SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

(Mark One)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES ý  NO o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  YES o  NO ý

 

Applicable only to corporate issuers

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, no par value, 300 outstanding shares

 

 

FORM 10-Q

 

TABLE OF CONTENTS

 

PART I. –	FINANCIAL INFORMATION
Item 1.	Financial Statements.
	Condensed Consolidated Balance Sheets (Unaudited)
	Condensed Consolidated Statements of Income (Unaudited)
	Condensed Consolidated Statements of Cash Flows (Unaudited)
	Condensed Consolidated Statements of Stockholders’ (Deficiency) Equity (Unaudited)
	Notes To Condensed Consolidated Financial Statements (Unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosure About Market Risk
Item 4.	Controls and Procedures
PART II –	OTHER INFORMATION
Item 1.	Legal proceedings
item 2.	Changes in Securities and Use of Proceeds
item 3.	Defaults Upon Senior Securities
item 4.	Submission of Matters to a Vote of Security Holders
item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8K

 

 

PART I. - FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

 

HERBST GAMING, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (Unaudited)

 

		December 31, 2002			September 30, 2003
Assets
Current assets
Cash and cash equivalents		$	55,035		$	46,901
Accounts receivable, net		1,389			1,119
Notes and loans receivable		266			774
Prepaid expenses		3,520			4,236
Inventory		1,143			970
Total current assets		61,353			54,000
Property and equipment, net		99,932			106,880
Lease acquisition costs, net		15,140			61,692
Due from related parties		546			1,074
Other assets, net		6,742			9,409
Total assets		$	183,713		$	233,055
Liabilities and stockholders’ (deficiency) equity
Current liabilities
Current portion of long-term debt		$	127		$	159
Accounts payable		4,695			5,450
Accrued expenses		10,707			7,918
Due to related parties		430			—
Total current liabilities		15,959			13,527
Long-term debt, less current portion		167,814			217,092
Other liabilities		1,175			877
Commitments and contingencies
Stockholders’ (deficiency) equity
Common stock (no par value; 2,500 shares authorized; 300 shares issued and outstanding)		2,368			2,368
Additional paid-in capital		1,631			1,631
Accumulated deficit		(5,234		)	(2,440		)
Total stockholders’ (deficiency) equity		(1,235		)	1,559
Total liabilities and stockholders’ (deficiency) equity		$	183,713		$	233,055

 

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

 

1

 

HERBST GAMING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS)

(UNAUDITED)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2003			2002			2003
Revenues:
Route operations		$	45,272		$	62,266		$	136,683		$	177,490
Casino operations		17,692			19,340			54,463			58,025
Other		910			734			2,255			2,183
Total revenues		63,874			82,340			193,401			237,698
Less promotional allowances		(2,457		)	(2,727		)	(7,393		)	(8,344		)
Net revenues		61,417			79,613			186,008			229,354
Costs and expenses:
Route operations		37,732			50,505			112,117			140,422
Casino operations		12,558			13,202			36,993			37,792
Depreciation and amortization		3,993			6,426			11,778			17,852
General and administrative		2,635			3,246			8,074			9,309
Total costs and expenses		56,918			73,379			168,962			205,375
Income from operations		4,499			6,234			17,046			23,979
Other income (expense):
Interest income		83			49			250			182
Interest expense, net of capitalized interest		(4,714		)	(5,891		)	(14,122		)	(17,041		)
Gain (loss) on sale of assets		144			(40		)	92			129
Total other expense		(4,487		)	(5,882		)	(13,780		)	(16,730		)
Net income		$	12		$	352		$	3,266		$	7,249

 

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

 

2

 

HERBST GAMING, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS) (UNAUDITED)

 

