United States Securities and Exchange Commission

Washington, D.C.  20549

 

Form 10-Q

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2004

 

Commission file number      1-16791

 

Dover Downs Gaming & Entertainment, Inc.

(Exact name of registrant as specified in its charter)

 

 

1131 North DuPont Highway, Dover, Delaware  19901

(Address of principal executive offices)

 

(302) 674-4600

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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 ý   No o

 

As of April 30, 2004, the number of shares of each class of the registrant’s common stock outstanding is as follows:

 

 

 

Part I – Financial Information

 

Item 1. Financial Statements

 

DOVER DOWNS GAMING & ENTERTAINMENT, INC.
CONSOLIDATED STATEMENT OF EARNINGS
In Thousands, Except Per Share Amounts
(Unaudited)

 

		Three Months Ended March 31,
		2004			2003
Revenues:
Gaming		$	47,309		$	41,557
Other operating		8,288			6,798
Gross revenues		55,597			48,355
Less – promotional allowances		5,037			4,156
		50,560			44,199
Expenses:
Gaming		37,652			32,521
Other operating		2,441			2,254
General and administrative		1,147			954
Depreciation		1,691			1,502
		42,931			37,231
Operating earnings		7,629			6,968
Interest expense		153			214
Earnings before income taxes		7,476			6,754
Income taxes		3,042			2,747
Net earnings		$	4,434		$	4,007
Net earnings per common share (Note 3):
Basic		$	0.17		$	0.15
Diluted		$	0.17		$	0.15

 

The Notes to the Consolidated Financial Statements are an integral part of these consolidated statements.

 

2

 

DOVER DOWNS GAMING & ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEET
In Thousands, Except Share and Per Share Amounts
(Unaudited)

 

		March 31, 2004			December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents		$	15,859		$	14,138
Accounts receivable		3,696			1,914
Due from State of Delaware		3,328			8,670
Inventories		1,875			1,801
Prepaid expenses and other		1,335			2,414
Receivable from Dover Motorsports, Inc.		3			—
Deferred income taxes		786			878
Total current assets		26,882			29,815
Property and equipment, net		123,553			122,344
Total assets		$	150,435		$	152,159
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	6,105		$	6,516
Purses due horsemen		3,213			7,957
Accrued liabilities		5,332			6,015
Payable to Dover Motorsports, Inc.		—			96
Income taxes payable		2,194			53
Deferred revenue		240			261
Total current liabilities		17,084			20,898
Notes payable to banks		29,775			31,225
Deferred income taxes		5,492			5,061
Commitments and contingencies (see Notes to the Consolidated Financial Statements)
Stockholders’ equity:
Preferred stock, $0.10 par value; 1,000,000 shares authorized; issued and outstanding: none		—			—
Common stock, $0.10 par value; 74,000,000 shares authorized; issued and outstanding: March 31, 2004-10,333,112 shares; December 31, 2003-10,333,112 shares		1,033			1,033
Class A common stock, $0.10 par value; 50,000,000 shares authorized; issued and outstanding: March 31, 2004-16,145,059 shares; December 31, 2003-16,145,059 shares		1,615			1,615
Additional paid-in capital		67,454			67,454
Retained earnings		27,982			24,873
Total stockholders’ equity		98,084			94,975
Total liabilities and stockholders’ equity		$	150,435		$	152,159

 

The Notes to the Consolidated Financial Statements are an integral part of these consolidated statements.

 

3

 

DOVER DOWNS GAMING & ENTERTAINMENT, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
In Thousands
(Unaudited)

 

		Three Months Ended March 31,
		2004			2003
Operating activities:
Net earnings		$	4,434		$	4,007
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation		1,691			1,502
Amortization of credit facility origination fees		13			—
Deferred income taxes		193			192
Changes in assets and liabilities:
Accounts receivable		(1,782		)	(677		)
Due from State of Delaware		5,342			5,502
Inventories		(74		)	(23		)
Prepaid expenses and other		1,066			623
Receivable from/payable to Dover Motorsports, Inc.		(99		)	(697		)
Accounts payable		(411		)	1,427
Purses due horsemen		(4,744		)	(4,922		)
Accrued liabilities		(683		)	(698		)
Income taxes payable		2,471			3,242
Deferred revenue		(21		)	58
Net cash provided by operating activities		7,396			9,536
Investing activities:
Capital expenditures		(2,900		)	(892		)
Net cash used in investing activities		(2,900		)	(892		)
Financing activities:
Borrowings from revolving debt		46,150			33,550
Repayments of revolving debt		(47,600		)	(36,740		)
Dividends paid		(1,325		)	(1,330		)
Repurchase of common stock		—			(1,174		)
Net cash used in financing activities		(2,775		)	(5,694		)
Net increase in cash and cash equivalents		1,721			2,950
Cash and cash equivalents, beginning of period		14,138			12,836
Cash and cash equivalents, end of period		$	15,859		$	15,786
Supplemental information:
Interest paid		$	167		$	246
Income taxes paid		$	378		$	—

 

The Notes to the Consolidated Financial Statements are an integral part of these consolidated statements.

