UNITED STATES

**SECURITIES AND EXCHANGE COMMISSION**

Washington, D. C. 20549 

 

**FORM 10-KSB**

 

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

SECURITIES EXCHANGE ACT OF 1934 

 

For the fiscal year ended

December 31, 2006

 

*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: $5,351,298

 

As of March 21, 2007, the aggregate market value of the voting stock held by non-affiliates of the Issuer, 46,386,137 shares, was $788,564. 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 $0.016. 

 

The number of shares of the issuer’s Common Stock, par value $0.0001 issued and outstanding as of March 21, 2007, was 96,397,506.

 

Exhibit Index located on Page 57

 

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 | 13 |
|---------|---------------------------------------------------------------------------------------------|----|

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

|   | Report of Independent Registered Public Accounting Firm | 22 |
|--------|---------------------------------------------------------|----|

|   | Consolidated Balance Sheet at |
|--------|-------------------------------|

|   | December 31, 2006 | 23 |
|--------|-------------------|----|

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

|   | December 31, 2006 and December 31, 2005 | 25 |
|--------|-----------------------------------------|----|

|   | Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended |
|--------|-------------------------------------------------------------------------------------|

|   | December 31, 2006 and December 31, 2005 | 26 |
|--------|-----------------------------------------|----|

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

|   | December 31, 2006 and December 31, 2005 | 27 |
|--------|-----------------------------------------|----|

|   | Notes to Consolidated Financial Statements | 29 |
|--------|--------------------------------------------|----|

| ITEM 8. | Changes In and Disagreements With Accountants on Accounting and Financial Disclosure | 47 |
|---------|--------------------------------------------------------------------------------------|----|

| ITEM 8A. | Controls and Procedures | 47 |
|----------|-------------------------|----|

 

 

**PART III**

 

| ITEM 9. | Directors, Executive Officers, Promoters and Control Persons | 48 |
|---------|--------------------------------------------------------------|----|

| ITEM 10. | Executive Compensation | 50 |
|----------|------------------------|----|

| ITEM 11. | Security Ownership of Certain Beneficial Owners and Management | 51 |
|----------|----------------------------------------------------------------|----|

| ITEM 12. | Certain Relationships and Related Transactions | 52 |
|----------|------------------------------------------------|----|

| ITEM 13. | Exhibits and Reports on Form 8-K | 53 |
|----------|----------------------------------|----|

| ITEM 14. | Principal Accountant Fees and Services | 54 |
|----------|----------------------------------------|----|

 

| SIGNATURES | 56 |
|------------|----|

 

| EXHIBITS INDEX | 57 |
|----------------|----|

 

 

2

**NOTE ON FORWARD-LOOKING INFORMATION**

 

This Form 10-KSB 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, 2006.

 

All information in this Form 10-KSB 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 for the “out-of-home” interactive gaming market, contracting with operators in malls, amusement parks, family entertainment centers, casinos and trade shows 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 12simulators and NASCAR merchandise are sold at each site.  The Company is positioning itself to be a world leader in the “out-of-home”, multi-site virtual league market as further described in Current Operations, Recent Developments and Plan for the Future.

 

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 (see Note 6 to the Consolidated Financial Statements), 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, 2006, the Company’s racing centers, leased and revenue share simulators and sold simulators generated revenue of approximately $5.4 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.  

 

Major Agreements:  During 2006, the Company entered into sales contracts for 15 SMS simulators and 29 Reactor simulators.  This included Reactors that were installed in Mobile Experiences for high profile clients such as Dodge, Toyota and Sprint Nextel.  

 

Perfect Line’s race simulators, including those owned by Race Car Simulation Corporation as discussed herein, are currently featured in the following locations:  

 

 

5

**Locations**

 

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

 

| ***Location*****              | ***Year***** | ***Market*****  | ***Sq. Ft.***** | ***Simulators***** |
|-------------------------------|--------------|-----------------|-----------------|--------------------|
| ***1)***   Mall of America    | 2001         | Minneapolis, MN | 5,899           | 12 SMS             |
| ***2)***   Universal CityWalk | 2001         | Los Angeles, CA | 5,000           | 12 SMS             |

 

 

***Revenue Share (71 Simulators):***

 

| ***Location*****                          | ***Year***** | ***Market*****   | ***Sq. Ft.***** | ***Simulators***** |
|-------------------------------------------|--------------|------------------|-----------------|--------------------|
| ***1)***    NASCAR SpeedPark              | 2003         | Sevierville, TN  | 1,584           | 6 SMS#             |
| ***2)***    NASCAR SpeedPark              | 2003         | St. Louis, MO    | 1,496           | 6 SMS#             |
| ***3)***    Burdick Driver’s Village | 2004         | Syracuse, NY     | 3,472           | 8 SMS#             |
| ***4)***    Bass Pro Outdoor              | 2004         | Harrisburg, PA   | 500             | 2 SMS              |
| ***5)***    Mall of Georgia               | 2004         | Atlanta, GA      | 5,895           | 8 SMS!!            |
| ***6)***    Riverchase Galleria           | 2004         | Birmingham, AL   | 6,188           | 8 SMS              |
| ***7)***    Jordan Creek Town Ctr         | 2004         | Des Moines, IA   | 4,000           | 8 SMS              |
| ***8)***    NASCAR SpeedPark              | 2005         | Toronto, Canada  | 1,500           | 6 SMS#             |
| ***9)***    Bass Pro Outdoor              | 2005         | Clarksville, IN  | 750             | 3 SMS              |
| ***10)***  University Mall                | 2005         | Burlington, VT   | 3,700           | 5 SMS              |
| ***11)***  NASCAR SpeedPark               | 2006         | Myrtle Beach, SC | 1,600           | 6 SMS#             |
| ***12)***  Bass Pro Outdoor**             | 2006         | Springfield, MO  | 500             | 3 SMS              |
| ***13)***  Bass Pro Outdoor               | 2006         | San Antonio, TX  | 500             | 2 SMS              |

 

 

***Mobile Units (56 Simulators):***

 

| ***Buyer*****                                | ***Year***** | ***Market***                            | ***Simulators*** |
|----------------------------------------------|--------------|-----------------------------------------|------------------|
| ***1)***    Nextel Mobile Experience         | 2004         | 2004-06 NASCAR Nextel Cup series events | 6 SMS#           |
| ***2)***    Nextel Mini Experiences          | 2004         | Nextel regional marketing               | 6 SMS#           |
| ***3)***    DaimlerChrysler                  | 2005         | European Auto Shows                     | 2 SMS            |
| ***4)***    Perfect Line/NTI Experience      | 2005         | Mobile Experience                       | 2 SMS            |
| ***5)***    H&H Motorsports**            | 2006         | Mobile Experience                       | 4 Reactors       |
| ***6)***    Florida Simulated Racing Network | 2006         | Mobile Experience                       | 4 Reactors       |
| ***7)***    Exhibit Enterprises (Dodge)      | 2006         | Mobile Experience                       | 4 Reactors       |
| ***8)***    Exhibit Enterprises (Dodge)      | 2006         | Mobile Experience                       | 4 Reactors       |
| ***9)***    DGI, Inc (Nextel) **             | 2006         | Mobile Experience                       | 6 Reactors       |
| ***10)***  DGI, Inc (Toyota)                 | 2006         | Mobile Experience                       | 4 Reactors       |
| ***11)***  DGI, Inc (Nextel, Toyota)         | *            | Mobile Experience                       | 14 Reactors      |

 

 

6

***Sales of Simulators (72 Simulators):***

 

| ***Buyer*****                    | ***Year***** | ***Market*****             | ***Simulators***** |
|----------------------------------|--------------|----------------------------|--------------------|
| ***1)***    Opry Mills           | 2004         | Nashville, TN              | 10 SMS!!           |
| ***2)***   Gurnee Mills          | 2004         | Chicago, IL                | 6 SMS              |
| ***3)***   Concord Mills         | 2004         | Charlotte, NC              | 12 SMS!!           |
| ***4)***    I-Vision Tech.       | 2004         | Abu Dhabi, UAE             | 2 SMS              |
| ***5)***    I-Vision Tech.       | 2005         | Abu Dhabi, UAE             | 4 SMS              |
| ***6)***    Ft. Gordon           | 2005         | Ft. Gordon, GA             | 2 SMS              |
| ***7)***    Fun City             | 2005         | Burlington, IA             | 1 SMS              |
| ***8)***    DaimlerChrysler      | 2005         | US Auto Shows              | 2 SMS              |
| ***9)***    Gate A Sports        | 2006         | Cleveland, OH              | 5 SMS              |
| ***10)***  Skycoaster of Florida | 2006         | Kissimmee, FL              | 6 SMS              |
| ***11)***  Vacationland F.E.     | 2006         | Brainerd, MN               | 4 SMS              |
| ***12)***  NASCAR SpeedPark      | 2006         | Concord, NC                | 3 Reactors         |
| ***13)***  Roltex                | *            | Moscow, Russian Federation | 8 SMS              |
| ***14)***  Tonne Mgmt.           | *            | Wisconsin Dells, WI        | 4 SMS              |
| ***15)***Prime Time FEC          | *            | Abilene, TX                | 3 SMS              |

 

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

* Denotes that simulators are not yet installed

!! Denotes site that CFL closed in January, and may or may not re-open 

 

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 and operated 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 planned 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.  Reactor simulators are sold in the $36,000-$38,000 range excluding support software features.

