As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

11/08/06  Station Casinos Inc               10-Q        9/30/06    5:1.0M                                   Merrill Corp-MD/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report Pursuant to Sections 13 or 15(D)   HTML    667K 
 2: EX-31.1     Certification per Sarbanes-Oxley Act (Section 302)  HTML     13K 
 3: EX-31.2     Certification per Sarbanes-Oxley Act (Section 302)  HTML     13K 
 4: EX-32.1     Certification per Sarbanes-Oxley Act (Section 906)  HTML      9K 
 5: EX-32.2     Certification per Sarbanes-Oxley Act (Section 906)  HTML      9K 

STATION CASINOS, INC.

INDEX

 

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PART I—FINANCIAL INFORMATION

Item 1.   Financial Statements

STATION CASINOS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share data)

 

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

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STATION CASINOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share data)
(unaudited)

 

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

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STATION CASINOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)

 

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

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STATION CASINOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.   Basis of Presentation

Station Casinos, Inc. (the “Company”), a Nevada corporation, is a gaming and entertainment company that currently owns and operates nine major hotel/casino properties (one of which is 50% owned) and seven smaller casino properties (two of which are 50% owned), in the Las Vegas metropolitan area, as well as manages a casino for a Native American tribe. The accompanying condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and MPM Enterprises, LLC (which is 50% owned by the Company and required to be consolidated). Investments in all other 50% or less owned affiliated companies are accounted for under the equity method. All significant intercompany accounts and transactions have been eliminated.

The accompanying condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of the results for the interim periods have been made. The results for the three and nine months ended September 30, 2006 are not necessarily indicative of results to be expected for the full fiscal year. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Certain amounts in the condensed consolidated financial statements for the three and nine months ended September 30, 2005 have been reclassified to be consistent with the current year presentation. These reclassifications had no effect on the previously reported net income.

Recently Issued Accounting Standards

In September 2006, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”, (“SFAS 157”). This statement defines fair value, establishes a framework for measuring fair value for both assets and liabilities through a fair value hierarchy and expands disclosure requirements. SFAS 157 is effective for financial statements issued for fiscals years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is evaluating SFAS 157 and has not yet determined the impact the adoption will have on the consolidated financial statements.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, (“FIN 48”). This interpretation, among other things, creates a two step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions and it has expanded disclosure requirements. FIN 48 is effective for fiscal years beginning after

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1.   Basis of Presentation (Continued)

December 15, 2006, in which the impact of adoption should be accounted for as a cumulative-effect adjustment to the beginning balance of retained earnings. The Company is evaluating FIN 48 and has not yet determined the impact the adoption will have on the consolidated financial statements.

In December 2004, the FASB issued SFAS 123R, “Share-Based Payment”, replacing and superseding both SFAS 123, “Accounting for Stock-Based Compensation”, and APB Opinion 25, “Accounting for Stock Issued to Employees”. SFAS 123R requires fair value measurement and recognition in the financial statements for all share-based compensation arrangements. SFAS 123R also requires additional disclosures related to income tax effects and cash flows resulting from share-based compensation arrangements. Adoption of SFAS 123R on January 1, 2006 reduced earnings consistent with past pro forma share-based compensation disclosures for the three and nine months ended September 30, 2006. See Note 6 for additional information.

2.   Investments in Joint Ventures

The Company has various investments in 50% owned joint ventures and a 6.7% investment in a joint venture that owns the Palms Casino Resort in Las Vegas, Nevada, which are accounted for under the equity method. Under the equity method, original investments are recorded at cost and adjusted by the Company’s share of earnings, losses and distributions of the joint ventures. The investment balance also includes interest capitalized during the construction period. Investments in joint ventures consist of the following (amounts in thousands):

 

Summarized balance sheet information for the joint ventures is as follows (amounts in thousands):

 

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2.   Investments in Joint Ventures (Continued)

Summarized results of operations for the joint ventures are as follows (amounts in thousands, unaudited):

 

The operating earnings from these joint ventures are shown as a separate line item on the Company’s condensed consolidated statements of operations after operating income. In addition, interest and other expense from these joint ventures is shown as a separate component under other income (expense) in the Company’s condensed consolidated statements of operations. The following table identifies the total equity earnings from joint ventures (amounts in thousands, unaudited):

 

3.   Management Fees

The Company manages Thunder Valley on behalf of the United Auburn Indian Community (the “UAIC”) and receives a management fee equal to 24% of net income (as defined in the management agreement). The Company is also the managing partner for Green Valley Ranch, Barley’s and The Greens and receives a management fee equal to 2% of revenues and approximately 5% of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) from Green Valley Ranch and 10% of EBITDA from Barley’s and The Greens. The Company’s management fees are included in net revenues on the Company’s condensed consolidated statements of operations.

