UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

 

HERBST GAMING, INC.

(Exact name of registrant as specified in its charter)

 

NEVADA		88-0446145
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
3440 West Russell Road, Las Vegas, Nevada		89118
(Address of principal executive offices)		(Zip Code)
(702) 889-7695
(Registrant’s telephone number, including area code)
Not Applicable
(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

 

Applicable Only to Issuers Involved in Bankruptcy Proceedings During the Preceding Five Years

 

Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by court.  YES  o  NO  o  Not Applicable

 

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 Operations (unaudited)
	Condensed Consolidated Statements of  Stockholders’ Equity (unaudited)
	Condensed Consolidated Statements of Cash Flows (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 DISCLOSURES 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 8-K

 

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PART I. – FINANCIAL INFORMATION

 

Item 1.                       Financial Statements.

 

HERBST GAMING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

 

		December 31, 2003			March 31, 2004
		(in thousands)
Assets
Current assets
Cash and cash equivalents		$	54,030		$	55,932
Accounts receivable, net		1,216			971
Notes and loans receivable		706			479
Prepaid expenses		4,070			3,716
Inventory		1,039			1,060
Total current assets		61,061			62,158
Property and equipment, net		106,824			106,942
Lease acquisition costs, net		59,620			57,357
Due from related parties		563			358
Other assets, net		9,000			9,018
Total assets		$	237,068		$	235,833
Liabilities and stockholders’ equity
Current liabilities
Current portion of long-term debt		$	170		$	162
Accounts payable		5,727			6,557
Accrued expenses		13,599			8,293
Total current liabilities		19,496			15,012
Long-term debt, less current portion		215,099			215,075
Other liabilities		919			956
Commitments and contingencies
Stockholders’ 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) retained earnings		(2,445		)	791
Total stockholders’ equity		1,554			4,790
Total liabilities and stockholders’ equity		$	237,068		$	235,833

 

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

 

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HERBST GAMING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 

		Three Months Ended March 31,
		2003			2004
		(in thousands)
Revenues:
Route operations		$	53,783		$	68,951
Casino operations		19,521			22,826
Other		728			823
Total revenues		74,032			92,600
Less promotional allowances		(2,739		)	(2,957		)
Net revenues		71,293			89,643
Costs and expenses:
Route operations		42,610			54,526
Casino operations		12,121			13,811
Depreciation and amortization		5,217			6,634
General and administrative		2,766			3,445
Total costs and expenses		62,714			78,416
Income from operations		8,579			11,227
Other income (expense):
Interest income		80			51
Interest expense, net of capitalized interest		(5,323		)	(5,792		)
Total other expense		(5,243		)	(5,741		)
Net income		$	3,336		$	5,486

 

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

 

4

 

HERBST GAMING, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF
STOCKHOLDERS’ EQUITY
(UNAUDITED)

 

		Common Stock			Additional Paid-In Capital			(Accumulated Deficit) Retained Earnings			Total
		(in thousands)
Balance, January 1, 2004		$	2,368		$	1,631		$	(2,445	)	$	1,554
Stockholders’ distributions		—			—			(2,250		)	(2,250		)
Net income		—			—			5,486			5,486
Balance, March 31, 2004		$	2,368		$	1,631		$	791		$	4,790

 

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

 

5

 

HERBST GAMING, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

 

