Item 1. Business
Dover Downs Gaming & Entertainment, Inc. is a diversified gaming and entertainment company whose operations consist of Dover Downs Slots - a 91,000 square foot video lottery (slot) casino complex; the Dover Downs Hotel - featuring luxury accommodations with conference, banquet, fine dining, ballroom and concert hall facilities; and Dover Downs Raceway - a harness racing track with pari-mutuel wagering on live and simulcast horse races.
Gaming & Entertainment is a public holding company that has two wholly owned subsidiaries: Dover Downs, Inc. and Dover Downs Management Corp. Dover Downs, Inc. was incorporated in 1967 and began motorsports and harness racing operations in 1969. In June of 1994, legislation authorizing video lottery operations in the State of Delaware (the “State”) was adopted. The Company’s video lottery (slot) casino operations began on December 29, 1995. As a result of several restructurings, Dover Downs, Inc. became a wholly owned subsidiary of Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) (“DVD”), and became the operating entity for all of DVD’s gaming operations.
Dover Downs Gaming & Entertainment, Inc. was incorporated in the State in December of 2001 as a wholly owned subsidiary of DVD. Effective March 31, 2002, DVD completed a tax-free spin-off of its gaming operations by contributing 100% of the issued and outstanding common stock of Dover Downs, Inc. to the Company, and subsequently distributing 100% of the issued and outstanding common stock of the Company to DVD stockholders. Immediately following the spin-off, Dover Downs Gaming & Entertainment, Inc. became an independent public company.
The Company is authorized to conduct video lottery operations as a “Licensed Agent” under the Delaware State Lottery Code. Pursuant to Delaware’s Horse Racing Redevelopment Act, enacted in 1994, the Delaware State Lottery Office administers and controls the operation of the video lottery.
The Company’s license from the Delaware Harness Racing Commission (the “Commission”) to hold harness race meetings on our premises and to offer pari-mutuel wagering on live and simulcast horse races must be renewed on an annual basis. In order to maintain its license to conduct video lottery operations, the Company is required to maintain its harness horse racing license. The Company has received an annual license from the Commission for the past 37 consecutive years and management believes that its relationship with the Commission remains good.
Our entertainment complex is located in Dover, the capital of the State of Delaware. Approximately 70% of our customers come from Maryland, Pennsylvania, Virginia and the District of Columbia.
Due to the nature of the Company’s business activities, it is subject to various federal, state and local regulations.
Dover Downs Slots
Our video lottery (slot) machine casino opened in December 1995 with approximately 500 video lottery (slot) machines. Due to its popularity, the video lottery (slot) machine casino has expanded four times since its opening and the number of machines has increased steadily to 2,500 (the maximum number allowed by the Director of the Delaware State Lottery Office (the “Lottery Director”)) at December 31, 2005. The most recent expansion occurred in the first quarter of 2004 with the construction of 11,000 additional square feet of gaming space and the installation of 500 machines within the existing casino complex.
Our video lottery (slot) machines range from our popular penny machines to $100 machines in the Premium Slots area and include many popular franchise games found in the country’s major gaming jurisdictions. Additional
amenities include the Garden Cafe, which becomes a lounge with live entertainment several nights a week. The Las Vegas style video lottery casino housing the gaming equipment was designed and built using expertise from Caesars World Gaming Development Corporation (“Caesars”), a leader in the gaming industry. Our facilities are open every day of the year, except Christmas and Easter, and were visited by an estimated 3 million patrons in 2005.
The Delaware State Lottery Office administers and controls our video lottery (slot) machine operations. We are a Licensed Agent authorized to conduct video lottery operations under the Delaware State Lottery Code and one of only three locations permitted to do so in the State of Delaware. We are permitted by law to set the payout to customers between 87% and 95%. Since the introduction of our video lottery (slot) machine operations, we have maintained an average payout of approximately 91.5%. We believe that this represents a competitive payout percentage.
Since our video lottery (slot) machine casino opened in 1995, we had been party to a management agreement with Caesars, under which Caesars was our agent to supervise, manage and operate our video lottery (slot) machine casino. Effective December 28, 2004, that management agreement expired and we opted not to renew the agreement. As a result, we are no longer required to pay to Caesars a management fee. We have not had and do not expect to incur any material costs to replace functions for which Caesars had responsibility under this agreement.
We use sophisticated database marketing to develop long-term relationships with our patrons and to target promotions to specific customer segments. Our Capital Club, a slots players club and tracking system, allows us to identify customers and to reward their level of play through various marketing programs. Membership in this club currently stands at approximately 150,000 active patrons. During 2004, we installed a new state-of-the-art customer management and slot data system. This system allows us to market our property more effectively and has allowed for the conversion of a majority of our casino floor to ticket-in, ticket-out (cashless) technology. As of December 31, 2005, we have converted 1,923 of our 2,500 video lottery (slot) machines to ticket-in, ticket-out technology and we expect to have the remainder of our video lottery (slot) machines using the ticket-in/ticket-out technology by the end of 2006.
We have implemented extensive procedures for financial and accounting controls, safekeeping and accounting of monies, and security provisions. Security over the gaming operations involves the integration of surveillance cameras, observation and oversight by employees, security and gaming staff, and various security features built into the video lottery (slot) machines. The above, when combined with proper internal control procedures and daily monitoring of each video lottery (slot) machine by the Delaware State Lottery Office, are intended to maintain the security, integrity and accountability of the video lottery operations.
On May 30, 2003, a committee created by the Delaware House of Representatives (the “Committee”) issued a favorable assessment as to the merits of conducting sports wagering in the State through its video lottery agents. The Committee concluded that sports gaming is feasible in the State, outlined proposed structures for its implementation and provided various financial projections. The report has been provided to the Delaware General Assembly for consideration. By Federal law, Delaware is the only state east of Montana, and one of only four states in the United States, where sports betting is legally permitted. Enabling legislation would need to be passed by the Delaware General Assembly to establish sports gaming operations at our property.
The State of Delaware recently passed legislation which allows the Company to expand its operating hours, add additional slot machines and provide free promotional play through its recently enhanced slots marketing system. The increased operating hours will begin with 24 hour gaming on Friday nights and two additional hours on Saturday nights, and may be expanded in the future. The legislation increased the number of allowable slot machines for each of the three licensed facilities in Delaware from 2,500 to 4,000. Each slot machine in excess of 2,500 will require payment of an annual fee of $1,100 per machine for the first 500 machines added, $700 per machine for the next 500 machines added, and $300 per machine for the last 500 machines added.
