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Pinnacle Entertainment, Inc. 10-Q 2006
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

 

¨ 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: 001-13641

 


PINNACLE ENTERTAINMENT, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   95-3667491
(State of Incorporation)  

(I.R.S. Employer

Identification No.)

3800 Howard Hughes Parkway

Las Vegas, NV 89109

(Address of Principal Executive Offices) (Zip Code)

(702) 784-7777

(Registrant’s Telephone Number, Including Area Code)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer    x  Accelerated Filer    ¨  Non-Accelerated Filer    ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

The number of outstanding shares of the registrant’s common stock, as of the close of business on November 6, 2006: 48,075,156.

 



Table of Contents

PINNACLE ENTERTAINMENT, INC.

TABLE OF CONTENTS

 

   PART I   

Item 1.

  

Financial Statements (Unaudited)

  
  

Condensed Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2006 and 2005

   1
  

Condensed Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005

   2
  

Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2006 and 2005

   3
  

Notes to Condensed Consolidated Financial Statements (Unaudited)

   4

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   34
  

Results of Operations

   36
  

Liquidity and Capital Resources

   40
  

Other Supplemental Data

   44
  

Contractual Obligations and Other Commitments

   47
  

Factors Affecting Future Operating Results

   47
  

Critical Accounting Policies

   48
  

Forward-Looking Statements

   48

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   49

Item 4.

  

Controls and Procedures

   50
   PART II   

Item 1.

  

Legal Proceedings

   51

Item 1A.

  

Risk Factors

   53

Item 6.

  

Exhibits

   56

Signature

   58


Table of Contents

PART I

ITEM 1.    FINANCIAL STATEMENTS

PINNACLE ENTERTAINMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

    For the three months
ended September 30,
    For the nine months
ended September 30,
 
    2006     2005     2006     2005  
    (in thousands, except per share data)  

Revenues:

       

Gaming

  $ 199,000     $ 141,616     $ 599,043     $ 369,277  

Food and beverage

    12,540       11,199       34,973       26,113  

Truck stop and service station

    9,628       9,354       23,643       21,212  

Hotel and recreational vehicle park

    9,286       7,480       23,884       14,256  

Other operating income

    6,275       4,761       18,156       10,588  
                               
    236,729       174,410       699,699       441,446  
                               

Expenses and other costs:

       

Gaming

    111,437       92,223       333,702       224,916  

Food and beverage

    11,592       11,784       32,966       25,741  

Truck stop and service station

    9,139       8,885       22,360       20,009  

Hotel and recreational vehicle park

    4,117       3,866       11,126       7,130  

General and administrative

    44,764       33,775       127,813       84,700  

Depreciation and amortization

    17,341       16,329       50,710       38,339  

Other operating expenses

    3,001       3,107       7,639       7,384  

Pre-opening and development costs

    6,963       2,322       18,003       26,289  
                               
    208,354       172,291       604,319       434,508  
                               

Operating income

    28,375       2,119       95,380       6,938  

Merger termination proceeds, net of expenses

    0       0       44,821       0  

Other non-operating income

    5,551       725       11,519       2,663  

Interest expense, net of capitalized interest

    (13,055 )     (14,096 )     (40,740 )     (34,719 )

Loss on early extinguishment of debt

    0       67       0       (1,352 )
                               

Income (loss) from continuing operations before income taxes

    20,871       (11,185 )     110,980       (26,470 )

Income tax (expense) benefit

    (8,284 )     14,943       (44,272 )     19,671  
                               

Income (loss) from continuing operations

    12,587       3,758       66,708       (6,799 )

Income from discontinued operations, net of taxes

    9,805       1,284       15,165       5,432  
                               

Net income (loss)

  $ 22,392     $ 5,042     $ 81,873     $ (1,367 )
                               

Income (loss) per common share—basic

       

Income (loss) from continuing operations

  $ 0.26     $ 0.09     $ 1.40     $ (0.17 )

Income from discontinued operations, net of taxes

    0.21       0.03       0.32       0.14  
                               

Income (loss) per common share—basic

  $ 0.47     $ 0.12     $ 1.72     $ (0.03 )
                               

Income (loss) per common share—diluted

       

Income (loss) from continuing operations

  $ 0.25     $ 0.09     $ 1.36     $ (0.17 )

Income from discontinued operations, net of taxes

    0.20       0.03       0.31       0.14  
                               

Income (loss) per common share—diluted

  $ 0.45     $ 0.12     $ 1.67     $ (0.03 )
                               

Number of shares—basic

    48,022       40,812       47,464       40,617  

Number of shares—diluted

    49,481       43,440       49,033       40,617  

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Table of Contents

PINNACLE ENTERTAINMENT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

     September 30,
2006
    December 31,
2005
 
    

(in thousands,

except share data)

 
ASSETS     

Current Assets:

    

Cash and cash equivalents

   $ 302,241     $ 147,332  

Insurance receivable related to inventory and continuing expenses

     0       16,734  

Accounts receivable, net of allowance for doubtful accounts of $3,116 and $3,349

     18,939       16,777  

Inventories

     6,376       6,435  

Prepaid expenses and other assets

     17,815       16,141  

Income tax receivable

     4,719       4,742  

Deferred income taxes

     6,573       5,819  
                

Total current assets

     356,663       213,980  

Restricted cash

     5,695       9,138  

Insurance receivable related to property and equipment impairment charges

     0       32,813  

Property and equipment, net

     917,934       890,318  

Goodwill

     26,656       26,656  

Gaming licenses, net

     20,934       21,082  

Debt issuance costs, net

     18,441       21,091  

Investment in bonds

     61,762       0  

Deposits on pending transactions

     76,769       0  

Other assets

     11,651       7,330  

Assets held for sale

     45,000       22,469  
                
   $ 1,541,505     $ 1,244,877  
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current Liabilities:

    

Accounts payable

   $ 32,396     $ 40,651  

Accrued interest

     7,348       10,766  

Accrued compensation

     29,067       34,064  

Other accrued liabilities

     76,784       57,412  

Current portion of long-term debt

     146       139  
                

Total current liabilities

     145,741       143,032  

Long-term debt, less current portion

     637,241       657,534  

Other long-term liabilities

     15,944       1,474  

Deferred income taxes

     47,261       4,497  

Liabilities associated with assets held for sale

     0       10,526  

Commitments and contingencies (Note 9)

    

Stockholders’ Equity:

    

Preferred stock

     0       0  

Common stock—$0.10 par value, 48,060,242 and 40,975,588 shares outstanding, net of treasury shares

     5,007       4,298  

Additional paid in capital

     621,378       435,512  

Retained earnings

     101,076       19,203  

Accumulated other comprehensive loss

     (12,053 )     (11,109 )

Treasury stock, at cost

     (20,090 )     (20,090 )
                

Total stockholders’ equity

     695,318       427,814  
                
   $ 1,541,505     $ 1,244,877  
                

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Table of Contents

PINNACLE ENTERTAINMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

     For the nine months
ended September 30,
 
     2006     2005  
     (in thousands)  

Cash flows from operating activities:

    

Net income (loss)

   $ 81,873     $ (1,367 )

Depreciation and amortization

     50,710       45,189  

Gain on sale of assets

     (27,165 )     0  

Amortization of debt issuance costs

     2,722       2,410  

Asset impairment

     4,939       0  

Share-based compensation expense

     3,916       0  

Excess tax benefits relating to share-based payment arrangements

     (1,046 )     0  

Loss on early extinguishment of debt

     0       1,352  

Changes in working capital:

    

Accounts and insurance receivables, net

     (9,066 )     (16,182 )

Prepaid expenses and other assets

     (2,190 )     (5,632 )

Accounts payable

     (10,784 )     9,513  

Other accrued liabilities

     21,484       (1,971 )

Accrued interest

     (3,418 )     (5,411 )

Change in deferred taxes

     43,331       0  

All other, net

     396       (2,381 )
                

Net cash provided by operating activities

     155,702       25,520  
                

Cash flows from investing activities:

    

Decrease in restricted cash

     3,443       46,582  

Additions to property and equipment

     (128,401 )     (223,489 )

Receipts from disposition of property and equipment

     43,526       178  

Receipts from insurance proceeds

     60,000       5,000  

Investment in bonds

     (61,762 )     0  

Deposits on pending transactions

     (76,769 )     0  

Other

     (1,313 )     0  
                

Net cash used in investing activities

     (161,276 )     (171,729 )
                

Cash flows from financing activities:

    

Proceeds from credit facility

     0       199,008  

Payment of credit facility

     (20,000 )     (69,000 )

Payment of senior subordinated notes

     0       (65,000 )

Payment of other secured and unsecured notes payable

     (1,349 )     (1,854 )

Debt issuance costs

     (72 )     (1,002 )

Common stock options exercised

     1,930       4,464  

Common stock equity offering

     178,862       0  

Excess tax benefits relating to share-based payment arrangements

     1,046       0  

Other financing activities, net

     232       146  
                

Net cash provided by financing activities

     160,649       66,762  
                

Effect of exchange rate changes on cash and cash equivalents

     (166 )     (151 )
                

Increase (decrease) in cash and cash equivalents

     154,909       (79,598 )

Cash and cash equivalents at the beginning of the period

     147,332       202,374  
                

Cash and cash equivalents at the end of the period

   $ 302,241     $ 122,776  
                

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1—Summary of Significant Accounting Policies

General Pinnacle Entertainment, Inc. owns and operates gaming entertainment facilities in numerous gaming markets. These include five properties in the United States, located in southeastern Indiana (“Belterra Casino Resort”); Lake Charles, New Orleans and Bossier City, Louisiana (“L’Auberge du Lac,” “Boomtown New Orleans” and “Boomtown Bossier City,” respectively); and Reno, Nevada (“Boomtown Reno”).

In addition, we are building a major casino-hotel in downtown St. Louis, Missouri (“St. Louis City Project”) and a major casino-hotel in south St. Louis County, Missouri (to be known as the “River City Project”); we own the Embassy Suites Hotel adjacent to the St. Louis City Project; and are seeking to purchase a riverboat casino within walking distance of our St. Louis City Project.

We have also signed an agreement to purchase The Sands Hotel & Casino in Atlantic City, New Jersey and adjacent real estate parcels, including the Traymore site (collectively, the “Sands/Traymore site”); we have signed an agreement to acquire certain gaming assets that include two additional gaming licenses in Louisiana, one of which we intend to utilize to build a second casino resort in Lake Charles (“Sugarcane Bay”) and the other of which we intend to utilize to develop a new casino in Baton Rouge, Louisiana; and we are one of five companies that have filed a gaming license application for one of two available licenses in Philadelphia, Pennsylvania.

Internationally, we operate several small casinos in Argentina (“Casino Magic Argentina”); and since May 2006, we have operated a casino adjoining the Four Seasons Resort Great Exuma at Emerald Bay in the Bahamas (“The Casino at Emerald Bay”); we have also filed a gaming license application for an available license in Rancagua, Chile.

Finally, we have a significant insurance claim and related lawsuit associated with a casino-hotel previously operated in Biloxi, Mississippi (“Casino Magic Biloxi”), which casino barge was destroyed by Hurricane Katrina, and which site we are in the process of selling (see Note 3).

Acquisition On September 3, 2006, we entered into an acquisition agreement with Atlantic Coast Entertainment Holdings, Inc. (“ACE Hi”), American Real Estate Holdings Limited Partnership (“AREH”) and certain entities owned by or affiliated with AREH to acquire the Sands/Traymore site for approximately $250 million, plus an additional $20 million for certain tax-related benefits and additional real estate. Cumulatively, the land being acquired comprises approximately 18 contiguous acres at the heart of Atlantic City, with extensive frontage along The Boardwalk, Pacific Avenue and Brighton Park. Pursuant to the purchase agreement, we deposited $50 million into an escrow account toward the purchase price as included in “Deposits on pending transactions” on the consolidated balance sheet at September 30, 2006.

We anticipate completing the acquisition in mid-November 2006. Prior to our acquisition and consistent with the purchase agreement, the existing casino-hotel, including all retail and guest amenity services, will be closed. We plan to design and build an entirely new casino-hotel on the site, which is intended to be among the largest and most spectacular resorts in the region.

The transaction is subject to the satisfaction of customary closing conditions and is not subject to financing.

Terminated Merger Agreement In March 2006, we entered into an agreement to acquire Aztar Corporation for $38 per share, subject to approval by Aztar’s shareholders. Under the agreement, Aztar’s board was permitted to evaluate and recommend to its shareholders any unsolicited, superior proposals from qualified entities in accordance with its fiduciary duties. We had the right to match any such proposals. If we chose to not match a superior proposal, Aztar could terminate the merger agreement with proper notification to us and by making a merger termination payment.

 

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Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

During April and May, Aztar received several proposals that its board deemed to be superior to ours. We matched or exceeded several of these proposals. Ultimately, we chose not to match a proposal to acquire Aztar for $54 per share. Aztar’s board then terminated its merger agreement with us and made a merger termination payment of $78 million.

We utilized the services of several investment banking and legal firms in pursuing our planned acquisition of Aztar. In payment for such services, and in particular for the commitment of more than $3.5 billion of capital that would have been needed to consummate the transaction, these firms were paid significant fees, some of which involved percentages of our merger termination fee, subject to a cap. Net of such fees and expenses, the merger termination payment received by us was approximately $44.8 million. This, in accordance with current accounting principles, is included in our cash provided by operating activities on the condensed consolidated statements of cash flows for the nine months ended September 30, 2006.