		Three Months Ended March 31,
		2003			2004
		(in thousands)
Cash flows from operating activities:
Net income		$	3,336		$	5,486
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		5,217			6,634
Debt discount amortization		50			11
Gain on sale of assets		(4		)	(39		)
Decrease (increase) in:
Accounts receivable		281			245
Prepaid expenses		338			354
Inventory		66			(21		)
Due from related parties		(73		)	205
Increase (decrease) in:
Accounts payable		(289		)	496
Accrued expenses		(3,255		)	(5,306		)
Due to related parties		(383		)	—
Other liabilities		(133		)	37
Net cash provided by operating activities		5,151			8,102
Cash flows from investing activities:
Net cash paid for acquisition of Anchor Coin’s slot route assets		(57,171		)	—
Additions to notes receivable		(217		)	(300		)
Collection on notes receivable		222			141
Proceeds from sale of property and equipment		21			106
Purchases of property and equipment		(2,942		)	(3,567		)
Lease acquisition costs		(269		)	(249		)
Net cash used in investing activities		(60,356		)	(3,869		)
Cash flows from financing activities:
Proceeds from long-term debt		49,115			—
Reduction of long-term debt		(41		)	(43		)
Loan origination fees		(2,474		)	(38		)
Stockholders’ distributions		(900		)	(2,250		)
Net cash provided by (used) in financing activities		45,700			(2,331		)
Net (decrease) increase in cash and cash equivalents		(9,505		)	1,902
Cash and cash equivalents:
Beginning of period		55,035			54,030
End of period		$	45,530		$	55,932
Supplemental cash flow information - Cash paid during the period for interest		$	9,475		$	11,556
Supplemental schedule of non-cash investing and financing activities -
Purchase of assets through accounts payable		$	1,497		$	833
Acquisition of Anchor Coin’s slot route assets 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			—
Other liabilities		(578		)	—
Cash paid, net of cash acquired		$	57,171		$	—

 

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

 

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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 L.L.C. (“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.

 

Interim Financial Statements —The accompanying financial statements for the three months ended March 31, 2003 and 2004, 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 months ended March 31, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004.  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, 2003.

 

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.

 

Reclassifications—Certain prior period amounts have been reclassified in the consolidated financial statements to conform to the current period’s presentation.  Such reclassifications had no impact on net income.

 

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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 fair 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 10 3/4% 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 $2.5 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 slot route operations of the Company and Anchor Coin as if the acquisition had taken place at January 1, 2003 (dollars in thousands).  The Anchor acquisition was fully absorbed in the March 31, 2004 quarter which is included for comparative purposes only:

 

		Three months ended March 31, 2003 Pro forma			Three months ended March 31, 2004 Actual
Gross revenues		$	80,188		$	92,600
Net income		$	2,365		$	5,486

 

Included in the pro forma net income for the three months ended March 31, 2003 is approximately $453,000 of interest expense. 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 2003.

 

3.                                      BUSINESS SEGMENTS

 

The Company operates through two business segments—slot route operations and casino operations.  The slot route operations involve the installation, operation, and service of slot machines at strategic, high traffic non-casino locations, such as grocery stores, drug stores, convenience stores, bars, and restaurants.  Casino operations consist of the following five 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):

 

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		Three Months Ended March 31,
		2003			2004
Net revenues:
Slot route operations		$	53,680		$	68,835
Casino operations		16,885			19,985
Other operations (1)		728			823
Total net revenues		$	71,293		$	89,643
Income from segment operations (excluding general and administrative expense):
Slot route operations		$	7,503		$	9,291
Casino operations		3,230			4,666
Total income from segment operations		10,733			13,957
Other (1)		(2,154		)	(2,730		)
Total income from operations		$	8,579		$	11,227
Depreciation/amortization:
Slot route operations		$	3,567		$	5,018
Casino operations		1,534			1,508
Other (1)		116			108
Total depreciation/amortization		$	5,217		$	6,634
Segment EBITDA (2):
Slot route operations		$	11,070		$	14,309
Casino operations		4,764			6,174
Total segment EBITDA (2):		15,834			20,483
Other (1) and Corporate		(1,958		)	(2,571		)
Depreciation and amortization		(5,217		)	(6,634		)
Interest expense, net of capitalized interest		(5,323		)	(5,792		)
Net income		$	3,336		$	5,486

 

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

(2)                      Segment EBITDA consists of income from segment operations plus depreciation and amortization, and is calculated before allocation of overhead.

 

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4.                                      LEASE ACQUISITION COSTS

 

		As of December 31, 2003						As of March 31, 2004
		(dollars in thousands)
		Gross Carrying Amount			Accumulated Amortization			Gross Carrying Amount			Accumulated Amortization
Lease acquisition costs		$	76,221		$	16,601		$	76,470		$	19,113

 

The aggregate amortization expense for the three months ended March 31, 2003 and 2004 was $1,611,419, and $2,512,244, respectively.

 

Estimated amortization expense for the nine months ended December 31, 2004, and the twelve months ended December 31, 2005, 2006, 2007, 2008 and 2009 is $7,438,000, $9,684,000, $9,467,000, $9,321,000, $8,569,000, and $6,191,000, respectively.

