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ACEP Senior Secured Revolving Credit Facility
Effective May 11, 2006, ACEP, and certain of ACEP’s subsidiaries, as guarantors, entered into an amended and restated credit agreement with Wells Fargo Bank N.A., as syndication agent, Bear Stearns Corporate Lending Inc., as administrative agent, and certain other lender parties. As of June 30, 2007, the interest rate on the outstanding borrowings under the credit facility was 6.82% per annum. The credit agreement amends and restates, and is on substantially the same terms as, a credit agreement entered into as of January 29, 2004. Under the amended and restated credit agreement, ACEP will be permitted to borrow up to $60.0 million. Obligations under the credit agreement are secured by liens on substantially all of the assets of ACEP and its subsidiaries. The credit agreement has a term of four years and all amounts are due and payable on May 10, 2010. As of June 30, 2007, there were $40.0 million of borrowings under the credit agreement. The borrowings were incurred to finance a portion of the purchase price of the Aquarius.
The credit agreement includes covenants that, among other things, restrict the incurrence of additional indebtedness by ACEP and its subsidiaries, the issuance of disqualified or preferred stock, as defined, the creation of liens by ACEP or its subsidiaries, the sale of assets, mergers, consolidations or sales of substantially all of ACEP’s assets, the lease or grant of a license or concession, other agreements to occupy, manage or use ACEP’s assets, the issuance of capital stock of restricted subsidiaries and certain related party transactions. The credit agreement also requires that, as of the last date of each fiscal quarter, ACEP’s ratio of consolidated first lien debt to consolidated cash flow be not more than 1.0 to 1.0. As of June 30, 2007, such ratio was less than 1.0 to 1.0. As of June 30, 2007, ACEP was in compliance with each of the covenants.
The restrictions imposed by ACEP’s senior secured notes and the credit facility likely will limit our receiving payments from the operations of our hotel and gaming properties.
As described in Note 3, on April 22, 2007, AEP entered into an agreement to sell all of the issued and outstanding membership interests of ACEP. Pursuant to the terms of the agreement, AEP is required to cause ACEP to repay from funds provided by AEP, the principal, interest, prepayment penalty or premiums due on ACEP’s 7.85% senior secured rates due 2012 and ACEP’s senior secured credit facility. Accordingly, these obligations are now classified as current liabilities in the consolidated balance sheets.
Mortgages Payable
Mortgages payable, all of which are non-recourse to us, bear interest at rates between 4.97% and 7.99% and have maturities between September 1, 2008 and July 1, 2016.
WestPoint Home Secured Revolving Credit Agreement
On June 16, 2006, WestPoint Home, Inc., an indirect wholly owned subsidiary of WPI, entered into a $250.0 million loan and security agreement with Bank of America, N.A., as administrative agent and lender. On September 18, 2006, The CIT Group/Commercial Services, Inc., General Electric Capital Corporation and Wells Fargo Foothill, LLC were added as lenders under this credit agreement. Under the five-year agreement, borrowings are subject to a monthly borrowing base calculation and include a $75.0 million sub-limit that may be used for letters of credit. Borrowings under the agreement bear interest, at the election of WestPoint Home, either at the prime rate adjusted by an applicable margin ranging from minus 0.25% to plus 0.50% or LIBOR adjusted by an applicable margin ranging from plus 1.25% to 2.00%. WestPoint Home pays an unused line fee of 0.25% to 0.275%. Obligations under the agreement are secured by WestPoint Home’s receivables, inventory and certain machinery and equipment.
The agreement contains covenants including, among others, restrictions on the incurrence of indebtedness, investments, redemption payments, distributions, acquisition of stock, securities or assets of any other entity and capital expenditures. However, WestPoint Home is not precluded from effecting any of these transactions if excess availability, after giving effect to such transaction, meets a minimum threshold.
As of June 30, 2007, there were no borrowings under the agreement, but there were outstanding letters of credit of approximately $26.8 million, the majority of which relate to trade obligations.
Quarterly Distributions
On August 3, 2007, the Board of Directors approved a payment of a quarterly cash distribution of $0.15 per unit on our depositary units payable in the third quarter of fiscal 2007. The distribution will be paid on
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September 7, 2007 to depositary unitholders of record at the close of business on August 27, 2007. Under the terms of the indenture dated April 5, 2007 governing our senior convertible notes due 2013, we will also be making a $0.05 distribution to holders of these notes in accordance with the formula set forth in the indenture.
On May 4, 2007, the Board of Directors approved a $0.05 increase in our quarterly distribution policy and payment of a quarterly cash distribution of $0.15 per unit on our depositary units in the second quarter of fiscal 2007. The distribution was paid on June 1, 2007 to depositary unitholders of record at the close of business on May 22, 2007. Under the terms of the indenture dated April 5, 2007 governing our senior convertible notes due 2013, we paid a $0.05 distribution to holders of these notes in accordance with the formula set forth in the indenture.
The payment of future distributions will be determined by the Board of Directors quarterly. There can be no assurance as to whether or in what amounts any future distributions might be paid.
Contractual Commitments
As of June 30, 2007 other than the issuance of an additional $500.0 million aggregate principal amount of the additional 7.125% senior notes due 2013 and $600.0 million of variable rate senior convertible notes due 2013, there were no other material changes in our contractual obligations or any other long-term liabilities reflected on our consolidated balance sheet as compared to those reported in our Annual Report on Form 10-K for fiscal 2006, filed with the Securities and Exchange Commission on March 6, 2006.
Off Balance Sheet Arrangements
We do not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others.
Segment Liquidity and Capital Resources
Real Estate
Our real estate operating units generate cash though rentals, leases and asset sales (principally sales of rental and residential properties) and the operation of resorts. All of these operations generate cash flows from operations.
Real estate development activities require a significant amount of funds. In fiscal 2007, our development operations are expected to require cash expenditures of approximately $40 million. We expect that such amounts will be funded from unit sales and, to the extent such proceeds are insufficient, by AREP from available cash.
