market price of our outstanding shares of common stock. If we issue any additional shares of common or preferred stock, proportionate ownership of our common stock and voting power will be reduced. Further, any new issuance of common or preferred shares may prevent a change in our control or management. 

 

Issuance of our preferred stock could depress the market value of current shareholders. We have 10,000,000 authorized shares of convertible preferred stock (with zero shares outstanding) that may be issued by action of our Board of Directors. Our Board of Directors may designate voting control, liquidation, dividend and other preferred rights to preferred stock holders. Our Board of Directors’ authority to issue preferred stock without shareholder consent may have a depressive effect on the market value of our common stock. The issuance of preferred stock, under various circumstances, could have the effect of delaying or preventing a change in our control or other take-over attempt and could adversely affect the rights of holders of our shares of common stock. 

 

**High-Risk Investment and Restrictions on Marketability**

 

Our common stock has traded on the Over-the Counter Bulletin Board since August 2002. The bid price of our common stock has been less than $5.00 during this period. As such, our stock is subject to the penny stock rules adopted by the Securities and Exchange Commission that require brokers to provide extensive disclosure to its customers prior to executing trades in penny stocks. These disclosure requirements may cause a reduction in the trading activity of our common stock. 

 

Broker-dealer practices in connection with transactions in penny stocks are regulated by certain penny stock rules adopted by the Securities and Exchange Commission. Penny stocks generally are equity securities with a price of less than $5.00. Penny stock rules require a broker dealer prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. In addition, the penny stock rules generally require that prior to a transaction in a penny stock, the broker-dealermakes a special written determination that the penny stock is a suitable investment for the purchaser and receives the purchaser’s written agreement to the transaction. 

 

Because we are subject to the penny stock rules our shareholders may find it difficult to sell their shares. 

 

 

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**ITEM 7. FINANCIAL STATEMENTS** 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of

Interactive Motorsports and Entertainment Corp. and Subsidiaries

Indianapolis, Indiana

 

We have audited the accompanying consolidated balance sheet of Interactive Motorsports and Entertainment Corp. and Subsidiaries, as of December 31, 2005, and the related consolidated statements of operations, shareholders’ equity (deficit) and cash flows for the years ended December 31, 2005 and 2004.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Interactive Motorsports and Entertainment Corp. and Subsidiaries, as of December 31, 2005, and the results of their operations and their cash flows for the years ended December 31, 2005 and 2004, in conformity with United States generally accepted accounting principles.

 

The Company has restated the consolidated financial statements to correct the Company’s accounting for a borrowing transaction which is described in Note 14 to the financial statements.

 

 

HJ & Associates, LLC

Salt Lake City, Utah

March 1, 2006 except for Note 14 which is October 10, 2006

 

 

 

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**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Consolidated Balance Sheet 

 

 

**ASSETS**

 

 

|                                       |   |     |      |   | *December 31, 2005*** |
|--------------------------------------------|--------|----------|-----------|--------|-----------------------|
|                                       |   | * * |      |   | (Restated)            |
| CURRENT ASSETS                             |   |     |      |   |                  |
| Cash                                       |   |     |      | $      | 353,180               |
| Accounts Receivable                        |   |     |      |   | 212,156               |
| Inventory                                  |   |     |      |   | 208,453               |
| Prepaid Expenses                           |   |     |      |   | 73,314                |
| Notes Receivable                           |   |     |      |   | 21,600                |
| Total Current Assets                       |   |     |      |   | 868,703               |
|                                       |   |     |      |   |                  |
| TOTAL PROPERTY AND EQUIPMENT, NET (Note 4) |   |     | 1,187,811 |
|                                       |   |     |      |   |                  |
| OTHER ASSETS                               |   |     |      |   |                  |
| Deposits                                   |   |     |      |   | 28,471                |
| Other Intangible Assets, Net               |   |     |      |   | 1,742                 |
| Notes Receivable                           |   |     |      |   | 290,400               |
| Total Other Assets                         |   |     |      |   | 320,613               |
|                                       |   |     |      |   |                  |
| Total Assets                               |   |     |      | $      | 2,377,127             |

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

25

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Consolidated Balance Sheet (Continued)

 

 

**LIABILTIES AND SHAREHOLDERS’ EQUITY (DEFICIT)**

 

 

|                                                                                                 |     |     |        |      | *December 31, 2005*** |
|------------------------------------------------------------------------------------------------------|----------|----------|-------------|-----------|-----------------------|
|                                                                                                 |     | * * |        |      | (Restated)            |
| CURRENT LIABILITIES                                                                                  | * * | * * | * *    | * *  | * *              |
| Accounts Payable                                                                                     |     |     |        | $         | 925,761               |
| Accrued Payroll Expense                                                                              |     |     |        |      | 56,438                |
| Accrued Sales Tax Payable                                                                            |     |     |        |      | 12,018                |
| Gift Certificates & Customer Deposits                                                            |     |     |        | 22,624    |
| Deposits on Simulator Sales (Note 13)                                                                |     |     |        | 1,257,101 |
| Accrued Liabilities (Note 12)                                                                        |     |     |        |      | 379,820               |
| Notes Payable - Related Parties (Note 9)                                                             |     |     |        | 146,000   |
| Notes Payable – Current Portion (Note 5)                                                        |     |     |        | 1,074,696 |
| Total Current Liabilities                                                                            |     |     |        |      | 3,874,458             |
|                                                                                                 |     |     |        |      |                  |
| LONG-TERM LIABILITIES                                                                                |     |     |        |      |                  |
| Notes  Payable – Long Term Portion (Note 5)                                                     |     |     | 1,898,170   |
|                                                                                                 |     |     |        |      |                  |
| Total Liabilities                                                                                    |     |     |        |      | 5,772,628             |
|                                                                                                 |     |     |        |      |                  |
| COMMITMENTS AND CONTINGENCIES (Note 8)                                                               |     |     |        |
|                                                                                                 |     |     |        |      |                  |
| SHAREHOLDERS’ EQUITY (DEFICIT)**                                                                |     | * * | * *    |      |
| Common stock, $0.0001 par value, 200,000 shares authorized

93,769,177 shares issued and outstanding |     |     | 9,377       |
| Additional Paid in Capital                                                                           |     |     |        |      | 5,360,270             |
| Retained Deficit                                                                                     |     |     |        |      | (8,765,148)           |
| Total Shareholders’ Equity (Deficit)                                                            |     |     | (3,395,501) |
|                                                                                                 |     |     |        |      |                  |
| Total Liabilities & Shareholders’ Equity (Deficit)                                          | * * | $**      | 2,377,127   |

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

26

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Consolidated Statements of Operations

 

 

| * *                                     |   |   | *For the Years Ended*

*December 31* |
|----------------------------------------------|--------|--------|--------------------------------------|
| * *                                     |   |   | 2005                                 |   |   | 2004 |
| * *                                     |   |   | (Restated)                           |   |   | (Restated) |
| REVENUES**                                   |   |   |                                 |   |   |   |
| Company Owned Stores                         |   | $      | 2,363,740                            |   | $ | 4,236,350 |
| Revenue Share Revenues                       |   |   | 581,145                              |   |   | 975,296 |
| Leasing Revenues                             |   |   | 57,000                               |   |   | 262,500 |
| Sales of Simulator Systems                   |   |   | 1,837,103                            |   |   | 294,958 |
| Total Revenues                               |   |   | 4,838,988                            |   |   | 5,769,104 |
|                                         |   |   |                                 |   |   |   |
| COST OF SALES                                |   |   |                                 |   |   |   |
| COGS - Merchandise                           |   |   | 115,972                              |   |   | 279,519 |
| Group Sales Expenses                         |   |   | 12,645                               |   |   | 18,749 |
| COGS - Sale of Simulators                    |   |   | 418,617                              |   |   | 127,165 |
| Total Cost of Sales                          |   |   | 547,234                              |   |   | 425,433 |
|                                         |   |   |                                 |   |   |   |
| GROSS PROFIT                                 |   |   | 4,291,754                            |   |   | 5,343,671 |
|                                         |   |   |                                 |   |   |   |
| GENERAL & ADMIN. EXPENSES                |   |   |                                 |   |   |   |
| Payroll Related Expenses                     |   |   | 1,995,651                            |   |   | 2,920,426 |
| Occupancy Expenses                           |   |   | 1,161,423                            |   |   | 1,575,332 |
| Other Operating Expenses                     |   |   | 1,750,162                            |   |   | 1,728,915 |
| Total Operating Expenses                     |   |   | 4,907,236                            |   |   | 6,224,673 |
|                                         |   |   |                                 |   |   |   |
| INCOME (LOSS) BEFORE OTHER INCOME  (EXPENSE) |   |   | (615,482)                            |   |   | (881,002) |
|                                         |   |   |                                 |   |   |   |
| OTHER INCOME (EXPENSE)                       |   |   |                                 |   |   |   |
| Interest Expense                             |   |   | (506,156)                            |   |   | (404,746) |
| Gain on Extinguishments of Debt              |   |   | 26,564                               |   |   | 50,329 |
| Total Other Income (Expense)                 |   |   | (479,592)                            |   |   | (354,417) |
|                                         |   |   |                                 |   |   |   |
| INCOME (LOSS) BEFORE INCOME TAXES            |   |   | (1,095,074)                          |   |   | (1,235,419) |
|                                         |   |   |                                 |   |   |   |
| INCOME TAX EXPENSE                           |   |   | -                                    |   |   | - |
|                                         |   |   |                                 |   |   |   |
| NET INCOME (LOSS)                            |   | $      | (1,095,074)                          |   | $ | (1,235,419) |
|                                         |   |   |                                 |   |   |   |
| INCOME (LOSS) PER SHARE                      |   | $      | (0.01)                               |   | $ | (0.01) |
|                                         |   |   |                                 |   |   |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING          |   | $      | 90,278,841                           |   | $ | 85,900,541 |