Dover Downs Hotel
Our luxury hotel facility, the Dover Downs Hotel, is located adjacent to our casino. The facility was partially opened in the first quarter of 2002 and was completed in April 2002. The hotel includes 232 rooms, a multi-purpose ballroom/concert hall, a fine dining restaurant, swimming pool and health spa. Construction that occurred
simultaneously with building the hotel included, among other things, building a 425-seat buffet restaurant, renovating the enclosed harness racing grandstand with state-of-the-art simulcasting facilities and building an HVAC plant. This facility has allowed us to offer a wider range of entertainment options to our patrons, including concerts featuring prominent entertainers, live boxing, gourmet dining, trade shows and conferences. The facility allows us to attract new patrons and lengthen the stay of current patrons. Since opening the Dover Downs Hotel, we have managed its operations ourselves. In 2005, hotel occupancy averaged almost 94% and the hotel was awarded the AAA Four Diamond Award for the third consecutive year.
The Company is exploring the possibility of an expansion to the Dover Downs Hotel and has hired architects, engineers and other professionals to prepare drawings and cost estimates. The total cost of this preliminary work is estimated at $1,750,000 and is expected to be completed by the end of the first quarter of 2006.
Dover Downs Raceway
Dover Downs Raceway has presented pari-mutuel harness racing events for 37 consecutive years. Live harness races are conducted at Dover Downs Raceway between November and April and are simulcast to tracks and other off-track betting locations across North America on each of the Company’s more than 130 live race dates. Our races currently are transmitted to more than 400 tracks and off-track betting locations. The harness horse racing track is a 5/8-mile track and is lighted for nighttime operations. The track is adjacent to our casino and hotel on land owned by DVD on the inside of DVD’s auto racing superspeedway. Use of the track is pursuant to an easement granted by DVD.
Within our main grandstand is the simulcast parlor where our patrons can wager on harness and thoroughbred races received by satellite into Dover Downs Raceway year round from numerous tracks across North America. Television monitors throughout the parlor area provide views of all races simultaneously and the parlor’s betting windows are connected to a central computer allowing bets to be received on all races from all tracks. Additional amenities include the Winners Circle Restaurant.
Harness racing in the State of Delaware is governed by the Delaware Harness Racing Commission. We hold a license from the Commission authorizing us to hold harness race meetings on our premises and to offer pari-mutuel wagering on live and simulcast horse races.
Harness racing refers to any racing of horses in which the horses competing or participating are harnessed to a two-wheeled sulky, which carries the driver. Pari-mutuel wagering refers to pooled betting by which the wagering public, not the track, determines the odds and the payoff. The track retains a commission, which is a percentage of the total amount wagered (“handle”). Simulcasting refers to the transmission of live horse racing by television, cable or satellite signal from one race track to another with pari-mutuel wagering being conducted at the sending and receiving track and a portion of the handle being shared by the sending and receiving tracks.
The legislation authorizing video lottery operations in the State of Delaware was adopted in June 1994, and is referred to as the “Horse Racing Redevelopment Act.” The Delaware General Assembly’s stated purpose in approving the legislation was to (i) provide non-state supported assistance in the form of increased economic activity and vitality for Delaware’s harness and thoroughbred horse racing industries, which activity and vitality will enable the industry to improve its facilities and breeding stock, and cause increased employment; and (ii) restrict the location of such lottery to locations where wagering is already permitted and controls exist. A portion of the proceeds from the wagering on the video lottery (slot) machines is allocated to increase the purses for harness horse races held at Dover Downs Raceway and is intended to provide increased vitality for Delaware’s horse racing industry.
We have an agreement with the Delaware Standardbred Owner’s Association, Inc. (“DSOA”) effective August 1, 2003 and continuing through July 31, 2007. DSOA’s membership consists of owners, trainers and drivers of harness horses participating in harness race meetings at our facilities and elsewhere in the United States and Canada. The DSOA has been organized and exists for the purpose of promoting the sport of harness racing; improving the lot of owners, drivers and trainers of harness racing horses participating in race meetings; establishing health, welfare and insurance programs for owners, drivers and trainers of harness racing horses; negotiating with harness racing tracks on behalf of owners, trainers, drivers and grooms of harness racing horses; and generally rendering assistance
to them whenever and wherever possible. Under the DSOA agreement, we are required to distribute as purses for races conducted at our facilities, a percentage of our retained share of pari-mutuel revenues, depending on the level of the average daily dollar handle.
We enjoy a good relationship with representatives of DSOA and anticipate that this relationship will continue. We believe that the DSOA agreement is typical of similar agreements in the industry.
Licensing and Regulation by Gaming and Other Authorities
General
We are subject to extensive federal, state and local regulations related to our operations, particularly our video lottery (slot) operations, live harness racing and pari-mutuel wagering. These operations are contingent upon continued government approval of such operations as forms of legalized gaming and could be subjected at any time to additional or more restrictive regulations. The following is a brief outline of some of the more significant regulations affecting our gaming operations and not intended as a recitation of all regulations applicable to our business.
Delaware law regulates the percentage of commission we are entitled to receive from our gaming activities, which comprises a significant portion of our overall revenues. Our licenses to conduct video lottery (slot) machine operations, harness horse races and pari-mutuel wagering could be modified or repealed at any time and we could be required to terminate our gaming operations.
Video Lottery (Slot) Operations
General. Video lottery (slot) operations are by statute operated and administered by the Lottery Director. We are a Licensed Agent authorized to conduct video lottery (slot) operations under the Delaware State Lottery Code.
A “video lottery (slot) machine” is defined by law as any machine in which bills, coins or tokens are deposited in order to play in a game of chance in which the results, including options available to the player, are randomly and immediately determined by the machine. A machine may use spinning reels or video displays or both, and may or may not dispense coins or tokens directly to winning players. A machine shall be considered a video lottery (slot) machine notwithstanding (i) the use of an electronic credit system making the deposit of bills, coins or tokens unnecessary, or (ii) the fact that the video lottery (slot) machine has employed dual function terminal technology. Various video lottery (slot) machines are in use at our casino. All accept $5, $10, $20, $50 and $100 bills.
The Lottery Director has discretion to adopt such rules and regulations as the Lottery Director deems necessary or desirable for the efficient and economical operation and administration of the system, including (i) type and number of games permitted, (ii) pricing of games, (iii) numbers and sizes of prizes, (iv) manner of payment, (v) value of bills, coins or tokens needed to play, (vi) requirements for licensing agents and service providers, (vii) standards for advertising, marketing and promotional materials used by Licensed Agents, (viii) procedures for accounting and reporting, (ix) registration, kind, type, number and location of video lottery (slot) machines on a Licensed Agent’s premises, (x) security arrangements for the video lottery system, and (xi) reporting and auditing of financial information of Licensed Agents.
Licensing Requirements. We were granted a license on December 13, 1995.