During the six months ended June 30, 2007, we sold one rental real estate property for $4.4 million, which was unencumbered by mortgage debt. In addition, we sold a resort property for $2.1 million.
During the six months ended June 30, 2006, we sold eight rental real estate properties for $8.3 million, which were unencumbered by mortgage debt.
Home Fashion
For the first half of fiscal 2007, our Home Fashion segment had a negative cash flow from operations of $56.1 million. The negative cash flow from operations was principally due to net operating losses and ongoing restructuring efforts offset in part by a reduction in working capital. As discussed above, WPI continues its restructuring efforts and, accordingly, expects that restructuring charges and operating losses will continue to be incurred through the end of fiscal 2007.
At June 30, 2007, WPI had $115.4 million of unrestricted cash and cash equivalents. There were no borrowings under the WestPoint Home senior secured revolving credit agreement, but there were outstanding letters of credit of $26.8 million. Based upon the eligibility and reserve calculations within the agreement, WestPoint Home had unused borrowing availability of approximately $117.8 million at June 30, 2007.
The senior secured revolving credit agreement contains various covenants including, among others, restrictions on indebtedness, investments, redemption payments, distributions, acquisition of stock, securities
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or assets of any other entity and capital expenditures. However, WestPoint Home is not precluded from effecting any of these, if excess availability, as defined, after giving effect to any such debt issuance, investment, redemption, distribution or other transition or payment restricted by covenant meets a minimum threshold. At June 30, 2007, the excess availability was greater than the minimum threshold.
Capital expenditures by WPI were $21.6 million for the six months ended June 30, 2007 (including $9.8 million for further upgrades to the WPI’s manufacturing plant in Bahrain and $7.2 million of non-recurring expenditures related to termination of long-term equipment leases for closed facilities), compared to $3.0 million for the comparable period last year. Capital expenditures for the remainder of 2007 are expected to total approximately $6.5 million, which is primarily dependant upon the requirements of WPI’s facility in Bahrain. During the six months ended June 30, 2007, WPI received $13.5 million of net proceeds from sale of assets as compared to $11.7 million in the comparable period last year.
Through a combination of its existing cash on hand and its borrowing availability under the WestPoint Home senior secured revolving credit facility, WPI believes that it has adequate capital resources and liquidity to meet its anticipated requirements to continue its operational restructuring initiatives and for working capital, capital spending and scheduled payments on the notes payable at least through the next twelve months. However, depending upon the levels of additional acquisitions and joint venture investment activity, if any, additional financing, if needed, may not be available to WPI, or if available, the financing may not be on terms favorable to WPI. WPI’s estimates of its reasonably anticipated liquidity needs may not be accurate and new business opportunities or other unforeseen events could occur, resulting in the need to raise additional funds from outside sources.
Discontinued Operations
Gaming
ACEP’s primary source of cash is from the operation of its properties. At June 30, 2007, ACEP had cash and cash equivalents of $84.0 million. For the six months ended June 30, 2007, net cash provided by operating activities (including the operations of the Aquarius) totaled approximately $43.2 million compared to approximately $36.6 million for the six months ended June 30, 2006. The change in cash provided by operating activities was attributable to the increase in net income from $16.0 million for the six months ended June 30, 2006 to $23.3 millions for the six months ended June 30, 2007, reflecting factors discussed above. In addition to cash from operations, cash is available to ACEP, if necessary, under ACEP’s senior secured revolving credit facility entered into by ACEP, as borrower, and certain of its subsidiaries, as guarantors. The revolving credit facility allows for borrowings of up to $60.0 million, including the issuance of letters of credit of up to $10.0 million. Loans made under the revolving credit facility will mature and commitments under them will terminate in May 2010.
ACEP’s primary use of cash during the six months ended June 30, 2007 was for operating expenses, to pay interest on its 7.85% senior secured notes due 2012 and interest under its senior secured revolving credit facility. ACEP’s capital spending was approximately $15.2 million and $16.6 million for the six months ended June 30, 2007 and 2006, respectively. For fiscal 2007, capital spending to date includes $2.7 million for improvements to the Aquarius. ACEP has estimated its fiscal 2007 capital spending for its existing facilities at approximately $31.1 million, which it anticipates to include approximately $14.9 million to purchase new and convert existing slot machines and approximately $7.0 million for remaining Aquarius hotel renovations. The remainder of ACEP’s capital spending estimate for fiscal 2007 will be for upgrades or maintenance to our existing assets.
ACEP believes operating cash flows will be adequate to meet its anticipated requirements for working capital, capital spending and scheduled interest payments on the notes and under the senior secured revolving credit facility, lease payments and other indebtedness at least through the next twelve months. However, additional financing, if needed, may not be available to ACEP, or if available, the financing may not be on terms favorable to it. ACEP’s estimates of its reasonably anticipated liquidity needs may not be accurate and new business opportunities or other unforeseen events could occur, resulting in the need to raise additional funds from outside sources.
The indenture governing ACEP’s 7.85% senior secured notes due 2012 contains certain covenants that restrict payment of cash dividends, the purchase of equity interests, and the purchase, redemption, defeasance
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or acquisition of debt subordinated to the investments as “restricted payments.” The indenture also prohibits the incurrence of debt and issuance of disqualified or preferred stock unless certain ratios as described in the indenture are maintained. The revolving credit facility contains similar restrictive covenants.
On April 22, 2007, AEP, our wholly owned subsidiary, entered into an agreement to sell all of the issued and outstanding membership interests of ACEP, which comprises our remaining gaming operations
Forward-Looking Statements
Statements included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are not historical in nature are intended to be, and are hereby identified as, “Forward-Looking Statements” for purposes of the safe harbor provided by Section 27A of the Securities Act and Section 21E of the 1934 Act, as amended by Public Law 104-67.
Forward looking statements regarding management’s present plans or expectations involve risks and uncertainties and changing economic or competitive conditions, as well as the negotiation of agreements with third parties, which could cause results to differ from present plans or expectations, and such differences could be material. Readers should consider that such statements speak only as of the date hereof.
