Table of Contents
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: June 30, 2003 |
o | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _________________________ to _________________________ |
Commission File Number: 1-9481
ARCHON CORPORATION
(Exact name of registrant as specified in its charter)
Nevada (State or jurisdiction of incorporation or organization) | 88-0304348 (I.R.S. Employer Identification Number) |
3993 Howard Hughes Parkway, Suite 630, Las Vegas, Nevada 89109
(Address of principal executive office and zip code)
(702) 732-9120
(Registrant’s telephone number, including area code)
__________________________________________________________________________
(Former name, former address and former fiscal year, if changed since last report)
Indicate by a 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 x NO o
Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES o NO x
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. YES o NO o
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.
6,221,431 as of August 11, 2003
Table of Contents
ARCHON CORPORATION
INDEX
|
|
|
|
| Page |
|
|
|
|
|
|
PART I. |
| FINANCIAL INFORMATION |
| ||
|
|
|
|
|
|
|
| Item 1 |
| Consolidated Condensed Financial Statements |
|
|
|
|
|
|
|
|
|
|
| Consolidated Condensed Balance Sheets (Unaudited) June 30, 2003 and September 30, 2002 | 2 |
|
|
|
|
|
|
|
|
|
| 3 | |
|
|
|
|
|
|
|
|
|
| 4 | |
|
|
|
|
|
|
|
|
|
| 5 | |
|
|
|
|
|
|
|
|
|
| Notes to Consolidated Condensed Financial Statements (Unaudited) | 6 |
|
|
|
|
|
|
|
| Item 2 |
| Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 |
|
|
|
|
|
|
|
| Item 3 |
| 28 | |
|
|
|
|
|
|
|
| Item 4 |
| 28 | |
|
|
|
|
|
|
PART II. |
| 29 |
1
Table of Contents
Archon Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
(Unaudited)
|
| June 30, |
| September 30, |
| ||
|
|
|
| ||||
|
|
|
|
|
|
|
|
ASSETS |
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
Cash and cash equivalents |
| $ | 5,020,445 |
| $ | 8,615,412 |
|
Investment in marketable securities |
|
| 11,783,308 |
|
| 12,180,399 |
|
Accounts receivable, net |
|
| 175,971 |
|
| 3,225,944 |
|
Inventories |
|
| 264,706 |
|
| 286,585 |
|
Prepaid expenses and other |
|
| 1,076,707 |
|
| 975,199 |
|
|
|
|
| ||||
Total current assets |
|
| 18,321,137 |
|
| 25,283,539 |
|
Land held for development |
|
| 23,109,400 |
|
| 23,109,400 |
|
Property held for investment, net |
|
| 137,617,561 |
|
| 139,996,477 |
|
Property and equipment, net |
|
| 34,639,504 |
|
| 34,171,292 |
|
Restricted cash |
|
| 13,423,476 |
|
| 13,021,550 |
|
Other assets |
|
| 6,850,191 |
|
| 6,503,307 |
|
|
|
|
| ||||
Total assets |
| $ | 233,961,269 |
| $ | 242,085,565 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
LIABILITIES and STOCKHOLDERS’ EQUITY |
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
Accounts payable |
| $ | 2,434,053 |
| $ | 1,926,804 |
|
Interest payable |
|
| 269,796 |
|
| 2,285,248 |
|
Accrued and other liabilities |
|
| 2,083,237 |
|
| 2,360,996 |
|
Current portion of long-term debt |
|
| 737,062 |
|
| 93,100 |
|
Current portion of non-recourse debt |
|
| 6,358,392 |
|
| 5,733,795 |
|
|
|
|
| ||||
Total current liabilities |
|
| 11,882,540 |
|
| 12,399,943 |
|
Long-term debt – less current portion |
|
| 1,264,354 |
|
| 261,966 |
|
Non-recourse debt – less current portion |
|
| 111,363,027 |
|
| 117,401,909 |
|
Obligation under lease |
|
| 36,303,820 |
|
| 35,365,308 |
|
Deferred income taxes |
|
| 31,418,862 |
|
| 34,091,076 |
|
Other liabilities |
|
| 15,256,915 |
|
| 11,269,374 |
|
Stockholders’ equity |
|
| 26,471,751 |
|
| 31,295,989 |
|
|
|
|
| ||||
Total liabilities and stockholders’ equity |
| $ | 233,961,269 |
| $ | 242,085,565 |
|
|
|
|
|
See the accompanying Notes to Consolidated Condensed Financial Statements (Unaudited).
2
Table of Contents
Archon Corporation and Subsidiaries
Consolidated Condensed Statements of Operations
(Unaudited)
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
|
|
| ||||||||||
|
| 2003 |
| 2002 |
| 2003 |
| 2002 |
| ||||
|
|
|
|
|
| ||||||||
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Casino |
| $ | 6,857,398 |
| $ | 6,345,538 |
| $ | 21,660,534 |
| $ | 23,393,762 |
|
Hotel |
|
| 770,332 |
|
| 770,796 |
|
| 1,996,872 |
|
| 1,996,248 |
|
Food and beverage |
|
| 2,134,371 |
|
| 1,928,230 |
|
| 5,785,314 |
|
| 6,130,140 |
|
Investment properties |
|
| 3,100,562 |
|
| 3,100,562 |
|
| 9,301,685 |
|
| 9,301,685 |
|
Other |
|
| 500,125 |
|
| 682,320 |
|
| 2,242,669 |
|
| 2,370,769 |
|
|
|
|
|
|
| ||||||||
Gross revenues |
|
| 13,362,788 |
|
| 12,827,446 |
|
| 40,987,074 |
|
| 43,192,604 |
|
Less casino promotional allowances |
|
| (1,881,248 | ) |
| (1,444,555 | ) |
| (5,130,094 | ) |
| (5,376,472 | ) |
|
|
|
|
|
| ||||||||
Net operating revenues |
|
| 11,481,540 |
|
| 11,382,891 |
|
| 35,856,980 |
|
| 37,816,132 |
|
|
|
|
|
|
| ||||||||
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Casino |
|
| 3,928,101 |
|
| 3,775,549 |
|
| 12,575,899 |
|
| 12,443,582 |
|
Hotel |
|
| 214,140 |
|
| 243,435 |
|
| 557,881 |
|
| 607,315 |
|
Food and beverage |
|
| 1,091,158 |
|
| 1,105,955 |
|
| 2,949,379 |
|
| 3,182,233 |
|
Other |
|
| 403,382 |
|
| 470,828 |
|
| 1,497,004 |
|
| 1,568,731 |
|
Selling, general and administrative |
|
| 1,258,326 |
|
| 1,141,967 |
|
| 3,608,758 |
|
| 3,603,454 |
|
Corporate expenses |
|
| 731,779 |
|
| 732,843 |
|
| 2,048,296 |
|
| 2,189,688 |
|
Utilities and property expenses |
|
| 1,302,496 |
|
| 1,397,490 |
|
| 3,784,430 |
|
| 4,258,783 |
|
Depreciation and amortization |
|
| 1,725,391 |
|
| 1,442,938 |
|
| 4,821,804 |
|
| 4,587,012 |
|
Reserve for receivable and investment |
|
| 1,000,000 |
|
|
|
|
| 1,000,000 |
|
|
| |
|
|
|
|
|
| ||||||||
Total operating expenses |
|
| 11,654,773 |
|
| 10,311,005 |
|
| 32,843,451 |
|
| 32,440,798 |
|
|
|
|
|
|
| ||||||||
Operating income (loss) |
|
| (173,233 | ) |
| 1,071,886 |
|
| 3,013,529 |
|
| 5,375,334 |
|
Interest expense |
|
| (3,881,193 | ) |
| (3,983,272 | ) |
| (11,948,705 | ) |
| (12,184,767 | ) |
Interest income |
|
| 402,734 |
|
| 360,293 |
|
| 1,075,722 |
|
| 930,059 |
|
|
|
|
|
|
| ||||||||
Loss before income tax expense benefit |
|
| (3,651,692 | ) |
| (2,551,093 | ) |
| (7,859,454 | ) |
| (5,879,374 | ) |
Federal income tax (expense) benefit |
|
| 1,241,575 |
|
| (1,131,616 | ) |
| 2,672,214 |
|
| 0 |
|
|
|
|
|
|
| ||||||||
Net loss |
|
| (2,410,117 | ) |
| (3,682,709 | ) |
| (5,187,240 | ) |
| (5,879,374 | ) |
Dividends accrued on preferred shares, net |
|
| (386,176 | ) |
| (397,116 | ) |
| (1,143,504 | ) |
| (1,164,554 | ) |
|
|
|
|
|
| ||||||||
Net loss applicable to common shares |
| $ | (2,796,293 | ) | $ | (4,079,825 | ) | $ | (6,330,744 | ) | $ | (7,043,928 | ) |
|
|
|
|
|
| ||||||||
Average common shares outstanding |
|
| 6,221,431 |
|
| 6,192,213 |
|
| 6,221,431 |
|
| 6,166,242 |
|
|
|
|
|
|
| ||||||||
Average common and common equivalent shares outstanding |
|
| 6,221,431 |
|
| 6,192,213 |
|
| 6,221,431 |
|
| 6,166,242 |
|
|
|
|
|
|
| ||||||||
Loss per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
| $ | (0.45 | ) | $ | (0.66 | ) | $ | (1.02 | ) | $ | (1.14 | ) |
|
|
|
|
|
| ||||||||
Diluted |
| $ | (0.45 | ) | $ | (0.66 | ) | $ | (1.02 | ) | $ | (1.14 | ) |
|
|
|
|
|
|
See the accompanying Notes to Consolidated Condensed Financial Statements (Unaudited).
3
Table of Contents
Archon Corporation and Subsidiaries
Consolidated Condensed Statements of Stockholders’ Equity
(Unaudited)
|
| Common |
| Preferred |
| Additional |
| Accumulated |
| Accumulated |
| Stock |
| Treasury |
| Total |
| ||||||||
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Balances, October 1, 2002 |
| $ | 62,214 |
| $ | 18,146,756 |
| $ | 57,437,482 |
| $ | (44,094,268 | ) | $ | (94,678 | ) | $ | (73,743 | ) | $ | (87,774 | ) | $ | 31,295,989 |
|
Net loss |
|
|
|
|
|
|
|
|
|
|
| (5,187,240 | ) |
|
|
|
|
|
|
|
|
|
| (5,187,240 | ) |
Preferred stock dividends accrued, net |
|
|
|
|
| 1,143,504 |
|
|
|
|
| (1,143,504 | ) |
|
|
|
|
|
|
|
|
|
| 0 |
|
Preferred stock purchased |
|
|
|
|
| (1,513,766 | ) |
| 918,068 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| (595,698 | ) |
Unrealized gain on marketable securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 958,700 |
|
|
|
|
|
|
|
| 958,700 |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Balances, June 30, 2003 |
| $ | 62,214 |
| $ | 17,776,494 |
| $ | 58,355,550 |
| $ | (50,425,012 | ) | $ | 864,022 |
| $ | (73,743 | ) | $ | (87,774 | ) | $ | 26,471,751 |
|
|
|
|
|
|
|
|
|
|
|
See the accompanying Notes to Consolidated Condensed Financial Statements (Unaudited).
