Item 1. Business. General
We are a diversified gaming company that focuses on two business lines: slot route operations and casino operations. Our slot route operations involve the exclusive installation and operation of slot machines in certain strategic, high traffic, non-casino locations, such as grocery stores, drug stores, convenience stores, bars and restaurants. We currently own and operate approximately 7,200 slot machines in our slot route business and are one of the largest slot machine operators in Nevada. As of December 31, 2006, our casino operations in Nevada consisted of five casinos that focus on local gaming patrons, and included the ownership and operation of Terrible’s Hotel & Casino in Las Vegas, Nevada and four other small casinos in southern Nevada operated under the Terrible’s name. As of December 31, 2006, these casinos contained an aggregate of approximately 2,016 slot machines and 18 table games. At the end of our 2006 fiscal year, our casino operations outside of Nevada consisted of Terrible’s St. Jo Frontier Casino in St. Joseph, Missouri (“ St. Jo”), Terrible’s Mark Twain Casino in LaGrange, Missouri (“Mark Twain”), and Terrible’s Lakeside Casino Resort in Osceola, Iowa (“Lakeside Iowa”). At that time these three properties contained an aggregate of approximately 2,265 slot machines and 44 table games. As a result of the completion of our acquisition of The Sands Regent (the “Sands Regent Acquisition”) on January 3, 2007 described below, as of that date our casino operations also included the Rail City Casino in Sparks, Nevada (“Rail City”); the Sands Regency Casino Hotel in downtown Reno, Nevada (“Sands”); the Gold Ranch Casino and RV Resort in Verdi, Nevada (“Gold Ranch”) and Depot Casino (“Depot Casino”) and Red Hawk Sports Bar (“Red Hawk”, and together with Rail City, Sands, Gold Ranch and Depot Casino, the “Sands Regent Casinos”) in Dayton, Nevada, which as of that date contained an aggregate of approximately 1,661 slot machines and 27 table games.
Herbst Gaming, Inc. was incorporated in Nevada on January 21, 1997. It commenced business operations as a holding company of subsidiaries conducting slot route and casino operations on August 23, 2001.
Our principal executive offices are located at 3440 West Russell Road, Las Vegas, Nevada 89118 and our telephone number is (702) 889-7695.
Herbst Gaming, Inc. has elected to be taxed as an S corporation.
As used in this Form 10-K, the terms the “Company,” “we,” “us,” “our” and “Herbst Gaming” refer to Herbst Gaming, Inc. and its subsidiaries, unless the context indicates otherwise.
Available Information
Our Internet address is www.herbstgaming.com. We make available free of charge on or through our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”).
Recent Developments
Entry into Primm Acquisition Purchase Agreement
On October 31, 2006, the Company and MGM MIRAGE entered into a purchase agreement whereby the Company will acquire from MGM MIRAGE the Buffalo Bill’s, Primm Valley and Whiskey Pete’s hotel-casinos (collectively known as “Primm Valley Resorts”) located in Primm, Nevada, for $400 million (the “Primadonna Acquisition.”). The transaction is subject to customary closing conditions and the parties anticipate the transaction to close in the second quarter of 2007.
Closing of the Sands Regent Acquisition
On January 3, 2007, we consummated the Sands Regent Acquisition, paying approximately $119 million in cash for the outstanding securities of The Sands Regent. The Sands Regent operates casinos and tourist-based facilities, including Rail City Casino in Sparks, Nevada, which has approximately 16,600 square feet of gaming space housing 622 slots and 7 table games; the Sands Regency Casino Hotel in downtown Reno, Nevada, which contains 539 slot machines, 20 table games and an 833-room hotel; the Gold Ranch Casino and RV Resort in Verdi, Nevada, which contains 245 slot machines, a California lottery station located on the Nevada/California border, a 105-space RV park and an ARCO gas station and convenience store; and Depot Casino and Red Hawk Sports Bar in Dayton, Nevada, which together contain an aggregate of approximately 255 slot machines. We used proceeds from our credit agreement described below to fund the Sands Regent Acquisition.
Amended and Restated Credit Agreement
On January 3, 2007, we entered into a second amended and restated credit agreement (the “credit agreement”) with Bank of America, N.A. (“Bank of America”), as Administrative Agent, Swing Line Lender and L/C Issuer, Lehman Commercial Paper, Inc. and Wachovia Bank, National Association, as Syndication Agents, U.S. Bank, National Association, as Documentation Agent and Lehman Brothers Inc. and Wachovia Capital Markets, LLC, as Joint Lead Arrangers and Joint Book Runners. The credit agreement was an amendment and restatement of our previous amended and restated credit agreement dated as of October 8, 2004.
We borrowed $375 million in term loans under the credit agreement on January 3, 2007 to finance the Sands Regent Acquisition. Subject to certain conditions set forth in the credit agreement, proceeds from delay draw term loans will be available to finance the Primadonna Acquisition if and when it closes.
Passage of Anti-Smoking Initiative
On November 7, 2006, voters in Nevada passed Question 5, an initiative that prohibits smoking in indoor places of employment, including, but not limited to, bars and taverns that serve food, grocery stores, malls and other retail establishments, and that gives future control over smoking regulation to individual counties or municipalities. The Company had supported a competing initiative which banned smoking in restaurants and other locations frequented by minors and vested all future smoking regulation with the Nevada State Legislature. Since its adoption, Question 5 has led to significant decreased patron play at our route locations.
Narrative Description of Business
Our business focuses on attracting and fostering repeat business from local gaming patrons in both our route and casino operations. Local patrons are typically sophisticated gaming customers who seek convenient locations, high payouts and a pleasant atmosphere.
Route Operations
Our route operations involve the exclusive installation and operation of slot machines in chain store and street account locations. At December 31, 2006, we operated approximately 7,200 slot machines throughout the state of Nevada. We define chain stores as grocery stores, drug stores, merchandise stores and convenience stores, each with more than five locations. Our chain store contracts are primarily with large, national retailers such as Albertsons, Vons, Safeway, SavOn, Smith’s, Kmart and Rite Aid, as well as Terrible Herbst gas stations and convenience stores. Street accounts include local bars, restaurants and non-chain convenience stores. Nevada law limits slot route operations to certain types of non-casino locations including bars, taverns, convenience stores, grocery stores and drug stores. Most locations are limited to offering no more than 15 slot machines.
We generally enter into two types of route contracts: space lease arrangements and revenue-sharing arrangements. Under space lease arrangements, which we principally enter into with chain stores, we pay a fixed monthly fee for each location in which we place slot machines. Under revenue-sharing arrangements, which we typically enter into with street accounts, we pay the location owner a percentage of the revenues generated by our
slot machines located at that particular street account. In order to enter into a revenue-sharing arrangement, the location owner must hold a gaming license. Both space lease and revenue-sharing arrangements typically involve long-term contracts that provide us with the exclusive right to install our slot machines at particular locations. In the case of chain stores, our contracts give us the exclusive right to install slot machines at stores opened in the future.
Casino Operations
Our casino operations consist of eleven casinos in northern and southern Nevada, six of which we acquired as of January 3, 2007 pursuant to the Sands Regent Acquisition, and three casinos in Missouri and Iowa. All of our casino properties focus on local customers, with an emphasis on slot play. The following table summarizes our casino assets as of December 31, 2006 after giving effect to the Sands Regent Acquisition:
(1) Expected to be operated under the Terrible’s name.
Terrible’s Hotel & Casino Terrible’s Hotel & Casino in Las Vegas, Nevada (“Terrible’s”), opened on December 6, 2000. Terrible’s offers a buffet and a 24-hour café. There are currently 255 rooms with standard amenities as well as a pool and spa. Terrible’s is conveniently located approximately one mile east of the Las Vegas Strip, which we believe appeals to locals who wish to avoid the congestion of the Strip. Terrible’s favorable location has made it popular with Strip casino employees. Although we are not a tourist destination, we receive a certain amount of tourist traffic through our casino due to our location near the airport, the Strip and the Las Vegas Convention Center.
Terrible’s Lakeside Casino Resort Lakeside Iowa, a riverboat casino located on West Lake in Osceola, Iowa, is a facility that opened in January 2000. Lakeside Iowa offers a 60 room, all-suite hotel, modular conference and meeting facilities that can seat up to 900 people and that are used for meetings, banquets and concerts, a fitness center, an outdoor pool and a gift shop. In addition, Lakeside Iowa offers a newly renovated 280-seat restaurant/buffet and lounge located in the main lobby, two bars located in the casino, a convenience store and gas station that are located adjacent to the casino and 47 RV spaces with utility hookups. Lakeside Iowa owns 121 acres of land, 88 acres of which are undeveloped.
Terrible’s Mark Twain Casino Mark Twain, located in a man-made basin adjacent to the Mississippi River in LaGrange, Missouri, is facility that opened in July 2001. Mark Twain offers a 165-seat restaurant, an 80-seat bar and an additional bar in the casino. The casino has a locally popular theme based on Mark Twain, who grew up in and wrote about nearby Hannibal, Missouri.
Terrible’s St. Jo Frontier Casino St. Jo, located in a man-made basin adjacent to the Missouri River in St. Joseph, Missouri, is a facility that opened in May 1998 as a successor to a casino that opened in June 1994. St. Jo offers a recently remodeled bar and buffet. Additionally, St. Jo offers over 2,400 total square feet of modular conference and meeting space. The casino and its amenities have a locally popular Pony Express western theme that plays off St. Joseph’s heritage as the founding location and headquarters of the Pony Express. St. Jo owns 40 acres of land, 32 acres of which are undeveloped.
Rail City Casino
Rail City has approximately 16,600 square feet of gaming space housing 622 slots, 7 table games, including keno, a sports book operated by an independent party, a 24-hour family-style restaurant and a bar. Rail City’s customer base comes primarily from northern Nevada and a majority of its customers reside in close proximity to the casino. The casino is currently undergoing an expansion that will add over 200 new slot machines as well as a new bar and restaurant. The renovation began in the fourth quarter of 2006 and is expected to be completed early in the second quarter of 2007.
Sands Regency Casino Hotel
The Sands has approximately 29,000 square feet of gaming space and a full selection of gaming alternatives, including 539 slot machines and 20 table games, including keno, bingo, live poker and a sports book operated by an independent party. Additionally, the Sands resort complex has 833 hotel rooms, including 29 suites, a health spa, and a large outdoor swimming pool. Dining options at the Sands include Cabana Café, a coffee house/deli-style restaurant, The Buffet at the Sands, and Fuzio’s, a new Italian restaurant, that is scheduled to open in the first quarter of 2007. The property also has a Mels, the Original, diner style restaurant, and an Arby’s restaurant, both of which are operated by third-parties. The facility also includes an entertainment cabaret, three cocktail
lounges, a comedy club operated by a third party and approximately 12,000 square feet of convention and meeting space. Third-parties lease space from the Sands and operate a wedding chapel, a bicycle and ski rental shop, and a beauty shop. The Sands facility contains multiple parking areas, including a parking garage, with total combined capacity for approximately 1,100 vehicles. A substantial portion of the Sands business, particularly our hotel customer base, is arranged through travel groups, both air and motor coach wholesalers, which offer economy rates, and are primarily from Western Canada, the Pacific Northwest and Northern California.
Gold Ranch Casino and RV Resort
As of January 3, 2007, we own the business assets and lease the real property on which the Gold Ranch is located. The real property lease has a twenty-year term with four five-year extension options ending in 2042. We possess the option to purchase the real property on which the Gold Ranch is located. Gold Ranch offers approximately 245 slot machines in an 8,370 square foot casino, a sports book operated by a third party, a family-style restaurant, a Jack-in-the-Box restaurant leased to and operated by a third-party, a bar, a 105-space RV park, a California lottery station, an ARCO gas station, and a convenience store. Gold Ranch’s guests include both tourists and local residents with local residents generating over half of the property’s casino patronage. Gold Ranch attempts to attract local residents through mid-week promotions geared toward enhancing local play mainly through lottery, casino, and restaurant programs. Tourist programs emphasize the RV Park, casino and restaurant cross-promotions. Gold Ranch attempts to attract as much traffic as possible off Interstate 80, the major Nevada/California thoroughfare.
Dayton Depot Casino and Red Hawk Sports Bar
As of January 3, 2007, we own Depot Casino and Red Hawk, each of which is located in Dayton, Nevada. This ownership includes, with respect to the Depot Casino, the two buildings that house the Depot Casino and the 4.5 acres of real property on which the Depot Casino is located, and, with respect to Red Hawk, the building which houses the Red Hawk and the 0.5 acres of real property on which the Red Hawk is located. Depot Casino has 16,000 square feet of casino space, a family-style restaurant, two bars, 237 slot machines and a sports book operated by a third party. Red Hawk, located across Highway 50 from Depot Casino, houses 30 slot machines.
Financial Information
The primary source of our revenue and income is from our route and casino operations, although we view the restaurants, bars and services on our premises to be important adjuncts to our casino operations. The following table sets forth the contribution to total net revenues on a dollar and percentage basis of our major activities for the years ended December 31, 2004, 2005 and 2006.
(1) Calendar year 2005 reflects a partial year of operations of the casinos purchased pursuant to the acquisition of our casinos located outside of Nevada from Grace Entertainment, Inc. (the “Grace Acquisition”) in February 2005. As a result, the results of operations for calendar year 2005 may not be comparable to the results of operations in 2004 or 2006.
(2) Route and casino revenues are the net difference between gaming wins and losses. Promotional allowances consist primarily of food and beverages furnished gratuitously to customers. The retail value of such services is included in the respective revenue classifications and is then deducted as promotional allowances. See “Note 1. Description of Business and Summary of Significant Accounting Policies” to the accompanying consolidated financial statements in “Item 8. Financial Statements and Supplementary Data”.
(3) Does not include interest income.
See “Item 8. Financial Statements and Supplementary Data” for additional financial information about us.
Marketing
Nevada Market
Since we believe that a vast majority of our patrons at our casinos in southern Nevada are locals, our marketing efforts are primarily focused on the local population of Clark County, Nevada. These marketing efforts seek to capitalize on the strong recognition and high level of quality and value associated with the Terrible Herbst trade name and its cowboy logo, which are used in over 80 gasoline stations and convenience stores in southern Nevada and 9 gasoline stations and convenience stores in California and Arizona. The Terrible Herbst brand is prominently displayed in our route and casino operations. We license the Terrible Herbst trade name from Terrible Herbst, Inc., a related party, through 2011. Subject to mutual consent, we may extend the term of the agreement for two successive 5-year periods.
In addition, we have implemented a unique players club that rewards customers with points for playing at our route and casino locations, as well as for purchases made at Terrible Herbst gas stations and convenience stores in the Las Vegas area. Points may be redeemed for cash as well as free or discounted rooms, food or other goods or services provided at any such location.
The customer base of the casinos we acquired pursuant to the Sands Regent Acquisition ranges from locals living in northern Nevada, in the case of Rail City, to customers from Western Canada, the Pacific Northwest and Northern California, in the case of the Sands. The marketing efforts for the Sands Regent Casinos prior to our acquisition were primarily focused on attracting locals and value-minded out-of-market visitors through aggressive promotions and customer loyalty programs. We expect to continue this focus through the adoption of a players club points program that is similar to those that have proven successful at our other casinos.
Midwest Market
Each of Lakeside Iowa, Mark Twain and St. Jo have a highly recognizable brand name within its respective community. In addition, each of Lakeside Iowa, Mark Twain and St. Jo operates a slot club that rewards customers with points for every coin-in. Points are redeemable for vouchers that may be used for food, valet or retail items. Each of the three casinos also hosts blackjack and slot tournaments as well as other special events on the casino premises that seek to recognize and cultivate regular casino patrons.
Business Strategy
Our business strategy focuses on attracting and fostering repeat business from local gaming patrons in both our route and casino operations. Local patrons are typically sophisticated gaming customers who seek convenient locations, high payouts and a pleasant atmosphere. Because local gaming consumers represent high potential repeat business, generating customer satisfaction and loyalty is a critical component of our strategy.
Route Operations
We believe that route patrons choose to play slot machines near their homes. We attract and retain these players by installing state-of-the-art slot machines with popular games, offering a high level of customer service and
providing an attractive, comfortable atmosphere at our route locations. We actively manage our route locations as if they were casinos. For example, we extend patrons’ slot play by offering free snacks and beverages at some of our route locations. We place our gaming machines in locations where they will receive maximum customer traffic, generally near a store’s entrance. In addition, we utilize a game tracking system and other technology to monitor the play of our patrons. Upon reviewing and analyzing our customer play, we adjust the types of games available.
We also maximize profitability through cost-saving technologies. For example, our multi-denominational, multi-game machines, which allow patrons to tailor their gaming experience to their preferences, may be upgraded by exchanging a computer chip instead of replacing the entire machine. Recent technologies also allow patron jackpot payments on site and help to reduce the need for slot route technicians to drive to locations to fill slot machines with coins or to pay jackpots.
Casino Operations
Our casino operations strategy is to offer high quality gaming, hotel and dining experiences at affordable prices. Our primary target market consists of value oriented local middle market gaming patrons who gamble frequently. We believe that we attract our targeted customers and that they return to our casinos because of our convenient locations, great food, ample parking and high slot machine payout rates. Because locals demand variety and quality in their slot and video poker machine play, our casino properties offer the latest in slot and video poker technology. Although perceived value initially attracts a customer to our casino properties, actual value generates customer satisfaction and loyalty.
As part of our commitment to providing a quality entertainment experience for our patrons, we are dedicated to ensuring a high level of customer satisfaction and loyalty by providing attentive customer service in a friendly, casual atmosphere. We recognize that consistent quality and a comfortable atmosphere stem from the collective care and friendliness of each employee.
Competition
Nevada Market
Our slot route operations are subject to substantial direct competition for our revenue-sharing and fixed space lease locations from one large route operator and numerous small operators, located principally in Las Vegas, Nevada. The principal method of competition for slot route operators includes the economic terms of the revenue-sharing or space lease arrangement, the services provided and the reputation of the route operator. Price competition for revenue-sharing or space lease arrangements is intense and we believe that price competition among slot route operators will continue. We are one of the largest route operators with approximately 7,200 slot machines situated in locations outside of our casinos as of December 31, 2006.
With respect to our casino operations in Las Vegas, Terrible’s Hotel & Casino competes for local gaming customers with other locals-oriented casino-hotels in Las Vegas. We do not believe that we are in direct competition with many of the resort-casino properties on the Las Vegas Strip, which focus primarily on attracting tourist players. Instead, we believe that our principal competitors in our casino operations are the two other local casinos located within a one mile radius. We compete with these properties on the basis of the desirability of location, payout rates, personalized approach, casino promotions, comfort and value of restaurants and hotel rooms and the variety and value of entertainment. The construction of new casinos or the expansion of existing casinos near our casinos could have a negative impact on our casino operations.
Our casino operations in Pahrump, Henderson, and Searchlight, Nevada face competition from other casinos located in the vicinity of these properties.
Competition among casinos in the markets in which the Sands Regent Casinos are located, particularly the Reno/Sparks market, is intense. The expansion and maturation of Native American gaming in Northern California, the Pacific Northwest, and British Columbia has had an adverse impact on total gaming revenues of the greater Reno
area. Over the last few years, existing Native American casinos in Northern California have undergone significant expansions and now offer most of the amenities that casinos in Reno offer, including big name entertainment and hotel rooms. In addition, Thunder Valley, on the Interstate-80 corridor in California has grown to be one of the country’s busiest and most profitable casinos. More Native American casinos and expansions to existing casinos are planned in northern California and many are partnering with existing gaming companies that have financial resources to promote their facilities. Many of our direct competitors in the Reno market have greater financial and other resources than we do.
Midwest Market
Each of Lakeside Iowa, Mark Twain and St. Jo competes for local gaming customers with other casinos in their respective markets.