Certain Trends and Uncertainties
Our future results could differ materially from our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to those discussed in this document. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those predicted. Also, please see Risk Factors in Part I, Item 1A in our Annual Report on Form 10-K for fiscal 2006 and in Part II, Item 1A of this Quarterly Report on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates and commodity prices. Our significant market risks are primarily associated with interest rates and equity prices. Reference is made to Part II, Item 7A of our Annual Report on Form 10-K for fiscal 2006 that we filed with the SEC on March 6, 2007 for disclosures relating to interest rates and our equity prices. As of June 30, 2007 there have been no material changes in the market risks in these two categories.
Item 4. Controls and Procedures
As of June 30, 2007, our management, including our Principal Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s and our subsidiaries’ disclosure controls and procedures pursuant to the Rule 13a-15(e) and 15d-15(e) promulgated under the ’34 act. Based upon that evaluation, our Principal Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are currently effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting during the six months ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are from time to time parties to various legal proceedings arising out of our businesses. We believe however, that other than the proceedings described in Part I, Item 3 of our Annual Report on Form 10-K for fiscal 2006, filed with the SEC on March 6, 2007, including that relating to WPI and Lear discussed below, there are no proceedings pending or threatened against us which, if determined adversely, would have a material adverse effect on our business, financial condition, results of operations or liquidity.
WPI Litigation
Federal Proceedings
In November and December 2005, the U.S. District Court for the Southern District of New York rendered a decision inContrarian Funds Inc. v. WestPoint Stevens, Inc. et al., and issued orders reversing certain provisions of the Bankruptcy Court order, or the Sale Order, pursuant to which we acquired our ownership of a majority of the common stock of WPI. WPI acquired substantially all of the assets of WestPoint Stevens, Inc. On April 13, 2006, the Bankruptcy Court entered a remand order, or the Remand Order, which provides, among other things, that all of the shares of common stock and rights to acquire shares of common stock of WPI issued to us and the other first lien lenders or held in escrow pursuant to the Sale Order constituted “replacement collateral”, other than 5,250,000 shares of common stock that we acquired for cash. The 5,250,000 shares represent approximately 27% of the 19,498,389 shares of common stock of WPI now outstanding. According to the Remand Order, we would share pro rata with the other first lien lenders in proceeds realized from the disposition of the replacement collateral and, to the extent there is remaining replacement collateral after satisfying first lien lender claims, we would share pro rata with the other second lien lenders in any further proceeds. We were holders of approximately 39.99% of the outstanding first lien debt and approximately 51.21% of the outstanding second lien debt. On April 13, 2006, the Bankruptcy Court also entered an order staying the Remand Order pending appeal. The parties filed cross-appeals of the Remand Order and Contrarian Funds and certain other first lien lenders, or the Contrarian Group, filed a motion to lift the stay of the Remand Order pending appeal. Oral argument was held in the District Court on October 19, 2006.
On May 9, 2007, the District Court issued an order conditioning the continuation of the Bankruptcy Court's stay on the posting of a bond. No bond was posted. On May 22, 2007, WPI, its subsidiary WestPoint Home, Inc., and we filed a Petition for a Writ of Mandamus in the U.S. Court of Appeals for the Second Circuit requesting, among other relief, the reinstatement of the Sale Order. The Second Circuit held oral argument on June 26, 2007 and denied the Petition on June 28, 2007, instructing the District Court to set a new deadline for posting a bond. On July 3, 2007, the District Court issued an order setting July 11, 2007 as the deadline for posting a bond. No bond was posted and The District Court has not ruled on the parties’ cross-appeals of the Remand Order.
Delaware Proceedings
On December 18, 2006, the Contrarian Group filed an action in the Court of Chancery of the State of Delaware, New Castle County,Contrarian Funds, LLC, et al v. WestPoint International Inc., et al., seeking, among other things, a temporary order restraining WPI from proceeding with a stockholders' meeting scheduled for December 20, 2006, which was to consider corporate actions relating to a proposed offering of $200 million of preferred stock of WPI and related relief. The application was denied by order dated December 19, 2006. The stockholders' meeting took place on December 20, 2006, the preferred stock offering was approved, and other corporate actions were taken. We purchased all of the $200.0 million of preferred stock.
On January 19, 2007, Beal Bank and the Contrarian Group filed an Amended Complaint, captionedBeal Bank, S.S.B., et al. v. WestPoint International, Inc., et al. Plaintiffs seek, among other relief, an order declaring that WPI is obliged to register the common stock (other than the 5,250,000 shares purchased by us) in Beal Bank's name, an order declaring certain corporate governance changes implemented in 2005 invalid, an order declaring invalid the actions taken at the December 20, 2006 stockholders' meeting and an order to “unwind” the issuance of the preferred stock, or, alternatively, directing that such preferred stock be held in trust. On
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July 18, 2007, Plaintiffs filed a motion for leave to file a Second Amended Complaint asserting additional causes of action. The parties are in the initial stages of discovery. The Delaware action remains pending and we intend to vigorously defend against such claims.
We currently own approximately 67.7% of the outstanding shares of common stock and 100% of the preferred stock of WPI. As a result of the District Court’s November, 2005 order in the Bankruptcy case, the proceedings on remand, and the proceedings in the Delaware action, our percentage of the outstanding shares of common stock of WPI could be reduced to less than 50% and perhaps substantially less and our ownership of the preferred stock of WPI could also be affected. If we were to lose control of WPI, it could adversely affect the business and prospects of WPI and the value of our investment in it. In addition, we consolidated the balance sheet of WPI as of June 30, 2007 and WPI’s results of operations for the period from the date of acquisition through June 30, 2007. If we were to own less than 50% of the outstanding common stock or the challenge to our preferred stock ownership is successful, we would have to evaluate whether we should consolidate WPI and if so our financial statements could be materially different than as presented as of June 30, 2007, March 31, 2007, December 31, 2006 and December 31, 2005 and for the periods then ended.