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

27

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Statements of Shareholders’ Equity (Deficit)

 

 

|                                                       |   |            |   |         |   |   | Additional

Paid-In

Capital |   |   | Retained

Deficit |   |   | Total

Shareholders’

Equity (Deficit) |
|------------------------------------------------------------|--------|-----------------|--------|--------------|--------|--------|------------------------------|--------|--------|-------------------|--------|--------|---------------------------------------------|
|                                                       |   | Preferred Stock |   | Common Stock |   |   |                         |   |   |              |
|                                                       |   | Shares          |   |         | Amount |   | Shares                       |   |   | Amount            |   |   |                                        |   |   |   |
| Balance at

December 31, 2003                              |   | 2,272,728       |   | $            | 227    |   | 74,314,183                   |   | $      | 7,431             |   | $      | 4,029,002                                   |   | $ | (6,434,655) |   | $ | (2,397,995) |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Common stock issued for

2003 Bridge Loan Interest         |   | -               |   |         | -      |   | 935,726                      |   |   | 94                |   |   | 78,112                                      |   |   | - |   |   | 78,206 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Common stock issued

for services                          |   | -               |   |         | -      |   | 260,000                      |   |   | 26                |   |   | 17,248                                      |   |   | - |   |   | 17,274 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Conversion of preferred

stock to common stock             |   | (2,272,728)     |   |         | (227)  |   | 11,363,640                   |   |   | 1,136             |   |   | (909)                                       |   |   | - |   |   | - |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Fair value of options and

warrants granted                |   | -               |   |         | -      |   | -                            |   |   | -                 |   |   | 571,779                                     |   |   | - |   |   | 571,779 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Common stock issued for

payment of prior year accruals    |   | -               |   |         | -      |   | 842,361                      |   |   | 85                |   |   | 115,535                                     |   |   | - |   |   | 115,620 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Net loss for the year ended 

December 31, 2004 (Restated) |   | -               |   |         | -      |   | -                            |   |   | -                 |   |   | -                                           |   |   | (1,235,419) |   |   | (1,235,419) |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Balance at 

December 31, 2004                             |   | -               |   |         | -      |   | 87,715,910                   |   |   | 8,772             |   |   | 4,810,767                                   |   |   | (7,670,074) |   |   | (2,850,535) |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Common stock issued for

payment of Loan Interest          |   | -               |   |         | -      |   | 5,053,267                    |   |   | 1,363             |   |   | 376,466                                     |   |   | - |   |   | 377,829 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Common stock issued

for services                          |   | -               |   |         | -      |   | 1,000,000                    |   |   | 100               |   |   | 69,900                                      |   |   | - |   |   | 70,000 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Warrant issued for

Dolphin Asset Purchase                 |   | -               |   |         | -      |   | -                            |   |   | (858)             |   |   | 87,250                                      |   |   | - |   |   | 86,392 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Cost of options

for 2005 notes                            |   | -               |   |         | -      |   | -                            |   |   | -                 |   |   | 15,887                                      |   |   | - |   |   | 15,887 |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Net loss for the year ended

December 31, 2005 (restated)  |   | -               |   |         | -      |   | -                            |   |   | -                 |   |   | -                                           |   |   | (1,095,074) |   |   | (1,095,074) |
|                                                       |   |            |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |   |   |   |
| Balance at

December 31, 2005 (restated)                   |   | -               |   | $            | -      |   | 93,769,177                   |   | $      | 9,377             |   | $      | 5,360,270                                   |   | $ | (8,765,148) |   | $ | (3,395,501) |

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

28

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Consolidated Statements of Cash Flows

 

 

|                                                   |   |   | For the Years Ended

December 31 |
|--------------------------------------------------------|--------|--------|----------------------------------|
|                                                   |   |   |
|                                                   |   |   | 2005

(Restated)                 |   |   | 2004

(Restated) |
|                                                   |   |   |                             |   |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                   |   |   |                             |   |   |   |
|                                                   |   |   |                             |   |   |   |
| Net Income (Loss)                                      |   | $      | (1,095,074)                      |   | $ | (1,235,419) |
| Adjustments to reconcile net income (loss) to net cash |   |   |                             |   |   |   |
| used by operating activities:                          |   |   |                             |   |   |   |
| Depreciation and amortization                          |   |   | 454,337                          |   |   | 374,362 |
| Common stock issued for services and interest          |   |   | 119,829                          |   |   | 211,100 |
| Warrants issued related to sales agreements            |   |   | 86,392                           |   |   | 295,657 |
| Amortization of notes payable discount                 |   |   | 37,455                           |   |   | (51,512) |
| Gain on extinguishment of debt                         |   |   | (26,564)                         |   |   | (50,329) |
| Bad debt expense                                       |   |   | 253,481                          |   |   | 15,266 |
| Net changes in operating assets and liabilities:       |   |   |                             |   |   |   |
| Increase in trade accounts and other receivable        |   |   | (348,910)                        |   |   | (394,533) |
| (Increase) decrease in inventory                       |   |   | 51,478                           |   |   | (211,056) |
| Increase in prepaid expenses and other assets          |   |   | (24,294)                         |   |   | (141,392) |
| Decrease in intangibles                                |   |   | 12,927                           |   |   | - |
| Increase (decrease) in accounts payable                |   |   | 533,510                          |   |   | (1,093,394) |
| Decrease in accrued payroll and payroll taxes          |   |   | (10,947)                         |   |   | (31,473) |
| Decrease in sales tax payable                          |   |   | (14,705)                         |   |   | (24,586) |
| Decrease in gift certificates and customer deposits    |   |   | (20,264)                         |   |   | (70,199) |
| Increase (decrease) in accrued expenses                |   |   | (683,524)                        |   |   | 462,169 |
| Increase (decrease) in deposits on simulator sales     |   |   | (316,877)                        |   |   | 1,221,286 |
|                                                   |   |   |                             |   |   |   |
| Net Cash Provided (Used) by Operations                 |   |   | (991,750)                        |   |   | (724,053) |
|                                                   |   |   |                             |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                   |   |   |                             |   |   |   |
|                                                   |   |   |                             |   |   |   |
| Purchase of property and equipment                     |   |   | (1,024,410)                      |   |   | (190,793) |
| Sale of property and equipment                         |   |   | 202,430                          |   |   |   |
|                                                   |   |   |                             |   |   |   |
| Net Cash Used by Investing Activities                  |   |   | (821,980)                        |   |   | (190,793) |
|                                                   |   |   |                             |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                   |   |   |                             |   |   |   |
|                                                   |   |   |                             |   |   |   |
| Loans from and (repayments to) related parties         |   |   | -                                |   |   | (50,000) |
| Proceeds from issuance (payment) of notes payable      |   |   | 832,237                          |   |   | 2,050,514 |
|                                                   |   |   |                             |   |   |   |
| Net Cash Provided by Financing Activities              |   |   | 832,237                          |   |   | 2,000,514 |
|                                                   |   |   |                             |   |   |   |
| INCREASE (DECREASE) IN CASH                            |   |   | (981,493)                        |   |   | 1,085,668 |
|                                                   |   |   |                             |   |   |   |
| CASH, BEGINNING OF YEAR                                |   |   | 1,334,673                        |   |   | 249,005 |
|                                                   |   |   |                             |   |   |   |
| CASH, END OF YEAR                                      |   | $      | 353,180                          |   | $ | 1,334,673 |
|                                                   |   |   |                             |   |   |   |

 

 

The accompanying notes are an integral part of these consolidated financial statements.

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Consolidated Statements of Cash Flows (Continued)

 

29

 

 

|                                                   |   |   | For the Years Ended

December 31 |
|--------------------------------------------------------|--------|--------|----------------------------------|
|                                                   |   |   |
|                                                   |   |   | 2005

(Restated)                 |   |   | 2004

(Restated) |
|                                                   |   |   |                             |   |   |   |
| SUPPLEMENTAL CASH FLOW DISCLOSURES:                    |   |   |                             |   |   |   |
|                                                   |   |   |                             |   |   |   |
| Cash paid for interest                                 |   | $      | 87,455                           |   | $ | 122,332 |
| Cash paid for income taxes                             |   | $      | -                                |   | $ | - |
|                                                   |   |   |                             |   |   |   |
| SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:      |   |   |                             |   |   |   |
|                                                   |   |   |                             |   |   |   |
| Common stock issued for payment of prior year accruals |   | $      | -                                |   | $ | 115,620 |
| Common stock issued for services and interest          |   | $      | 447,829                          |   | $ | 95,480 |
| Warrants sold                                          |   | $      | 86,392                           |   | $ | 571,779 |
| Options granted on notes payable                       |   | $      | 15,887                           |   | $ | - |
|                                                   |   |   |                             |   |   |   |

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

30

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 1 - | BASIS OF PRESENTATION |
|----------|-----------------------|

 

Interactive Motorsports and Entertainment Corp was incorporated in Indiana and began operations on August 3, 2002.  Perfect Line, Inc. was also incorporated in Indiana, and began operations on August 2, 2002.

 

Interactive Motorsports and Entertainment Corp, through its wholly owned subsidiary, Perfect Line, Inc. (the Company), (1) owns and operates three NASCAR Silicon Motor Speedway stores offering licensed NASCAR-branded entertainment products, (2) has ongoing revenue share agreements with third parties allowing them use of our NASCAR racing simulators and proprietary software, (3) sells its simulators and licenses its proprietary software to third parties, (4) leases its simulators and its proprietary software to third parties..  The cornerstone of the Company’s revised business model includes the expansion of the revenue share base.  In revenue sharing, the Company enters into an agreement whereby the Company is entitled to an agreed percentage of the revenue generated by the simulator, subject to a minimum due each month.