 

4

 

DOVER DOWNS GAMING & ENTERTAINMENT, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 – Basis of Presentation

 

References in this document to “the Company,” “Gaming & Entertainment,” “we,” “us” and “our” mean Dover Downs Gaming & Entertainment, Inc. and its wholly owned subsidiaries.

 

The accompanying consolidated financial statements have been prepared in compliance with Rule 10-01 of Regulation S-X and accounting principles generally accepted in the United States of America, but do not include all of the information and disclosures required for audited financial statements.  These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K filed on March 9, 2004.  In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of operations, financial position and cash flows for the interim periods presented.  Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

 

NOTE 2 - Business Operations

 

Dover Downs Gaming & Entertainment, Inc. is a diversified gaming and entertainment company whose operations consist of Dover Downs Slots – a 91,000 square foot video lottery (slots) casino complex; the Dover Downs Hotel and Conference Center – featuring luxury accommodations with conference, banquet, fine dining, ballroom and concert hall facilities; and Dover Downs Raceway – a harness racing track with pari-mutuel wagering on live and simulcast horse races.

 

Our entertainment complex is located in Dover, the capital of the State of Delaware.  Approximately 70% of our customers come from Maryland, Pennsylvania, Virginia and the District of Columbia.

 

Gaming & Entertainment has two wholly owned subsidiaries; Dover Downs, Inc. and Dover Downs Management Corp.  Dover Downs, Inc. was incorporated in 1967 and began motorsports and harness racing operations in 1969.  In June of 1994, legislation authorizing video lottery operations in the State of Delaware (the “State”) was adopted.  The Company’s video lottery (slots) casino operations began on December 29, 1995.  As a result of several restructurings, Dover Downs, Inc. became a wholly owned subsidiary of Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) (“DVD”), and became the operating entity for all of DVD’s gaming operations.

 

Gaming & Entertainment was incorporated in the State in December of 2001 as a wholly owned subsidiary of DVD.  Effective March 31, 2002, DVD completed a tax-free spin-off of its gaming operations by contributing 100% of the issued and outstanding common stock of Dover Downs, Inc. to the Company, and subsequently distributing 100% of the issued and outstanding common stock of the Company to DVD stockholders.  Immediately following the spin-off, Dover Downs Gaming & Entertainment, Inc. became an independent public company.

 

The Company is authorized to conduct video lottery operations as a “Licensed Agent” under the Delaware State Lottery Code. Pursuant to Delaware’s Horse Racing Redevelopment Act, enacted in 1994, the Delaware State Lottery Office administers and controls the operation of the video lottery.

 

5

 

The Company’s license from the Delaware Harness Racing Commission (the “Commission”) to hold harness race meetings on our premises and to offer pari-mutuel wagering on live and simulcast horse races must be renewed on an annual basis. In order to maintain its license to conduct video lottery operations, the Company is required to maintain its harness horse racing license.  The Company has received an annual license from the Commission for the past 35 consecutive years and management believes that its relationship with the Commission remains good.

 

Due to the nature of the Company’s business activities, it is subject to various federal, state and local regulations.

 

NOTE 3 - Summary of Significant Accounting Policies

 

Basis of consolidation—The consolidated financial statements include the accounts of Gaming & Entertainment and its wholly owned subsidiaries.  Intercompany transactions and balances have been eliminated.

 

Revenue and expense recognition—Gaming revenues represent (i) the net win from video lottery (slot) machine wins and losses and (ii) commissions from pari-mutuel wagering.  Other operating revenues consist of hotel rooms revenue, food and beverage sales and other miscellaneous income.

 

For the video lottery operations, which account for more than 80% of gross revenues for all periods presented, the difference between the amount wagered by bettors and the amount paid out to bettors is referred to as the win. The win is included in the amount recorded in the Company’s consolidated financial statements as gaming revenue. The Delaware State Lottery Office sweeps the win from the video lottery operations, collects the State’s share of the win and the amount due to the vendors under contract with the State who provide the video lottery (slot) machines and associated computer systems, collects the amount allocable to purses for harness horse racing, and remits the remainder to the Company as its commission for acting as a Licensed Agent. Gaming expenses include the amounts collected by the State (i) for the State’s share of the win, (ii) for remittance to the providers of the video lottery (slot) machines and associated computer systems, and (iii) for harness horse racing purses. The Company recognizes revenues from pari-mutuel commissions earned from live harness horse racing and importing of simulcast signals from other race tracks when the race occurs. Revenues from hotel rooms, food and beverage sales and other miscellaneous income are recognized at the time the service is provided.

 

The retail value of hotel rooms, food, beverage and other items that are provided to customers without charge has been included in gross revenues, and a corresponding amount has been deducted as promotional allowances. The estimated direct cost of providing these items has been charged to the casino through interdepartmental allocations and is included in gaming expenses in the consolidated statement of earnings.