		Nine Months Ended September 30,
		2002			2003
Cash flows from operating activities:
Net income		$	3,266		$	7,249
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		11,778			17,852
Debt discount amortization		316			72
Gain on sale of assets		(92		)	(129		)
Decrease (increase) in:
Accounts receivable		368			281
Prepaid expenses		(792		)	(509		)
Inventory		(279		)	173
Due from related parties		(133		)	(528		)
Increase (decrease) in:
Accounts payable		(179		)	340
Accrued expenses		(4,646		)	(3,367		)
Due to related parties		(550		)	(430		)
Other liabilities		236			(298		)
Net cash provided by operating activities		9,293			20,706
Cash flows from investing activities:
Net cash paid for acquisition of Anchor Coin’s Slot Route Assets		—			(57,171		)
Additions to notes receivable		(179		)	(544		)
Collection on notes receivable		132			546
Proceeds from sale of property and equipment		344			533
Purchases of property and equipment		(7,474		)	(11,587		)
Lease acquisition costs		(527		)	(2,601		)
Net cash used in investing activities		(7,704		)	(70,824		)
Cash flows from financing activities:
Proceeds from long-term debt		—			49,115
Reduction of long-term debt		(69		)	(115		)
Loan origination fees		(191		)	(2,561		)
Stockholders’ distributions		—			(4,455		)
Net cash (used in) provided by financing activities		(260		)	41,984
Net increase (decrease) in cash and cash equivalents		1,329			(8,134		)
Cash and cash equivalents:
Beginning of period		44,750			55,035
End of period		$	46,079		$	46,901
Supplemental cash flow information -
Cash paid during the period for interest		$	18,687		$	21,139
Supplemental schedule of non-cash Investing and financing activities -
Purchase of assets through direct financing		$	70		$	238
Purchase of assets through accounts payable		237			674
Acquisition of assets of Anchor Coin slot route
Fair value of assets and liabilities acquired -
Current assets, other than cash		$	—		$	717
Property and equipment		—			5,200
Lease acquisition costs		—			50,532
Other long-term assets		—			1,300
Accrued expenses		—			(578		)
Cash paid, net of cash acquired		—			$	57,171

 

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

 

3

 

HERBST GAMING, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIENCY)

EQUITY (IN THOUSANDS) (UNAUDITED)

 

		Common Stock			Additional Paid-In Capital			Accumulated Deficit			Total
Balance, January 1, 2003		$	2,368		$	1,631		$	(5,234	)	$	(1,235	)
Stockholders’ distributions		—			—			(4,455		)	(4,455		)
Net income		—			—			7,249			7,249
Balance, September 30, 2003		$	2,368		$	1,631		$	(2,440	)	$	1,559

 

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

 

4

 

HERBST GAMING, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.             DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Description of Business and Principles of Consolidation—The accompanying interim condensed 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, LLC (“E-T-T Enterprises”), and Flamingo Paradise Gaming, LLC (“FPG”).  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, and FPG have been eliminated in the consolidated financial statements.

 

The Company conducts business in the gaming industry and generates 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 owns and operates Terrible’s Hotel & Casino in Las Vegas, Nevada, Terrible’s Town Casino & Bowl (Henderson) in Henderson, Nevada, Terrible’s Searchlight 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.

 

The gaming industry in the State of Nevada 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, and local jurisdictions.

 

Interim Financial Statements —The accompanying financial statements for the three and nine months ended September 30, 2002 and 2003, are unaudited but, in the opinion of management, include all adjustments (consisting only of normal, recurring adjustments) necessary for a fair presentation of the financial results of the interim periods.  The results of operations for the three and nine months ended September 30, 2003 are not necessarily indicative of the results to be expected for the year ending December 31, 2003.  These accompanying unaudited  interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2002.

 

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 our consolidated financial statements include the estimated useful lives for depreciable and amortizable assets, the estimated allowance for doubtful accounts receivable and estimated cash flows in assessing the recoverability of long-lived assets.  Actual results could differ from those estimates.

 

5

 

2.             ACQUISITION

 

On February 21, 2003, the Company acquired the assets of the slot route business of Anchor Coin, a wholly owned subsidiary of International Game Technology, Inc.  The acquisition was an asset acquisition and the only liabilities assumed were progressive jackpots.  The initial purchase price was $62.0 million with a subsequent adjustment to $61.0 million.  A portion of the purchase price has been allocated to the assets acquired and liabilities assumed based on estimated market value at the date of acquisition, with the remaining balance of $50.5 million recorded as lease acquisition costs for the route contracts acquired.  Such intangible asset is being amortized on a straight-line basis over the remaining life of the contracts.  The acquisition was funded in part by the issuance of $47.0 million of additional 10¾% senior secured notes maturing in 2008.  The remaining $14.0 million of the purchase price was funded with cash.  In conjunction with the issuance of the notes, the Company capitalized $2.6 million of debt issuance costs, which are being amortized over the life of the notes.