United Auburn Indian Community

The Company has entered into a Development Services Agreement and a Management Agreement with the UAIC. The Company’s seven-year Management Agreement was approved by the National Indian Gaming Commission (the “NIGC”) and expires in June 2010. Pursuant to those agreements, and in compliance with a Memorandum of Understanding entered into by the UAIC and Placer County, California, the Company and the UAIC developed Thunder Valley, a gaming and entertainment facility on approximately 49 acres located approximately seven miles north of Interstate 80 on Highway 65, in Placer County, California, near Sacramento, which opened on June 9, 2003.

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4.   Long-term Debt

Long-term debt consists of the following (amounts in thousands):

 

Revolving Facility

In December 2005, the Company increased its availability under its revolving credit facility (the “Revolving Facility”) from $1.0 billion to $2.0 billion and extended the maturity by one year to December 2010. The Revolving Facility contains no principal amortization. The Borrowers are the major operating subsidiaries and the Revolving Facility is secured by substantially all of the Company’s assets. Borrowings under the Revolving Facility bear interest at a margin above the Alternate Base Rate or the Eurodollar Rate (each as defined in the Revolving Facility), as selected by the Company. The margin above such rates, and the fee on the unfunded portions of the Revolving Facility, will vary quarterly based on the Company’s combined consolidated ratio of debt to Adjusted EBITDA (as defined in the Revolving Facility). As of September 30, 2006, the Borrowers’ margin above the Eurodollar Rate on borrowings under the Revolving Facility was 2.00%. The maximum margin for Eurodollar Rate borrowings is 2.25%. The maximum margin for Alternate Base Rate borrowings is 1.00%. As of September 30, 2006, the fee for the unfunded portion of the Revolving Facility was 0.30%.

The Revolving Facility contains certain financial and other covenants, some of which were amended in June and September 2006. These include a maximum funded debt to Adjusted EBITDA ratio for the Borrowers combined of 4.00 to 1.00 for each quarter and a minimum fixed charge coverage ratio for the

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4.   Long-term Debt (Continued)

preceding four quarters for the Borrowers combined of 1.25 to 1.00 for each quarter. As of September 30, 2006, the Borrowers’ funded debt to Adjusted EBITDA ratio was 2.40 to 1.00 and the fixed charge coverage ratio was 1.72 to 1.00. In addition, the Revolving Facility has financial and other covenants, which require that the maximum consolidated funded debt to Adjusted EBITDA ratio can be no more than 7.00 to 1.00 through June 30, 2007, which reduces to 6.75 to 1.00 on September 30, 2007 through June 30, 2008, to 6.50 to 1.00 on September 30, 2008 through December 31, 2008, to 5.75 to 1.00 on March 31, 2009 through December 31, 2009 and to 5.00 to 1.00 on March 31, 2010. Other covenants limit prepayments of indebtedness or rent (including subordinated debt other than re-financings meeting certain criteria), asset dispositions, dividends, indebtedness, stock repurchases and investments. As of September 30, 2006, the Company’s consolidated funded debt to Adjusted EBITDA ratio was 5.94 to 1.00. The Company has pledged the stock of all of its major subsidiaries.

Senior and Senior Subordinated Notes

On August 15, 2006, the Company issued $400.0 million of 73¤4% senior notes due August 15, 2016. On March 13, 2006, the Company issued $300.0 million of 65¤8% senior subordinated notes due March 2018. Proceeds from the sale of the notes were used to reduce a portion of the amount outstanding on the Company’s Revolving Facility.