 

 

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 race car 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, leased and purchased simulators for mall merchandise retailers, family entertainment centers, amusement parks, casinos, trade shows, 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, LLC (“Checker Flag Lightning” or “CFL”) of Grandville, Michigan in November of 2003, the Company assigned an additional six (6) mall leases to CFL in March of 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.  The sale is accounted for as a borrowing in accordance with the guidance provided in paragraphs 21-22 of SFAS 13.  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 anotherforty-four (44) simulators into the market on a revenue share basis.  This, coupled with the fact that Checker Flag Lightning stopped paying on its revenue share agreements (approximately $1,000,000 annually) created cash flow issues for the Company during 2005 and 2006.  The sale of SMS simulators during this period helped to offset the cash flow problem.

 

 

8

The Company launched a new product in November of 2005 called the Reactor.  It was designed to incorporate the patented motion platform and proprietary game engine software, but the size was reduced and the unit was more mobile and portable.  This opened the door to more mobile marketing experience customers (including Dodge, Toyota and Sprint Nextel).  This resulted in 29 Reactors sold in 2006 along with 15 of the original SMS simulators, giving the Company an operating loss of $41,909 in 2006, a decrease of $573,573 or 93%, compared to the $615,482 operating loss in 2005.

 

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

 

The Company’s goal is to leverage its patented motion platform and proprietary game engine software, along with its embedded base of simulator assets, to be the world leader in the “out of home” interactive gaming market. The Company is currently 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 and on the NSMS web site, (see Note 6 to Consolidated Financial Statements).  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 drivers such as Dale Earnhardt, Jr., Tony Stewart and Jeff Gordon. 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 featured six of the Company’s SMS race simulators.  The Nextel Experience continues to have a prominent location at each of the NASCAR Nextel Cup events.  Nextel also featured SMS simulators within three mini Mobile Experiences that were used for promotional events around the country, each featuring two of the Company’s SMS simulators. Beginning in 2006, the Company sold and leased simulators to DaimlerChrysler for their domestic and international trade show exhibits, and the Dodge division has exhibited two of the Company’s simulators at selected NASCAR events.  The SMS simulators continue to be featured in the world’s largest auto shows, including Detroit, Chicago, New York, Paris, Frankfurt, Geneva and Shanghai.

 

 

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.  Managementbelieved that the combination of greater mobility, portability and a lower price point would broaden the market for simulator purchases and leases. 

 

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 was towed by a 2-ton pickup truck.  By the third and fourth quarter of 2006, two Reactor Mobile Experience units were sold to Exhibit Enterprises, the operator for Dodge motorsports, and one Reactor Mobile Experience was sold to an operator in Florida.  Sprint Nextel and Toyota placed their orders for a total of 10 Reactors that would be installed in time for their fan experiences at the Daytona 500 in February of 2007.  A total of 29 Reactor simulators were sold in 2006.

 

Another major development in the works by the end of the 2006 year was the beginning of a licensing relationship with iRacing.com.  iRacing.com was founded by well-known game developer David Kaemmer (co-founder of Papyrus Racing Games) and entrepreneur John Henry (principle owner of the Boston Red Sox among other properties).  iRacing.com has signed a letter of intent to license to the Company certain gaming technology, and as iRacing.com develops new physics models for race circuits and race cars for the in-home online gaming market, the Company desires to license those properties for its customers in the out-of-home market, although there can be no assurances.  The Company plans to have its engineers begin work on multi-site, virtual league play featuring additional NASCAR race tracks for our operators, but there can be no assurance that this will be completed soon or any time in the foreseeable future.Management believes that once completed, the multi-site, virtual league play will generate an additional revenue steam for the Company and the operators, although there can be no assurance. 

 

The Company has made several technological improvements to the simulation in recent years, resulting in an enhanced racing experience.  *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 system has been updated to a Linux platform, and beginning in 2006 was available as an upgrade to race simulator operators.  The newoperating 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.

 

For the Sprint Nextel and Toyota fan experiences in 2007, the Company added the capability of showing a pre-race video along with the option of showing interstitial or commercial video between the races.  For Sprint Nextel, the Company also streamlined the data acquisition process and added a Top Twelve leaderboard that updates every sixty seconds within the Nextel Experience. 

 

 

10

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 and at-track experiences, and then potentially grow to local dealers, although there can be no assurance.   

 

**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 March 31, 2008, with an option for the Company to be released from the lease on September 30, 2007. 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 lease expires October 31, 2007.****In addition, the Company has a warehouse in Concord, North Carolina that is currently on a month-to-month lease.****The Company believes its headquarters and engineering space is adequate for the present time and isreviewing 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.  The Company’s subsidiary Perfect Line, Inc. filed a complaint in the U.S. District Court, Southern District of Indiana on December 6, 2006 against Checker Flag Lightning, LLC and Mike Schuelke, seeking a Declaratory Judgment, Injunctive Relief and Damages for failing to make the required payments (at least $559,119) under certain lease agreements between Checker Flag Lightning and Perfect Line. The Company cannot be sure of the outcome of this litigation. 

 

On September 6, 2006, Perfect Line and its lease assignee, Checker Flag Lightning, were served a complaint from Mall of Georgia for past due rent totaling $164,726 between the two parties of which $95,580 is directly attributable to past rent due by Perfect Line.  The non-performance of CFL in paying either its rent obligations to Mall of Georgia under the assigned lease or the payments due to Perfect Line under their revenue share agreement has resulted in this complaint from Mall of Georgia.  Perfect Line has agreed to the basic terms of a settlement agreement with Mall of Georgia and is waiting on the settlement agreement draft for review at the time of this filing. The terms of the settlement will allow Perfect Line the ability to remove the 8 SMS simulators at the Mall of Georgia location and permits Perfect Line a reasonable time period for the payment of its obligations to Mall of Georgia while itreactivates the simulators into the market.  As of the filing of this Annual Report on Form 10-KSB, the Company is not aware of any 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 21, 2007 there were approximately 272 holders of record of our Common Stock consisting of 96,397,506 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 |
| March 31,2006      |   | .07                    |   | .03 |   | .04 |
| June 30, 2006      |   | .05                    |   | .02 |   | .04 |
| September 30, 2006 |   | .04                    |   | .02 |   | .02 |
| December 31, 2006  |   | .03                    |   | .01 |   | .02 |

 

 

12

**Recent Sale of Unregistered Securities**

 

On July 14, 2006, Interactive Motorsports and Entertainment Corp (the “Company”) and its wholly owned subsidiary, Perfect Line, Inc. (“Perfect Line”) entered into Note and Warrant Purchase and Security Agreements with ten (10) investors in a private placement which is exempt from the registration provisions of the Securities Act of 1933, as amended, pursuant to Reg. D and Rule 506 adopted thereunder.  The Notes, totaling $950,000, were issued by Perfect Line, will be fully paid down July 17, 2010 and bear interest at a rate of 15% per annum for the total interest amount over the four year period of $314,988.  Each note came with an option to purchase common shares of the Company equal to two and one half times the amount of notes purchased divided by the exercise price of the option.  The principle and interest on the Notes are payable weekly over a four year term and are secured by afirst security interest in 20 of the simulators owned by Perfect Line.

 

The Company issued Common Stock to Ropart Asset Management in 2006 in accordance with the terms of the 2003 Bridge Notes as described in this filing. 

 

**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. 

 

**Overview**

 

The Company generated its first quarterly operating profit and quarterly net profit in the third quarter of 2004, and again in the first and fourth quarters of 2006.  The Company had an operating loss of $41,909 in 2006, a decrease of $573,573 or 93%, compared to the $615,482 operating loss in 2005.  Since inception on May 31, 2001 and through December 31, 2006, the Company has accumulated aggregate losses totaling $9,363,302, which includes the net loss of $598,154 for the twelve months ended December 31, 2006, the net loss of $1,095,074 for the twelve months ended December 31, 2005, and the net loss of $7,670,074 for the period from inception to December 31, 2004. 

 

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 race car simulators, net proceeds of $855,000 borrowed in September of 2006 and $769,147 by delaying payments to its vendors.  See further discussion under “Liquidity and Capital Resources” and “Risk Factors” below.