 

The table below reflects unaudited pro forma combined results of the Company and Anchor Coin’s Slot Route operations as if the acquisition had taken place at the beginning of 2002 (dollars in thousands): 

 

		Three Months Ended September 30, 2002			Nine Months Ended September 30,
					2002			2003
Gross revenues		$	74,762		$	227,189		$	243,858
Net income (loss)		$	(824	)	$	2,222		$	6,278

 

Included in the pro forma net income (loss) for the three months ended September 30, 2002 is approximately $1,165,000 of interest expense.  Included in the pro forma net income for the nine months ended September 30, 2002 and 2003 are approximately $3,495,000 and $453,000 of interest expense, respectively.  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 2002.

 

3.             BUSINESS SEGMENTS

 

The Company has adopted Statement of Financial Standard (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information.”  SFAS No. 131 established standards for the way public companies are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to stockholders.  It also established standards for related disclosures about products and services, geographic areas, and major customers.

 

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 the following four casinos:  Terrible’s Town Casino in Henderson, Nevada, Terrible’s Searchlight in Searchlight, Nevada, 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.

 

Revenues, income from operations, and depreciation and amortization for these segments are as follows (dollars in thousands):

 

6

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2003			2002			2003
Net revenues:
Slot route operations		$	45,147		$	62,178		$	136,462		$	177,202
Casino operations		15,360			16,701			47,291			49,969
Other operations(1)		910			734			2,255			2,183
Total net revenues		$	61,417		$	79,613		$	186,008		$	229,354
Income from operations:
Slot route operations		$	4,987		$	6,845		$	17,232		$	23,822
Casino operations		1,335			2,016			5,928			7,631
Other and general and administrative(1)		(1,823		)	(2,627		)	(6,114		)	(7,474		)
Total income from operations		$	4,499		$	6,234		$	17,046		$	23,979
Depreciation/amortization:
Slot route operations		$	2,428		$	4,828		$	7,113		$	12,958
Casino operations		1,467			1,483			4,370			4,546
Other(1)		98			115			295			348
Total depreciation/amortization		$	3,993		$	6,426		$	11,778		$	17,852
Segment EBITDA(2):
Slot route operations		$	7,415		$	11,673		$	24,345		$	36,780
Casino operations		2,802			3,499			10,298			12,177
Other and corporate(1)		(1,498		)	(2,503		)	(5,477		)	(6,815		)
Consolidated EBITDA(2)		$	8,719		$	12,669		$	29,166		$	42,142

 

(1)   Amount represents primarily other—non-gaming revenues and general and administrative expenses.

 

(2)   Consolidated EBITDA consists of net income plus depreciation and amortization and interest expense, net of capitalized interest.  Segment EBITDA for route and casino is calculated before allocation of overhead. Other EBITDA represents other revenue, general and administrative expenses, interest income and other income. EBITDA is presented because it is used as a performance measure to analyze the performance of our business segments and because we believe it is frequently used by securities analysts, investors and others in the evaluation of companies in our industry. However, other companies in our industry may calculate EBITDA differently. EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be considered as an alternative to cash flow from operating activities or as a measure of liquidity or as an alternative to net income or as an indicator of operating performance or any other measure of performance derived in accordance with generally accepted accounting principles.

 

The following table is a reconciliation of net income to EBITDA (in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2003			2002			2003
Net income		$	12		$	352		$	3,266		$	7,249
Adjustments:
Depreciation and amortization		3,993			6,426			11,778			17,852
Interest expense, net of capitalized interest		4,714			5,891			14,122			17,041
Consolidated EBITDA(2)		$	8,719		$	12,669		$	29,166		$	42,142

 

7

 

4.                                      LEASE ACQUISITION COSTS

 

		As of December 31, 2002						As of September 30, 2003
		(dollars in thousands)
		Gross Carrying Amount			Accumulated Amortization			Cross Carrying Amount			Accumulated Amortization
Lease acquisition costs		$	22,668		$	7,528		$	75,797		$	14,105

 

The aggregate amortization expense for the three months ended September 30, 2002 and 2003 was $738,000 and $2,525,000, respectively.  The aggregate amortization expense for the nine months ended September 30, 2002 and 2003 was $2,185,000 and $6,580,000, respectively

 

Estimated amortization expense for the three months ending December 31, 2003, and the twelve months ending December 31, 2004, 2005, 2006, 2007 and 2008 is $2,526,000, $9,813,000, $9,563,000, $9,339,000, $9,194,000, and $9,016,000, respectively.