 

| NOTE 2 - | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
|----------|--------------------------------------------|

 

a. USE OF ESTIMATES 

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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. 

 

b. SIGNIFICANT ESTIMATES 

 

The most significant estimates made by management are determining the estimated useful lives of the fixed assets, determining the obsolescence of merchandise inventory, and assessing the realization of deferred tax benefits relating to the Company’s net operating loss carry forwards. 

 

 

 

31

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 2 - | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
|----------|--------------------------------------------------------|

 

c. LONG-LIVED ASSETS 

 

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparison of the carrying amount to future net undiscounted cash flows expected to be generated by the related asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair market value of the assets. To date, no adjustments to the carrying amount of long-lived assets have been required.

 

d. MERCHANDISE INVENTORY

 

Merchandise inventories are carried at the lower of cost or market as determined by the first-in, first-out (FIFO) method. The Company reduces the stated value of inventory for excess quantities or obsolescence in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional reductions in stated value may be required. 

 

e. MANUFACTURING INVENTORY

 

Manufacturing inventories are carried at the lower of cost or market as determined by the first-in, first-out method.  These inventories consist of completed simulators that are ready to be installed in a site, as well as various components of our simulation system that have not been allocated to a specific site.

 

f. PROPERTY AND EQUIPMENT 

 

The Company records its property and equipment at cost and once in service, depreciates it using the straight-line method over the estimated useful lives of the respective asset classes as follows: 

 

Software 3 Years, Furniture, Fixtures, and Equipment 5 to 7 Years 

 

 

32

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 2 - | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
|----------|--------------------------------------------------------|

 

g. CONSTRUCTION IN PROGRESS 

 

The Company records all costs associated with the acquisition of components and build out of new sites in Construction in Progress.  Once the site build is completed, costs associated with the build are capitalized as Property and Equipment, and are depreciated as noted in paragraph (f) above.

 

h. DIVIDENDS 

 

The Company has not paid any dividends and any dividends that may be paid in the future will depend upon the financial requirements of the Company and other relevant factors. The Company does not presently intend to pay dividends at any point in the foreseeable future. 

 

i. CONSOLIDATION 

 

The consolidated financial statements at December 31, 2005 and 2004 include the accounts of the Company and its wholly owned operating subsidiaries, Perfect Line, Inc. and Race Car Simulators.  Intercompany transactions and balances have been eliminated in consolidation. 

 

j. NET LOSS PER SHARE 

 

The computation of net loss per share of common stock is based on the weighted average number of shares outstanding during the periods presented. The Company calculates loss per share pursuant to Statement of Financial Accounting Standards No. 148 (“SFAS 148”), Earnings Per Share. Basic loss per share is computed based upon the weighted average number of common shares issued and outstanding during each year. Diluted loss per share amounts assume conversion, exercise, or issuance of all potential common stock instruments (stock options, warrants and convertible preferred stock). Potentially dilutive securities including preferred stock, warrants and stock options are excluded from diluted loss per share during net loss periods because these securities would be anti-dilutive.  The Company has excluded 9,228,695 of dilutive instruments at December 31, 2005.

 

 

33

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 2 - | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
|----------|--------------------------------------------------------|

 

k. INCOME TAXES 

 

The Company provides for income taxes based on the liability method, which requires recognition of deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. At December 31, 2005, the Company’s net deferred tax asset is fully offset by a valuation allowance.

 

l. REVENUE RECOGNITION AND UNEARNED REVENUE 

 

The Company recognizes revenue for its services at the time the services have been rendered. In the case of gift certificates and customer deposits for group events, these amounts are deferred and recognized when the associated services are rendered or upon expiration.  During 2003 the Company began a program of selling some of its new or used simulators.  The Company has outstanding as of December 31, 2005, deposits of $1,257,101 relating to these sales.  The Company’s policy is to recognize revenue on a percentage of completion basis throughout the procurement and installation process until all terms of the contract have been met and no obligations remain for the Company to perform.  The percentage of completion for any given sales contract is determined by the ratio of costs incurred to date to the total estimated cost for each site build.  Costs incurred consist of purchasedcomponents, outside services, and outside contract labor cost.

 

On December 31, 2004, the Company and its two subsidiaries entered into an agreement to sell 34 of its race car simulators and granted an option to purchase 10 additional simulators.  The purchase price of $1,536,600 was paid in cash by the date of the agreement. In addition to transferring title to the simulators, the Company sold a management agreement to provide services for the term of the contract and sold 5,161,500 common stock warrants which are exercisable for 5 years at $0.10 per warrant.  The purchase agreement is being treated as a borrowing in accordance with the guidance provided in paragraphs 21-22 of the Statement of Financial Accounting Standards No. 13 (SFAS 13).  The purchase price is being amortized over a five year term with an annual rate of 15% for a $176,608 increase to revenue per quarter.

 

Furthermore, on March 31, 2005 and April 15, 2005, the Company and its two subsidiaries entered into an agreement to sell the additional 10 simulators referred to in the purchase option above.  The purchase price of $720,000 and $600,000 respectively, was paid in cash by the date of the agreement. In addition to transferring title to the simulators, the Company sold management agreements to provide services for the term of the contracts and sold 1,080,000 and 900,000 common stock warrants, respectively, which are exercisable for 5 years at $0.10 per warrant.  The purchase agreement is being treated as a borrowing in accordance with the guidance provided in paragraphs 21-22 of the Statement of Financial Accounting Standards No. 13 (SFAS 13).  The purchase price is being amortized over a five year term with an annual rate of 15% for a $176,608 increase to revenue per quarter.

 

 

34

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

 

| NOTE 2 - | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
|----------|--------------------------------------------------------|

 

In accordance with EITF 00-21, the Company estimated the future costs of the management service agreement.  These revenues were deferred and are being recognized over the life of the agreement.  As outlined in EITF 00-21 the Company recognized the purchase price less the fair value of the management service agreements as sales in 2004 and 2005.  

 

m. CASH AND CASH EQUIVALENTS 

 

For purposes of the statement of cash flows, the Company considers all demand deposit balances and all highly liquid debt instruments purchased with maturity of three months or less to be cash equivalents. 

 

n. CONCENTRATION OF RISK  

 

The Company maintains a demand deposit account where the balance in the account may at times exceed the FDIC insurance limits of $100,000.  At December 31, 2005, the amount exceeding the FDIC limit was $72,962.

 

o. ADVERTISING 

 

Advertising expenses were $75,702 and $42,787 for the years ended December 31, 2005 and 2004, respectively. 

 

p. RECLASSIFICATIONS 

 

Certain prior year amounts have been reclassified to conform to the current year presentation. 

 

q. INVENTORY

 

At December 31, 2005, inventory consisted of the following:

 

|   | Merchandise Inventory | $      | 7,763   |
|--------|-----------------------|--------|---------|
|   | Simulators Inventory  |   | 205,690 |
|   | Net of Reserve        |   | (5,000) |
|   |                  |   |    |
|   | Total Inventory       | $      | 208,453 |

 

 

 

35

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 3 - | EQUITY TRANSACTIONS AND COMMON STOCK WARRANTS |
|----------|-----------------------------------------------|

 

|   | Preferred Stock |
|--------|-----------------|

 

At June 30, 2002, Perfect Line placed with investors 4,745,456 shares of convertible preferred stock (the, “Preferred Stock”) for cash proceeds of $2,610,050 under a private placement memorandum dated May 10, 2002. These funds were to be held in escrow until the occurrence of certain events.. The proceeds of this offering were used to pay down debt and other liabilities and to provide working capital funds for the business. The Preferred Stock is mandatorily convertible one year after issuance into one share of Common Stock or one dollar worth of Common Stock as of the conversion date, as calculated by the 10-day trailing average of the bid and ask price prior to conversion, whichever is more favorable to the shareholder.  On July 31, 2003 the Company entered into an agreement with one preferred shareholder which extended the conversion date to January 1, 2004. These shareswere subsequently converted into 11,363,640 Common shares on January 29, 2004. 

 

For every two shares of Preferred Stock, the investor received one warrant (the “Preferred Stock Warrants”) to purchase Common Stock at a price of $1.50 per share expiring three years from the date of issuance. The Preferred Stock Warrants are callable by the Company for $0.10 per warrant at any time at the option of the Company. At December 31, 2005 all these warrants had expired. 

 

Common Stock

 

In connection with a certain asset purchase agreement, the Company granted warrants to allow the seller to purchase up to $2 million in value of the Company’s common stock at a price equal to the value per share at the time the warrants are exercised. The warrants are exercisable at any time prior to December 14, 2011, upon the occurrence of certain events. Management has determined the likelihood of occurrence of these certain events is remote and has therefore assigned no value to these warrants. No warrants have been exercised as of December 31, 2005.

 

On May 12, 2005, the Company issued 1,000,000 shares of common stock for consulting services that were rendered.  Total consulting expense associated with this issuance was $70,000.

 

On July 26, 2005, the Company issued 4,100,000 shares of common stock for the repayment of a 2004 Note and Option Purchase Agreement.  The value of the options were $328,000.

 

On November 10, 2005, the Company issued 953,267 shares of common stock per the terms of the Secured Bridge Notes due December 31, 2003 (Note 5).  Total interest expense associated with this issuance was $49,829.