Lakeside Iowa is located along Interstate 35, approximately 40 miles southwest of Des Moines, Iowa. The primary competitors of Lakeside Iowa are Prairie Meadows racino and the Meskwaki Bingo Casino Hotel. The Prairie Meadows racino is located approximately 60 miles from Lakeside Iowa east of Des Moines. The Meskwaki Bingo Casino Hotel is located in Tama, Iowa and is approximately 110 miles from Lakeside Iowa. Riverside Casino and Golf Resort, a new casino that opened in 2006 in Riverside, Iowa, is approximately 175 miles from Osceola.
Mark Twain is the only casino in northeast Missouri and is approximately 15 miles from Quincy, Illinois and approximately 25 miles from Hannibal, Missouri. The closest casino to Mark Twain is the Catfish Bend Casino, which spends the summer docked in Fort Madison, Iowa and spends the winter docked in Burlington, Iowa, which are approximately 55 miles and 75 miles, respectively, from LaGrange.
St. Jo is approximately 50 miles north of Kansas City, Missouri. St. Jo primarily targets residents of St. Joseph, Missouri and is the only casino in St. Joseph. However, St. Jo competes indirectly with four riverboats in Kansas City, Missouri, which is approximately 50 miles to the south of St. Joseph, and to a lesser extent with several Native American casinos, none of which is closer than 45 miles from St. Joseph.
Certain states have recently legalized, and other states are considering legalizing, casino gaming in certain areas. In addition, states such as Illinois, Missouri, Iowa and Kansas have recently considered awarding additional gaming licenses or expanding permitted gaming.
Seasonality
We do not believe that our business as a whole is seasonal to any significant degree. However, our casinos in the Midwest and in northern Nevada do experience some business interruption during the winter months.
Environmental Laws
Compliance with federal, state and local laws enacted for the protection of the environment to date had no material effect upon our capital expenditures, earnings or competitive position and we do not anticipate any material adverse effects in the future based on the nature of our operations.
Employees
As of December 31, 2006, we employed approximately 3,300 employees. None of our current employees is or will be covered by a collective bargaining agreement. We believe that our relationship with our employees is good.
Regulation And Licensing
Nevada
The ownership and operation of casino gaming facilities and slot routes in Nevada are subject to the Nevada Gaming Control Act and the regulations promulgated thereunder, or the Nevada Act, and various local regulations.
Our gaming operations are subject to the licensing and regulatory control of the Nevada Gaming Commission, the Nevada State Gaming Control Board, the Clark County Liquor and Gaming Licensing Board, and the Cities of Las Vegas, Reno, Henderson and other local regulatory authorities, or the Nevada Gaming Authorities.
The laws, regulations and supervisory procedures of the Nevada Gaming Authorities are based upon declarations of public policy which are concerned with, among other things:
· the prevention of unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity;
· the establishment and maintenance of responsible accounting practices and procedures;
· the maintenance of effective controls over the financial practices of licensees, including the establishment of minimum procedures for internal fiscal affairs and the safeguarding of assets and revenues, providing reliable record keeping and requiring the filing of periodic reports with the Nevada Gaming Authorities;
· the prevention of cheating and fraudulent practices; and
· providing a source of state and local revenues through taxation and licensing fees.
Changes in these laws, regulations and procedures could have an adverse effect on our gaming operations.
Corporations and other entities that operate casinos or slot routes in Nevada are required to be licensed by the Nevada Gaming Authorities. A gaming license for such activities requires the periodic payment of fees and taxes and is not transferable. Herbst Gaming is registered by the Nevada Gaming Commission as a publicly traded corporation (a “registered corporation”). As a registered corporation, we are required periodically to submit detailed financial and operating reports to the Nevada Gaming Commission and furnish any other information that the Nevada Gaming Commission may require. Herbst Gaming has been found suitable by the Nevada Gaming Commission to own the stock of ETT, which is licensed by the Nevada Gaming Commission as a casino and slot route operator, Market Gaming, Inc., which is licensed as a slot route operator, and Flamingo Paradise Gaming, LLC, which is licensed as a casino operator. ETT is also registered by the Nevada Gaming Commission as an intermediary holding company (the “Intermediary Company”) and has been found suitable to own the stock of Corral Country Coin, Inc., Cardivan Company, and Corral Coin, Inc., all of which are licensed by the Nevada Gaming Authorities as slot route operators (all of the foregoing, including Market Gaming, Inc., and Flamingo Paradise Gaming, LLC, are referred to as the “Gaming Subsidiaries”). No person may become a stockholder of, or receive any percentage of the profits from, the Intermediary Company or any of the Gaming Subsidiaries without first obtaining licenses and approvals from the Nevada Gaming Authorities. Herbst Gaming, the Intermediary Company, and all of the Gaming Subsidiaries have obtained from the Nevada Gaming Authorities the various registrations, approvals, permits and licenses required in order to engage in gaming activities in Nevada.
The Nevada Gaming Authorities may investigate any individual who has a material relationship to, or material involvement with, Herbst Gaming, the Intermediary Company or the Gaming Subsidiaries in order to determine whether such individual is suitable or should be licensed as a business associate of a gaming licensee. Officers, directors and certain key employees of Herbst Gaming, the Intermediary Company, and the Gaming Subsidiaries must file applications with the Nevada Gaming Authorities and are required to be licensed by the
Nevada Gaming Authorities. The Nevada Gaming Authorities may deny an application for licensing for any cause that they deem reasonable. A finding of suitability is comparable to licensing, and both require submission of detailed personal and financial information followed by a thorough investigation. Changes in licensed positions must be reported to the Nevada Gaming Authorities, and, in addition to their authority to deny an application for a finding of suitability or licensure, the Nevada Gaming Authorities have jurisdiction to disapprove a change in a corporate position.
If the Nevada Gaming Authorities were to find an officer, director or key employee unsuitable for licensing or unsuitable to continue having a relationship with us, we would have to sever all relationships with that person. In addition, the Nevada Gaming Commission may require us to terminate the employment of any person who refuses to file appropriate applications. Determinations of suitability or of questions pertaining to licensing are not subject to judicial review in Nevada.
Herbst Gaming, the Intermediary Company, and the Gaming Subsidiaries are required to submit detailed financial and operating reports to the Nevada Gaming Commission. Substantially all material loans, leases, sales of securities and similar financing transactions by Herbst Gaming, the Intermediary Company and the Gaming Subsidiaries must be reported to the Nevada Gaming Commission.
If it were determined that Herbst Gaming, the Intermediary Company or the Gaming Subsidiaries violated the Nevada gaming laws, our gaming licenses and registrations with the Nevada Gaming Commission could be limited, conditioned, suspended or revoked, subject to compliance with certain statutory and regulatory procedures. In addition, Herbst Gaming, the Intermediary Company, the Gaming Subsidiaries and the persons involved could be subject to substantial fines for each separate violation of the Nevada laws at the discretion of the Nevada Gaming Commission. Further, the Nevada Gaming Commission could appoint a supervisor to operate our gaming properties and, under certain circumstances, earnings generated during the supervisor’s appointment (except for the reasonable rental value of our gaming properties) could be forfeited to the State of Nevada. Limitation, conditioning or suspension of any gaming license or the appointment of a supervisor could (and revocation of any gaming license would) materially adversely affect our operations.
Any beneficial holder of Herbst Gaming’s voting securities, regardless of the number of shares owned, may be required to file an application, be investigated, and have his suitability as a beneficial holder of Herbst Gaming’s voting securities determined if the Nevada Gaming Commission has reason to believe that such ownership would otherwise be inconsistent with the declared policies of the State of Nevada. The applicant must pay all costs of investigation incurred by the Nevada Gaming Authorities in conducting such investigation.
Although we do not intend to register or sell any equity securities, Nevada law requires any person who acquires more than 5% of a registered corporation’s voting securities to report the acquisition to the Nevada Gaming Commission. Nevada law requires that beneficial owners of more than 10% of a registered corporation’s voting securities apply to the Nevada Gaming Commission for a finding of suitability within 30 days after the Chairman of the Nevada State Gaming Control Board mails the written notice requiring the filing for a finding of suitability. Under certain circumstances, an “institutional investor,” as defined in the regulations of the Nevada Gaming Commission, which acquires more than 10%, but not more than 15%, of our voting securities may apply to the Nevada Gaming Commission for a waiver of such finding of suitability if that institutional investor holds the voting securities for investment purposes only. An institutional investor will not be deemed to hold voting securities for investment purposes unless the voting securities were acquired and are held in the ordinary course of business as an institutional investor and not for the purpose of causing, directly or indirectly, the election of a majority of the members of our board of directors, any change in our corporate charter, bylaws, management, policies or operations, or any of our gaming affiliates, or any other action which the Nevada Gaming Commission finds to be inconsistent with holding our voting securities for investment purposes only. Activities which are not deemed to be inconsistent with holding voting securities for investment purposes only include:
· voting on all matters voted on by stockholders;
· making financial and other inquiries of management of the type normally made by securities analysts for informational purposes and not to cause a change in its management, policies or operations; and
· other activities as the Nevada Gaming Commission may determine to be consistent with such investment intent.
If the beneficial holder of voting securities who must be found suitable is a corporation, partnership or trust, it must submit detailed business and financial information including a list of beneficial owners. The applicant is required to pay all costs of investigation.
Any person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Nevada Gaming Commission or the Chairman of the Nevada State Gaming Control Board, may be found unsuitable. The same restrictions apply to a record owner if the record owner, after request, fails to identify the beneficial owner. Any stockholder found unsuitable and who holds, directly or indirectly, any beneficial ownership of the common stock of a registered corporation beyond the period of time as may be prescribed by the Nevada Gaming Commission may be guilty of a criminal offense. Herbst Gaming, the Intermediary Company or the Gaming Subsidiaries may become subject to disciplinary action if, after receipt of notice that a person is unsuitable to be a stockholder or to have any other relationship with Herbst Gaming, the Intermediary Company or the Gaming Subsidiaries, Herbst Gaming:
· pays that person any dividend or interest upon voting securities;
· allows that person to exercise, directly or indirectly, any voting right conferred through securities held by that person;
· pays remuneration in any form to that person for services rendered or otherwise; or
· fails to pursue all lawful efforts to require the unsuitable person to relinquish his voting securities for cash at fair market value.
Additionally, the Clark County Liquor and Gaming Licensing Board has taken the position that it has the authority to approve all persons owning or controlling the stock of any corporation controlling a gaming license.
Herbst Gaming may be required to disclose to the Nevada State Gaming Control Board and the Nevada Gaming Commission the identities of all holders of its debt securities. The Nevada Gaming Commission may, in its discretion, require the holder of any debt security of a registered corporation to file applications, be investigated and be found suitable to own the debt security of a registered corporation. If the Nevada Gaming Commission determines that a person is unsuitable to own a debt security, then pursuant to Nevada law, the registered corporation can be sanctioned, including the loss of its approvals, if without the prior approval of the Nevada Gaming Commission, it:
· pays to the unsuitable person any dividend, interest, or any distribution whatsoever;
· recognizes any voting right by the unsuitable person in connection with debt securities;
· pays the unsuitable person remuneration in any form; or
· makes any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction.
Herbst Gaming is required to maintain a current ledger in Nevada, which may be examined by the Nevada Gaming Authorities at any time. If any securities are held in trust by an agent or by a nominee, the record holder may be required to disclose the identity of the beneficial holder to the Nevada Gaming Authorities. A failure to make such disclosure may be grounds for finding the record holder unsuitable. We are also required to render maximum assistance in determining the identity of the beneficial owner. The Nevada Gaming Commission has the power to require our securities to bear a legend indicating that the securities are subject to the Nevada Act. However, to date, the Nevada Gaming Commission has not imposed such a requirement on Herbst Gaming.
Herbst Gaming may not make a public offering of securities without the prior approval of the Nevada Gaming Commission if the securities or proceeds from the securities are intended to be used to construct, acquire or finance gaming facilities in Nevada, or to retire or extend obligations incurred for the purposes of constructing, acquiring or financing gaming facilities. Furthermore, any approval, if granted, does not constitute a finding, recommendation or approval by the Nevada Gaming Commission or the Nevada State Gaming Control Board as to the accuracy or adequacy of the prospectus or the investment merits of the securities offered. Any representation to the contrary is unlawful.
Changes in the control of Herbst Gaming through merger, consolidation, stock or asset acquisitions, management or consulting agreements, or any act or conduct by a person whereby that person obtains control (including foreclosure on the pledged shares), may not occur without the prior approval of the Nevada Gaming Commission. Entities seeking to acquire control or ownership of a registered corporation must satisfy the Nevada State Gaming Control Board and Nevada Gaming Commission in a variety of stringent standards prior to assuming control of such registered corporation. The Nevada Gaming Commission may also require the stockholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process relating to the transaction.
License fees and taxes, computed in various ways depending on the type of gaming or activity involved, are payable to the State of Nevada and to the counties and cities in which the Nevada licensee’s respective operations are conducted. Depending upon the particular fee or tax involved, these fees and taxes are payable either monthly, quarterly or annually and are based upon either:
· a percentage of the gross revenues received;
· the number of gaming devices operated; or
· the number of table games operated.
Any person who is licensed, required to be licensed, registered, required to be registered, or is under common control with such persons, or Licensees, and who is or who proposes to become involved in a gaming venture outside of Nevada, is required to deposit with the Nevada State Gaming Control Board, and thereafter maintain, a revolving fund in the amount of $10,000 to pay the expenses of investigation by the Nevada State Gaming Control Board of the Licensees’ participation in foreign gaming. The revolving fund is subject to increase or decrease in the discretion of the Nevada Gaming Commission. Thereafter, Licensees are also required to comply with certain reporting requirements imposed by the Nevada gaming laws. Licensees are also subject to disciplinary action by the Nevada Gaming Commission if they knowingly violate any laws of the foreign jurisdiction pertaining to a foreign gaming operation, fail to conduct the foreign gaming operation in accordance with the standards of honesty and integrity required of Nevada gaming operations, engage in activities or enter into associations that are harmful to the State of Nevada or its ability to collect gaming taxes and fees, or employ, contract with or associate with a person in the foreign operation who has been denied a license or a finding of suitability in Nevada on the ground of personal unsuitability.
Missouri
On November 3, 1992, a statewide referendum authorized gaming in the State of Missouri on the Missouri and the Mississippi Rivers. On April 29, 1993, Missouri enacted revised legislation (as amended, the “Missouri Gaming Law”) which amended the existing legislation. In a decision handed down on January 25, 1994, the Missouri Supreme Court held that games of chance were prohibited under the Missouri constitution. In a statewide election held on November 8, 1994, Missouri voters approved the adoption of an amendment to the Missouri Constitution which permits the legislature to allow games of chance to be conducted on excursion boats and floating facilities on the Mississippi River and the Missouri River. As a result of the amendment, games of chance are also permitted, subject to Missouri Gaming Law. Pursuant to the Missouri Gaming Law, there are eleven operating riverboat gaming facility sites in Missouri: one in Caruthersville; one in Boonville; three in the St. Louis area; four in the Kansas City area; one in LaGrange; and one in St. Joseph.
Opponents of gaming in Missouri have brought several legal challenges to gaming in the past and may possibly bring similar challenges in the future. On November 25, 1997, the Missouri Supreme Court overturned a state lower court and held that a portion of the Missouri Gaming Law that authorized excursion gaming facilities in “artificial basins” up to 1,000 feet from the Mississippi or Missouri rivers was unconstitutional. This ruling created uncertainty as to the legal status of several excursion gaming riverboat facilities in the state. On November 3, 1998, a statewide referendum was held, whereby the voters amended the constitution to allow “artificial basins” for existing facilities, effectively overturning the above Missouri Supreme Court decision. There can be no assurances that any future challenges, if brought, would not further interfere with gaming operations in Missouri, including the operations of St. Jo and Mark Twain.
Under the Missouri Gaming Law, the ownership and operation of riverboat gaming facilities in Missouri are subject to extensive state and local regulation. Herbst Gaming, HGI-St. Jo, Inc., the subsidiary of Herbst Gaming that owns St. Jo and the current licensee and HGI-Mark Twain, Inc., the subsidiary of Herbst Gaming that owns Mark Twain and the current licensee, any subsidiaries, and some of their officers and employees are and will be subject to specific regulations, including ongoing licensing requirements. As part of the application and licensing process for a gaming license, the applicant must submit detailed financial, operating and other reports to the Missouri Gaming Commission. Each applicant has an ongoing duty to update the information provided to the Missouri Gaming Commission in the application, usually within seven days of a material change in the information on file with the Missouri Gaming Commission. Each of St. Jo and Mark Twain have frequently updated its application materials since it was initially licensed. In addition to the information required of the applicant, directors, officers, affiliated business entities and other defined “key persons” (which include individuals and companies designated by the Missouri Gaming Commission) must submit Personal Disclosure Forms, which include detailed financial information, and are subject to thorough investigations. In addition, some officers and directors of Herbst Gaming, as well as Herbst Gaming itself, have submitted Personal Disclosure Forms and applications to the Missouri Gaming Commission. All gaming employees must obtain an occupational license issued by the Missouri Gaming Commission. Suppliers are also subject to licensing requirements of the Missouri Gaming Commission.
The operators’ licenses (or “Class A” gaming licenses) are issued through application to the Missouri Gaming Commission, which requires, among other things:
· suitability investigations into an applicant’s character, financial responsibility, experience and qualifications;
· suitability investigations into each designated key person or affiliated business entity’s character, financial responsibility, experience and qualifications;
· disclosure of required financial (see above) and other personal information on each key person or designated affiliated business entity;
· disclosure of detailed information about the applicant’s history, business, affiliations, officers, directors and owners;
· an affirmative action plan for the hiring and training of minorities and women; and
· an economic development or impact report.
License fees cover all related costs of the Missouri Gaming Commission investigation and are a minimum of $50,000 for the initial application and $25,000 annually thereafter. Each of Herbst Gaming, HGI-St. Jo and HGI-Mark Twain has undergone a full licensing investigation and hearing in connection with its licensing.
The Missouri Gaming Law and implementing regulations impose restrictions on the use of and do not permit the transfer of the gaming licenses as well as limitations on transactions engaged in by licensees. The licenses issued by the Missouri Gaming Commission may not be transferred nor pledged as collateral. The Missouri
Gaming Law regulations bar a licensee from taking any of the following actions without prior notice to, and approval by, the Missouri Gaming Commission:
· any transfer or issuance of an ownership interest in a gaming licensee that is not a publicly held company;
· any transfer or issuance of an ownership interest of five percent or more of the issued and outstanding ownership interest of Herbst Gaming which is publicly traded and is a holding company;
· any private incurrence of debt by the licensee or any holding company of $1,000,000 or more;
· any public issuance of debt by a licensee or its holding company; and
· defined “significant related party transactions.”
In addition, the licensee must notify the Missouri Gaming Commission of other transactions that include the transfer of five percent or more of an ownership interest in the licensee or holding company if publicly held and any transaction of at least $1,000,000.
The restrictions on transfer of ownership apply to Herbst Gaming as well as the direct licensees, HGI-St. Jo and HGI-Mark Twain. Gaming equipment may not be pledged. Corporate stock of some licensees may not be pledged except in narrow circumstances and subject to regulatory conditions.
Missouri statutes and administrative rules contain detailed requirements and conditions concerning the operation of a licensed excursion gaming boat facility, including but not limited to the following:
· a charge of two dollars per gaming customer per excursion that licensees must either collect from each customer or pay itself to the Missouri Gaming Commission;
· minimum payouts;
· the payment of a 20% tax on adjusted gross receipts;
· prohibitions against providing credit to gaming customers;
· the use of credit cards and cashing of checks by customers;
· providing security on the excursion gambling boat, including a requirement that each licensee reimburse the Missouri Gaming Commission for all costs of any Missouri Gaming Commission staff, including Missouri Highway Patrol Officers, necessary to protect the public on the licensee’s riverboat;
· the receipt of liquor licenses from the Missouri Gaming Commission and local jurisdictions; and
· the adoption of minimum control standards for the conduct of gaming and the operation of the facility approved by the Missouri Gaming Commission.