 

Item 2.          Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

We are a gaming company that owns and operates approximately 8,200 slot machines throughout the State of Nevada.  Our route operations involve the exclusive installation and operation of approximately 6,600 slot machines in strategic, high traffic, non-casino locations, such as grocery stores, drug stores, convenience stores, bars and restaurants.  We also own and operate Terrible’s Hotel & Casino in Las Vegas, as well as four other small casinos.

 

We generally enter into two types of route contracts.  With chain store customers, 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.

 

In August 2001, the Company restructured substantially all of its debt with a $170.0 million senior secured note offering and in February 2003, the Company purchased the slot route assets of Anchor Coin, a subsidiary of International Game Technologies, Inc., for approximately $61.0 million.  The Anchor Coin transaction was financed in part by a $47.0 million addition to our previous $170.0 million 10¾% senior secured note offering, resulting in $217.0 million in senior secured notes outstanding, and all of which are due in 2008.

 

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.

 

8

 

Three Months Ended September 30, 2003 Compared to Three Months Ended September 30, 2002

 

Route Operations

 

Route operations accounted for 76% of total revenues during the quarter ended September 30, 2003 compared to 71% during the quarter ended September 30, 2002.  Total revenues from route operations were $62.3 million for the quarter ended September 30, 2003, an increase of $17.0 million, or 38%, from $45.3 million for the quarter ended September 30, 2002.  The increase in revenues was primarily due to the new locations that we added in connection with the purchase of the slot route assets of Anchor Coin in February 2003 as well as growth in revenues at the Company’s base locations.

 

Route operating costs were $50.5 million, or 81%, of route revenues for the quarter ended September 30, 2003.  This compares to $37.7 million, or 81%, of route revenues for the same period in 2002.  The increase in route operating expenses of $12.8 million was related to increases in rents resulting from the exercise of options to extend the term of certain agreements at some of our space lease locations as well as costs associated with new locations that we added in connection with the purchase of the slot route assets of Anchor Coin in February 2003.

 

Route EBITDA (defined as segment revenues less promotional allowances less segment costs with no corporate allocation for overhead) for the quarter ended September 30, 2003 was $11.7 million, an increase of $4.3 million, or 58%, from $7.4 million for the quarter ended September 30, 2002.

 

Casino Operations

 

Casino operations accounted for 23% of total revenues for the quarter ended September 30, 2003 compared to 28% of total revenues for the quarter ended September 30, 2002.  The decrease in the percentage of casino operations revenues to total revenues is primarily due to the purchase of the slot route assets of Anchor Coin in February 2003.  Total revenues derived from casino operations were $19.3 million for the quarter ended September 30, 2003, an increase of $1.6 million, or 9%, from $17.7 million for the quarter ended September 30, 2002.  This increase was due to an increase in play at all casino properties.  Casino operating costs were $13.2 million, or 68%, of casino revenues for the quarter ended September 30, 2003, compared to $12.6 million, or 71%, of casino revenues for the quarter ended September 30, 2002.  Casino EBITDA (defined as segment revenues less promotional allowances less segment costs with no corporate allocation for overhead) was $3.5 million for the quarter ended September 30, 2003, which was a $0.7 million, or 25%, increase over the results for September 30, 2002, which were $2.8 million.

 

Other Revenue

 

Other revenue consists of non-gaming revenue items, such as ATM fees, pay phone charges, rental income and other miscellaneous items.  This accounted for approximately 1% of total revenues, or $0.7 million and $0.9 million, for the quarters ended September 30, 2003 and 2002, respectively.

 

Promotional Allowances

 

Promotional allowances were $2.7 million, or 3.3% of total revenues, for the quarter ended September 30, 2003, an increase of $0.2 million, or 8%, from $2.5 million, or 3.9% of total revenues, for the quarter ended September 30, 2002.

 

9

 

Other Costs

 

General and administrative expenses, or G&A, were $3.2 million for the quarter ended September 30, 2003 and $2.6 million for the same period in 2002.  G&A expenses as a percentage of total revenue were 3.9% of revenue for the quarter ended September 30, 2003 and 4.1% of revenue for the quarter ended September 30, 2002.