There are continuing licensure requirements for all officers, directors, key employees and persons who own directly or indirectly 10% or more of a Licensed Agent, which licensure requirements shall include the satisfaction of such security, fitness and background standards as the Lottery Director may deem necessary relating to competence, honesty and integrity, such that a person’s reputation, habits and associations do not pose a threat to the public interest of the State or to the reputation of or effective regulation and control of the video lottery; it being specifically understood that any person convicted of any felony, a crime involving gambling, or a crime of moral turpitude within 10 years prior to applying for a license or at any time thereafter shall be deemed unfit.
There are similar licensure requirements for providers of the video lottery (slot) machines and certain companies that seek to provide services to a Licensed Agent.
Revocation, Suspension or Modification of License. The Lottery Director may revoke or suspend the license of a Licensed Agent, such as ours, for “cause.” “Cause” is broadly defined and could potentially include falsifying any application for license or report required by the rules and regulations, the failure to report any information required by the rules and regulations, the material violation of any rules and regulations promulgated by the Lottery Director or any conduct by the licensee which undermines the public confidence in the video lottery system or serves the interest of organized gambling or crime and criminals in any manner. A license may be revoked for an unintentional violation of any federal, state or local law, rule or regulation provided that the violation is not cured within a reasonable time as determined by the Lottery Director. A hearing officer’s decision revoking or suspending the license shall be appealable to the Delaware Superior Court under the provisions of the Administrative Procedures Act. All existing or new officers, directors, key employees and owners of a Licensed Agent are subject to background investigation. Failure to satisfy the background investigation may constitute cause for suspension or revocation of the License.
Ownership Changes. Under Delaware law, a change of ownership of a Licensed Agent will automatically terminate its license 90 days after the change of ownership occurs, unless the Lottery Director determines after application to issue a new license to the new owners. Change of ownership may occur if any new individual or entity acquires, directly or indirectly, 10% or more of the Licensed Agent or if more than 20% of the legal or beneficial interest in the Licensed Agent is transferred, whether by direct or indirect means. The Commission may require extensive background investigations of any new owner acquiring a 10% or greater interest in a Licensed Agent, including criminal background checks. Accordingly, the Company has a restrictive legend on its shares of common stock which require that (a) any holders of common stock found to be disqualified or unsuitable or not possessing the qualifications required by any appropriate gaming authority could be required to dispose of such stock and (b) any holder of common stock intending to acquire 10% or more of the outstanding common stock of the Company must first obtain prior written approval from the Delaware State Lottery Office.
Harness Racing Events. In order to maintain our license for video lottery (slot) machine gaming, we are required to maintain our license for harness horse racing with the Commission and must conduct a minimum of 80 live race days each racing season, subject to the availability of racing stock.
Control Over Equipment and Technology. The Company does not own or lease the video lottery (slot) machines or computer systems used by the State in connection with its video lottery gaming operations. The Lottery Director enters into contracts directly with the providers of the video lottery (slot) machines and computer systems (the “Technology Providers”). Equipment is provided to the State by sale or lease and all Technology Providers must be licensed by the Lottery Director. There are also limitations on the number of video lottery (slot) machines that may be used at any one facility that are supplied by the same Technology Provider. The operations of the Company could be disrupted in the event that a licensed Technology Provider in any way breaches its agreement with the State or ceases to be properly licensed for any reason. Such an event would be outside of the control of the Company.
Harness Racing and Pari-Mutuel Wagering
Licensing Requirements. Harness racing in the State of Delaware is governed by the Delaware Harness Racing Commission. The Company holds a license from the Commission by which it is authorized to hold harness race meetings on its premises and to make, conduct and sell pools by the use of pari-mutuel machines or totalizators. The license must be renewed on an annual basis. The Commission may reject an application for a license for any cause which it deems sufficient and the action of the Commission is final. The Commission may also suspend or revoke a license which it has issued and its action in that respect is final, subject to review, upon questions of law only, by the Superior Court of the County within which the license was granted. The action of the Commission stands unless and until reversed by the Court. The Company has received an annual license from the Commission for the past 37 consecutive years and management believes that its relationship with the Commission remains good. However, there can be no assurances that the Company will continue to be licensed by the Commission in the future.
Under the law, the Commission has broad powers of supervision and regulation. The Commission may prescribe rules, regulations and conditions under which all harness racing and betting pools shall be conducted; may regulate the performance of any service or the sale of any article on the premises of a licensee; may compel the production of books and documents of a licensee and require that books and records be kept in such manner as the Commission may prescribe; may visit, investigate and place accountants or other persons as it deems necessary, at the expense of a licensee, in the office, track or place of business of a licensee; may summon witnesses and administer oaths; and may require the removal of any employee or official employed by a licensee. All proposed extensions, additions or improvements to the property of a licensee are subject to the approval of the Commission.
The Commission is required to inspect a licensee’s racing plant not less than five days prior to a race meeting and may withdraw the license for the meeting if the racing plant is found to be unsafe for animals or persons or is not rendered safe prior to the opening of the meeting. A licensee must deposit with the Commission, ten days before a race meeting, a policy of insurance against personal injury liability in an amount to be approved by the Commission.
USTA. Any license granted by the Commission is also subject to such reasonable rules and regulations as may be prescribed from time to time by the United States Trotting Association (“USTA”). The USTA sets various rules relating to the conduct of harness racing. According to its Articles of Incorporation, the purposes of the USTA shall include the improvement of the breed of trotting and pacing horses, the establishment of rules regulating standards and the registration of such horses thereunder, the advancement and promotion of the interest of harness racing in the United States, the investigation, ascertainment and registration of the pedigrees of such horses, the regulation and government of the conduct of the sport of harness racing, the establishment of rules for the conduct thereof, not inconsistent with the laws of the various states, and the sanctioning of the holding of exhibitions of such horses and meetings for the racing thereof, the issuance of licenses to qualified persons to officiate at harness race meetings and exhibitions, the issuance of licenses to the owners of horses permitting the exhibition and racing of such horses and the qualification thereof, the issuance of licenses to drivers of horses participating in such races or exhibitions, and providing for the enforcement of the rules promulgated by the USTA, and providing for the fixing of penalties, fines, and the suspension or expulsion from membership, or privileges or for any other misconduct detrimental to the sport.
Gaming Taxes and Fees
We believe that the prospect of significant additional tax revenue is one of the primary reasons why jurisdictions have legalized gaming. As a result, gaming operators are typically subject to significant taxes and fees in addition to normal federal and state corporate income taxes. These taxes and fees are subject to increase at any time. We pay substantial taxes and fees with respect to our operations and would likely incur similar burdens in any other jurisdiction in which we may conduct gaming operations in the future.
Compliance with Other Laws
We are subject to various federal, state and local laws and regulations in addition to gaming regulations. These laws and regulations include, but are not limited to, restrictions and conditions concerning alcoholic beverages, environmental matters, employees, currency transactions, taxation, zoning and building codes, and marketing and advertising.