The Missouri Gaming Commission has the power, as well as broad discretion in exercising this power, to revoke or suspend gaming or occupational licenses and impose other penalties for violations of the Missouri Gaming Law and the rules and regulations promulgated thereunder, including without limitation, forfeiture of all gaming equipment used for improper gaming and fines of up to three times a licensee’s highest daily gross receipts during the preceding twelve months.
Although the Missouri Gaming Law provides no limit on the amount of riverboat space that may be used for gaming, the Missouri Gaming Commission is empowered to impose space limitations through the adoption of
rules and regulations. In addition, the Missouri Gaming Law imposes as to each customer a $500 loss limit per two-hour period established by each licensee with the approval of the Missouri Gaming Commission. In order to establish an excursion schedule, which allows patrons to enter and exit the gaming floor during the excursion, the licensee must prove to the satisfaction of the Missouri Gaming Commission that it can enforce the $500 loss limit.
In addition, the Missouri Gaming Commission is empowered to determine on a city and county-specific basis where “dockside” or permanently-docked gaming is appropriate and may be permitted. The Missouri Gaming Commission has authorized all eleven licensed sites to operate all or a portion of their facilities on a continuously docked basis. On February 23, 2000, the Missouri Gaming Commission granted Mark Twain Casino, L.L.C., from which Herbst Gaming purchased the Mark Twain, the authority to permanently dock the excursion gambling riverboat facility known as the “Mark Twain Casino.” On February 15, 1996, the Missouri Gaming Commission granted St. Joseph Riverboat Partners, from which Herbst Gaming purchased St. Jo, the authority to permanently dock the excursion gambling riverboat facility known as the “Biloxi Bell, II.”
Iowa
In 1989, the State of Iowa legalized riverboat gaming on the Mississippi River and other waterways located in Iowa. Under Iowa law, a license to conduct gaming may be issued in a county only if the county electorate has approved gaming. The electorate of Clarke County, Iowa, approved gaming on February 28, 1995 by referendum. Gaming conducted by the Lakeside Casino Resort was approved by referendum on November 18, 1997. In addition, a referendum must be held every eight years in each of the counties where gambling games are conducted and the proposition to continue to allow gambling games in such counties must be approved by a majority of the county electorate voting on the proposition. Such a referendum took place on November 5, 2002 with approximately 80% of the electorate voting on the proposition favoring continued gaming on riverboats in Clarke County. The next referendum is scheduled for 2010. If any reauthorization referendum is defeated, Iowa law provides that any previously issued gaming license will remain valid and subject to renewal for a total of nine years from the date of original issuance of the license, subject to earlier non-renewal or revocation under Iowa law and regulations applicable to all licenses.
In addition, Iowa law authorizes the granting of licenses to non-profit corporations that, in turn, are permitted to enter into operating agreements with qualified persons who also actually conduct riverboat gaming operations. Such operators must likewise be approved and licensed by the Iowa Racing and Gaming Commission (the “Iowa Gaming Commission”).
In July 1997, Clarke County Development Corporation, a non-profit corporation organized for the purpose of facilitating riverboat gaming in Osceola, Iowa, entered into an operator’s contract, since amended, for Lakeside Iowa for a term of up to 50 years. Under the operator’s contract, as amended, Clarke County Development Corporation is to be paid a monthly fee equal to 1.5% of the adjusted gross gaming revenue of Lakeside Iowa. Further, pursuant to a dock site agreement executed in August 1997 (which also has a term of up to 50 years), Lakeside Iowa is required to pay a monthly fee to the City of Osceola and the Water Works Board of Trustees equal to 1.25% of the adjusted gross gaming revenue of Lakeside Iowa and an annual fee, to be paid in equal monthly installments, equal to approximately $160,000, with such amount to increase each year by 1% until termination of the lease. In September 2004, we entered into an agreement whereby upon the later of our obtaining approval from the Iowa Gaming Commission or our closing the transactions contemplated with Southern Iowa Gaming Company, Southern Iowa will immediately pay $3.2 million to the City of Osceola. Beginning eight years from the date of such payment and continuing for so long as the operator’s contract, as amended, remains in effect, we will pay the City of Osceola an additional 1% of annual adjusted gross receipts from Lakeside Iowa. We may, however, offset up to 50% of this 1% annual payment with any expenditures we have made for capital improvements (excluding gaming devices and improvements to the gaming facility, casino floor, development of a truck stop and general repairs and maintenance).
Iowa law permits gaming licensees to offer unlimited stakes gaming on games approved by the Iowa Gaming Commission on a 24-hour basis. Dockside casino gaming is authorized by the Iowa Gaming Commission and the Iowa Legislature, subject to certain limitations not applicable to Lakeside Iowa, eliminated the requirement that gaming licensees cruise, effective May 6, 2004. The legal age for gaming is 21.
All Iowa excursion gambling boat licenses were approved for renewal at a March 1, 2007 meeting of the Iowa Gaming Commission. These licenses are not transferable and will need to be renewed annually and prior to the commencement of each subsequent annual renewal period.
The ownership and operation of gaming facilities in Iowa are subject to extensive state laws, regulations of the Iowa Gaming Commission and various county and municipal ordinances (collectively, the “Iowa Gaming Laws”), concerning the responsibility, financial stability and character of gaming operators and persons financially interested or involved in gaming operations. Iowa Gaming Laws seek to: (1) prevent unsavory or unsuitable persons from having direct or indirect involvement with gaming at any time or in any capacity; (2) establish and maintain responsible accounting practices and procedures; (3) maintain effective control over the financial practices of licensees (including the establishment of minimum procedures for internal fiscal affairs, the safeguarding of assets and revenues, the provision of reliable record keeping and the filing of periodic reports with the Iowa Gaming Commission); (4) prevent cheating and fraudulent practices; and (5) provide a source of state and local revenues through taxation and licensing fees. Changes in Iowa Gaming Laws could have a material adverse effect on the Iowa gaming operations.
Gaming licenses granted to individuals must be renewed every year, and licensing authorities have broad discretion with regard to such renewals. Licenses are not transferable. The Iowa gaming operations must submit detailed financial and operating reports to the Iowa Gaming Commission. Certain contracts of licensees in excess of $100,000, that exceed three years in term or that involve related parties must be submitted to and approved by the Iowa Gaming Commission.
Officers, directors, managers and employees of the Iowa gaming operations are required to be licensed by the Iowa Gaming Commission. Employees associated with gaming must obtain a license and these licenses are subject to immediate suspension under specific circumstances. In addition, anyone having a material relationship or involvement with the Iowa gaming operations may be required to be found suitable or to be licensed, in which case those persons would be required to pay the costs and fees of the Iowa Gaming Commission in connection with the investigation. The Iowa Gaming Commission may deny an application for a license for any cause deemed reasonable. In addition to its authority to deny an application for license, the Iowa Gaming Commission has jurisdiction to disapprove a change in position by officers or key employees and the power to require the Iowa gaming operations to suspend or dismiss officers, directors or other key employees or sever relationships with other persons who refuse to file appropriate applications or whom the Iowa Gaming Commission finds unsuitable to act in such capacities.
The Iowa Gaming Commission may revoke a gaming license if the licensee:
· has been suspended from operating a gaming operation in another jurisdiction by a board or commission of that jurisdiction;
· has failed to demonstrate financial responsibility sufficient to meet adequately the requirements of the gaming enterprise;
· is not the true owner of the enterprise;
· has failed to disclose ownership of other persons in the enterprise;
· is a corporation 10% of the stock of which is subject to a contract or option to purchase at any time during the period for which the license was issued, unless the contract or option was disclosed to the Iowa Gaming Commission and the Iowa Gaming Commission approved the sale or transfer during the period of the license;
· knowingly makes a false statement of a material fact to the Iowa Gaming Commission;
· fails to meet a monetary obligation in connection with an excursion gaming boat;
· pleads guilty to, or is convicted of, a felony;
· loans to any person, money or other thing of value for the purpose of permitting that person to wager on any game of chance;
· is delinquent in the payment of property taxes or other taxes or fees or a payment of any other contractual obligation or debt due or owed to a city or county; or
· assigns, grants or turns over to another person the operation of a licensed excursion boat (this provision does not prohibit assignment of a management contract approved by the Iowa Gaming Commission) or permits another person to have a share of the money received for admission to the excursion boat.
If it were determined that the Iowa Gaming Laws were violated by a licensee, the gaming licenses held by a licensee could be limited, made conditional, suspended or revoked. In addition, the licensee and the persons involved could be subject to substantial fines for each separate violation of the Iowa Gaming Laws in the discretion of the Iowa Gaming Commission. Limitations, conditioning or suspension of any gaming license could (and revocation of any gaming license would) have a material adverse effect on operations.
The Iowa Gaming Commission may also require any individual who has a material relationship with the Iowa gaming operations to be investigated and licensed or found suitable. The Iowa Gaming Commission, prior to the acquisition, must approve any person who acquires 5% or more of a licensee’s equity securities in the event that approval by the Iowa Gaming Commission is not otherwise contemplated by the operative acquisition document. The applicant stockholder is required to pay all costs of this investigation.
Gaming taxes approximating 22% of the adjusted gross receipts above $3,000,000 will be payable by each licensee on its operations to the State of Iowa. In addition, there was a prepaid assessment due on June 1, 2005 and another prepaid assessment paid on June 1, 2006, in an aggregate amount equal to 2.152% of each licensee’s estimated adjusted gross receipts for fiscal year 2004. These assessments will be offset by future state gaming taxes paid by each licensee with a credit for 20% of the assessments paid allowed each year beginning July 1, 2010 for five consecutive years. The state of Iowa is also reimbursed by the licensees for all costs associated with monitoring and enforcement by the Iowa Gaming Commission and the Iowa Department of Criminal Investigation.
Item 1A.
Item 1A. Risk Factors. The following risk factors, among others, could cause our financial performance to differ significantly from the goals, plans, objectives, intentions and expectations expressed in this report. If any of the following risks and uncertainties or other risks and uncertainties not currently known to us or not currently considered to be material actually occur, our business, financial condition or operating results could be harmed substantially.
Risks Related to Our Company
Our operations have been adversely affected by the adoption of certain anti-smoking regulations.
On November 7, 2006, voters in Nevada passed Question 5, an initiative that prohibits smoking in indoor places of employment including, but not limited to, bars and taverns that serve food, grocery stores, malls and other retail establishments, and that gives future control over smoking regulation to individual counties or municipalities. The Company had supported a competing initiative which banned smoking in restaurants and other locations frequented by minors and vested all future smoking regulation with the Nevada State Legislature. Since its adoption, Question 5 has led to significant decreased patron play at our route locations. If we are not able to offset such decreased patron play, or such patron play continues to decrease, there may be a material adverse effect on our business, financial condition and results of operations.
The success of our route operations is dependent on our ability to renew our contracts.
We conduct our route operations under contracts with third parties. Both contracts with chain and street customers are renewable at the option of the owner of the respective chain store or street account. As our route contracts expire, we are required to compete for renewals. Although we have historically been able to renew our contracts, if we are unable to renew a material portion of our route contracts because our competitors offer more favorable terms or for any other reason, our business, financial condition and results of operations would be adversely affected. We cannot assure you that our current chain or street contracts will be renewed.
We may experience a loss of market share.
The gaming industry is highly competitive. Our slot-route operations are subject to substantial direct competition for our revenue-sharing and fixed space lease locations from one large route operator and numerous small operators, located principally in Las Vegas, Nevada. With respect to our casino operations in Nevada, we compete for local gaming customers with other locals-oriented casino-hotels and other casinos located in the vicinity of these properties. Our casino operations in the Midwest face competitors that include land-based casinos, dockside casinos, riverboat casinos, casinos located on Native American reservations and racing and pari-mutuel operations. If our competitors operate more successfully, if existing route operations or properties are enhanced or expanded, or if additional competitors are established in and around the locations in which we conduct business, we may lose market share. In particular, the expansion of route operations or casino gaming in or near any geographic area from which we attract or expect to attract a significant number of our customers could have a material adverse effect on our business, financial condition and results of operations.
Changes to applicable tax laws could have a material adverse effect on our financial condition.
We pay substantial taxes and fees in connection with our operations as a gaming company. From time to time, federal, state and local legislators and other government officials have proposed and adopted changes in tax laws, or in the administration of those laws affecting the gaming industry. It is not possible to determine the likelihood of changes in tax laws or in the administration of those laws. If adopted, changes to applicable tax laws could have a material adverse effect on our business, financial condition and results of operations. For example, during the 2003 Nevada state legislative session, there was an increase in the payroll taxes to 0.7% of payroll, an increase of the gross casino gaming taxes from 6.25% to 6.75% and a 33% increase in fees imposed on the operation of slot machines located in a restricted location (15 machines or less). In addition, in April 2004, the Iowa state legislature approved an increase on the maximum tax rate on gaming revenues of riverboat casinos from 20% to 22%.
We face extensive regulation from gaming and other government authorities.
As owners and operators of gaming facilities, we are subject to extensive state and local regulations in Nevada, Iowa and Missouri. State and local government authorities in such jurisdictions, including the Nevada Gaming Commission, the Iowa Racing and Gaming Commission and the Missouri Gaming Commission, require us and our subsidiaries to obtain gaming licenses and require our officers, key employees and business entity affiliates to demonstrate suitability to hold gaming licenses, and such state and local government authorities may limit, condition, suspend or revoke a license for any cause deemed reasonable by the respective licensing agency. They may also levy substantial fines against us or our subsidiaries or the individuals involved in violating any gaming laws or regulations. The violation of any such state and local regulations could have a material adverse effect on our business, financial condition and results of operations.
In Nevada, the Nevada Gaming Commission could request that a state court appoint a supervisor to operate any non-restricted gaming establishment operated by us if the licenses held by us are revoked, suspended or otherwise lapse. In such extraordinary circumstances, earnings generated by gaming operations during a supervisor’s appointment (except for reasonable rental value) could be forfeited to the State of Nevada. The occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
Any future public offering of debt or equity securities by Herbst Gaming will require review of and prior approval by the Nevada Gaming Commission, the Iowa Racing and Gaming Commission and the Missouri Gaming Commission. The Missouri Gaming Commission also requires notice of the intended incurrence of any private debt exceeding $1,000,000 and reserves the right to elect to have prior review and approval.
We are subject to a variety of other rules and regulations, including zoning, environmental, construction and land-use laws, regulations and permits that govern the serving of alcoholic beverages. Any changes to these laws could have a material adverse effect on our business, financial condition and results of operations.
From time to time, legislators and special interest groups have proposed legislation that would expand, restrict or prevent gaming operations in the jurisdictions in which we operate. Any such change to the regulatory environment or the adoption of new federal, state or local government legislation could have a material adverse effect on our business.
For a more complete summary of regulations that affect our business, see “Item 1. Business-Regulation and Licensing.”
We depend upon our key employees and certain members of our management.
Our success is substantially dependent upon the efforts and skills of Edward J. Herbst, our chairman of the board, chief executive officer and president, and Mary E. Higgins, our chief financial officer. We have entered into employment agreements with Mr. Herbst through 2006 and Ms. Higgins through 2008. These agreements automatically renew for successive one-year periods unless sooner terminated or unless either party to the respective agreements notifies the other in writing at least 60 days prior to the date the respective agreement is scheduled to expire. If we were to lose the services rendered by either of them, our operations could be adversely affected. In addition, we compete with other potential employers for employees, and we may not succeed in hiring and retaining the executives and other employees that we need. An inability to hire quality employees could have a material adverse effect on our business, financial condition and results of operations.
Our executive officers and members of our board of directors own 100% of the company and conflicts of interests could arise.
Edward, Timothy and Troy Herbst own all of the outstanding stock of Herbst Gaming. This concentration of ownership gives them the power to control the outcome of all matters requiring stockholder approval, including the election of all directors, and will give them the power to hinder or delay a change of control of the Company. In addition, Edward, Timothy and Troy Herbst are all officers and directors of Terrible Herbst, Inc., a company owned by parties related to us. We currently engage in transactions with Terrible Herbst, Inc. and plan to continue to do so in the future. These related-party transactions could lead to potential conflicts of interest. See “Item 13. Certain Relationships and Related Transactions.”
The gaming operations and casinos owned by the Company may be adversely impacted if the economy of certain markets declines, which could lead to an adverse impact on the operations of the Company.
Our properties in southern Nevada depend on our customers living principally in southern Nevada, an area that has recently experienced significant population growth. However, we cannot be certain that this growth will continue. In addition, these properties are to a large part dependent on the economy of southern Nevada. An economic downturn in southern Nevada could have a material adverse effect on our operating results, and we cannot assure you that the economy in southern Nevada will continue to grow.
Lakeside Iowa, Mark Twain and St. Jo depend on customers living principally in south central Iowa and northeast and northwest Missouri, respectively, and on the economy of those areas. An economic downturn in such areas could have a material adverse effect on our operating results.
The Sands Regent heavily markets to and relies upon business from Reno area residents. In recent years, Reno has enjoyed robust business growth and has attracted a number of technology, product distribution and marketing companies. These businesses have created jobs and helped fuel residential development, including the Reno metropolitan area. Should there be negative changes in the business and job conditions in Reno, the locals business of The Sands Regent, which is a substantial part of its overall business, could be adversely impacted, which could lead to an adverse impact on the overall results of the Company.
Our properties use significant amounts of electricity, natural gas and other forms of energy. While no shortages of energy have been experienced, the substantial increases in the cost of electricity, natural gas and gasoline in the United States in general, and in southern and northern Nevada, south central Iowa and northeast and northwest Missouri in particular, may negatively affect our operating results. In addition, further energy price increases in such areas could result in a decline in disposable income of potential customers and a corresponding decrease in visitation and spending at our route and casino operations, which could negatively impact revenues. Gaming industry revenues are sensitive to general economic conditions and are influenced by consumer confidence in the economy and other factors. An extended period of reduced discretionary spending could significantly harm our operations and we may not be able to lower our costs rapidly enough, or at all, to offset a decrease in revenues.
The business of The Sands Regent may be adversely impacted by expanded Native American gaming operations in California and the Pacific Northwest, which could lead to an adverse impact on the operations of the Company.
The largest sources of tourist customers for casinos owned by The Sands Regent are California and the Pacific Northwest, including a large number who drive to Reno from the San Francisco and Sacramento metropolitan areas. The expansion of Native American casinos in California, Oregon and Washington continues to have an impact on casino revenues in Nevada in general, and some analysts have predicted the impact will be significant on the Reno-Tahoe market.
For example, Thunder Valley Casino, a large new Native American casino managed by Station Casinos, Inc., opened June 9, 2003, 110 miles west of Reno in Rocklin, California. California’s well-documented budgetary problems have state officials in active negotiations to renegotiate certain compacts with Native American tribes. Some Native American casino compacts have already been changed to allow for additional slot machines. The effect of increased gaming in California and other states is difficult to predict. However, the business of The Sands Regent would be adversely impacted if Thunder Valley and other casinos attract patrons who would otherwise travel to Reno. In addition, a significant portion of The Sands Regent’s customer base is made up of Reno area residents. If other Reno area casinos lose business due to competition from Native American casinos, they may intensify their marketing efforts to Reno area residents as well, which could materially and adversely impact the business and financial results of The Sands Regent and thereby the overall business and financial results of the Company.
Adverse winter weather conditions in the Sierra Nevada Mountains and Reno-Lake Tahoe area could have a material adverse effect on the results of operations and financial condition of The Sands Regent, which could lead to an adverse impact on the results of operation and financial condition of the Company.