4
Table of Contents
Archon Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
(Unaudited)
|
| Nine Months Ended June 30, |
| ||||
|
|
| |||||
|
| 2003 |
| 2002 |
| ||
|
|
|
| ||||
Cash flows from operating activities: |
|
|
|
|
|
|
|
Cash and cash equivalents provided by (used in) operations: |
| $ | 573,076 |
| $ | (468,038 | ) |
Changes in assets and liabilities: |
|
|
|
|
|
|
|
Accounts receivable, net |
|
| 3,049,973 |
|
| 2,836,161 |
|
Inventories |
|
| 21,879 |
|
| (22,595 | ) |
Prepaid expenses and other |
|
| (101,508 | ) |
| (176,053 | ) |
Deferred income taxes |
|
| (2,672,214 | ) |
| 0 |
|
Other assets |
|
| (1,491,923 | ) |
| (1,715,637 | ) |
Reserve for receivable and investment |
|
| 1,000,000 |
|
| 0 |
|
Accounts payable |
|
| 507,249 |
|
| 36,790 |
|
Interest payable |
|
| (2,015,452 | ) |
| (2,162,399 | ) |
Accrued and other liabilities |
|
| 3,709,782 |
|
| 3,444,889 |
|
|
|
|
| ||||
Net cash provided by operating activities |
|
| 2,580,862 |
|
| 1,773,118 |
|
|
|
|
| ||||
Cash flows from investing activities: |
|
|
|
|
|
|
|
Decrease (increase) in restricted cash |
|
| (403,219 | ) |
| 3,122,964 |
|
Capital expenditures |
|
| (1,049,233 | ) |
| (3,907,230 | ) |
Marketable securities purchased |
|
| (822,711 | ) |
| (3,876,930 | ) |
Marketable securities sold |
|
| 2,179,795 |
|
| 1,107,779 |
|
|
|
|
| ||||
Net cash used in investing activities |
|
| (95,368 | ) |
| (3,553,417 | ) |
|
|
|
| ||||
Cash flows from financing activities: |
|
|
|
|
|
|
|
Paid on long-term debt |
|
| (5,484,763 | ) |
| (4,908,575 | ) |
Preferred stock purchased |
|
| (595,698 | ) |
| (7,594 | ) |
|
|
|
| ||||
Net cash used in financing activities |
|
| (6,080,461 | ) |
| (4,916,169 | ) |
|
|
|
| ||||
Decrease in cash and cash equivalents |
|
| (3,594,967 | ) |
| (6,696,468 | ) |
Cash and cash equivalents, beginning of period |
|
| 8,615,412 |
|
| 16,213,088 |
|
|
|
|
| ||||
Cash and cash equivalents, end of period |
| $ | 5,020,445 |
| $ | 9,516,620 |
|
|
|
|
|
See the accompanying Notes to Consolidated Condensed Financial Statements (Unaudited).
5
Table of Contents
ARCHON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. | Basis of Presentation and General Information |
Archon Corporation (the “Company” or “Archon”), is a publicly traded Nevada corporation. The Company’s primary business operations are conducted through a wholly-owned subsidiary corporation, Pioneer Hotel Inc. (“PHI”), which operates the Pioneer Hotel & Gambling Hall (the “Pioneer”) in Laughlin, Nevada under long-term lease and license agreements. In addition, the Company owns real estate on Las Vegas Boulevard South (the “Strip”) and at the corner of Rainbow and Lone Mountain Road, both in Las Vegas, Nevada, and also owns investment properties in Dorchester, Massachusetts and Gaithersburg, Maryland. Until October 2, 2000, the Company, through its wholly-owned subsidiary SFHI Inc., formerly known as Santa Fe Hotel, Inc. (“SFHI”), owned and operated the Santa Fe Hotel and Casino (the “Santa Fe”), located in Las Vegas, Nevada. On October 2, 2000, SFHI sold substantially all of its assets, including the rights to the name “Santa Fe Hotel and Casino,” for $205.0 million (the “SFHI Asset Sale”).
The consolidated condensed financial statements included herein are unaudited and have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of results for the interim periods have been made. The results for the three and nine month periods are not necessarily indicative of results to be expected for the full fiscal year. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended September 30, 2002 and the Company’s Quarterly Reports on Form 10-Q for the quarters ended December 31, 2002 and March 31, 2003.
2. | Summary of Significant Accounting Policies |
Principles of Consolidation. The accompanying unaudited consolidated condensed financial statements include the accounts of Archon and its wholly-owned subsidiaries. Amounts representing the Company’s investment in less than majority-owned companies in which a significant equity ownership interest is held are accounted for on the equity method. All material intercompany accounts and transactions have been eliminated in consolidation.
Earnings Per Share. The Company presents its per share results in accordance with Statement of Accounting Standards (“SFAS”) No. 128, “Earnings Per Share” (“SFAS 128”). SFAS 128 requires the presentation of basic net income (loss) per share and diluted net income (loss) per share. Basic per share amounts are computed by dividing net income (loss) by average shares outstanding during the period, while diluted per share amounts reflect the impact of additional dilution for all potentially dilutive securities, such as stock options. The effect of options outstanding was not included in diluted calculations during the three and nine months ended June 30, 2003 and June 30, 2002 since the Company incurred a net loss. The dilutive effect of the assumed exercise of stock options increased the weighted average number of shares of common stock by 546,360 for the three and nine months ended June 30, 2003, and by 572,721 shares and 597,930 for the three and nine months ended June 30, 2002, respectively.
6
Table of Contents
Accounting for Stock-Based Compensation. The Company has a Key Employee Stock Option Plan (the “Stock Option Plan”) which terminates in 2003. The Company accounts for the Stock Option Plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the Stock Option Plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation (in thousands except for per share amounts).
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
|
|
| ||||||||||
|
| 2003 |
| 2002 |
| 2003 |
| 2002 |
| ||||
|
|
|
|
|
| ||||||||
Net loss |
| $ | (2,796 | ) | $ | (4,080 | ) | $ | (6,331 | ) | $ | (7,044 | ) |
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
|
| 0 |
|
| 0 |
|
| (1 | ) |
| (10 | ) |
|
|
|
|
|
| ||||||||
Pro forma net loss |
| $ | (2,796 | ) | $ | (4,080 | ) | $ | (6,332 | ) | $ | (7,054 | ) |
|
|
|
|
|
| ||||||||
Loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic-as reported |
| $ | (0.45 | ) | $ | (0.66 | ) | $ | (1.02 | ) | $ | (1.14 | ) |
|
|
|
|
|
| ||||||||
Basic-pro forma |
| $ | (0.45 | ) | $ | (0.66 | ) | $ | (1.02 | ) | $ | (1.14 | ) |
|
|
|
|
|
| ||||||||
Diluted-as reported |
| $ | (0.45 | ) | $ | (0.66 | ) | $ | (1.02 | ) | $ | (1.14 | ) |
|
|
|
|
|
| ||||||||
Diluted-pro forma |
| $ | (0.45 | ) | $ | (0.66 | ) | $ | (1.02 | ) | $ | (1.14 | ) |
|
|
|
|
|
|
Estimates and Assumptions. 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 reporting period. Significant estimates used by the Company include those related to customer incentives, bad debts, inventories, investments, estimated useful lives for depreciable and amortizable assets, valuation reserves and estimated cash flows in assessing the recoverability of long-lived assets, estimated liabilities for slot club bonus point programs, income taxes, contingencies and litigation. Actual results may differ from estimates.
Reclassifications. Certain reclassifications have been made in the prior year’s unaudited consolidated condensed financial statements to conform to the presentation used in fiscal 2003.
Recently Issued Accounting Standards. In April 2003, the FASB issued SFAS No. 149 (“SFAS No. 149”), Amendments of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends SFAS No. 133 (“SFAS No. 133”), Accounting for Derivative and Instruments and Hedging Activities, and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and or hedging activities under SFAS 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The provisions of this statement that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective
7
Table of Contents
effective dates. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150 (“SFAS No, 150”), Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted the standard on July 1, 2003 and have determined that the adoption does not have a material impact on the Company’s consolidated financial position or results of operations.
3. | Cash and Cash Equivalents |
At June 30, 2003, the Company held cash and cash equivalents of $5.0 million compared to $8.6 million at September 30, 2002. Approximately $1.0 million was held by PHI and was subject to certain restrictions and limitations on its use, including restrictions on its availability for distribution to the Company, by the terms of the agreements entered into in connection with the sale/leaseback transactions in December 2000 relating to the Pioneer. See Note 9
At June 30, 2003 approximately $1.6 million was held in escrow pursuant to the agreements related to the SFHI Asset Sale.
4. | Restricted Cash |
At June 30, 2003, the Company held restricted cash of $13.4 million compared to $13.0 million at September 30, 2002. See Note 9
5. | Other Assets |
J & J Mortgage is owned by LICO, which in turn is wholly-owned by Paul W. Lowden, the President, Chief Executive Officer and majority stockholder of the Company. John W. Delaney, a director of the Company, is the president of J & J Mortgage. Included in other assets at June 30, 2003 is $735,000 of commercial and residential mortgage loans, representing loans originally funded by J & J Mortgage to unaffiliated third parties as well as loans made directly by Archon to J & J Mortgage under a master loan agreement. The loans purchased by the Company were purchased for the principal amount, plus accrued interest, if any. The advances to J & J Mortgage under the master loan arrangement bear interest at the prime rate plus 2%.