 

The Company currently has a point loyalty program for its video lottery customers which allows them to earn points based on the volume of their video lottery activity.  The points can be redeemed for various services and merchandise throughout the gaming facility; however, they are not redeemable for cash or casino play. The Company records the points as an expense when they are redeemed by the customers. The value of all points outstanding as of March 31, 2004 and December 31, 2003 was $4,763,000 and $4,592,000, respectively.

 

Earnings per share-Basic and diluted earnings per share (“EPS”) are calculated in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 128, Earnings Per Share.  Weighted average shares used in computing basic and diluted EPS are as follows:

 

		Three months ended March 31,
		2004		2003
Basic EPS		26,478,000		26,579,000
Effect of dilutive options		67,000		26,000
Diluted EPS		26,545,000		26,605,000

 

For the three months ended March 31, 2004 and 2003, options to purchase 296,000 and 676,000 shares of common stock, respectively, were outstanding, but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common stock during the period.

 

6

 

Accounting for stock options—The Company accounts for stock options in accordance with FASB Statement No. 123, Accounting for Stock-Based Compensation, as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123.  Statement No. 123 defines a fair-value based method of accounting for stock-based compensation plans; however, it allows the continued use of the intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The Company has elected to continue to use the intrinsic value method and based on this method did not record any stock-based compensation expense during the three-month periods ended March 31, 2004 and 2003.

 

The following table illustrates the effect on net earnings and net earnings per common share if the Company had applied the fair-value recognition provisions of Statement No. 123 to stock-based employee compensation:

 

		Three months ended March 31,
		2004			2003
Net earnings, as reported		$	4,434,000		$	4,007,000
Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards		(146,000		)	(154,000		)
Pro forma net earnings		$	4,288,000		$	3,853,000
Net earnings per common share:
Basic – as reported		$	0.17		$	0.15
Basic – pro forma		$	0.16		$	0.14
Diluted – as reported		$	0.17		$	0.15
Diluted – pro forma		$	0.16		$	0.14

 

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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Reclassifications—Certain reclassifications have been made to the prior period consolidated financial statements to conform to the current period presentation.  These reclassifications had no effect on net earnings.

 

NOTE 4 – Indebtedness

 

The Company has a $40,000,000 credit facility, as amended effective February 19, 2004, that expires on April 30, 2006.  Interest is based, at the Company’s option, upon (i) LIBOR plus 0.75% or (ii) the base rate (the greater of the prime rate or the federal funds rate plus 0.5%) minus 1%.  The terms of the credit facility contain, among others, minimum net worth, interest coverage and maximum leverage covenant requirements.  Material adverse changes in the Company’s results of operation could impact its ability to maintain financial ratios necessary to satisfy these requirements. The facility is for seasonal funding needs, capital improvements and other general corporate purposes.  At March 31, 2004, the Company was in compliance with all terms of the facility and there was $29,775,000 outstanding at a weighted average interest rate of 1.95%.  After consideration of stand by letters of credit outstanding, $10,125,000 was available pursuant to the facility at March 31, 2004.

 

NOTE 5 – Pension Plans

 

The Company maintains a non-contributory, tax qualified defined benefit pension plan. All of Gaming & Entertainment’s full time employees are eligible to participate in the pension plan.  Benefits provided by the Gaming & Entertainment pension plan are based on years of service and employees’ remuneration over their term of employment.  Pension costs are funded in accordance with the provisions of the Internal Revenue Code. The Company also maintains a non-qualified, non-contributory defined benefit pension plan for certain employees to restore pension benefits reduced by federal income tax regulations. The cost associated with the plan is determined using the same actuarial methods and assumptions as those used for the Company’s qualified pension plan.

 

7

 

The components of net periodic pension cost are as follows:

 

 

The Company contributed $300,000 to its pension plans during the three months ended March 31, 2004 and expects to contribute a total of approximately $500,000 to its pension plans in 2004.

 

NOTE 6 – Stockholders’ Equity

 

Changes in the components of stockholders’ equity are as follows:

 

		Common Stock			Class A Common Stock			Additional Paid-in Capital			Retained Earnings
Balance at December 31, 2003		$	1,033,000		$	1,615,000		$	67,454,000		$	24,873,000
Net earnings		—			—			—			4,434,000
Dividends paid, $0.05 per share		—			—			—			(1,325,000		)
Balance at March 31, 2004		$	1,033,000		$	1,615,000		$	67,454,000		$	27,982,000

 

On April 28, 2004, the Company’s Board of Directors declared a quarterly cash dividend on both classes of common stock of $0.06 per share.  The dividend represents a 20% increase from the previously paid $0.05 per share.  The dividend is payable on June 10, 2004 to shareholders of record at the close of business on May 10, 2004.