Adverse winter weather conditions, particularly snowfall, can deter customers of The Sands Regent from traveling or make it difficult for them to frequent its facilities. Adverse winter weather would most significantly affect the drive-in customers of The Sands Regent from northern California and the Pacific Northwest. If the Reno area itself were to experience prolonged adverse winter weather conditions, the results of operations and financial condition of The Sands Regent could also be materially adversely affected, thereby adversely affecting the results of operations and financial condition of the Company in the event the Sands Regent Merger is consummated.
We may be unable to obtain slot machines or related technology from our third party supplier on a timely, cost-effective basis.
We currently primarily rely on International Game Technology, Inc. for our supply of slot machines and related technology, which are only available from a limited number of suppliers. We cannot assure you that we can obtain slot machines or related technology on a cost-effective basis. As a result, we may be forced to incur significant unanticipated costs to secure alternative third party suppliers or adjust our operations.
Riverboats and dockside facilities are subject to risks relating to weather or mechanical failure and must comply with applicable regulations.
We own and operate riverboat and dockside casino facilities, which are subject to risks in addition to those associated with land-based casinos, including loss of service due to casualty, mechanical failure, extended or extraordinary maintenance, flood or other severe weather. Reduced patronage and the loss of a dockside or riverboat casino from service for any period of time could adversely affect our results of operations.
Although not required to cruise, to the extent that the casino boat of Lakeside Iowa, the USS Osceola, cruises, it and the gaming and support facilities located on board must comply with U.S. Coast Guard requirements as to boat design, on-board facilities, equipment, personnel and safety or requirements of state and local law, including the requirements of state gaming authorities, or both. If the USS Osceola fails to meet these requirements, we might be forced to stop operating Lakeside Iowa. The USS Osceola must hold a Certificate of Inspection or must be approved by the American Bureau of Shipping for stabilization and flotation, and may also be subject to local zoning and building codes, as well as additional requirements mandated by state law or by the gaming regulatory authority with jurisdiction over the facilities. The U.S. Coast Guard requirements establish design standards, set limits on the operation of the cruising vessels and require individual licensing of all personnel involved with the operation of the cruising vessels. Loss of a Certificate of Inspection or American Bureau of Shipping approval or other approval mandated by state law or by the gaming regulatory authority with respect to the USS Osceola would preclude its use as a floating casino.
The failure to achieve the anticipated benefits of the past or future acquisition could adversely impact our business.
The Sands Regent Acquisition constitutes a material acquisition on the part of the Company. We will incur significant capitalized costs and commit significant management time in integrating operations, information, communications and other systems, among other items, which will involve fees and expenses of professionals and consultants involved in completing the acquisition process, integrating technology and other transaction costs associated with the purchase, including financial advisor, attorney, accountant and other fees. However, despite the incurrence of such costs or the commission of such resources, difficulties may arise due to factors such as integrating personnel with disparate corporate cultures, reconciling different information, communications and other systems and managing customer relationships. The failure to achieve the anticipated benefits of the Sands Regent Acquisition could harm our business and results of operations.
We have spent and may continue to spend significant resources identifying businesses to acquire. The efficient and effective integration of any businesses we acquire into our organization is critical to our growth. Our
acquisitions of Lakeside Iowa, Mark Twain and St. Jo, and any future acquisitions or mergers, involve numerous risks including difficulties in integrating the operations, technologies and personnel of the acquired companies, the diversion of management’s attention from other business concerns and the potential loss of key employees of the acquired companies and businesses. Additional risks include:
· negative impacts on employee morale and performance as a result of job changes and reassignments;
· difficulties attracting key personnel;
· loss of customers; and
· unanticipated incompatibility of logistics, marketing and administration methods.
Failure to achieve the anticipated benefits of any of our past, pending and future acquisitions or mergers or to successfully integrate the operations of the companies we acquire could also harm our business, results of operations and cash flows. Additionally, we cannot assure you that we will not incur material charges in future quarters to reflect additional costs associated with any future acquisitions we may make.
As we expand our casino operations into states other than Nevada, we will, among other things, incur additional management costs, face different regulatory requirements and be affected by different economic environments and tax laws, any of which could adversely affect our business.
Historically, our route and casino operations were located exclusively in Nevada. However, the Grace Acquisition has resulted in casino operations in Iowa and Missouri. In addition, in the future we may consummate additional acquisitions outside of Nevada. As we begin to expand our operations in other states, we will face risks that we would not have faced had our operations remained solely in Nevada. Certain aspects inherent in maintaining operations in multiple jurisdictions could negatively impact our business results, including:
· costs and difficulties in staffing and managing operations outside of Nevada;
· regulatory requirements and changes in regulatory requirements;
· local political and economic conditions; and
· changes to applicable tax laws.
Risks Related to Our Outstanding Indebtedness
Our substantial indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under our outstanding indebtedness.
We have a significant amount of indebtedness. The following chart shows certain important statistics with respect to such indebtedness.
(1) For purposes of determining the ratio of earnings to fixed charges, earnings are defined as earnings before fixed charges and loss on early retirement of debt (other than capitalized interest). Fixed charges consist of interest expensed and capitalized and the interest component of rent expense.
In addition, on January 3, 2007, we entered into a second amended and restated credit agreement with Bank of America, as Administrative Agent, which provides for borrowings in an aggregate principal amount of $875 million consisting of (1) a revolving credit facility in an aggregate principal amount of up to $175 million, (2) initial term B loans in an aggregate principal amount of $375 million (the “initial term B loans”) and (3) delay draw term B loans in an aggregate principal amount of $325 million (the “delay draw term B loans”, and together with the initial term B loans, the “term B loans”). We have the option to request further increases to such facilities under certain circumstances as set forth in the credit agreement.
The initial term B loans were funded on January 3, 2007 to repay the previous facility balance and to finance the Sands Regent Acquisition. Proceeds from the delay draw term B loans on will be available to finance the Primadonna Acquisition if and when it closes.
Our substantial indebtedness could have important consequences. For example, it could:
· make it more difficult to satisfy our obligations with respect to the instruments governing our outstanding indebtedness;
· increase our vulnerability to general adverse economic and industry conditions;
· require us to dedicate a substantial portion of our cash flow from operations to debt service, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;
· limit our flexibility in planning for, or reacting to, competitive pressures and changes in our business and the industry in which we operate;
· place us at a competitive disadvantage compared to our competitors that have less debt; and
· limit, along with the financial and other restrictive covenants in our indebtedness, among other things, our ability to borrow additional funds.
Furthermore, all of our indebtedness under our credit facility will bear interest at variable rates. If these rates were to increase significantly, our ability to borrow additional funds may be reduced and the risks related to our substantial indebtedness would intensify.
If interest rates rise, the amount of interest paid by us under our credit facility will increase.
The interest on revolving borrowings and on the term loan under our credit facility in effect as of December 31, 2006 is based on a floating rate (a base rate or LIBOR, at our option), plus a leverage grid-based variable amount. At December 31, 2006, the principal amount of the borrowings under such credit facility was approximately $193 million. We cannot predict the interest rate environment or guarantee that interest rates will not rise in the near future. A hypothetical 1.0% increase in LIBOR would result in an approximately $1.9 million annual increase in interest expense. Should interest rates rise significantly, our ability to satisfy our obligations under the instruments governing our outstanding indebtedness will be adversely affected.
Despite our significant indebtedness, we and our subsidiaries may still be able to incur substantially more debt, which could further exacerbate the risks described above.
We will have the right to incur substantial additional indebtedness in the future. The terms of our credit facility and the indentures governing our indebtedness restrict our ability to incur additional indebtedness, but do not prohibit us from doing so. Subject to satisfying the conditions for borrowing under our credit facility, we could borrow up to the committed amount in full. If new debt is added to our current debt levels, the related risks that we now face could intensify.
We will require a significant amount of cash to service our indebtedness. Our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on and to refinance our indebtedness, and to fund our operations will depend upon our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in amounts sufficient to enable us to pay our indebtedness, or to fund our other liquidity needs. In addition, if we consummate significant acquisitions in the future, our cash requirements may increase significantly. If we are unable to generate sufficient cash flow and are unable to refinance or extend outstanding borrowings, we may have to:
· reduce or delay planned expansion and capital expenditures;
· sell assets;
· restructure debt; or
· raise additional capital.
Furthermore, we may need to refinance all or a portion of our debt on or before maturity. We cannot assure you that we will be able to refinance any of our debt on commercially reasonable terms or at all.
Our indebtedness imposes restrictive covenants on us.
Our credit facility and the indentures governing our 8 1¤8% senior subordinated notes due 2012 and our 7% senior subordinated notes due 2014 impose operational and financial restrictions on us and our subsidiaries. The restrictions imposed under these debt instruments include, among other obligations, limitation on our and our subsidiaries’ ability to:
· incur additional debt;
· make payments on subordinated obligations;
· make dividends or distribution and repurchase stock;
· make investments;
· grant liens on our property to secure debt;
· enter into certain transactions with affiliates;
· sell assets or enter into mergers or consolidations;
· sell equity interests in our subsidiaries;
· create dividend and other payment restrictions affecting subsidiaries;
· change the nature of our lines of business;
· make capital expenditures; and
· designate restricted and unrestricted subsidiaries.
Our credit facility imposes various customary affirmative covenants on us and our subsidiaries, including among others, reporting covenants, covenants to maintain insurance, comply with laws, maintain properties and other covenants customary in senior credit financings of this type. In addition, our credit facility will require us to comply with various restrictive financial covenants, including interest coverage and debt to operating cash flow ratios, and capital spending limits.
Our ability to comply with these provisions may be affected by general economic conditions, industry conditions, and other events beyond our control. As a result, we cannot assure you that we will be able to comply with these covenants. Our failure to comply with the covenants contained in the instruments governing our indebtedness, including our credit facility and the indentures governing our outstanding senior subordinated notes, including failure as a result of events beyond our control, could result in an event of default, which could materially and adversely affect our operation results and our financial condition.
If there were an event of default under one of our debt instruments, the holders of the defaulted debt could cause all amounts outstanding with respect to that debt to be due and payable, subject to applicable grace periods. This could trigger cross-defaults under our other debt instruments. We cannot assure you that our assets or cash flow would be sufficient to fully repay borrowings under our outstanding debt instruments if accelerated upon an event of default, or that we would be able to repay, refinance or restructure the payments on any of those debt instruments.
Item 1B.
Item 1B. Unresolved Staff Comments. None.
Item 2.
Item 2. Properties. Our principal properties consist of the following:
Nevada
Company Headquarters and Warehouse.
We lease a four-acre site in Las Vegas and own the 50,000 square foot building where our executive offices and operational headquarters are located. This facility houses our executive and administrative offices and is used for sub-assembly and warehouse space for our slot route operations. The lease between the Herbst Family Limited Partnership II, a Nevada limited partnership, and us ends on June 30, 2017, with options to renew the lease for five additional successive terms of ten years each.
Office Space and Convenience Store.
We lease a three-acre site and a 50,000 square foot building where our employment center and purchasing department are located. The lease between the Herbst Grandchildren’s Trust, a trust governed under the laws of the State of Nevada and a related party, and us ends on November 27, 2012, with options to renew the lease for five additional successive terms of ten years each.
Terrible’s Searchlight Casino.
We lease the space in which Terrible’s Searchlight Casino is located in Searchlight, Nevada. The space is leased from Terrible Herbst, Inc. and the lease ends on June 30, 2022, with options to renew the lease for five additional successive terms of ten years each.
Terrible’s Hotel & Casino.
We own the ten-acre site in Las Vegas on which Terrible’s Hotel & Casino is located, consisting of a 45,000 square foot casino with 255 guest rooms.
Terrible’s Town Casino.
Terrible’s Town Casino in Pahrump, Nevada, which is approximately 60 miles from Las Vegas, comprises an approximately 30,000 square foot building on approximately three acres. We lease the land from the Herbst Family Limited Partnership I, a Nevada limited partnership and a related party. The lease expired on June 30, 2006 and was extended for five additional years. The new expiration is June 30, 2011. We also have an option to further extend the lease for three additional successive terms of five years, meaning we can extend the lease through 2026.
Terrible’s Lakeside Casino & RV Park.
We own the land in Pahrump, Nevada on which Terrible’s Lakeside Casino & RV Park, an approximately 8,000 square foot casino on 30 acres, is located.
Terrible’s Town Casino & Bowl.
We lease the land and building on which our Terrible’s Town Casino & Bowl is located in Henderson, Nevada from an unrelated third party. The lease ends on February 9, 2014, with options to renew the lease for five additional successive terms of ten years each. We own a 0.8-acre lot adjacent to Terrible’s Town Casino & Bowl that we are holding for possible future development.
Midwest
Lakeside Casino Resort.
We own the land in Osceola, Iowa on which certain facilities of Lakeside Iowa are located, including the all-suite hotel, convention facilities, RV park and convenience store and own an additional 121 acres of land adjacent to or nearby the casino. We lease the use of West Lake and certain real estate surrounding West Lake from the City of Osceola, Iowa. The lease ends on March 11, 2009. We also have an option to further extend the lease for seven additional successive terms of five years each.
Mark Twain Casino.
We own the land in LaGrange, Missouri on which certain facilities of Mark Twain are located, and own an additional 14 acres of land adjacent to or nearby the casino.
St. Jo Frontier Casino.
We own the land in St. Joseph, Missouri on which certain facilities of St. Jo are located, and own an additional 72 acres of land adjacent to or nearby the casino.
Item 3.
Item 3. Legal Proceedings. On February 17, 2006, the Clark County Circuit Court entered judgment of a jury verdict delivered against ETT for $4.2 million in compensatory damages and $10.1 million in punitive damages. The jury verdict was lowered in a post trial ruling from $10.1 million to $4.2 to match compensatory damages. The verdict was delivered in connection with an action brought by the family of an individual that alleged that ETT had negligently retained and negligently supervised a temporary employee who in 2001 stole a truck from ETT and, while drunk, hit and killed the individual. The Company believes the award of compensatory and punitive damages against ETT, the liability of ETT, and the amount thereof, are not supportable in either law or in fact and plans to vigorously pursue all appropriate post-trial and other remedies, including exercising its right to appeal.
From time to time, we are a party to various claims arising in the normal course of business. Management believes, however, that there are no proceedings pending or threatened against us which, if determined adversely, would have a material adverse effect on our financial condition, results of operations or liquidity.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders. Not applicable.
PART II Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. (a) Market Information
There is no established public trading market for any class of our common equity. No class of our capital stock has been registered under the Securities Act of 1933, as amended, or under Section 12 of the Exchange Act. All 300 shares of our outstanding common stock are beneficially owned by Edward, Timothy and Troy Herbst.
(b) Holders
Edward, Timothy and Troy Herbst beneficially own all of the outstanding shares of our common stock.
(c) Dividends
Dividends of $12.1 million and $31.3 million were paid in respect of our outstanding common stock in fiscal 2005 and 2006, respectively.
Our credit agreement and the indentures governing our 81/8% senior subordinated notes due 2012 and our 7% senior subordinated notes due 2014 restrict our ability to declare or make distributions on our capital shares. To date, the only distributions that we have made on our common stock are distributions permitted by the instruments governing our outstanding indebtedness. Subject to contractual restrictions contained in our credit facility and these indentures, any future determinations as to the payment of dividends will be at the discretion of our board of directors, and will depend on our financial condition, results of operations, capital requirements, and such other factors as the board of directors deems relevant. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” and “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements.”
Item 6.
Item 6. Selected Financial Data. We derived the selected consolidated financial data as of and for each of the five years ended December 31, 2006 from our audited consolidated financial statements, as of and for each of the three years ended December 31, 2006, which are included elsewhere in this report. In February 2003, we acquired the slot route assets of Anchor Coin. As a result, the periods beginning on or after January 1, 2003 may not be comparable to prior years. Similarly, in February 2005, we consummated the Grace Acquisition, and as a result the period beginning on January 1, 2005 may not be comparable to prior years. The following table summarizes certain selected consolidated financial data, which you should read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this report and under “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis should be read in conjunction with “Item 6. Selected Financial Data” and with “Item 8. Financial Statements and Supplementary Data”.
Overview
We are a diversified gaming company that focuses on two business lines: slot route operations and casino operations. At December 31, 2006, we owned and operated approximately 11,000 slot machines. Our route operations involve the exclusive installation and operation of approximately 7,200 slot machines as of December 31, 2006 in strategic, high traffic, non-casino locations, such as grocery stores, drug stores, convenience stores, bars and restaurants. Our casino operations consist of eight casinos located in Nevada, Iowa and Missouri, all operated under the “Terrible’s” brand.
We generally enter into two types of route contracts. With chain store customers, such as Albertsons, Vons, Safeway, SavOn, Smith’s, Kmart, Terrible Herbst and Rite Aid, we pay a fixed monthly fee for each location in which we place slot machines. With our street accounts, such as bars, restaurants and non-chain convenience stores, we share in the revenues on a percentage basis with the location owner.
Our revenues are primarily derived from gaming revenues, which include revenues from slot machines and table games. Gaming revenues is generally defined as gaming wins less gaming losses. Our largest component of revenues is from our slot machines. Promotional allowances consist primarily of food and beverages furnished
gratuitously to customers. The retail value of such services is included in the respective revenue classifications and is then deducted as promotional allowance. We calculate income from operations as net revenues less total operating costs and expenses. Income from operations represents only those amounts that relate to our operations and excludes interest income, interest expense, and other non-operating income and expenses. Segment EBITDA consists of income from segment operations plus depreciation and amortization, and is calculated before an allocation of overhead.
We have elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code of 1986. Under those provisions, the owners of our company pay income taxes on our taxable income. Accordingly, a provision for income taxes is not included in our financial data.
Year 2006 Compared to Year 2005
Route Operations
Route operations accounted for 58% of total revenues during the year ended December 31, 2006. This was a decrease from 61% of total revenues for the year ended December 31, 2005. Total revenues from route operations were $347.0 million for the year ended December 31, 2006, an increase of $8.4 million, or 2.0%, from $338.6 million for the year ended December 31, 2005. The increase in route revenue was a result of increased number of games during 2006. At December 31, 2006, we were operating approximately 7,200 slot machines, which is 100 greater than the 7,100 we operated at December 31, 2005.
Route operating costs were $270.1 million, or 78%, of route revenues for the year ended December 31, 2006. This compares to $258.1 million and 76% of route revenues for the same period in 2005. The increase in route operating expenses was primarily associated with expenses that correlate with increases in revenue such as participation costs and payroll. In addition, partly due to staff additions to our systems and operations departments, payroll and insurance costs grew during the year, which increase is unrelated to growth in revenue.
As a result of the increased expenses, Route EBITDA for the year ended December 31, 2006 was $76.8 million, a decrease of $3.5 million, or 4%, from $80.3 million for the year ended December 31, 2005.
Casino Operations
Casino operations accounted for 40% of total revenues for the year ended December 31, 2006 and 38% of revenues for the year ended December 31, 2005. Total revenues derived from casino operations were $236.5 million for the year ended December 31, 2006, an increase of $23.6 million, or 11%, from $212.9 million for the year ended December 31, 2005. This increase was due to growth from the Midwest properties, particularly at St. Jo and Lakeside Iowa, where we made extensive casino renovations.
Casino operating costs were $148.4 million, or 63%, of casino revenues for the year ended December 31, 2006, compared to $138.4 million, or 65%, of casino revenues for the year ended December 31, 2005. The increase in expenses was due primarily to expenses that correlate with increases in revenue such as payroll and gaming taxes.
As a result of the factors mentioned above, Casino EBITDA was $55.5 million for the year ended December 31, 2006, an increase of $2.4 million, or 5%, from $53.1 million from the year ended December 31, 2005.
The following paragraphs divide the results from our casino operations geographically between casinos in Nevada and those in other states.