We intend to vigorously defend against all claims asserted in these actions and believe that we have valid defenses. However, we cannot predict the outcome of these proceedings or the ultimate impact on our investment in WPI or the business prospects of WPI.
Lear Corporation
On February 9, 2007, we, through a wholly owned subsidiary, entered into an agreement and plan of merger, or the merger agreement, pursuant to which we would acquire Lear Corporation, or Lear, a publicly traded company that provides automotive interior systems worldwide, for an aggregate consideration of approximately $5.2 billion, including the assumption by the surviving entity of certain outstanding indebtedness of Lear and refinancing of Lear's existing term loan and credit facility. The consummation of the transaction was subject to a shareholder vote.
On July 16, 2007, at Lear’s 2007 Annual Meeting of Stockholders the merger did not receive the affirmative vote of the holders of a majority of the outstanding shares of Lear’s common stock. As a result, the merger agreement terminated in accordance with its terms. As required by the merger agreement, in connection with the termination, Lear (i) paid to our subsidiary $12.5 million, (ii) issued to the subsidiary 335,570 shares of Lear’s common stock and (iii) increased from 24% to 27% the share ownership limitation under the limited waiver of Section 203 of the Delaware General Corporation Law granted by Lear to us and affiliates of and funds managed by Carl C. Icahn. In addition, if (1) Lear stockholders enter into a definitive agreement with respect to an Acquisition Proposal, as defined in the merger agreement, within 12 months after the termination of the merger agreement and such transaction is completed and (2) such Acquisition Proposal has received approval, if required by applicable Law, by the affirmative vote or consent of the holders of a majority of the outstanding shares of Lear common stock within such 12 month period, Lear will be required to pay to our subsidiary an amount in cash equal to the Superior Fee, as defined in the merger agreement, less $12.5 million.
In connection with the termination of the Merger Agreement, the commitment letter, dated as of February 9, 2007, or the Commitment Letter, by and among our subsidiary, Bank of America, N.A. and Banc of America Securities LLC, also terminated pursuant to its terms. The Commitment Letter provided for certain credit facilities intended to refinance and replace Lear’s existing credit facilities and to fund the transactions contemplated by the merger agreement.
We were named as a defendant in various actions filed in connection with the merger agreement. Since the merger did not receive approval from Lear’s shareholders and the merger agreement has terminated, the consolidated action filed in Michigan and the complaint filed in the United States District Court for the Eastern District of Michigan, have each been dismissed. Our motion to dismiss the consolidated action filed in the Court of Chancery of the State of Delaware is pending. We intend to vigorously defend the Delaware action but we cannot predict the outcome of the motion.
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Item 1A. Risk Factors
The risk factors included in our Annual Report on Form 10-K for fiscal 2006, filed with the SEC on March 6, 2007, have not materially changed, except as disclosed below.
Our general partner and its control person could exercise their influence over us to your detriment.
Mr. Icahn, through affiliates, currently owns 100% of API, our general partner, and approximately 86.5% of our outstanding preferred units and approximately 90% of our depositary units, and, as a result, has the ability to influence many aspects of our operations and affairs, including the timing and amount of any distribution to unitholders. API also is the general partner of AREH.
The interests of Mr. Icahn, including his interests in entities in which he and we have invested or may invest in the future, may differ from your interests as a unitholder and, as such, he may take actions that may not be in your interest. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, Mr. Icahn’s interests might conflict with your interests.
In addition, if Mr. Icahn were to sell, or otherwise transfer, some or all of his interests in us to an unrelated party or group, a change of control could be deemed to have occurred under the terms of the indentures governing certain of our notes which would require us to offer to repurchase all such outstanding notes at 101% of their principal amount plus accrued and unpaid interest and liquidated damages, if any, to the date of repurchase. In the case of the variable rate senior convertible notes due 2013, or the variable rate senior convertible notes, we also would be obligated to make a “make whole” payment in the form of additional depositary units to any holder of convertible notes who converts such notes following a change of control. However, it is possible that we will not have sufficient funds at the time of such change of control to make the required repurchase of such notes.
We have engaged, and in the future may engage, in transactions with our affiliates.
We have invested and may in the future invest in entities in which Mr. Icahn also invests. We also have purchased and may in the future purchase entities or investments from him or his affiliates. Although API has never received fees in connection with our investments, our partnership agreement allows for the payment of these fees. Mr. Icahn may pursue other business opportunities in industries in which we compete and there is no requirement that any additional business opportunities be presented to us.
Mr. Icahn previously proposed that we acquire his interest in American Railcar, Inc., or American Railcar, and Philip Services Corporation, or Philip Services. American Railcar is a publicly traded company that is primarily engaged in the business of manufacturing covered hoppers and tank railcars. Philip Services is an industrial services company that provides industrial outsourcing, environmental services and metal services to major industry sectors throughout North America. A committee of independent directors of the board was formed to consider those proposals. Currently, at Mr. Icahn’s request, only the proposal regarding the potential acquisition of the metal services business of Philip Services is being considered by the committee. Any acquisition would be subject to, among other things, the negotiation, execution and closing of a definitive agreement and the receipt of a fairness opinion.
We continuously identify, evaluate and engage in discussions concerning potential investments and acquisitions, including potential investments in and acquisitions of affiliates of Mr. Icahn. There cannot be any assurance that any potential transactions that we consider will be completed.
We or our subsidiaries may be able to incur substantially more debt.
We or our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of our 8.125% senior notes due 2012, our 7.125% senior notes due 2013 and our variable rate senior convertible notes do not prohibit us or our subsidiaries from doing so. We and AREH may incur additional indebtedness if we comply with certain financial tests contained in the indentures that govern these notes. As of June 30, 2007, based on these tests, we and AREH could have incurred up to approximately $1.2 billion of additional indebtedness. However, our subsidiaries, other than AREH, are not subject to any of the covenants contained in the indentures with respect to our senior notes, including the covenant restricting debt incurrence. If new debt is added to our and our subsidiaries’ current debt levels, the related risks that we, and they, now face could intensify.