 

Depreciation and amortization expense was $6.4 million for the quarter ended 2003, an increase of $2.4 million, or 60%, from $4.0 million for the second quarter of 2002.  The increase was due to the addition of the assets of the Anchor Coin slot route as well as the additional depreciation from the capital expenditures made during the remainder of 2002 and 2003.

 

Income from Operations

 

As a result of the factors discussed above, income from operations was $6.2 million for the quarter ended September 30, 2003, an increase of $1.7 million, from $4.5 million for the quarter ended September 30, 2002.  As a percentage of total revenues, income from operations increased from 7.0% during the second quarter of 2002 to 7.6% during the same period in 2003.

 

Other Expense

 

Other expense was $5.9 million for the quarter ended September 30, 2003, increasing $1.4 million from $4.5 million in 2002.  This increase was due primarily to interest expensed as a result of the additional debt associated with the purchase of the Anchor Coin slot route assets in February 2003.

 

Net Income

 

As a result of the items discussed above, net income for the quarter ended September 30, 2003 was $352,000, an increase in earnings of $340,000 from $12,000 net income for the quarter ended September 30, 2002.

 

Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002

 

Route Operations

 

Route operations accounted for 75% of total revenues during the nine months ended September 30, 2003 compared to 71% during the nine months ended September 30, 2002.  Total revenues from route operations were $177.5 million for the nine months ended September 30, 2003, an increase of $40.8 million, or 30%, from $136.7 million for the nine months ended September 30, 2002.  The increase in revenues was primarily due to the new locations that we added in connection with the purchase of the slot route assets of Anchor Coin in February 2003 as well as growth in revenues at the Company’s base locations.

 

Route operating costs were $140.4 million, or 77%, of route revenues for the nine months ended September 30, 2003.  This compares to $112.1 million, or 82%, of route revenues for the same period in 2002.  The increase in route operating expenses of $28.3 million was related to increases in rents resulting from the exercise of options to extend the term of certain agreements at some of our space lease locations as well as costs associated with new locations that we added in connection with the purchase of the slot route asset of Anchor Coin in February 2003.

 

10

 

Route EBITDA for the nine months ended September 30, 2003 was $36.8 million, an increase of $12.5 million, or 51.4%, from $24.3 million for the nine months ended September 30, 2002.

 

Casino Operations

 

Casino operations accounted for 24% of total revenues for the nine months ended September 30, 2003 compared to 28% of total revenues for the nine months ended September 30, 2002.  The decrease in percentage or casino operations revenues to total revenues is primarily due to the purchase of the slot route assets of Anchor Coin in February 2003.  Total revenues derived from casino operations were $58.0 million for the nine months ended September 30, 2003, an increase of $3.5 million, or 6%, from $54.5 million for the nine months ended September 30, 2002.  This increase was due to an increase in play at all casino properties.  Casino operating costs were $37.8 million, or 65%, of casino revenues for the nine months ended September 30, 2003, compared to $37.0 million, or 68%, of casino revenues for the nine months ended September 30, 2002.  Casino EBITDA was $12.2 million for the nine months ended September 30, 2003, which was a $1.9 million, or 18.4%, increase over the results for September 30, 2002, which were $10.3 million.

 

Other Revenue

 

Other revenue consists of non-gaming revenue items, such as ATM fees, pay phone charges, rental income and other miscellaneous items.  This accounted for approximately 1% of total revenues, or $2.2 million, for the nine months ended September 30, 2003 and 1%, or $2.3 million, for the same period in 2002.

 

Promotional Allowances

 

Promotional allowances were $8.3 million, or 3.5% of total revenues, for the nine months ended September 30, 2003, an increase of $0.9 million, or 12%, from $7.4 million, or 3.8% of total revenues, for the nine months ended September 30, 2002.

 

Other Costs

 

G&A expenses were $9.3 million for the nine months ended September 30, 2003 and $8.1 million for the nine months ended September 30, 2002.  G&A expenses as a percentage of total revenue were 3.9% of revenue for the nine months ended September 30, 2003 and approximately 4.2% for the nine months ended September 30, 2002.