 

 

36

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 3 - | EQUITY TRANSACTIONS AND COMMON STOCK WARRANTS (Continued) |
|----------|-----------------------------------------------------------|

 

Warrants

 

On December 31, 2004, March 31, 2005 and April 15, 2005, the Company and its two subsidiaries entered into agreements to sell 44 of its race car simulators to a single buyer.  Simultaneous to this transaction, the Company sold the buyer 5,161,500, 1,080,000 and 900,000 common stock warrants, respectively, which are exercisable for 5 years from the date of the transaction at $0.10 per warrant.  Using the Black Schoales valuation model, the Company determined the value of these warrants to be $ 287,308, $47,123 and $39,269, respectively, assuming a risk-free interest rate of 3.95% over a period of 5 years.

 

| NOTE 4 - | PROPERTY AND EQUIPMENT |
|----------|------------------------|

 

At December 31, 2005, property and equipment was comprised of the following: 

 

|   |                              | 2005   |
|--------|-----------------------------------|--------|
|   |                              |   |   |
|   | Furniture, Fixtures and Equipment | $      | 1,599,729 |
|   | Revenue share installation costs  |   | 278,299 |
|   | Construction in Progress          |   | 201,992 |
|   | Software                          |   | 659,574 |
|   | Total Property and Equipment      |   | 2,739,594 |
|   |                              |   |   |
|   | Less:  Accumulated depreciation   |   | 1,551,783 |
|   |                              |   |   |
|   | Property and Equipment, net       | $      | 1,187,811 |

 

 

Depreciation expense for the years ended December 31, 2005 and 2004 was $454,337 and $374,362 respectively. 

 

 

37

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 5 - | DEBT AND CREDIT ARRANGEMENTS |
|----------|------------------------------|

 

On March 7, 2003, Perfect Line, Inc. issued Secured Bridge Notes due December 31, 2003 (the “Bridge Notes”) in the aggregate principal amount of $700,000 to one institutional investor and three related-party investors (See Note 9).  Under the terms of the agreement; Ropart Asset Management Fund, LLC (“Ropart”), Tampa Bay Financial, Inc. (related-party), William R. Donaldson (related-party) and Erik R. Risman (related-party at that time), were to receive the principal sum of $500,000, $100,000, $50,000 and $50,000, respectively, on December 31, 2003. Interest was to be paid on the unpaid principal balance existing prior to maturity at an annual rate of twelve percent (12%). Interest on the unpaid principal under the Notes was due and payable in arrears on the first day of each month, commencing April 1, 2003. Additionally, interest accrued at an annual rate of twelvepercent (12%), which was to be repaid in shares of common stock.  All amounts due under the notes were due and payable December 31, 2003.  Ropart and Donaldson have signed amendments extending the note until the end of December 2005, Tampa Bay Financial’s balance was transferred to a third party controlled by a major Company shareholder, and along with an additional Company obligation, was rolled over to the Company’s February 2 2004 Note and Option and Security offering (below) and Risman was paid in full in  2004 by the Company.

 

Ropart and Risman also received warrants in the amounts of 2,941,176 and 294,118, respectively, entitling them to purchase from the Company, at an exercise price of $0.17, common shares of the Company at any time before the earlier of June 30, 2004 or six months following payment of the Bridge Note in full.  The warrants expired unexercised in 2004.

 

Pursuant to the Note and Option Purchase Agreement and Security Agreement dated February 2, 2004 (“2004 Agreement”), the Company issued notes bearing an interest rate of 9.6% payable in the total amount of $750,000.  These notes were issued between February 2, 2004 and June 6, 2004.  Each note came with an option to purchase common shares of the Company equal to the amount of notes purchased divided by the fair market value of the Company’s stock on the date of issuance.  The notes became due on February 2, 2005, and $260,000 of the notes was paid in full at that time.  A note holder of an additional $344,000 of the notes elected to receive a cash payment of $16,000 and exercise options granted with the note purchase for full payment of the note per the terms of the 2004 Agreement.  The note holder of the final $146,000 in notes has been repaid $50,000, and has agreed toextend the maturity date of their note to December 31, 2005, with the expiration of the accompanying option to February 1, 2006.  

 

 

38

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 5 - | DEBT AND CREDIT ARRANGEMENTS (Continued) |
|----------|------------------------------------------|

 

The value of the options was amortized to interest expense over their original life which expired March 1, 2005.  Amortization of option discount for the options related to the 2004 Agreement of $51,812 was included in interest expense for the twelve months ended December 31,2005.

 

Pursuant to the Note and Option Purchase Agreement and Security Agreement dated November 2005 (“2005 Agreement”), the Company issued notes bearing an interest rate of 12% payable in the total amount of $122,500.  These notes were issued between October 13, 2005 and November 4, 2005.  Each note came with an option to purchase common shares of the Company equal to the amount of notes purchased divided by the exercise price of the option.  The notes are due on October 1, 2007.

 

The value of the options will be amortized to interest expense over their life which expires on November 1, 2007.  Amortization of option discount for the options related to the 2005 Agreement of $1,530 was included in interest expense for the twelve months ended December 31, 2005.

 

 

39

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 5 - | DEBT AND CREDIT ARRANGEMENTS (Continued) |
|----------|------------------------------------------|

 

Notes Payable consisted of the following at December 31, 2005:

 

| Note payable to investor bearing interest at 12%,

due December 31, 2005. Secured by certain

simulators of the Company and a personal guaranty

of the President of the Company. | $      | 600,000     |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|
|                                                                                                                                                                              |   |        |
| Note payable to individuals, bearing interest at 12%,

due October 1, 2007. Secured by certain

simulators of the Company.                                                        |   | 122,500     |
|                                                                                                                                                                              |   |        |
| Note payable to a landlord bearing interest at 10.9%,

due May, 2006.                                                                                                             |   | 95,580      |
|                                                                                                                                                                              |   |        |
| Borrowing transaction with RCS bearing interest

at 15%, 5 year term.                                                                                                             |   | 2,169,143   |
|                                                                                                                                                                              |   |        |
| Less:  unamortized discount                                                                                                                                                       |   | (14,357)    |
| Total Notes Payable                                                                                                                                                               |   | 2,972,866   |
|                                                                                                                                                                              |   |        |
| Less:  Current Portion                                                                                                                                                            |   | (1,074,696) |
| Total Notes Payable – Long Term Portion                                                                                                                                      | $      | 1,898,170   |
|                                                                                                                                                                              |   |        |
| Future maturities of notes payable as of December 31,                                                                                                                             |   |        |
| 2006                                                                                                                                                                              | $      | 1,074,696   |
| 2007                                                                                                                                                                              |   | 611,440     |
| 2008                                                                                                                                                                              |   | 550,234     |
| 2009                                                                                                                                                                              |   | 638,686     |
| 2010                                                                                                                                                                              |   | 97,810      |
| Total Notes Payable                                                                                                                                                               | $      | 2,972,866   |

 

 

 

40

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 6 - | LICENSING AND CONSULTING AGREEMENTS |
|----------|-------------------------------------|

 

The Company has a licensing agreement with the National Association for Stock Car Auto Racing, Inc. (“NASCAR”) for location-based entertainment, which allows the Company to use the NASCAR name and logo. The Company’s confidential licensing agreement with NASCAR requires annual royalty payments in 2002 and quarterly royalty payments from 2003 through 2009 based on simulator, merchandise, food, beverage, sponsor, and remote site revenues at varying percentages. The licensing agreement is subject to renewal on December 31, 2009.

 

The Company also has licensing agreements with several NASCAR race teams, drivers, and racetracks that expire on various dates between December 31, 2005 and December 31, 2007. 

 

| NOTE 7 - | RENT COMMITMENTS |
|----------|------------------|

 

The Company rents various office and retail space under long-term, non-cancelable operating leases, some of which include renewal options, expiring on various dates through 2010. The Company also leases certain office equipment pursuant to a non-cancelable operating lease with terms of three years. Rent expense approximated $1,035,336 and $1,289,294 for the years ended December 31, 2005 and 2004, respectively. During 2004, the Company entered into various agreements with Checker Flag Lightning (CFL) and the landlords of specific company stores whereby CFL assumed the operation of the store, and assumed primary responsibility for payments of the monthly rent.  The first column below shows the full impact of all the rental agreements the Company is a party to.  The second column shows the Company’s rental obligations as a consequence of our agreements with CFL and various mall owners.

 

At December 31, 2005, the future minimum rental payments required under all non-cancelable operating leases were as follows: 

 

 

|                           |  

Payable In |      | All

Rental Payments |      | Net of CFL

Rental Payments |
|--------------------------------|--------------------|-----------|----------------------|-----------|-----------------------------|
|                           | 2006               | $         | 954,306              | $         | 623,561                     |
|                           | 2007               |      | 933,718              |      | 580,510                     |
|                           | 2008               |      | 749,866              |      | 396,658                     |
|                           | 2009               |      | 703,677              |      | 379,944                     |
|                           | 2010               |      | 379,944              |      | 379,944                     |
|                           |               |      |                 |      |                        |
| Total Required Rental Payments | $                  | 3,721,571 | $                    | 2,360,617 |

 

 

41

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 8 - | COMMITMENTS AND CONTINGENCIES |
|----------|-------------------------------|

 

From time to time, the Company may be party to various legal actions and complaints arising in the ordinary course of business.  As of December 31, 2005, the Company is not aware of any material legal actions directed against the Company.

 

| NOTE 9 - | RELATED PARTY NOTES PAYABLE |
|----------|-----------------------------|

 

| Note payable to the President of the Company, bearing 

interest at 12% per annum.  Due December 31, 2005.