The Internal Revenue Service (“IRS”), requires operators of casinos located in the United States to file information returns for United States citizens, including names and addresses of winners, for all winnings in excess of stipulated amounts. The IRS also requires operators to withhold taxes on certain winnings.
Regulations adopted by the Financial Crimes Enforcement Network of the Treasury Department (“FinCEN”) require us to report currency transactions in excess of stipulated amounts occurring within a gaming day, including identification of the patron by name and social security number. FinCEN has also established regulations that require us to file suspicious activity reports on all transactions that we know, suspect, or have reason to suspect fall into specific categories that are deemed to be suspicious. We believe our programs meet the requirements of the applicable regulations.
Laws and regulations are always subject to change, can be interpreted differently in the future, and new laws and regulations may be enacted which could adversely affect the tax, regulatory, operational or other aspects of the gaming industry and our company. Furthermore, noncompliance with one or more of these laws and regulation could result in the imposition of substantial penalties against us.
Competition
The gaming industry in the United States is intensely competitive and features many participants, including riverboat casinos, dockside casinos, land-based casinos, video lottery (slot) and poker machines, whether or not located in casinos, native American gaming, pari-mutuel wagering on live and simulcast horse racing, off track betting, state run lotteries, internet gambling and other forms of gambling. Gaming competition is particularly intense in each of these markets.
We compete in local and regional markets with horse tracks, off-track betting parlors, state run lotteries, casinos and other gaming facilities. We cannot be certain that we will maintain our market share or compete more effectively with our competitors. The introduction or expansion of gaming in neighboring jurisdictions, particularly Maryland, Virginia, Washington, D.C., Pennsylvania or New Jersey, or the legalization of additional gaming venues in Delaware, could have a material adverse effect on our cash flows and results of operations. Approximately 70% of our customers come from Maryland, Pennsylvania, Virginia and the District of Columbia. In July 2004, Pennsylvania adopted legislation which authorizes up to 61,000 slot machines at various existing and proposed venues throughout the state. It is difficult for us to predict the effect that such legislation will have on us, but we estimate that one or more facilities in Pennsylvania may begin operations in the latter half of 2006. Pennsylvania will have one of the highest effective tax rates on slot machine gaming in the country and will charge an up front $50,000,000 license fee to the horse racing and casino venues that are granted a gaming license. Management has estimated that slot win from Pennsylvania patrons represents approximately 6% of our total slot win.
Pennsylvania, Maryland and New Jersey all have state-run lotteries. Atlantic City, New Jersey is located approximately 100 miles from our entertainment facility and offers a full range of gaming products. Maryland, Virginia and Washington, D.C. do not permit video lottery (slot) machine operations
Competition in horse racing is varied since racetracks in the surrounding area differ in many respects. Some tracks only offer thoroughbred or harness horse racing; others have both. Tracks have live racing seasons that may or may not overlap with neighboring tracks. Depending on the purse structure, tracks that are farther apart may compete with each other more for quality horses than for patrons.
Live harness racing also competes with simulcasts of thoroughbred and harness racing. All racetracks in the region are involved with simulcasting. In addition, a number of off-track betting parlors compete with track simulcasting activities. With respect to the simulcasting of our live harness races to tracks and other locations, our simulcast signals are in direct competition with live races at the receiving track and other races being simulcast to the receiving location.
Within the State of Delaware, we face little direct live competition from the State’s other two tracks. Harrington Raceway, a south central Delaware fairgrounds track, conducts harness horse racing periodically between May and November. There is no overlap presently with our live race season. Delaware Park, a northern Delaware track, conducts thoroughbred horse racing from April through mid-November. Its race season only overlaps with ours for approximately six weeks each year.
We compete with harness and thoroughbred racing and simulcasting facilities in the neighboring states of Pennsylvania, Maryland and New Jersey. We also receive simulcast harness and thoroughbred races from approximately 80 race tracks.
Competition for our hotel varies and consists of local and regional competition. With respect to hotel accommodations only, we compete with a variety of nearby hotels in the Dover area; however, few of these offer the luxury accommodations that we offer. Our hotel is the only hotel in the Dover area, and one of only three hotels in the State, to receive the AAA Four Diamond Award. With respect to trade shows, conferences, concerts and hotel room packages tied to these events or tied to our casino and other gaming offerings, we compete at a regional level
with the other gaming operations referred to above and with convention centers and larger hotels in major cities such as Philadelphia, Washington, D.C., Baltimore and Wilmington.
In addition, our activities compete with other leisure, entertainment and recreational activities.
Growth Strategies
We offer a unique gaming and entertainment experience and make available to our patrons a number of different options: slot machine gaming, live harness horse racing, fine dining, national recording and entertainment acts, live boxing and simulcasting of thoroughbred and harness horse races from across the United States. Our mission is simple: to provide all of our customers a premier gaming and entertainment experience with a focus on quality customer service. Our growth strategy is to foster customer loyalty by following this mission, focus on our most valuable customers, expand and improve the quality of our slot gaming positions, enhance our gaming products with additional entertainment offerings and create an exciting gaming environment while focusing on areas that we believe will increase our revenue and profitability. Our efforts in this regard include the following:
Increase The Utilization Of Our Casino
We use a sophisticated database marketing program to develop long-term relationships with our patrons and to target promotions to specific customer segments. Our Capital Club, a slots players club and tracking system, allows us to identify customers and to reward their level of play through various marketing programs. Membership in this club currently stands at approximately 150,000 active patrons. During 2004, we installed a new state-of-the-art customer management and slot data system. This system allows us to market our property more effectively and has allowed for the conversion of a majority of our casino floor to ticket-in, ticket-out (cashless) technology. As of December 31, 2005, we have converted 1,923 of our 2,500 video lottery (slot) machines to ticket-in, ticket-out technology and we expect to have the remainder of our video lottery (slot) machines using the ticket-in/ticket-out technology by the end of 2006. We expect to increase attendance at both our casino and hotel through effective promotional use of our database and by making improvements to our facilities and gaming offerings based on what we learn from our Capital Club members. For example, we continue to add machines with differing denominations and progressive slot machines with large jackpot sizes because they offer patrons a more exciting gaming experience.
On May 30, 2003, a committee created by the Delaware House of Representatives issued a favorable assessment as to the merits of conducting sports wagering in the State through its video lottery agents. The Committee concluded that sports gaming is feasible in the State, outlined proposed structures for its implementation and provided various financial projections. The report has been provided to the Delaware General Assembly for consideration. By Federal law, Delaware is the only state east of Montana, and one of only four states in the United States, where sports betting is legally permitted. Enabling legislation would need to be passed by the Delaware General Assembly to establish sports gaming operations at our property.