 

Depreciation and amortization expense was $17.9 million for the nine months ended September 30, 2003, an increase of $6.1 million, or 52%, from $11.8 million for the same period in 2002.  The increase was due to the addition of the assets of the Anchor Coin slot route as well as the additional depreciation from the capital expenditures made during the remainder of 2002 and 2003.

 

Income from Operations

 

As a result of the factors discussed above, income from operations was $24.0 million for the nine months ended September 30, 2003, an increase of $7.0 million from $17.0 million for the nine months ended September 30, 2002.  As a percentage of total revenues, income from operations increased from 8.8% during the same period in 2002 to 10.1% during the same period in 2003.

 

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Other Expense

 

Other expense was $16.7 million for the nine months ended September 30, 2003, increasing $2.9 million from $13.8 million for the same period in 2002.  This increase was due primarily to interest expensed as a result of the additional debt incurred for the purchase of the Anchor Coin slot route assets in February 2003.

 

Net Income

 

As a result of the items discussed above, net income for the nine months ended September 30, 2003 was $7.2 million, an increase in earnings of $3.9 million, or 118%, from $3.3 million net income for the nine months ended September 30, 2002.

 

Liquidity and Capital Resources

 

Cash Flows

 

At September 30, 2003, we maintained $46.9 million in cash and equivalents.  We expect to fund our operations, debt service and capital needs from operating cash flow and cash on hand.  Based upon our anticipated future operations, we believe that cash on hand together with available cash flow, will be adequate to meet our anticipated working capital requirements, capital expenditures and scheduled payments of interest on the notes for at least the foreseeable future.  No assurances can be given, however, that our cash flow will be sufficient for that purpose.  There can be no assurance that our estimates of our cash needs are accurate or that new business developments or other unforeseeable events will not occur, resulting in the need to raise additional funds.

 

Operating Activities

 

During the nine months ended September 30, 2003, operating activities provided $20.7 million in cash flows on $7.2 million in net income.  Net income for the nine months ended September 30, 2003 included non-cash expenses (depreciation and amortization) of $17.9 million.

 

Investing Activities and Capital Expenditures

 

For the nine months ended September 30, 2003, we had net cash used for investing activities of $70.8 million primarily related to the net cash used to purchase the slot route assets of Anchor Coin and to purchase additional gaming equipment.

 

Capital expenditures for the remainder of 2003 are anticipated to be approximately $1.5 million.  These funds will be primarily used for maintenance capital expenditures and for the purchase of slot machines.

 

Financing Activities

 

Cash flows provided by financing activities were $42.0 million in the first nine months of 2003.  This was primarily the result of the additional debt of $49.1 million issued for the purchase of the Anchor Coin slot route assets and fees associated with that transaction, as well as the costs associated with the amendments made to our 10¾% senior secured notes maturing in 2008.  The acquisition was funded in part by the issuance of $47.0 million of additional 10¾% senior secured notes maturing in 2008.  The remaining $14.0 million of the purchase price was funded with cash.  In conjunction with the issuance of the notes, we capitalized $2.6 million of debt issuance costs that are being amortized over the life of the

 

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notes.  We have distributed $4.5 million in cash to our stockholders, with approximately $2.0 million being made for the purpose of payment of subchapter S corporation taxes.

 

Our ability to service our debt will depend 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.

 

We maintain a $10.0 million revolving credit facility from US Bank of Nevada.  The line of credit has not been utilized and is available for working capital purposes.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of September 30, 2003.

 

		Payments Due by Period
		Total			Less than 1 Year			1-3 Years			4-5 Years			After 5 Years
		(in thousands)
Contractual obligations:
Long-term debt		$	217,251		$	159		$	202		$	216,890		$	—
Operating leases		338,190			74,176			135,427			89,289			39,298
Total contractual obligations		$	555,441		$	74,335		$	135,629		$	306,179		$	39,298

 

The table above includes all rent increases that were scheduled in conjunction with performance measures set forth in a settlement agreement with one of our slot route customers and agreed to in conjunction with our decision to extend slot route leases.  In July 2003, increases in rents to certain of our major slot route accounts became effective as a result of our exercise of options to extend the term of certain agreements at some of our space lease locations as well as costs associated with new locations that we added in connection with the purchase of the slot route assets of Anchor Coin in February 2003.