Basis of Presentation The accompanying interim condensed consolidated financial statements include the accounts of Pinnacle Entertainment, Inc. and subsidiaries and have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, the interim condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the interim condensed consolidated financial statements presented herein reflect all adjustments of a normal and recurring nature, which are considered necessary for a fair presentation of the results for the interim periods presented, and all inter-company accounts and transactions have been eliminated. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ended December 31, 2006. The condensed consolidated financial statements and these notes to the condensed consolidated financial statements reflect certain assets held for sale and the related treatment of operations of such assets as discontinued for all periods presented. These condensed financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005.

Use of Estimates The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and (iii) the reported amounts of revenues and expenses during the reporting period. Estimates used by us include, among other things, (i) the evaluation of the non-impairment of property, equipment and other long-term assets, (ii) the evaluation of the future realization of deferred tax assets, (iii) the determination of the adequacy of reserves, and (iv) estimates of the forfeiture rate, expected life of the option and stock price volatility when computing the share-based compensation expense. Actual results could differ from those estimates.

Accounts Receivable Accounts receivable consist primarily of casino, hotel and other receivables, net of an allowance for doubtful accounts of $3,116,000 and $3,349,000 as of September 30, 2006 and December 31, 2005, respectively. The allowance for doubtful accounts is estimated based upon, among other things, collection experience, customer credit evaluations and the age of the receivables.

We extend casino credit to approved customers following background checks and investigations of creditworthiness. In May 2005, we opened L’Auberge du Lac, wherein we have experienced, and anticipate continuing to experience, a higher volume of credit play than has historically been experienced at our other casinos.

 

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Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Deposits on Pending Transactions Deposits on pending transactions includes monies we have in escrow for the Sands/Traymore site and the Harrah’s Entertainment, Inc. (“Harrah’s”) acquisitions and the President Casino riverboat purchase. Also included is a portion of the monies received from the Hollywood Park Casino sale, which is held by a qualified intermediary while we explore the potential of a deferred like-kind exchange of the property under Section 1031 of the Internal Revenue Code (see Note 6).

Capitalization of Interest Capitalized interest was $1,466,000 and $142,000 for the three months ended September 30, 2006 and 2005, respectively, and $2,815,000 and $6,663,000 for the nine months ended September 30, 2006 and 2005, respectively. Such amounts were deducted from interest expense on the accompanying condensed consolidated statements of operations and represent the cost of capital incurred on construction projects while they are under construction. The 2006 capitalized interest relates primarily to the St. Louis projects, which interest will increase as the accumulated investment in the projects increases. The 2005 capitalized interest was primarily related to construction of L’Auberge du Lac, which opened in May 2005.

Debt Issuance Costs and Related Amortization Amortization of debt issuance costs included in interest expense was $908,000 and $770,000 for the three months ended September 30, 2006 and 2005, respectively, and $2,721,000 and $2,352,000 for the nine months ended September 30, 2006 and 2005, respectively. Accumulated amortization as of September 30, 2006 and December 31, 2005 was $7,322,000 and $4,601,000, respectively.

Revenue Recognition Revenues in the accompanying condensed consolidated statements of operations exclude the retail value of hotel rooms, food and beverage and other items provided to patrons on a complimentary basis. Complimentary revenues that have been excluded from the accompanying condensed consolidated statements of operations are $20,528,000 and $17,151,000 for the three months ended September 30, 2006 and 2005, respectively, and $60,950,000 and $39,602,000 for the nine months ended September 30, 2006 and 2005, respectively. The estimated cost of providing these promotional allowances (which is included in gaming expenses) was $15,831,000 and $14,293,000 for the three months ended September 30, 2006 and 2005, respectively, and $47,531,000 and $31,440,000 for the nine months ended September 30, 2006 and 2005, respectively. The majority of the increase in complimentary revenue and the associated cost results from the May 2005 opening of L’Auberge du Lac.

Advertising Costs Advertising costs (excluding such expenses included in pre-opening and development costs) were $5,453,000 and $6,881,000 for the three months ended September 30, 2006 and 2005, respectively, and $15,121,000 and $13,448,000 for the nine months ended September 30, 2006 and 2005, respectively. Such costs are included in gaming expenses on the accompanying condensed consolidated statements of operations.

Pre-opening and Development Costs Pre-opening and development costs in the 2006 periods were primarily associated with the St. Louis development projects and the Sands/Traymore site acquisition. L’Auberge du Lac and the St. Louis development projects accounted for most of such costs in the 2005 periods.

Other Non-operating Income In addition to interest income in each period, other non-operating income for the three and nine months ended September 30, 2006 includes a gain on the sale of Aztar stock of $1,803,000.

Comprehensive Income We do not actively trade equity securities and therefore, pursuant to Statement of Financial Accounting Standard No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” we record any after-tax, unrealized gain or loss associated with owned securities during a period to accumulated “Other Comprehensive Income” account until such time as we dispose of such securities, at which time we record a pre-tax gain or loss on the consolidated statements of operations. We determine fair value of the securities based on the closing market price of the securities.

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Based on the sale of a portion of the equity securities in the 2006 third quarter, we reversed an unrealized after-tax gain in the “Other Comprehensive Income” account of $1,081,000 in the three months ended September 30, 2006. However, as we held some remaining securities at September 30, we had an after-tax unrealized gain of $2,000 for the 2006 year-to-date period. We did not hold any such securities as of September 30, 2005.

Our comprehensive income (loss), which is the sum of net income (loss) and our foreign currency translation activity and unrealized gain (loss) on securities, is as follows:

 

    For the three months
ended September 30,
    For the nine months
ended September 30,
 
    2006     2005     2006     2005  
    (in thousands)  

Net income (loss)

  $ 22,392     $ 5,042     $ 81,873     $ (1,367 )

Foreign currency translation loss

    (371 )     (323 )     (946 )     (57 )

Unrealized gain (loss) on securities, net of income taxes

    (1,081 )     0       2       0  
                               

Comprehensive income (loss)

  $ 20,940     $ 4,719     $ 80,929     $ (1,424 )
                               

Earnings per Share Diluted earnings per share assume exercise of in-the-money stock options (those options with exercise prices at or below the weighted average market price for the periods presented) outstanding at the beginning of the period or at the date of the issuance, unless the assumed exercises are antidilutive. We calculate the effect of dilutive securities using the treasury stock method. As of September 30, 2006 and 2005, our only share-based awards issued under our Stock Option Plans (defined below) were common stock option grants.

For the three and nine months ended September 30, 2006, the dilutive effect of the in-the-money common stock options was an increase of 1,459,000 and 1,569,000 shares, respectively. There were 284,000 common stock options in the 2006 periods that were not in-the-money.

For the three and nine months ended September 30, 2005, the dilutive effect of the in-the-money common stock options was an increase of 2,628,000 and 2,160,000 shares, respectively, which amounts were not affected by the adoption of SFAS No. 123R. As we incurred a net loss in the nine-month period and the inclusion of the in-the-money options would be antidilutive, the shares were not included in the diluted calculation for that period. All of the common stock options were in-the-money in the 2005 periods.

Recently Issued Accounting Pronouncements Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”) In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment,” which requires all companies to measure compensation costs for all share-based payments (including employee stock options) at “fair value.” This statement became effective for us January 1, 2006. See Note 2 for additional information.

FASB Interpretation No. 48 (“FIN 48”) In July 2006, the FASB released FIN 48, “Uncertainty in Income Taxes,” which defines accounting for uncertain tax positions and includes amendments to SFAS No. 109, “Accounting for Income Taxes.” FIN 48 addresses the recognition, measurement, classification and disclosure issues related to the recording of financial statement benefits for income tax positions that have some degree of uncertainty. FIN 48 is effective for us January 1, 2007 (our first fiscal year after December 15, 2006). We have not yet determined the effect FIN 48 will have on our consolidated financial statements.

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”) In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value in GAAP and expands disclosures about fair value measurements. This Statement is effective for us January 1, 2008 (our first fiscal year after November 15, 2007). We have not yet determined the effect, if any, SFAS No. 157 will have on our consolidated financial statements.

Statement of Financial Accounting Standards No. 158 (“SFAS No. 158”) In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-An amendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. This Statement is effective for us December 31, 2006 (effective the first fiscal year-end after December 15, 2006). We have not yet determined the effect, if any, SFAS No. 158 will have on our consolidated financial statements.

Staff Accounting Bulletin No. 108 (“SAB No. 108”) In September 2006, the SEC released SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB No. 108 requires companies to quantify misstatements using both a balance-sheet and income-statement approach to evaluate whether an error is material in light of relevant quantitative and qualitative factors. This statement is effective for us in the quarter ended March 31, 2007 (the first quarter after our fiscal year ends on December 31, 2006). We have not yet determined the effect, if any, SAB No. 108 will have on our consolidated financial statements.

Note 2—Stock-based Compensation

As of September 30, 2006, we have approximately 5.8 million share-based awards issued, all of which are common stock options. Such options have been granted pursuant to our 2005 Equity and Performance Incentive Plan, (which plan provides for the granting of stock options, stock appreciation rights, restricted stock and other performance awards—the “2005 Plan”), prior stock option plans or are individual stock option grants (collectively, the “Stock Option Plans”). There were approximately 1.05 million share-based awards remaining available for grant under the 2005 Plan as of September 30, 2006.

Our stock options become exercisable ratably over a vesting period as determined by the Compensation Committee of our board of directors (the “Compensation Committee”) (generally five years for options granted since mid-2002 and three years for options granted prior to such time period) and expire over terms not exceeding 10 years from the date of grant. The purchase price for all shares granted under the Stock Option Plans shall be determined by the Compensation Committee, but in the case of incentive stock options, the price will not be less than the fair market value of the common stock at the date of grant. Substantially all options issued historically have been exercisable at the market price on the date of the grant.

In October 2006, we granted 50,000 shares of restricted stock pursuant to the 2005 Plan. Such restricted stock vests in five equal annual installments on each January 31 of 2007, 2008, 2009, 2010 and 2011.

On January 1, 2006, we adopted SFAS No. 123R using the modified prospective method. Accordingly, we have not restated prior-year amounts. Pursuant to SFAS No. 123R, for all share-based awards granted after the adoption of SFAS No. 123R and for the unvested portion of previously granted share-based awards that were outstanding on the date of adoption, compensation costs related to our share-based payment transactions are to be measured at fair value on the grant date and recognized in the financial statements over the vesting period during which the employee provides service in exchange for the award.

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Pursuant to SFAS No. 123R, we recorded pre-tax compensation expense of approximately $1.3 million and $3.9 million in the three and nine months ended September 30, 2006, respectively, all of which was incremental expense as we did not incur share-based compensation prior to the adoption of SFAS No. 123R. Such expense resulted in a reduction in net income of $812,000 (net of a tax benefit of $534,000) for the three months ended September 30, 2006 and approximately $2.4 million (net of a tax benefit of approximately $1.6 million) for the nine months ended September 30, 2006. The reduction of diluted earnings per share was $0.02 and $0.05 for the three and nine months ended September 30, 2006, respectively. Theoretical compensation costs not yet amortized related to stock options granted totaled approximately $20.4 million at September 30, 2006, and the weighted average period over which the costs are expected to be recognized is approximately three years.

The aggregate amount of cash we received from the exercise of stock options was $546,000 and $3,501,000 for the three months ended September 30, 2006 and 2005, respectively, and $1,930,000 and $4,464,000 for the nine months ended September 30, 2006 and 2005, respectively, which shares, consistent with prior periods, were newly issued common stock. Prior to the adoption of SFAS No. 123R, we reported tax benefits resulting from the exercise of stock options as operating cash flows. In accordance with SFAS No. 123R, we now present such tax benefits as financing cash flows. Such tax benefit for the nine months ended September 30, 2006 was $1,046,000.

The following table summarizes information related to our common stock options under the Stock Option Plans:

 

     Number of
Stock Options
    Weighted Average
Exercise Price

Options outstanding at January 1, 2006

     5,504,227     $ 11.48

Granted

     600,000     $ 26.38

Exercised

     (186,154 )   $ 10.37

Cancelled

     (138,004 )   $ 12.18
          

Options outstanding at September 30, 2006

     5,780,069     $ 13.05
          

Options exercisable at September 30, 2006

     2,993,973     $ 9.61

Weighted-average value per granted option calculated using the Black-Scholes option-pricing model for options granted during the nine months ended:

    

September 30, 2006

   $ 13.46    

September 30, 2005

   $ 8.19    

Substantially all options granted in both periods have exercise prices equal to the market value on the date of grant. The increase in the value per granted option reflects the increase in our stock price and U.S. Treasury rates, offset by a decrease in our implied volatility, which are key factors in the Black-Scholes option-pricing model.