 

On October 23, 2002, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s outstanding common stock.  The purchases may be made in the open market or in privately negotiated transactions as conditions warrant.  The repurchase authorization does not obligate the Company to acquire any specific number of shares and may be suspended at any time.   During the three months ended March 31, 2003, the Company purchased and retired 120,245 shares of its outstanding common stock at an average purchase price of $9.76 per share. Gaming & Entertainment did not repurchase any outstanding shares of its common stock during the three months ended March 31, 2004.

 

The Company has a stock incentive plan which provides for the grant of up to 1,500,000 shares of stock to our officers and key employees through stock options and/or awards valued in whole or in part by reference to our common stock, such as restricted stock awards.  Under the plan, option grants must have an exercise price of not less than 100% of the fair market value of the underlying shares of common stock at the date of the grant.  The options have eight-year terms and generally vest equally over a period of six years from the date of grant.  As of March 31, 2004, there were 626,859 stock awards available for grant.

 

NOTE 7 - Related Party Transactions

 

During the three months ended March 31, 2004 and 2003, Gaming & Entertainment allocated costs of $256,000 and $421,000, respectively, to DVD for certain administrative and operations services, including DVD’s use of office space.  Additionally, DVD allocated costs of $29,000 to Gaming & Entertainment for the three months ended March 31, 2004.  The allocations were based on an analysis of each company’s share of the costs.  As of March 31, 2004, Gaming & Entertainment’s consolidated balance sheet includes a $3,000 receivable from DVD for the aforementioned costs and for other payments made by the Company on DVD’s behalf.  The Company has since settled the receivable in the second quarter of 2004.  The net costs incurred by each company for these services are not necessarily indicative of the costs that would have been incurred if the companies had been separate, independent entities and/or had otherwise independently managed these functions; however, management believes that these costs are reasonable.

 

8

 

The Company’s use of DVD’s 5/8-mile harness racing track is under an easement granted to the Company by DVD which does not require the payment of any rent. Under the terms of the easement the Company has exclusive use of the harness track during the period beginning November 1 of each year and ending April 30 of the following year, together with set up and tear down rights for the two weeks before and after such period.  The harness track is located on property owned by DVD and is on the inside of DVD’s motorsports superspeedway.  The Company’s indoor grandstands are used by DVD at no charge in connection with its motorsports events. DVD also leases its principal executive office space from the Company.  Various easements and agreements relative to access, utilities and parking have also been entered into between DVD and the Company relative to their respective Dover, Delaware facilities.

 

NOTE 8 – Commitments and Contingencies

 

The Company is a party to ordinary routine litigation incidental to its business.  Management does not believe that the resolution of any of these matters is likely to have a serious adverse effect on our results of operations, financial condition or cash flows.

 

Item 2.                              Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

 

The following discussion is based upon and should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

 

Dover Downs Gaming & Entertainment, Inc. is a diversified gaming and entertainment company whose operations consist of Dover Downs Slots – a 91,000 square foot video lottery (slots) casino complex; the Dover Downs Hotel and Conference Center – featuring luxury accommodations with conference, banquet, fine dining, ballroom and concert hall facilities; and Dover Downs Raceway – a harness racing track with pari-mutuel wagering on live and simulcast horse races.

 

More than 80% of the Company’s gross revenue is derived from video lottery (slot) machine win (as defined below).  Several factors contribute to the video lottery (slot) machine win for any gaming company, including, but not limited to:

 

•                       Proximity to major population bases,

•                       Competition in the company’s market,

•                       The quantity and types of machines available,

•                       The quality of the physical property,

•                       Other amenities offered on site,

•                       Customer service levels, and

•                       Marketing programs.

 

The Company believes that it is holds a strong position in each of these areas.  Our entertainment complex is located in Dover, the capital of the State of Delaware. We draw patrons from several major metropolitan areas. Philadelphia, Baltimore and Washington, D.C. are all within a 2 hour drive. According to the 2000 United States Census, approximately 32.8 million people live within 150 miles of the complex.  There are significant barriers to entry related to the gaming business in Delaware, such as the statutory limitation of gaming licenses to the three existing horse racing facilities.  The Company’s property, designed and developed with the assistance of Caesars World Gaming Development Corporation (“Caesars”) is similar to properties found in the country’s largest gaming markets.  The Company offers the only luxury hotel in the Delaware gaming market, providing a strong marketing tool, especially to higher end players.  The Company utilizes, and is currently upgrading, its slot marketing system to allow for the most efficient marketing programs and the highest levels of customer service.

 

9

 

The biggest risks to the Company are increased competition in surrounding states from the legalization of new or additional casino or other gaming venues and the fact that all of our operations are located at one facility.  The Company has therefore focused on creating the region’s premier gaming destination and building and rewarding customer loyalty through innovative marketing efforts and unparalleled customer service.

 

Results of Operations

 

Gaming revenues represent (i) the net win from video lottery (slot) machine wins and losses and (ii) commissions from pari-mutuel wagering.  Other operating revenues consist of hotel rooms revenue, food and beverage sales and other miscellaneous income.