Secured by certain assets of the Company.                                                                            | $      | 50,000  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|
|                                                                                                                                                                                                                             |   |    |
| Note payable to an entity controlled by a major shareholder

of the Company, bearing interest at 9.6% per annum, due 

February 2, 2005. Secured by certain simulators of the Company 

and personal guarantee of the President. |   | 96,000  |
|                                                                                                                                                                                                                             |   |    |
| Total Related Parties Notes Payable                                                                                                                                                                                              | $      | 146,000 |

 

 

| NOTE 10 - | INCOME TAXES |
|-----------|--------------|

 

Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely that not that some portion or all of the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

 

Net deferred tax assets consist of the following components as of December 31, 2005 and 2004:

 

|                      |   |   | 2005        |   |   | 2004        |
|---------------------------|--------|--------|-------------|--------|--------|-------------|
|                      |   |   |        |   |   |        |
| Deferred tax assets:      |   |   |        |   |   |        |
| NOL Carryover             |   | $      | 5,371,782   |   | $      | 6,237,539   |
| Depreciation              |   |   | 75,370      |   |   | 48,667      |
|                      |   |   |        |   |   |        |
| Deferred tax liabilities: |   |   |        |   |   |        |
| Valuation allowance       |   |   | (5,447,152) |   |   | (6,286,206) |
|                      |   |   |        |   |   |        |
| Net deferred tax asset    |   | $      | -           |   | $      | -           |

 

 

42

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 10 - | INCOME TAXES (continued) |
|-----------|--------------------------|

 

The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate of 39% to pretax income from continuing operations for the years ended December 31, 2005 and 2004 due to the following:

 

 

| Book loss                          |   | $      | (427,118) |   | $      | (481,852) |
|------------------------------------|--------|--------|-----------|--------|--------|-----------|
|                               |   |   |      |   |   |      |
| Loss on the Sale of Assets         |   |   | (153,795) |   |   | -         |
|                               |   |   |      |   |   |      |
| Depreciation                       |   |   | 29,394    |   |   | -         |
|                               |   |   |      |   |   |      |
| Meals and Entertainment            |   |   | 1,823     |   |   | 1,621     |
|                               |   |   |      |   |   |      |
| Stock for services/options expense |   |   | -         |   |   | 136,810   |
| Other                              |   |   | 49,733    |   |   | 46,733    |
| Valuation Allowance                |   |   | 499,963   |   |   | 296,688   |
|                               |   |   |      |   |   |      |
| Net Income tax provision           |   | $      | -         |   | $      | -         |

 

 

At December 31, 2005, the Company had net operating loss carryforwards of approximately $5,371,782 that may be offset against future taxable income from the year 2005 through 2024.  No tax benefit has been reported in the December 31, 2005 financial statements since the potential tax benefit is offset by a valuation allowance of the same amount.

 

Due to the change in ownership provisions of the Tax Reform Act of 1986, net operating loss carryforwards for Federal income tax reporting purposes are subject to annual limitations.  Should a change in ownership occur, net operating loss carryforwards may be limited as to use in the future years.

 

 

43

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 11 - | RECENT ACCOUNTING PRONOUNCEMENTS |
|-----------|----------------------------------|

 

During the year ended December 31, 2004, the Company adopted the following accounting pronouncements:

 

On December 16, 2004 the FASB issued SFAS No. 123(R), *Share-Based Payment*, which is an amendment to SFAS No. 123, *Accounting for Stock-Based Compensation.*  This new standard eliminates the ability to account for share-based compensation transactions using Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees,*and generally requires such transactions to be accounted for using a fair-value-based method and the resulting cost recognized in our financial statements.  This new standard is effective for awards that are granted, modified or settled in cash in interim and annual periods beginning after June 15, 2005.  In addition, this new standard will apply to unvested options granted prior to the effectivedate.  We will adopt this new standard effective for the fourth fiscal quarter of 2005, and have not yet determined what impact this standard will have on our financial position or results of operations. 

 

In November 2004, the FASB issued SFAS No. 151, *Inventory Costs - an amendment of ARB No.* *43, Chapter* *4*. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be so abnormal as to require treatment as current period charges. . . .” This Statement requires that those items be recognized as current- 

period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not believe the adoption of this Statement will have any immediate material impact on the Company. 

 

 

44

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 11 - | RECENT ACCOUNTING PRONOUNCEMENTS (continued) |
|-----------|----------------------------------------------|

 

In December 2004, the FASB issued SFAS No. 152, *Accounting for Real Estate Time-sharing Transactions*, which amends FASB statement No. 66, Accounting for Sales of Real Estate, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, Accounting for Real Estate Time-Sharing Transactions. This statement also amends FASB Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2. This Statement is effective for financial statements for fiscal years beginningafter June 15, 2005. Management believes the adoption of this Statement will have no impact on the financial statements of the Company.

 

In December 2004, the FASB issued SFAS No.153, *Exchange of Nonmonetary Assets*. This Statement addresses the measurement of exchanges of nonmonetary assets. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This Statement iseffective for financial statements for fiscal years beginning after June 15, 2005. Earlier application is permitted for non-monetary asset exchanges incurred during fiscal years beginning after the date of this statement is issued.  Management believes the adoption of this Statement will have no impact on the financial statements of the Company.

 

The implementation of the provisions of these pronouncements are not expected to have a significant effect on the Company’s consolidated financial statement presentation.

 

 

45

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 12 - | ACCRUED LIABILITIES |
|-----------|---------------------|

 

Accrued Liabilities consisted of the following at December 31, 2005

 

 

| Back rent owed to various landlords on sites now operated

by Checker Flag Lightning, Inc. The Company is in various

stages of negotiation to resolve this liability. | $      | 125,834 |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|
| Vacation pay accrual                                                                                                                                                   |   | 60,617  |
| Accrued warrant expenses on sold simulators                                                                                                                            |   | 26,302  |
| Accrued licensing fees                                                                                                                                                 |   | 106,401 |
| Accrued property taxes                                                                                                                                                 |   | 22,354  |
| Accrued miscellaneous expenses                                                                                                                                         |   | 38,312  |
|                                                                                                                                                                   |   |    |
| Total Accrued Liabilities                                                                                                                                              | $      | 379,820 |

 

 

| NOTE 13 - | DEPOSITS ON SIMULATOR SALES |
|-----------|-----------------------------|

 

Deposits on simulator sales consist of the following on December 31, 2005

 

| Company                           |   | Number of Simulators |   | Amount  |
|-----------------------------------|--------|----------------------|--------|---------|
|                              |   |                 |   |    |
| Roltex Group                      |   | 8                    | $      | 552,692 |
| Kissimmee                         |   | 6                    | $      | 250,000 |
| Tonne Management                  |   | 4                    | $      | 222,000 |
| Burroughs & Chapin            |   | 4                    | $      | 108,000 |
| H & H Motorsports, Inc.       |   | 4 (1 RME)            | $      | 91,020  |
| All Others                        |   |                 | $      | 33,389  |
|                              |   |                 |   |    |
| Total deposits on simulator sales | $      | 1,257,101            |
|                              |   |                 |   |    |

 

 

| NOTE 14 - | RESTATEMENT |
|-----------|-------------|

 

Company management made the decision to restate the Company’s financials from the period beginning with Form 10-KSB for the year ended December 31, 2004 to the current date in order to account for the transactions with Race Car Simulator Corporation (“RCSC”) as a borrowing rather than an asset purchase in accordance with the guidance provided in paragraphs 21-22 of the Statement of Financial Accounting Standards No. 13 (SFAS 13).  Management has concluded that it made a misinterpretation of this technical accounting rule.  In order to make a fair presentation of its financials in compliance with Generally Accepted Accounting Principles, the Company is revising its revenue recognition policy with respect to sales where the Company retains substantial risk of ownership as defined in SFAS 13.   

 

46

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 14 - | RESTATEMENT (Continued) |
|-----------|-------------------------|

 

SFAS 13, paragraph 21 states, “The sale of property subject to an operating lease, or of a property that is leased by or intended to be leased by the third-party purchaser to another party, shall not be treated as a sale if the seller or any party related to the seller retains substantial risks of ownership in the leased property.”  The paragraph goes on to describe an example where, in the case of a default by lessee or termination of the lease, the arrangements may involve a commitment by the seller to substitute an existing lease or to secure a replacement lessee under a remarketing agreement.  A remarketing agreement by itself shall not disqualify accounting for the transaction as a sale if the seller (a) will receive a reasonable fee commensurate with the effort involved at the time of securing a replacement lessee for the property and (b) is not required to give priorityto the re-leasing of the property owned by the third party purchaser over similar property owned by the seller.  In the case of the Company’s Asset Purchase Agreements and Management Agreements with RCSC, Section 4.12 of the Asset Purchase Agreement provides RCSC, the Buyer, with a performance guarantee from the Company, the Seller, that Buyer shall receive at least the minimum guaranteed minimum payment amounts with respect to each Lease in effect on the date of the transaction.  Since most of the Leases had terms of 3 years, the Company is considered to maintain “significant risk” during this guarantee period of time as defined in SFAS 13.  Secondly, Section 1(a)(ii) of the Management Agreement between the Company and RCSC states that if any Simulators are not, at any time, being utilized to generate revenue for RCSC, the Company is obligated to place such Simulators into service under Leases with operators prior to placing any of its own Simulators into any sucharrangements.  Management has determined that the “substantial risk” under the Asset Purchase Agreements with RCSC is valid for a three year period since the risk of receiving ongoing minimum guarantees from the lease or revenue share agreements shifts to the Buyer after the three year period.   Management has determined that the “substantial risk” under the Management Agreement is valid for a five year period since this is the expected time period for RCSC’s Aggregate Investment Amount to reach zero as detailed in Section 4 (a) of the Management Agreement.  Once the Aggregate Investment Amount has reached zero (five years at the minimum payment levels of the leases/revenue share agreements), then the Company is compensated with 75% of the aggregate cash payments received by RCSC from the leases/revenue share agreements.  Under the guidance provided in SFAS 13, the risk shifts to the Buyer (RCSC) at this time since the Seller (the Company) is being reasonablycompensated for the effort under the Management Agreement. Management has concluded that the because ‘substantial risk”, as defined within SFAS 13, exists during the five year period after the Asset Purchase Agreement and Management Agreement transactions with RCSC and that such risk shifts at the three and five year periods, the Company’s transactions with RCSC on December 31, 2004, March 31, 2005 and April 15, 2005 shall each be treated from an accounting standpoint as a borrowing rather than an asset sale, and has restated its financials during this period of time to reflect this change in accounting.  