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Stock options outstanding as of September 30, 2006, were as follows:

 

Exercise Price Ranges

   Number of
Stock Options
   Weighted Average
Remaining Life
   Weighted Average
Exercise Price
   Number of
Exercisable
Stock Options
   Weighted Average
Exercise Price
          (in years)               

$5.00–$8.00

   1,042,943    6.0    $ 6.37    756,647    $ 6.34

$8.01–$9.00

   999,101    5.5    $ 8.41    978,401    $ 8.41

$9.01–$13.00

   945,900    5.6    $ 10.19    710,300    $ 10.05

$13.01–$15.00

   1,011,735    7.5    $ 14.52    318,547    $ 14.38

$15.01–$20.00

   1,180,390    8.5    $ 17.14    220,078    $ 16.97

$20.01–$30.00

   600,000    9.6    $ 26.38    10,000    $ 28.48
                  
   5,780,069    7.0    $ 13.05    2,993,973    $ 9.61
                  

Our stock price has generally risen relative to the average price on the date that our stock options were granted. As a result, the total intrinsic value of options outstanding and exercisable (which options had a weighted average remaining contractual term of 5.7 years) at September 30, 2006 was approximately $55.4 million. The total intrinsic value for stock options exercised during the three and nine months ended September 30, 2006 was approximately $820,000 and $3.5 million, respectively. The “intrinsic value” is the number of exercisable options multiplied by the excess of the current share price over the weighted average exercise price of such options.

As permitted under SFAS No. 123R, we continued to use a Black-Scholes option-pricing model in order to calculate the compensation costs of employee stock-based compensation. Such model requires the use of subjective assumptions, including the expected life of the option, the expected volatility of the underlying stock, and the expected dividend on the stock.

In computing the stock-based compensation, the following is a weighted-average of the assumptions used:

 

     Risk-Free
Interest Rate
    Expected Life
at Issuance
   Expected
Volatility
    Expected
Dividends

Options granted in the following periods:

         

September 30, 2006

   4.8 %   6.7 years    42.6 %   None

September 30, 2005

   4.0 %   6.7 years    44.7 %   None

The expected volatility was derived from the implied volatilities of traded options in our common stock. Future volatility may be substantially less or greater than the implied volatility. We do not currently pay dividends and we do not anticipate that dividends will be paid within the average expected life of existing options. U.S. Treasury rates with similar maturities are used as the proxy for the risk-free rate. The expected life at issuance is based on our experience as to the average historical term of option grants that were exercised, cancelled or forfeited.

Prior to adopting SFAS No. 123R, we accounted for our employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and related interpretations. Pursuant to APB No. 25, we did not record share-based compensation, but followed the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation.”

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following sets forth the theoretical pro forma costs and effect on our net income (loss) as if we had applied the fair value recognition provisions of SFAS No. 123R to our employee stock-based compensation plans for the three and nine months ended September 30, 2005 (in thousands, except per share data):

 

     For the three
months ended
September 30, 2005
    For the nine
months ended
September 30, 2005
 

Income (loss) from continuing operations as reported

   $ 3,758     $ (6,799 )

Pro forma stock-based compensation expense, net of taxes

     (723 )     (2,168 )
                

Pro forma income (loss) from continuing operations

     3,035       (8,967 )

Income from discontinued operations, net of taxes

     1,284       5,432  
                

Pro forma net income (loss)

   $ 4,319     $ (3,535 )
                

As reported per share data:

    

Income (loss) from continuing operations

   $ 0.09     $ (0.17 )

Income from discontinued operations, net of taxes

     0.03       0.14  
                

Net income (loss) per share—basic

   $ 0.12     $ (0.03 )
                

Income (loss) from continuing operations

   $ 0.09     $ (0.17 )

Income from discontinued operations, net of taxes

     0.03       0.14  
                

Net income (loss) per share—diluted

   $ 0.12     $ (0.03 )
                

Pro forma per share data:

    

Pro forma income (loss) from continuing operations

   $ 0.08     $ (0.22 )

Income from discontinued operations, net of taxes

     0.03       0.13  
                

Pro forma net income (loss) per share—basic

   $ 0.11     $ (0.09 )
                

Pro forma income (loss) from continuing operations

   $ 0.07     $ (0.22 )

Income from discontinued operations, net of taxes

     0.03       0.13  
                

Pro forma net income (loss) per share—diluted

   $ 0.10     $ (0.09 )
                

Number of shares:

    

Basic

     40,812       40,617  

Diluted

     43,440       40,617  

Note 3—Hurricane-Related Matters

Casino Magic Biloxi As a result of extensive damage caused by Hurricane Katrina, Casino Magic Biloxi was closed in late August 2005. In April 2006, we filed a $346.5 million insurance claim for our losses related to Casino Magic Biloxi. Net of our insurance deductible, such claim would be approximately $340 million. Such claim includes approximately $259 million for property damage, approximately $80 million for business interruption insurance (including approximately $37 million for our lost profits) and approximately $7.6 million for emergency, mitigation and demolition expenses. As of September 30, 2006, we had received $85 million in advances towards our insurance claim. In October, we received and recorded an additional $15 million.

On August 1, 2006, we filed suit in the United States District Court for the District of Nevada against three of our excess insurance carriers. Collectively, the three insurers provide $300 million of coverage in excess of $100 million of coverage provided to us by other insurers. In total, our policies applicable to the Hurricane Katrina loss provide an aggregate of up to $400 million of coverage for loss caused by a Weather Catastrophe

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Occurrence (as defined by the policies) and up to $100 million of inclusive coverage for loss caused by a Flood Occurrence (as defined by the policies). Our insurance policies also permit a “replacement” facility to be built anywhere in the United States. The three insurers are Allianz Global Risks US Insurance Company, Arch Specialty Insurance Company and RSUI Indemnity Company.

The suit alleges, among other things, that the defendants have improperly asserted that our losses were due to a Flood Occurrence as opposed to a Weather Catastrophe Occurrence; that, after the close of the proposed sale of certain Casino Magic Biloxi assets to Harrah’s, we are not covered for any continued business interruption losses at Casino Magic Biloxi; and that we are not entitled to designate our River City Project as a replacement for Casino Magic Biloxi. These positions, among others, taken by the insurers could, if upheld in the courts, materially reduce our recovery with respect to the claim.

The suit seeks damages equal to the outstanding amount of Pinnacle’s claim (totaling $346.5 million, less the $100 million paid through October 2006). It also seeks declarations that our River City Project constitutes a permissible replacement property under the applicable policies and that we are entitled to receive the full amount of Casino Magic Biloxi business interruption losses resulting from Hurricane Katrina, even though we are in the process of selling the Casino Magic Biloxi site and certain related assets to Harrah’s. Finally, the suit also seeks unspecified punitive damages for the improper actions of the defendants in connection with our claim. We anticipate that any negotiated or litigated resolution of our insurance claim will be protracted.

Although the River City Project is expected to cost more than it would have cost to rebuild and repair Casino Magic Biloxi, recovery under the policies is nevertheless limited to the lesser of what would have been the cost to rebuild and repair Casino Magic Biloxi or the actual cost incurred in constructing the River City Project.

We wrote down by approximately $57.8 million the net book value of property and equipment impaired by the storm and a corresponding insurance receivable was recorded. We also recorded receivables for inventory write-downs and expenses covered by insurance of approximately $26.2 million. We have insurance coverage for interruption of income at the property, but pursuant to GAAP will not book such income until the insurance claim is resolved.

As noted immediately above, as of September 30, 2006, we have received $85 million in advances towards our claim, approximately $1.1 million more than the insurance receivables as of such date. Therefore, we have eliminated these receivable balances. However, as the insurers have not designated the payments as being specific to any particular part of the claim, and because we anticipate incurring additional insured expenses, the excess proceeds of $1.1 million received through September 30 were recorded as a deferred gain on the consolidated balance sheet as of September 30, 2006.

The Company’s ultimate insurance claim and recovery amounts are based on replacement costs rather than book value and are unrelated to, computed differently from, and likely to be substantially larger than the impairment charges recorded.

Boomtown New Orleans In the 2006 second quarter, we filed an insurance claim aggregating approximately $11.0 million for 2005 property damage and business interruption losses associated with Hurricane Katrina at Boomtown New Orleans. Net of our insurance deductible, the claim would be approximately $6.2 million. We have not recorded any potential recovery for lost profits.

L’Auberge du Lac recorded various costs and expenses in 2005 in connection with Hurricane Rita. Our deductible amounts under our insurance policies are based on the declared value of the specific damaged asset.

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

L’Auberge du Lac is larger and was relatively less damaged than the Biloxi and New Orleans facilities. Hence, the expenses incurred and lost profits resulting from the storm do not presently appear to exceed the relevant insurance deductible. Therefore, we do not anticipate filing an insurance claim for such losses.

Note 4—Property and Equipment

Property and equipment held at September 30, 2006 and December 31, 2005 consisted of the following:

 

    

September 30,

2006

    December 31,
2005
 
     (in thousands)  

Land and land improvements

   $ 155,815     $ 175,176  

Buildings

     492,984       513,867  

Equipment

     301,494       293,450  

Vessels

     140,075       137,905  

Construction in progress

     110,522       25,880  
                
     1,200,890       1,146,278  

Less accumulated depreciation

     (282,956 )     (255,960 )
                
   $ 917,934     $ 890,318  
                

Depreciation expense for the three months ended September 30, 2006 and 2005 was $17,247,000 and $16,283,000, respectively, and $50,389,000 and $38,187,000 for the nine months ended September 30, 2006 and 2005, respectively.

On July 7, 2006, we closed on the sale of approximately 28 acres of land to Cabela’s Retail, Inc. for approximately $5.1 million. Cabela’s intends to begin construction of a large retail store featuring outdoor sporting goods adjacent to Boomtown Reno by the end of 2006 or early 2007. We currently use a portion of such land to provide parking for our existing truck stop and satellite casino and therefore are leasing back approximately 12 acres from Cabela’s for a nominal fee. That lease, which land is intended to be used by Cabela’s for surface parking, terminates on the date that is 60 days prior to the opening of the Cabela’s facility.

We also entered into an agreement under which we may sell or lease to Cabela’s an additional parcel of approximately two acres, following the receipt of certain environmental clearances. Such parcel is currently utilized by the existing truck stop and satellite casino. In connection with this transaction, we intend to begin construction of a new truck stop and satellite casino by the end of 2006 or early 2007 at another location on our Reno property. We estimate the cost to be approximately $20 million and that the project will be completed in 2007. At such time, we intend to remove the truck stop and other improvements on the two-acre parcel and begin environmental remediation activities, if needed, to obtain the environmental clearances required. In the event we are unable to obtain such clearances, and Cabela’s does not waive such condition and elects to lease the site, we would enter into a 99-year lease with Cabela’s. The net book value of the existing truck stop and satellite casino is approximately $0.2 million, which assets are being depreciated over a revised estimated life of one year.

Pursuant to current accounting guidelines, our continuing involvement in the two-acre parcel (contiguous to the larger parcel and an integral part of the transaction with Cabela’s) precludes us from recognizing a gain on the sale of the larger parcel at this time. In the event we execute the long-term lease for the smaller parcel, the gain on the larger parcel will be deferred and amortized over the 99-year lease, with such gain offset by the costs, if any, of our continued involvement with the smaller parcel. In the event Cabela’s completes a purchase of the smaller parcel, the gain on the larger parcel will be recognized at such time.

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

For tax purposes, we completed a deferred like-kind exchange of the 28-acre parcel under Section 1031 of the Internal Revenue Code with land recently acquired and therefore do not anticipate paying any income taxes on the sale of the site.

Design and development activity to improve access to the overall site has begun, with construction anticipated to commence in late 2007. It is expected a portion of the cost needed for such improvements will be financed through the issuance of industrial revenue bonds through local or state governmental authorities. The bonds are expected to be serviced by a portion of the sales taxes generated by the new retail facilities. We have agreed to purchase at par, if necessary, some of these bonds. We estimate that we may be required to purchase between $4 million and $10 million of these bonds and believe such bonds could be resold to other investors, particularly after the new retail facilities have opened.

Note 5—Expansion and Development

St. Louis Projects: In 2005, we broke ground on our St. Louis City Project, which is located adjacent to the St. Louis convention district just north of the famed Gateway Arch. The facility is planned to include a casino with approximately 2,000 slot machines and 40 table games, a 200-guestroom luxury hotel, spa, several restaurants and 12,000 square feet of meeting and convention space. The project budget is approximately $430 million. We anticipate opening the facility in the fall of 2007, subject to licensing by the Missouri Gaming Commission (“MGC”). We have also committed to arrange or provide $50 million of investment in other nearby developments within five years of the opening of the casino and hotel, $25 million of which may be satisfied by the condominium joint venture project discussed below.

Also in 2005, we completed the purchase of the Embassy Suites Hotel, a 297-suite hotel that adjoins the St. Louis City Project, at a cost of approximately $38 million. In the 2006 third quarter, we completed our analysis of the purchase price allocation, which results did not materially differ from our original purchase price allocation of approximately $5 million to land and land improvements, approximately $4 million to equipment, approximately $29 million to building and building improvements and no intangible assets. Therefore, no changes to the consolidated financial statements were required.

Overall, we own or have an option to purchase approximately 18 acres of contiguous land for and around the St. Louis City Project. Of this, approximately eight acres underlie the casino-hotel project and approximately one acre underlies the Embassy Suites. Most of the balance is expected to be utilized for surface parking at the time of the opening of the casino-hotel, but could be utilized for future development, including additional hotels or condominium projects.