The State of Delaware recently passed legislation which allows the Company to expand its operating hours, add additional slot machines and provide free promotional play through its recently enhanced slots marketing system. The increased operating hours will begin with 24 hour gaming on Friday nights and two additional hours on Saturday nights, and may be expanded in the future. The legislation increased the number of allowable slot machines for each of the three licensed facilities in Delaware from 2,500 to 4,000. Each slot machine in excess of 2,500 will require payment of an annual fee of $1,100 per machine for the first 500 machines added, $700 per machine for the next 500 machines added, and $300 per machine for the last 500 machines added. The Company is currently examining its need for additional machines and other amenities.
Capitalize On Our Luxury Hotel
Our luxury hotel facility, the Dover Downs Hotel, is located adjacent to our casino. It is the only hotel in the Dover area, and one of only three hotels in the State, to receive the AAA Four Diamond Award. The facility was partially opened in the first quarter of 2002 and was completed in April 2002. The hotel includes 232 rooms, a multi-purpose ballroom/concert hall, a fine dining restaurant, swimming pool and health spa. Construction that occurred simultaneously with building the hotel included, among other things, building a new 425-seat buffet restaurant, renovating the enclosed harness racing grandstand with state-of-the-art simulcasting facilities and building an
HVAC plant. This facility has allowed us to offer a wider range of entertainment options to our patrons, including concerts featuring prominent entertainers, live boxing, gourmet dining, trade shows and conferences. The facility allows us to attract new patrons and lengthen the stay of current patrons.
The Company is exploring the possibility of an expansion to the Dover Downs Hotel and has hired architects, engineers and other professionals to prepare drawings and cost estimates. The total cost of this preliminary work is estimated at $1,750,000 and is expected to be completed by the end of the first quarter of 2006.
Increase Wagering On Live Harness Horse Racing Through Increased Purse Levels
With a percentage of video lottery (slot) machine revenues supplementing the purses for the horsemen, we have experienced dramatic increases in the amount of our purses. As of the end of our 2004-2005 season, our average daily purse distribution had increased to approximately $200,000 from $8,000 in 1995. The result is that we continue to attract higher quality horses. We have prestigious events such as our annual “Progress Pace” with an estimated $400,000 purse, an event which attracts the country’s top three-year-old horses. Bettors are attracted to races with larger purses and typically wager more on the higher quality and more predictable horses. We have also completed various upgrades to enhance the harness horse racing facilities, including renovations to the track and grounds, receiving barn and paddock areas and, more recently, our simulcast parlor which has state-of-the-art facilities that allow year round wagering. We continue to focus on improvements that we believe allow us to increase attendance and wagering, including wagering on our events from other tracks and off track wagering facilities that receive our racing signal during our race season.
Seasonality
Gaming & Entertainment’s quarterly operating results are affected by weather and the general economic conditions in the United States. Our quarterly operating results are generally distributed evenly throughout the year. However, the results for any quarter are not necessarily indicative of results to be expected in any future period.
Employees
As of December 31, 2005, Gaming & Entertainment had approximately 778 full-time employees and 144 part-time employees. We engage temporary personnel to assist during our live harness racing season. None of our employees are party to a collective bargaining agreement and we believe that our relationship with our employees is good.
Available Information
We file annual, quarterly and current reports, information statements and other information with the United States Securities and Exchange Commission (the “SEC”). The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.
Internet Address
We maintain a website where additional information concerning our business and various upcoming events can be found. The address of our Internet website is http://www.doverdowns.com. We provide a link on our website, under Investor Relations, to our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports.
Item 1A.
Item 1A. Risk Factors
Disclosure regarding the most significant factors that may adversely affect our business, operations, industry or financial position or our future financial performance is set forth under the section entitled, “Factors That May Affect Operating Results; Forward-Looking Statements,” beginning on page 21.
Item 1B.
Item 1B. Unresolved Staff Comments
We have not received any written comments that were issued more than 180 days before December 31, 2005, the end of the fiscal year covered by this report, from the SEC staff regarding our periodic or current reports under the Securities Exchange Act of 1934 that remain unresolved.
Item 2.
Item 2. Properties
We own our principal executive office located in Dover, Delaware; Dover Downs Slots-our 91,000 square foot casino; the Dover Downs Hotel-featuring luxury accommodations with conference, banquet, fine dining, ballroom and concert hall facilities; and the Dover Downs Raceway-indoor grandstands, betting and simulcasting parlors, all of which are located at our entertainment complex situated on approximately 69 acres of land owned by us.
The Company’s use of DVD’s 5/8-mile harness racing track is pursuant to an easement granted to the Company by DVD which does not require the payment of any rent. Under the terms of the easement, the Company has exclusive use of the harness track during the period beginning November 1 of each year and ending April 30 of the following year, together with set up and tear down rights for the two weeks before and after such period. The harness track is located on property owned by DVD and is on the inside of DVD’s motorsports superspeedway. The Company’s indoor grandstands are used by DVD at no charge in connection with its motorsports events. DVD also leases its principal office space from the Company. Various easements and agreements relative to access, utilities and parking have also been entered into between DVD and the Company relative to their respective Dover, Delaware facilities.
Item 3.
Item 3. Legal Proceedings
We are a party to ordinary routine litigation incidental to our business. Management does not believe that the resolution of any of these matters is likely to have a serious negative effect on our financial condition, cash flows or profitability.
Item 4.
Item 4. Submission Of Matters To A Vote Of Security Holders
No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders.
Part II
Item 5.
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases Of Equity Securities
Gaming & Entertainment’s common stock is listed on the New York Stock Exchange under the ticker symbol “DDE.” Gaming & Entertainment Class A common stock is not publicly traded but is freely convertible into Gaming & Entertainment common stock at any time at the option of the holder thereof. As of February 28, 2006, there were 9,681,437 shares of common stock and 11,899,687 shares of Class A common stock outstanding. There were 1,044 holders of record for common stock and 15 holders of record for Class A common stock.
The high and low sales prices for the Company’s common stock on the New York Stock Exchange and the dividends declared per share for the years ended December 31, 2005 and 2004 are detailed in the following table.
Equity Compensation Plan Information
The Company has a stock incentive plan which provides for the grant of up to 1,500,000 shares of common stock to our officers and key employees through stock options and/or awards valued in whole or in part by reference to our common stock, such as restricted stock awards. Refer to NOTE 8-Stockholders’ Equity of the consolidated financial statements included elsewhere in this Form 10-K for further discussion. Securities authorized for issuance under equity compensation plans at December 31, 2005 are as follows:
On October 23, 2002, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s outstanding common stock. The purchases may be made in the open market or in privately negotiated transactions as conditions warrant. The repurchase authorization does not obligate the Company to acquire any specific number of shares and may be suspended at any time. At December 31, 2005, the Company had remaining repurchase authority of 1,779,155 shares.