Included in other assets at June 30, 2003, is $500,000 receivable from Duke’s compared to $100,000 at September 30, 2002. See Note 7
8
Table of Contents
6. | Comprehensive Loss |
Comprehensive loss is the total of net loss and all other non-stockholder changes in stockholders’ equity. Comprehensive loss for the three and nine months ended June 30, 2003 and 2002 is as follows (in thousands):
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
|
|
| ||||||||||
|
| 2003 |
| 2002 |
| 2003 |
| 2002 |
| ||||
|
|
|
|
|
| ||||||||
Net loss |
| $ | (2,410 | ) | $ | (3,683 | ) | $ | (5,187 | ) | $ | (5,879 | ) |
Unrealized gain on marketable securities |
|
| 728 |
|
| 103 |
|
| 959 |
|
| 413 |
|
|
|
|
|
|
| ||||||||
|
| $ | (1,682 | ) | $ | (3,580 | ) | $ | (4,228 | ) | $ | (5,466 | ) |
|
|
|
|
|
|
7. | Related Parties |
The Company has entered into a Patent Rights and Royalty Agreement with David Lowden, brother of Paul W. Lowden, with respect to certain gaming technology for which David Lowden has been issued a patent. The Company has agreed to pay certain royalty payments with respect to the technology incorporated into gaming devices placed in operation, as well as costs related to maintain the patent. David Lowden has granted the Company an exclusive five-year license expiring in January 2007 in the United States with respect to the technology, which will be automatically renewed for additional two-year terms unless Archon terminates the agreement within thirty days prior to the renewal or the agreement is otherwise earlier terminated in accordance with its terms. The Company also has an understanding with David Lowden that it will pay for the costs of commercial development of the technology. As of September 30, 2002, the Company had expended $245,000 for commercial development of the technology. No further amounts have been expended in the nine months ended June 30, 2003.
In fiscal 2001, the Company purchased for $100,000 Class B member interests in Duke’s-Sparks (“Duke’s”), a Nevada limited liability company that developed Duke’s Casino, a restricted slot operation, restaurant and entertainment facility in Sparks, Nevada. Christopher Lowden, son of Paul W. Lowden, is a limited partner in the company that is the managing member of Duke’s.
On October 8, 2002 the Company entered into a Subordinated Loan Agreement (the “Duke’s Loan Agreement”) with Duke’s. Under the Duke’s Loan Agreement, Duke’s was entitled to borrow up to $1.1 million for construction, equipment, furnishings and other costs related to the completion and opening of Duke’s Casino. The loan, which is secured on a subordinated basis by the real property on which Duke’s is located (the “Duke’s Real Property”) and on a senior basis by non-gaming equipment and certain other personal property, matures on October 8, 2009 and bears interest at an annual rate of 15%, plus additional interest at an annual rate of 10% until such time as the option described in the following sentence is exercised. In connection with the Duke’s Loan Agreement, the Company received an option to acquire 70% of the equity in the entity that owns Duke’s. Duke’s borrowed the entire $1.1 million available under the Duke’s Loan Agreement by December 31, 2002. Furthermore, the Company has advanced Duke’s an additional approximately $333,000 on an unsecured basis, which advances are evidenced by a promissory note payable on demand.
9
Table of Contents
The Company’s advances to Dukes under the Duke’s Loan Agreement are subordinate to a senior loan in the amount of $4.0 million, which is secured on a senior basis by the Duke’s Real Property (the “Duke’s Senior Loan”). Duke’s is in default under both the Duke’s Senior Loan and the Company’s loans to Duke’s pursuant to the Duke’s Loan Agreement and the promissory note. Both the senior lender and the Company recorded notices of default and elections to sell the Duke’s Real Property and provided notice of such recordation to Duke’s and other parties in interest as required by Nevada law. On August 13, 2003, the trustee under the deed of trust with respect to the Duke’s Senior Loan held a foreclosure sale of the property. In the foreclosure sale, the senior lender acquired the Duke’s Real Property in partial satisfaction of the Duke’s Senior Loan, as a result of which the Company’s security interest in the Duke’s Real Property was extinguished. Pursuant to the terms of the Company’s loan agreement with Duke’s, Duke’s is prohibited from making payments on the Company’s loans until the Duke’s Senior Loan is paid in full or the senior lender waives the requirement.
The Company and the senior lender have agreed in principle that the senior lender will sell the Duke’s Real Property to the Company for $3.7 million payable no later than June 1, 2007, subject to increase to $3.8 million if not paid in full by June 1, 2005. The purchase price will be evidenced by a promissory note which will bear interest during the first 36 months of the loan at the rate of 1.75% plus the senior lender’s actual cost of funds (currently the prime rate less 25 basis points) increasing to a rate of 2.5% plus the senior lender’s cost of funds for months 37 through 48. Interest will accrue monthly, commencing as of June 1, 2003, and be payable on a monthly basis. All principal and accrued but unpaid interest will be payable on or before June 1, 2007. The promissory note will be secured by a deed of trust on the Duke’s Real Property. Consummation of the purchase is subject to the execution of a mutually acceptable purchase and sale agreement, promissory note, security agreement and related closing documents no later than September 1, 2003. Additionally, the purchase is subject to approval of the Board of Directors of the Company. Until such time as a final agreement is reached with the senior lender with respect to the purchase of the Duke’s Real Property and the Company acquires the Duke’s Real Property, the Company expects to continue to operate Duke’s on the same terms as provided in the Duke’s-Sparks Lease described below. If the Company and the senior lender are unable to reach agreement and the Company does not acquire the Duke’s Real Property, the Duke’s-Sparks Lease will be voided. As a result of the foreclosure of the Duke’s Real Property and continuing default under the Duke’s Senior Loan and the Company’s loans to Duke’s, the Company has established a reserve in the amount of $900,000 with respect to its loans to Duke’s. In addition, the Company wrote-off its $100,000 initial investment in Duke’s.
On October 4, 2002, a subsidiary of the Company entered into a lease (the “Duke’s-Sparks Lease”) with Duke’s, with respect to the Duke’s Casino. The Duke’s-Sparks Lease provides that it will commence on the first day of the month (the “Commencement Date”) following the month in which the Company’s subsidiary obtained all required gaming regulatory approvals to conduct gaming activities at Duke’s, provided that the Commencement Date will not occur until all the remodeling work being performed by Duke’s at the facility has been substantially completed and the City of Sparks has issued a certificate of occupancy for the facility, and that it will expire on the date which is the earlier of three years after the Commencement Date or the date which is the first day of the month which immediately follows the month in which Duke’s receives the necessary regulatory approvals to operate the casino. The Duke’s Sparks Lease provides for monthly base rent in the amount of $81,216. The required gaming regulatory approvals were obtained by the Company’s subsidiary on January 24, 2003, and the Company began operating Duke’s on February 7, 2003. However, the remodeling of the facility is not substantially complete, so the Company has not paid any rent to Duke’s to date. Until such time as a final agreement is reached with the senior lender with respect to the Company’s purchase of the Duke’s Real Property and the Company acquires the Duke’s Real Property, the senior lender has agreed that the Company to continue to operate Duke’s on the same terms as provided in the Duke’s-Sparks Lease. If the Company and the
10
Table of Contents
senior lender are unable to reach agreement and the Company does not acquire the Duke’s Real Property, the Duke’s-Sparks Lease will be voided. In addition, the Company owns and has installed approximately 190 slot and video poker machines in Duke’s Casino valued at approximately $1.7 million.
See Note 5 for information regarding transactions between the Company and J & J Mortgage.
8. | Federal Income Tax |
The Company recorded a federal income tax benefit of $1.2 million for the quarter ended June 30, 2003, compared to a $1.1 million tax expense for the quarter ended June 30, 2002. The operating losses incurred by the Company through the third quarter of fiscal 2002 were substantially higher than forecasted by management at the beginning of the fiscal year, and exceeded any projected gains or income from transactions expected to occur in the fiscal years ended September 30, 2002 or ending September 30, 2003. As such, the Company reversed the income tax benefit of approximately $1.1 million recorded for the first two quarters of fiscal 2002 in the quarter ended June 30, 2002.
9. | Contingencies |
On December 29, 2000, the Company entered into a series of agreements to transfer, pursuant to Sections 721 and 351 of the Internal Revenue Code of 1986 as amended, the real and personal property, excluding gaming equipment, and intangible assets used in the operation of the Pioneer to a third party (the “Purchaser”) and agreed to lease and license the assets for up to 20 years, during which period the Company will operate the Pioneer (collectively, the “Pioneer Transactions”).
Pursuant to the agreements relating to the Pioneer Transactions, Archon is required to make capital contributions and, in certain circumstances, deposits of cash into a restricted cash account, if PHI’s ratio of fixed charges to operating cash flow is less than 1.00 to 1.00. Additionally, Archon is not entitled to receive the management fee otherwise payable to it if PHI’s ratio of fixed charges to operating cash flow is less than 1.00 to 1.00, and Archon has not received payment of the management fee since April 2001. PHI’s ratio of fixed charges to operating cash flow was 0.60 to 1.00 for the four quarters ended June 30, 2003, the fourth consecutive quarter in which the ratio was less than 1.00 to 1.00. As a result, the Company will make the required deposit to the restricted cash account in the amount of $489,000. PHI’s ratio of fixed charges to operating cash flow for the four quarters ended June 30, 2002, September 30, 2002, December 31, 2002 and March 31, 2003 were 0.92 to 1.00, 0.87 to 1.00, 0.81 to 1.00 and 0.55 to 1.00, respectively. As a result, Archon made capital contributions to PHI in the amounts of approximately $375,000, $275,000, $314,000 and $1,372,000 with respect to the four-quarter periods ended June 30, September 30, December 31, 2002 and March 31, 2003, respectively. Additionally, it deposited $484,000 and $487,000 in the restricted cash account for the four quarters ended December 31, 2002 and March 31, 2003, respectively. The Company expects that future operating results at the Pioneer will result in fixed charge coverage ratios of less than 1.00 to 1.00, so that the Company will be required to continue to make capital contributions and significant deposits to restricted cash accounts for the foreseeable future.
Furthermore, Archon would have been required to make capital contributions aggregating approximately $400,000 as a result of PHI’s fixed charge ratios for the four quarters ended December 31, 2001 and March 31, 2002, in which the ratio of fixed charges to operating cash flow was 0.93 to 1.00, and 0.92 to 1.00, respectively. However, in May 2002, the Company completed the purchase, for approximately $2.1 million, of leased gaming equipment with $1.9 million of cash from
11
Table of Contents
the restricted cash account and cash from operations. The elimination of the rent payments reduced fixed charges in periods subsequent to the repurchase date. Giving effect to the gaming equipment purchase as if it had occurred at the beginning of the relevant four-quarter period, on a pro forma basis PHI’s ratio of fixed charges to operating cash flow for the four quarters ended December 31, 2001 and March 31, 2002 would have been 1.04 to 1.00 and 1.05 to 1.00, respectively. Archon advised the Purchaser that it was not making any capital contributions to PHI for the four-quarter periods ended December 31, 2001 and March 31, 2002 based on the pro forma fixed charge ratios giving effect to the May 2002 purchase of leased gaming equipment. The Purchaser has not advised the Company whether it agrees that the Company has the right to calculate the ratios on a pro forma basis. If the Purchaser disagrees, the Company will be required to make capital contributions with respect to the four-quarter periods ended December 31, 2001 and March 31, 2002 and will be required to deposit additional cash to the restricted cash account.