 

For the video lottery operations, the difference between the amount wagered by bettors and the amount paid out to bettors is referred to as the win. The win is included in the amount recorded in the Company’s financial statements as gaming revenue. The Delaware State Lottery Office sweeps the win from the video lottery operations, collects the State’s share of the win and the amount due to the vendors under contract with the State who provide the video lottery (slot) machines and associated computer systems, collects the amount allocable to purses for harness horse racing and remits the remainder to the Company as its commission for acting as a Licensed Agent. Gaming expenses include the amounts collected by the State (i) for the State’s share of the win, (ii) for remittance to the providers of the video lottery (slot) machines and associated computer systems, and (iii) for harness horse racing purses. The Company recognizes revenues from pari-mutuel commissions earned from live harness horse racing and importing of simulcast signals from other race tracks when the race occurs. Revenues from hotel rooms, food and beverage sales and other miscellaneous income are recognized at the time the service is provided.

 

The retail value of hotel rooms, food, beverage and other items that are provided to customers without charge has been included in gross revenues and a corresponding amount has been deducted as promotional allowances. The estimated direct cost of providing these items has been charged to the casino through interdepartmental allocations and is included in gaming expenses in the consolidated statement of earnings.

 

Three Months Ended March 31, 2004 vs. Three Months Ended March 31, 2003

 

Gaming revenues increased by $5,752,000, or 13.8%, to $47,309,000, primarily the result of increased play in our casino.  During 2003, our gaming revenues were negatively impacted by the enactment of the Delaware Clean Indoor Air Act (the “Act” or the “smoking ban”) on November 27, 2002.  As a result of the Act, we redirected our marketing efforts to attract more casino customers to our hotel by providing additional complimentary and discounted rooms.  In December 2003, slot win compared to the same month in the prior year increased for the first time since the enactment of the smoking ban.  We believe that our marketing efforts have been effective at attracting customers to our casino and consequently increasing slot win.  Additionally, we added 500 new video lottery (slot) machines during the quarter which increased our average number of machines from 2,000 in the first quarter of 2003 to 2,230 in the first quarter of 2004.

 

Other operating revenues increased by $1,490,000, or 21.9%, to $8,288,000, primarily due to higher occupancy levels at the Dover Downs Hotel and Conference Center and increased food, beverage and concert sales.

 

Other operating revenues for the first quarter of 2004 and 2003 included $5,037,000 and $4,156,000, respectively, related to promotional items provided to customers without charge.  The increase in promotional allowances is primarily due to the Company’s expanded marketing efforts to attract more casino customers to the hotel by providing additional complimentary and discounted hotel rooms.

 

Gaming expenses increased by $5,131,000, or 15.8%, reflecting the higher gaming revenues. Amounts retained by the State of Delaware and the amount collected by the State for payment to the vendors under contract with the State who provide the video lottery machines and associated computer systems increased by $2,327,000 and $426,000, respectively.  Amounts allocated from the video lottery operation for harness horse racing purses increased from $4,650,000 in the first quarter of 2003 to $5,321,000 in the first quarter of 2004.  Collectively, these statutory costs increased as a percentage of gaming revenues in the first quarter of 2004 as compared to the first quarter of 2003 primarily due to a 1.25% surcharge imposed by the State on the Company’s share of the video lottery (slot) proceeds that took effect in the third quarter of 2003.  The cost of advertising and promotions increased

 

10

 

$718,000 in the first quarter of 2004.  As a percentage of gaming revenues, advertising and promotions expenses remained consistent as compared with the first quarter of 2003.  The remaining $989,000 increase in gaming expenses relates primarily to higher payroll and benefit costs.

 

Other operating expenses increased by $187,000, or 8.3%, reflecting the higher other operating revenues.  Payroll and related costs in the food and beverage department represented the largest increase in other operating expenses.

 

General and administrative expenses increased by $193,000 to $1,147,000 from $954,000 in the first quarter of 2003 primarily the result of higher legal costs and franchise taxes.

 

Depreciation expense increased by $189,000, primarily due to information system upgrades in the casino and administrative departments that occurred during 2003.

 

Interest expense decreased by $61,000, primarily due to the Company’s average interest rate being 2.19% during the first quarter of 2003 as compared to 1.98% during the first quarter of 2004 and the decrease in outstanding borrowings under our credit facility.

 

The Company’s effective income tax rate was 40.7% for the first quarter ended March 31, 2004 and 2003.

 

Net earnings were $4,434,000 in the first quarter of 2004 as compared to $4,007,000 in the first quarter of 2003.  The increase of $427,000, or 10.7%, was primarily due to the improved results for our gaming operations.

 

Liquidity and Capital Resources

 

Net cash provided by operating activities was $7,396,000 for the three months ended March 31, 2004 compared to $9,536,000 for the three months ended March 31, 2003.  The decrease was primarily due to the timing of cash receipts from the Delaware State Lottery Office related to our commission and the timing of income tax payments and payments to vendors, partially offset by the increase in net earnings before depreciation and amortization from $5,509,000 in the first quarter of 2003 to $6,138,000 in the first quarter of 2004.