On December 19, 2005, the Company commenced a tender offer to purchase up to 1,063,937 shares of its common stock and up to 1,325,468 shares of its Class A common stock at a fixed price of $14.50 per share. The offer expired on January 19, 2006. The Company purchased 1,063,937 shares of its common stock and 1,325,000 shares of its Class A common stock for $35,006,000, including expenses, in connection with the tender offer.
Item 6.
Item 6. Selected Financial Data
The following table summarizes certain selected consolidated financial data of Gaming & Entertainment, which has been derived from its consolidated financial statements for the years ended December 31, 2005, 2004, 2003, 2002 and 2001. This information set forth below should be read in conjunction with management’s discussion and analysis of financial condition and results of operations, the consolidated financial statements and the notes thereto, included elsewhere in this document.
Five Year Selected Financial Data
(a) Effective December 2004, the Company changed its policy relating to its point loyalty program to allow points earned by customers to be redeemed for cash under certain circumstances. As a result, the Company recorded a non-recurring charge of $2,250,000 ($1,338,000 after income tax benefit) in the fourth quarter of 2004 to record the net impact of the program change. The estimated amount of points redeemable for cash was recorded as a reduction of revenue and the estimated amount of points redeemable for services and merchandise was recorded as gaming expense.
(b) On December 28, 2005, the Company’s wholly-owned subsidiary, Dover Downs, Inc., closed on the sale of a shopping center it owned in Dover, Delaware. The shopping center consisted of approximately 7.7 acres of real property with a one-story building of approximately 95,700 square feet. The sales price was $12,450,000 and the Company recognized a gain on the sale of $5,837,000 ($3,461,000 after income taxes). The proceeds from the sale were used to pay down outstanding amounts on the Company’s credit facility.
(c) Net earnings per common share information for periods prior to April 1, 2002, the day after the effective date of the spin-off from DVD, was calculated using the pro forma average outstanding common shares and Class A common shares for Gaming & Entertainment. The pro forma average outstanding common shares and Class A common shares were derived from DVD’s common shares and Class A common shares outstanding for the periods presented using the distribution ratio of 0.7 shares of Gaming & Entertainment common stock and Class A common stock for each share of DVD common stock and Class A common stock, respectively. Outstanding stock options of Gaming & Entertainment were calculated assuming the stock options related to each individual who became a Gaming & Entertainment employee or both a DVD and a Gaming & Entertainment employee subsequent to the spin-off were outstanding Gaming & Entertainment options during each period presented.
(d) On April 1, 2002 in connection with our spin-off from DVD, Gaming & Entertainment paid down $45 million of the amounts outstanding under DVD’s credit facility. This payment was recorded as a charge to stockholders’ equity.
On November 10, 2004, the Company commenced a tender offer to purchase up to 1,040,421 shares of its common stock and up to 1,607,506 shares of its Class A common stock at a fixed price of $12.00 per share. The offer expired on December 10, 2004. The Company purchased 1,040,421 shares of its common stock and 1,600,000 shares of its Class A common stock for $32,045,000, including expenses, in connection with the tender offer.
Item 7.
Item 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
The following discussion is based upon and should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.
Dover Downs Gaming & Entertainment, Inc. is a diversified gaming and entertainment company whose operations consist of Dover Downs Slots - a 91,000 square foot video lottery (slots) casino complex; the Dover Downs Hotel - featuring luxury accommodations with conference, banquet, fine dining, ballroom and concert hall facilities; and Dover Downs Raceway - a harness racing track with pari-mutuel wagering on live and simulcast horse races.
Approximately 90% of the Company’s revenue is derived from video lottery (slot) machine win (as defined below). Several factors contribute to the video lottery (slot) machine win for any gaming company, including, but not limited to:
• Proximity to major population bases,
• Competition in the company’s market,
• The quantity and types of slot machines available,
• The quality of the physical property,
• Other amenities offered on site,
• Customer service levels, and
• Marketing programs.
The Company believes that it holds a strong position in each of these areas. Our entertainment complex is located in Dover, the capital of the State of Delaware. We draw patrons from several major metropolitan areas. Philadelphia, Baltimore and Washington, D.C. are all within a 2 hour drive. According to the 2000 United States Census, approximately 32.8 million people live within 150 miles of the complex. There are significant barriers to entry related to the gaming business in Delaware, such as the statutory limitation of gaming licenses to the three
existing horse racing facilities. The Company’s property, designed and developed with the assistance of Caesars, is similar to properties found in the country’s largest gaming markets. The Company offers the only luxury hotel in the Delaware gaming market, providing a strong marketing tool, especially to higher-end players. The Company also utilizes its recently improved slot marketing system to allow for the most efficient marketing programs and the highest levels of customer service.
Because all of our operations are located at one facility, we face the risk of increased competition from the legalization of new or additional gaming venues. The Company has therefore focused on creating the region’s premier gaming destination and building and rewarding customer loyalty through innovative marketing efforts and unparalleled customer service.
Results of Operations
Gaming revenues represent (i) the net win from video lottery (slot) machine wins and losses and (ii) commissions from pari-mutuel wagering. Other operating revenues consist of hotel rooms revenue, food and beverage sales and other miscellaneous income. Revenues do not include the retail amount of hotel rooms, food and beverage and other miscellaneous goods and services provided without charge to customers as promotional items. The estimated direct cost of providing these items has been charged to the casino through interdepartmental allocations and is included in gaming expenses in the consolidated statement of earnings.
For the video lottery operations, the difference between the amount wagered by bettors and the amount paid out to bettors is referred to as the win. The win is included in the amount recorded in the Company’s consolidated financial statements as gaming revenue. The Delaware State Lottery Office sweeps the win from the video lottery operations, collects the State’s share of the win and the amount due to the vendors under contract with the State who provide the video lottery (slot) machines and associated computer systems, collects the amount allocable to purses for harness horse racing and remits the remainder to the Company as its commission for acting as a Licensed Agent. Gaming expenses include the amounts collected by the State (i) for the State’s share of the win, (ii) for remittance to the providers of the video lottery (slot) machines and associated computer systems, and (iii) for harness horse racing purses. The Company recognizes revenues from pari-mutuel commissions earned from live harness horse racing and importing of simulcast signals from other race tracks when the race occurs. Revenues from hotel rooms, food and beverage sales and other miscellaneous income are recognized at the time the service is provided.
Year Ended December 31, 2005 vs. Year Ended December 31, 2004
Gaming revenues increased by $8,450,000, or 4.4%, to $202,372,000 in 2005, primarily the result of increased play in our casino. During the first quarter of 2004, we added 500 new video lottery (slot) machines which increased our average number of machines from 2,432 in 2004 to 2,500 in 2005.