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We have only recently made cash distributions to our unitholders and to holders of our variable rate convertible notes, and future distributions, if any, can be affected by numerous factors.
While we made cash distributions with respect to each of the four quarters of 2006 in the amount of $0.10 per depositary unit and the first quarter of 2007 in the amount of $0.15 per depositary unit and a $0.05 distribution to holders of our variable rate convertible notes starting in the second quarter of fiscal 2007 as set forth in the indenture agreement, the payment of future distributions will be determined by the board of directors of our general partner quarterly, based on a review of a number of factors, including those described below and other factors that it deems relevant at the time that declaration of a distribution is considered. Our ability to pay distributions will depend on numerous factors, including the availability of adequate cash flow from operations; the proceeds, if any, from divestitures; our capital requirements and other obligations; restrictions contained in our financing arrangements; and our issuances of additional equity and debt securities. The availability of cash flow in the future depends as well upon events and circumstances outside our control, including prevailing economic and industry conditions and financial, business and similar factors. No assurance can be given that we will be able to make distributions or as to the timing of any distribution. If distributions are made, there can be no assurance that holders of depositary units may not be required to recognize taxable income in excess of cash distributions made in respect of the period in which a distribution is made.
We may become taxable as a corporation.
We believe that we have been and are properly treated as a partnership for federal income tax purposes. This allows us to pass through our income and deductions to our partners. However, the Internal Revenue Service, or IRS, could challenge our partnership status and we could fail to qualify as a partnership for past years as well as future years. Qualification as a partnership involves the application of highly technical and complex provisions of the Internal Revenue Code of 1986, as amended. For example, a publicly traded partnership is generally taxable as a corporation unless 90% or more of its gross income is “qualifying” income, which includes interest, dividends, oil and gas revenues, real property rents, gains from the sale or other disposition of real property, gain from the sale or other disposition of capital assets held for the production of interest or dividends, and certain other items. We believe that in all prior years of our existence at least 90% of our gross income was qualifying income and we intend to structure our business in a manner such that at least 90% of our gross income will constitute qualifying income this year and in the future. However, there can be no assurance that such structuring will be effective in all events to avoid the receipt of more than 10% of non-qualifying income. If less than 90% of our gross income constitutes qualifying income, we may be subject to corporate tax on our net income, at a federal rate of up to 35% plus possible state taxes. Further, if less than 90% of our gross income constituted qualifying income for past years, we may be subject to corporate level tax plus interest and possibly penalties. In addition, if we register under the Investment Company Act, it is likely that we would be treated as a corporation for U.S. federal income tax purposes. The cost of paying federal and possibly state income tax, either for past years or going forward, could be a significant liability and would reduce our funds available to make distributions to holders of units, and to make interest and principal payments on our debt securities. To meet the qualifying income test, we may structure transactions in a manner that is less advantageous than if this were not a consideration, or we may avoid otherwise economically desirable transactions. Recently proposed legislation may affect the status of publicly traded partnerships such as AREP. Although as proposed the legislation would not impact AREP’s status as a partnership for tax purposes, it is unclear whether such legislation would be enacted or, if enacted, what its final form and effect would be.
Our sale of ACEP may not be successfully completed.
On April 22, 2007, AEP entered into a Membership Interest Purchase Agreement with Whitehall Street Real Estate Funds to sell all of the issued and outstanding membership interests of ACEP, which comprises our gaming operations. The transaction is subject to the approval of the Nevada Gaming Commission and the Nevada State Gaming Control Board, as well as customary conditions. The parties expect to close the transaction in approximately December 2007; however, we cannot assure you that we will be able to consummate the transaction.
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We cannot guarantee that we will be able to recover our investment made in connection with the acquisition of the Aquarius.
On May 19, 2006, our wholly owned subsidiary, AREP Laughlin Corporation, acquired the Aquarius Casino Resort, or the Aquarius, from affiliates of Harrah’s Operating Company, Inc., or Harrah’s, for approximately $113.6 million, including working capital. Acquisitions generally involve significant risks, including difficulties in the assimilation of the operations, services and corporate culture of the acquired company.
Pursuant to the Membership Interest Purchase Agreement that AEP has entered into with Whitehall Street Real Estate Funds to sell the issued and outstanding membership interests of ACEP, we have agreed to make capital expenditures, including $10.5 million through 2007 to refurbish rooms, upgrade amenities and acquire new gaming equipment for the Aquarius.
There can be no assurance that this acquisition will be profitable or that we will be able to recover our investments either upon the sale of ACEP or, if the sale is not consummated, in our future gaming operations.
Pending legal proceedings may result in our ownership of WPI’s common stock being reduced to less than 50%. A legal action in Delaware challenges the issuance to us of the preferred stock of WPI. Uncertainties arising from these proceedings may adversely affect WPI’s operations and prospects and the value of our investment in it.
We currently own approximately 67.7% of the outstanding shares of common stock and 100% of the preferred stock of WPI. As a result of the decision of the U.S. District Court for the Southern District of New York, or the District Court, reversing certain provisions of the Bankruptcy Court order pursuant to which we acquired our ownership of a majority of the common stock of WPI, the proceedings in the Bankruptcy Court on remand and the proceedings in the Delaware action, our percentage of the outstanding shares of common stock of WPI could be reduced to less than 50% and perhaps substantially less and our ownership of the preferred stock of WPI could also be affected.
Recent decisions resulted in the lifting of the stay of the remand order issued by the Bankruptcy Court. In addition, discovery has begun in the Delaware proceedings and the plaintiffs have filed a motion in Delaware for leave to file a Second Amended Complaint asserting additional causes of action.