During the nine months ended September 30, 2005, the Company redeemed the remaining $16.9 million of outstanding 83¤8% senior notes due 2008 and $17.4 million of outstanding 97¤8% senior subordinated notes due 2010. As a result of these redemptions, the Company recorded a loss on early retirement of debt of approximately $0.6 million and $1.3 million in the three and nine months ended September 30, 2005 to reflect the write-off of the unamortized loan costs, discounts and call premium.

The indentures (the “Indentures”) governing the Company’s senior and senior subordinated notes (the “Notes”) contain certain customary financial and other covenants, which limit the Company and its subsidiaries’ ability to incur additional debt. At September 30, 2006, the Company’s Consolidated Coverage Ratio (as defined in the Indentures) was 2.80 to 1.00. The Indentures provide that the Company may not incur additional indebtedness, other than specified types of indebtedness, unless the Consolidated Coverage Ratio is at least 2.00 to 1.00. In the event the Company’s Consolidated Coverage Ratio is below 2.00 to 1.00, the covenant limits the Company’s ability to incur additional indebtedness for borrowings under the Revolving Facility not to exceed the greater of $200 million or 1.5 times Operating Cash Flow (as defined in the Indentures) for the four most recent quarters, plus $15 million. The Indentures also give the holders of the Notes the right to require the Company to purchase the Notes at 101% of the principal amount of the Notes plus accrued interest thereon upon a Change of Control and Rating Decline (each as defined in the Indentures) of the Company. In addition, the indenture governing the senior notes contains a limitation on liens the Company can incur.

Interest Rate Swaps

The Company has entered into various interest rate swaps with members of its bank group to manage interest expense. As of September 30, 2006, the Company has interest rate swaps with a combined notional amount of $550.0 million. The Company entered into a fair value hedge interest rate swap with a notional amount of $50.0 million tied directly to the Company’s 6% senior notes converting a portion of the Company’s fixed-rate debt to a floating-rate based upon three-month LIBOR rates, terminating in April 2012. This interest rate swap qualifies for the “shortcut” method allowed under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (and as amended by SFAS 138 and 149), which allows for an assumption of no ineffectiveness. As such, there is no income statement impact from changes in the fair value of the hedging instrument. Instead, the fair value of the instrument is recorded as

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4.   Long-term Debt (Continued)

an asset or liability on the Company’s balance sheet with an offsetting adjustment to the carrying value of the related debt. In accordance with SFAS 133, the Company recorded a liability of $2.3 million and $2.1 million as of September 30, 2006 and December 31, 2005, respectively, representing the fair value of this interest rate swap and a corresponding decrease in long-term debt, as this interest rate swap is considered highly effective under the criteria established by SFAS 133. The Company paid a rate based on LIBOR, which approximated 7.2% as of September 30, 2006 and received a fixed rate of 6.0%.

The Company has entered into two cash flow hedge interest rate swaps with a combined notional amount of $500.0 million tied directly to the Company’s Revolving Facility converting a portion of the Company’s floating-rate debt to a fixed-rate based on three-month LIBOR rates, terminating in December 2010. As of September 30, 2006, the Company paid an average fixed rate of 4.9% and received three-month LIBOR which approximated 5.4%. These interest rate swaps are designated and qualify as cash flow hedges resulting in the effective portion of the gain or loss reported as a component of other comprehensive income (loss) with an offsetting adjustment to the carrying value of the related debt. For the three and nine months ended September 30, 2006, the Company recorded other comprehensive loss of $5.8 million and $1.0 million, respectively, related to the change in market value of these interest rate swaps. As a result, the Company recorded an increase in long-term debt of $1.7 million as of September 30, 2006 and $0.8 million as of December 31, 2005.

The difference between amounts received and paid under such agreements, as well as any costs or fees, is recorded as a reduction of, or an addition to, interest expense as incurred over the life of the swaps. The net effect of the interest rate swaps resulted in a reduction of interest expense of approximately $103,000 and $21,000 for the three and nine months ended September 30, 2006. For the three and nine months ended September 30, 2005, the net effect of the interest rate swaps resulted in a reduction of interest expense of approximately $0.1 million and $2.1 million, respectively.