Casino Operations - Nevada
Nevada casino operations accounted for 16% of total Company revenues for the year ended December 31, 2006 and 17% of total revenues for the year ended December 31, 2005. Revenues derived from Nevada casino operations were $95.6 million for the year ended December 31, 2006 compared with $95.4 million for the year ended December 31, 2005. These results reflect the slight decrease in revenue at Terrible’s Hotel & Casino in Las Vegas as a result of the disruption to operations caused by the demolition of one-third of its hotel rooms in connection with the construction of its new parking structure and casino floor expansion, which was completed in the fourth quarter of 2006.
Nevada casino operating costs were $60.5 million, or 63%, of revenues for the year ended December 31, 2006, compared to $59.1 million, or 62%, of revenues for the year ended December 31, 2004. This increase in costs was due to an increase in spending at Terrible’s to maintain business during the disruption from the construction described in the previous paragraph as well as increase in payroll and insurance costs..
Casino Operations - Other states
Casino operations in other states accounted for 24% of total company revenues for the year ended December 31, 2006, which is up from 21% in 2005. Total revenues derived from casino operations located in states other than Nevada were $140.9 million, an increase of $ 23.4 million, or 20%, compared to $117.5 million for the year ended December 31, 2005. Other state casino operating costs were $ 87.9 million, or 62% of revenues, for the year ended December 31, 2006 compared to $79.2 million, or 67% of revenues, for the year ended December 31, 2005. We began floor improvements at our casinos in other states in the second quarter of 2005. The floor renovations consisted of over 1,200 new machines, new “ticket-in, ticket-out” software at each casino, new carpet and entirely new slot bases. The revenues during these periods were helped by significant increases in our cash promotions, player point promotions and food specials, which were incurred to offset the disruption from, and to keep player loyalty during, these extensive floor renovations. As these renovations were completed during the last quarter of 2006, these costs should begin to normalize.
Other Revenue
Other revenue consists of revenue items such as ATM fees, pay phone charges, rental income, gas and convenience store revenue and other miscellaneous items unrelated to route and casino operations. Other revenues were $11.2 million for the year ended December 31, 2006 compared to $6.0 million for the year ended December 31, 2005. The growth in this revenue was primarily due to a full year of gasoline sales at Lakeside Iowa.
Promotional Allowances
Promotional allowances were $32.7 million, or 5.5% of total revenues, for the year ended December 31, 2006, an increase of $11.0 million, or 51%, from $21.7 million, or 3.9% of total revenues, for the year ended December 31, 2005. The increase was due to the increase in promotions during the year to offset business disruption resulting from the significant renovations at the majority of our larger casino properties.
Other Costs
General and administrative expenses, or G&A, were $18.4 million for the year ended December 31, 2006, an increase of $3.2 million, or 21%, from $15.2 million for the year ended December 31, 2005. The increase was primarily due to increase in payroll, utilities and insurance costs. G&A expenses as a percentage of revenue were 3.1% of the revenue for the year ended December 31, 2006, compared to 2.7% of revenue during fiscal year ended December 31, 2005.
Depreciation and amortization expense was $38.1 million for the year ended December 31, 2006, an increase of $4.2 million, or 12%, from $33.9 million for the year ended December 31, 2005. The increase was due primarily to the depreciation and amortization expenses associated with the parking structure construction and casino expansion at Terrible’s, as well as the renovations at our Midwest casino properties.
Other Non-Gaming Expense
Other non-gaming expense consists of expenses related to the operations of our gasoline and convenience stories. In 2006, this expense was $6.5 million. This amount is primarily related to the cost of gasoline and convenience store operations.
Income from Operations
As a result of the factors discussed above, income from operations was $80.5 million for the year ended December 31, 2006, a decrease of $6.3 million, or 7%, from $86.8 million for the year ended December 31, 2005. As a percentage of total revenues, income from operations decreased from 15.6% during 2005 to 13.5% during the same period in 2006.
Other Expenses
Other expense was $38.4 million for the year ended December 31, 2006, an increase of $2.4 million from expenses of $36.0 million for the year ended December 31, 2005. This increase was primarily a result of the increase in the interest rates on our debt that coincided with the increases in the prime lending rate during 2006.
Our interest costs increased from $36.5 million during the year ended December 31, 2005 to $39.1 million during the year ended December 31, 2006. The Company’s debt grew from $500.6 million at December 31, 2005 to $522.6 million at December 31, 2006.
Net Income
Net income for the year ended December 31, 2006 was $42.1 million compared to the net income of $50.8 million recorded for year ended December 31, 2005. The year over year decrease was primarily the result of the increased expenses discussed above.
Year 2005 Compared to Year 2004
Route Operations
Route operations accounted for 61% of total revenues during the year ended December 31, 2005. This was a decrease from 76% of total revenues for the year ended December 31, 2004. Total revenues from route operations were $338.6 million for the year ended December 31, 2005, an increase of $45.4 million, or 15%, from $293.2 million for the year ended December 31, 2004. The increase in route revenue was a result of growth from the strong Las Vegas market during 2005. At December 31, 2005, we were operating approximately 7,100 slot machines, which is 300 greater than the 6,800 we operated at December 31, 2004.
Route operating costs were $258.1 million, or 76%, of route revenues for the year ended December 31, 2005. This compares to $227.9 million and 78% of route revenues for the same period in 2004. The dollar increase in route operating expenses was primarily associated with expenses that correlate with increases in revenue such as participation costs and payroll.
Route EBITDA for the year ended December 31, 2005 was $80.3 million, an increase of $15.4 million, or 24%, from $64.9 million for the year ended December 31, 2004. The increase in EBITDA was a direct result of revenue increases from our existing locations.
Casino Operations
Casino operations accounted for 38% of total revenues for the year ended December 31, 2005 and 23% of revenues for the year ended December 31, 2004. Total revenues derived from casino operations were $212.9 million for the year ended December 31, 2005, an increase of $121.6 million, or 133%, from $91.3 million for the year ended December 31, 2004. This increase was due to the inclusion of the results from the assets acquired in February 2005 pursuant to the Grace Acquisition, as well as growth from our existing operations.
Casino operating costs were $138.4 million, or 65%, of casino revenues for the year ended December 31, 2005, compared to $56.3 million, or 62%, of casino revenues for the year ended December 31, 2004. The increase in expenses was due to the inclusion of expenses incurred by the casinos acquired pursuant to the Grace Acquisition.
As a result of the factors described above, Casino EBITDA was $53.1 million for the year ended December 31, 2005, an increase of $30.3 million, or 133%, from $22.8 million from the year ended December 31, 2004. The following paragraphs divide the results from our casino operations geographically between casinos in Nevada and those in other states.
Casino Operations - Nevada
Nevada casino operations accounted for 17% of total Company revenues for the year ended December 31, 2005 and 23% of total revenues for the year ended December 31, 2004. Revenues derived from Nevada casino operations were $95.4 million for the year ended December 31, 2005 compared with $91.3 million for the year ended December 31, 2004, an increase of $4.1 million or 4%. Each of the Nevada properties other than Terrible’s contributed to this increase of revenues. These results reflect the slight decrease in revenue at Terrible’s as a result of the disruption to operations caused by the demolition of one-third of its hotel rooms in connection with the construction of its new parking structure and casino floor expansion. This construction should be completed by September 2006.
Nevada casino operating costs were $59.1 million, or 62%, of revenues for the year ended December 31, 2005, compared to $56.3 million, or 62%, of revenues for the year ended December 31, 2004.
Casino Operations - Other states
Casino operations in other states accounted for 21% of total company revenues for the year ended December 31, 2005. Total revenues derived from casino operations located in states other than Nevada were $117.5 million for the year ended December 31, 2005. Other state casino operating costs were $79.2 million, or
67%, of revenues for the year ended December 31, 2005. We began floor improvements at our casinos in other states in the second quarter of 2005. The floor renovations consisted of over 1,200 new machines, new “ticket-in, ticket-out” software at each casino, new carpet and entirely new slot bases. The revenues during these periods were helped by significant increases in our cash, player point promotions and food specials, which were incurred to offset the disruption and to keep player loyalty during these extensive floor renovations. As these renovations are completed and the gaming floor stabilizes, these costs should be reduced. We anticipate the improvements to the gaming floors to be completed early in the first quarter of 2006, after which we will begin renovating the land-based facilities of these casinos, by upgrading amenities such as the restaurants and common areas. These renovations should be completed by late 2006.
Other Revenue
Other revenue consists of revenue items such as ATM fees, pay phone charges, rental income, gas and convenience store revenue and other miscellaneous items unrelated to route and casino operations. Other revenues were $6.0 million for the year ended December 31, 2005 compared to $3.6 million for the year ended December 31, 2004. The growth in this revenue was primarily due to the addition of ancillary revenue sources from the assets acquired pursuant to the Grace Acquisition.
Promotional Allowances
Promotional allowances were $21.7 million, or 3.9% of total revenues, for the year ended December 31, 2005, an increase of $9.2 million, or 74%, from $12.5 million, or 3.2% of total revenues for the year ended December 31, 2004. The increase was due to heavier promotional spending at the Nevada casinos, and the inclusion of the new casino properties acquired pursuant to the Grace Acquisition.
Other Costs
General and administrative expenses, or G&A, were $15.2 million for the year ended December 31, 2005, an increase of $0.8 million, or 6.0%, from $14.4 million for the year ended December 31, 2004. The increase was primarily due to the overhead associated with the casinos acquired pursuant to the Grace Acquisition. G&A expenses as a percentage of revenue were 2.7% of the revenue for the year ended December 31, 2005, compared to 3.7% of revenue during fiscal year ended December 31, 2004.
Depreciation and amortization expense was $33.9 million for the year ended December 31, 2005, an increase of $8.5 million, or 33.0%, from $25.4 million for the year ended December 31, 2004. The increase was due primarily to the depreciation and amortization expenses associated with the acquired casino assets of Grace Entertainment, Inc.
For the year ended December 31, 2005, we incurred approximately $3.4 million in expense related to the demolition of a portion of Terrible’s Hotel & Casino in Las Vegas in connection with the construction of its new parking structure and casino floor expansion.
Income from Operations
As a result of the factors discussed above, income from operations was $86.8 million for the year ended December 31, 2005, an increase of $35.8 million, from $51.0 million for the year ended December 31, 2004. This was a 70% increase. As a percentage of total revenues, income from operations increased from 13.1% during 2004 to 15.6% during the same period in 2005.
Other Expenses
Other expense was $36.0 million for the year ended December 31, 2005, a decrease of $23.7 million from expenses of $59.7 million for the year ended December 31, 2004. This decrease was a primarily a result of $38.0 million costs incurred in 2004 for the early retirement of debt.
Our interest costs increased from $22.1 million during the year ended December 31, 2004 to $36.5 million during the year ended December 31, 2005 due to the debt incurred in connection with the Grace Acquisition in February 2005. The Company’s debt grew from $333.4 million at December 31, 2004 to $500.6 million at December 31, 2005.
The Company incurred approximately $0.2 million in early retirement of debt charges associated with the repayment of the remaining principal amount of the Company’s 10 ¾% senior subordinated notes due 2008.
Net Income
Net income for the year ended December 31, 2005 was $50.8 million. This is an improvement of $59.6 million from a net loss of $8.8 million recorded for year ended December 31, 2004. The year over year increase was primarily the result of a $38.0 million loss on the early retirement of debt in 2004 and is also attributable to increased profitability of existing businesses and income provided by the casinos acquired in 2005 pursuant to the Grace Acquisition.
Liquidity and Capital Resources
Cash Flows
At December 31, 2006, we had cash and cash equivalents of approximately $65.6 million on hand and approximately $79.4 million available under our revolving credit facility. Based upon our anticipated future operations, we believe that cash on hand, available cash flow and borrowings under our revolving credit facility will be adequate to meet our anticipated working capital requirements, capital expenditures, and scheduled payments of interest on our outstanding indebtedness for at least the next 12 months. We cannot assure you, however, that these sources will be sufficient for that purpose or that additional financing, if required, will be available or, if available, will be on terms favorable to us.
On January 3, 2007, we entered into the credit agreement, which was an amendment and restatement of our previous amended and restated credit agreement dated as of October 8, 2004. We borrowed $375.0 million in term loans under the credit agreement on the date of the agreement to finance the Sands Regent Acquisition. Subject to certain conditions set forth in the credit agreement, proceeds from delay draw term loans will be available to finance the Primadonna Acquisition if and when it closes.
Operating Activities
During the year ended December 31, 2006, operating activities provided $ 81.5 million in cash flows on net income of $42.1 million.
Investing Activities and Capital Expenditures
For the year ended December 31, 2006, we had net cash used for investing activities of $79.8 million of which $66.6 million related to the net cash used to purchase of new property and equipment including gaming devices.
For the year ended December 31, 2006, we made expenditures of $26.6 million in order to complete the construction of a new parking structure, casino expansion and general property renovations at Terrible’s Hotel & Casino in Las Vegas. In addition, we made expenditures in 2006 totaling $18.0 million in connection with renovations at the casinos acquired pursuant to the Grace Acquisition that consisted of adding new and updating existing slot machines and remodeling each property’s casino floor.
On January 3, 2007, we consummated the Sands Regent Acquisition, paying approximately $119.0 million in cash for the outstanding securities of The Sands Regent.
On October 31, 2006, we announced that we had entered into a purchase agreement to acquire from MGM MIRAGE the Buffalo Bill’s, Primm Valley and Whiskey Pete’s hotel-casinos for $400 million. We anticipate the transaction will close in the second quarter of 2007.
Capital projects for 2007 are anticipated to be approximately $34.0 million plus general maintenance and capital expenditures costs of approximately $12 million. This includes the expansion at Rail City in Sparks, Nevada as well as a conversion to the IGT Advantage slot system at Terrible’s, Terrible’s Town Pahrump, Terrible’s Lakeside in Pahrump and the Primm Valley Resorts should the Primm Acquisition close.
Financing Activities
Cash flows used by financing activities were $9.9 million during the year ended December 31, 2006. Also in 2006, we made distributions to our stockholders of $31.3 million. The distribution included $25.2 million for S-corporation taxes and $6.1 million for recurring annual distributions.
We may from time to time seek to retire our outstanding debt through cash purchases, in open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Our ability to service our debt will be dependent on our future performance, which will be affected by, among other things, prevailing economic conditions and financial, business and other factors, certain of which are beyond our control.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2006.
(1) Estimated interest for variable rate debt is based on rates at December 31, 2006
On October 31, 2006, we entered into a purchase agreement to purchase from MGM MIRAGE the Primm Valley Resorts for $400.0 million. The transaction is subject to customary closing conditions and the parties anticipate the transaction to close in the second quarter of 2007.
On January 3, 2007, we consummated the Sands Regent Acquisition, paying approximately $119.0 million in cash for the outstanding securities of The Sands Regent.
Other significant operating uses of cash in 2006 include interest and distributions made to stockholders for payment of S corporation taxes and discretionary distributions. Our cash payments for interest were $37.8 million for the year ended December 31, 2006 and cash distributions to stockholders were $31.3 million for the year ended December 31, 2006. The distributions to stockholders included $25.2 million in distributions for S corporation taxes and the recurring annual distributions of approximately $6.1 million.
Recurring stockholder distributions in 2007 should be approximately the same as 2006. Stockholder distributions for S corporation taxes will be lower in 2007 as net income will be significantly lower due to the recent Sands Regent Acquisition and the pending Primm Acquisition. Interest costs will increase significantly when and if the Primm acquisition takes place.
Critical Accounting Policies
The preparation of our financial statements requires our management to adopt accounting policies and make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. Our business and industry is highly regulated. The majority of our revenue is counted in the form of cash, chips and tokens and therefore, is not subject to any significant or complex estimation procedures.
We have determined that the following accounting policies and related estimates are critical to the preparation of our consolidated financial statements:
Long-Lived Assets
We have a significant investment in long-lived property and equipment and lease acquisition costs. Significant accounting policies that affect the reported amounts for these assets include the determination of the assets’ estimated useful life, evaluation of the assets’ recoverability and the likelihood of technological obsolescence. We estimate useful lives for property and equipment based on historical experience and estimates of products’ commercial lives. Significant incremental costs associated with the acquisition of location leases are capitalized and amortized using the straight-line method over the term of the related leases, which range from 1 to 20 years. Should the actual useful life of an asset differ from the estimated useful life, future operating results could be positively or negatively affected. We review useful lives, obsolescence, and assess commercial viability of these assets periodically.
We assess the recoverability of long-lived assets when circumstances indicate that the carrying amount of an asset may not be fully recoverable. If undiscounted expected cash flows to be generated by a long-lived asset or asset group are less than its carrying amount, we record an impairment to write down the long-lived asset or asset group to its estimated fair value. Fair value is determined based on undiscounted expected future cash flows. An adverse change to the estimate of these undiscounted future cash flows could necessitate an impairment charge that could adversely affect operating results.
Goodwill and Intangible Assets
We have a significant investment in goodwill and other intangible assets on our consolidated balance sheet as of December 31, 2006. The purchase price of an acquisition is allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. The estimated fair values of the assets acquired pursuant to the Grace Acquisition, a substantial portion of which consisted of intangible assets comprised of license rights, were arrived at by management after consideration of an independent appraisal and other consideration of fair values. To the
extent that the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired, such excess is allocated to goodwill.
We review the investment in goodwill and license rights for impairment annually. The annual evaluation of goodwill and license rights requires the use of estimates about future operating results of each reporting unit to determine their estimated fair value. Changes in forecasted operations can materially affect these estimates. Once impairment of goodwill or other intangible assets has been recorded, it cannot be reversed. An adverse change to the estimate of these future cash flows could necessitate an impairment charge that could adversely affect operating results.
Recently Issued and Adopted Accounting Standards
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by SFAS No. 159 permits all companies to choose to measure eligible items at fair value at specified election dates. At each subsequent reporting date, a company shall report in earnings any unrealized gains and losses on items for which the fair value option has been elected. SFAS No. 159 is effective as of the beginning of a company’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the company also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements” (see below). We are currently evaluating whether to adopt the fair value option under this SFAS No. 150 and evaluating what impact such adoption would have on our consolidated financial statements.
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 No. 158 requires employers to recognize the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. This Statement also requires employers to measure the funded status of a plan as of the date of its year end and is effective for publicly traded companies as of the end of the fiscal year ending after December 31, 2006. The adoption of SFAS No. 158 did not have a material effect on our consolidated financial statements as we do not currently have a defined benefit postretirement plan that meets the criteria specified under SFAS No. 158.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact that the adoption of SFAS No. 157 will have on our consolidated financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB No. 108”), which adds Section N to Topic 1, “Financial Statements”. Section N provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. To provide full disclosure, registrants electing not to restate prior periods should reflect the effects of initially applying the guidance in Topic 1N in their financial statements covering the first fiscal year ending after November 15, 2006. The adoption of SAB No. 108 did not have a material effect on our consolidated financial statements.
In June 2006, the Emerging Issues Task Force reached a consensus on Issue No. 06-3 (“EITF 06-3”), “Disclosure Requirements for Taxes Assessed by a Governmental Authority on Revenue-Producing Transactions.” The consensus allows companies to choose between two acceptable alternatives based on their accounting policies for transactions in which the company collects taxes on behalf of a governmental authority, such as sales taxes.
Under the gross method, taxes collected are accounted for as a component of sales revenue with an offsetting expense. Conversely, the net method allows a reduction to sales revenue. If such taxes are reported gross and are significant, companies should disclose the amount of those taxes. The guidance should be applied to financial reports through retrospective application for all periods presented, if amounts are significant, for interim and annual reporting beginning February 1, 2007. We have historically presented sales net of tax collected and we do not intend to change our policy; therefore, we do not expect the adoption of EITF 06-3 to have a material effect on our consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140”. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to irrevocably account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued after December 31, 2006. We do not expect the adoption of SFAS No. 155 to have a material effect on our consolidated financial statements, as we do not currently have any financial instruments that meet the criteria specified under SFAS No. 155.