 

 

13

During the twelve months ended December 31, 2006, the Company had total revenues of $5,351,298 compared to $4,838,988 for the twelve months ended December 31, 2005.  The 11% increase in revenue is due primarily to the final implementation of the Company’s revised business model and the sale of new Reactor simulators during 2006.  The sale of 29 new Reactor simulators along with the sale of 15 SMS simulators in 2006 helped to offset the revenue that was not generated from the Checker Flag Lightning sites (28 simulators) due to non-performance in paying the revenue share payments due, and the 21 simulators that are in inventory.  Same store revenues in the Company’s two owned and operated stores were down 28%, primarily due to the Company’s inability to purchase sufficient merchandise inventory to generate past sales levels. 

 

**Review of Consolidated Financial Position**

 

**Cash and Cash Equivalents**: The Company had $216,323 in cash as of December 31, 2006 compared with $353,180 at December 31, 2005, a decrease of $136,857.  This decrease in cash for the year ended December 31, 2006 relates principally to the paydown of invoices to vendors in the second half of 2006.

 

**Trade Accounts Receivable**: The balance at December 31, 2005 of $212,156 increased by $17,350 in 2006 to  $229,506 net of a $238,781 reserve for uncollectible accounts related to Checker Flag Lightning.  Trade accounts receivable is primarily revenue share and credit card receivables.  The increase is attributable to the addition of revenue share sites and sale of Reactors in the fourth quarter of 2006.

 

**Inventory:** At December 31, 2006, inventory of $254,322 consisted of merchandise inventory of $17,496,  simulator inventory of $158,462 and manufacturing inventory of $82,364.  In addition, the merchandise inventory has a very conservative $4,000 reserve against it.  Merchandise inventory increased by $9,733 from December 31, 2005 due primarily to the placement of merchandise in the Company’s two outlet stores.  Inventory of manufactured simulators increased by $39,269 to build the new reactors at the Santa Clara, California location.  December 31, 2006 simulator inventory available for placement in new revenue share sites, or available for sale, totaled four new simulators and seventeen refurbished simulators.

 

**Accounts Payable:**The balance of accounts payable of $581,281 at December 31, 2006 represents a decrease of  $344,480 from the balance at December 31, 2005 of $925,761.  This decrease is primarily attributable to the paydown of vendors’ invoices.  

 

**Accrued Liabilities:**The balance of accrued liabilities of $432,745 at December 31, 2006 represents an increase of $52,925 from the balance at December 31, 2005 of  $379,820.  This increase is primarily related to the cost to build Reactors at the end of the year. 

 

**Notes Payable:**  On December 31, 2006, the Company had balances of $96,000 on the 2004 Note Payable,  $1,760,761 on the 2004 Race Car Simulator Corporation (“RCS”) Borrowing, and $122,500 on the 2005 Agreement.    The Company amortizes the RCS Borrowing and recognizes the associated revenue over the five year period of the borrowing.  The Company decreased the RCS Borrowing by $408,382 and $305,407 in 2006 and 2005 respectively.  

 

On March 29, 2006, Perfect Line and MOAC Mall Holdings, LLC, the Mall of America landlord, agreed to a stipulation agreement whereby Perfect Line signed a promissory note totaling $294,652 payable in five (5) quarterly installments, with the first payment of $78,471 made on February 28, 2006, and payments of $54,045 to be made beginning July 14, 2006 and ending July 15, 2007.  The $54,045 payments for 2006 were made on July 14 and November 15.

 

 

14

On July 14, 2006, Interactive Motorsports and Entertainment Corp (the “Company”) and its wholly owned subsidiary, Perfect Line, Inc. (“Perfect Line”) entered into Note and Warrant Purchase and Security Agreements with ten (10) investors in a private placement which is exempt from the registration provisions of the Securities Act of 1933, as amended, pursuant to Reg. D and Rule 506 adopted thereunder.  The Notes, totaling $950,000,were issued by Perfect Line, will be fully paid down July 17, 2010 and bear interest at a rate of 15% per annum for the total interest amount over the four year period of $314,988.  Each note came with an option to purchase common shares of the Company equal to two and one half times the amount of notes purchased divided by the exercise price of the option.  The principle and interest on the Notes are payable weekly over a four year term and are secured by afirst security interest in 20 of the simulators owned by Perfect Line.

 

**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. 

 

**Review of Consolidated Results of Operations**

 

Sales for the twelve months ended December 31, 2006 were $512,310 higher than for the twelve month period ending December 31, 2005 due primarily to the final implementation of the Company’s revised business model and the sale of the new Reactor simulators during 2006.  All but two of the Company store locations at December 31, 2003 have been converted to Checker Flag Lightning 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 first quarter of 2005.  Revenue was further impacted by the non-payment of revenue share income by the Checker Flag Lightning organization.  This resulted in the Company experiencing cash flow shortages sufficient to hamper its ability to replenish its stock of merchandiseinventory, and also impacted the Company’s ability to replace the simulators sold, 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 2006, the Company recorded the sale or partial sale of 44 simulators in 10 transactions totaling approximately $2.8 million, as compared to the approximately $1.8 million generated by the sale of 45 simulators in 6 transactions in 2005.  

 

Operating expenses for the year ended December 31, 2006 declined by approximately 16% from the period ending December 31, 2005.  These expenses represented approximately 77% of net sales and approximately 101% for the comparable period in 2005.  Continued implementation of the Company’s revised business model resulted in a reduction in operating expenses of approximately $775,233, with reductions occurring primarily in payroll of $426,300 and occupancy costs of $54,627, as the Company either converted company owned stores to revenue share locations, or closed locations with sub-par performance.  

 

The increase in revenues and reduction in expenses has had a favorable effect on the Company’s overall financial position.  The Company had an operating loss of $41,909 in 2006, a decrease of $573,573 or 93%, compared to the $615,482 operating loss in 2005, and a net loss of  $598,154, a decrease of  $496,920 or 45%, compared to the $1,095,074 net loss in 2005.  

 

Additionally, interest expense increased by approximately $50,089 as the Company increased the liability on notes payable.

 

 

15

**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. 

 

**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, 2006 included in Item **7** in this Form 10-KSB. The Company has consistently applied these policies in the year ended December 31, 2006. 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**

 

On December 31, 2004, and again on March 31 and April 15, 2005, the Company entered into an Asset Purchase Agreement 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.  

 

During the year ended December 31, 2006, the operating activities of the Company used net cash of $735,985 compared to net cash used of $1,267,100 for the comparable period in 2005. The drivers for the $531,115 decrease in net cash can be attributed to the increase in profitability, the decrease in simulator deposits, and the increase in accounts receivable.  These requirements for cash were offset by decreases in accounts payable of $65,100, and increases in inventory related to the production and delivery of new race car simulators of approximately $45,869.

 

During the year ended December 31, 2006, the Company used $84,956 of net cash in investing activities compared with $821,980 of net cash used in investing activities during the comparable period in 2005. 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.

 

 

16

During the year ended December 31, 2006, the Company generated $684,084 of cash from financing activities compared with $1,107,587 of cash generated during the comparable period in 2005.  The Company was able to secure additional financing from the sale of $950,000 in new notes.  This was offset by the decrease of $265,916 of the 2004 notes payable.

 

As of December 31, 2006, the Company had cash totaling $216,323 compared to $353,180 at December 31, 2005. Current assets totaled $726,018 at December 31, 2006 compared to $868,703 on December 31, 2005. Current liabilities totaled $3,843,284 on December 31, 2006 compared with $3,874,458 on December 31, 2005. As such, these amounts represent an overall decrease in working capital of $111,511 from December 31, 2005. 

 

**Inflation**

 

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

 

**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 mall-based business model under which SEI operated, as more fully described under Overview above. While the concept was a modification and improvement upon the prior model, the modified mall-based 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 and lease agreements with operators, and the sales of the race car simulators.  Perfect Line is subject to numerous risks, expenses, problems, and difficulties typically encountered in establishing any business. For the five 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.  For the year ended December 31, 2006, the Company had net sales of $5,351,298 generating a loss of $598,154.  This overall financial performance resulted in an accumulated deficit of $9,363,302 as of December 31, 2006 for the Company.  Management believes the revenue from its two owned and operated sites, upcoming sales and licensing revenues from the new Reactor and Reactor Mobile Experience operators, upcoming new sales and installations in revenue share and lease sites and revenue from potential new revenue streams (multi-site leaguesand full size vehicle simulation experiences), will return the Company to profitability in the future, although there can be no assurance.  