If we were to lose control of WPI, it could adversely affect the business and prospects of WPI and the value of our investment in it. In addition, we consolidated the balance sheet of WPI as of June 30, 2007 and WPI’s results of operations for the period from the date of acquisition through June 30, 2007. If we were to own less than 50% of the outstanding common stock or the challenge to our preferred stock ownership is successful, we would have to evaluate whether we should consolidate WPI and if so our financial statements could be materially different than as presented as of June 30, 2007, March 31, 2007, December 31, 2006 and December 31, 2005 and for the periods then ended. See Part II, Item 1. Legal Proceedings.
Item 5. Other Information
On August 8, 2007, we entered into a Contribution and Exchange Agreement (the “Contribution Agreement”), among us, CCI Offshore Corp. (“CCI Offshore”), CCI Onshore Corp. (“CCI Onshore”), Icahn Management LP (“Icahn Management” and, together with CCI Offshore and CCI Onshore, the “Contributors”) and Carl C. Icahn, pursuant to which, as more fully described below, we simultaneously acquired the general partnership interests in the general partners of the private investment funds (which are referred to herein as the “Master Funds”) controlled by Mr. Icahn and in the management company that provides certain management and administrative services to the Master Funds and certain funds that invest in the Master Funds (the “Feeder Funds”). Mr. Icahn controlled the Contributors.
New Icahn Management and the General Partners (as such terms are defined below) of the Master Funds (collectively, the “Management Entities”) provide investment advisory and certain other management services to the Master Funds and the Feeder Funds (collectively, the “Funds”). The Management Entities do not provide investment advisory or other management services to any other entities, individuals or accounts, and interests in the Funds are offered only to certain sophisticated and accredited investors on the basis of exemptions from the registration requirements of the federal securities laws and are not publicly available. The Management Entities generate income from amounts earned pursuant to contractual arrangements with the Funds. Such amounts typically include an annual management fee of 2.5% of assets under management and
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performance-based, or incentive, allocation of 25% of net realized and unrealized gains earned by the Funds subject to a “high water mark”, although such amounts have been (and may in the future be) modified or waived in certain circumstances. The Management Entities and their affiliates may also earn income through their principal investments in the Funds.
As of June 30, 2007, the Management Entities had approximately $7 billion of committed funds (including $1.8 billion from Mr. Icahn and affiliated entities on which no management fees or incentive allocations are applicable). For the 12-months ended June 30, 2007, there was an average of approximately $3.5 billion in third-party fee paying assets under management, which generated approximately $80 million of management fees and approximately $240 million in incentive allocations (a portion of which is accrued but not earned until the end of the year) for a total of approximately $320 million in fees. Today, there is approximately $5 billion of third-party fee paying assets under management. Mr. Icahn formed the Management Entities in November 2004 when certain of the Funds commenced investment operations with approximately $1 billion under management, of which $300 million was provided by Mr. Icahn and his affiliated entities. The investment strategy employed by the Management Entities for the Funds is set and led by Mr. Icahn. The Funds pursue a value-oriented activist investment philosophy. The Funds invest across a variety of industries and types of securities, including long and short equities, long and short bonds, bank debt and other corporate obligations, risk arbitrage and capital structure arbitrage and other special situations. The Funds invest a material portion of their capital in publicly traded equity and debt securities of companies that the Management Entities believe to be undervalued by the marketplace. The Funds sometimes take significant positions in the companies in which they invest.
We presently intend to purchase approximately $700 million of limited partnership interests in the Funds on which no management fees or incentive allocations would be applicable.
As consideration for the contribution to us of the Partnership Interests (as defined below), we delivered to the Contributors 8,632,679 AREP Units at the closing, representing $810 million of AREP Units based on the volume-weighted average price of the AREP Units on the NYSE for the 20-trading-day period ending on August 7, 2008 (the day before the closing). In addition, we have agreed to make certain contingent earn-out payments to the Contributors over a five-year period payable in additional AREP Units based on our after-tax earnings from the Fund management business we acquired, which includes both management fees and performance-based (incentive) allocations paid by the Funds to the Management Entities. The earn-out payments will be calculated as set forth in the Contribution Agreement, with the maximum earn-out payment equaling $120 million in 2007 (if such after tax earnings exceed $289 million, with after tax earnings for 2007 including the 2.5% annual management fee for only the fourth quarter of 2007), $165 million for 2008 (if such after tax earnings exceed $540 million), $223 million for 2009 (if such after tax earnings exceed $746 million), $279 million for 2010 (if such after tax earnings exceed $1.004 billion) and $334 million for 2011 (if such after tax earnings exceed $1.327 billion). There is a catch-up after 2011, based on total after tax earnings in the five-year earn-out period, with a maximum aggregate earn-out (including any catch-up) of $1.121 billion which is subject to achieving total after tax earnings in such period of at least $3.906 billion.
Simultaneously with the closing of the transactions contemplated by the Contribution Agreement, we and Mr. Icahn entered into a non-compete agreement pursuant to which Mr. Icahn agreed, for a period of ten years, not to engage, directly or indirectly, in any other business that generates at least 25% of its revenue or income from investment management activities (a “Competing Business”). Mr. Icahn also agreed, for a period of ten years, not to solicit on behalf of a Competing Business any investor in any of the Funds or any employee of any general partner or manager of any of the Funds.