Statement on Forward-Looking Information
We make statements in this report that relate to matters that are not historical facts that we refer to as “forward-looking statements” regarding, among other things, our business strategy, our prospects and our financial position. These statements may be identified by the use of forward-looking terminology such as “believes,” “estimates,” “expects,” “intends,” “may,” “will,” “should” or “anticipates” or the negative or other variation of these or similar words, or by discussions of strategy or risks and uncertainties. Forward-looking statements in this report include, among other things, statements concerning:
· projections of future results of operations or financial condition;
· expectations for our route operations and our casino properties; and
· expectations of the continued availability of capital resources.
Any forward-looking statement made by us necessarily is based upon a number of estimates and assumptions that, while considered reasonable by us, is inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control, and are subject to change. Actual results of our operations may vary materially from any forward-looking statement made by or on our behalf. Forward-looking statements should not be regarded as a representation by us or any other person that the forward-looking statements will be achieved. Undue reliance should not be placed on any forward-looking statements. Some of the contingencies and uncertainties to which any forward-looking statement contained herein is subject include, but are not limited to, the following:
· Our substantial indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under the instruments governing our outstanding indebtedness.
· We will require a significant amount of cash to service our indebtedness. Our ability to generate cash depends on many factors beyond our control.
· The success of our route operations is dependent on our ability to renew our contracts.
· Our indebtedness imposes restrictive covenants on us.
· We may not be able to successfully integrate the operations of casinos we acquire into our business.
· We may experience a loss of market share due to intense competition.
· We face extensive regulation from gaming and other government authorities.
· Changes to applicable tax laws could have a material adverse effect on our financial condition.
· Our operations could be adversely affected due to the recent adoption of anti-smoking regulations.
· We depend upon our key employees and certain members of our management.
· Our executive officers and members of our board of directors own 100% of the Company, which could lead to conflicts of interest.
· Our business relies heavily on certain markets and an economic downturn in these markets could have a material adverse effect on our results.
For additional contingencies and uncertainties, see “Item 1. Business-Risk Factors.”
Industry and Market Data
This report includes market and industry data that we obtained from our own research, studies conducted by third party sources that we believe to be reliable and industry and general publications published by third parties and, in some cases, management estimates based on industry and other knowledge. We have not independently verified any of the data from third party sources, and we make no representation as to the accuracy of such information. While we believe internal company estimates are reliable and market definitions are appropriate, they have not been verified by any independent sources, and we make no representations as to the accuracy of such estimates.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates, and commodity prices. We do not have any cash or cash equivalents as of December 31, 2006 that are subject to market risk based on changes in interest rates. As a result of borrowings under our credit facility in existence as of December 31, 2006, we are exposed to some market risk due to floating or variable interest rates. The interest on revolving borrowings and on the additional term loan under our credit facility is based on a floating rate (a base rate or LIBOR, at our option), plus a leverage grid-based variable amount. At December 31, 2006, the principal amount of borrowings under our credit facility was approximately $193.0 million. A hypothetical 1.0% increase in LIBOR would result in an approximately $1.9 million annual increase in interest expense.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets
As of December 31, 2005 and 2006
Consolidated Statements of Operations
For the years ended December 31, 2004, 2005 and 2006
Consolidated Statements of Stockholders’ Equity (Deficiency)
For the years ended December 31, 2004, 2005 and 2006
Consolidated Statements of Cash Flows
For the years ended December 31, 2004, 2005 and 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of
Herbst Gaming, Inc. and subsidiaries
Las Vegas, Nevada
We have audited the accompanying consolidated balance sheets of Herbst Gaming, Inc. and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity (deficiency), and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Herbst Gaming, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
Herbst Gaming, Inc.
Consolidated Balance Sheets
(in thousands)
See notes to consolidated financial statements.
Herbst Gaming, Inc.
Consolidated Statements of Operations
(in thousands)
See notes to consolidated financial statements.
Herbst Gaming, Inc.
Consolidated Statements of Stockholders’ Equity
(in thousands)
See notes to consolidated financial statements.
Herbst Gaming, Inc.
Consolidated Statements of Cash Flows
(in thousands)
See notes to consolidated financial statements.
See notes to consolidated financial statements.
Herbst Gaming, Inc.
Notes to consolidated financial statements
1. Description of Business and Summary of Significant Accounting Policies
Description of Business and Principles of Consolidation-The accompanying consolidated financial statements of Herbst Gaming, Inc. (“Herbst” or the “Company”) include the accounts of Herbst and its subsidiaries: E-T-T, Inc. and Subsidiaries (“E-T-T”), Market Gaming, Inc. (“MGI”), E-T-T Enterprises L.L.C. (“E-T-T Enterprises”), Flamingo Paradise Gaming, LLC (“FPG”), HGI-Lakeside, Inc. (“ HGI-L ”), HGI-St Jo, Inc. (“ HGI-ST ”) and HGI-Mark Twain, Inc. (“HGI-MT ”). The financial statements of E-T-T are consolidated and include the following wholly-owned subsidiaries: Cardivan Company, Corral Coin, Inc., and Corral Country Coin, Inc.
All significant intercompany balances and transactions between Herbst, E-T-T, MGI, E-T-T Enterprises, FPG, HGI-L, HGI-ST and HGI- MT have been eliminated in the consolidated financial statements.
Herbst Gaming, Inc. was incorporated in Nevada on January 21, 1997. In August of 2001, a restructuring occurred, wherein E-T-T, MGI, FPG and E-T-T Enterprises became wholly-owned subsidiaries of Herbst. This restructuring occurred in conjunction with the $170.0 million offering of senior secured notes that was used to retire the majority of the existing debt of the consolidated entities. Prior to August of 2001, the newly consolidated entities were combined for presentation purposes.
E-T-T and MGI conduct business in the gaming industry and generate revenue principally from gaming machine route operations and casino operations. Gaming machine route operations involve the installation, operation, and service of gaming machines owned by the Company that are located in licensed, leased, or subleased space in retail stores (supermarkets, convenience stores, etc.), bars, and restaurants throughout the State of Nevada. The Company operates Terrible’s Town Casino & Bowl in Henderson, Nevada, Terrible’s Searchlight Casino in Searchlight, Nevada, and Terrible’s Town Casino and Terrible’s Lakeside Casino & RV Park, both of which are located in Pahrump, Nevada, a community 60 miles west of Las Vegas.
E-T-T Enterprises develops and leases real estate to E-T-T.
FPG owns and operates Terrible’s Hotel & Casino in Las Vegas, Nevada, which began operations in December 2000.
HGI-L owns and operates Terrible’s Lakeside Casino in Osceola, Iowa, which was acquired in February 2005.
HGI-ST owns and operates Terrible’s St Jo Frontier Casino in St Joseph, Missouri, which was acquired in February 2005.
HGI-MT owns and operates Terrible’s Mark Twain Casino in La Grange, Missouri which was acquired in February 2005.
The gaming industry in the States of Nevada, Iowa, and Missouri is subject to extensive state and local government regulation. The Company’s gaming operations are subject to the licensing and regulatory control of the Nevada Gaming Commission, the Nevada Gaming Control Board, the Iowa Race and Gaming Commission, the Missouri Gaming Commission as well as local jurisdictions.
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 disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the period. Significant estimates incorporated into the Company’s consolidated financial statements include the estimated useful lives for depreciable and amortizable assets, the estimated allowance for doubtful accounts receivable and the estimated cash flows in assessing the recoverability of long-lived assets. Actual results could differ from those estimates.
1. Description of Business and Summary of Significant Accounting Policies (continued)
Reclassifications-Certain prior period amounts have been reclassified in the consolidated financial statements to conform to the current period’s presentation. Such reclassifications had no impact on net income (loss), or equity.
Cash and Cash Equivalents-Cash and cash equivalents include highly liquid investments with a maturity at the date of purchase of three months or less. The carrying value of these investments approximates their fair value due to their short maturities.
Fair Value of Financial Instruments-The carrying value of the Company’s cash, notes and loans receivable, and trade payables approximates fair value primarily because of the short maturities of these instruments. The fair value of the Company’s long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. Based on the borrowing rates currently available to the Company for debt with similar terms and average maturities, the estimated fair value of long-term debt outstanding is approximately $527,709,000 as of December 31, 2006.
Accounts Receivable-Receivables consist primarily of amounts due from customers as a result of normal business operations. The Company periodically performs credit evaluations of its customers. The Company reviews accounts receivable balances in order to determine an allowance for potential credit losses based on our collections experience and the age of the receivables. At December 31, 2005 and 2006, an allowance for potential credit losses was $626,000 and $488,000, respectively.
Notes and Loans Receivable-In order to secure various route locations, the Company has provided certain incentives to the location operators in the form of loans. The loans, made for build-outs, tenant improvements, and initial operating expenses, are generally secured by the personal guarantees of the operators and the locations’ assets. The majority of the loans are non-interest bearing and are expected to be repaid within one year from the locations’ share of net gaming win.
The Company regularly evaluates the collectibility of the loans by individually evaluating each location’s operating results and cash flows. Management provides for the carrying value of loans that are determined to be uncollectible. At December 31, 2005 and 2006, no allowance for potential credit losses was deemed necessary.
Inventory-Inventories are stated at the lower of cost or market value. Cost is determined using the first-in, first-out method.
Property and Equipment-Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset. Useful lives are as follows:
Lease Acquisition Costs- Significant incremental costs associated with the acquisition of location leases are capitalized and amortized using the straight-line method over the term of the related leases. Lease acquisition
costs are stated at cost less accumulated amortization of $35,833,000 and $43,110,000 at December 31, 2005 and 2006, respectively.
Debt Issuance Costs-Debt issuance costs incurred in connection with the issuance of long-term debt are capitalized and amortized to interest expense over the terms of the related debt agreements. Debt issuance costs are included in other assets on the balance sheets (see Note 6).
1. Description of Business and Summary of Significant Accounting Policies (continued)
Long-Lived Assets-In accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company evaluates the potential impairment of long-lived assets when events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. If it is determined that the carrying value of long-lived assets may not be recoverable based upon the relevant facts and circumstances, the Company estimates the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected undiscounted future cash flows is less than the carrying value of the asset, the Company will recognize an impairment loss for the difference between the carrying value of the asset and its fair value. The Company believes that no impairment of long-lived assets exists at December 31, 2006.
Goodwill and Intangible Assets-We had approximately $3,255,000 in goodwill on our consolidated balance sheet as of December 31, 2005 and December 31, 2006. We had $199,934,000 and $200,219,000 in other intangible assets on our consolidated balance sheet as of December 31, 2005 and December 31, 2006, respectively. These amounts are primarily a result of the Grace Acquisition in 2005 (see Note 2). The purchase price of an acquisition is allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. The estimated fair values of the assets acquired pursuant to the Grace Acquisition were arrived at by management after consideration of an independent appraisal and other consideration of fair values. To the extent that the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired, such excess is allocated to goodwill.
SFAS No. 142, “Goodwill and Other Intangible Assets,” requires a review of goodwill, license rights and indefinite-lived intangibles for impairment at least annually. We complete our annual assessment for impairment in the fourth quarter of each year. The annual evaluation of goodwill and the license rights requires the use of estimates about future operating results of each reporting unit to determine their estimated fair value. Changes in forecasted operations can materially affect these estimates. Once impairment of goodwill or other intangible assets has been recorded, it cannot be reversed.
Revenue and Promotional Allowances-In accordance with industry practice, the Company recognizes as gaming revenues the net win from route operations, which is the difference between gaming wins and losses. The Company recognizes total net win from gaming devices as revenues from gaming routes that operate under revenue-sharing arrangements. Revenue-sharing payments to route locations are recorded as costs of route operations. Revenues from casino operations are gaming wins less losses. Revenues from retail sales are presented net of sales tax. Revenues from casino operations include the retail value of food and beverage and goods and services provided to customers on a complimentary basis. Such amounts are then deducted as promotional allowances. The estimated cost of providing these promotional allowances is as follows:
These costs are reclassified out of the respective department into the casino department.
Liabilities in respect of the Company’s player’s club program are recognized as points are earned and are included in the “Other liabilities” line of the Company’s balance sheet. Expenses in respect of the Company’s player’s club program are included in the “Promotional allowances” line of the Company’s statement of operations.
Location Rent Expense- Fixed rental payments (including scheduled increases) are recorded on a straight-line basis over the agreement term. Renewal agreements are considered new agreements and are accounted for as described above over the new agreement term.
Income Taxes-Herbst, E-T-T and MGI have elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code. Under those provisions, the owners are liable for income tax on the taxable income of the Company as it affects the owners’ individual income tax returns. Therefore, a provision for income taxes has not been included in the accompanying consolidated financial statements.
Concentrations of Credit Risk-The Company maintains cash balances at certain financial institutions located in southern Nevada. The balances are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $100,000. At times, cash balances may be in excess of FDIC limits. As of December 31, 2006, the Company does not consider itself to have any significant concentrations of credit risk.
Recently Issued and Adopted Accounting Standards
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by SFAS No. 159 permits all companies to choose to measure eligible items at fair value at specified election dates. At each subsequent reporting date, a company shall report in earnings any unrealized gains and losses on items for which the fair value option has been elected. SFAS No. 159 is effective as of the beginning of a company’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the company also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements” (see below). We are currently evaluating whether to adopt the fair value option under this SFAS No. 150 and evaluating what impact such adoption would have on our consolidated financial statements.
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 No. 158 requires employers to recognize the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. This Statement also requires employers to measure the funded status of a plan as of the date of its year end and is effective for publicly traded companies as of the end of the fiscal year ending after December 31, 2006. The adoption of SFAS No. 158 did not have a material effect on our consolidated financial statements as we do not currently have a defined benefit postretirement plan that meets the criteria specified under SFAS No. 158.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact that the adoption of SFAS No. 157 will have on our consolidated financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB No. 108”), which adds Section N to Topic 1, “Financial Statements”. Section N provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. To provide full disclosure, registrants electing not to restate prior periods should reflect the effects of initially applying the guidance in Topic 1N in their financial statements covering the first fiscal year ending after November 15, 2006. The adoption of SAB No. 108 did not have a material effect on our consolidated financial statements.
In June 2006, the Emerging Issues Task Force reached a consensus on Issue No. 06-3 (“EITF 06-3”), “Disclosure Requirements for Taxes Assessed by a Governmental Authority on Revenue-Producing Transactions.” The consensus allows companies to choose between two acceptable alternatives based on their accounting policies for transactions in which the company collects taxes on behalf of a governmental authority, such as sales taxes. Under the gross method, taxes collected are accounted for as a component of sales revenue with an offsetting expense. Conversely, the net method allows a reduction to sales revenue. If such taxes are reported gross and are significant, companies should disclose the amount of those taxes. The guidance should be applied to financial reports through retrospective application for all periods presented, if amounts are significant, for interim and annual reporting beginning February 1, 2007. We have historically presented sales net of tax collected and we do not intend to change our policy; therefore, we do not expect the adoption of EITF 06-3 to have a material effect on our consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140”. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to irrevocably account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued after December 31, 2006. We do not expect the adoption of SFAS No. 155 to have a material effect on our consolidated financial statements, as we do not currently have any financial instruments that meet the criteria specified under SFAS No. 155.
2. Acquisitions
On February 1, 2005, the Company consummated the purchase of assets consisting of three casinos from Grace Entertainment, Inc. for an aggregate cash purchase price of $266.8 million (the “Grace Acquisition”). The purchase price does not include $2.4 million in fees associated with the consummation of the Grace Acquisition that are included in the table below. The acquired assets consist of the Lakeside Casino Resort, located in Osceola, Iowa, or Lakeside Iowa, which contains 921 slot machines, 31 table games and an adjacent 60 room all-suite hotel, the Mark Twain Casino, located in LaGrange, Missouri, or Mark Twain, which contains 505 slot machines and 17 table games, and the St. Jo Frontier Casino, located in St. Joseph, Missouri, or St. Jo, which contains 487 slot machines and 15 table games. The Company used proceeds from a $170.0 million 7% senior subordinated notes offering along with borrowings under its amended and restated credit facility to fund the purchase price of the Grace Acquisition. The Grace Acquisition was recorded under the purchase method of accounting and the results of operations of the Grace assets will be included in the Company’s consolidated results from the date of acquisition.
The allocation of the purchase price is as follows:
Estimated Fair Market Value of assets acquired (in thousands) net of cash
Estimated Fair Market Value of liabilities assumed (in thousands)
The table below reflects unaudited pro forma consolidated results of the Company as if the Grace Acquisition had taken place at January 1, 2005 (dollars in thousands).
In management’s opinion, these unaudited pro forma amounts are not necessarily indicative of what the actual combined results of operations might have been if the acquisition had been effective at the beginning of the earliest period presented.
A third-party valuation firm was engaged by the Company to value the assets acquired pursuant to this acquisition and to assist in the allocation of the purchase price. These tasks included the identification and valuation of any intangible assets acquired and resulted in the recognition of certain intangible assets, such as gaming licenses, customer lists and an executive non-competition agreement, as well as goodwill. The Company allocated approximately $200.8 million to intangible assets acquired pursuant to the Grace Acquisition. For a description of the nature of the intangibles acquired, as well as whether they are amortizable, and if so, over what period of time, see “Note 5-Goodwill and Other Intangible Assets”.
The Company has allocated $3.3 million to goodwill, which the Company believes is attributable to the strong cash flows generated by these properties as well as the enhancement and diversification of the Company’s base businesses outside the state of Nevada.
3. Property and Equipment
Property and equipment consist of the following (in thousands):
4. Lease Acquisition Costs
The aggregate amortization expense for the years ended December 31, 2004, 2005 and 2006 was $10,036,000 $10,011,000 and $10,272,000 respectively.
Estimated amortization expense for the years ended 2007, 2008, 2009, 2010 and 2011 is $10,262,000, $8,625,000, $6,774,000, $6,607,000 and $583,000, respectively.
5. Goodwill and Other Intangible Assets
During 2005 we acquired the casino assets of Grace Entertainment, Inc. pursuant to the Grace Acquisition. In connection with this transaction, we recorded significant amounts of intangible assets and goodwill during the year ended December 31, 2005 that are included in the table below.
Intangible assets consist of the following (dollars in thousands):
The changes in the carrying amount of goodwill for the year ended December 31, 2006 are as follows:
License rights are intangible assets acquired from the purchase of gaming entities that operate in gaming jurisdictions where competition is limited, such as states where only a certain number of operators are allowed by law. Intangible license rights are not currently subject to amortization as we have determined they have an indefinite useful life.
Customer lists are being ratably amortized over a four year period.
Non-competition agreements were entered with the previous owners and management and are amortized over five years.
Goodwill represents the excess of total acquisition costs over the fair market value of net assets acquired in a business combination. Goodwill has been determined to have an indefinite life and is therefore not amortized.
For the year ended December 31, 2006, amortization expense of intangibles was $1,035,000. The expected annual amortization of those assets for the years ended December 31, 2007, 2008, 2009, 2010 and 2011, the amortization costs will be $1,161,000, $1,161,000, $496,000, $234,000 and $126,000, respectively.
During 2005, we had a third party valuation completed on all intangible assets acquired from Grace
Entertainment. Additionally, we prepared a direct value method valuation to test for impairment of all of those indefinite lived assets. There was no impairment noted for the year ended December 31, 2005.
Pursuant to the Grace Acquisition, the Company also acquired two lease agreements with the City of LaGrange, Missouri and the City of Osceola, Iowa (see “Note 10. ─ Commitments and Contingencies”). However, because such agreements are not material to our business operations and are essentially a payment obligation to each such locality, the Company believes such leases have no value. As a result, such leases are not subject to amortization.
6. Other Assets
Other assets consist of the following (dollars in thousands):
7. Accrued Expenses
Accrued expenses consist of the following (dollars in thousands):
8. Long-Term Debt
Long-term debt consists of the following (dollars in thousands):
8 1¤8% Senior Subordinated Notes
On June 11, 2004, the Company issued (through a private placement) $160 million in 8 1¤8% senior subordinated notes due June 1, 2012 (the “8 1¤8% notes”).