We have entered into an agreement with a joint venture partner to develop a $25 million, 10-story luxury condominium project near our St. Louis City Project site (but not included in the 18 acres cited above) and overlooking the Mississippi River. In the 2006 third quarter, we invested approximately $1.3 million, which funds were used primarily to acquire land and secure non-recourse project financing of approximately $19 million (such amount was unfunded at September 30, 2006). We have remaining investment commitments to the joint venture of approximately $2.7 million.

Located within walking distance of our St. Louis City Project site is the President Casino-St. Louis riverboat casino (“President Riverboat”), which is operating under the protection of federal bankruptcy law. In early 2006, we entered into an agreement with President Casinos, Inc. to potentially purchase the President Riverboat for $31.5 million through the bankruptcy auction process. In March 2006, we deposited $1.5 million toward the purchase price of $31.5, which is included in “Deposits on pending transactions” on the consolidated balance

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

sheet at September 30, 2006. In July 2006, in order to facilitate the acquisition of the President Riverboat, we launched a tender offer to purchase all of the outstanding bonds of President Casinos, Inc., as well as the claims of other general unsecured creditors. While we anticipate retiring the bonds in connection with the transaction described below, such bonds are deemed available for sale under GAAP as of September 30, 2006. In October 2006, we reached a settlement agreement with President Casinos, Inc., President Riverboat Casino-Missouri, Inc. (“PRC-MO”) (wholly owned subsidiary of President Casinos, Inc. and owner of the President Riverboat) and the Official Committee of Equity Security Holders’ of President Casinos, Inc. (the “Equity Committee”). As part of the settlement, the Equity Committee will withdraw its competing reorganization plan and support the PRC-MO’s reorganization plan, which plan provides for the sale of 100% of the PRC-MO common stock to Pinnacle for $31.5 million. A hearing to consider confirmation of the reorganization plan is scheduled to take place on November 29, 2006. It is expected that the MGC will consider Pinnacle’s request for change of control after the PRC-MO reorganization plan is confirmed by the bankruptcy court. If the approvals are successful, we expect the purchase to be completed by the end of the year or early 2007. Pursuant to such various agreements, if consummated, we will have effectively paid approximately $41.5 million for the President Casino-St Louis and related assets. Of the difference between this amount and the original purchase price, Pinnacle may receive up to another $5 million in payments at a later date and has agreed to waive $5 million in claims.

At the River City Project, our $375 million project in south St. Louis County, site work continues. The facility is scheduled to open in late 2008, approximately one year after the opening of the St. Louis City Project, subject to licensing by the MGC. The River City Project will include a casino with approximately 3,000 slot machines and 60 table games, a 100-guestroom hotel, full-service spa, restaurants, a boutique bowling alley, a multiplex movie theatre, an indoor ice rink, a public park with athletic fields and a hatch-shell music and entertainment venue.

In 2004, we were selected by the MGC for both St. Louis projects for “priority investigation,” a term used by the MGC as an indication that it has accepted an application for licensure and that it will investigate the application on a priority basis in order to reach a final determination on licensure. In July 2006, the MGC approved the Company as a key business entity, suitable to operate the facilities if licensed at the end of the construction process. We will not be able to open either facility, nor begin operating the President Riverboat, until we have MGC approval.

Lake Charles, Louisiana: In September 2006, we broke ground on our approximately $45 million, 250-guestroom expansion of L’Auberge du Lac, which when completed will bring the total guestrooms at the property to nearly 1,000. We intend to complete such construction by the end of 2007.

In May 2006, we signed a definitive agreement under which we will acquire certain Harrah’s entities that own Lake Charles, Louisiana gaming assets, including two casino boats and related gaming licenses. Additionally, Harrah’s will acquire our Casino Magic Biloxi site and certain related assets. Harrah’s will also receive an additional payment of approximately $25 million from us as the negotiated price of the assets we are acquiring is higher than the negotiated price of the assets we are selling. Each company will retain its respective insurance claims related to extensive damage resulting from last year’s hurricanes. We expect to complete the transaction on November 9, 2006, subject to receipt of all remaining regulatory approvals.

In June 2006, we announced plans to build Sugarcane Bay, a new $350 million casino resort located adjacent to L’Auberge du Lac. Sugarcane Bay’s design suggests the laid-back island feeling of the Caribbean, combined with gracious Southern hospitality in an environment of comfortable luxury. It will feature approximately 1,500 slot machines, a state-of-the-art poker room, table games, 400 guestrooms, various dining and retail shopping amenities, a tropical pool area and an extensive spa. In August 2006, the Louisiana Gaming Control Board (“LGCB”) approved the project, subject to certain conditions (see “Sugarcane Bay Development

Conditions” in Note 9). On November 7, 2006, voters passed a required local-option referendum necessary to

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

permit the relocation of the berthing site from its current location to a site adjacent to L’Auberge du Lac. Construction on Sugarcane Bay is expected to begin in 2007, with a planned opening in 2009.

Louisiana law provides for a fixed number of casino riverboat licenses, all of which have been granted. Sugarcane Bay is planned to utilize one of the gaming licenses associated with the pending Harrah’s transaction. We continue to explore our options with regard to the other assets including the additional riverboat and gaming license included in the Harrah’s transaction. We recently purchased 54 acres of land in Baton Rouge, Louisiana and submitted plans to the LGCB for a preliminary casino on that site. Such plans include a 300-guestroom hotel and a casino with approximately 1,500 slot machines. Construction and operation of such casino will require multiple approvals, including the approval of the LGCB and passage of a local referendum in East Baton Rouge Parish.

In July 2006, we executed our option to lease an additional 60 acres of unimproved land for construction of the Sugarcane Bay casino resort. The terms of the lease for the additional acreage are substantially similar on a per-acre basis to the terms of the lease for the adjacent 242 acres at L’Auberge du Lac. The term of such lease, including all extensions, expires in May 2075. Rent is currently approximately $325 per acre, per month and adjusts periodically for inflation.

Additional Guestroom Expansions: In early 2006, we announced plans to add 250 guestrooms to Belterra Casino Resort for approximately $45 million. When complete, Belterra will have a total of approximately 850 guestrooms. In addition, we announced plans for an approximately $30 million, 200-guestroom hotel at Boomtown New Orleans, our first guestrooms at that property. We anticipate beginning construction on both expansion projects in late 2006, with completion planned for late 2007.

Philadelphia, Pennsylvania: In December 2005, we filed an application seeking one of two available gaming licenses for Philadelphia. We are one of five applicants. In April 2006, we presented our development plans to the Pennsylvania Gaming Control Board (“PGCB”). If selected, we intend to build a single-level, 80,000-square-foot casino with approximately 3,000 slot machines; 3,000 parking spaces; five restaurants; a food court; a multiplex movie theater; an expansive, outdoor waterfront reflection pool that becomes an ice skating rink in the winter; and 36,000 square feet of retail and entertainment outlets. We estimate this initial phase, including land and Pennsylvania’s $50 million initial gaming license fee, will cost between $300 million and $400 million. In connection with filing the application, we posted a $50 million letter of credit for the benefit of the PGCB. Such letter of credit will be drawn upon by the PGCB only in the event we are awarded a gaming license and we do not pay the $50 million licensing fee within approximately 10 days of the award.

Additional phases may be added to the project at a later date, contingent on the success of the initial phase, including the possible expansion of the casino to accommodate a total of approximately 5,000 slot machines, the addition of a 500-guestroom hotel tower, the construction of a residential and office tower, and the further addition of restaurants, retail and entertainment outlets.

Great Exuma, Bahamas: In May 2006, we opened The Casino at Emerald Bay, our casino located on the picturesque island of Great Exuma in the Bahamas. The Casino at Emerald Bay adjoins the Four Seasons Resort Great Exuma and is the first and only casino on the island. It includes 65 slot machines and eight table games, including blackjack, craps and roulette, as well as a full-service bar.

Chile: In August 2005, we submitted bids for two of the 17 licenses the Chilean government declared available earlier in the year—one in Antofagasta and one in Rancagua. In July 2006, the Chilean government announced that it had chosen a competing proposal for the sole license in Antofagasta. The competing proposal promised a greater investment in the market than we believed was warranted. The government’s decision regarding Rancagua is expected later this year.

 

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In connection with the filing of the applications in August 2005, we posted two letters of credit totaling approximately $2 million. Such letters of credit are for the benefit of the Chilean Superintendent of Gaming in support of our proposed projects. A letter of credit will only be drawn in the event we are awarded a gaming license and do not fulfill our construction obligations for the particular project.

Note 6—Assets Held for Sale

In April 2006, we completed the sale of our Crystal Park Casino card club for net cash proceeds of approximately $16.5 million. Although we generated a pre-tax book gain of approximately $10.7 million in the 2006 second quarter, our tax basis in the sold assets was above the sale price and therefore we do not anticipate paying any income taxes on the sale.

In connection with the agreement to sell our Casino Magic Biloxi site, we reclassified the $45 million net book value of assets being sold to Harrah’s (comprised entirely of property and equipment) to assets held for sale. In addition, the results of operations for Casino Magic Biloxi, including an impairment charge of approximately $4.9 million recorded in the 2006 first quarter, have been reported as discontinued operations for all periods, net of income taxes.

In July 2006, we closed on the sale of our leasehold interest and related receivables in the Hollywood Park Casino card club for net cash proceeds of approximately $24.2 million plus the cancellation of our lease obligation, resulting in a pre-tax book gain of approximately $16.5 million. The lease obligation was for $3 million per year and expired in 2009. We had an option to extend such lease to 2019, with the rent adjusting pursuant to a formula based upon the Consumer Price Index.

Unlike the Crystal Park Casino sale, the sale of the Hollywood Park Casino assets generated taxable income. Therefore, to enable a potential like-kind exchange of the property under Section 1031 of the Internal Revenue Code within the required 180 days, we deposited $21.7 million of the sale proceeds into a qualified intermediary account. Such funds are included in “Deposits on pending transactions” on the consolidated balance sheet at September 30, 2006.

Revenues, operating income and income from discontinued operations associated with the assets held for sale are summarized as follows:

 

     For the three months
ended September 30,
    For the nine months
ended September 30,
 
     2006     2005     2006     2005  
     (in thousands)  

Revenues

   $ 113     $ 15,124     $ 3,695     $ 62,899  
                                

Operating income

   $ 16,489     $ 2,312     $ 25,753     $ 9,624  

Interest expense

     (11 )     (154 )     (266 )     (487 )
                                

Income before income taxes

     16,478       2,158       25,487       9,137  

Income tax expense

     (6,673 )     (874 )     (10,322 )     (3,705 )
                                

Income from discontinued operations

   $ 9,805     $ 1,284     $ 15,165     $ 5,432  
                                

 

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Note 7—Long-Term Debt

Long-term debt at September 30, 2006 and December 31, 2005 consisted of the following:

 

     September 30,
2006
    December 31,
2005
 
     (in thousands)  

Secured credit facility

   $ 200,000     $ 220,000  

Unsecured 8.25% Notes due 2012

     302,913       303,227  

Unsecured 8.75% Notes due 2013

     133,276       133,144  

Other secured and unsecured notes payable

     1,198       1,302  
                
     637,387       657,673  

Less current maturities

     (146 )     (139 )
                
   $ 637,241     $ 657,534  
                

At September 30, 2006, we had a $750 million senior secured bank credit facility (the “credit facility”) consisting of a $450 million five year revolving credit facility and a $300 million six-year term loan, of which $200 million was outstanding at September 30, 2006 and $100 million of which can be drawn on a delayed basis up to July 2, 2007. During the nine months ended September 30, 2006, we repaid the $20 million of revolver facility borrowings outstanding at December 31, 2005. As of September 30, 2006, we had issued letters of credit aggregating approximately $65.8 million, which bore facility fees of 1.50% per annum, and therefore had approximately $384.2 million of the revolving credit facility available.

On October 11, 2006, we executed the second amendment to our credit facility (the “Second Amendment”), which amendment becomes effective upon completion of the acquisition of the Sands/Traymore site and receipt of regulatory approvals. The Second Amendment, among other things, modifies certain covenants of the credit facility to permit us to complete the acquisition of the Sands/Traymore site in an unrestricted subsidiary, to increase the maximum permitted consolidated leverage ratio and consolidated senior debt ratio during certain time periods, to permit capital expenditures associated with our guestroom expansions at L’Auberge du Lac, Belterra and Boomtown New Orleans, to increase the maximum permitted capital expenditures for our two St. Louis projects to a total of $850 million (consistent with and slightly higher than their current projected project costs totaling $805 million), and to establish a separate investment basket related to our planned purchase of PRC-MO.

We have received the necessary commitments from lenders for our third amendment to our credit facility, increasing the credit facility by $250 million to $1.0 billion. This consists of a $175 million increase to the revolving credit facility and a $75 million increase to the term loan. Execution of an amendment to the credit facility reflecting such increase is expected to occur in the fourth quarter.

Interest on the credit facility is subject to change based on the floating rate index selected. For borrowings under the revolving loan facility, the interest rate margin is based on our “leverage ratio,” which margin was 1.50% over LIBOR as of September 30, 2006. The term loan bore an interest rate of 7.33% per annum (2.00% over LIBOR) as of September 30, 2006. The undrawn revolver facility bore a facility fee for unborrowed amounts of 0.25% per annum as of September 30, 2006, which rate is also based on our leverage ratio. The delayed draw term loan bore a commitment fee of 0.75% per annum at September 30, 2006, which fee will increase to 1.00% per annum in December 2006 for the duration of the delayed draw period.