 

Net cash used in investing activities was $2,900,000 for the three months ended March 31, 2004 compared to $892,000 for the three months ended March 31, 2003.  The increase in 2004 as compared with 2003 was primarily due to the construction of 11,000 additional square feet of gaming space to accommodate the installation of 500 newly authorized video lottery (slot) machines within our existing casino complex.

 

Net cash used in financing activities was $2,775,000 for the three months ended March 31, 2004 compared to $5,694,000 for the three months ended March 31, 2003.  The change was primarily due to higher repayments of outstanding borrowings under our credit facility and the repurchase of 120,245 shares of the Company’s outstanding common stock during the first quarter of 2003.  Additionally, the Company paid $1,325,000 in regular quarterly cash dividends during the three months ended March 31, 2004.

 

On April 28, 2004, the Company’s Board of Directors declared a quarterly cash dividend on both classes of common stock of $0.06 per share.  The dividend represents a 20% increase from the previously paid $0.05 per share.  The dividend is payable on June 10, 2004 to shareholders of record at the close of business on May 10, 2004.

 

On October 23, 2002, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s outstanding common stock.  The purchases may be made in the open market or in privately negotiated transactions as conditions warrant.  The repurchase authorization does not obligate the Company to acquire any specific number of shares and may be suspended at any time.  During the three months ended March 31, 2003, the Company purchased and retired 120,245 shares of its outstanding common stock at an average purchase price of $9.76 per share.  The Company did not repurchase any outstanding shares of its common stock during the three months ended March 31, 2004.

 

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Based on current business conditions, the Company expects to make additional capital expenditures of approximately $7,000,000 through 2004.  These expenditures primarily relate to additional amenities at our luxury hotel and site improvements, such as parking and signage, as well as the purchase of a new customer management and slot data system and the conversion of our casino floor to ticket-in, ticket-out (cashless) technology.  Additionally, the Company expects to contribute approximately $500,000 to its pension plans in 2004, of which $300,000 was contributed in the first quarter of 2004.

 

We have a $40,000,000 unsecured revolving line of credit agreement.  At March 31, 2004, $29,775,000 was outstanding under the facility.  Based on current business trends, we believe that our cash flows from operations and the funds available pursuant to our revolving credit facility will be sufficient to meet our short and long-term cash needs.  Any significant expansion of our gaming facility that we may decide to undertake, any significant acquisitions, or any material adverse change in our operations could cause the need for additional financing.  The Company expects that its net cash flows from operating activities and funds available from its credit facility will be sufficient to provide for its working capital needs and capital spending requirements at least through 2004, as well as any cash dividends the Company’s Board of Directors may declare.  We expect cash flows from operating activities and funds available from our credit facility to also provide for long-term liquidity.

 

Related Party Transactions

 

See NOTE 7 – Related Party Transactions of the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

 

Critical Accounting Policies

 

The accounting policies described below are those the Company considers critical in preparing its consolidated financial statements and/or include significant estimates made by management using information available at the time the estimates are made. However, as described below, these estimates could change materially if different information or assumptions were used. The descriptions below are summarized and have been simplified for clarity.

 

Points Program

 

The Company currently has a point loyalty program for its video lottery customers which allows them to earn points based on the volume of their video lottery activity.  The Company records the points as an expense when they are redeemed by the customers.  The points can be redeemed for various services and merchandise throughout the gaming facility; however, they are not redeemable for cash or casino play.  The value of all points outstanding as of March 31, 2004 was $4,763,000.

 

Accrued Pension Cost

 

The benefits provided by the Company’s defined-benefit pension plans are based on years of service and employee’s remuneration over their employment with the Company.  The Company establishes accrued pension costs in accordance with the provisions of Financial Accounting Standards Board Statement No. 87, Employers’ Accounting for Pensions. Accrued pension costs are developed using actuarial principles and assumptions which consider a number of factors, including estimates for the discount rate, assumed rate of compensation increase, and expected long-term rate of return on assets.  Changes in these estimates would impact the amounts that the Company records in its consolidated financial statements.

 

Property and Equipment

 

Property and equipment are recorded at cost. Depreciation is provided for financial reporting purposes using the straight-line method over estimated useful lives ranging from 5 to 10 years for furniture, fixtures and equipment and up to 40 years for facilities.  These estimates require assumptions that are believed to be reasonable. Long-lived assets are evaluated for impairment when an event occurs that indicates an impairment may exist.