We have also entered into an employment agreement (the “Icahn Employment Agreement”) with Mr. Icahn pursuant to which, over a five-year term, Mr. Icahn will serve as our Chairman and as Chairman and Chief Executive Officer of Icahn Capital Management LP, a Delaware limited partnership (“New Icahn Management”). Mr. Icahn also serves as the Chief Executive Officer of the General Partners. During the employment term, Mr. Icahn has agreed to devote his substantial time and efforts to overseeing our strategic and business affairs and the asset management operations of New Icahn Management, subject in each case to his ability to continue to engage in certain permitted outside activities relating to his ongoing investment and business endeavors. During his period of employment, and for a period of two years following a termination
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of employment upon his resignation (other than for “Good Reason,” as such term is defined in the Icahn Employment Agreement), or a termination upon expiration of the employment term (or subsequent termination of employment if he remains employed following the expiration of the term), Mr. Icahn will be subject to non-competition restrictions that will prohibit him from engaging in business activities that generate in excess of 25% of their revenue or income from investment management activities and additional restrictions that will prohibit him from soliciting investors in funds under our management or soliciting or hiring investment professionals or executives of ours or New Icahn Management. In the event Mr. Icahn is terminated during the term by us without “Cause” or he resigns for “Good Reason” (other than in connection with a change in control) the period of non-competition will be one year following such termination. Mr. Icahn will not be subject to any such post-termination restrictions if his employment is terminated as a result of his death or disability or the termination by him for “Good Reason” or by us without “Cause,” in each case in connection with a change in control.
During the employment term, we will pay Mr. Icahn an annual base salary of $900,000 and an annual incentive bonus based on a bonus formula with two components. The first component is based on the annual return on assets under management by the Management Entities as follows: the amount of this bonus component is determined by applying a percentage payout rate (ranging from 0.30% to 1.10%, depending on the aggregate annual percentage returns realized for the year in question) to the annual realized and unrealized net profits (prior to reduction for management fees or incentive allocations) of managed funds on all fee-paying assets under management, provided that in calculating the annual return on all fee-paying assets and the appropriate percentage payout rate, the annual profits in any year shall be reduced to reflect previously incurred losses that have not already been offset against annual returns.
The second component of the annual bonus payable by us is tied to the growth in our annual net income (other than income or losses resulting from the operations of the Management Entities) (“Covered Net Income”) as compared to a fixed annual base amount of $400 million (pro-rated for 2007) (the “Base Amount”) as follows: no portion of this annual bonus shall be payable unless Covered Net Income for the bonus year under consideration equals or exceeds the Base Amount, in which case the annual bonus shall consist of an increasing percentage of the amount by which Covered Net Income exceeds the Base Amount (ranging generally from 8% to 20%). In determining Covered Net Income, certain adjustments are provided for, including the exclusion of expenses relating to bonus determination under the Icahn Employment Agreement and expenses relating to the acquisition described above. Further, in determining this bonus component, net losses (if any) from the prior calendar years are carried forward and applied to reduce the payout amount through the application of an adjustment factor, determined as follows: Covered Net Income for the bonus year in question will be multiplied by a fraction (no less than zero) where (x) the numerator is equal to current year Covered Net Income minus any carried forward net loss, and (y) the denominator is equal to the current year Covered Net Income.
Fifty percent of all bonus amounts payable by us and New Icahn Management shall be subject to mandatory deferral and treated as though invested in the funds and as though subject to a 2% annual management fee (but no incentive allocation). Such deferred amounts shall be subject to vesting in equal annual installments over a three-year period commencing from the last day of the year giving rise to the bonus. Amounts deferred generally are not subject to acceleration and unvested deferred amounts shall be forfeited if Mr. Icahn ceases to be employed under his employment agreement, provided that all deferred amounts shall vest in full and be payable in a lump sum payment thereafter if either the employment of Mr. Icahn is terminated by us without “Cause,” Mr. Icahn terminates his employment for “Good Reason” or upon Mr. Icahn’s death or disability during the employment term. In addition, upon Mr. Icahn’s completion of service through the end of the employment term, Mr. Icahn will also vest in full in any mandatory deferrals. Vested deferred amounts (and all deferred returns, earnings and profits thereon) shall be paid to Mr. Icahn within sixty (60) days following the vesting date. Returns on amounts subject to deferral shall be subject to management fees charged by New Icahn Management, but not any incentive fees.
In the event that Mr. Icahn is terminated by us without “Cause” or he terminates his employment for “Good Reason,” he shall be entitled to a lump sum payment equal to one year of base salary, the average aggregate annual bonus paid to him by us during the three most recently completed years (or the average annualized bonus paid to him for any shorter period during which he has been employed) and a pro rata
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Annual Bonus for the year of termination. If, within twelve (12) months following the occurrence of a change in control of us, Mr. Icahn is terminated by us without “Cause” or he resigns for “Good Reason” (which is limited to defined events relating to a material adverse change in his position and responsibilities, our material breach of the Icahn Employment Agreement or the relocation of his principal place of work), Mr. Icahn shall be entitled to a payment equal to two times his base salary and two times the Average Bonus and a pro-rata Annual Bonus for the year of termination. If Mr. Icahn is terminated as a result of his death or disability, he (or his estate, if applicable) shall receive a lump sum payment equal to the remaining base salary payable through December 31 of the year of termination, any unpaid bonus relating to prior years and one-half of the pro rata Annual Bonus for the year of termination (based on actual results through the date of termination annualized for the year of termination). If Mr. Icahn resigns without “Good Reason,” he shall be entitled to certain accrued benefits, one-half of any unpaid bonus relating to prior years and one-half of the pro-rata Annual Bonus (as determined in the case of death or disability). All such payments shall be conditioned on Mr. Icahn (or his estate, if applicable) signing a general release in favor of us and our affiliates.
If at any time between the effective date of the Icahn Employment Agreement and the fifth anniversary of such date Mr. Icahn ceases to serve as Chairman and Chief Executive Officer of New Icahn Management and as the individual primarily responsible for the management of the Funds’ investment portfolios for any reason, Mr. Icahn (directly or through his affiliates other than AREP) will be required to maintain investments in one or more of the Funds for a defined commitment period (the later of the fifth (5th) anniversary of the effective date of the Icahn Employment Agreement or the third anniversary of his cessation of management responsibility for the Funds) an aggregate amount equal to not less than $1 billion (along with any amounts earned thereon) (the “Committed Funds”), except that he shall not have any obligation regarding the Committed Funds if his employment has been terminated without “Cause” by the affirmative vote of a majority of the Board including a majority of the independent directors. During such period of time, the Committed Funds will be subject to a management fee of 2% and an incentive allocation of 20%. If at any time during this commitment period the value of the Committed Funds falls below $1 billion, the management fee and incentive allocation assessed against the Committed Funds will be equal to the fees applicable if the value of the Committed Funds were $1 billion.