 

 

47

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP. AND SUBSIDIARIES**

Notes to the Consolidated Financial Statements

December 31, 2005 and 2004

 

| NOTE 14 - | RESTATEMENT (Continued) |
|-----------|-------------------------|

 

The discovery has prompted management to restate its 2004 financial statements to recognize a change in Net Income (Loss) through an adjustment to revenue from simulator sales.

 

 

|                | As Reported | As Adjusted | Difference | Change in EPS |
|---------------------|-------------|-------------|------------|---------------|
| For the Year ended  |        |        |       |          |   |   |   |   |
| 12/31/2004          |        |        |       |          |   |   |   |   |
| Total Assets        | $           | 2,877,216   | $          | 2,935,658     | $ | 441,647 |   |   |
| Total Liabilities   | $           | 4,618,647   | $          | 5,786,193     | $ | 1,167,546 |   |   |
| Shareholder Deficit | $           | (1,741,431) | $          | (2,850,535)   | $ | (1,109,104) |   |   |
| Net Income (Loss)   | $           | 8,869       | $          | (1,235,419)   | $ | (1,244,288) | $ | (0.01) |
|                |        |        |       |          |   |   |   |   |
|                |        |        |       |          |   |   |   |   |
| For the Year ended  |        |        |       |          |   |   |   |   |
| 12/31/2005          |        |        |       |          |   |   |   |   |
| Total Assets        | $           | 1,978,330   | $          | 2,377,127     | $ | 398,797 |   |   |
| Total Liabilities   | $           | 3,722,200   | $          | 5,772,628     | $ | (2,050,428) |   |   |
| Shareholder Deficit | $           | (1,743,870) | $          | (3,395,501)   | $ | (1,651,631) |   |   |
| Net Income (Loss)   | $           | (560,460)   | $          | (1,095,074)   | $ | (534,614) | $ | (0.01) |

 

 

| NOTE 15 - | SUBSEQUENT EVENTS |
|-----------|-------------------|

 

The Company has completed the sale of four SMS simulators to the operator of the Mentor, OH location, the sale of six SMS simulators to an operator in Kissimmee, FL, and the sale of two SMS simulators to be used by DaimlerChrysler at various North American automotive shows and corporate events.  In addition, the Company has completed the sale of its first Reactor Mobile Experience to an operator in North Carolina, and has a purchase agreement and deposit for the sale of 4 SMS simulators from Vacationland Family Entertainment in Brainerd, MN. 

 

While waiting for a response to a payment plan proposed by Perfect Line to the Mall of America landlord (MOAC Mall Holdings, LLC), Perfect Line received an eviction summons from the landlord on February 16, 2006.  Perfect Line has since contacted the landlord and the parties have agreed to terms for a stipulation agreement whereby Perfect Line will sign a promissory note totaling $293,642 payable in five (5) quarterly installments, the first of which has already been paid.  The agreement and note are being drafted and are expected to be signed by the end of March. 

 

48

**ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

By letter dated March 15, 2004, Crowe Chizek and Company LLC (Crowe Chizek) informed the Company that it was notifying the Securities and Exchange Commission of its earlier termination of the client-auditor relationship between Crowe Chizek and the Company.  That letter referred to the letter to the Company dated December 31, 2003 that effective December 31, 2003 Crowe Chizek terminated the client-auditor relationship with the Company.  However, the Company continued to meet with and provide information to Crowe Chizek after receipt of the December 31, 2003 letter.  The Company believed that Crowe Chizek had continuing interest in an auditor-client relationship with the Company and as late as March 1, 2004 had held discussions with representatives of Crowe Chizek requesting continuation of the auditor-client relationship in connection with the audit for the fiscal year ended December 31, 2003.  It was notuntil the March 15, 2004 letter that the Company believed the relationship had ended.

 

The report of Crowe Chizek for the fiscal year ended December 31, 2002, the only year for which the Company was subject to the reporting provisions of the Securities Exchange Act of 1934 and which Crowe Chizek served as auditors of the Company, contained a “going concern” uncertainty explanatory paragraph, but did not contain an adverse opinion or disclaimer of opinion, or qualification as to audit scope or accounting principles.

 

During the fiscal year ended December 31, 2002 and the periods up to and including December 31, 2003, there were no disagreements between the Company and Crowe Chizek on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to the satisfaction of Crowe Chizek, would have caused it to make reference to the subject matter of the disagreement in connection with its report on the Company’s consolidated statements for such periods; and there were no reportable events as defined in Item 304(a)(1) of Regulation S-K.

 

The Company has provided Crowe Chizek with a copy of the information disclosed in the Current Report on Form 8-K which was filed with the Commission on March 18, 2004 and is incorporated herein by reference.  Crowe Chizek provided the Company a letter dated March 18, 2004, for filing as an Exhibit to the Form 8-K which indicated.  The letter stated, in essence, that Crowe Chizek did not disagree with the above disclosure, although it expressed no opinion as to what the Company believed as stated in the fourth and fifth sentences of the first paragraph of this Item 8.

 

Effective March 17, 2004, the Company engaged HJ & Associates, L.L.C. (“HJ”) of Salt Lake City, Utah, as its new independent accountant to audit the Company’s financial statements for the year ended December 31, 2003.  The retention of HJ was reported on a current report on Form 8-K on March 19, 2003, which is incorporated herein by reference. 

 

During the years ended December 31, 2002 and 2003 and the interim period up to and including March 17, 2004, neither the Company nor anyone acting on the Company’s behalf consulted HJ regarding either: (i) the application of accounting principles to a specified transaction, either contemplated or proposed; to the type of audit opinion that might be rendered on the Company’s financial statements, and neither a written report nor oral advice was provided by HJ to the Company that HJ concluded was an important factor considered by the Company in reaching a decision as to any accounting, auditing or financial reporting issues; or (ii) any matter that was either the subject of a “disagreement” as that term is describe in Item 304 (a)(1)(iv) of Regulation S-K promulgated under the Securities Exchange Act of 1934, as amended, and the related instruction to Item 304 of Regulation S-K, or a“reportable event” as that term is described in Item 304 (a)(1)(v) of Regulation S-K.

 

 

49

The Company has provided to HJ a copy of the disclosure regarding its retention as auditors to the Company, prior to filing of the Form 8-K reporting the retention.  HJ informed the Company that it did not disagree with the disclosure contained in the Form 8-K which is substantially duplicated in the immediately proceeding paragraph of this Item 8.

 

**ITEM 8A. CONTROLS AND PROCEDURES** 

 

The Principal Executive Officer (“PEO”), who is also the Principal Financial Officer (“PFO”) of the Company has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-14 of the Exchange Act), as recently modified, within 90 days prior to the filing of this amended report. Based on that evaluation, the PEO/PFO has concluded that the Company’s disclosure controls and procedures are adequate and effective. There have been no significant changes in the Company’s internal controls, or in factors that could significantly affect internal controls, subsequent to the most recent evaluation of such controls.

 

 

**PART III**

 

**ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT**

 

The Board of Directors and Executive Officers of the Company consist of the persons named in the table below. Vacancies in the Board of Directors may only be filled by the Board of Directors by majority vote at a Board of Director’s meeting, or at a shareholders meeting at which stockholders holding a majority of the issued and outstanding shares of capital stock are present. The directors are elected annually by the stockholders at the annual meetings. Each director shall be elected for the term of one year, and until his or her successor is elected and qualified, or until his earlier resignation or removal. The bylaws provide that we have at least one director. The directors and executive officers of the Company are as follows: 

 

| **Name**             | **Age** | **Position**                                     |
|----------------------|---------|--------------------------------------------------|
|                 |    |                                             |
| William R. Donaldson | 49      | Chairman, Chief Executive Officer, and Secretary |
| Carl L. Smith, Sr.   | 63      | Director                                         |
| Cary Agajanian       | 64      | Director                                         |

 

Mr. Donaldson has been a major influence in the international racing industry for over 25 years. He served as the Executive Vice President of the Indianapolis Motor Speedway (“IMS”), the largest spectator stadium in the world, and concurrently served as President of IMS subsidiaries, IMS Properties and IMS Events. At IMS, he was on the executive management team that initiated such events as the NASCAR Brickyard 400, Indy FanFest, the Senior PGA Tournament held at Brickyard Crossing, the Indy 200 at Walt Disney World, and the launch of the Indy Racing League. Donaldson also managed the Inaugural NASCAR Winston Cup event at Las Vegas Motor Speedway, and he managed the launch of the Petit Le Mans at Road Atlanta, and the American and European Le Mans Series.  He has extensive experience with domestic and international television broadcasting. He has a Bachelor of Arts degree from DePauw University inGreencastle, Indiana.