10. | Supplemental Statement of Cash Flows Information |
Supplemental statement of cash flows information for the nine month periods ended June 30, 2003 and 2002 is presented below:
|
| Nine Months Ended June 30, |
| ||||
|
|
| |||||
|
| 2003 |
| 2002 |
| ||
|
|
|
| ||||
|
| (amounts in thousands) |
| ||||
Operating activities: |
|
|
|
|
|
|
|
Cash paid during the period for interest |
| $ | 13,010 |
| $ | 11,438 |
|
|
|
|
| ||||
Cash paid during the period for income taxes |
| $ | 0 |
| $ | 0 |
|
|
|
|
| ||||
Investing and financing activities: |
|
|
|
|
|
|
|
Long-term debt incurred in connection with the acquisition of machinery and equipment |
| $ |
|
| $ |
|
|
|
|
|
| ||||
Negative amortization of obligation under lease |
| $ | 939 |
| $ | 824 |
|
|
|
|
| ||||
Unrealized gain on marketable securities |
| $ | 959 |
| $ | 413 |
|
|
|
|
|
12
Table of Contents
11. | Segment Information |
The Company’s operations are in the hotel/casino industry and investment properties. The Company’s hotel/casino operations are conducted at the Pioneer in Laughlin, Nevada. The Company owns investment properties in Dorchester, Massachusetts and Gaithersburg, Maryland. “Other and Eliminations” below includes financial information for the Company’s corporate operations, Archon Sparks Management Company, adjusted to reflect eliminations upon consolidation.
Set forth below is the financial information for the segments in which the Company operates for the three-month and nine-month periods ended June 30, 2003 and 2002:
|
| Three Months Ended June 30, |
| ||||
|
|
| |||||
|
| 2003 |
| 2002 |
| ||
|
|
|
| ||||
|
| (dollars in thousands) |
| ||||
Pioneer Hotel: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 7,910 |
| $ | 8,176 |
|
|
|
|
| ||||
Operating loss |
| $ | (171 | ) | $ | (472 | ) |
Depreciation and amortization |
|
| 614 |
|
| 507 |
|
Interest income |
|
| 6 |
|
| 6 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | 449 |
| $ | 41 |
|
|
|
|
| ||||
Interest expense |
| $ | 1,229 |
| $ | 1,190 |
|
|
|
|
| ||||
Capital expenditures |
| $ | 218 |
| $ | 2,335 |
|
|
|
|
| ||||
Investment Properties: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 3,101 |
| $ | 3,101 |
|
|
|
|
| ||||
Operating income |
| $ | 2,250 |
| $ | 2,250 |
|
Depreciation and amortization |
|
| 851 |
|
| 851 |
|
Interest income |
|
| 0 |
|
| 0 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | 3,101 |
| $ | 3,101 |
|
|
|
|
| ||||
Interest expense |
| $ | 2,619 |
| $ | 2,831 |
|
|
|
|
| ||||
Capital expenditures |
| $ | 0 |
| $ | 0 |
|
|
|
|
| ||||
Other and Eliminations: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 471 |
| $ | 106 |
|
|
|
|
| ||||
Operating loss |
| $ | (2,252 | ) | $ | (706 | ) |
Depreciation and amortization |
|
| 260 |
|
| 85 |
|
Interest income |
|
| 397 |
|
| 354 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | (1,595 | ) | $ | (267 | ) |
|
|
|
| ||||
Interest expense |
| $ | 33 |
| $ | (38 | ) |
|
|
|
| ||||
Capital expenditures |
| $ | 2,323 |
| $ | 87 |
|
|
|
|
| ||||
Total: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 11,482 |
| $ | 11,383 |
|
|
|
|
|
13
Table of Contents
|
| Three Months Ended June 30, |
| ||||
|
|
| |||||
|
| 2003 |
| 2002 |
| ||
|
|
|
| ||||
|
| (dollars in thousands) |
| ||||
Operating income (loss) |
| $ | (173 | ) | $ | 1,072 |
|
Depreciation and amortization |
|
| 1,725 |
|
| 1,443 |
|
Interest income |
|
| 403 |
|
| 360 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | 1,955 |
| $ | 2,875 |
|
|
|
|
| ||||
Interest expense |
| $ | 3,881 |
| $ | 3,983 |
|
|
|
|
| ||||
Capital expenditures |
| $ | 2,541 |
| $ | 2,422 |
|
|
|
|
|
______________
(1) | EBITDA represents earnings before interest, taxes, depreciation and amortization. The Company’s definition of EBITDA may not be the same as that of similarly captioned measures used by other companies. EBITDA is presented solely as a supplemental disclosure because management believes that it is (i) a widely used measure of operating performance in the gaming industry and (ii) a principal basis of valuation of gaming companies by certain analysts and investors. Management uses segment-level EBITDA as the primary measure of the Company’s business segments’ performance. EBITDA should not be construed as a substitute for operating income or a better indicator of liquidity than cash flow from operating, investing and financing activities, which are determined in accordance with generally accepted accounting principles. |
|
| Nine Months Ended June 30, |
| ||||
|
|
| |||||
|
| 2003 |
| 2002 |
| ||
|
|
|
| ||||
|
| (dollars in thousands) |
| ||||
Pioneer Hotel: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 25,207 |
| $ | 27,933 |
|
|
|
|
| ||||
Operating income (loss) |
| $ | (399 | ) | $ | 901 |
|
Depreciation and amortization |
|
| 1,867 |
|
| 1,482 |
|
Interest income |
|
| 16 |
|
| 11 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | 1,484 |
| $ | 2,394 |
|
|
|
|
| ||||
Interest expense |
| $ | 3,659 |
| $ | 3,562 |
|
|
|
|
| ||||
Capital expenditures |
| $ | 443 |
| $ | 3,699 |
|
|
|
|
| ||||
Identifiable assets (2) |
| $ | 35,267 |
| $ | 37,908 |
|
|
|
|
| ||||
Investment Properties: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 9,302 |
| $ | 9,302 |
|
|
|
|
| ||||
Operating income |
| $ | 6,749 |
| $ | 6,459 |
|
Depreciation and amortization |
|
| 2,553 |
|
| 2,842 |
|
Interest income |
|
| 0 |
|
| 0 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | 9,302 |
| $ | 9,301 |
|
|
|
|
| ||||
Interest expense |
| $ | 8,332 |
| $ | 8,731 |
|
|
|
|
| ||||
Capital expenditures |
| $ | 0 |
| $ | 0 |
|
|
|
|
| ||||
Identifiable assets (2) |
| $ | 141,992 |
| $ | 144,736 |
|
|
|
|
|
14
Table of Contents
|
| Nine Months Ended June 30, |
| ||||
|
|
| |||||
|
| 2003 |
| 2002 |
| ||
|
|
|
| ||||
|
| (dollars in thousands) |
| ||||
Other and Eliminations: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 1,348 |
| $ | 581 |
|
|
|
|
| ||||
Operating loss |
| $ | (3,336 | ) | $ | (1,985 | ) |
Depreciation and amortization |
|
| 402 |
|
| 263 |
|
Interest income |
|
| 1,060 |
|
| 919 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | (1,874 | ) | $ | (803 | ) |
|
|
|
| ||||
Interest expense |
| $ | (42 | ) | $ | (108 | ) |
|
|
|
| ||||
Capital expenditures |
| $ | 2,323 |
| $ | 312 |
|
|
|
|
| ||||
Identifiable assets (2) |
| $ | 56,702 |
| $ | 58,603 |
|
|
|
|
| ||||
Total: |
|
|
|
|
|
|
|
Operating revenues |
| $ | 35,857 |
| $ | 37,816 |
|
|
|
|
| ||||
Operating income |
| $ | 3,014 |
| $ | 5,375 |
|
Depreciation and amortization |
|
| 4,822 |
|
| 4,587 |
|
Interest income |
|
| 1,076 |
|
| 930 |
|
|
|
|
| ||||
EBITDA (1) |
| $ | 8,912 |
| $ | 10,892 |
|
|
|
|
| ||||
Interest expense |
| $ | 11,949 |
| $ | 12,185 |
|
|
|
|
| ||||
Capital expenditures |
| $ | 2,766 |
| $ | 4,011 |
|
|
|
|
| ||||
Identifiable assets (2) |
| $ | 233,961 |
| $ | 241,247 |
|
|
|
|
|
______________
(1) | EBITDA represents earnings before interest, taxes, depreciation and amortization. The Company’s definition of EBITDA may not be the same as that of similarly captioned measures used by other companies. EBITDA is presented solely as a supplemental disclosure because management believes that it is (i) a widely used measure of operating performance in the gaming industry and (ii) a principal basis of valuation of gaming companies by certain analysts and investors. Management uses segment-level EBITDA as the primary measure of the Company’s business segments’ performance. EBITDA should not be construed as a substitute for operating income or a better indicator of liquidity than cash flow from operating, investing and financing activities, which are determined in accordance with generally accepted accounting principles. |
(2) | Identifiable assets represent total assets less elimination for intercompany items. |
15
Table of Contents
ARCHON CORPORATION
Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
General
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses Archon’s consolidated condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to customer incentives, bad debts, inventories, investments, estimated useful lives for depreciable and amortizable assets, valuation reserves and estimated cash flows in assessing the recoverability of long-lived assets, estimated liabilities for slot club bonus point programs, income taxes, contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies, among others, affects its more significant judgments and estimates used in the preparation of its consolidated financial statements:
Allowance for Doubtful Accounts. We allow for an estimated amount of receivables that may not be collected. We estimate our allowance for doubtful accounts using a specific formula applied to aged receivables as well as a specific review of large balances. Historical experience is considered, as are customer relationships, in determining specific reserves.
Long-Lived Assets. We have a significant investment in long-lived property and equipment. We estimate that the undiscounted future cash flows expected to result from the use of these assets exceeds the current carrying value of these assets. Any adverse change in the estimate of these undiscounted future cash flows could necessitate an impairment charge that would adversely affect operating results. We estimate useful lives for our assets based on historical experience, estimates of assets’ commercial lives, and the likelihood of technological obsolescence. Should the actual useful life of a class of assets differ from the estimated useful life, we would record an impairment charge. We review useful lives and obsolescence and we assess commercial viability of these assets periodically.