 

 

17

**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 and from experiential marketing budgets from major sponsors within NASCAR. 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, or if experiential marketing budgets are reduced, it is likely that the Company will experience a similar reduction in simulator usage, merchandise sales and mobile Reactor purchases and leases 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 popular NASCAR teams and tracks, and the ability to take its driving experience to the public through the activation of its new Reactor Mobile Experience, create significant points of difference between the Company and its competitors. However, there can be no assurance that these factors will be sufficient to assure successful product development into the marketplace. 

 

**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 within revenue share, leased or purchased racing center sites to meet the installation demand.  At December 31, 2006, 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 27 (23 used or refurbished and 4 new) 3 were at corporate offices and 24 were at the Company’s warehouse orat Elan being prepared to install into future asset purchase, revenue share or lease racing center sites.  In addition, the Company had built and installed 30 Reactors and is in the process of building 14 new Reactor simulators to be installed in the first quarter of 2007.  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.  As an example, in order to re-capture the $83,000 per month as detailed above, the sale of one SMS and two Reactors per month would be required under current circumstances.  The Company sold 15 SMS and 29 Reactors in 2006.  

 

 

18

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

 

The Company relies on the timely payments from its revenue share operators 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 and lease operators 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.

 

**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 tracks. The Company currently has executed either contracts or term sheets with many of the prominent NASCAR Nextel Cup teams and race tracks. The Company has established licensing relationships with a significant number of racetracks at which NASCAR events areheld. The Company has incorporated to date six NASCAR tracks and over 30 Nextel Cup car images 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 2003 through 2009 based on simulator, merchandise, food, beverage, sponsor, and remote siterevenues 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 (see Note 6 to the Consolidated Financial Statements).

 

**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. 

 

 

19

**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 articles 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 articles 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. 

 

**Market and Capital Risks**

 

Future issuance of Common Stock of the Company, including the exercise of currently outstanding Warrants and the issuance of shares to Ropart Asset Management as part of their compensation for the 2003 Bridge Note, 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. 

 

 

20

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. 

 

 

 

21

**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, 2006, and the related consolidated statements of operations, shareholders’ equity (deficit) and cash flows for the years ended December 31, 2006 and 2005.  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 audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits 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, 2006, and the results of their operations and their cash flows for the years ended December 31, 2006 and 2005, in conformity with United States generally accepted accounting principles.

 

*/s/ HJ & Associates, LLC*

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

HJ & Associates, LLC

Salt Lake City, Utah

February 27, 2007

 

 

 

22

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

Consolidated Balance Sheet 

 

 

**ASSETS**

 

 

|                                       |   | *For the Year Ended December 31, 2006* |
|--------------------------------------------|--------|----------------------------------------|
|                                       |   | * *                               |
| CURRENT ASSETS                             |   |                                   |
| Cash                                       | $      | 216,323                                |
| Accounts Receivable, net                   |   | 229,506                                |
| Inventory                                  |   | 254,322                                |
| Prepaid Expenses                           |   | 22,724                                 |
| Notes Receivable                           |   | 3,143                                  |
| Total Current Assets                       |   | 726,018                                |
|                                       |   |                                   |
| TOTAL PROPERTY AND EQUIPMENT, NET (Note 4) |   | 885,711                                |
|                                       |   |                                   |
| OTHER ASSETS                               |   |                                   |
| Deposits                                   |   | 28,471                                 |
| Notes Receivable                           |   | 305,642                                |
| Total Other Assets                         |   | 334,113                                |
|                                       |   |                                   |
| Total Assets                               | $      | 1,945,842                              |

 

 

 

 

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

 

23

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

Consolidated Balance Sheet (Continued)

 

 

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

 

 

|                                                                                                       |     | *For the Year Ended December 31, 2006*** |
|------------------------------------------------------------------------------------------------------------|----------|------------------------------------------|
|                                                                                                       |     | * *                                 |
| CURRENT LIABILITIES                                                                                        | * * | * *                                 |
| Accounts Payable                                                                                           | $        | 581,281                                  |
| Accrued Payroll Expense                                                                                    |     | 66,762                                   |
| Accrued Sales Tax Payable                                                                                  |     | 34,360                                   |
| Gift Certificates & Customer Deposits                                                                  |     | 23,248                                   |
| Deposits on Simulator Sales (Note 13)                                                                      |     | 1,019,093                                |
| Accrued Liabilities (Note 12)                                                                              |     | 432,745                                  |
| Notes Payable - Related Parties (Note 9)                                                                   |     | 146,000                                  |
| Notes Payable – Current Portion (Note 5)                                                              |     | 1,539,795                                |
| Total Current Liabilities                                                                                  |     | 3,843,284                                |
|                                                                                                       |     |                                     |
| LONG-TERM LIABILITIES                                                                                      |     |                                     |
| Notes  Payable – Long Term Portion (Note 5)                                                           |     | 1,957,471                                |
|                                                                                                       |     |                                     |
| Total Liabilities                                                                                          |     | 5,800,755                                |
|                                                                                                       |     |                                     |
| COMMITMENTS AND CONTINGENCIES (Note 8)                                                                     |     |                                     |
|                                                                                                       |     |                                     |
| SHAREHOLDERS’ EQUITY (DEFICIT)                                                                        |     |                                     |
| Common stock, $0.0001 par value, 200,000,000 shares

Authorized,  96,397,506 shares issued and outstanding |     | 9,640                                    |
| Additional Paid in Capital                                                                                 |     | 5,498,749                                |
| Retained Deficit                                                                                           |     | (9,363,302)                              |
| Total Shareholders’ Equity (Deficit)                                                                  |     | (3,854,913)                              |
|                                                                                                       |     |                                     |
| Total Liabilities & Shareholders’ Equity (Deficit)                                                | $        | 1,945,842                                |

 

 

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

 

24

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

Consolidated Statements of Operations

 

 

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

*December 31* |
|-------------------------------------|--------|--------|--------------------------------------|
| * *                            |   |   | 2006                                 |   |   | 2005 |
| * *                            |   |   |                                 |   |   |   |
| REVENUES**                          |   |   |                                 |   |   |   |
| Company Owned Stores                |   | $      | 1,853,647                            |   | $ | 2,363,740 |
| Revenue Share Revenues              |   |   | 383,523                              |   |   | 581,145 |
| Leasing Revenues                    |   |   | 69,667                               |   |   | 57,000 |
| Sales of Simulator Systems          |   |   | 2,827,451                            |   |   | 1,837,103 |
| Special Events Sales                |   |   | 217,010                              |   |   | - |
| Total Revenues                      |   |   | 5,351,298                            |   |   | 4,838,988 |
|                                |   |   |                                 |   |   |   |
| COST OF SALES                       |   |   |                                 |   |   |   |
| COGS - Merchandise                  |   |   | 45,660                               |   |   | 115,972 |
| Group Sales Expenses                |   |   | 3,297                                |   |   | 12,645 |
| COGS - Sale of Simulators           |   |   | 1,052,481                            |   |   | 418,617 |
| COGS – Special Events          |   |   | 159,766                              |   |   | - |
| Total Cost of Sales                 |   |   | 1,261,204                            |   |   | 547,234 |
|                                |   |   |                                 |   |   |   |
| GROSS PROFIT                        |   |   | 4,090,094                            |   |   | 4,291,754 |
|                                |   |   |                                 |   |   |   |
| GENERAL & ADMIN. EXPENSES       |   |   |                                 |   |   |   |
| Payroll Related Expenses            |   |   | 1,569,354                            |   |   | 1,995,651 |
| Occupancy Expenses                  |   |   | 1,106,796                            |   |   | 1,161,423 |
| Other Operating Expenses            |   |   | 1,455,853                            |   |   | 1,750,162 |
| Total Operating Expenses            |   |   | 4,132,003                            |   |   | 4,907,236 |
|                                |   |   |                                 |   |   |   |
| OPERATING LOSS                      |   |   | (41,909)                             |   |   | (615,482) |
|                                |   |   |                                 |   |   |   |
| OTHER INCOME (EXPENSE)              |   |   |                                 |   |   |   |
| Interest Expense                    |   |   | (556,245)                            |   |   | (506,156) |
| Gain on Extinguishments of Debt     |   |   | -                                    |   |   | 26,564 |
| Total Other Income (Expense)        |   |   | (556,245)                            |   |   | (479,592) |
|                                |   |   |                                 |   |   |   |
| LOSS BEFORE INCOME TAXES            |   |   | (598,154)                            |   |   | (1,095,074) |
|                                |   |   |                                 |   |   |   |
| INCOME TAX EXPENSE                  |   |   | -                                    |   |   | - |
|                                |   |   |                                 |   |   |   |
| NET LOSS                            |   | $      | (598,154)                            |   | $ | (1,095,074) |
|                                |   |   |                                 |   |   |   |
| LOSS PER SHARE                      |   | $      | (0.01)                               |   | $ | (0.01) |
|                                |   |   |                                 |   |   |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING |   |   | 94,378,209                           |   |   | 90,278,841 |