 

 

50

Mr. Smith is a successful entrepreneur, whose business interests and ownerships have over his professional life, spanned a wide variety of products and services. With over 38 years of experience in business development, marketing, sales and finance, he provides a diverse level of knowledge and expertise to the Company. He was the founder of Catalyst Marketing Corporation, a public company that, under his leadership, grew to become one of the most successful telecommunications marketing agencies for products and services of industry giant, MCI, which was later acquired by WorldCom. In 1991, he co-founded Tampa Bay Financial, Inc., a former venture capital firm that specialized in micro-cap, first stage corporate investments and, one year later, was selected as a member of the prestigious “Who’s Who of American Business Executives”. Mr. Smith has successfully engineered the turn around andrevitalization of several troubled public companies and has also been involved in capitalizing and taking many young private companies public through a reverse merger strategy. He presently sits on the Board of Directors of NeoGenomics, Inc. (OTCBB: NOGN) and several private companies. 

 

Mr. Agajanian literally grew up in the sport of auto racing, with his family running racing teams and racetracks. He now owns Motorsports Management International, a multi-faceted company that is an industry leader in the areas of event representation, corporate consulting, and sponsorship negotiation. For the past 10 years, Mr. Agajanian has served on Motorsports boards such as the Automobile Competition Committee of the United States (ACCUS), the American Motorcyclist Association (AMA, Vice-Chairman) and United States Auto Club (USAC) Properties. Mr. Agajanian’s company has been involved in securing hundreds of sponsorship arrangements and is the only company in the United States to offer star race drivers premium representation services in corporate structures, pension benefits, trusts and estates and contract negotiation. NASCAR NEXTEL Cup star Tony Stewart has been represented by MotorsportsManagement International, and Agajanian also previously represented Jeff Gordon. Mr. Agajanian’s car ownership division has entered cars in the Indianapolis 500 for 36 consecutive years and now owns one of the premier teams in the NASCAR Busch Series. 

 

The Company has no standing or separate audit committee, but rather the entire Board of Directors functions as the audit committee,  The Board of Directors has determined that due to the size of the board of directors, and the limited resources of the Company, it is in the Company’s best interest to have the entire board function as the audit committee.

 

Our Executive Officers are elected by the Board on an annual basis and serve at the discretion of the Board. 

 

**Section 16(a) Beneficial Ownership Reporting Compliance**

 

Section 16(a) of the Securities Exchange Act of 1934 requires that our executive officers, directors and persons who beneficially own more than 10% of the Company’s Common Stock to file initial reports of ownership and reports of changes in ownership with the SEC. Such persons are required by SEC regulations to furnish us with copies of all Section 16(a) forms filed by such persons. 

 

Based solely on our review of such forms furnished to us and representations from certain reporting persons, filing requirements applicable to our executive officers, directors and more than 10% stockholders have been complied with during  the twelve months ending December 31, 2005        with the exception of James Matheny, who has failed to file a Form 3, Initial Statement of Beneficial Ownership, reporting their ownership of in excess of 10% of the issued and outstanding voting shares of the Company. 

 

 

51

**Code of Ethics**

 

The Company has adopted a Code of Ethics which is applicable to all officers, directors and employees of the Company.  A copy of the Code of Ethics is available on the Company’s website which is www.smsonline.com under the investor relations button.  The Company will forward, without charge, a copy of the Code of Ethics to any person requesting a copy.  Requests should be directed to Interactive Motorsports and Entertainment Corp. Attn: Code of Ethics at 5624 W. 73rd Street, Indianapolis, Indiana,  46278.

 

**ITEM 10. EXECUTIVE COMPENSATION** 

 

The following table sets forth information concerning the compensation paid to all persons serving as the Company’s chief executive officer and the Company’s most highly compensated executive officers other than its chief executive officer who were serving as executive officers at December 31, 2005 and whose annual compensation exceeded $100,000 during such year (collectively, the “Named Executive Officers”). 

 

|                                                       |                                        | **Annual Compensation**                    | **Long-Term Compensation Awards**         |
|------------------------------------------------------------|---------------------------------------------|--------------------------------------------|-------------------------------------------|
|  

 

 

**Name and Principal****Position** |  

 

 

**Year/****Period** |  

 

 

 

**Salary** |  

 

 

 

**Bonus** |  

 

**Other Annual Compensation****(2)** |  

 

**Restricted Stock****Awards** |  

**Securities Underlying Options/SARs****(#)** |  

 

 

**LTIP****Payouts** |
|                                                       |                                        |                                       |                                      |   |   |   |   |
| William R. Donaldson,

Chairman and CEO                    | 2005                                        | $150,000                                   | -                                         | $7,055 | - | - | - |
|                                                       |                                        |                                       |                                      |   |   |   |
| 2004                                                       | $150,000                                    | -                                          | $6,659                                    | - | - | - |
|                                                            |                                             |                                            |                                           |  |  |  |  |  |

 

 (2)  Includes cost of medical and life insurance.

 

**Director Compensation**

 

Directors of the Company are currently not paid for their services; however, the Company intends to establish a compensation plan utilizing stock awards versus cash payments in 2006.

 

**Indemnification for Securities Act Liabilities**

 

Indiana law authorizes, and the Company’s Bylaws and Indemnity Agreements provide for, indemnification of the Company’s directors and officers against claims, liabilities, amounts paid in settlement and expenses in a variety of circumstances. Indemnification for liabilities arising under the Act may be permitted for directors, officers and controlling persons of the Company pursuant to the foregoing or otherwise. However, the Company has been advised that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. 

 

 

52

**Stock Options and Warrants**

 

The Company does not currently have a stock option plan.

 

**Compensation Committee Interlocks and Insider Participation**

No executive officers of the Company serve on the Compensation Committee (or in a like capacity) for the Company or any other entity. 

 

**ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

**Security Ownership of Certain Beneficial Owners**

 

The following table sets forth certain information with respect to the beneficial ownership of our Common Stock as of March 22, 2006 for each person or entity that is known by us to beneficially own more than 5 percent of our Common Stock. As of March 22, 2006, the Company had 93,769,177 shares of Common Stock outstanding. 

 

|  

 

**Name and Address of Beneficial Owner** | **Amount of Beneficial****Ownership** |  

**Nature of****Ownership** |  

**Percent of****Class** |
|----------------------------------------------------------|---------------------------------------|------------------------------------|---------------------------------|
|                                                     |                                  |                               |                            |
| William R. Donaldson, Carmel, IN                         | 17,736,450                            | Direct                             | 18.92%                          |
| Vikki Cook, Sarasota, FL                                 | 10,833,324                            | Direct                             | 11.44%                          |
| James Matheny, Cary, NC                                  | 8,691,151                             | Direct                             | 9.27%                           |
| Alliance Investment Management, LTD, Nassau, Bahamas     | 7,287,846                             | Direct                             | 7.77%                           |
| Norman Pessin, New York, NY                              | 5,000,000                             | Direct                             | 5.33%                           |
|                                                     |                                  |                               |                            |
| Dolphin Direct Equity Partners, LP (**a**)               | 7,141,500                             | Direct                             | 7.62%                           |
|                                                     |                                  |                               |                            |
| Total                                                    | 49,548,771                            |                                    | 52.73%                          |

 

|   | **(a)** | Dolphin Direct Equity Partners, LP (Dolphin) is the beneficial owner of 5,161,500 and  $1,980,000 warrants that expire December 31, 2009 and March 31, 2010, respectively, and are exercisable at any time prior to expiration. The calculation used to determine The Percent of Class attributable to Dolphin assumes all the warrants held by Dolphin are exercised.  The Totals do not include Dolphin’s beneficial ownership. |
|--------|---------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

53

**Security Ownership of Management**

 

The following table sets forth certain information with respect to the beneficial ownership of our Common Stock as of March 22, 2006 for each of our directors and each of our Named Executive Officers, and all directors and executive officers as a group. As of March 22, 2006 the Company had 93,769,177 shares of Common Stock outstanding. 

 

|  

**Name, Position and Address of Beneficial Owner**                              | **Amount of Beneficial****Ownership (1)** |  

**Nature of****Ownership** |  

**Percent of****Class** |
|-----------------------------------------------------------------------------------------|-------------------------------------------|------------------------------------|---------------------------------|
|                                                                                    |                                      |                               |                            |
| William R. Donaldson, Chairman, Chief Executive Officer, and Secretary; Carmel, Indiana | 17,736,450                                | Direct                             | 18.92%                          |
| Carl L. Smith, Director; Sarasota, Florida                                              | -                                         | n/a                                | -                               |
| Cary Agajanian, Director; Los Angeles, California                                       | -                                         | n/a                                | -                               |
| Total                                                                                   | 17,736,450                                |                               | 18.92%                          |
|                                                                                    |                                      |                               |                            |
| All Executive Officers & Directors as a Group 

(3 persons)                         |  

17,736,450                        |                               |  

18.92%                  |

 

(1) Beneficial ownership is determined in accordance with SEC rules and generally includes holding voting and investment power with respect to the securities. Shares of Common Stock subject to options or warrants currently exercisable, or exercisable within 60 days, are deemed outstanding for computing the percentage of the total number of shares beneficially owned by the designated person, but are not deemed outstanding for computing the percentage for any other person. 

 

**Change in Control**

 

We are not currently engaged in any activities or arrangements that we anticipate will result in a change in control of the Company. 

 

**ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS** 

 

On March 10, 2003, the Company issued to three related parties a total of $200,000 of Secured Bridge Notes as previously disclosed in that Form 8-K filed on March 13, 2003. These notes were issued to Tampa Bay Financial and Mr. William R. Donaldson in the amounts of $100,000 and $50,000, respectively. The Chairman and Chief Executive Officer of Tampa Bay Financial, Mr. Carl L. Smith, is also a director of the Company. Mr. Donaldson is the Chairman and Chief Executive Officer of the Company.  On February 17, 2004, at the direction of Mr. Smith, the note was transferred to a third party controlled by a major Company shareholder.