Income Taxes. The Company has recorded a valuation allowance to reduce its deferred tax assets to the balance the Company believes can be recovered based on forecasted taxable income. Realization of the net deferred tax assets is dependent on the Company’s ability to generate profits from operations or from the sale of long-lived assets. There can be no assurance that the Company will generate profits from operations or sell those assets or will generate profits from sales if they were to occur in the future. In the event the Company does generate profits from sales of long-lived assets in the future, an adjustment to the valuation allowance would increase income in the period in which the profit is realized.
16
Table of Contents
Results of Operations – Nine Months Ended June 30, 2003 and 2002
Consolidated
Net Operating Revenues. Consolidated net operating revenues for the nine months ended June 30, 2003 were $35.9 million, a $1.9 million, or 5.2%, decrease from $37.8 million for the nine months ended June 30, 2002. Income from the investment properties was $9.3 million in each of the nine months ended June 30, 2003 and 2002. Revenues decreased $2.7 million to $25.2 million at the Pioneer Hotel and Gambling Hall (the “Pioneer”) for the nine months ended June 30, 2003 compared to $27.9 million for the nine months ended June 30, 2002. Archon Sparks Management Company (“ASMC”), which began operating Duke’s Casino in February 2003, had revenues of $800,000.
Operating Expenses. Total operating expenses increased $400,000, or 1.2%, to $32.8 million for the nine months ended June 30, 2003 from $32.4 million for the nine months ended June 30, 2002. Total operating expenses as a percentage of revenue increased to 91.6% in the current year period from 85.8% in the prior year period. Operating expenses decreased $1.4 million, or 5.3%, at the Pioneer, by $300,000 at the investment properties and by $200,000 at corporate. The decrease in operating expenses at the investment properties was due to an adjustment to depreciation and amortization expenses in the prior year period. The decrease at corporate was due to development costs associated with the development of certain gaming technology incurred in the prior year period. ASMC had operating expenses of $1.3 million. The Company recorded a $1.0 million reserve for receivable and investment in the current period.
Operating Income. Consolidated operating income for the nine months ended June 30, 2003 was $3.0 million, a $2.4 million decrease from $5.4 million for the nine months ended June 30, 2002. Operating income decreased $1.3 million at the Pioneer and increased $300,000 at the investment properties. ASMC had an operating loss of $600,000.
Interest Expense. Consolidated interest expense for the nine months ended June 30, 2003 was approximately $12.0 million, a $200,000 decrease compared to $12.2 million in the nine months ended June 30, 2002. Interest expense from the investment properties decreased $400,000 due to a reduction through principal payments of outstanding debt. Interest expense increased $100,000 at the Pioneer due to increase in outstanding debt through negative amortization of debt. ASMC had $100,000 in interest expense.
Interest Income. Interest income for the nine months ended June 30, 2003, was $1.1 million, an increase of $200,000 from $900,000 for the nine months ended June 30, 2002 due to a higher return on investments.
Loss Before Income Tax. Consolidated loss before income tax for the nine months ended June 30, 2003 was $7.9 million, a $2.0 million increase compared to a loss of $5.9 million for the nine months ended June 30, 2002.
Federal Income Tax. The Company recorded a federal income tax benefit of $2.7 million for the nine months ended June 30, 2003. The Company recorded no federal income tax benefit in the prior nine month period. The operating losses incurred by the Company through the third quarter of fiscal 2002 were substantially higher than forecasted by management at the beginning of the fiscal year, and exceeded any projected gains or income from transactions expected to occur in that year. As such, the Company reversed the income tax benefit of approximately $1.1 million recorded for the first two quarters of fiscal 2002 in the quarter ended June 30, 2002.
Preferred Share Dividends. Dividends of approximately $1.1 million and $1.2 million for the nine month periods ended June 30, 2003 and 2002, respectively, accrued on the preferred stock. The dividend rate increased to 15.5% effective April 1, 2003 from 15.0% beginning on October 1, 2002. The dividend rate increases by 50 basis points on each October 1 and April 1, up to a maximum
17
Table of Contents
dividend rate of 16%, in accordance with the terms of the Certificate of Designations of the preferred stock.
Net Loss. Consolidated net loss attributable to common shares was $6.3 million, or $1.02 per common share, for the nine months ended June 30, 2003 compared to a net loss attributable to common shares of $7.0 million, or $1.14 per common share, for the nine months ended June 30, 2002.
Pioneer
Net Operating Revenues. Revenues at the Pioneer decreased $2.7 million, or 9.8%, to $25.2 million in the nine months ended June 30, 2003 from $27.9 million in the nine months ended June 30, 2002 due to a decrease in the number of casino patrons, which management believes is due primarily to expansion of Native American gaming facilities in Southern California, Arizona and New Mexico and a loss of market share in the Laughlin market.
Casino revenues decreased $2.4 million, or 10.3%, to $21.0 million in the nine months ended June 30, 2003 from $23.4 million in the nine months ended June 30, 2002. Slot and video poker revenues decreased $2.2 million, or 10.9%, to $18.1 million in the nine months ended June 30, 2003 from $20.3 million in the nine months ended June 30, 2002. Management believes that the decrease results from fewer casino patrons. Other gaming revenues, including table games, decreased $200,000, or 6.6%, to $2.9 million in the nine months ended June 30, 2003 from $3.1 million in the nine months ended June 30, 2002. Casino promotional allowances decreased $400,000, or 6.5%, to $5.0 million in the nine months ended June 30, 2003 from $5.4 million in the nine months ended June 30, 2002.
Hotel revenues were relatively unchanged at $2.0 million for the nine months ended June 30, 2003 and 2002, as an increase in occupancy rate to 76.5% from 75.0% was offset by a decrease in the average daily room rate. Food and beverage revenues decreased $500,000, or 8.3% to $5.6 million for the nine months ended June 30, 2003 compared to $6.1 million for the nine months ended June 30, 2002, due to the decrease in the number of casino patrons. Other revenues decreased $200,000, or 8.9%, to $1.6 million in the nine months ended June 30, 2003 from $1.8 million in the nine months ended June 30, 2002, due to decreased sales in the Pioneer’s retail outlets caused by fewer patrons and competition from retail sales in other casinos in Laughlin.
Operating Expenses. Operating expenses decreased $1.4 million, or 5.3%, to $25.6 million in the nine months ended June 30, 2003 from $27.0 million in the nine months ended June 30, 2002. Operating expenses as a percentage of revenue increased to 101.6% in the current year period from 96.8% in the prior year period.
Casino expenses decreased $600,000, or 4.6%, to $11.9 million in the nine month period ended June 30, 2003 from $12.5 million in the nine month period ended June 30, 2002, related to the decrease in casino promotional allowances. Casino expenses as a percentage of casino revenues increased to 56.5% in the current year period from 53.2% in the prior year period.
Hotel expenses were unchanged at $600,000 in the nine months ended June 30, 2003 and 2002. Food and beverage expenses decreased $400,000, or 11.4%, to $2.8 million in the nine months ended June 30, 2003 from $3.2 million in the nine months ended June 30, 2002 due to the decrease in food and beverage revenues. Food and beverage expenses as a percentage of food and beverage revenues decreased to 50.1% in the current year period from 51.9% in the prior year period. Other expenses were unchanged at $1.5 million despite the decrease in revenues due to an increase in the cost of sales in the retail outlets for the nine months ended June 30, 2003 and 2002. Other expenses as a percentage of other revenues increased to 89.7% in the current year period from 86.5% in the prior year period.
Selling, general and administrative expenses decreased $200,000, or 3.7%, to $3.9 million in the nine months ended June 30, 2003 from $4.1 million in the nine months ended June 30, 2002 due to
18
Table of Contents
decreased payroll and advertising expenses. Selling, general and administrative expenses as a percentage of revenues increased to 15.6% in the current year period from 14.7% in the prior year period. Utilities and property expenses decreased $600,000, or 15.8%, to $3.1 million in the nine months ended June 30, 2003 from $3.7 million in the nine months ended June 30, 2002, due to decreased rent expense resulting from the purchase in May 2002 of gaming equipment that was leased in the prior year period. Utilities and property expenses as a percentage of revenues decreased to 12.3% in the current year period from 13.2% in the prior year period. Depreciation and amortization expenses increased $400,000, or 26.0%, to $1.9 million in the nine months ended June 30, 2003 from $1.5 million in the nine months ended June 30, 2002, due to the purchase of gaming equipment in May 2002.
Results of Operations – Three Months Ended June 30, 2003 and 2002
Consolidated
Net Operating Revenues. Consolidated net operating revenues for the quarter ended June 30, 2003 were $11.5 million, a $100,000, or 0.9%, increase from $11.4 million for the quarter ended June 30, 2002. Income from the investment properties was $3.1 million in each of the quarters ended June 30, 2003 and 2002. Revenues decreased by $300,000, or 3.3%, at the Pioneer and by $100,000 at SFHI. ASMC had revenues of $500,000.
Operating Expenses. Total operating expenses increased $1.4 million, or 13.0%, to $11.7 million for the quarter ended June 30, 2003 from $10.3 million for the quarter ended June 30, 2002. Total operating expenses as a percentage of revenue increased to 101.5% in the quarter ended June 30, 2003 from 90.6% from the quarter ended June 30, 2002. Operating expenses decreased $600,000, or 6.6%, at the Pioneer and were unchanged at the investment properties and at corporate. ASMC had operating expenses of $900,000. The Company recorded a $1.0 million reserve for receivable and investment in the current period.
Operating Income (Loss). Consolidated operating loss for the quarter ended June 30, 2003 was $200,000, a $1.3 million, or 116.2% a decrease from $1.1 million consolidated operating income for the quarter ended June 30, 2002. Operating loss decreased $300,000 at the Pioneer and operating income decreased $100,000 at SFHI. ASMC had an operating loss of $400,000.
Interest Expense. Consolidated interest expense for the quarter ended June 30, 2003 was $3.9 million, a $100,000 decrease compared to $4.0 million in the quarter ended June 30, 2002. Interest expense from the investment properties decreased $200,000 due to reduction through principal payments of outstanding debt. ASMC had $100,000 in interest expense.
Interest Income. Interest income was $400,000 for the quarters ended June 30, 2003 and 2002.
Loss Before Income Tax. Consolidated loss before income tax for the quarter ended June 30, 2003 was $3.7 million, a $1.1 million increase compared to a loss of $2.6 million for the quarter ended June 30, 2002.