 

Critical Accounting Policies

 

The preparation of our condensed consolidated 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 condensed consolidated 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 policy 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 lives, evaluation of the asset’s 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

 

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method over the term of the related leases, including expected renewals, 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 discounted expected future cash flows.  An adverse change to the estimate of these future cash flows could necessitate an impairment charge that would adversely affect operating results.

 

Certain Forward-Looking Statements

 

Certain information included herein contains statements that may be considered forward-looking, such as statements relating to projections of future results of operations or financial condition, expectations for our route operations and 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:

 

•                  The success of our route operations is dependent on our ability to renew our contracts.

 

•                  Our substantial indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under the indenture.   The following chart shows certain important information regarding our indebtedness:

 

		September 30, 2003
		(in thousands)
Long-term debt, including current portion		$	217,251
Stockholders’ equity		1,559
Ratio of earnings to fixed charges		1.4		x

 

•                  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 indebtedness imposes restrictive covenants on us.

 

•                  We may experience reduced operating margins and loss of market share due to intense competition from companies with longer operating histories, greater resources and more established brand names.

 

•                  We face extensive regulation from gaming and other government authorities.

 

•                  Our operations could be adversely affected if anti-smoking regulations are adopted.

 

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•                  We are unable to predict the future impact that terrorism and the uncertainty of war may have on our business and operations.

 

•                  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 Herbst Gaming and could have interests that conflict with the holders of our 10¾% senior secured notes.

 

•                  Our business relies heavily on certain markets and an economic downturn in these markets could have a material adverse effect on our results.

 

Item 3.          Quantitative and Qualitative Disclosure 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.

 

On August 24, 2001, we issued $170.0 million in 10¾% senior secured notes.  The proceeds of these notes were used to refinance substantially all of our existing debt and for working capital purposes.  All debt is currently at a fixed rate of interest. In February 2003, we issued $47.0 million in additional 10¾% senior secured notes.  The notes were sold at a premium and the proceeds were used to partially fund the purchase of the slot route assets of Anchor Coin, a subsidiary of International Game Technology, Inc.

 

The fair value of our long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to us for debt of the same remaining maturities.  Based on the borrowing rates currently available to us for debt with similar terms and average maturities, the estimated fair value of long-term debt outstanding is approximately $242 million at September 30, 2003.

 

We do not invest in derivative financial instruments, interest rate swaps or other investments that alter interest rate exposure.

 

We do not have any cash or cash equivalents as of September 30, 2003 that are subject to market risk based on changes in interest rates.

 

Item 4.          Controls and Procedures

 

(a)           Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of Herbst Gaming’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2003 (the “Evaluation Date”).  Based on such evaluation, such officers have concluded that, as of the Evaluation Date, Herbst Gaming’s disclosure controls and procedures are effective and are adequate and designed to ensure that material information relating to Herbst Gaming (including its consolidated subsidiaries) would be made known to them by others within those entities.

 

(b)           Changes in Internal Controls.  Since the Evaluation Date, there have not been any significant changes in the Company’s internal controls or in other factors that could significantly affect such controls.

 

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PART II - OTHER INFORMATION

 

Item 1.		Legal Proceedings
None.
Item 2.		Changes in Securities and Use of Proceeds
None.
Item 3.		Defaults Upon Senior Securities
None.
Item 4.		Submission of Matters to a Vote of Security Holders
None.
Item 5.		Other Information
None.
Item 6.		Exhibits and Reports on Form 8-K
(a)			Exhibits.
			The following exhibits are filed as part of this Form 10-Q:
			31.1	Certifications of Edward J. Herbst and Mary E. Higgins pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
			32.1	Certifications of Edward J. Herbst and Mary E. Higgins pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
(b)			Reports on Form 8-K.
On November 5, 2003, Herbst Gaming furnished a Current Report on Form 8-K under Item 12 (Results of Operations and Financial Condition), containing a copy of its earnings release for the period ended September 30, 2003 (including financial statements).

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date:  November 13,  2003		Herbst Gaming, Inc.
		(Registrant)
		By:	/s/ Mary E. Higgins
				Mary E. Higgins
		Its:		Chief Financial Officer
				(Chief Financial Officer and Duly Authorized Officer)

 

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EXHIBIT INDEX

 

Exhibit Number		Description
31.1		Certifications of Edward J. Herbst and Mary E. Higgins pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
32.1		Certifications of Edward J. Herbst and Mary E. Higgins pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).

 

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