5.   Stockholders’ Equity

Treasury Stock

During the three months ended September 30, 2006, the Company repurchased 2.6 million shares of its common stock for approximately $142.5 million at an average price of $55.79 per share. During the nine months ended September 30, 2006, the Company repurchased 12.7 million shares of its common stock for approximately $880.0 million at an average price of $69.20 per share, primarily through a combination of open market purchases and an accelerated stock buyback (“ASB”) program, completing the Company’s previously authorized stock repurchase. Of the shares repurchased in the nine months ended September 30, 2006, 3.0 million shares related to the ASB program at a cost of approximately $232 million. On July 24, 2006, the Board of Directors authorized the repurchase up to an additional 10.0 million shares. As of September 30, 2006 the Company is authorized to repurchase approximately 7.5 million additional shares of its common stock.

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5.   Stockholders’ Equity (Continued)

Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income”, requires companies to disclose comprehensive income and the components of such income. Comprehensive income is the total of net income (loss) and all other non-stockholder changes in equity. The Company has recorded the mark-to-market valuation of its interest rate swaps and its 50% interest in the mark-to-market valuation of the interest rate swaps at Green Valley Ranch as comprehensive income. Comprehensive income was computed as follows (amounts in thousands, unaudited):

 

Earnings Applicable to Common Stock

In accordance with the provisions of SFAS 128, “Earnings Per Share”, basic EPS is computed by dividing net income applicable to common stock by the weighted-average common shares outstanding, excluding unvested restricted stock, during the period. Diluted EPS reflects the additional dilution for all potentially dilutive securities such as stock options and unvested restricted stock.

The weighted average number of common shares used in the calculation of basic and diluted earnings per share consisted of the following (amounts in thousands, unaudited):

 

On December 4, 2006, the Company will pay a quarterly cash dividend of $0.2875 per share to shareholders of record on November 13, 2006. During the nine months ended September 30, 2006, the Company paid a quarterly cash dividend of $0.25 per share to shareholders of record on February 10, 2006 and May 12, 2006 and a quarterly cash dividend of $0.2875 per share to shareholders of record on August 11, 2006 for a total of approximately $48.9 million.

During the nine months ended September 30, 2005, the Company paid a quarterly cash dividend of $0.21 per share to shareholders of record on February 11, 2005 and May 13, 2005 and a quarterly cash dividend of $0.25 per share to shareholders of record on August 12, 2005 for a total of approximately $45.5 million.

6.   Share-Based Compensation

In May 2005, the stockholders approved and the Company adopted the 2005 Stock Compensation Plan (the “2005 Plan”) which provides for grants of stock options, stock appreciation rights, restricted stock, restricted stock units and other stock awards (collectively, the “Awards”). Individuals eligible to

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6.   Share-Based Compensation (Continued)

receive Awards under the 2005 Plan include employees, directors and independent contractors of the Company. New shares are issued upon option exercise or restricted stock awards. Each share grant subject to an award of restricted stock, restricted stock unit or other stock award shall reduce the shares available for grant by 1.9 shares. See Note 12 of the Company’s consolidated financial statements in its Annual Report on Form 10-K for the year ended December 31, 2005, for additional information related to the Company’s share-based compensation plan.

Summarized information under the 2005 Plan for the nine months ended September 30, 2006, is as follows (unaudited):

 

Effective January 1, 2006, the Company adopted SFAS 123R utilizing the modified prospective application. Under the modified prospective application, SFAS 123R applies to new awards and to awards that were outstanding on December 31, 2005 that are subsequently modified, repurchased or cancelled. Under the modified prospective application, compensation cost recognized for the three and nine months ended September 30, 2006 includes compensation cost of all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimate in accordance with the original provisions of SFAS 123 and compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimate in accordance with the provisions of SFAS 123R. Accordingly, prior period amounts are not restated to reflect the impact of adopting SFAS 123R under the modified prospective application.

The recognition of compensation expense related to the issuance of restricted stock has not changed with the adoption of SFAS 123R, with the exception of the inclusion of the estimate of forfeitures, and such compensation expense continues to be expensed in the statements of operations. The following table reflects the impact in net income of adopting SFAS 123R reflecting compensation expense related to stock option awards that were previously not recognized in the financial statements due to the Company’s prior application of APB Opinion 25 (amounts in thousands, except per share data, unaudited):

 

The Company receives a tax deduction for certain stock option exercises during the period the options are exercised, generally for the excess of the market price of the option exercised over the exercise price of such options. In accordance with SFAS 123R, for the nine months ended September 30, 2006, the

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6.   Share-Based Compensation (Continued)

Company reported the tax benefit from the exercise of stock options as financing cash flows rather than operating cash flows as reported prior to the adoption of 123R. For the nine months ended September 30, 2006, the Company reported $1.8 million of excess tax benefit.