Federal Income Tax. The Company recorded a federal income tax benefit of $1.2 million for the quarter ended June 30, 2003, compared to a $1.1 million tax expense for the quarter ended June 30, 2002. The operating losses incurred by the Company through the third quarter of fiscal 2002 were substantially higher than forecasted by management at the beginning of the fiscal year, and exceeded any projected gains or income from transactions expected to occur in the fiscal years ended September 30, 2002 or ending September 30, 2003. As such, the Company reversed the income tax benefit of approximately $1.1 million recorded for the first two quarters of fiscal 2002 in the quarter ended June 30, 2002.
19
Table of Contents
Preferred Share Dividends. Dividends of approximately $400,000 for each of the quarters ended June 30, 2003 and 2002 accrued on the preferred stock. The dividend rate was 15.5% in the 2003 quarter compared to 14.5% in the 2002 quarter.
Net Loss. Consolidated net loss attributable to common shares was $2.8 million, or $0.45, per common share, for the quarter ended June 30, 2003, compared to a net loss attributable to common shares of $4.1 million, or $0.66, per common share for the quarter ended June 30, 2002.
Pioneer
Net Operating Revenues. Revenues at the Pioneer decreased $300,000, or 3.3%, to $7.9 million in the quarter ended June 30, 2003 from $8.2 million in the quarter ended June 30, 2002. Management believes that the decrease resulted from lower average amounts spent on gaming by casino patrons, even though the number of patrons did not decrease.
Casino revenues increased $100,000, or 1.5%, to $6.4 million in the quarter ended June 30, 2003 from $6.3 million in the quarter ended June 30, 2002. Slot and video poker revenues increased $100,000, or 2.0%, to $5.5 million in the quarter ended June 30, 2003 from $5.4 million in the quarter ended June 30, 2002 despite a 10.5% decrease in slot and video poker handle, due to a 0.6% increase in slot and video poker hold. The increase in slot hold is due to a change in the slot machine mix. Other gaming revenues, including table games, were unchanged at $900,000 for the quarters ended June 30, 2003 and 2002. Casino promotional allowances increased $300,000, or 23.1%, to $1.8 million in the quarter ended June 30, 2003 from $1.5 million in the quarter ended June 30, 2002 due to changes in promotional programs implemented to recapture market share.
Hotel revenues were unchanged at $800,000 for the quarters ended June 30, 2003 and June 30, 2002, as an increase in occupancy rate to 80.0% from 77.5% was offset by a decrease in the average daily room rate. Food and beverage revenues were relatively unchanged at $2.0 million in the quarter ended June 30, 2003 compared to $1.9 million in the quarter ended June 30, 2002. Food promotions have increased the number of customers at a lower average food cover. Other revenues decreased $100,000, or 11.9%, to $500,000 in the quarter ended June 30, 2003 from $600,000 in the quarter ended June 30, 2002 due to decreased sales in the Pioneer’s retail outlets caused by competition from retail sales in other casinos in Laughlin.
Operating Expenses. Operating expenses decreased $600,000, or 6.6%, to $8.1 million in the quarter ended June 30, 2003 from $8.7 million in the quarter ended June 30, 2002. Operating expenses as a percentage of revenue decreased to 102.2% in the current year quarter from 105.8% in the prior year quarter.
Casino expenses decreased $100,000, or 2.7%, to $3.7 million in the quarter ended June 30, 2003 from $3.8 million in the quarter ended June 30, 2002. Reductions in payroll expenses were partially offset by the increase in promotional allowances. Casino expenses as a percentage of casino revenues decreased to 57.1% in the current year quarter from 59.5% in the prior year quarter.
Hotel expenses were unchanged at $200,000 in the quarters ended June 30, 2003 and 2002. Food and beverage expenses decreased $100,000, or 13.2%, to $1.0 million in the quarter ended June 30, 2003 from $1.1 million in the quarter ended June 30, 2002. Reductions in payroll expenses were partially offset by an increase in the cost of food sales. The increase in the cost of sales was the result of food promotions that offered a better quality product at a lower price. Food and beverage expenses as a percentage of food and beverage revenues decreased to 48.7% in the current year quarter from 57.4% in the prior year quarter. Other expenses decreased $100,000, or 16.7%, to $400,000 for the quarter ended June 30, 2003 compared to $500,000 for the quarter ended June 30, 2002 due to the decrease in other revenues. Other expenses as a percentage of other revenues decreased to 76.4% in the current year quarter from 80.8% in the prior year quarter.
20
Table of Contents
Selling, general and administrative expenses decreased $100,000, or 9.0%, to $1.2 million in the quarter ended June 30, 2003 from $1.3 million in the quarter ended June 30, 2002 due to decreased payroll and advertising expenses. Selling, general and administrative expenses as a percentage of revenues decreased to 15.5% in the current year quarter from 16.5% in the prior year quarter. Utilities and property expenses decreased $200,000, or 16.4%, to $1.0 million in the quarter ended June 30, 2003 from $1.2 million in the quarter ended June 30, 2002, due to decreased rent expense resulting from the purchase in May 2002 of gaming equipment that was leased in the prior year quarter. Utilities and property expenses as a percentage of revenues decreased to 12.7% in the current year quarter from 14.7% in the prior year quarter. Depreciation and amortization expenses increased $100,000, or 21.0%, to $600,000 in the quarter ended June 30, 2003 from $500,000 in the quarter ended June 30, 2002, due to the purchase of gaming equipment in May 2002.
Liquidity and Capital Resources; Trends and Factors Relevant to Future Operations
Contractual Obligations and Commitments: The following table summarizes the Company’s fiscal year contractual obligations and commitments as of June 30, 2003 (for the three-month period ending September 30, 2003 and for the fiscal years ending September 30, 2004, 2005, 2006, 2007, 2008 and 2009 and thereafter).
|
| Payments Due By Periods |
| |||||||||||||||||||||||
|
|
| ||||||||||||||||||||||||
|
| 2003 |
| 2004 |
| 2005 |
| 2006 |
| 2007 |
| 2008 |
| 2009 and |
| Total |
| |||||||||
|
|
|
|
|
|
|
|
| ||||||||||||||||||
|
| (dollars in thousands) |
| |||||||||||||||||||||||
Non-recourse debt: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Gaithersburg |
| $ | 320 |
| $ | 1,411 |
| $ | 1,658 |
| $ | 1,915 |
| $ | 2,195 | $ | 2,490 |
| $ | 43,130 |
| $ | 53,119 |
| ||
Sovereign |
|
| 0 |
|
| 5,003 |
|
| 28,400 |
|
| 0 |
|
| 0 | 0 |
|
| 31,199 |
|
| 64,602 |
| |||
Obligations under lease: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Pioneer Hotel Inc. |
|
| 853 |
|
| 3,902 |
|
| 4,155 |
|
| 4,280 |
|
| 4,408 | 4,907 |
|
| 87,583 |
|
| 110,088 |
| |||
Long-term debt: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Building |
|
| 14 |
|
| 61 |
|
| 70 |
|
| 80 |
|
| 14 | 0 |
|
| 0 |
|
| 239 |
| |||
Other |
|
| 256 |
|
| 607 |
|
| 575 |
|
| 334 |
|
| 0 | 0 |
|
| 0 |
|
| 1,772 |
| |||
Operating leases: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Ground lease |
|
| 200 |
|
| 792 |
|
| 792 |
|
| 792 |
|
| 792 | 792 |
|
| 55,664 |
|
| 59,824 |
| |||
Corporate offices |
|
| 36 |
|
| 127 |
|
| 108 |
|
| 54 |
|
| 0 | 0 |
|
| 0 |
|
| 325 |
| |||
|
|
|
|
|
|
|
| |||||||||||||||||||
|
| $ | 1,679 |
| $ | 11,903 |
| $ | 35,758 |
| $ | 7,455 |
| $ | 7,409 | $ | 8,189 |
| $ | 217,576 |
| $ | 289,969 |
| ||
|
|
|
|
|
|
|
|
|
Our ability to service our contractual obligations and commitments will be dependent on the future performance of the Pioneer, which will be affected by, among other things, prevailing economic conditions and financial, business and other factors, including competitive pressure from the expansion of Native American gaming facilities in the southwest United States, certain of which are beyond our control. In addition, we will be dependent on the continued ability of the tenants in the investment properties in Gaithersburg, Maryland and Dorchester, Massachusetts to make payments pursuant to the leases with the Company. The payments under the leases are contractually committed to be used to make payments on the Company’s non-recourse debt obligations related to the properties.
21
Table of Contents
As of June 30, 2003, the Company held cash and cash equivalents of $5.0 million compared to $8.6 million at September 30, 2002. Approximately $1.0 million was held by PHI and was subject to certain restrictions and limitations on its use, including restrictions on its availability for distribution to the Company, by the terms of the agreements entered into in connection with the sale/leaseback transactions in December 2000 relating to the Pioneer. Approximately $1.6 million at June 30, 2003 was held in escrow pursuant to the agreements related to the sale of the Santa Fe assets. In addition, the Company had $11.8 million in investment in marketable securities at June 30, 2003. Management believes that the Company will have sufficient available cash and cash resources to meet its cash requirements through the twelve month period ending June 30, 2004.
Cash Flow from Operating Activities. The Company’s cash provided by operations was $2.6 million for the nine months ended June 30, 2003 compared to $1.8 million for same period in the prior year. In the 2003 period, cash was provided by operations of $600,000, accounts receivable, net $3.0 million, and accrued and other liabilities $3.7 million and cash was used in deferred income tax $2.7 million, other assets $1.5 million and interest payable $2.0 million. In the 2002 period, cash was provided by accounts receivable, net $2.8 million and accrued and other liabilities $3.4 million and was used in operations $500,000, other assets $1.7 million and interest payable $2.2 million.
Cash Flow from Investing Activities. Cash used in investing activities was $100,000 during the nine months ended June 30, 2003, compared to $3.6 million during the nine months ended June 30, 2002. In the 2003 period, capital expenditures were $1.0 million while marketable securities decreased a net of $1.4 million, due to the timing of securities trades around June 30, 2003. In the 2002 period, the Company invested an additional $2.8 million, net, in marketable securities and used approximately $3.9 million in capital expenditures. These uses of cash were funded in part by a decrease of $3.1 million, net of interest income, in the restricted cash accounts.
Cash Flow from Financing Activities. Cash used in financing activities was $6.1 million in the nine month period ended June 30, 2003 compared to $4.9 million during the same period in 2002. In the nine months ended June 30, 2003 and 2002, the Company repaid $5.5 million and $4.9 million of debt, respectively. In the 2003 period, the Company also used $600,000 to acquire shares of its preferred stock.