Under our most restrictive indenture for our unsecured notes, we are permitted to incur up to $350 million in senior indebtedness, substantially all of which was available to us as of September 30, 2006. Our indentures also

 

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permit us to incur additional indebtedness (senior or otherwise) in excess of the $350 million for debt refinancing, such as a portion of the credit facility that was used to refinance the remaining 9.25% senior subordinated notes outstanding in February 2005.

We may also incur additional indebtedness if, at the time the indebtedness is proposed to be incurred, our consolidated coverage ratio for a trailing four-quarter period on a pro forma basis (as defined in the indentures) would be at least 2.0 to 1.0. We had previously issued senior debt under the senior indebtedness basket. Based on the achievement of the 2:1 ratio at the end of the 2006 first quarter, we reclassified such debt as indebtedness incurred under the consolidated coverage ratio, thereby reinstating the ability to borrow the full amount allowed under the senior indebtedness basket. Our consolidated coverage ratio at September 30, 2006 continued to exceed 2.0 to 1.0.

The credit facility has customary restrictive financial covenants and capital spending limits, and other affirmative and negative covenants, with which we were in compliance as of September 30, 2006.

Note 8—Stockholders’ Equity

Common Stock: In early 2006, we consummated a public offering of 6.9 million newly issued common shares (including over-allotment shares) at $27.35 per share, resulting in net proceeds to us of approximately $179 million after underwriters’ fees and expenses. The funds will be used for general corporate purposes.

Shelf Registration: Also in early 2006, we filed an automatic shelf registration statement with the SEC, which registration statement was used to issue the 6.9 million shares of common stock. Such registration statement permits the issuance of debt, equity or other securities, and is not limited in the cumulative amount of securities to be issued over a three-year period. There can be no assurance, however, that we will be able to issue any additional securities on terms acceptable to us in future periods.

Note 9—Commitments and Contingencies

Redevelopment Agreement: In connection with our St. Louis City Project, we have a redevelopment agreement, which we amended in the 2006 third quarter and which, among other things, commits us to: (a) invest at least $325 million to construct a gaming and multi-use facility; (b) invest, potentially with one or more development partners, a minimum of $50 million in residential housing, retail, or mixed-use developments in the City of St. Louis within five years of the opening of the casino and hotel; (c) pay, beginning after the facility opens, the City of St. Louis annual and other services fees; and, (d) pay $10 million in penalties to the City of St. Louis if the project fails to open on or before December 31, 2008 or if the casino is unable to continue operating for a period of at least 10 years from the date of initial licensure.

Lease and Development Agreement: In connection with our River City Project, we have a lease and development agreement, which, among other things, commits us to: (a) lease a parcel of land for 99 years (not including certain termination provisions) for annual rent of $4 million or 2.5% of adjusted gross receipts (whichever is greater, as defined in the lease agreement) commencing on the date the project opens; (b) invest a minimum of $300 million to construct a gaming and multi-use facility; (c) construct a combination retail, commercial and/or entertainment facility within three years of the casino opening; (d) construct additional community and recreational facilities; (e) construct a roadway into the facility; (f) remediate the 80-acre site, with lease termination provisions for our benefit if the cost exceeds a certain amount; and (g) pay penalties if the project fails to open prior to certain future dates.

 

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In May 2005, we deposited $2.5 million into escrow pursuant to the lease and development agreement. In August 2006, we amended such agreement to, among other things, reduce the contractual rent obligations in the first 12 months of operations by approximately $2.5 million and release the $2.5 million held in escrow to St. Louis County.

Sugarcane Bay Development Conditions: As noted above, in May 2006, we entered into an agreement with Harrah’s to purchase certain entities owning gaming assets, which include two riverboat casinos. On August 15, 2006, the LGCB approved, among other things, the transfer of ownership interests to us and the relocation of the berth site of one of the riverboat casinos, subject to certain conditions upon completion of the transaction with Harrah’s. On November 7, 2006, voters passed the required local-option referendum necessary to permit the relocation of the berthing site. The LGCB conditions include, among other things, an obligation for us to invest a minimum of $350 million in a new casino-hotel (including a 400-guestroom casino-hotel). We will be required to complete certain milestones within certain timeframes and complete construction within 18 months of commencing excavating and grading work for the foundations.

Pennsylvania Gaming Application: As noted above, we submitted a bid for the development of a slots-only casino in Philadelphia, Pennsylvania, and posted a $50 million irrevocable letter of credit for the benefit of the PGCB. The letter of credit posted will be drawn upon by the PGCB only in the event we are awarded a gaming license and we do not pay the $50 million licensing fee within approximately 10 days of the award.

Chilean Gaming Applications: As noted above, we have a bid for the development of a gaming site in Chile. The $0.9 million letter of credit posted for the project will be drawn upon by the Chilean government only in the event we are awarded a gaming license for the proposed location and do not fulfill our construction obligation.

Employment and Severance Agreements: We have entered into employment agreements with certain employees, including the executive officers. Such agreements require severance payments in the case of certain triggering events, including a change of control. As of September 30, 2006, the maximum aggregate amount that would be paid to this group of 22 employees if a triggering event occurs, in every case following a change in control where applicable, is approximately $23.4 million.

Deferred Bonus Plan: In 2004, we established a deferred bonus plan in which a portion of an employee’s bonus is deferred and paid in three equal annual installments contingent on the individual remaining employed by the Company. Payments are accelerated under certain circumstances, including death, disability and a change in control. We are expensing the deferred portion over the remaining service period. As of September 30, 2006, the deferred bonus commitment (inclusive of bonuses awarded and deferred for 2004 and 2005), which for example would have to be paid commensurate with a change in control, was approximately $2.6 million.

Directors Health and Medical Insurance Plan: In June 2006, the board of directors, subject to final documentation, approved a director’s health and medical plan designed to provide health and medical insurance benefits comparable to those provided to corporate executives. To the extent that a covered individual has other insurance or Medicare coverage, the benefits under the Company’s coverage would be supplemental to those otherwise provided. The plan terms have not been finalized at this time. We anticipate that the plan will cover directors and their dependents while the director is in office and provides life time benefits for those directors who leave the board after age 70 and their dependents. It will also provide such benefits for directors who have at least three years of service at the time of a change of control and their dependents. At present, three members of the board are over age 70.

Self Insurance: We self-insure various levels of general liability, property, workers’ compensation and medical coverage. Insurance reserves include accruals for estimated settlements for known claims, as well as accruals for estimates of claims not yet made, which are included in accrued compensation and other accrued liabilities on the condensed consolidated balance sheet.

 

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Legal

Indiana State Sales Tax Dispute: The State of Indiana conducted a sales and use tax audit at our Belterra entity in 2001. In October 2002, we received a proposed assessment in the amount of approximately $3.1 million with respect to the Miss Belterra casino riverboat, including interest and a penalty. A protest was filed by us in December of 2002. The Indiana Department of Revenue (“IDR”) conducted an administrative hearing of our protest on March 24, 2006. On April 24, 2006, the IDR issued a Letter of Findings denying our protest with respect to almost the entire assessment. On May 23, 2006, we filed an appeal of the IDR’s findings with the Indiana Tax Court regarding a portion of the original assessment and conceded on a smaller portion (which amount was expensed in the 2006 first quarter). In the 2006 third quarter, the Indiana Tax Court ordered the parties to file summary judgment motions on or before March 9, 2007 for the remaining tax dispute. As of September 30, 2006, the remaining disputed assessment is approximately $1.8 million, which amount would be capitalized to the book value of the riverboat if we were unsuccessful in our dispute. Interest and penalties through such date were approximately $0.9 million. Until such time as we settle this dispute, the assessment will increase due to ongoing interest costs. We have reserved approximately $0.6 million for this matter as of September 30, 2006.

Louisiana Use Tax Matter: The Department of Revenue for the State of Louisiana (“LDR”) filed suit against several licensees in that state, asserting that payments made to third parties on participating progressive slot machines are lease obligations and subject to a use tax. Our Bossier City property was served with two such suits in December 2002, relating to two separate tax audit periods and primarily relating to this progressive slots issue. In 2003, a federal bankruptcy court in a similar case involving a third-party casino ruled the vendor relationship represents a service arrangement and therefore is not a taxable lease arrangement. The U.S. District Court affirmed the bankruptcy court decision. The LDR appealed the U.S. District Court decision and the 5th Circuit Court of Appeals ruled in favor of the taxpayer, holding that the payments under the agreements in that case are not taxable. In a decision rendered on August 25, 2005, and by judgment entered on September 27, 2005, the 19th Judicial District Court in the Parish of East Baton Rouge in another similar case reached the same conclusions reached by the bankruptcy court as affirmed by the District Court and the Fifth Circuit Court of Appeals. On August 29, 2005, we were informed by the LDR that it will no longer pursue the progressive slots issue for the current audit cycle and that the LDR has conceded this issue in all pending litigation. On April 3, 2006, the 26th Judicial District Court dismissed one of the two matters with prejudice, as it involved only the progressive slot issue. We advised the LDR that we believe that we are also entitled to a dismissal of the LDR’s claim in the remaining lawsuit and the LDR has agreed to do so if we paid a nominal sum allegedly owed that is unrelated to the progressive slot matter. We paid a nominal $2,000 in return for which the LDR has agreed to dismiss the remaining lawsuit with prejudice. The dismissal was entered by the court on August 2, 2006.

Hubbard Litigation: In connection with the resignation of R.D. Hubbard as our Chairman in 2002 (“former Chairman”), we agreed to extend the exercise period for stock options (“subject options”) covering 322,000 shares held by the former Chairman with a weighted average exercise price of $10.60 per share provided that the Indiana Gaming Commission approve or not disapprove of such extension. In December 2004, the former Chairman sought to exercise stock options (“specific options”) covering an aggregate of 185,000 of these shares (“requested option shares”). We did not allow such exercise, pending clarification of the position of the Indiana Gaming Commission. On January 21, 2005, the Indiana Gaming Commission advised us that it did not approve the extension of the former Chairman’s option exercise. On January 25, 2005, we filed an action seeking a declaratory judgment in the U.S. District Court for the Southern District of Indiana (“Indiana Action”), naming the former Chairman and the Indiana Gaming Commission as defendants, and requesting an order from the court determining whether the former Chairman is entitled to exercise the subject options and whether we are obligated to sell the former Chairman the requested option shares. On or about January 26, 2005, our former Chairman commenced litigation against us and our current Chairman by filing a Complaint in the Superior Court of the

 

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County of Riverside, California (“California Action”). The former Chairman, in that action, has asserted claims for breach of contract, breach of the implied covenant of good faith and fair dealing, fraud, equitable estoppel and indemnity. The former Chairman seeks compensatory damages in an amount greater than $5 million and punitive damages based on our allegedly wrongful failure to sell to the former Chairman the requested option shares pursuant to the former Chairman’s attempted exercise of the specific options. In the California Action, we have removed the action from the state court in California to the United States District Court for the Central District of California. At the initial pretrial conference in the Indiana Action held on April 11, 2005, the parties agreed to stay both the Indiana Action and the California Action to help facilitate settlement negotiations and to allow the parties to participate in court-sponsored settlement discussions in the Indiana Action. The stay in the Indiana Action was lifted as of October 7, 2005. On November 16, 2005, we dismissed the Indiana Gaming Commission from the Indiana Action. On November 30, 2005, we dismissed the former Chairman from the Indiana Action. The stay was lifted in the California Action as of November 14, 2005. The parties are engaging in discovery and trial is currently set for November 14, 2006. While the outcome of this litigation is uncertain, management intends to defend it vigorously.

In April 2006, 85,000 of the subject options expired under the original 10-year term of the option grant. Due to the litigation surrounding the remaining 237,000 subject options, we continue to include such subject options in the balance of our outstanding options as of September 30, 2006 disclosed in Note 2 above.

Columbia Sussex Litigation: On January 26, 2005, Columbia Sussex Corporation (“Columbia Sussex”) and three other plaintiffs filed a petition against the MGC and Casino One Corporation (“Casino One”), our wholly owned subsidiary, in the Circuit Court of Cole County, Missouri. At that time, Columbia Sussex had an agreement to purchase the President Riverboat, an existing bankrupt casino in downtown St. Louis that is near our project now under construction. In addition to Columbia Sussex, named plaintiffs are Wimar Tahoe Corporation (a company related to Columbia Sussex), as an owner of property near the proposed Casino One site; President of Columbia Sussex William J. Yung, as a Missouri taxpayer; and Fred Dehner, a resident of Osage Beach, Missouri, as a registered Missouri voter and taxpayer. The City of St. Louis filed a motion to intervene as defendants in the case, which was granted by the Court on April 8, 2005. The plaintiffs sought to undo the MGC’s approval of Casino One’s docking site on the St. Louis riverfront under a claim for judicial review by original writ, declaratory judgment, writ of prohibition and appeal of the decision of the MGC to the Missouri Court of Appeals. The factual allegations for each claim were that the Commission could not grant approval to Casino One because the facility’s planned gaming floor is allegedly not within 1,000 feet of the Mississippi River, as required under the Missouri constitution.