Other operating revenues were $14,480,000 in 2005 as compared to $13,822,000 in 2004. Net rooms revenue increased $542,000 in 2005 as compared to 2004 primarily due to an increase in cash sales and fewer rooms being provided to customers on a complimentary basis. Net food and beverage revenues increased $680,000 to $9,778,000 from $9,098,000 in 2004 primarily due to higher casino attendance. Partially offsetting these increases was a decrease in concert revenues as a result of the Company promoting fewer shows in 2005 as compared to 2004, including a large outdoor concert promoted in 2004 that generated revenues of $840,000 which was not promoted in 2005. Other operating revenues do not include the retail amount of promotional allowances which are provided to customers on a complimentary basis of $15,103,000 and $19,973,000 in 2005 and 2004, respectively. The decrease in promotional allowances was primarily due to a decrease in retail room rates. Promotional allowances represented 51% and 59% of gross other operating revenues in 2005 and 2004, respectively.
Gaming expenses decreased by $752,000 primarily due to the fact that we no longer incur expenses associated with a management agreement with Caesars that expired on December 28, 2004. During 2004, the Company expensed $4,448,000 in gaming expenses pursuant to this agreement. Additionally, the Company reduced its marketing and advertising costs in 2005 as compared to 2004. Amounts retained by the State of Delaware and the amount collected by the State for payment to the vendors under contract with the State who provide the video lottery (slot) machines and associated computer systems increased by $3,279,000 and $979,000, respectively. Amounts allocated from the
video lottery operation for harness horse racing purses increased from $22,269,000 in 2004 to $23,292,000 in 2005. These expenses increased as a result of our increased slot win.
Other operating expenses increased by $154,000, or 1.2%. Expenses related to our food and beverage operations were $10,999,000 in 2005 as compared to $9,669,000 in 2004. The increase resulted primarily from higher payroll and related employee costs and food costs necessary to support added amenities at the Company’s facility, the increase in food and beverage sales and the addition of higher quality menu items. Additionally, fewer expenses were allocated to the gaming operations through interdepartmental charges in 2005 since a lower percentage of gross revenues represent promotional items provided to gaming customers on a complimentary basis as compared to 2004. Partially offsetting these increases was a decrease in concert expenses of $2,599,000 as a result of the Company promoting fewer shows in 2005 as compared to 2004, including a large outdoor concert promoted in 2004 that was not promoted in 2005.
General and administrative expenses increased by $162,000 to $4,765,000 from $4,603,000 in 2004 primarily the result of higher wages and benefits and pension costs.
Depreciation expense increased to $6,998,000 in 2005 from $6,791,000 in 2004 primarily due to assets being placed in service related to the continued conversion of video lottery (slot) machines to ticket-in, ticket-out (cashless) technology.
Interest expense increased by $1,113,000, primarily due to the increase in average outstanding borrowings during the year under our credit facility resulting from our self tender in the fourth quarter of 2004 and an increase in the Company’s average interest rate from 2.33% during 2004 to 4.23% during 2005.
The Company’s effective income tax rates were 40.7% and 40.6% for the years ended December 31, 2005 and 2004, respectively.
Net earnings were $26,040,000 in 2005 as compared to $16,381,000 in 2004, an increase of $9,659,000, or 59.0%.
On December 28, 2005, Dover Downs, Inc. closed on the sale of a shopping center it owned in Dover, Delaware. The shopping center consisted of approximately 7.7 acres of real property with a one-story building of approximately 95,700 square feet. The sales price was $12,450,000 and the Company recognized a gain on the sale of $5,837,000 ($3,461,000 after income taxes). Additionally, effective December 2004, the Company changed its policy relating to its point loyalty program to allow points earned by customers to be redeemed for cash under certain circumstances. As a result, the Company recorded a non-recurring charge of $2,250,000 ($1,338,000 after income tax benefit) in the fourth quarter of 2004 to record the net impact of the program change. The Company believes that excluding the impact of these items will enhance comparative analysis of its results.
The following table reconciles and compares results reported in accordance with Generally Accepted Accounting Principles (“GAAP”) for 2005 and 2004 with results excluding the impact of the sale of the shopping center in 2005 and the change in our point loyalty program in 2004:
Excluding the gain on sale of the shopping center in 2005 and the net, non-recurring charge for the 2004 change in our point loyalty program, pro forma net earnings in 2005 increased $4,860,000, or 27.4%, to $22,579,000 compared to 2004 pro forma net earnings of $17,719,000. The increase was primarily due to the improved results
for our gaming operations that resulted from an increase in slot win and the elimination of the Caesars’ management fee, partially offset by increased general and administrative, depreciation and interest expenses.
Year Ended December 31, 2004 vs. Year Ended December 31, 2003
Gaming revenues increased by $18,899,000, or 10.8%, to $193,922,000 in 2004, entirely the result of increased play in our casino. During the first quarter of 2004, we added 500 new video lottery (slot) machines which increased our average number of machines from 2,000 in 2003 to 2,432 in 2004. Additionally, we have redirected our marketing efforts to attract more profitable casino customers by providing additional complimentary and discounted rooms in our hotel. We believe that our marketing efforts have been effective at attracting customers to our casino and consequently increasing slot win.
Other operating revenues were $13,822,000 and $13,809,000 in 2004 and 2003, respectively. Net food and beverage revenues increased by $922,000 to $9,098,000 from $8,176,000 in 2003, primarily due to an increase in cash sales and a reduction in the amount of complimentary beverages being offered to patrons. Additionally, the Company promoted an outdoor concert for the first time in 2004 that generated revenues of $840,000. Partially offsetting these increases was the receipt of $1,300,000 in 2003 related to the settlement of a business interruption insurance claim and a decrease in net rooms revenue due to the change in the Company’s marketing efforts which focused on providing a higher percentage of its hotel rooms to customers on a complimentary basis. Other operating revenues do not include the retail amount of promotional allowances which are provided to customers on a complimentary basis of $19,973,000 and $18,667,000 in 2004 and 2003, respectively.
Gaming expenses increased by $14,302,000, or 10.3%, reflecting the higher gaming revenues. Amounts retained by the State of Delaware and the amount collected by the State for payment to the vendors under contract with the State who provide the video lottery (slot) machines and associated computer systems increased by $7,096,000 and $1,475,000, respectively. Amounts allocated from the video lottery operation for harness horse racing purses increased from $20,143,000 in 2003 to $22,269,000 in 2004. Collectively, these statutory costs increased as a percentage of gaming revenues in 2004 as compared to 2003 in part due to a 1.25% surcharge imposed by the State on the Company’s share of the video lottery (slot) proceeds that took effect in June of 2003. The remaining $3,605,000 increase in gaming expenses relates primarily to higher payroll and benefits, primarily as a result of our casino expansion, and increased marketing costs.