The Company’s primary source of operating cash is from Pioneer operations and from interest income on available cash and cash equivalents and investments in marketable securities. Rental income from the Company’s two investment properties is contractually committed to reducing the non-recourse indebtedness issued or assumed in connection with the acquisition of the investment properties. Under the two leases, the tenants are responsible for substantially all obligations related to the property. Sahara Las Vegas Corp. (“SLVC”), an indirect wholly-owned subsidiary of the Company, owns an approximately 27-acre parcel of real property on Las Vegas Boulevard South which is subject to a lease with a water theme park operator. SLVC generates minimal cash from the lease agreement after payment of property costs.
The Company’s primary use of funds is for operations of Archon, which includes costs of executive and administrative personnel, administrative functions, costs to explore development opportunities and required capital contributions to Pioneer and deposits of cash in the Pioneer restricted cash accounts pursuant to the terms of the agreements related to the Pioneer transactions (see “Pioneer”). Additionally, the Company has the option to acquire the Pioneer during the period from December 1, 2003 to December 31, 2007. If the Company elects to exercise the option, it will need to obtain financing to fund the purchase. No assurance can be given that it will be successful in arranging any financing.
22
Table of Contents
Pioneer
Pioneer’s principal uses of cash are for payments of obligations under lease, rent, capital expenditures to maintain the facility and, to the extent permitted to be paid, the management fee payable to the Company. The Company has implemented changes in personnel, promotional programs and slot equipment to address the decreases in revenues and operating income. One of management’s main focus is to recapture market share that has been lost in the Laughlin market. Additionally, capital improvements to the Pioneer’s food and beverage and other retail outlets are underway. The capital expenditures are expected to total approximately $700,000 and are being funded with cash from Pioneer’s restricted cash accounts.
Payments of obligations under lease were $900,000 for the three months ended June 30, 2003 and 2002 and $2.6 million for the nine months ended June 30, 2003 and 2002. Rent expense was $200,000 and $300,000 in the three months ended June 30, 2003 and 2002, respectively, and $600,000 and $1.1 million in the nine months ended June 30, 2003 and 2002, respectively. Rent expense decreased as the result of the purchase in May 2002 of gaming equipment previously under lease. Capital expenditures are expected to be funded primarily from the restricted cash account.
On December 29, 2000, the Company entered into a series of agreements to transfer, pursuant to Sections 721 and 351 of the Internal Revenue Code of 1986 as amended, the real and personal property, excluding gaming equipment, and intangible assets used in the operation of the Pioneer to a third party (the “Purchaser”) and agreed to lease and license the assets for up to 20 years, during which period the Company will operate the Pioneer (collectively, the “Pioneer Transactions”). The consideration for the Pioneer Transactions consisted of the assumption and immediate repayment by the Purchaser of $32.5 million of debt owed by Pioneer Hotel Inc. (“PHI”) to SFHI Inc. (“SFHI”) and preferred stock of the Purchaser having a $1.0 million liquidation preference.
Archon and SFHI guaranteed the payments under the lease and license agreements and agreed to certain covenants, including restrictions on the payment of management fees, competing in the Laughlin, Nevada area and payment of dividends with respect to the Archon preferred stock. In addition, Archon agreed to maintain consolidated liquidity (as defined in the agreements relating to the Pioneer Transactions) of not less than $25.0 million. At June 30, 2003, Archon’s consolidated liquidity was $70.0 million. Archon has agreed to forgo all or a portion of the management fees payable by PHI if PHI’s ratio of operating cash flow to fixed charges falls below 1.20 to 1.00. Further, Archon has agreed to contribute capital to PHI and in certain events to deposit cash in restricted cash accounts in the event PHI’s ratio of fixed charges to operating cash flow falls below 1.00 to 1.00 during any rolling four-quarter period, calculated on a quarterly basis.
Specifically, if the ratio of fixed charges to operating cash flow is less than 1.00 to 1.00 for any four-quarter period ending on or before December 31, 2003, Archon is obligated to contribute capital to PHI in the amount of the deficiency and, if the fixed charge coverage ratio is less than 1.00 to 1.00 for three consecutive quarters during that period, to deposit additional cash to restricted cash accounts based upon a specified percentage of the stipulated loss value set forth in the lease, with payments ranging from $500,000 for the quarter ended June 30, 2003 to $2,000,000 for the quarter ending December 31, 2003, with significant increases thereafter. With respect to four-quarter periods ending after December 31, 2003, if the fixed charge coverage ratio requirement is not met, Archon will be required to make a capital contribution in the amount of the deficiency and an additional cash payment to the restricted cash account based upon a specified percentage of the stipulated loss value set forth in the lease. Notwithstanding the foregoing, if the fixed charge coverage ratio is less than 1.00 to 1.00 for four consecutive quarters and the fourth consecutive quarter ends after the quarter ending December 31, 2003, Archon will not be permitted to cure the deficiency. If Archon fails to make any required payments or is not permitted to cure a deficiency with respect to quarters ending after the quarter ending December 31, 2003, an event of default will occur under the lease.
23
Table of Contents
Pursuant to the agreements relating to the Pioneer Transactions, Archon has foregone the management fee otherwise payable to it since April 2001. PHI’s ratio of fixed charges to operating cash flow was 0.60 to 1.00 for the four quarters ended June 30, 2003, the fourth consecutive quarter in which the ratio was less than 1.00 to 1.00. As a result, the Company will make the required deposit to the restricted cash account in the amount of $489,000. PHI’s ratio of fixed charges to operating cash flow for the four quarters ended June 30, 2002, September 30, 2002, December 31, 2002 and March 31, 2003 were 0.92 to 1.00, 0.87 to 1.00, 0.81 to 1.00 and 0.55 to 1.00, respectively. As a result, Archon made capital contributions to PHI in the amounts of approximately $375,000, $275,000, $314,000 and $1,372,000 with respect to the four-quarter periods ended June 30, September 30, December 31, 2002 and March 31, 2003, respectively. Additionally, it deposited $484,000 and $487,000 in the restricted cash account for the four quarters ended December 31, 2002 and March 31, 2003, respectively. The Company expects that future operating results at the Pioneer will result in fixed charge coverage ratios of less than 1.00 to 1.00, so that the Company will be required to continue to make capital contributions and significant deposits to restricted cash accounts for the foreseeable future.
Furthermore, Archon would have been required to make capital contributions aggregating approximately $400,000 as a result of PHI’s fixed charge ratios for the four quarters ended December 31, 2001 and March 31, 2002, in which the ratio of fixed charges to operating cash flow was 0.93 to 1.00, and 0.92 to 1.00, respectively. However, in May 2002, the Company completed the purchase, for approximately $2.1 million, of leased gaming equipment with $1.9 million of cash from the restricted cash account and cash from operations. The elimination of the rent payments reduced fixed charges in periods subsequent to the repurchase date. Giving effect to the gaming equipment purchase as if it had occurred at the beginning of the relevant four-quarter period, on a pro forma basis PHI’s ratio of fixed charges to operating cash flow for the four quarters ended December 31, 2001 and March 31, 2002 would have been 1.04 to 1.00 and 1.05 to 1.00, respectively. Archon advised the Purchaser that it was not making any capital contributions to PHI for the four-quarter periods ended December 31, 2001 and March 31, 2002 based on the pro forma fixed charge ratios giving effect to the May 2002 purchase of leased gaming equipment. The Purchaser has not advised the Company whether it agrees that the Company has the right to calculate the ratios on a pro forma basis. If the Purchaser disagrees, the Company will be required to make capital contributions with respect to the four-quarter periods ended December 31, 2001 and March 31, 2002 and will be required to deposit additional cash to the restricted cash account.
The agreements related to the Pioneer Transactions provide an option for the Company to purchase the assets under the lease and license agreements to PHI during the period from December 31, 2003 and December 31, 2007, at purchase price amounts ranging between $35.5 million and $38.7 million, which, as of the date of the agreements, approximated estimated fair market value at the relevant purchase dates, and at the end of the lease term for fair market value. No assurance can be given that the Company will be able to raise sufficient funds to exercise the option.
Archon Sparks Management Company
In fiscal 2001, the Company purchased for $100,000 Class B member interests in Duke’s-Sparks (“Duke’s”), a Nevada limited liability company that developed Duke’s Casino, a restricted slot operation, restaurant and entertainment facility in Sparks, Nevada. Christopher Lowden, son of Paul W. Lowden, is a limited partner in the company that is the managing member of Duke’s.
On October 8, 2002 the Company entered into a Subordinated Loan Agreement (the “Duke’s Loan Agreement”) with Duke’s. Under the Duke’s Loan Agreement, Duke’s was entitled to borrow up to $1.1 million for construction, equipment, furnishings and other costs related to the completion and opening of Duke’s Casino. The loan, which is secured on a subordinated basis by the real property on which Duke’s is located (the “Duke’s Real Property”) and on a senior basis by non-gaming equipment and certain other personal property, matures on October 8, 2009 and bears interest at an annual rate of
24
Table of Contents
15%, plus additional interest at an annual rate of 10% until such time as the option described in the following sentence is exercised. In connection with the Duke’s Loan Agreement, the Company received an option to acquire 70% of the equity in the entity that owns Duke’s. Duke’s borrowed the entire $1.1 million available under the Duke’s Loan Agreement by December 31, 2002. Furthermore, the Company has advanced Duke’s an additional approximately $333,000 on an unsecured basis, which advances are evidenced by a promissory note payable on demand.
The Company’s advances to Dukes under the Duke’s Loan Agreement are subordinate to a senior loan in the amount of $4.0 million, which is secured on a senior basis by the Duke’s Real Property (the “Duke’s Senior Loan”). Duke’s is in default under both the Duke’s Senior Loan and the Company’s loans to Duke’s pursuant to the Duke’s Loan Agreement and the promissory note. Both the senior lender and the Company recorded notices of default and elections to sell the Duke’s Real Property and provided notice of such recordation to Duke’s and other parties in interest as required by Nevada law. On August 13, 2003, the trustee under the deed of trust with respect to the Duke’s Senior Loan held a foreclosure sale of the property. In the foreclosure sale, the senior lender acquired the Duke’s Real Property in partial satisfaction of the Duke’s Senior Loan, as a result of which the Company’s security interest in the Duke’s Real Property was extinguished. Pursuant to the terms of the Company’s loan agreement with Duke’s, Duke’s is prohibited from making payments on the Company’s loans until the Duke’s Senior Loan is paid in full or the senior lender waives the requirement.