On March 7, 2005, the Defendants filed a motion to dismiss this lawsuit on the grounds that the court lacks subject matter jurisdiction over decisions of the MGC. On April 8, 2005, the court granted Defendants’ motion and dismissed the suit. On May 11, 2005, the plaintiffs filed an appeal of the April 8, 2005 decision of the Circuit Court of Cole County, Missouri. On September 28, 2005, the plaintiffs filed a motion for an extension of time until October 18, 2005 to file an appellate brief in the matter.

On April 18, 2005, the plaintiffs filed a petition with the Missouri Court of Appeals Western District, seeking a hearing and de novo review of the MGC’s approval of Casino One’s docking site. On August 8, 2005, plaintiffs filed a motion to consolidate the case with the appeal of the decision of the Circuit Court of Cole County, Missouri. The Court denied plaintiffs’ motion on August 18, 2005. On September 13, 2005, plaintiffs filed a motion to stay or, alternatively, for appointment of a special master pending resolution of the appeal of the decision of the Circuit Court of Cole County, Missouri. On September 27, 2005, the Court of Appeals ruled that the briefing schedule in the April 18, 2005 petition is to be stayed pending the Court of Appeals’ opinion in the appeal of the decision of the Circuit Court of Cole County, Missouri.

 

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On October 25, 2005, the bankrupt casino indicated publicly that Columbia Sussex had withdrawn its application for licensure in Missouri related to its planned purchase of such facility. Following the withdrawal of its application, Columbia Sussex then terminated its agreement to purchase the President Casino. The bankrupt casino company then moved to intervene in both appeals, which motion has been denied by the Court of Appeals. The appeal of the decision of the Circuit Court of Cole County dismissing that case for lack of subject matter jurisdiction has been fully briefed by the City of St. Louis, the Missouri Gaming Commission and by us. The direct appeal from the decision of the Missouri Gaming Commission remains stayed pending a resolution of the appeal of the Cole County decision. The appeal of the Cole County decision was argued before a three-judge panel of the Court of Appeals on February 9, 2006. On April 25, 2006 the Missouri Court of Appeals upheld the lower court’s dismissal of the lawsuit. The Court agreed with our position that plaintiff had no standing to sue. On May 9, 2006, plaintiffs filed a Motion for Rehearing or Rehearing En Banc in the Court of Appeals. Plaintiffs also filed in the Court of Appeals an application to transfer the case to the Missouri Supreme Court (“Motions”). On May 30, 2006, the Motions were denied by the Court of Appeals. On June 14, 2006, Plaintiffs filed in the Missouri Supreme Court an Application for Transfer of the case from the Missouri Court of Appeals to the Missouri Supreme Court. The Missouri Supreme Court denied the Plaintiffs’ Application on August 22, 2006.

On August 25, 2006, Plaintiffs moved the Court of Appeals to dismiss its petition relating to Plaintiffs’ seeking of a hearing and de novo review of the Missouri Gaming Commission’s approval of Casino One’s docking site. The Court of Appeals subsequently dismissed the action on August 29, 2006. Each of the matters filed by the Plaintiffs in the Court of Appeals is now concluded.

After Columbia Sussex terminated its agreement to purchase the President Casino—St. Louis, we entered into an agreement with the bankrupt entities (President Casinos and President Riverboat Casino-Missouri) to acquire the President Riverboat for $31.5 million (the “Pinnacle Agreement”). The Pinnacle Agreement provides that we will buy from President Casinos 100% of the common stock of President Riverboat Casino-Missouri, the entity that owns and operates the casino. The purchase price was subject to potential overbids by third parties and served as the opening bid at an auction scheduled on May 16, 2006. For this reason, the purchase price was subject to potential overbids by third parties. No other bids were received and, on May 26, 2006, the bankruptcy court entered an order approving the Pinnacle Agreement. However, the sale of the President Riverboat will not be final until a plan of reorganization for President Riverboat Casino-Missouri incorporating the Pinnacle Agreement is confirmed by the bankruptcy court. The completion of the acquisition of the casino also is subject to several approvals by the MGC. As noted above, a plan of reorganization for President Riverboat Casino-Missouri incorporating the Pinnacle Agreement has been filed with the bankruptcy court. In the 2006 third quarter, we tendered for and acquired over 99% (in the aggregate) of the outstanding President Casinos, Inc. bonds (which are guaranteed by President Riverboat Casino-Missouri) and President Riverboat Casino-Missouri trade claims. On August 25, 2006, an official committee of equity security holders was appointed for the President Casinos bankruptcy case. Shortly thereafter, the equity committee proposed a plan of reorganization for both debtors that, if confirmed, would have caused the termination of the Pinnacle Agreement. On about October 10, 2006, we entered a settlement agreement with the debtors and the equity committee. Pursuant to the settlement agreement, the equity committee will withdraw its competing plan of reorganization and will support the plan of reorganization filed by President Riverboat Casino-Missouri. A hearing to consider confirmation of President Riverboat Casino-Missouri’s plan of reorganization is scheduled for November 29, 2006. Although we cannot be certain, we anticipate that the President Riverboat Casino-Missouri reorganization plan incorporating the Pinnacle Agreement will be confirmed before the end of 2006. If so, the series of transactions will result in our acquisition of President Riverboat Casino-Missouri and certain other claims for approximately $41.5 million. Of the difference between this amount and the original purchase price, Pinnacle may receive up to another $5 million in payments at a later date and has agreed to waive $5 million in claims.

 

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Action by Greek Authorities: Prior to our acquisition of Casino Magic Corp. in 1998, Casino Magic had a Greek subsidiary that conducted gaming-related operations in Greece in 1995 and 1996. By the time of our

acquisition of Casino Magic, that Greek subsidiary had become inactive. The Greek taxing authorities assessed

penalties against the subsidiary and against certain former representatives of the Greek subsidiary arising out of its pre-acquisition activities and such representatives were also prosecuted and convicted in absentia. We defended those former representatives, one of whom was then a director of our company and one of whom was then an employee of our company. Their criminal convictions were overturned by a Greek court in 2003. In October 2005, we learned that the Greek taxing authorities had commenced a new proceeding against the former employee and another former representative of the Greek subsidiary seeking to collect fines and assessments of approximately $6.7 million from these individuals stemming from their status as representatives of the Greek subsidiary. Some or all of the fines and assessments involved in this new action relate to the penalties originally assessed against the Greek subsidiary. We are obligated to indemnify the former employee and have retained counsel to defend him in this current action. The other former representative is now deceased. While the outcome of this litigation is uncertain, counsel retained to defend the former employee intends to defend him vigorously.

Insurance Litigation: On August 1, 2006, we filed suit in the United States District Court for the District of Nevada against three of our excess insurance carriers. The suit relates to the loss incurred by us as a result of Hurricane Katrina at our Casino Magic property in Biloxi, Mississippi. Collectively, the three insurers provide $300 million of coverage, in excess of $100 million of coverage provided to us by other insurers. In total, our policies applicable to the Hurricane Katrina loss provide an aggregate of up to $400 million of coverage for loss caused by a Weather Catastrophe Occurrence (as defined by the policies) and up to $100 million of inclusive coverage for loss caused by a Flood Occurrence. The three insurers are Allianz Global Risks US Insurance Company, Arch Specialty Insurance Company and RSUI Indemnity Company.

The suit alleges, among other things, that the defendants have improperly asserted that our losses were due to a Flood Occurrence as opposed to a Weather Catastrophe Occurrence; that, after the close of the proposed sale of certain Casino Magic Biloxi assets to Harrah’s, we are not covered for any continued business interruption loss at Casino Magic Biloxi incurred after that sale; and that we are not entitled to designate our River City Project as a replacement for Casino Magic Biloxi. These positions, among others, taken by the insurers could materially reduce our recovery with respect to the claim.

The suit seeks damages equal to the outstanding amount of our claim (totaling $346.5 million, less the deductible of approximately $6.5 million and the $100 million previously paid). It also seeks declarations that our River City Project constitutes a permissible replacement property under the applicable policies and that we are entitled to receive the full amount of our Casino Magic Biloxi business interruption loss arising out of Hurricane Katrina, even though we are in the process of selling certain Casino Magic Biloxi assets to Harrah’s. Our insurance policies permit a “replacement” facility to be built anywhere in the United States. Finally, the suit seeks unspecified punitive damages for the improper actions of the defendants in connection with our claim.

We anticipate that any negotiated or litigated resolution of our insurance claim will be protracted. Although the River City Project is expected to cost more than it would have to rebuild and repair Casino Magic Biloxi, recovery under the policies is nevertheless limited to the lesser of what would have been the cost to rebuild and repair Casino Magic or the actual cost incurred in constructing the River City Project.

Jebaco Litigation: On August 9, 2006, Jebaco, Inc. (“Jebaco”) filed suit in the U.S. District Court for the Eastern District of Louisiana against Harrah’s Operating Co., Inc., Harrah’s Lake Charles, LLC, Harrah’s Star Partnership, Players LC, LLC, Players Riverboat Management, LLC, Players Riverboat II, LLC, and Pinnacle Entertainment, Inc. The lawsuit arises out of an agreement between Jebaco and Harrah’s (as successor in interest to the various Players defendants) whereby Harrah’s is obligated to pay Jebaco an annual fee based on the

 

24


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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

number of patrons entering Harrah’s two Lake Charles, Louisiana riverboat casinos “Jebaco Agreement”). As a result of the severe damage to the riverboats caused by Hurricane Rita, Harrah’s ceased all gaming operations in Lake Charles and ceased payments to Jebaco, pursuant to the terms of the Jebaco Agreement. As noted above, in May 2006, we entered into an agreement to acquire Harrah’s Lake Charles subsidiaries, including the two riverboats. The lawsuit filed by Jebaco asserts that Harrah’s, in ceasing gaming operations in Lake Charles and ceasing payments to Jebaco, breached its contractual obligations to Jebaco and asserts damages of approximately $34 million. Jebaco also asserts our agreement with Harrah’s violates state and federal antitrust laws. The lawsuit seeks an injunction to prevent the closing of our transaction with Harrah’s and also seeks antitrust damages based on a trebling of the $34 million in contract damages. On September 25, 2006, we filed an answer to the complaint, denying all claims and asserting that the lawsuit is barred, among other reasons, because of the approval of our transaction with Harrah’s by the Louisiana Gaming Control Board and the lack of antitrust injury to Jebaco. While the outcome of this litigation is uncertain, management intends to defend it vigorously.

Other: We are party to a number of other pending legal proceedings. Management does not expect that the outcome of such proceedings, either individually or in the aggregate, will have a material effect on our financial position, cash flows or results of operations.

 

25


Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Note 10—Consolidating Condensed Financial Information

Our subsidiaries (excluding Casino Magic Argentina and certain non-material subsidiaries) have fully and unconditionally, jointly and severally guaranteed the payment of all obligations under the 8.25% Notes and 8.75% Notes. Separate financial statements and other disclosures regarding the subsidiary guarantors are not included herein. In lieu thereof we include the following:

 

    Pinnacle
Entertainment,
Inc.
    Wholly Owned
Guarantor
Subsidiaries (a)
    Wholly Owned
Non-
Guarantor
Subsidiaries (b)
    Consolidating
and
Eliminating
Entries
    Pinnacle
Entertainment,
Inc.
Consolidated
 

As of September 30, 2006

         

Balance Sheet

         

Current assets

  $ 221,380     $ 127,434     $ 7,849     $ 0     $ 356,663  

Property and equipment, net

    19,358       881,576       17,000       0       917,934  

Other non-current assets

    175,991       78,998       1,068       10,851       266,908  

Investment in subsidiaries

    493,129       13,567       0       (506,696 )     0  

Inter-company

    553,684       2,667       0       (556,351 )     0  
                                       
  $ 1,463,542     $ 1,104,242     $ 25,917     $ (1,052,196 )   $ 1,541,505  
                                       

Current liabilities

  $ 42,978     $ 97,603     $ 5,160     $ 0     $ 145,741  

Notes payable, long term

    636,189       1,052       0       0       637,241  

Other non-current liabilities

    71,297       4,114       0       (12,206 )     63,205  

Inter-company

    17,688       531,473       7,190       (556,351 )     0  

Equity

    695,390       470,000       13,567       (483,639 )     695,318  
                                       
  $ 1,463,542     $ 1,104,242     $ 25,917     $ (1,052,196 )   $ 1,541,505  
                                       

For the three months ended September 30, 2006

         

Statement of Operations

         

Revenues:

         

Gaming

  $ 0     $ 192,297     $ 6,703     $ 0     $ 199,000  

Food and beverage

    0       11,813       727       0       12,540  

Equity in subsidiaries

    25,517       1,385       0       (26,902 )     0  

Other

    37       25,152       0       0       25,189  
                                       
    25,554       230,647       7,430       (26,902 )     236,729  
                                       

Expenses:

         

Gaming

    0       109,137       2,300       0       111,437  

Food and beverage

    0       10,729       863       0       11,592  

Administrative and other

    5,172       61,408       1,404       0       67,984  

Depreciation and amortization

    252       16,449       640       0       17,341  
                                       
    5,424       197,723       5,207       0       208,354  
                                       

Operating income (loss)

    20,130       32,924       2,223       (26,902 )     28,375  

Merger termination proceeds, net of expenses

    0       0       0       0       0  

Interest (expense) and non-operating income, net

    (10,577 )     3,160       (87 )     0       (7,504 )
                                       