Stock Options

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model and expensed using the straight-line approach. Option valuation models require the input of highly subjective assumptions and changes in the assumptions used can materially affect the fair value estimate. Expected volatility and dividends are based on implied and historical factors related to the Company’s common stock. The expected term represents the weighted-average time between grant date and exercise date and the risk-free interest rate is based on U.S. Treasury rates appropriate for the expected term. No stock options were granted during 2005 or 2006 resulting in no assumptions for dividend yield, expected volatility, risk-free interest rate or expected term of option.

The Company uses historical data and projections to estimate expected employee behaviors related to option exercises and forfeitures. SFAS 123R requires that forfeitures be included as part of the grant date estimate. The effect of forfeitures related to previous SFAS 123 pro forma expense was not material. At September 30, 2006, there was $0.9 million of unrecognized compensation expense related to share-based payments which is expected to be recognized over a weighted-average period of 0.7 years. Based on stock options outstanding at September 30, 2006, the Company estimates $0.6 million of additional expense in 2006, $0.3 million in 2007 and virtually zero thereafter. The remaining weighted average contractual term for options outstanding at September 30, 2006 is 4.9 years and 4.7 years for options exercisable at September 30, 2006.

The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the stock option. At September 30, 2006, the aggregate intrinsic value of stock options outstanding was $101.4 million and the aggregate intrinsic value of stock options exercisable was $77.8 million. Total intrinsic value of stock options exercised was $30,000 and $5.4 million, for the three and nine months ended September 30, 2006, respectively.

Net cash proceeds from the exercise of stock options were $1.1 million and $14.2 million for the nine months ended September 30, 2006 and 2005, respectively. The actual income tax benefit realized from stock option exercises was $1.8 million and $24.1 million for the same periods, respectively.

Restricted Stock

The unearned share-based compensation related to restricted stock is amortized to compensation expense over the period the restrictions lapse (generally five to ten years). The share-based expense for these awards was determined based on the market price of our stock at the date of grant applied to the total number of shares that were anticipated to fully vest and then amortized over the vesting period. Upon adoption of SFAS 123R, the Company recognizes compensation expense based on its expectation of which restricted stock awards will vest over the requisite service period for such awards. Prior to implementing SFAS 123R, the Company recognized deferred compensation as a contra-equity account representing the amount of unrecognized restricted stock expense that was reduced as the expense was recognized. Under the provisions of SFAS 123R, the previously recorded deferred compensation was netted against additional paid-in capital.

As of September 30, 2006, the Company has unearned share-based compensation of $147.2 million associated with these awards. The total fair value of restricted shares that vested for the three months ended September 30, 2006 and 2005 was $8.3 million and $8.6 million, respectively. The total fair value of

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6.   Share-Based Compensation (Continued)

restricted shares that vested for the nine months ended September 30, 2006 and 2005 was $15.2 million and $14.2 million, respectively.

Upon adoption of SFAS 123R, the Company began recognizing compensation expense related to stock option awards that were previously disclosed as pro forma information regarding net income and earnings per share. Compensation expense related to restricted stock awards continues to be expensed as under APB Opinion 25, with the addition of estimated forfeitures.

The following table represents where reported share-based compensation expense was classified in the accompanying condensed consolidated statements of operations (amounts in thousands, unaudited):

 

The following table compares actual net income reflecting SFAS 123R share-based compensation expense of $4.0 million and $11.4 million, respectively, as reported for the three and nine months ended September 30, 2006 to the prior year’s pro forma SFAS 123 fair value compensation expense of $0.7 million and $2.0 million, respectively and reported APB Opinion 25 intrinsic value compensation expense of $2.1 million and $6.0 million, respectively, related to restricted stock amortization (amounts in thousands, except per share data, unaudited):

 

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