 

ITEM 2.                             MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

We are a gaming company that owned and operated approximately 8,400 slot machines throughout the State of Nevada as of March 31, 2004.  Our route operations involve the exclusive installation and operation of approximately 6,800 slot machines as of March 31, 2004 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, such as Albertsons, Vons, Safeway, SavOn, Smith’s, Kmart, Terrible Herbst and Rite Aid, we pay a fixed monthly fee for each location in which we place slot machines.  With our street accounts, such as bars, restaurants and non-chain convenience stores, we share in the revenues on a percentage basis with the location owner.

 

In February 2003, we acquired the slot route assets of Anchor Coin, Inc.  This acquisition dramatically impacted our operations.  We paid for these assets by (i) issuing another $47.0 million in senior secured notes due 2008 under our indenture and (ii) $14.0 million of cash.

 

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.

 

Our revenues are primarily derived from gaming revenues, which include revenues from slot machines and table games.  Gaming revenues is generally defined as gaming wins less gaming losses.  Our largest component of revenues is from our slot machines.  Promotional allowances consist primarily of food and beverages furnished gratuitously to customers.  The retail value of such services is included in the respective revenue classifications and is then deducted as promotional allowance.  We calculate income from operations as net revenues less total operating costs and expenses.  Income from operations represents only those amounts that relate to our operations and excludes interest income, interest expense, and other non-operating income and expenses.  Segment  EBITDA consists of income from segment operations plus

 

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depreciation and amortization, and is calculated before allocation of overhead.

 

Financial Highlights for the three months ended March 31, 2003 and 2004

 

Slot Route Operations

 

		Three months ended March 31, 2003					Three months ended March 31, 2004
		$			% of revenue		$			% of revenue
		(dollar amount in thousands)
Slot route revenue		$	53,783		100.0	%	$	68,951		100.0	%
Promotional allowances		(103		)	0.2		(116		)	0.2
Direct expenses		42,610			79.2		54,526			79.0
EDITDA		11,070			20.6		14,309			20.8
Depreciation and amortization		3,567			6.6		5,018			7.3
Income from slot route operations		$	7,503		14.2	%	$	9,291		13.5	%

 

Casino Operations

 

		Three months ended March 31, 2003					Three months ended March 31, 2004
		$			% of revenue		$			% of revenue
		(dollar amount in thousands)
Casino revenue		$	19,521		100.0	%	$	22,826		100.0	%
Promotional allowances		(2,636		)	13.5		(2,841		)	12.4
Direct expenses		12,121			62.0		13,811			60.5
EDITDA		4,764			24.5		6,174			27.1
Depreciation and amortization		1,534			7.9		1,508			6.6
Income from casino operations		$	3,230		16.6	%	$	4,666		20.5	%

 

Other Costs

 

		Three months ended March 31, 2003					Three months ended March 31, 2004
		$			% of total revenues		$			% of total revenues
		(dollar amount in thousands)
General and administrative		$	2,766		3.7	%	$	3,445		3.7	%

 

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THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004

 

Route Operations

 

Route operations accounted for 74% of total revenues during the three months ended March 31, 2004.  This was an increase from 73% of total revenues for the three months ended March 31, 2003.  Total revenues from route operations were $69.0 million for the three months ended March 31, 2004, an increase of $15.2 million, or 28%, from $53.8 million for the three months ended March 31, 2003.  At March 31, 2004, we were operating approximately 6,800 slot machines, an increase of 200 machines from March 2003.  The increase in route revenue in the 2004 quarter primarily reflects a full quarter of operations of the slot machines acquired from Anchor Coin, Inc. versus a partial quarter of operations in 2003 as well as the continued replacement and refurbishment of existing slot machines during 2004.

 

Route operating costs were $54.5 million, or 79%, of route revenues for the three months ended March 31, 2004.  This compares to $42.6 million and 79% of route revenues for the same period in 2003.  The increase in route operating expenses was primarily associated with the cost of operating the slot machines acquired from Anchor Coin, Inc. for a full quarter of operations in 2004 as compared to a partial quarter of operations in 2003 as well as increases in some participation expenses and scheduled space lease increases to our existing slot route contracts.