Income (loss) before inter-company activity, taxes and discontinued operations

    9,553       36,084       2,136       (26,902 )     20,871  

Management fee & inter-company interest (expense) income

    10,310       (10,214 )     (96 )     0       0  

Income tax (expense) benefit

    (7,455 )     (174 )     (655 )     0       (8,284 )
                                       

Income (loss) from continuing operations

    12,408       25,696       1,385       (26,902 )     12,587  

Income from discontinued operations, net of taxes

    9,984       (179 )     0       0       9,805  
                                       

Net income (loss)

  $ 22,392     $ 25,517     $ 1,385     $ (26,902 )   $ 22,392  
                                       

 

26


Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    Pinnacle
Entertainment,
Inc.
    Wholly Owned
Guarantor
Subsidiaries (a)
    Wholly Owned
Non-
Guarantor
Subsidiaries (b)
    Consolidating
and
Eliminating
Entries
    Pinnacle
Entertainment,
Inc.
Consolidated
 

For the three months ended September 30, 2005

         

Statement of Operations

         

Revenues:

         

Gaming

  $ 0     $ 136,577     $ 5,039     $ 0     $ 141,616  

Food and beverage

    0       10,697       502       0       11,199  

Equity in subsidiaries

    102       1,121       0       (1,223 )     0  

Other

    74       21,521       0       0       21,595  
                                       
    176       169,916       5,541       (1,223 )     174,410  
                                       

Expenses:

         

Gaming

    0       90,672       1,551       0       92,223  

Food and beverage

    0       10,932       852       0       11,784  

Administrative and other

    6,947       43,164       1,844       0       51,955  

Depreciation and amortization

    200       15,843       286       0       16,329  
                                       
    7,147       160,611       4,533       0       172,291  
                                       

Operating income (loss)

    (6,971 )     9,305       1,008       (1,223 )     2,119  

Loss on early extinguishment of debt

    67       0       0       0       67  

Interest (expense) income, net

    (13,679 )     334       (26 )     0       (13,371 )
                                       

Income (loss) before inter-company activity, taxes and discontinued operations

    (20,583 )     9,639       982       (1,223 )     11,185  

Management fee & inter-company interest (expense) income

    10,331       (10,253 )     (78 )     0       0  

Income tax (expense) benefit

    14,623       103       217       0       14,943  
                                       

Income (loss) from continuing operations

    4,371       (511 )     1,121       (1,223 )     3,758  

Income from discontinued operations, net of taxes

    671       613       0       0       1,284  
                                       

Net income (loss)

  $ 5,042     $ 102     $ 1,121     $ (1,223 )   $ 5,042  
                                       

For the nine months ended September 30, 2006

         

Statement of Operations

         

Revenues:

         

Gaming

  $ 0     $ 580,690     $ 18,353     $ 0     $ 599,043  

Food and beverage

    0       33,122       1,851       0       34,973  

Equity in subsidiaries

    94,030       3,585       0       (97,615 )     0  

Other

    63       65,620       0       0       65,683  
                                       
    94,093       683,017       20,204       (97,615 )     699,699  
                                       

Expenses:

         

Gaming

    0       327,960       5,742       0       333,702  

Food and beverage

    0       30,358       2,608       0       32,966  

Administrative and other

    30,579       152,344       4,018       0       186,941  

Depreciation and amortization

    695       48,259       1,756       0       50,710  
                                       
    31,274       558,921       14,124       0       604,319  
                                       

Operating income (loss)

    62,819       124,096       6,080       (97,615 )     95,380  

Merger termination proceeds, net of expenses

    44,821       0       0       0       44,821  

Interest (expense) and non-operating income, net

    (33,040 )     3,947       (128 )     0       (29,221 )
                                       

Income (loss) before inter-company activity, taxes, and discontinued operations

    74,600       128,043       5,952       (97,615 )     110,980  

Management fee & inter-company interest (expense) income

    31,154       (30,881 )     (273 )     0       0  

Income tax (expense) benefit

    (42,032 )     (146 )     (2,094 )     0       (44,272 )
                                       

Income (loss) from continuing operations

    63,722       97,016       3,585       (97,615 )     66,708  

Income from discontinued operations, net of taxes

    18,151       (2,986 )     0       0       15,165  
                                       

Net income (loss)

  $ 81,873     $ 94,030     $ 3,585     $ (97,615 )   $ 81,873  
                                       

 

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Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    Pinnacle
Entertainment,
Inc.
    Wholly Owned
Guarantor
Subsidiaries (a)
    Wholly Owned
Non-
Guarantor
Subsidiaries (b)
    Consolidating
and
Eliminating
Entries
    Pinnacle
Entertainment,
Inc.
Consolidated
 

For the nine months ended September 30, 2005

         

Statement of Operations

         

Revenues:

         

Gaming

  $ 0     $ 355,888     $ 13,389     $ 0     $ 369,277  

Food and beverage

    0       24,969       1,144       0       26,113  

Equity in subsidiaries

    16,446       2,878       0       (19,324 )     0  

Other

    74       45,982       0       0       46,056  
                                       
        16,520       429,717       14,533       (19,324 )     441,446  
                                       

Expenses:

         

Gaming

    0       221,018       3,898       0       224,916  

Food and beverage

    0       24,109       1,632       0       25,741  

Administrative and other

    21,225       120,422       3,865       0       145,512  

Depreciation and amortization

    588       37,108       643       0       38,339  
                                       
    21,813       402,657       10,038       0       434,508  
                                       

Operating income (loss)

    (5,293 )     27,060       4,495       (19,324 )     6,938  

Loss on early extinguishment of debt

    (1,352 )     0       0       0       (1,352 )

Interest (expense) income, net

    (39,001 )     6,963       (18 )     0       (32,056 )
                                       

Income (loss) before inter-company activity, taxes and discontinued operations

    (45,646 )     34,023       4,477       (19,324 )     (26,470 )

Management fee & inter-company interest (expense) income

    21,234       (21,066 )     (168 )     0       0  

Income tax (expense) benefit

    20,999       103       (1,431 )     0       19,671  
                                       

Income (loss) from continuing operations

    (3,413 )     13,060       2,878       (19,324 )     (6,799 )

Income from discontinued operations, net of taxes

    2,046       3,386       0       0       5,432  
                                       

Net income (loss)

  $ (1,367 )   $ 16,446     $ 2,878     $ (19,324 )   $ (1,367 )
                                       

For the nine months ended September 30, 2006

         

Statement of Cash Flows

         

Net cash provided by (used in) operating activities

  $ 166,941     $ (16,728 )   $ 5,489     $ 0     $ 155,702  

Net cash provided by (used in) investing activities

    (167,647 )     8,006       (1,635 )     0       (161,276 )

Net cash provided by (used in) financing activities

    160,752       (103 )     0       0       160,649  

Effect of exchange rate changes on cash

    0       (15 )     (151 )     0       (166 )

For the nine months ended September 30, 2005

         

Statement of Cash Flows

         

Net cash provided by (used in) operating activities

  $ (187,690 )   $ 203,246     $ 9,964     $ 0     $ 25,520  

Net cash provided by (used in) investing activities

    27,377       (186,601 )     (12,505 )     0       (171,729 )

Net cash provided by financing activities

    66,742       20       0       0       66,762  

Effect of exchange rate changes on cash

    0       0       (151 )     0       (151 )

 

28


Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

    Pinnacle
Entertainment,
Inc.
  Wholly Owned
Guarantor
Subsidiaries (a)
  Wholly Owned
Non-
Guarantor
Subsidiaries (b)
  Consolidating
and
Eliminating
Entries
    Pinnacle
Entertainment,
Inc.
Consolidated

As of December 31, 2005

         

Balance Sheet

         

Current assets

  $ 65,092   $ 144,203   $ 4,685   $ 0     $ 213,980

Property and equipment, net

    33,758     838,942     17,618     0       890,318

Other non-current assets

    56,590     71,922     1,216     10,851       140,579

Investment in subsidiaries

    522,001     10,912     0     (532,913 )     0

Inter-company

    489,100     2,685     0     (491,785 )     0
                               
  $ 1,166,541   $ 1,068,664   $ 23,519   $ (1,013,847 )   $ 1,244,877
                               

Current liabilities

  $ 51,117   $ 87,035   $ 4,880   $ 0     $ 143,032

Notes payable, long term

    656,372     1,162     0     0       657,534

Other non-current liabilities

    28,553     150     0     (12,206 )     16,497

Inter-company

    2,685     481,373     7,727     (491,785 )     0

Equity

    427,814     498,944     10,912     (509,856 )     427,814
                               
  $ 1,166,541   $ 1,068,664   $ 23,519   $ (1,013,847 )   $ 1,244,877
                               

(a) The following material subsidiaries are treated as guarantors of the 8.25% Notes and 8.75% Notes: Belterra Resort Indiana LLC, Boomtown, LLC, PNK (Reno), LLC, Louisiana—I Gaming, PNK (Lake Charles), LLC, Casino Magic Corp., Biloxi Casino Corp., PNK (Bossier City), Inc. and Casino One Corporation. HP/Compton, Inc. and Crystal Park Hotel and Casino Development Company, LLC were guarantors through March 2006.
(b) Our only material non-guarantors of the 8.25% Notes and 8.75% Notes are Casino Magic Neuquen S.A. and its subsidiary Casino Magic Support Services.

 

29


Table of Contents

PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Note 11—Segment Information

As noted above, we opened The Casino at Emerald Bay in the Bahamas in May 2006. We have combined its operations, including its pre-opening and development costs, with the results of our other international operation, Casino Magic Argentina, and renamed the segment “International.”

The following table reconciles our segment activity to our condensed consolidated results of operations for the three and nine months ended September 30, 2006 and 2005.

 

     For the three months
ended September 30,
    For the nine months
ended September 30,
 
     2006     2005     2006     2005  
     (in thousands)  

Revenues and expenses

        

Boomtown New Orleans

        

Revenues

   $ 46,221     $ 19,532     $ 161,460     $ 78,140  

Expenses, excluding depreciation and amortization

     (29,088 )     (16,575 )     (93,012 )     (57,735 )

Depreciation and amortization

     (2,079 )     (1,675 )     (6,078 )     (5,117 )
                                

Net operating income—Boomtown New Orleans

   $ 15,054     $ 1,282     $ 62,370     $ 15,288  
                                

L’Auberge du Lac

        

Revenues

   $ 79,174     $ 51,492     $ 236,440     $ 80,940  

Expenses, excluding pre-opening costs and depreciation and amortization

     (59,449 )     (51,702 )     (181,679 )     (73,289 )

Pre-opening costs

     0       0       0       (21,081 )

Depreciation and amortization

     (6,397 )     (5,922 )     (18,943 )     (7,730 )
                                

Net operating income (loss)—L’Auberge du Lac

   $ 13,328     $ (6,132 )   $ 35,818     $ (21,160 )
                                

Belterra Casino Resort

        

Revenues

   $ 47,397     $ 45,102     $ 130,654     $ 127,348  

Expenses, excluding depreciation and amortization

     (35,765 )     (33,773 )     (99,934 )     (96,628 )

Depreciation and amortization

     (3,643 )     (4,729 )     (10,808 )     (14,040 )
                                

Net operating income—Belterra Casino Resort

   $ 7,989     $ 6,600     $ 19,912     $ 16,680  
                                

Boomtown Bossier City

        

Revenues

   $ 24,643     $ 23,736     $ 73,980     $ 71,969  

Expenses, excluding depreciation and amortization

     (19,056 )     (18,888 )     (54,914 )     (56,858 )

Depreciation and amortization

     (2,104 )     (1,791 )     (6,063 )     (5,299 )
                                

Net operating income—Boomtown Bossier City

   $ 3,483     $ 3,057     $ 13,003     $ 9,812  
                                

Boomtown Reno

        

Revenues

   $ 27,739     $ 27,564     $ 67,137     $ 67,073  

Expenses, excluding depreciation and amortization

     (24,070 )     (22,269 )     (61,142 )     (58,567 )

Depreciation and amortization

     (1,619 )     (1,575 )     (4,748 )     (4,771 )
                                

Net operating income—Boomtown Reno

   $ 2,050     $ 3,720     $ 1,247     $ 3,735  
                                

International

        

Revenues

   $ 8,043     $ 5,541     $ 20,943     $ 14,533  

Expenses, excluding pre-opening costs and depreciation and amortization

     (5,574 )     (3,764 )     (13,749 )     (8,785 )

Pre-opening costs

     (7 )     (483 )     (577 )     (610 )

Depreciation and amortization

     (794 )     (286 )     (2,016 )     (643 )
                                

Net operating income—International

   $ 1,668     $ 1,008     $ 4,601     $ 4,495  
                                

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

     For the three months
ended September 30,
    For the nine months
ended September 30,
 
     2006     2005     2006     2005  
     (in thousands)  

Embassy Suites and other

        

Revenues

   $ 3,512     $ 1,443     $ 9,085     $ 1,443  

Expenses, excluding depreciation amortization

     (2,700 )     (816 )     (7,541 )     (784 )

Depreciation and amortization

     (453 )     (151 )     (1,359 )     (151 )
                                

Net operating income—Embassy Suites and other

   $ 359     $ 476     $ 185     $ 508  
                                

Total Reportable Segments

        

Revenues

   $ 236,729     $ 174,410     $ 699,699     $ 441,446  

Expenses, excluding pre-opening costs and depreciation and amortization

     (175,702 )     (147,787 )     (511,971 )     (352,646 )

Segment pre-opening costs

     (7 )     (483 )     (577 )     (21,691 )

Depreciation and amortization

     (17,089 )     (16,129 )     (50,015 )     (37,751 )
                                

Net operating income—Total Reportable Segments

   $ 43,931     $ 10,011     $ 137,136     $ 29,358  
                                

Reconciliation to Income (Loss) from Continuing Operations Before Taxes

        

Total net operating income for reportable segments

   $ 43,931     $ 10,011     $ 137,136     $ 29,358  

Unallocated income and expenses:

        

Corporate expense

     (8,600 )     (6,053 )     (24,330 )     (17,822 )

Other pre-opening and development costs (a)

     (6,956 )     (1,839 )     (17,426 )     (4,598 )

Other non-operating income

     5,551       725       11,519       2,663  

Merger termination proceeds, net of expenses

     0       0       44,821       0  

Loss on early extinguishment of debt

     0       67       0       (1,352 )

Interest expense, net of capitalized interest

     (13,055 )     (14,096 )     (40,740 )     (34,719 )
                                

Income (loss) from continuing operations before income taxes

   $ 20,871     $ (11,185 )   $ 110,980     $ (26,470 )
                                

(a) Includes St. Louis project pre-opening and development costs of approximately $2.7 million and $10.1 million for the three and nine months ended September 30, 2006, respectively, and approximately $0.9 million and $3.3 million for the three and nine months ended September 30, 2005, respectively.