The Company and the senior lender have agreed in principle that the senior lender will sell the Duke’s Real Property to the Company for $3.7 million payable no later than June 1, 2007, subject to increase to $3.8 million if not paid in full by June 1, 2005. The purchase price will be evidenced by a promissory note which will bear interest during the first 36 months of the loan at the rate of 1.75% plus the senior lender’s actual cost of funds (currently the prime rate less 25 basis points) increasing to a rate of 2.5% plus the senior lender’s cost of funds for months 37 through 48. Interest will accrue monthly, commencing as of June 1, 2003, and be payable on a monthly basis. All principal and accrued but unpaid interest will be payable on or before June 1, 2007. The promissory note will be secured by a deed of trust on the Duke’s Real Property. Consummation of the purchase is subject to the execution of a mutually acceptable purchase and sale agreement, promissory note, security agreement and related closing documents no later than September 1, 2003. Additionally, the purchase is subject to approval of the Board of Directors of the Company. Until such time as a final agreement is reached with the senior lender with respect to the purchase of the Duke’s Real Property and the Company acquires the Duke’s Real Property, the Company expects to continue to operate Duke’s on the same terms as provided in the Duke’s-Sparks Lease described below. If the Company and the senior lender are unable to reach agreement and the Company does not acquire the Duke’s Real Property, the Duke’s-Sparks Lease will be voided. As a result of the foreclosure of the Duke’s Real Property and continuing default under the Duke’s Senior Loan, and the Company’s loans to Duke’s, the Company has established a reserve in the amount of $900,000 with respect to its loans to Duke’s. In addition, the Company wrote-off its $100,000 initial investment in Duke’s.
On October 4, 2002, a subsidiary of the Company entered into a lease (the “Duke’s-Sparks Lease”) with Duke’s, with respect to the Duke’s Casino. The Duke’s-Sparks Lease provides that it will commence on the first day of the month (the “Commencement Date”) following the month in which the Company’s subsidiary obtained all required gaming regulatory approvals to conduct gaming activities at Duke’s, provided that the Commencement Date will not occur until all the remodeling work being performed by Duke’s at the facility has been substantially completed and the City of Sparks has issued a certificate of occupancy for the facility, and that it will expire on the date which is the earlier of three years after the Commencement Date or the date which is the first day of the month which immediately follows the month in which Duke’s receives the necessary regulatory approvals to operate the casino.
25
Table of Contents
The Duke’s-Sparks Lease provides for monthly base rent in the amount of $81,216. The required gaming regulatory approvals were obtained by the Company’s subsidiary on January 24, 2003, and the Company began operating Duke’s on February 7, 2003. However, the remodeling of the facility is not substantially complete, so the Company has not paid any rent to Duke’s to date. Until such time as a final agreement is reached with the senior lender with respect to the Company’s purchase of the Duke’s Real Property and the Company acquires the Duke’s Real Property, the senior lender has agreed that the Company to continue to operate Duke’s on the same terms as provided in the Duke’s-Sparks Lease. If the Company and the senior lender are unable to reach agreement and the Company does not acquire the Duke’s Real Property, the Duke’s-Sparks Lease will be voided. In addition, the Company owns and has installed approximately 190 slot and video poker machines in Duke’s Casino valued at approximately $1.7 million.
Preferred Stock
The Company’s preferred stock provides that dividends accrue on a semi-annual basis, to the extent not declared. Prior to fiscal 1997, the Company satisfied the semiannual dividend payments on its preferred stock through the issuance of paid-in-kind dividends. The Company has accrued the semiannual preferred stock dividends since October 1, 1996. The dividend rate per annum was equal to 8% of $2.14 for each share of preferred stock until September 30, 1998, at which date the dividend rate increased to 11%; the dividend rate continues to increase by an additional 50 basis points on each succeeding semiannual dividend payment date up to a maximum of 16% per annum. In April 2003, the dividend rate increased to 15.5%. The accrued stock dividends have been recorded as an increase to the preferred stock account. As of June 30, 2003, the aggregate liquidation preference of the preferred stock was $17.4 million, or $3.73 per share.
Pursuant to the Certificate of Designations of Preferred Stock, dividends are payable only when, as and if declared by the Board of Directors and the liquidation preference is payable only upon a liquidation, dissolution or winding up of the Company. Because dividends in an amount equal to dividend payments for one dividend period have accrued and remain unpaid for at least two years, the preferred stockholders, voting as a separate class, are entitled to elect two directors. The agreements relating to the Pioneer Transactions contain provisions restricting the payment of dividends on the preferred stock.
The Board of Directors of the Company authorized an increase in the amount of cash that may be used to purchase preferred stock to $2.5 million. As of August 11, 2003, the Company had purchased 752,158 shares of preferred stock for $1,140,084 under this program. In addition, in April 2001 the Company acquired approximately 3.5 million shares of preferred stock as part of a litigation settlement agreement.
Recently Issued Accounting Standards
In April 2003, the FASB issued SFAS No. 149 (“SFAS No. 149”), Amendments of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends SFAS No. 133 (“SFAS No. 133”), Accounting for Derivative and Instruments and Hedging Activities, and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and or hedging activities under SFAS 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The provisions of this statement that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003,
26
Table of Contents
should continue to be applied in accordance with their respective effective dates. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150 (“SFAS No, 150”), Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted the standard on July 1, 2003 and have determined that the adoption does not have a material impact on the Company’s consolidated financial position or results of operations.
Effects of Inflation
The Company has been generally successful in recovering costs associated with inflation through price adjustments in its hotel. Any such future increases in costs associated with casino operations and maintenance of properties may not be completely recovered by the Company.
Forward Looking Statements
Certain statements in this Quarterly Report on Form 10-Q which are not historical facts are forward-looking statements, such as statements relating to future operating results, existing and expected competition, financing and refinancing sources and availability and plans for future development or expansion activities, capital expenditures and expansion of business operations into new areas. Such forward-looking statements involve a number of risks and uncertainties that may significantly affect the Company’s liquidity and results in the future and, accordingly, actual results may differ materially from those expressed in any forward-looking statements. Such risks and uncertainties include, but are not limited to, those related to effects of competition, leverage and debt service, general economic conditions, changes in gaming laws or regulations (including the legalization of gaming in various jurisdictions) and risks related to development activities and the startup of non-gaming operations.
27
Table of Contents
Item 3. | MARKET RISK DISCLOSURE |
Market risk is the risk of loss arising from changes in market rates and prices, such as interest rates, foreign currency exchange rates and commodity process. The Company has no debt instruments subject to interest rate fluctuation.
The Company holds investments in various available-for-sale securities; however, management believes that exposure to price risk arising from the ownership of these investments is not material to our consolidated financial position, results of operations or cash flow.
Item 4. | CONTROLS AND PROCEDURES |
Within the 90 days prior to the date of filing this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company’s Audit Committee and the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to the Securities Exchange Act of 1934 Rules 13a-14 and 15d-14. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings with the Securities and Exchange Commission. Subsequent to the date of that evaluation, there have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls, nor were any corrective actions required with regard to significant deficiencies and material weaknesses.
28
Table of Contents
ARCHON CORPORATION
PART II – OTHER INFORMATION
Item 1. | Legal Proceedings |
None
Item 2 | Changes in Securities |
None
Item 3. | Defaults Upon Senior Securities |
The Company has outstanding redeemable exchangeable cumulative preferred stock (“Preferred Stock”). Prior to fiscal 1997, the Company satisfied the semi-annual dividend payments on its Preferred Stock through the issuance of paid-in-kind dividends. Commencing in fiscal 1997, dividends paid on the Preferred Stock, to the extent declared, must be paid in cash. No dividends have been declared on the Preferred Stock since October 1, 1996. Pursuant to the terms of the Certificate of Designation with respect to the Preferred Stock, dividends that are not declared are cumulative and accrue. The dividend rate per annum was equal to 8% of $2.14 for each share of preferred stock until September 30, 1998, at which date the dividend rate increased to 11%; the dividend rate continues to increase by an additional 50 basis points on each succeeding semiannual dividend payment date up to a maximum of 16% per annum. The dividend rate is 15.5% effective April 1, 2003. The accrued stock dividends have been recorded as an increase to the preferred stock account. As of June 30, 2003, the aggregate liquidation preference of the Preferred Stock was $17.4 million, or $3.73 per share.
29
Table of Contents
Item 4. | Submission of Matters to a Vote of Security Holders |
At the Annual Meeting of Stockholders held on May 21, 2003, common stockholders elected two directors and voted on a proposal to ratify the selection of Deloitte & Touche LLP as the Company’s public accountants. Preferred stockholders elected one special director.
The Directors whose terms in office continued after the meeting are as follows:
Charles W. Sandefur |
| 2004 |
Paul W. Lowden |
| 2005 |
William J. Raggio |
| 2005 |
There were 6,221,431 shares of Common Stock entitled to vote at the meeting. A total of 6,136,792 votes (98.64%) were represented at the meeting. The result of the vote taken on the election of Directors elected by the common stockholders to hold office until the 2006 Annual Meeting of Stockholders and until their successors are elected and have qualified are as follows:
|
| For |
| Withheld |
|
|
|
|
| ||
Suzanne Lowden |
| 6,109,742 |
| 27,050 |
|
John W. Delaney |
| 6,112,068 |
| 24,724 |
|
The result of the vote taken for ratification of selection of Deloitte & Touche LLP as the Company’s public accountants are as follows:
For |
| Against |
| Abstain |
| Broker Non-Vote |
|
|
|
|
| ||||
6,124,327 |
| 6,804 |
| 5,661 |
| 0 |
|
The special director elected by the preferred stockholders whose terms in office continued after the meeting is as follows:
Jay Parthemore |
| 2004 |
There were 5,246,781 shares of Preferred Stock entitled to voted at the meeting. A total of 4,921,358 votes (93.8%) were represented at the meeting. The result of the vote taken of the election of the special director by the preferred stockholders was as follows:
|
| For |
| Withheld |
|
|
|
|
| ||
Howard E. Foster |
| 4,119,152 |
| 802,206 |
|
30
Table of Contents
Item 5. | Other Information |
None
Item 6. | Exhibits and Reports on Form 8-K |
Exhibits
3.3 | Amended and Restated By-Laws. |
|
|
10.36 | Security Agreement and Second Deed of Trust Dated October 8, 2002 between Duke’s-Sparks, LLC (Grantor) and Archon Corporation (Beneficiary). |
|
|
31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002. |
|
|
31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
32 | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
Reports on Form 8-K
None
31
Table of Contents
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 authorized.
|
|
| ARCHON CORPORATION, Registrant |
| By: |
| |
|
|
| |
|
|
| Charles W. Sandefur, Chief Financial Officer |
Dated: August 14, 2003
32