 

 

54

**ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K**

 

| A. | Exhibits. |
|----|-----------|

|   | 3(i) | Articles of Incorporation 1 |
|--------|------|-----------------------------|

|   | 3(ii) | By-Laws1 |
|--------|-------|----------|

|   | 10.1 | Form of Secured Bridge Notes 2 |
|--------|------|--------------------------------|

|   | 10.2 | Form of Procurement Contract 3 |
|--------|------|--------------------------------|

|   | 10.3 | Form of Master Revenue Sharing Agreement 3 |
|--------|------|--------------------------------------------|

|   | 10.4 | Asset Purchase Agreement with Race Car Simulation Corporation, a portfolio company of Dolphin Direct Equity Partners, LP 4 |
|--------|------|----------------------------------------------------------------------------------------------------------------------------|

|   | 10.5 | Asset Purchase Agreement with Checker Flag Lightning, LLC (“CFL”), a Michigan limited liability corporation 5                           |
|--------|------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | 11.1 | Computation of Earnings (Loss) Per Share |
|--------|------|------------------------------------------|

|   | 14.1 | Code of Ethics |
|--------|------|----------------|

|   | 21.1 | Subsidiaries |
|--------|------|--------------|

|   | 31.1 | Certification of William R. Donaldson as Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14 of the Security Exchange Act of 1934. |
|--------|------|------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | 32.1 | Certification of William R. Donaldson as Chief Executive Officer pursuant to 18 U.S.C. Section 1350. |
|--------|------|------------------------------------------------------------------------------------------------------|

|   | 32.2 | Certification of William R. Donaldson as Chief Financial Officer and Treasurer pursuant to 18 U.S.C. Section 1350. |
|--------|------|--------------------------------------------------------------------------------------------------------------------|

 

|   | 1)  Incorporated by reference from Form 10-QSB filed on November 14, 2002 |
|--------|---------------------------------------------------------------------------|

|   | 2)  Incorporated by reference from Form 8-K filed on March 13, 2003 |
|--------|---------------------------------------------------------------------|

3)  Incorporated by reference from Form 10-QSB filed on May 17, 2004

|   | 4)  Incorporated by reference from Form 8-K filed on January 6, 2005 |
|--------|----------------------------------------------------------------------|

|   | 5)  Incorporated by reference from Form 8-K filed on January 6, 2006 |
|--------|----------------------------------------------------------------------|

 

| B. | Reports on Form 8-K. |
|----|----------------------|

 

| 1.     | Form 8-K | Filed March 14, 2005 | Announcement of the financial results for the Fourth Quarter, 2004. |
|--------|----------|----------------------|---------------------------------------------------------------------|
|   |     |                 |                                                                |

 

 

 

55

 

**ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

**Audit Fees**

Fees for audit services from HJ and Associates totaled $50,152 for the year ended December 31, 2004.  Fees for audit services from HJ and Associates totaled $43,491 for the year ended December 31, 2005.  Those auditing fees included fees associated with the annual audit, reviews of quarterly reports on Form 10-Q and procedures required by GAAP and GAAS.

 

**Audit-Related Fees**

Fees for audit-related services from HJ and Associates totaled $0 for the year ended December 31, 2004.  Fees for audit-related services from HJ and Associates totaled $6,320 for the year ended December 31, 2005.  These auditing services consisted of assistance related to comment letter responses.

 

**Tax Fees**

Fees from HJ and Associates for tax services, including fees for review of the consolidated federal income tax return, totaled $0 for the year ended December 31, 2004.  Fees from HJ and Associates for tax services, including fees for review of the consolidated federal income tax return, totaled $62 the year ended December 31, 2005.

 

**All Other Fees**

No fees were billed by HJ and Associates for the fiscal year ending December 31, 2004 and for the fiscal year ending December 31, 2005 other than those specified above. 

 

 

56

PRE-APPROVAL POLICY FOR AUDIT AND NON-AUDIT SERVICES

 

The Company does not have a standing audit committee, and the full Board performs all functions of an audit committee, including the pre-approval of all audit and non-audit services before the Company engages an accountant.  All of the  services  rendered  to  the Company by HJ & Associates, LLC after March 18, 2004  were  pre-approved  by  the  Board  of  Directors  of  the  Company.

 

The Company contemplates working with its legal counsel to establish formal pre-approval policies and procedures for future engagements of the Company’s accountants.  The  new  policies  and  procedures  will  be  detailed as to the particular service, will require that the Board or an audit committee thereof be informed  of  each  service,  and  will  prohibit the delegation of pre-approval responsibilities to management.  It is currently anticipated that the Company’s new  policy  will  provide (i) for an annual pre-approval, by the Board or audit committee,  of  all audit,  audit-related and non-audit services proposed to be rendered  by  the  independent  auditor  for  the  fiscal  year, as specifically described  in  the  auditor’s  engagement  letter,  and  (ii)  that  additional engagements  of  the auditor, which were not approved in the annual pre-approval process, and  engagements  that  are  anticipated to exceed previously approved thresholds,  will  be  presented  on  a  case-by-case basis, by the Chairman of the Board of Directors,  for pre-approval by the Board or audit committee, before management engages  the  auditors for any such purposes.  The new policy and procedures may authorize  the  Board  or  audit  committee  to  delegate, to one or more of its members,  the authority to pre-approve certain permitted services, provided that the estimated fee for any such service does not exceed a specified dollar amount (to  be determined).  All pre-approvals shall be contingent on a finding, by the Board,  audit  committee, or delegate, as the case may be, that the provision of the  proposed  services  is  compatible  with  the  maintenance of the auditor’s independence  in  the  conduct of its auditing functions.  In no event shall any non-audit  related  service  be  approved  that  would result in the independent auditor  no  longerbeing considered independent under the applicable rules and regulations  of  the  Securities  and  Exchange  Commission.

 

There were no fees in 2005 which were not pre-approved by the Board of Directors.  All services described above under the captions “Audit Fees”,  “Audit Related Fees” and “Tax Fees” were approved by the Board of Directors pursuant to SEC Regulation S-X, Rule 2-01(c)(7)(i).

 

 

 

57

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 

 

**INTERACTIVE MOTORSPORTS AND ENTERTAINMENT CORP.**

 

|   | Date: November 20, 2006 | By: | */s/ William R. Donaldson* |
|--------|-------------------------|-----|----------------------------|

*-----------------------------------------------*

William R. Donaldson

Chairman of the Board and Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. 

 

|   | Date: November 20, 2006 | By: | */s/ William R. Donaldson* |
|--------|-------------------------|-----|----------------------------|

*-----------------------------------------------*

William R. Donaldson

Chairman of the Board and Chief Executive Officer

|   | (Principal Executive Officer) |
|--------|-------------------------------|

 

|   | Date: November 20, 2006 | By: | */s/ William R. Donaldson* |
|--------|-------------------------|-----|----------------------------|

*-----------------------------------------------*

William R. Donaldson

Chief Financial Officer and Treasurer

|   | (Principal Financial Officer) |
|--------|-------------------------------|

 

|   | Date: November 20, 2006 | By: | */s/ Carl L. Smith* |
|--------|-------------------------|-----|---------------------|

*-----------------------------------------------*

Carl L. Smith

|   | Director |
|--------|----------|

 

|   | Date: November 20, 2006 | By: | */s/ Cary Agajanian* |
|--------|-------------------------|-----|----------------------|

*-----------------------------------------------*

|   | Cary Agajanian |
|--------|----------------|

|   | Director |
|--------|----------|

 

 

 

58

**EXHIBIT INDEX**

 

EXHIBITS:

 

Exhibits:

|   | 3(i) | Articles of Incorporation 1 |
|--------|------|-----------------------------|

|   | 3(ii) | By-Laws1 |
|--------|-------|----------|

|   | 10.1 | Form of Secured Bridge Notes 2 |
|--------|------|--------------------------------|

|   | 10.2 | Form of Procurement Contract 3 |
|--------|------|--------------------------------|

|   | 10.3 | Form of Master Revenue Sharing Agreement 3 |
|--------|------|--------------------------------------------|

|   | 10.4 | Asset Purchase Agreement with Race Car Simulation Corporation, a portfolio company of Dolphin Direct Equity Partners, LP 4 |
|--------|------|----------------------------------------------------------------------------------------------------------------------------|

|   | 10.5 | Asset Purchase Agreement with Checker Flag Lightning, LLC (“CFL”), a Michigan limited liability corporation 5                           |
|--------|------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | 11.1 | Computation of Earnings (Loss) Per Share |
|--------|------|------------------------------------------|

|   | 14.1 | Code of Ethics |
|--------|------|----------------|

|   | 21.1 | Subsidiaries |
|--------|------|--------------|

|   | 31.1 | Certification of William R. Donaldson as Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14 of the Security Exchange Act of 1934. |
|--------|------|------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | 32.1 | Certification of William R. Donaldson as Chief Executive Officer pursuant to 18 U.S.C. Section 1350. |
|--------|------|------------------------------------------------------------------------------------------------------|

|   | 32.2 | Certification of William R. Donaldson as Chief Financial Officer and Treasurer pursuant to 18 U.S.C. Section 1350. |
|--------|------|--------------------------------------------------------------------------------------------------------------------|

 

|   | 1)  Incorporated by reference from Form 10-QSB filed on November 14, 2002 |
|--------|---------------------------------------------------------------------------|

|   | 2)  Incorporated by reference from Form 8-K filed on March 13, 2003 |
|--------|---------------------------------------------------------------------|

3)  Incorporated by reference from Form 10-QSB filed on May 17, 2004

|   | 4)  Incorporated by reference from Form 8-K filed on January 6, 2005 |
|--------|----------------------------------------------------------------------|

|   | 5)  Incorporated by reference from Form 8-K filed on January 6, 2006 |
|--------|----------------------------------------------------------------------|

 

 

 

59