 

 

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

 

25

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

Statements of Shareholders’ Equity (Deficit)

 

 

|                                              |   |   |         |   |   | Additional

Paid-In

Capital |   |   | Retained

Deficit |   |   | Total

Shareholders’

Equity (Deficit) |
|---------------------------------------------------|--------|--------|--------------|--------|--------|------------------------------|--------|--------|-------------------|--------|--------|---------------------------------------------|
|                                              |   |   | Common Stock |   |   |                         |   |   |              |
|                                              |   |   | Shares       |   |   | Amount                       |   |   |              |   |   |                                        |
| 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   |   |   | -            |   |   | -                            |   |   | -                 |   |   | (1,095,074)                                 |   |   | (1,095,074) |
|                                              |   |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |
| Balance at 

December 31, 2005                    |   |   | 93,769,177   |   |   | 9,377                        |   |   | 5,360,270         |   |   | (8,765,148)                                 |   |   | (3,395,501) |
|                                              |   |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |
| Common stock issued for

payment of Loan Interest |   |   | 2,628,329    |   |   | 263                          |   |   | 77,737            |   |   | -                                           |   |   | 78,000 |
|                                              |   |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |
| Warrant issued for

Dolphin Asset Purchase        |   |   | -            |   |   | -                            |   |   | 60,742            |   |   | -                                           |   |   | 60,742 |
|                                              |   |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |
| Net loss for the year ended

December 31, 2006    |   |   | -            |   |   | -                            |   |   | -                 |   |   | (598,154)                                   |   |   | (598,154) |
|                                              |   |   |         |   |   |                         |   |   |              |   |   |                                        |   |   |   |
| Balance at

December 31, 2006                     |   |   | 96,397,506   |   | $      | 9,640                        |   | $      | 5,498,749         |   | $      | (9,363,302)                                 |   | $ | (3,854,913) |

 

 

 

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

 

26

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

Consolidated Statements of Cash Flows

 

 

|                                                           |   |   | For the Years Ended

December 31 |
|----------------------------------------------------------------|--------|--------|----------------------------------|
|                                                           |   |   |
|                                                           |   |   | 2006                             |   |   | 2005 |
|                                                           |   |   |                             |   |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                           |   |   |                             |   |   |   |
|                                                           |   |   |                             |   |   |   |
| Net Loss                                                       |   | $      | (598,154)                        |   | $ | (1,095,074) |
| Adjustments to reconcile net loss to net cash                  |   |   |                             |   |   |   |
| used by operating activities:                                  |   |   |                             |   |   |   |
| Depreciation and amortization                                  |   |   | 388,797                          |   |   | 454,337 |
| Common stock issued for services and interest                  |   |   | 78,000                           |   |   | 49,829 |
| Warrants issued related to sales agreements                    |   |   | 60,742                           |   |   | 86,392 |
| Amortization of notes payable discount                         |   |   | (45,953)                         |   |   | 43,879 |
| Amortization of dolphin Financing Agreement                    |   |   | (408,382)                        |   |   | (311,944) |
| Gain on extinguishment of debt                                 |   |   | -                                |   |   | (26,564) |
| Bad debt expense                                               |   |   | -                                |   |   | 253,481 |
| Net changes in operating assets and liabilities:               |   |   |                             |   |   |   |
| Increase in trade accounts and other receivable                |   |   | (14,135)                         |   |   | (348,910) |
| (Increase) decrease in inventory                               |   |   | (45,869)                         |   |   | 51,478 |
| (Increase) decrease in prepaid expenses and other assets       |   |   | 50,590                           |   |   | 45,706 |
| Decrease in intangibles                                        |   |   | -                                |   |   | 12,927 |
| Increase (decrease) in accounts payable                        |   |   | (65,100)                         |   |   | 533,510 |
| Increase (decrease) in accrued payroll and payroll taxes       |   |   | 10,344                           |   |   | 114,804 |
| Increase (decrease) in sales tax payable                       |   |   | 22,343                           |   |   | (14,705) |
| Increase (decrease) in gift certificates and customer deposits |   |   | 624                              |   |   | (20,264) |
| Increase (decrease) in accrued expenses                        |   |   | 68,176                           |   |   | (779,105) |
| Decrease in deposits on simulator sales                        |   |   | (238,008)                        |   |   | (316,877) |
|                                                           |   |   |                             |   |   |   |
| Net Cash Used by Operating Activities                          |   |   | (735,985)                        |   |   | (1,267,100) |
|                                                           |   |   |                             |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                           |   |   |                             |   |   |   |
|                                                           |   |   |                             |   |   |   |
| Purchase of property and equipment                             |   |   | (197,987)                        |   |   | (1,024,410) |
| Sale of property and equipment                                 |   |   | 113,031                          |   |   | 202,430 |
|                                                           |   |   |                             |   |   |   |
| Net Cash Used by Investing Activities                          |   |   | (84,956)                         |   |   | (821,980) |
|                                                           |   |   |                             |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                           |   |   |                             |   |   |   |
|                                                           |   |   |                             |   |   |   |
| Payments of notes payable                                      |   |   | (265,916)                        |   |   | (540,171) |
| Proceeds from issuance of notes payable                        |   |   | 950,000                          |   |   | 1,647,758 |
|                                                           |   |   |                             |   |   |   |
| Net Cash Provided by Financing Activities                      |   |   | 684,084                          |   |   | 1,107,587 |
|                                                           |   |   |                             |   |   |   |
| INCREASE (DECREASE) IN CASH                                    |   |   | (136,857)                        |   |   | (981,493) |
|                                                           |   |   |                             |   |   |   |
| CASH, BEGINNING OF YEAR                                        |   |   | 353,180                          |   |   | 1,334,673 |
|                                                           |   |   |                             |   |   |   |
| CASH, END OF YEAR                                              |   | $      | 216,323                          |   | $ | 353,180 |
|                                                           |   |   |                             |   |   |   |

 

 

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

 

27

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

Consolidated Statements of Cash Flows (Continued)

 

 

|                                              |   |   | For the Years Ended

December 31 |
|---------------------------------------------------|--------|--------|----------------------------------|
|                                              |   |   |
|                                              |   |   | 2006

                      |   |   | 2005

  |
|                                              |   |   |                             |   |   |   |
| SUPPLEMENTAL CASH FLOW DISCLOSURES:               |   |   |                             |   |   |   |
|                                              |   |   |                             |   |   |   |
| Cash paid for interest                            |   | $      | 165,372                          |   | $ | 87,455 |
| Cash paid for income taxes                        |   | $      | -                                |   | $ | - |
|                                              |   |   |                             |   |   |   |
| SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS: |   |   |                             |   |   |   |
|                                              |   |   |                             |   |   |   |
| Common stock issued for services and interest     |   | $      | 78,000                           |   | $ | 447,829 |
| Warrants sold                                     |   | $      | 60,742                           |   | $ | 86,392 |
| Options granted on notes payable                  |   | $      | -                                |   | $ | 15,887 |
|                                              |   |   |                             |   |   |   |

 

 

 

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

 

28

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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 two 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, and (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 and lease base of operators, and the sale or lease of its new Reactor simulators for mobile marketing applications.  In revenue sharing, the Company enters into an agreement whereby the Company is entitled to an agreed percentage of the revenuegenerated 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. 

 

c. CONSOLIDATION 

 

The consolidated financial statements at December 31, 2006 and 2005 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. 

 

d. 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. 

 

29

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

e. 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, 2006, the amount exceeding the FDIC limit was $68,883.

 

f. ACCOUNTS RECEIVABLE

 

Account receivables are carried at original invoice amount less an estimate made for doubtful accounts based on a review of all outstanding amounts on a quarterly basis.  Management determines the allowance for doubtful accounts by identifying troubled accounts and using historical experience applied to an aging of accounts.  Account receivables are written off when deemed uncollectible.  Recoveries of trade receivables previously written off are offset against the allowance when received.  At December 31, 2006 the balance of Accounts Receivable of $229,506 is net of a $238,781 reserve for uncollectible accounts related to Checker Flag Lightning.

 

g. 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 

 

h. 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.

 

i. 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. 

 

30

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

j. 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.

 

k. INVENTORY

 

At December 31, 2006, inventory consisted of the following:

 

| Merchandise Inventory   | $      | 17,496  |   |   |   |
|-------------------------|--------|---------|--------|--------|--------|
| Simulators Inventory    |   | 158,462 |   |   |   |
| Manufacturing Inventory |   | 82,364  |   |   |   |
| Inventory Reserve       |   | (4,000) |   |   |   |
|                    |   |    |   |   |   |
| Total Inventory         | $      | 254,322 |   |   |   |

 

l. 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 recognized as a cost of sale or capitalized as Property and Equipment, and are depreciated as noted in paragraph (f) above.