 

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Factors That May Affect Operating Results; Forward-Looking Statements

 

In addition to historical information, this Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, relating to our financial condition, profitability, liquidity, resources, business outlook, proposed acquisitions, market forces, corporate strategies, consumer preferences, contractual commitments, legal matters, capital requirements and other matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. To comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results and experience to differ substantially from the anticipated results or other expectations expressed in our forward-looking statements. When words and expressions such as: “believes,” “expects,” “anticipates,” “estimates,” “plans,” “intends,” “objectives,” “goals,” “aims,” “projects,” “forecasts,” “possible,” “seeks,” “may,” “could,” “should,” “might,” “likely,” “enable” or similar words or expressions are used in this document, as well as statements containing phrases such as “in our view,” “there can be no assurance,” “although no assurance can be given” or “there is no way to anticipate with certainty,” forward-looking statements are being made.

 

Various risks and uncertainties may affect the operation, performance, development and results of our business and could cause future outcomes to differ materially from those set forth in our forward-looking statements, including the following factors:

 

•                       success of or changes in our growth strategies;

 

•                       our development and potential acquisition of new facilities;

 

•                       anticipated trends in the gaming industry;

 

•                       patron demographics;

 

•                       general market and economic conditions, including consumer and corporate spending sentiment;

 

•                       our ability to finance future business requirements;

 

•                       our ability to effectively compete in the marketplace;

 

•                       the availability of adequate levels of insurance;

 

•                       our ability to successfully integrate acquired companies and businesses;

 

•                       management retention and development;

 

•                       changes in Federal, state, and local laws and regulations, including environmental, gaming license and tax legislation;

 

•                       the effect of weather conditions or travel on attendance at our facilities;

 

•                       military or other government actions; and

 

•                       national or local catastrophic events.

 

We undertake no obligation to publicly update or revise any forward-looking statements as a result of future developments, events or conditions.  New risk factors emerge from time to time and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ significantly from those forecast in any forward-looking statements. Given these risks and uncertainties, stockholders should not overly rely or attach undue weight to our forward-looking statements as an indication of our actual future results.

 

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Our Gaming Activities Compete Directly With Other Gaming Facilities And Other Entertainment Businesses

 

We compete in local and regional markets with horse tracks, off-track betting parlors, state run lotteries, casinos and other gaming facilities.  We cannot be certain that we will maintain our market share or compete more effectively with our competitors. The legalization of new or additional casino or other gaming venues in jurisdictions close to Delaware, particularly Maryland, Virginia, Washington, D.C., Pennsylvania or New Jersey, could negatively impact our gaming business. From time to time legislation is proposed for adoption in these jurisdictions, as it has been for several years in Maryland and Pennsylvania, which if enacted, would further expand state gambling and wagering opportunities, including video lottery (slot) machines at racetracks. Enactment of such legislation could increase our competition and could adversely affect our business, financial condition and overall profitability.  Approximately 70% of our customers come from Maryland, Pennsylvania, Virginia and the District of Columbia.

 

All Of Our Facilities Are In One Location

 

Our facilities are located adjacent to one another at a single location in Dover, Delaware. Any prolonged disruption of operations at these facilities due to destruction of or material damage to the facilities or other reasons could adversely affect our financial condition and results of operations. We maintain property and business interruption insurance to protect against such types of disruption, but there can be no assurance that the proceeds of such insurance would be adequate to repair or rebuild our facilities in such event or to compensate us for lost profit during the period of any such disruption.

 

The Revocation, Suspension Or Modification Of Our Gaming Licenses Would Adversely Affect Our Gaming Business

 

The Delaware State Lottery Office and the Delaware Harness Racing Commission regulate our gaming operations. Our license from the Commission must be renewed on an annual basis. To keep our license for video lottery (slot) machine gaming, we must remain licensed for harness horse racing by the Commission and conduct at least 80 live race days each racing season, subject to the availability of harness race horses. The Commission has broad discretion to reject any application for a license or suspend or revoke a license once it is issued. The Director of the Delaware State Lottery Office (the “Lottery Director”) has broad discretion to revoke, suspend or modify the terms of a video lottery license. Any modification or termination of existing licensing regulations or any revocation, suspension or modification of our licenses could adversely affect our business, financial condition and overall profitability.

 

Our Gaming Activities Are Subject To Extensive Government Regulation And Any Additional Government Regulation Or Taxation Of Gaming Activities Could Substantially Reduce Our Revenue Or Profit

 

Video lottery (slot) machine gaming, harness horse racing and pari-mutuel wagering are subject to extensive government regulation. Delaware law regulates the win we are entitled to retain and the percentage of commission we are entitled to receive from our gaming revenues, which comprises a significant portion of our overall revenues. The State granted us a license to conduct video lottery (slot) machine operations and a license to conduct harness horse races and pari-mutuel wagering. The laws under which these licenses are granted could be modified or repealed at any time and we could be required to terminate our gaming operations. If we are required to terminate our gaming operations or if the amount of the commission we receive from the State for conducting our gaming operations is decreased, our business operations and overall profitability would be significantly impaired.

 

We believe that the prospect of significant additional tax revenue is one of the primary reasons why jurisdictions have legalized gaming. As a result, gaming operators are typically subject to significant taxes and fees in addition to normal federal and state corporate income taxes. These taxes and fees are subject to increase at any time. We pay substantial taxes and fees with respect to our operations and will likely incur similar burdens in any other jurisdiction in which we may conduct gaming operations in the future. Any material increase in taxes or fees, or the adoption of additional taxes or fees, may have a material adverse effect on our future financial results.