 

Route EBITDA (as defined) for the three months ended March 31, 2004 was $14.3 million, an increase of $3.2 million, or 29%, from $11.1 million for the three months ended March 31, 2003. The increase in EBITDA was a result of a full quarter of operations of assets acquired from Anchor Coin, Inc. as well as base revenue increases and lower operating costs due to the cost savings of combining the Anchor locations with our existing route operations.

 

Casino Operations

 

Casino operations accounted for 25% of total revenues for the three months ended March 31, 2004 and 26% of revenues for the three months ended March 31, 2003.  Total revenues derived from casino operations were $22.8 million for the three months ended March 31, 2004, an increase of $3.3 million, or 17%, from $19.5 million for the three months ended March 31, 2003.  This increase in revenue was primarily due to increased customer play at Terrible’s Hotel & Casino in Las Vegas and our two casinos in Pahrump. During 2003 one of the main competitors in Pahrump, Nevada closed due to a fire. This closure helped our Pahrump properties achieve higher revenues. There is no indication when or if the competitor’s property will re-open.

 

Casino operating costs were $13.8 million, or 61%, of casino revenues for the three months ended March 31, 2004, compared to $12.1 million, or 62%, of casino revenues for the three months ended March 31, 2003.  Operating expenses increased primarily in the areas of promotions and taxes.  The increase in expenses were generally in areas that helped to drive the increase in revenue, such as comps, slot club and participation game fees.  Casino EBITDA (as defined) was $6.2 million for the three months ended March 31, 2004, an increase of $1.4 million, or 29%, from $4.8 million from the three months ended March 31, 2003.

 

Other Revenue

 

Other revenue consists of revenue items such as ATM fees, pay phone charges, rental income and other miscellaneous items unrelated to route and casino operations.  Other revenues were $.8 million for the three months ended March 31, 2004 compared to $.7 million for the three months ended March 31, 2003.

 

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Promotional Allowances

 

Promotional allowances were $3.0 million, or 3.2% of total revenues, for the three months ended March 31, 2004, an increase of $.3 million, or 11%, from $2.7 million, or 3.7% of total revenues for the three months ended March 31, 2003.  The increase was primarily due to heavier promotional spending at the casinos.

 

Other Costs

 

General and administrative expenses, or G&A, were $3.4 million for the three months ended March 31, 2004, an increase of $.6 million, or 21%, from $2.8 million for the three months ended March 31, 2003.  The increase was primarily due to overhead associated with the purchase of the slot route assets of Anchor Coin in February 2003.  G&A costs also increased due to costs associated with an increase in insurance expenses. G&A expenses as a percentage of revenue were 3.7% of the revenue for both periods.

 

Depreciation and amortization expense was $6.6 million for the three months ended March 31, 2004, an increase of $1.4 million, or 27%, from $5.2 million for the three months ended March 31, 2003.  The increase was due primarily to the amortization expenses associated with the acquired slot route contracts and depreciation expenses associated with new fixed assets.

 

Income from Operations

 

As a result of the factors discussed above, income from operations was $11.2 million for the three months ended March 31, 2004, an increase of $2.6 million from $8.6 million for the three months ended March 31, 2003.  As a percentage of total revenues, income from operations increased from 11.6% during 2003 to 12.1% during the same period in 2004.

 

Other Expenses

 

Other expense was $5.7 million for the three months ended March 31, 2004, an increase of $.5 million from the three months ended March 31, 2003.  The increase in expenses was primarily due to higher interest expense as a result of the $47.0 million additional offering of senior secured notes done in conjunction with the acquisition of the slot route assets of Anchor Coin completed in February 2003.

 

Net Income

 

Net income for the three months ended March 31, 2004 was $5.5 million.  This is an improvement of $2.2 million, or 67%, from a net income figure of $3.3 million recorded for three months ended March 31, 2003.

 

Liquidity and Capital Resources

 

Cash Flows

 

At March 31, 2004, we maintained $55.9 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

 

13

 

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 three months ended March 31, 2004, operating activities provided $8.1 million in cash flows on $5.5 million in net income.  Net income for the three months ended March 31, 2004 included non-cash expenses (depreciation and amortization) of $6.6 million.