 

m. 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. 

 

n. 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, 2006, deposits of $1,019,093 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.

 

31

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

On December 31, 2004, March 31, 2005 and April 15, 2005, the Company and its two subsidiaries entered into an agreement to sell 44 of its race car simulators.  The purchase price of $1,536,600, $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 a management agreement to provide services for the term of the contract and sold 5,161,500, 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%.  The annual amortization of the Dolphin borrowing decreased notespayable and increased net income by $408,382 and $305,407 for 2006 and 2005, respectively.  The annual revenue recognized was $706,432 and $605,845 for 2006 and 2005, respectively, and was offset by an interest expense of $298,050 and $300,437 for 2006 and 2005, respectively. 

 

o. 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 assumes 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 9,666,500 of dilutive instruments at December 31, 2006.

 

p. CONSOLIDATION 

 

The consolidated financial statements at December 31, 2006 and 2005 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. 

 

q. 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, 2006, the Company’s net deferred tax asset is fully offset by a valuation allowance.

 

32

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

r. ADVERTISING 

 

Advertising expenses were $57,751 and $75,702 for the years ended December 31, 2006 and 2005, respectively. 

 

s. WARRANTY POLICY DISCLOSURE 

 

The Company accrues a liability on the warranty of simulators sold for the cost of future repairs.  In general the warranty covers the cost of parts, labor and travel for a predetermined period of time ranging from six months to two years.  The warranty is determined by the Company on a per contract basis.  

 

|            |   | For the Year Ended December 31, |
|-----------------|--------|---------------------------------|
| Warranty Period |   | 2005                            |   | 2006 |
| 2006            | $      | 17,028                          |   |   |
| 2007            |   | 9,274                           | $ | 18,314 |
| 2008            |   |                            |   | 11,422 |
|            |   |                            |   |   |
| Total           |   | 26,302                          |   | 29,736 |

 

 

 

33

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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 shares weresubsequently 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, 2006 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, 2006.

 

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.

 

On September 11, 2006, the Company issued 1,818,484 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 $60,000.

 

34

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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

 

On December 9, 2006, the Company issued 809,845 shares of common stock per the terms of the Secured Bridge Notes initially due December 31, 2003 (Note 5).  Total interest expense associated with this issuance was $18,000.

 

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 Scholes 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.

 

On July 14, 2006, the Company entered into Note and Warrant Purchase and Security agreements to sell $950,000 15% notes in aggregate principal amount of its Secured Notes due August 1, 2010.  Simultaneous to this transaction, the Company sold the buyer 2,375,000 common stock warrants, which are exercisable for four years from the date of the transaction at $0.10 per warrant.  Using the Black Scholes valuation model, the Company determined the value of these warrants to be $60,742, assuming a risk-free interest rate of 4.96% over a period of four years.

 

NOTE 4 - PROPERTY AND EQUIPMENT 

 

At December 31, 2006, property and equipment was comprised of the following: 

 

| Furniture, Fixtures and Equipment |   | $      | 1,576,965 |   |   |
|-----------------------------------|--------|--------|-----------|--------|--------|
| Revenue share installation costs  |   |   | 289,339   |   |   |
| Construction in Progress          |   |   | 118,397   |   |   |
| Software                          |   |   | 791,864   |   |   |
| Total Property and Equipment      |   |   | 2,776,565 |   |   |
|                              |   |   |      |   |   |
| Less:  Accumulated depreciation   |   |   | 1,890,854 |   |   |
|                              |   |   |      |   |   |
| Property and Equipment, net       |   | $      | 885,711   |   |   |

 

Depreciation expense for the years ended December 31, 2006 and 2005 was $388,797 and $454,337 respectively. 

 

35

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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 (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 an undetermined date in 2006, 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 an undetermined date in 2007, with the expiration of the accompanying option to follow 30 days past the maturity date.  

 

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.

 

36

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 5 - DEBT AND CREDIT ARRANGEMENTS (Continued)

 

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 $7,831 and $1,530 was included in interest expense for the twelve months ended December 31, 2006 and 2005, respectively.

 

On March 29, 2006, Perfect Line and MOAC Mall Holdings, LLC, the Mall of America landlord, agreed to a stipulation agreement whereby Perfect Line signed a promissory note totaling $294,652 payable in five (5) quarterly installments, with the first payment of $78,471 made on February 28, 2006, and payments of $54,045 to be made beginning July 14, 2006 and ending July 15, 2007.  The $54,045 payments for 2006 were made on July 14 and November 15.

 

On July 14, 2006, Interactive Motorsports and Entertainment Corp. (the “Company”) and its wholly owned subsidiary, Perfect Line, Inc. (“Perfect Line”) entered into Note and Warrant Purchase and Security Agreements with ten (10) investors in a private placement which is exempt from the registration provisions of the Securities Act of 1933, as amended, pursuant to Reg. D and Rule 506 adopted thereunder.  The Notes, totaling $950,000, were issued by Perfect Line, will be fully paid down July 17, 2010 and bear interest at a rate of 15% per annum for the total interest amount over the four year period of $314,988.  Each note came with an option to purchase common shares of the Company equal to two and one half times the amount of notes purchased divided by the exercise price of the option.  

 

The value of the options will be amortized to interest expense over their life which expires on July 13, 2010.  Amortization of option discount for the options related to the 2006 Agreement of $6,598 was included in interest expense for the twelve months ended December 31, 2006.

 

37

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 5 - DEBT AND CREDIT ARRANGEMENTS (Continued)

 

Notes Payable consisted of the following at December 31, 2006:

 

| Note payable to investor bearing interest at 12%,

due at an undetermined date in 2007. 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, currently under negotiation                                                                                                                                         |   | 95,580      |
|                                                                                                                                                                                            |   |        |
| Note payable to a landlord, bearing interest at 10.9%, due July 15, 2007, two payments of $54,045 are due March and July of 2007                                                                |   | 108,091     |
|                                                                                                                                                                                            |   |        |
| Borrowing transaction with RCS bearing imputed interest

at 15%, 5 year term.                                                                                                                   |   | 1,760,761   |
|                                                                                                                                                                                            |   |        |
| Note payable to individuals, bearing interest at 15%,

due July 13, 2010. Secured by certain simulators of the Company.                                                                         |   | 870,644     |
|                                                                                                                                                                                            |   |        |
| Less:  unamortized discount                                                                                                                                                                     |   | (60,310)    |
| Total Notes Payable                                                                                                                                                                             |   | 3,497,266   |
|                                                                                                                                                                                            |   |        |
| Less:  Current Portion                                                                                                                                                                          |   | (1,539,795) |
| Total Notes Payable – Long Term Portion                                                                                                                                                    | $      | 1,957,471   |
|                                                                                                                                                                                            |   |        |
| Future maturities of notes payable as of December 31,                                                                                                                                           |   |        |
| 2007                                                                                                                                                                                            | $      | 1,539,795   |
| 2008                                                                                                                                                                                            |   | 787,253     |
| 2009                                                                                                                                                                                            |   | 909,189     |
| 2010                                                                                                                                                                                            |   | 261,029     |
| Total Notes Payable                                                                                                                                                                             | $      | 3,497,266   |

 

 

 

38

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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 has been in discussions with NASCAR about terminating the license for the “NASCAR Silicon Motor Speedway” logo since management feels the license is expensive for use in only 2 sites (Mall of America and Universal CityWalk).  Various options are being discussed with NASCAR currently, but the sites will all continue to use thelicensed NASCAR tracks and teams in any scenario.

 

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 $1,017,071, and $1,035,336 for the years ended December 31, 2006 and 2005, respectively. During 2004, the Company entered into various agreements with Checker Flag Lightning 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, 2006, 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 |
|--------------------------------|--------------------|-----------|----------------------|-----------|-----------------------------|
|                           | 2007               |      | 977,021              |      | 623,813                     |
|                           | 2008               |      | 754,602              |      | 401,394                     |
|                           | 2009               |      | 703,677              |      | 379,944                     |
|                           | 2010               |      | 379,944              |      | 379,944                     |
|                           |               |      |                 |      |                        |
| Total Required Rental Payments | $                  | 2,815,244 | $                    | 1,785,095 |

 

 

39

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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.  The Company’s subsidiary, Perfect Line, Inc., filed a complaint in the U.S. District Court Southern District of Indiana on December 6, 2006 against Checker Flag Lightning, LLC and Mike Schuelke, seeking a Declaratory Judgment, Injunctive Relief and Damages for failing to make the required payments (at least $559,119) under certain lease agreements between Checker Flag Lightning and Perfect Line.  The Company cannot be sure of the outcome of this litigation. 