The proceeds from the 8 1¤8 % notes, along with borrowings under the credit facility of the Company existing at the time, were used to retire 97% of its outstanding 10 3¤4% notes for $242.1 million and to pay a $15.0 million dividend to shareholders. Fees of $4.3 million associated with the 8 1¤8% notes and $3.5 million associated with such credit facility are included in other assets at December 31, 2006 and are being amortized over the life of the indebtedness. In connection with the retirement of 97% of the 10 3¤4% notes in 2004, the Company recorded a loss on the early retirement of debt of $38.0 million. The loss consisted of $31.3 million in debt prepayment premiums and $6.7 million in unamortized loan fees.
The 8 1¤8% notes mature on June 1, 2012. Interest is payable in cash at a rate of 8 1¤8% per annum on June 1 and December 1 of each year, beginning on December 1, 2004. The indenture under which the 8 1¤8% notes were issued contains various limitations and restrictions including (i) change in control provisions, (ii) limitations on indebtedness and (iii) limitations on certain payments such as dividends. The Company is in compliance with these covenants as of December 31, 2006.
In August 2004, the Company filed a Form S-4 registration statement with the SEC for the purpose of effecting the exchange of the 8 1¤8% notes for identical notes registered for resale under the federal securities laws.
This registration statement became effective in November 2004 and the exchange offer was consummated in December 2004.
7% Senior Subordinated Notes
On November 22, 2004, the Company issued (through a private placement) $170 million in 7% senior subordinated notes due November 15, 2014 (the “7% notes”).
The proceeds from the 7% notes, along with borrowings under the amended credit facility were used to finance the Grace Acquisition in February 2005 (see Note 2). Fees of $6.2 million associated with the 7% notes and amended credit facility are included in other assets at December 31, 2005 and are being amortized over the life of the indebtedness.
The 7% notes mature on November 15, 2014. Interest is payable in cash at a rate of 7% per annum on May 15 and November 15 of each year, beginning on May 15, 2005. The indenture under which the 7% notes were issued contains various limitations and restrictions including (i) change in control provisions, (ii) limitations on indebtedness and (iii) limitations on certain payments such as dividends. The Company is in compliance with these covenants as of December 31, 2006.
In February 2005, the Company filed a Form S-4 registration statement with the Securities and Exchange Commission for the purpose of effecting the exchange of the 7% notes for identical notes registered for resale under the federal securities laws. This registration statement became effective in April 2005 and the exchange offer was consummated in May 2005.
The Company’s senior notes are guaranteed by E-T-T, Inc., Cardivan Company, Corral Coin, Inc., Corral Country Coin, Inc., Corral Coin, Inc., E-T-T Enterprises L.L.C., Market Gaming, Inc., and Flamingo Paradise Gaming, LLC, HGI-Lakeside, HGI-St Jo and HGI-Mark Twain (100 percent-owned subsidiaries of Herbst Gaming, Inc.) (collectively, the “subsidiary guarantors”). Condensed consolidating financial information with respect to the subsidiary guarantors is not provided because the Company has no independent assets or operations, the subsidiary guarantees are full and unconditional and joint and several, and there are no other material subsidiaries of the Company other than the subsidiary guarantors. There are no significant restrictions on the ability of the Company’s subsidiary guarantors to transfer funds to the Company in the form of cash dividends, loans or advances.
Credit Facilities
On October 8, 2004, the Company amended and restated the senior secured credit facility it entered into on June 10, 2004 (the “amended credit facility”). The amendment provided for a $175 million revolving credit facility and included the ability to issue $100 million under a term facility for the acquisition of the Grace Entertainment assets. The facility was further amended in August of 2005 to revise pricing. Borrowings under the senior secured credit facility bear interest, selected monthly at the Company’s option, at a premium over the base rate or the one-, two-, three-, or six-month Eurodollar Rate (“Eurodollar”). The premium depends on a leverage ratio and can vary, if determined by reference to the base rate, between 0.0% and 1.125% and, if determined by reference to Eurodollar, between .875% and 2.375%. As of December 31, 2006, using the one-month Eurodollar option, the premium over Eurodollar was 1.75%. The Company incurs a commitment fee, payable quarterly in arrears, on the unused portion of the senior secured credit facility. This fee varies depending on a leverage ratio and can vary between 0.25% and 0.40% per annum. As of December 31, 2006, the fee was 0.35% per annum times the average unused portion of the facility.
The amended credit facility contains various limitations and restrictions, including with respect to leverage covenants (both senior and total) as well as a minimum fixed charge coverage ratio. The Company is in compliance with these covenants as of December 31, 2006.
Long-term debt is expected to mature as follows (dollars in thousands):
9. Related-Party Transactions
General.
Edward Herbst, Timothy Herbst and Troy Herbst are brothers and are the officers and directors of Herbst Gaming, Inc. and its wholly-owned subsidiaries. In addition, they are officers and directors of Terrible Herbst, Inc. (“Terrible Herbst”). There is no cross ownership between Herbst Gaming, Inc. and Terrible Herbst. Terrible Herbst is owned solely by Jerry and Maryanna Herbst, the parents of the Herbst brothers. Sean Higgins, the Company’s general counsel, is also the general counsel of Terrible Herbst.
Slot route contract with Terrible Herbst, Inc.
The Company rents space for certain slot machine route operations in convenience stores owned by Terrible Herbst. Rent expense of $5,599,500, $5,909,000 and $6,623,000 was incurred under this agreement for the years ended December 31, 2004, 2005 and 2006, respectively, for the exclusive placement of slot machines in Terrible Herbst convenience store locations. This contract expires in 2010 but may be extended at the option of the Company for two additional terms of five years.
Other arrangements with Terrible Herbst, Inc.
The Company has entered into a servicing arrangement with Terrible Herbst pursuant to which it provides accounting and administrative services related to the collection of daily deposits from Terrible Herbst convenience stores. The Company also provides personnel to Terrible Herbst to count, maintain and safeguard large amounts of coin and currency. Terrible Herbst reimburses the Company’s expenses in providing these services. Under this servicing arrangement, the Company was paid approximately $205,800 for services rendered for each of the years ended December 31, 2004, 2005 and 2006.
The Company has entered into a nonexclusive trademark and license agreement with Terrible Herbst for the use of the Terrible Herbst brand name and its cowboy logo which extends through 2011. Subject to mutual consent, the agreement provides for the ability to renew the agreement for two additional successive terms of five years each. Pursuant to this trademark and license agreement, the Company paid approximately $1,345,000, $1,412,000 and $1,483,000 to Terrible Herbst in the years ended December 31, 2004, 2005 and 2006, respectively.
Lease agreements.
Pursuant to a lease agreement that expires in 2067, including renewal periods, the Company leases the real property on which its corporate headquarters is located from The Herbst Family Limited Partnership II, or Herbst FLP II. The general partners of the Herbst FLP II are Jerry and Maryanna Herbst. The lease requires monthly rental payments of $14,416. In each of 2004, 2005 and 2006, the Company paid $172,992 under this lease.
Pursuant to a lease agreement that expires in 2026, including renewal periods, the Company leases the real property on which Terrible’s Town Casino in Pahrump is located from The Herbst Family Limited Partnership. The
lease requires monthly rental payments of $15,000. In each of 2004, 2005, the Company paid $150,000 under this lease. During 2006, the company paid $165,000 under this lease.
The Company leases land and office space in certain of its facilities to Terrible Herbst under various lease agreements with terms ranging from monthly to 20 years. Monthly rental income is $39,000 at year end. Under these leases, in each of 2004 and 2005 the Company received rental income of $762,000 and in 2006 the Company received rental income of $640,500.
The Company subleases the real property on which Terrible’s Searchlight Casino in Searchlight is located from Terrible Herbst for $15,000 per month, pursuant to a lease agreement entered into on June 30, 2002 that expires in 2022, with options to renew the lease for five additional successive terms of ten years each. Terrible Herbst leases that real property from an unrelated third party, pursuant to a lease agreement entered into on June 30, 2002 that expires in 2042, including renewal periods. In each of 2004, 2005 and 2006, amounts paid under this lease was $180,000.
The Company leases a warehouse located in Las Vegas, Nevada for its employment center and purchasing departments from the Herbst’s Grandchildren’s Trust. The lease began in November 2002 and requires payments of $46,500 per month through November 2012. Rent expense incurred under this lease arrangement was $522,300 for each of the years ended December 31, 2004, 2005 and $558,000 during 2006.
Future rental income under related-party agreements is as follows (dollars in thousands):
Related-party transactions.
Mr. Higgins is the Company’s General Counsel, the General Counsel of Terrible Herbst, Inc. and the brother of Mary E. Higgins, the Company’s Chief Financial Officer. Mr. Higgins received a salary for services rendered to us in 2004, 2005 and 2006 of $339,394, $426,763 and $625,851, respectively.
In 2003, the Company entered into a slot route contract to install, operate and service slot machines at a tavern owned by HIGCO, Inc., a company owned and operated by Mr. Higgins and two of his brothers. Pursuant to this revenue-sharing contract, HIGCO, Inc. paid the Company $118,756 in 2004, $155,804 in 2005 and $154,220 in 2006.
In 2004, E-T-T entered into a slot route contract with SamCon, Inc., a company owned and operated by Mr. Higgins, to install, operate and service slot machines at a new location. Terms of this revenue-sharing contract are similar to the terms of the contract the Company entered into with HIGCO in 2003. Pursuant to this revenue-sharing contract, SamCon, Inc. paid E-T-T $0 in 2004, $40,800 in 2005 and $21,112 in 2006.
In March 2006, E-T-T entered into a slot route contract to install, operate and service slot machines at a tavern owned by Prescott’s Bar LLC, a company owned and operated by Mr. Todd Sosey, the brother-in-law of Troy D. Herbst, one of the owners of the Company. Pursuant to this revenue-sharing contract, Prescott’s Bar LLC paid E-T-T $52,844 in 2006.
John N. Brewer, a member of the Company’s board of directors, is a partner with Kummer Kaempfer Bonner & Renshaw. The Company retained Kummer Kaempfer Bonner & Renshaw as outside legal counsel
through December 31, 2004, and Kummer Kaempfer Bonner & Renshaw has received fees for legal services in the amount of $274,310, $3,500 and $5,673 for 2004, 2005 and 2006, respectively
The balance sheet item “due from related parties” includes receivables of $160,000, $164,000 and $168,000 at December 31, 2004, 2005 and 2006, respectively, from Terrible Herbst, which are non-interest bearing.
Obligations due to related parties at December 31, 2004, 2005 and 2006 consisted of balances due to Terrible Herbst for expenditures made on behalf of the Company, accrued rent, and accrued management fees. The balances are non-interest bearing and payable on demand.
10. Commitments and Contingencies
At December 31, 2006, the Company has non-cancelable location license agreements for space leases at groups of affiliated stores that expire on various dates from 2006 through 2011, with certain options for renewal. Revenues from gaming machines in these stores accounted for approximately 33.5% of the Company’s total revenues for the year ended December 31, 2006.
Future minimum lease payments under non-cancelable operating leases and location license agreements are as follows (dollars in thousands):
Rent expense related to non-cancelable leases with terms exceeding one year was $72,228,000, $74,378,000 and $ 74,852,000 for the years ended December 31, 2004, 2005 and 2006, respectively.
On February 17, 2006, the Clark County Circuit Court entered judgment of a jury verdict delivered on January 14, 2006 against ETT for $4.1 million in compensatory damages and $10.1 million in punitive damages. The jury verdict was delivered in connection with an action brought by the family of an individual, that alleged that ETT had negligently retained and negligently supervised a temporary employee who in 2001 stole a truck from ETT and, while drunk, hit and killed the individual. The punitive damage award was subsequently lowered to $4.1 million in a post-trial ruling. The Company believes the award of compensatory and punitive damages against ETT, the liability of ETT, and the amount thereof, is not supportable in either law or in fact and plans to vigorously pursue all appropriate post-trial and other remedies, including exercising its right to appeal. Based on a review of the legal opinions and facts available to the Company at this time, the Company has not reserved for this lawsuit.
The Company is a party to certain other claims, legal actions, and complaints arising in the ordinary course of business or asserted by way of defense or counterclaim in actions filed by the Company. Management believes that its defenses are substantial in each of these matters and that the Company’s legal position can be successfully defended without material adverse effect on its consolidated financial statements.
11. Revenue Derived From Major Locations
Route operations revenues at three groups of affiliated store chains in the years ended December 31, 2004 and 2005 each accounted for more than 10 percent of the Company’s total route revenues. The total of such revenues were approximately $137,468,000, $150,933,000 and $0. in the years ended December 31, 2004, 2005 and 2006, respectively. Each individual store chain included in such affiliated group of store chains has a separate lease with the Company. No one chain accounted for more than 10% in 2006.
12. Business Segments
The Company operates through two business segments: slot route operations and casino operations. The slot route operations involve the installation, operation, and service of slot machines at strategic, high traffic non-casino locations, such as grocery stores, drug stores, convenience stores, bars, and restaurants. Casino operations consist of two geographic areas, Nevada and Other States. The Nevada locations include the following five casinos: Terrible’s Town Casino (Henderson) in Henderson, Nevada, Terrible’s Searchlight Casino in Searchlight, Nevada and Terrible’s Town Casino and Terrible’s Lakeside Casino, both of which are located in Pahrump, Nevada, and Terrible’s Hotel & Casino in Las Vegas, Nevada. Casinos located in other states are Terrible’s Lakeside Casino in Osceola, Iowa, Terrible’s St. Jo Frontier Casino in St. Joseph, Missouri and Terrible’s Mark Twain Casino in La Grange, Missouri.
Revenues and income for these segments are as follows (dollars in thousands):
(1) Represents non-gaming revenues, general and administrative expenses, interest income and loss on lease termination.
(2) Segment EBITDA is used by management to measure segment profits and losses and consists of income from segment operations plus depreciation and amortization and is calculated before allocation of overhead.
13. Subsequent Events
On January 3, 2007, the Company consummated the acquisition of The Sands Regent (the “Sands Regent Acquisition”), paying approximately $119.0 million in cash for the outstanding securities of The Sands Regent. The Company used proceeds from the credit agreement it entered into concurrently with the Sands Regent Acquisition to fund such transaction.
Selected Quarterly Financial Information (Unaudited)
(in thousands)
(1) Amount includes $3.4 million loss on retirement of assets.
(2) Amount includes a loss on early retirement of debt consisting of $31.3 million in a debt prepayment penalty and $6.7 million in unamortized loan fees.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.
Item 9A.
Item 9A. Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this report (the “Evaluation Date”), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.
Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective at the reasonable assurance level.
There has been no change in our internal controls over financial reporting during the fourth quarter ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reports.
Item 9B.
Item 9B. Other Information. None.
PART III Item 10.
Item 10. Directors and Executive Officers of the Registrant. The following information is furnished with respect to each member of the board of directors, each of whom, unless otherwise indicated, has served as a director continuously since the year set forth below. Directors are elected annually. Each director serves until his successor has been elected and qualified. Similar information is provided for our executive officers.
Directors and Executive Officers
The following is a list of our directors and executive officers:
Edward, Timothy and Troy Herbst are brothers. Timothy and Troy Herbst are members of our Executive Committee and Troy Herbst is a member of our Audit Committee, but they are not involved in day-to-day operations.
Edward J. Herbst has served as the Chief Executive Officer, President and Chairman of the Board of Directors of our company and its predecessors since their inception in 1987. Edward oversees all aspects of our business, including gaming route operations, casino operations, new business initiatives and the solicitation of new contracts. Edward also serves as a Vice President of Terrible Herbst, Inc. and sits as a member of U.S. Bank of Nevada’s advisory board of directors.
Timothy P. Herbst has served as Executive Vice President and a Director of our company and its predecessors since their inception in 1987. Timothy is a member of our Executive Committee. He also serves as a Vice President of Terrible Herbst, Inc.
Troy D. Herbst has served as Executive Vice President, Secretary, Treasurer and a Director of our company and its predecessors since their inception in 1987. Troy is a member of our Executive and Audit Committees. He also serves as a Vice President of Terrible Herbst, Inc.
Mary E. Higgins has been the Chief Financial Officer of our company since May 2000. Prior to joining our company, from March 1997 to June 2000, Ms. Higgins was the Chief Financial Officer of Camco, Inc., a Las Vegas based specialty finance company. From August 1987 to October 1996, Ms. Higgins was the Commercial Lending Division Manager of Southern Nevada for Wells Fargo Bank in Las Vegas.
John N. Brewer has served as a Director of our company since December 2001. Mr. Brewer is also a member of our Audit Committee. Mr. Brewer is a partner with the law firm of Kummer Kaempfer Bonner Renshaw & Ferrario in Las Vegas, Nevada, where he has practiced principally in corporate and securities law since its inception in 1994.
John F. O’Reilly has served as a Director of our company since November 2004. Mr. O’Reilly is the Chairman and Chief Executive Officer of the law firm of O’Reilly Law Group, LLC, in Las Vegas, Nevada, a position which he has held since 1999 and where he has practiced since its inception in 1977 and also serves as the Chairman and Chief Executive Officer of the O’Reilly Gaming Group, in Las Vegas, Nevada, which he has served since its inception in 1999. Mr. O’Reilly is also Chairman and an officer and/or Director of various family-owned business entities and related investments. Mr. O’Reilly has served as a Director of Nevada Power Company since 1995 and Sierra Pacific Resources and Sierra Pacific Power Company since 1999.
Code of Ethics
We have adopted a Code of Ethics for the senior management of the Company including the Chief Executive Officer and President, and our Chief Financial Officer and Chief Accounting Officer. This Code of Ethics is reasonably designed to deter wrongdoing and to promote:
· honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
· full, fair, accurate, timely, and understandable disclosure in reports and documents that a registrant files with, or submits to, the SEC and in other public communications made by us;
· compliance with applicable governmental laws, rules and regulations;
· the prompt internal reporting of violations of the code to an appropriate person or persons identified in the Code of Ethics; and
· accountability for adherence to the Code of Ethics.
Committees of our Board of Directors
Our board of directors has an Audit Committee and an Executive Committee. The Audit Committee’s functions are as follows:
· to review reports of our independent public accountants;
· to review our financial practices, internal controls and policies with officers and key employees;
· to review such matters with our auditors to determine scope of compliance with any deficiencies;
· to consider selection of independent public accountants;
· to review related party transactions; and
· to make periodic reports on such matters to the board of directors.
Our Audit Committee is comprised of Messrs. Troy Herbst and John Brewer. Mr. Brewer is the Chairman of the Audit Committee. Our board of directors has determined that Mr. Brewer is qualified as an audit committee financial expert as defined by Item 401(h) of Regulation S-K and is independent under the listing standards of the New York Stock Exchange.
The Executive Committee’s function is to review and make recommendations to our board of directors with respect to the salaries and bonuses of our executive officers and key employees. Directors Edward Herbst, Timothy Herbst and Troy Herbst serve on the Executive Committee.
Item 11.
Item 11. Executive Compensation. Executive Compensation
The following table lists all compensation we paid or accrued for services rendered by our executive officers whose aggregate cash compensation exceeded $100,000 for the last three fiscal years:
(1) We have entered into employment agreements with Edward J. Herbst and Mary E. Higgins.
(2) Includes stockholders’ distributions and fringe benefits, such as automobiles.
(3) We are an S corporation and taxes on our income are paid by the stockholders.