 

Investing Activities and Capital Expenditures

 

For the three months ended March 31, 2004, we had net cash used for investing activities of $3.9 million primarily related to the net cash used to purchase gaming devices.

 

Capital expenditures for the remainder of 2004 are anticipated to be approximately $10.0 million. These funds will be primarily used for maintenance capital expenditures and for the purchase of slot machines.

 

Financing Activities

 

Cash flows used in financing activities were $2.3 million in the first three months of 2004.  This was the result of distributions to owners of $2.3 million.

 

Our debt includes approximately $215.0 million of indebtedness related to our 10 ³/₄% Senior Secured Notes due 2008.  These notes may be called, pursuant to the terms of the indenture, in September 2005.  We are actively monitoring our cost of capital and may consider refinancing if or when it becomes advantageous to do so.

 

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.

 

Free Cash Flow

 

The following table summarizes our operating cash flow after deducting non-financed capital expenditures for the quarters ended March 31:

 

		Three months ended March 31,
		2003			2004
		(in millions)
Cash flow from operations		$	5,151		$	8,102
Cash paid for capital expenditures		2,942			3,567
Operating cash less non-financed capital expenditures		$	2,209		$	4,535

 

Our ability to service our debt will be dependent on our future performance, which will be affected by, among other things, prevailing economic conditions and financial, business and other factors certain of which are beyond our control.

 

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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 assets’ recoverability and the likelihood of technological obsolescence.  We estimate useful lives for property and equipment based on historical experience and estimates of products’ commercial lives.  Significant incremental costs associated with the acquisition of location leases are capitalized and amortized using the straight-line method over the term of the related leases, 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.  An adverse change to the estimate of these undiscounted 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.

 

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•                  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:

 

		March 31, 2004
		(in thousands)
Long-term debt, including current portion		$	215,237
Stockholders’ equity		4,790
Ratio of earnings to fixed charges		1.9		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.

 

•                  We face legislative pressures to increase taxation and any material increase in our tax rate could have a material adverse effect on our financial condition.

 

•                  Our operations could be adversely affected due to the adoption of anti-smoking regulations.

 

•                  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 yours.

 

•                  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 DISCLOSURES ABOUT MARKET RISK

 

Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates, and commodity prices.

 

On August 24, 2001, we issued $170.0 million in 10 3/4% 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 10 3/4% 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 $243 million at March 31, 2004.

 

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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 March 31, 2004 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-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report (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 in alerting them on a timely basis to material information relating to Herbst Gaming (including its consolidated subsidiaries) required to be included in our periodic filings under the Exchange Act.

 

(b)           Changes in Internal Controls.  There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quater that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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

 

(a)           On March 9, 2004, the Company held its annual meeting of stockholders.

 

(b)           The following persons were elected to the Board of Directors to serve for a period of one year or until their successors are elected:

 

•                  Edward Herbst

 

•                  Timothy Herbst

 

•                  Troy Herbst

 

•                  John Gaughan, and

 

•                  John Brewer.

 

(c)                                  The election of directors was unanimous.

 

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(d)                                 Not applicable.

 

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         Certification of Edward J. Herbst under Section 302 of the Sarbanes-Oxley Act of 2004.

 

31.2         Certification of Mary E. Higgins under Section 302 of the Sarbanes-Oxley Act of 2004.

 

32.1         Certification of the Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2004.

 

(b)           Reports on Form 8-K.

 

On May 5, 2004, Herbst Gaming furnished a Current Report on Form 8-K under Item 9, containing a copy of its earnings release for the period ended March 31, 2004 (including financial statements) pursuant to Item 12 (Results of Operations and Financial Condition).

 

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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:   May 10, 2004	HERBST GAMING, INC.
	(Registrant)
	By:	/s/ MARY E. HIGGINS
		Mary E. Higgins
	Its:	Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit Number		Description
31.1		Certification of Edward J. Herbst pursuant to Section 302 of the Sarbanes-Oxley Act of 2004
31.2		Certification of Mary E. Higgins pursuant to Section 302 of the Sarbanes-Oxley Act of 2004
32.1		Certification of the Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2004

 

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