 

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We Do Not Own Or Lease Our Video Lottery (Slot) Machines And Related Technology

 

We do not own or lease the video lottery (slot) machines or central computer systems used in connection with our video lottery gaming operations. The Lottery Director enters into contracts directly with the providers of the video lottery (slot) machines and computer systems. The State purchases or leases all equipment and the Lottery Director licenses all technology providers. Our operations could be disrupted if a licensed technology provider violates its agreement with the State or ceases to be licensed for any reason. Such an event would be outside of our control and could adversely affect our gaming revenues.

 

Item 3.                      Quantitative And Qualitative Disclosures About Market Risk

 

The Company does not utilize financial instruments for trading purposes and holds no derivative financial instruments which could expose it to market risk. Our exposure to market risks related to fluctuations in interest rates is limited to our variable rate borrowings of $29,775,000 at March 31, 2004 under our revolving credit facility.  A change in interest rates of one percent on the balance outstanding at March 31, 2004 would cause a change in total annual interest costs of $298,000. The carrying values of these borrowings approximate their fair values at March 31, 2004.

 

Item 4.                    Controls and Procedures

 

(a)               Disclosure Controls and Procedures.

 

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that material information relating to the Company required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. In designing and evaluating the disclosure controls and procedures, the Company’s management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. The Company currently is in the process of further reviewing and documenting its disclosure controls and procedures, and its internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

 

(b)              Changes in Internal Control Over Financial Reporting.

 

There were no changes in our internal control over financial reporting during the first quarter of fiscal year 2004 that have materially affected, or that are reasonably likely to materially affect our internal controls over financial reporting.

 

Part II – Other Information

 

Item 1.                      Legal Proceedings

 

We are a party to ordinary routine litigation incidental to our business.  Management does not believe that the resolution of any of these matters is likely to have a serious negative effect on our financial condition, cash flows or profitability.

 

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Item 2.                      Changes In Securities, Use Of Proceeds And Issuer Purchases of Equity Securities

 

On October 23, 2002, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s outstanding common stock.  The purchases may be made in the open market or in privately negotiated transactions as conditions warrant.  The repurchase authorization does not obligate the Company to acquire any specific number of shares and may be suspended at any time.  During the three months ended March 31, 2003, the Company purchased and retired 120,245 shares of its outstanding common stock at an average price of $9.76 per share.  Gaming & Entertainment did not repurchase any outstanding shares of its common stock during the three months ended March 31, 2004.  At March 31, 2004, the Company had remaining repurchase authority of 1,830,055 shares.

 

Item 3.                      Defaults Upon Senior Securities

 

None.

 

Item 4.                      Submission Of Matters To A Vote Of Security Holders

 

At the Annual Meeting of Stockholders held on April 28, 2004, John W. Rollins, Jr. and Melvin L. Joseph were re-elected as directors by the Company’s stockholders.  Directors whose terms of office continued after the meeting were Patrick J. Bagley, Kenneth K. Chalmers, Denis McGlynn, Jeffrey W. Rollins, R. Randall Rollins and Henry B. Tippie.

 

The Company’s stockholders also voted to approve changes to our 2002 Stock Incentive Plan that add to the plan the flexibility to make awards to our officers and key employees that are valued in whole or in part by reference to our common stock, such as restricted stock awards.

 

		Votes For		Votes Against		Votes Abstained		Shares Not Voted
Election of John W. Rollins, Jr..		170,291,986		—		551,218		940,498
Election of Melvin L. Joseph		169,251,058		—		1,592,146		940,498
Approval of changes to 2002 Stock Incentive Plan		168,901,341		498,958		19,276		2,364,127

 

Item 5.                      Other Information

 

None.

 

Item 6.                      Exhibits And Reports On Form 8-K

 

(a)               Exhibits

 

31.1               Certification of Chief Executive Officer pursuant to Rule 13a-14(a)

 

31.2               Certification of Chief Financial Officer pursuant to Rule 13a-14(a)

 

32.1               Certification of Chief Executive Officer Pursuant to 18 U.S.C. Sec. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2               Certification of Chief Financial Officer Pursuant to 18 U.S.C. Sec. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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(b)              Reports on Form 8-K

 

The Company furnished a Form 8-K on January 29, 2004 announcing that it had issued a press release on the same date regarding its fourth quarter and year-end 2003 financial results.

 

 

Signatures

 

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

 

 

DATED:	May 6, 2004		Dover Downs Gaming & Entertainment, Inc.
					Registrant
			/s/ Denis McGlynn
				Denis McGlynn
				President and Chief Executive Officer and Director
			/s/ Timothy R. Horne
				Timothy R. Horne
				Senior Vice President-Finance,
				Treasurer and Chief Financial Officer

 

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