Employment Agreements
On August 1, 2001, we entered into an employment agreement with Edward J. Herbst, our Chairman, Chief Executive Officer and President, in which we agreed to pay him annual base compensation of $465,000, which may be increased annually by five percent. This agreement commenced on August 1, 2001 and terminates on July 31, 2006, with the automatic renewal periods described below. In January of 2005, we entered into an a new employment agreement with Mary E. Higgins, our Chief Financial Officer, in which we agreed to pay her an annual base salary of $325,625 plus a non-discretionary bonus of $50,000 per year. That agreement terminates on December 31, 2008. Both of these agreements automatically renew for successive one-year periods unless sooner terminated or unless either party to the respective agreements notifies the other in writing at least 60 days prior to the date the respective agreement is scheduled to expire. Each employment agreement provides that if the executive’s employment is terminated for Cause (as defined in the employment agreement), such executive will receive no severance payment of any kind. If the executive voluntarily terminates employment, the executive will receive no severance payment of any kind. In the event that we choose to terminate the executive’s employment for
any reason other than Cause, the executive will receive a severance payment equal to one year’s salary. The employment agreements with these executives also contain a covenant to protect confidential information.
Executive Compensation and Bonus Plan
The board of directors has adopted the Executive Compensation and Bonus Plan for our executive officers who are also stockholders. Any payments to be made under this plan must be approved by our independent directors. Commencing with calendar year 2003 and each succeeding calendar year, the maximum aggregate amount of annual compensation and cash bonuses increases by 5%. To date, there have been no cash bonuses paid to the executive officers. If any cash bonus plan is implemented it will be administered by our independent directors.
Executive Committee Interlocks and Insider Participation
During the fiscal year ended December 31, 2006, Edward, Timothy and Troy Herbst were members of the Executive Committee of our board of directors. Our executive compensation is determined by the Executive Committee, all members of which are officers, and the owners, of Herbst Gaming.
Compensation of Directors
Our independent directors will receive compensation in the amount of $25,000 per year for serving on our board and in addition will receive $5,000 per board meeting attended and $1,500 per committee meeting attended.
Section 16(a) Beneficial Ownership Reporting Compliance
Not Applicable.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. The securities entitled to vote consist of shares of our common stock, no par value, with each share entitling its owner to one vote. Common stock is the only outstanding class of voting securities authorized by our articles of incorporation. The number of outstanding shares of common stock as of December 31, 2006 was 300.
(1) The address of each such person is c/o Herbst Gaming, Inc., 3440 West Russell Road, Las Vegas, Nevada 89118.
(2) Includes shares held in trusts for the benefit of each of Edward J. Herbst, Timothy P. Herbst and Troy D. Herbst.
Item 13.
Item 13. Certain Relationships and Related Transactions. We believe that all of the transactions mentioned below are on terms at least as favorable to us as would have been obtained from an unrelated third party.
General. Edward Herbst, Timothy Herbst and Troy Herbst are brothers and are the officers and directors of Herbst Gaming, Inc. and its wholly-owned subsidiaries. In addition, they are officers and directors of Terrible Herbst, Inc. There is no cross ownership between Herbst Gaming, Inc. and Terrible Herbst, Inc. Terrible Herbst, Inc. is owned solely by Jerry and Maryanna Herbst, the parents of the Herbst brothers. Sean Higgins, our general counsel, is also the general counsel of Terrible Herbst, Inc.
Slot route contract with Terrible Herbst, Inc. We rent space for certain slot machine route operations in convenience stores owned by Terrible Herbst, Inc., a corporation in which our owners are officers and which is owned by the father of our owners. Rent expense of $5,599,500, $5,909,000 and $6,623,000 was incurred under this agreement for the years ended December 31, 2004, 2005 and 2006, respectively, for the exclusive placement of slot machines in Terrible Herbst convenience store locations. This contract expires in 2010 but may be extended at our option for two additional terms of five years.
Other arrangements with Terrible Herbst, Inc. We have also entered into a servicing arrangement with Terrible Herbst pursuant to which we provide accounting and administrative services related to the collection of daily deposits from Terrible Herbst convenience stores. We also provide personnel to Terrible Herbst to count, maintain and safeguard large amounts of coin and currency. Terrible Herbst reimburses our expenses in providing these services. Under this servicing arrangement, we were paid approximately $205,800 for services rendered for each of the years ended December 31, 2004, 2005 and 2006.
We have entered into a nonexclusive trademark and license agreement with Terrible Herbst for the use of the Terrible Herbst brand name and its cowboy logo which extends through 2011. Subject to mutual consent, the agreement provides for the ability to renew the agreement for two additional successive terms of five years each. Pursuant to this trademark and license agreement, we paid approximately $1,345,000, $1,412,000 and $ 1,483,000 to Terrible Herbst in the years ended December 31, 2004, 2005 and 2006, respectively.
Lease agreements. Pursuant to a lease agreement that expires in 2067, including renewal periods, we lease the real property on which our corporate headquarters is located from The Herbst Family Limited Partnership II, or Herbst FLP II. The general partners of the Herbst FLP II are Jerry and Maryanna Herbst. In each of 2003, 2004 and 2005, we paid $172,992 under this lease.
Pursuant to a lease agreement that expires in 2026, including renewal periods, we lease the real property on which Terrible’s Town Casino in Pahrump is located from The Herbst Family Limited Partnership. The lease requires monthly rental payments of $15,000. In each of 2004 and 2005, we paid $150,000 under this lease and in 2006 we paid $165,000 under this lease.
We lease land and office space in certain of our facilities to Terrible Herbst under various lease agreements with terms ranging from month-to-month to 20 years. Monthly rental income is $39,000 at year end. In each of 2004 and 2005, we received rental income of $762,000 under these leases. In 2006 we received rental income of $641,000 under these leases.
We lease the real property on which Terrible’s Searchlight Casino in Searchlight is located from Terrible Herbst for $15,000 per month, pursuant to a lease agreement entered into on June 30, 2002 that expires in 2022, with options to renew the lease for five additional successive terms of ten years each. Terrible Herbst leases that real property from an unrelated third party, pursuant to a lease agreement entered into on June 30, 2002 that expires in 2042, including renewal periods. In each of 2004, 2005 and 2006, we paid $180,000 under this lease.
We lease a warehouse located in Las Vegas, Nevada for our employment center and purchasing departments from the Herbst’s Grandchildren’s Trust. The lease began in November 2002 and requires payments of
$46,500 per month through November 2012. In each of 2004 and 2005, we incurred rent expense of $522,300 under this lease. In 2006 this expense was $558,000
Related-party transactions. Mr. Higgins is our general counsel, the general counsel of Terrible Herbst and the brother of Mary E. Higgins, our chief financial officer. Mr. Higgins received a salary for services rendered to us in 2004, 2005 and 2006 of $339,394, $426,763 and $625,851, respectively.
In 2003, we entered into a slot route contract to install, operate and service slot machines at a tavern owned by HIGCO, Inc., a company owned and operated by Mr. Higgins and two of his brothers, G. Michael Higgins and Kevin J. Higgins. Pursuant to this revenue-sharing contract, HIGCO, Inc. paid us $118,756 in 2004 and $155,804 in 2005 and $154,220 in 2006
In 2004, ETT entered into a slot route contract with SamCon, Inc., a company owned and operated by Mr. Higgins, to install, operate and service slot machines at a new location. Terms of this revenue-sharing contract are similar to the terms of the contract we entered into with HIGCO in 2003. Pursuant to this revenue-sharing contract, SamCon, Inc. paid ETT $0 in 2004, $40,800 in 2005 and $21,112 in 2006.
In 2005, ETT entered into a slot route contract to install, operate and service slot machines at a tavern owned by Prescott’s Bar LLC, a company owned and operated by Mr. Todd Sosey, the brother-in-law of Troy D. Herbst, one of the owners of the Company. Pursuant to this revenue-sharing contract, Prescott’s paid ETT $0 in 2004 and 2005 and $52,844 in 2006.
John N. Brewer, a member of our board of directors, is a partner with Kummer Kaempfer Bonner & Renshaw. We retained Kummer Kaempfer Bonner & Renshaw as outside legal counsel through December 31, 2004, and Kummer Kaempfer Bonner & Renshaw has received fees for legal services in the amount of $274,310, $3,500 and $5,673 for 2004, 2005 and 2006, respectively.
Indemnification of Directors and Officers. Section 78.7502 of the Nevada Revised Statutes, Article VIII of our articles of incorporation and Article IX of our by-laws contain provisions for indemnification of our officers, directors, employees and agents. Our articles require us to indemnify such persons to the full extent permitted by Nevada law. Each person will be indemnified in any proceeding if he acted in good faith and in a manner that he reasonably believed to be in, or not opposed to, our best interests. Indemnification would cover expenses, including attorneys’ fees, judgments, fines and amounts paid in settlement.
Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or controlling persons of the registrants pursuant to the foregoing provisions, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.
Item 14.
Item 14. Principal Accountant Fees and Services. The aggregate accounting fees billed and services provided by our principal accountants for the years ended December 31, 2005 and 2006 are as follows:
(1) Represents the aggregate fees Deloitte & Touche LLP billed us in each of the last two fiscal years for professional services for the audits of our annual financial statements and review of financial statements
included in our periodic filings with the SEC and for services that are normally provided by Deloitte & Touche LLP in connection with those filings.
(2) Represents the aggregate fees Deloitte & Touche LLP billed us in each of the last two fiscal years for assurance and related services that are reasonably related to the performance of the audit, including audit-related services in conjunction with the acquisition of the Grace properties and our debt offerings.
It is our practice that all services provided to us by our independent auditors be pre-approved either by the Audit Committee or by the Chairman of the Audit Committee pursuant to authority delegated by the Audit Committee. No part of the independent auditor services related to the audit fees, audit-related fees, tax fees, or other fees listed in the table above was approved by the Audit Committee pursuant to the exemption from pre-approval provided by paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
PART IV Item 15.
Item 15. Exhibits and Financial Statement Schedules. (a) Financial Statements
1. List of Financial Statements
Included in Part II of this report:
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets As of December 31, 2005 and 2006
Consolidated Statements of Operations For the years ended December 31, 2004, 2005 and 2006
Consolidated Statements of Stockholders’ Equity (Deficiency) For the years ended December 31, 2004, 2005 and 2006
Consolidated Statements of Cash Flows For the years ended December 31, 2004, 2005 and 2006
Notes to Consolidated Financial Statements
2. Financial Statements Schedules
All schedules are omitted given the absence of conditions under which they are required to be included or because the required information is included in the financial statements or notes thereto.
(c) Exhibits
Index No.
Description
2.1(3)
Asset Purchase Agreement between Anchor Coin and Herbst Gaming, Inc. and Market Gaming, Inc. and E-T-T, Inc. dated as of November 21, 2002.
2.2(3)
First Amendment to Asset Purchase Agreement by and among Anchor Coin and Herbst Gaming, Inc. and Market Gaming, Inc. and E-T-T, Inc. dated as of January 14, 2003.
2.3(5)
Asset Purchase and Sale Agreement, dated July 20, 2004, made by and between Mark Twain Casino, L.L.C. and Herbst Gaming, Inc.
2.4(5)
Asset Purchase and Sale Agreement, dated July 20, 2004, made by and between St. Joseph Riverboat Partners and Herbst Gaming, Inc.
2.5(5)
Asset Purchase and Sale Agreement, dated July 20, 2004, made by and between Southern Iowa Gaming Company and Herbst Gaming, Inc.
Index No.
Description
2.6(7)
Amendment to Asset Purchase and Sale Agreement, made by and between Mark Twain Casino, L.L.C. and Herbst Gaming, Inc. dated as of December 2004.
2.7(7)
Amendment to Asset Purchase and Sale Agreement, made by and between St. Joseph Riverboat Partners and Herbst Gaming, Inc. dated as of December 2004.
2.8(7)
Amendment to Asset Purchase and Sale Agreement, made by and between Southern Iowa Gaming Company and Herbst Gaming, Inc. dated as of December 2004.
2.9(7)
Second Amendment to Asset Purchase and Sale Agreement made by and between Southern Iowa Gaming Company and Herbst Gaming, Inc., dated as of January 25, 2005.
2.10(9)
Agreement and Plan of Merger, dated as of May 16, 2006, by and among The Sands Regent, Herbst Gaming, Inc. and HGI-Casinos, Inc.
2.11(10)
Amendment No. 1 to the Agreement and Plan of Merger among The Sands Regent, Herbst Gaming, Inc. and HGI-Casinos, Inc. dated as of August 24, 2006
2.12(11)
Purchase Agreement, dated as of October 31, 2006, by and among New York-New York Hotel & Casino, LLC, PRMA Land Development Company, The Primadonna Company, LLC, and Herbst Gaming, Inc.
3.1(1)
Articles of Incorporation of Herbst Gaming, Inc.
3.2(2)
By-laws of Herbst Gaming, Inc.
4.1(6)
Indenture dated November 22, 2004 by and among Herbst Gaming, Inc., the guarantors identified therein and U.S. Bank National Association, as trustee, relating to 7% Senior Subordinated Notes due 2014.
4.2(6)
Specimen Form of 7% Senior Subordinated Notes due 2014 (included as part of the Indenture at Exhibit 4.1).
4.3(5)
Indenture dated June 11, 2004 by and among Herbst Gaming, Inc., the guarantors identified therein and U.S. Bank National Association, as trustee, relating to 8 1¤8% Senior Subordinated Notes due 2012.
10.1(1)
Trademark License Agreement dated August 24, 2001 by and between Herbst Gaming, Inc. and Terrible Herbst, Inc.
10.2++ (5)
Gaming Devices License Agreement dated October 26, 2004 by and between The Vons Companies, Inc. and Market Gaming, Inc.
10.3(1)
Letter Agreement dated May 31, 2006 among Albertson’s, Inc., SUPERVALU, Inc., AB Acquisition LLC and Cardivan Company.
Index No.
Description
10.4++(1)
Gaming License Agreement dated as of June 2, 2006 among Cardivan Company, Nevada CVS Pharmacy, L.L.C., Henderson CVS, L.L.C., Desert Eastern CVS, L.L.C., Maryland Parkway CVS, L.L.C., CVS 2989 Las Vegas, L.L.C. and Senip CVS, L.L.C.*
10.5+(1)
License Agreement dated April 24, 1997 between American Drug Stores, Inc. and Cardivan Company.
10.6+(1)
License Agreement dated April 24, 1997 between American Drug Stores, Inc. and Corral United, Inc. II-13
10.7+(1)
License Agreement dated March 12, 1999 between Rite Aid Corporation and Cardivan Company.
10.8+(1)
First Amendment to Cardivan License Agreement dated March 27, 2000 between Rite Aid Corporation and Cardivan Company.
10.9+(1)
License Agreement dated March 12, 1999 between Rite Aid Corporation and Corral Coin, Inc.
10.10+(1)
First Amendment to Corral Coin License Agreement dated March 27, 2000 between Rite Aid Corporation and Corral Coin, Inc.
10.11+(1)
Gaming Devices License Agreement dated December 20, 1999 by and between Terrible Herbst, Inc. and E-T-T, Inc.
10.12(1)
Amendment to Gaming Device License Agreement dated May , 2001 by and between E-T-T, Inc. and Terrible Herbst, Inc.
10.13+(1)
Agreement dated May 1, 1998 by and between Kmart Corporation and Cardivan Company.
10.14+(1)
License Agreement dated April 24, 1997 between Lucky Stores, Inc. and Cardivan Company.
10.15+(4)
Lease and Sublease Agreement dated July 28, 1993, by and between Smith’s Food & Drug Centers, Inc. and Anchor Coin, as amended.
10.16(4)
Hold Harmless Agreement dated as of September 2, 1993 executed by Anchor Coin in favor of Smith’s Food & Drug Centers, Inc.
10.17+(4)
Letter Agreement and Consent to Assignment dated January 16, 2003.
10.18(1)
Lease Agreement dated July 1, 1997 by and between The Herbst Family Limited Partnership II and E-T-T Enterprises, L.L.C.
10.19(1)
Lease Agreement dated July 1, 1996 by and between The Herbst Family Limited Partnership and E-T-T, Inc.
10.20(1)
Lease extension dated April 30, 2001 between The Herbst Family Limited Partnership and E-T-T, Inc.
Index No.
Description
10.21(1)
Lease dated September 3, 1993 between The 1993 Samuel Josephson Revocable Family Trust and Phoenix Associates.
10.22(1)
Agreement for Sale dated August 1, 1995 between Phoenix Associates and Market Gaming, Inc.
10.23(4)
Lease Agreement dated November 27, 2002 by and between Herbst Grandchildren’s Trust and Herbst Gaming, Inc.
10.24(4)
Lease dated June 2002 by and between Centennial Acquisitions, LLC and Terrible Herbst, Inc.
10.25(4)
Amendment to Lease dated July 30, 2002 by and between Centennial Acquisitions, LLC and Terrible Herbst, Inc.
10.26(4)
Lease Agreement dated July 1, 2002 by and between Terrible Herbst, Inc. and E-T-T, Inc.
10.27(1)
Employment Agreement with Edward J. Herbst dated August 1, 2001.
10.28(8)
Employment Agreement with Mary E. Higgins dated January 1, 2005.
10.29(1)
Form of Executive Compensation and Bonus Plan.
10.30(4)
Code of Ethics.
10.31(13)
Second Amended and Restated Credit Agreement dated as of January 3, 2007 by and among Herbst Gaming, Inc., Bank of America, N.A., as administrative agent and the other lending parties thereto.
10.32*
Gold Ranch Casino Lease, dated as of December 27, 2001, by and between Last Chance, Inc., Prospector Gaming Enterprises, Inc. and Target Investments, L.L.C.
10.33*
Option to Purchase the Gold Ranch Casino Property and Improvements, The Leach Field Property, the Frontage Parcel, the California Lottery Station and the California Lottery Property, and the Right of First Refusal, dated as of December 27, 2001, by and among Prospector Gaming Enterprises, Inc., Target Investments, L. L. C. and Last Chance, Inc.
12.1*
Computation of Ratio of Earnings to Fixed Charges.
21.1*
Subsidiaries of Herbst Gaming, Inc.
31.1*
Certification of Edward J. Herbst under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Edward J. Herbst under Section 302 of the Sarbanes-Oxley Act of 2002.
Index No.
Description
32.1*
Certifications of Edward J. Herbst and Mary E. Higgins pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
+
Confidential Treatment for a portion of this document has been granted pursuant to Rule 406 under the Securities Act. The omitted portions have been separately filed with the Commission.
++
Confidential Treatment for a portion of this document has been requested pursuant to Rule 406 under the Securities Act. The omitted portions have been separately filed with the Commission.
(1)
Incorporated herein by reference from our registration statement on Form S-4 (SEC No. 33-71094), Part II, Item 21.
(2)
Incorporated herein by reference from our quarterly report on Form 10-Q filed with the SEC on November 14, 2002.
(3)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on March 10, 2003.
(4)
Incorporated herein by reference from our annual report on Form 10-K filed with the SEC on March 24, 2003.
(5)
Incorporated herein by reference from our registration statement on Form S-4 (SEC No. 333-118068-05).
(6)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on November 23, 2004.
(7)
Incorporated herein by reference from our registration statement on Form S-4 (SEC No. 333-122837).
(8)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on March 15, 2006.
(9)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on May 16, 2006.
(10)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on August 28, 2006.
(11)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on November 2, 2006.
(12)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on August 7, 2006.
(13)
Incorporated herein by reference from our current report on Form 8-K filed with the SEC on January 9, 2007.
*
Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act 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.
NAME
TITLE
DATE
/s/ Edward J. Herbst
Chairman of the Board, Chief Executive
April 2,
Edward J. Herbst
Officer and President (Principal Executive Officer)
/s/ Mary E. Higgins
Chief Financial Officer (Principal
April 2,
Mary E. Higgins
Financial and Accounting Officer
/s/ Timothy P. Herbst
Executive Vice President and Director
April 2,
Timothy P. Herbst
/s/ Troy D. Herbst
Executive Vice President, Secretary,
April 2,
Troy D. Herbst
Treasurer and Director
/s/ John N. Brewer
Director
April 2,
John N. Brewer
/s/ John F. O’Reilly
Director
April 2,
John F. O’Reilly
S-1