 

On September 6, 2006, Perfect Line and its lease assignee, Checker Flag Lightning, were served a complaint from Mall of Georgia for past due rent totaling $164,726 between the two parties of which $95,580 is directly attributable past rent due by Perfect Line.  The non-performance of CFL in paying either its rent obligations to Mall of Georgia under the assigned lease or the payments due to Perfect Line under their revenue share agreement has resulted in this complaint from Mall of Georgia.  Perfect Line has agreed to the terms of a settlement agreement with Mall of Georgia and is waiting on the settlement agreement draft for review at the time of this filing. The terms of the settlement will allow Perfect Line the ability to remove the 8 SMS simulators at the Mall of Georgia location and permits Perfect Line a reasonable time period for the payment of its obligations to Mall of Georgiawhile it reactivates the simulators into the market.  

 

The Company has a contractual obligation to Dolphin binding Perfect Line to a minimum payment of guaranteed revenue for the term of the existing lease/revenue share agreements or three years, whichever comes later as stated in the Asset Purchase Agreement.  As of December 31, 2006, the Company was made aware of the default of $102,000 payments in arrears of one of the lease partners.  At the time of this filing, Dolphin and the lease partner were negotiating payment terms for the amount of the default, but the Company cannot assure that the parties can come to an agreement on terms acceptable to both parties. .

 

As of the filing of this Annual Report on Form 10-KSB, 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, 2007.

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, 2007. Secured by certain simulators of the Company 

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

 

 

40

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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 than 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, 2006 and 2005:

 

|                      |   |   | 2006        |   |   | 2005        |
|---------------------------|--------|--------|-------------|--------|--------|-------------|
|                      |   |   |        |   |   |        |
| Deferred tax assets:      |   |   |        |   |   |        |
| NOL Carryover             |   | $      | 2,623,550   |   | $      | 2,397,601   |
| Depreciation              |   |   | 66,550      |   |   | 130,787     |
|                      |   |   |        |   |   |        |
| Deferred tax liabilities: |   |   |        |   |   |        |
| Valuation allowance       |   |   | (2,690,100) |   |   | (2,528,388) |
|                      |   |   |        |   |   |        |
| Net deferred tax asset    |   | $      | -           |   | $      | -           |

 

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, 2006 and 2005 due to the following:

 

|                               |   |   | 2006      |   |   | 2005      |
|------------------------------------|--------|--------|-----------|--------|--------|-----------|
|                               |   |   |      |   |   |      |
| Book loss                          |   | $      | (233,280) |   | $      | (230,715) |
|                               |   |   |      |   |   |      |
| Loss on the Sale of Assets         |   |   | (4,705)   |   |   | (29,375)  |
|                               |   |   |      |   |   |      |
| Depreciation                       |   |   | 19,735    |   |   | 39,610    |
|                               |   |   |      |   |   |      |
| Meals and Entertainment            |   |   | 1,450     |   |   | 1,823     |
|                               |   |   |      |   |   |      |
| Stock for services/options expense |   |   | 30,320    |   |   | 180,160   |
| Other                              |   |   | -         |   |   | 4,145     |
| Valuation Allowance                |   |   | 225,950   |   |   | 34,352    |
|                               |   |   |      |   |   |      |
| Net Income tax provision           |   | $      | -         |   | $      | -         |

 

At December 31, 2006, the Company had net operating loss carryforwards of approximately $5,447,000 that may be offset against future taxable income from the year 2006 through 2024.  No tax benefit has been reported in the December 31, 2006 financial statements since the potential tax benefit is offset by a valuation allowance of the same amount.

 

41

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 10 - INCOME TAXES (continued)

 

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.

 

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

 

In May 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections.” This new standard replaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and represents another step in the FASB’s goal to converge its standards with those issued by the IASB. Among other changes, Statement 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented on the new accounting principle, unless it is impracticable to do so. Statement 154 also provides that (1) a change in method of depreciating or amortizing a long-lived non-financial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle, and (2) correction of errors inpreviously issued financial statements should be termed a “restatement.” The new standard is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. Early adoption of this standard is permitted for accounting changes and correction of errors made in fiscal years beginning after June 1, 2005. The adoption of SFAS 154 did not have an impact to the Company's overall results of operations or financial position. 

 

In February of 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments,” which is intended to simplify the accounting and improve the financial reporting of certain hybrid financial instruments (i.e., derivatives embedded in other financial instruments). The statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a replacement of FASB Statement No. 125.” SFAS No. 155 is effective for all financial instruments issued or acquired after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company is currently evaluating the impact SFAS No. 155 will have on its consolidated financial statements, if any. 

 

42

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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

In March of 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140” (SFAS 156).  SFAS 156 amends SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities a replacement of FASB Statement No. 125,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in any of the following situations: (a) a transfer of the servicer’s financial assets that meets the requirements for sale accounting, (b) a transfer of the servicer’s financial assets to a qualifying special-purpose entity in a guaranteed mortgage securitization inwhich the transferor retains all of the resulting securities and classifies them as either available-for-sale securities or trading securities, and (c) an acquisition or assumption of an obligation to service a financial asset that does not relate to financial assets of the servicer or its consolidated affiliates. SFAS 156 is effective for all servicing assets and liabilities as of the beginning of an entity's first fiscal year that begins after September 15, 2006.  The effect of adoption of SFAS 156 is not anticipated to have a material impact on the Company’s consolidated financial statements.

 

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (FIN 48) – an interpretation of FASB Statement No. 109, Accounting for Income Taxes (SFAS No. 109)” (FIN 48)*.* FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109 and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return. Guidance is also provided on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.  The effect of adoption of FIN 48 is not anticipated to have a material impact on the Company’s consolidatedfinancial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157).  SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Where applicable, SFAS 157 clarifies and codifies related guidance within other generally accepted accounting principles. SFAS 157 is effective for fiscal years beginning after November 15, 2007.  The effect of adoption of SFAS 157 is not anticipated to have a material impact on the Company’s consolidated financial statements.

 

43

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

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

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS 158).  SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income.  SFAS 158 also eliminates the option in SFAS 87 to measure plan assets and obligations up to three months prior to the financial statement date.  SFAS 158 is effective for fiscal years ending after December 15, 2006.  The adoption of SFAS 158 did not have an impact to the Company's overall results of operations or financial position.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment to SFAS No. 115” (SFAS  159).  SFAS 159 permits entities to elect to measure many financial instruments and certain other items at fair value. Upon adoption of SFAS 159, an entity may elect the fair value option for eligible items that exist at the adoption date. Subsequent to the initial adoption, the election of the fair value option should only be made at initial recognition of the asset or liability or upon a remeasurement event that gives rise to new-basis accounting. The decision about whether to elect the fair value option is applied on an instrument-by-instrument basis, is irrevocable and is applied only to an entire instrument and not only to specified risks, cash flows or portions of that instrument. SFAS 159 does notaffect any existing accounting standards that require certain assets and liabilities to be carried at fair value nor does it eliminate disclosure requirements included in other accounting standards. SFAS 159 is effective for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact of adopting SFAS 159 on its consolidated financial position and results of operations.

 

44

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 12 - ACCRUED LIABILITIES  

 

Accrued Liabilities consisted of the following at December 31, 2006

 

| 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. | $      | 125,835 |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|
| Vacation pay accrual                                                                                                                                                   |   | 55,442  |
| Accrued warrant expenses on sold simulators                                                                                                                            |   | 29,736  |
| Accrued licensing fees                                                                                                                                                 |   | 110,750 |
| Accrued property taxes                                                                                                                                                 |   | 29,500  |
| Accrued purchases                                                                                                                                                      |   | 60,500  |
| Accrued miscellaneous expenses                                                                                                                                         |   | 20,982  |
|                                                                                                                                                                   |   |    |
| Total Accrued Liabilities                                                                                                                                              | $      | 432,745 |

 

 

NOTE 13 - DEPOSITS ON SIMULATOR SALES

 

Deposits on simulator sales consist of the following on December 31, 2006

 

| Company                           |   | Number of Units    |   | Amount  |
|-----------------------------------|--------|--------------------|--------|---------|
|                              |   |               |   |    |
| Roltex Group*                     |   | 8 Simulators       | $      | 552,692 |
| Tonne Management*                 |   | 4 Simulators       |   | 222,000 |
| Bookstore Management              |   | 3 Simulators       |   | 140,000 |
| DGI, Inc.                         |   | 6 Reactors         |   | 84,000  |
| Daytona USA                       |   | Computers only (8) |   | 20,401  |
|                              |   |               |   |    |
| Total deposits on simulator sales | $      | 1,019,093          |
|                              |   |               |   |    |

 

* The Company has not been in recent communication with the principles of Roltex Group and Tonne Management in regards to the completion of the related contracts.