 

     For the three months
ended September 30,
    For the nine months
ended September 30,
 
     2006     2005     2006     2005  
     (in thousands)  

EBITDA (a)(b)

        

Boomtown New Orleans

   $ 17,133     $ 2,957     $ 68,448     $ 20,405  

L’Auberge du Lac (c)

     19,725       (210 )     54,761       (13,430 )

Belterra Casino Resort

     11,632       11,329       30,720       30,720  

Boomtown Bossier City

     5,587       4,848       19,066       15,111  

Boomtown Reno

     3,669       5,295       5,995       8,506  

International (d)

     2,462       1,294       6,617       5,138  

Embassy Suites and other

     812       627       1,544       659  

Corporate

     (8,348 )     (5,853 )     (23,635 )     (17,234 )

Other pre-opening and development costs

     (6,956 )     (1,839 )     (17,426 )     (4,598 )
                                
   $ 45,716     $ 18,448     $ 146,090     $ 45,277  
                                

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 


(a) We define EBITDA as earnings before interest expense and non-operating income, income taxes, depreciation, amortization, merger termination proceeds, discontinued operations and loss on early extinguishment of debt. We use EBITDA as a relevant and useful measure to compare operating results among its properties and between accounting periods. The presentation of EBITDA has economic substance because it is used by management as a performance measure to analyze the performance of our business segments. EBITDA is specifically relevant in evaluating large, long-lived casino-hotel projects because it provides a perspective on the current effects of operating decisions separated from the substantial, non-operational depreciation charges and financing costs of such projects. Management eliminates the results from discontinued operations as they are discontinued and also eliminates merger termination proceeds due to their non-recurring nature. Additionally, management believes some investors consider EBITDA to be a useful measure in determining a company’s ability to service or incur indebtedness and for estimating a company’s underlying cash flows from operations before capital costs, taxes and capital expenditures. EBITDA, subject to certain adjustments, is also a measure used in debt covenants in our debt agreements. Unlike net income, EBITDA does not include depreciation or interest expense and therefore does not reflect current or future capital expenditures or the cost of capital. We compensate for these limitations by using EBITDA as only one of several comparative tools, together with the common GAAP measurements, to assist in the evaluation of operating performance. Such GAAP measurements include operating income (loss), net income (loss), cash flows from operations and cash flow data. EBITDA is not calculated in the same manner by all companies and accordingly, may not be an appropriate measure of comparing performance among different companies. The following table is a reconciliation of net income to EBITDA:

 

     For the three months
ended September 30,
    For the nine months
ended September 30,
 
     2006     2005     2006     2005  
     (in thousands)  

Net income (loss)

   $ 22,392     $ 5,042     $ 81,873     $ (1,367 )

Income from discontinued operations, net of taxes

     (9,805 )     (1,284 )     (15,165 )     (5,432 )
                                

Income (loss) from continuing operations

     12,587       3,758       66,708       (6,799 )

Income tax expense (benefit)

     8,284       (14,943 )     44,272       (19,671 )
                                

Income before income taxes

     20,871       (11,185 )     110,980       (26,470 )

Merger termination proceeds, net of expenses

     0       0       (44,821 )     0  

Other non-operating income

     (5,551 )     (725 )     (11,519 )     (2,663 )

Loss on early extinguishment of debt

     0       (67 )     0       1,352  

Interest expense, net of capitalized interest

     13,055       14,096       40,740       34,719  
                                

Operating income

     28,375       2,119       95,380       6,938  

Depreciation and amortization

     17,341       16,329       50,710       38,339  
                                

EBITDA

   $ 45,716     $ 18,448     $ 146,090     $ 45,277  
                                

EBITDA includes the following items:

        
    

For the three months

ended September 30,

   

For the nine months

ended September 30,

 
     2006     2005     2006     2005  
     (in thousands)  

Pre-opening and development costs

   $ 6,963     $ 2,322     $ 18,003     $ 26,289  

Non-cash share-based compensation charge

   $ 1,320     $ 0     $ 3,916     $ 0  

 

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PINNACLE ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

(b) As discussed in Note 2 above, results for the three and nine month periods ended September 30, 2006 include non-cash share-based compensation costs of approximately $1.3 million and $3.9 million, respectively. There were no such costs in 2005. The 2006 costs were allocated as follows:
     For the three months
ended September 30, 2006
   For the nine months
ended September 30, 2006
     (in thousands)

Boomtown New Orleans

   $ 50    $ 126

L’Auberge du Lac (c)

     97      252

Belterra Casino Resort

     53      130

Boomtown Bossier City

     52      126

Boomtown Reno

     35      92

Corporate

     1,033      3,190
             

Total non-cash share-based compensation charge

   $ 1,320    $ 3,916
             
(c) L’Auberge du Lac opened in May 2005. Results for the nine months ended September 30, 2005 include pre-opening costs of $21,081,000.
(d) Includes pre-opening costs for the Casino Magic Argentina replacement casino opened in July 2005 and May 2006 opening of The Casino at Emerald Bay. Such costs were $7,000 and $483,000 for the three months ended September 30, 2006 and 2005, respectively, and $577,000 and $610,000 for the nine months ended September 30, 2006 and 2005, respectively.

 

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

The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and the notes thereto and other financial information included in our Annual Report on Form 10-K for the year ended December 31, 2005, and other filings with the Securities and Exchange Commission.

Overview and Summary

We are a rapidly growing, diversified, multi-jurisdictional owner and operator of gaming entertainment facilities. We own and operate five casinos in Nevada, Louisiana and Indiana. We are developing a major casino and luxury hotel adjacent to a hotel we own in downtown St. Louis, Missouri and have an agreement to purchase a riverboat casino near this site. We are developing a major casino-hotel in St. Louis County, Missouri. We signed an agreement to buy a casino site in Atlantic City, New Jersey. We signed an agreement to acquire two casino riverboats in Louisiana, we intend to replace one of such riverboats with a second casino resort in Lake Charles and relocate the other riverboat casino operation in a new facility in Baton Rouge. We have filed a gaming license application in Philadelphia. We have a significant insurance claim related to the casino-hotel we previously operated in Biloxi, Mississippi, which site we are selling. We filed suit against certain of our insurers on that insurance claim. We also operate casinos in Argentina; have opened a small casino in the Bahamas; and have filed an application for a gaming license in Chile.

In September 2006, we entered into an acquisition agreement to acquire the Sands/Traymore site for approximately $250 million, plus an additional $20 million for certain tax-related benefits and additional real estate. Cumulatively, the land being acquired comprises approximately 18 contiguous acres at the heart of Atlantic City, with extensive frontage along The Boardwalk, Pacific Avenue and Brighton Park.

In May 2006, Aztar Corporation terminated our merger agreement to acquire that company and consequently paid us a merger termination payment. Net of fees and expenses incurred, including fees earned by various investment banking and legal firms in pursuing the acquisition, the net merger termination payment received by us was approximately $44.8 million.

We are currently constructing our $430 million St. Louis City Project, scheduled to open in the fall of 2007. We are also continuing site development work for our River City Project, our $375 million south St. Louis County project, scheduled to open in 2008. We anticipate acquiring the President Riverboat in late 2006 or early 2007, at a total net cost of approximately $41.5 million.

In September of 2006, we broke ground on a 250-guestroom expansion at L’Auberge du Lac. We anticipate beginning construction on our two other guestroom expansion projects at Boomtown New Orleans (a 200-guestroom hotel) and Belterra Casino Resort (250 additional guestrooms) in the fourth quarter of 2006. The three expansion projects are expected to cost approximately $120 million with anticipated completion dates in late 2007.

We have announced plans to build Sugarcane Bay, a new $350 million casino resort to be built adjacent to our L’Auberge du Lac casino resort in Lake Charles, Louisiana, utilizing one of the two gaming licenses we anticipate acquiring in our transaction with Harrah’s (see below). With the passage of the November 7, 2006 local-option referendum, we expect to begin construction in 2007 with a planned opening in 2009.

Additionally, we purchased 54 acres of land in Baton Rouge, Louisiana and submitted plans to the LGCB for a preliminary casino on that site for potential use of the second Harrah’s gaming license (see below). Such plans include a 300-guestroom hotel and a casino with approximately 1,500 slot machines. Construction and operation of such casino will require multiple approvals, including the approval of the LGCB and passage of a local referendum in East Baton Rouge Parish.

 

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In May, we executed a definitive agreement with Harrah’s to purchase certain entities owning gaming assets, which include two riverboat casinos and related gaming licenses. In June 2006, we deposited $3.5 million toward the purchase price, which is included in “Deposits on pending transactions” on the consolidated balance sheet at September 30, 2006. Additionally, Harrah’s will acquire our Casino Magic Biloxi site and certain related assets and receive an additional payment of approximately $23.8 million (which amount is net of initial deposits) from us. Each company will retain its relevant insurance claims to its damaged property.

In Pennsylvania, we are one of five applicants vying for one of two slots-only casino licenses to be issued for Philadelphia. According to the PGCB, gaming licenses could be granted in December 2006. If selected, we intend to build a casino that would include approximately 3,000 slot machines, multiple bars and restaurants, and other amenities. We estimate this initial phase, including land and Pennsylvania’s $50 million initial gaming license fee, will cost between $300 million and $400 million.

In Rancagua, Chile, we are one of three applicants vying for a casino license. If selected, our proposed investment will be approximately $17 million. The government’s decision regarding Rancagua is expected later this year.

In April and July 2006, we completed the sale of our card club casinos for aggregate cash proceeds of approximately $40 million.

We filed a $346.5 million insurance claim for our losses associated with Hurricane Katrina at Casino Magic Biloxi. Net of our insurance deductible, such claim would be approximately $340 million. Through the end of October 2006, we have received $100 million in advances towards such claim. We have also sued several of our insurers related to this claim.

We have a $750 million senior secured credit facility, consisting of a $450 million five-year revolving credit facility and a $300 million six-year term loan, of which $200 million was drawn as of September 30, 2006 and $100 million of which can be drawn on a delayed basis. As of quarter end, some $384 million of the revolving credit facility was unutilized.

On October 11, 2006 we entered into a second amendment to the credit facility, which amendment does not become effective until completion of the Sands/Traymore site acquisition and receipt of all remaining regulatory approvals.

We anticipate executing a third amendment to the credit facility concurrently with the close of the Sands/Traymore site transaction. We have received definitive incremental commitments from our lenders and are proceeding with documentation. Such amendment will, among other things, increase the overall borrowing capacity of the credit facility to $1 billion, including increasing the revolver facility to $625 million and the term loan facility to $375 million.

In early 2006, we completed the issuance of 6.9 million newly issued common shares (including the over-allotment shares), resulting in net cash proceeds of approximately $179 million after underwriters’ fees and expenses.

Management believes the outlook for the gaming industry remains positive and that we can benefit from its potential growth. Management intends to grow the company by enhancing its current facilities and pursuing development projects or acquisitions to enhance shareholder value. However, there can be no assurance that these efforts will be successful.

 

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RESULTS OF OPERATIONS

The following table highlights our results of operations for the three and nine months ended September 30, 2006 and 2005 (a):

 

     For the three months
ended September 30, 2006
    For the nine months
ended September 30, 2006
 
           2006                 2005                 2006                 2005        
     (in thousands)  

Revenues from continuing operations

        

Boomtown New Orleans

   $ 46,221     $ 19,532     $ 161,460     $ 78,140  

L’Auberge du Lac (b)

     79,174       51,492       236,440       80,940  

Belterra Casino Resort

     47,397       45,102       130,654       127,348  

Boomtown Bossier City

     24,643       23,736       73,980       71,969  

Boomtown Reno

     27,739       27,564       67,137       67,073  

International

     8,043       5,541       20,943       14,533  

Embassy Suites and other (c)

     3,512       1,443