During the employment term, Mr. Icahn shall also be entitled to participate in our benefit programs and receive the level of perquisites generally made available to our senior executives.
The Contribution Agreement and the transactions contemplated thereby and the Icahn Employment Agreement were approved by the Special Committee of the independent directors of our general partner, and by the full board of directors. The Special Committee was represented by Debevoise & Plimpton LLP as its independent counsel. In addition, Sandler O’Neill & Partners, L.P. was retained by the Special Committee as its financial adviser. The Special Committee also retained Johnson & Associates, Inc. and BDO Seidman, LLP to advise on the terms of Mr. Icahn’s employment agreement.
CCI Offshore is the general partner of Icahn Offshore LP, a Delaware limited partnership (“Offshore GP”), which, in turn, is the general partner of each of Icahn Partners Master Fund LP, a Cayman Islands exempted limited partnership (“Offshore Master Fund I”), Icahn Partners Master Fund II L.P., a Cayman Islands exempted limited partnership (“Master Fund II”), and Icahn Partners Master Fund III L.P., a Cayman Islands exempted limited partnership (“Master Fund III” and, collectively with Offshore Master Fund I and Master Fund II, the “Offshore Master Funds”).
CCI Onshore is the general partner of Icahn Onshore LP, a Delaware limited partnership (“Onshore GP” and together with Offshore GP, the “General Partners”), which, in turn, is the general partner of Icahn Partners LP, a Delaware limited partnership (“Onshore Master Fund” and, collectively with the Offshore Master Funds, the “Master Funds”).
CCI Offshore contributed to us 100% of CCI Offshore’s general partnership interests in Offshore GP (the “Offshore Partnership Interests”) and CCI Onshore contributed to us 100% of CCI Onshore’s general partnership interests in Onshore GP (the “Onshore Partnership Interests”). The General Partners’ capital account with respect to the Offshore Partnership Interests and the Onshore Partnership Interests at the time of our acquisition aggregated $10 million.
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Immediately prior to the execution and delivery of the Contribution Agreement, Icahn Management and New Icahn Management entered into an agreement pursuant to which Icahn Management contributed substantially all of its assets and liabilities, other than certain rights in respect of deferred management fees, to New Icahn Management in exchange for 100% of the general partnership interests in New Icahn Management. Such contribution included the assignment of the Management Agreements with the Funds. Pursuant to the Contribution Agreement, Icahn Management contributed to us 100% of Icahn Management’s general partnership interests in New Icahn Management (the “New Icahn Management Partnership Interests” and collectively with the Onshore Partnership Interests and the Offshore Partnership Interests, the “Partnership Interests”).
We and the Funds also entered into an agreement (the “Covered Affiliate Agreement”), simultaneously with the closing of the transactions contemplated by the Contribution Agreement, pursuant to which we (and certain of our subsidiaries) agreed, in general, to be bound by certain restrictions on our investments in any assets that the Offshore GP and the Onshore GP deem suitable for the Funds, other than government and agency bonds, cash equivalents and investments in non-public companies. We and our subsidiaries will not be restricted from making investments in the securities of certain companies in which Mr. Icahn or companies he controlled had an interest in as of the date the initial Funds launched, and companies in which we currently have an interest. We and our subsidiaries, either alone or acting together with a group, will not be restricted from (i) acquiring all or any portion of the assets of any public company in or in connection with a negotiated transaction or series of related negotiated transactions or (ii) engaging in a negotiated merger transaction with a public company and, pursuant thereto, conducting and completing a tender offer for securities of the company. The terms of the Covered Affiliate Agreement may be amended, modified or waived with the consent of AREP and each of the Funds, provided, however, that a majority of the members of an investor committee maintained for certain of the Funds (which includes the three largest investors of certain of the Funds not affiliated with Mr. Icahn and who wish to serve as members) may (with AREP’s consent) amend, modify or waive any provision of the Covered Affiliate Agreement with respect to any particular transaction or series of related transactions.
Item 6. Exhibits
The list of exhibits required by Item 601 of Regulation S-K and filed as part of this report is set forth in the Exhibit Index.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
AMERICAN REAL ESTATE PARTNERS, L.P.
| By: | American Property Investors, Inc.,
its general partner |
| By: | /s/ KEITH MEISTER
Keith Meister
Principal Executive Officer |
Date: August 9, 2007
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EXHIBITS INDEX
 | | |
| Exhibit No. | | Description |
| Exhibit 10.1 | | Contribution and Exchange Agreement by and among American Real Estate Partners, L.P., CCI Offshore Corp., CCI Onshore Corp., Icahn Management LP and Carl C. Icahn |
| Exhibit 10.2 | | Employment Agreement by and among American Real Estate Partners, L.P., Icahn Capital Management LP and Carl C. Icahn |
| Exhibit 10.3 | | Non-Competition Agreement by and between American Real Estate Partners, L.P. and Carl C. Icahn |
| Exhibit 10.4 | | Covered Affiliate and Shared Expenses Agreement by and among American Real Estate Partners, L.P., Icahn Partners LP, Icahn Fund Ltd., Icahn Fund II Ltd., Icahn Fund III Ltd., Icahn Partners Master Fund L.P., Icahn Partners Master Fund II L.P., Icahn Partners Master Fund III L.P., Icahn Cayman Partners, L.P. and Icahn Partners Master Fund II Feeder LP |
| Exhibit 10.5 | | Amendment No. 1 to the Registration Rights Agreement, dated as of June 30, 2005, by and among American Real Estate Partners, L.P. and the Holders (as defined therein) |
| Exhibit 31.1 | | Certification of Principal Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. |
| Exhibit 31.2 | | Certification of Principal Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. |
| Exhibit 32.1 | | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002. |
| Exhibit 32.2 | | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002. |