 

NOTE 14 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

In December of 2006, DGI, Inc., an Indiana corporation managed by and under majority ownership of William R. Donaldson, purchased 10 Reactor simulators for $370,000 from Perfect Line and subsequently leased the simulators to Sprint Nextel (6) and Toyota (4).  Mr. Donaldson is the Chairman and Chief Executive Officer of the Company.

 

 

45

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

Notes to the Consolidated Financial Statements

December 31, 2006 and 2005

 

NOTE 15 – SUBSEQUENT EVENTS

 

On February 7, 2007, the Company and iRacing.com Motorsport Simulations signed a Letter of Intent to enter into a licensing relationship for Perfect Line’s exclusive use of iRacing.com’s Sim Technology (as defined) within Perfect Line’s motion platforms employed within their racing centers and mobile marketing units.   

 

Perfect Line has contracted with DGI, Inc. for an additional 14 Reactor simulators, 12 of which will be installed in three separate Sprint Nextel mobile marketing experiences (4 in each experience) and 2 which will be installed in a Toyota interactive show car experience. 

 

NOTE 16 – LIQUIDITY

Since inception, the Company has financed its operations through debt financing and proceeds generated from public offerings of its common stock. The proceeds from these transactions have been used primarily to fund research and development costs, and selling, general and administrative expenses. 

The Company has incurred substantial net operating losses since inception and negative cash flows from operating activities through December 31, 2006 resulting in an accumulated deficit of $9.3 million. During fiscal year 2006, cash decreased from $353,180 to $216,323, largely due the continued development of the new Reactor and interest paid on debt. 

The Company recorded a net loss of $598,154 in fiscal year 2006. As of December 31, 2006, the Company had $216,323 in cash to fund operations. 

The Company is dependent on available cash and operating cash flow to finance operations and meet its other capital needs. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand plus the additional liquidity that it expects to generate from operations will be sufficient to cover its working capital needs and fund expected capital expenditures over at least the next twelve months. 

 

46

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

 

None.

 

**ITEM 8A. CONTROLS AND PROCEDURES** 

 

(a) Disclosure Controls and Procedures.

 

The Principal Executive Officer (“PEO”), who is also the Principal Financial Officer (“PFO”) of the Company, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the fiscal period covered by this Annual Report on Form 10-KSB.  Based upon such evaluation, the PEO/PFO has concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed in this filing is accumulated and communicated to management and is recorded, processed, summarized and reported in a timely manner and in accordance with Securities and Exchange Commission rules and regulations.

 

47

**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 on 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. Each director shall be elected for the term of one year, and until his or her successor is elected and qualified, or until his or her 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 | 50      | Chairman, Chief Executive Officer and Secretary |
| Carl L. Smith, Sr.   | 65      | 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.  Mr. 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 DePauwUniversity in Greencastle, Indiana.

 

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. 

 

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 Mr. 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. 

 

48

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, 2006 

 

**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 West 73rd Street, Indianapolis, Indiana, 46278.

 

49

**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, 2006 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** |  

 

**All Other Compensation****** |
|                                                    |                                |                               |                              |                                         |   |   |   |   |
| William R. Donaldson,

Chairman and CEO                 | 2006                                | $150,000                           | -                                 | $7,513                                       | - | - | - | - |
| 2005                                                    | $150,000                            | -                                  | $7,055                            | -                                            | - | - | - |
| 2004                                                    | $150,000                            | -                                  | $6,659                            | -                                            | - | - | - |

 

|   | (2) | Includes cost of medical and life insurance. |
|--------|-----|----------------------------------------------|

 

Because the Company has not granted stock options or other equity awards to employees to date, the equity awards table is not included in this document.

 

**Director Compensation**

 

Directors of the Company are currently not paid for their services; however, the Company is considering establishing a compensation plan utilizing stock awards versus cash payments in 2007.

 

Because the Company has not compensated directors to date, the equity awards table is not included in this document.

 

**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. 

 

**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. 

 

50

**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 21, 2007 for each person or entity that is known by us to beneficially own more than 5% of our Common Stock. As of March 21, 2007, the Company had 96,397,506 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                             | 18.40%                          |
| Vikki Cook, Sarasota, FL                                 | 10,104,422                            | Direct                             | 10.48%                          |
| James Matheny, Cary, NC                                  | 8,691,151                             | Direct                             | 9.02%                           |
| Dolphin Direct Equity Partners, LP (**a**)               | 7,141,500                             | Direct                             | 7.41%                           |
| Alliance Investment Management, LTD, Nassau, Bahamas     | 6,337,846                             | Direct                             | 6.57%                           |
|                                                     |                                  |                               |                            |
| Total                                                    | 50,011,369                            |                                    | 51.88%                          |

 

|   | **(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 include Dolphin’s beneficial ownership of shares pursuant to the Warrants which are exercisable within 60 days. |
|--------|---------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Security Ownership of Management**

 

The following table sets forth certain information with respect to the beneficial ownership of our Common Stock as of March 21, 2007 for each of our directors and each of our Named Executive Officers, and all directors and executive officers as a group. As of March 21, 2007, the Company had 96,397,506 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                             | 18.40%                          |
| Carl L. Smith, Director; Sarasota, Florida                                              | -                                         | n/a                                | -                               |
| Cary Agajanian, Director; Los Angeles, California                                       | -                                         | n/a                                | -                               |
| Total                                                                                   | 17,736,450                                |                               | 18.40%                          |
|                                                                                    |                                      |                               |                            |
| All Executive Officers & Directors as a Group 

(3 persons)                         |  

17,736,450                        |                               |  

18.40%                  |

 

(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. 

 

51

**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.

 

In December of 2006, DGI, Inc., an Indiana corporation managed by and under majority ownership of William R. Donaldson, purchased 10 Reactor simulators for $370,000 from Perfect Line and subsequently leased the simulators to Sprint Nextel (6) and Toyota (4).  Mr. Donaldson is the Chairman and Chief Executive Officer of the Company.

 

 

52

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

 

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

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

|   | 3(ii) | ByLaws1 |
|--------|-------|---------|

|   | 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, a Michigan limited liability company 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 January 6, 2006 | Entered into an Asset Purchase Agreement pursuant to which it sold twenty-eight (28) of its race car simulators to Checker Flag Lightning, LLC, a Michigan limited liability company.

                                                                                                                                                                                                                                                  |
|--------|----------|-----------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.     | Form 8-K | Filed July 20, 2006   | Announcement of note, warrant, and security agreements with investors in a private placement.

                                                                                                                                                                                                                                                                                                                                          |
| 3.     | Form 8-K | Filed August 21, 2006 | 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 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). |
|   |     |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

 

 

53

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

 

**Audit Fees**

Fees for audit services from HJ and Associates totaled $43,491 for the year ended December 31, 2005.  Fees for audit services from HJ and Associates totaled $55,000 for the year ended December 31, 2006.  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 $6,320 for the year ended December 31, 2005.  There were no fees for audit-related services from HJ and Associates for the year ended December 31, 2006.  These auditing services consisted of assistance related to SEC staff 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 $62 for the year ended December 31, 2005.  Fees from HJ and Associates for tax services, including fees for review of the consolidated federal income tax return, totaled $6,155 the year ended December 31, 2006.

 

**All Other Fees**

No fees were billed by HJ and Associates for the fiscal year ending December 31, 2005 and for the fiscal year ending December 31, 2006 other than those specified above. 

 

 

54

PRE-APPROVAL POLICY FOR AUDIT AND NON-AUDIT SERVICES

 

The Company does not have a standing audit committee, and the full Board of Directors 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, if one is established, 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 theannual 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 theindependent auditor  no  longer  being considered independent under the applicable rules and regulations  of  the  Securities  and  Exchange  Commission.

 

There were no fees in 2006 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).

 

 

 

55

**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: March 28, 2007 | 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: March 28, 2007 | By: | */s/ William R. Donaldson* |
|--------|----------------------|-----|----------------------------|

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

William R. Donaldson

Chairman of the Board and Chief Executive Officer

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

 

|   | Date: March 28, 2007 | By: | */s/ William R. Donaldson* |
|--------|----------------------|-----|----------------------------|

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

William R. Donaldson

Chief Financial Officer and Treasurer

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

 

|   | Date: March 28, 2007 | By: | */s/ Carl L. Smith* |
|--------|----------------------|-----|---------------------|

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

Carl L. Smith

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

 

|   | Date: March 28, 2007 | By: | */s/ Cary Agajanian* |
|--------|----------------------|-----|----------------------|

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

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

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

 

 

 

56

**EXHIBIT INDEX**

 

EXHIBITS:

 

Exhibits:

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

|   | 3(ii) | ByLaws1 |
|--------|-------|---------|

|   | 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, a Michigan limited liability company 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 |
|--------|----------------------------------------------------------------------|

 

 

 

 

57