Other operating expenses increased by $3,114,000, or 31.5%. Expenses related to our food and beverage operations were $9,669,000 in 2004 as compared to $7,350,000 in 2003. The increase resulted primarily from higher payroll and related costs and food costs necessary to support added amenities at the Company’s facility and the addition of higher quality menu items. Additionally, less food and beverage expenses were allocated to the gaming operations through interdepartmental charges in 2004 since a lower percentage of food and beverages were provided to gaming customers on a complimentary basis. Concert promotion expenses of $1,212,000, relating to a large outdoor concert promoted by the Company in the third quarter of 2004, represented the remainder of the increase in other operating expenses. Partially offsetting these increases was a decrease in expenses for the Company’s hotel rooms operation as a result of cost savings in the housekeeping department and a larger portion of rooms expense being allocated to the gaming operations through interdepartmental charges since a higher percentage of rooms were provided to gaming customers on a complimentary basis in 2004.
General and administrative expenses increased by $286,000 to $4,603,000 from $4,317,000 in 2003 primarily the result of higher payroll and related costs, legal costs, and audit and consulting expenses related to the Company’s compliance with the Sarbanes-Oxley Act of 2002.
Depreciation expense increased by $504,000, primarily due to the construction of 11,000 additional square feet of gaming space to accommodate the installation of 500 video lottery (slot) machines within our existing casino complex during the first quarter of 2004 and the purchase of a new customer management and slot data system that was placed into service in April 2004.
Interest expense decreased by $80,000, primarily due to the decrease in outstanding borrowings under our credit facility for the first 11 months of 2004, partially offset by an increase in the Company’s average interest rate from 2.07% during 2003 to 2.33% during 2004.
The Company’s effective income tax rates were 40.6% and 40.7% for the years ended December 31, 2004 and 2003, respectively.
Net earnings were $16,381,000 in 2004 as compared to $17,237,000 in 2003, a decrease of $856,000, or 5.0%.
The Company currently has a point loyalty program for its video lottery customers which allows them to earn points based on the volume of their video lottery activity. Prior to December 2004, the points could be redeemed for various services and merchandise throughout the gaming facility; however, they were not redeemable for cash or casino play. Effective December 2004, the Company changed its policy relating to its point loyalty program to allow points earned by customers to be redeemed for cash under certain circumstances. As a result, the Company recorded a non-recurring charge of $2,250,000 ($1,338,000 after income tax benefit) in the fourth quarter of 2004 to record the net impact of the program change. The estimated amount of points redeemable for cash was recorded as a reduction of revenue and the estimated amount of points redeemable for services and merchandise was recorded as gaming expense. All reward points earned by customers are now expensed in the period earned. Additionally, net earnings for 2003 included proceeds of $1,300,000 ($771,000 after income taxes) relating to the settlement of a business interruption insurance claim. The Company believes that excluding the impact of these items will enhance comparative analysis of its results.
The following table reconciles and compares results reported in accordance with GAAP for 2004 and 2003 with results excluding the impact of the change in our point loyalty program in 2004 and receipt of insurance proceeds in 2003:
Excluding the net, non-recurring charge for the 2004 change in our point loyalty program and 2003 receipt of insurance proceeds from the settlement of a business interruption claim, pro forma net earnings in 2004 increased $1,253,000, or 7.6%, to $17,719,000 compared to 2003 pro forma net earnings of $16,466,000.
Liquidity and Capital Resources
Net cash provided by operating activities was $29,521,000 for the year ended December 31, 2005 compared to $27,807,000 for the year ended December 31, 2004. The increase was primarily due to the increase in net earnings before gain on sale of shopping center and non-recurring charges (which did not require the use of cash) from $17,719,000 in 2004 to $22,579,000 in 2005, and the timing of payments to vendors. The increase in earnings was partially offset by increased contributions to our pension plan and income tax payments.
Net cash provided by investing activities was $6,406,000 for the year ended December 31, 2005 compared to net cash used in investing activities of $6,329,000 for the year ended December 31, 2004. Proceeds from the sale of a shopping center owned by Dover Downs, Inc., net of transaction costs, were $11,918,000 for the year ended December 31, 2005. Capital expenditures for 2005 related primarily to the continued conversion of video lottery (slot) machines to ticket-in, ticket-out (cashless) technology, payments related to our customer management and slot data system and the addition of new harness track lighting. Capital expenditures for 2004 related primarily to the construction of 11,000 additional square feet of gaming space to accommodate the installation of 500 then newly authorized video lottery (slot) machines within our existing casino complex and the purchase of the new customer management and slot data system.
Net cash used in financing activities was $33,629,000 for the year ended December 31, 2005 compared to $17,928,000 for the year ended December 31, 2004. The increase in net cash used in financing activities in 2005 compared to 2004 was due to higher net repayments of borrowings under our credit facility in 2005. These net repayments in 2005 were higher than in 2004 primarily because of the use of $11,918,000 of proceeds from the sale of a shopping center owned by the Company to repay our credit facility and the fact that during 2004, the Company repurchased 2,691,321 shares of its outstanding common stock and Class A common stock for $32,555,000 using the credit facility and the Company paid down a portion of these borrowings during 2005 using cash from
operations. The Company paid $5,737,000 and $6,098,000 in regular quarterly cash dividends during 2005 and 2004, respectively.
On January 25, 2006, the Company’s Board of Directors declared a quarterly cash dividend on both classes of common stock of $0.06 per share. The dividend is payable on March 10, 2006 to shareholders of record at the close of business on February 10, 2006.
On October 23, 2002, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s outstanding common stock. The purchases may be made in the open market or in privately negotiated transactions as conditions warrant. The repurchase authorization does not obligate the Company to acquire any specific number of shares and may be suspended at any time. No purchases were made during the year ended December 31, 2005. During the year ended December 31, 2004, the Company purchased and retired 50,900 shares of its outstanding common stock pursuant to this plan at an average purchase price of $9.95 per share, not including nominal brokerage commissions. At December 31, 2005, the Company had remaining repurchase authority of 1,779,155 shares.
Based on current business conditions, the Company expects to make capital expenditures of approximately $4,500,000 during 2006, not including the $1,625,000 discussed below, or any additional amounts, related to the possible hotel expansion. These expenditures primarily relate to casino renovations, improvements in our food & beverage departments and the continued conversion of video lottery (slot) machines to ticket-in, ticket-out (cashless) technology. Additionally, the Company expects to contribute approximately $1,000,000 to its pension plans in 2006.
On December 15, 2005, the Company’s Board of Directors authorized the Company to commence a tender offer to purchase up to 1,063,937 shares of its common stock and up to 1,325,468 shares of its Class A common stock at a fixed price of $14.50 per share. The offer commenced on December 19, 2005 and expired at 5:00 P.M., eastern standard time, on January 19, 2006. The Company purchased 1,063,937 shares of its common stock and 1,325,000 shares of its Class A common stock for $35,006,000, including expenses, in connection with the tender offer. The tender offer was funded with borrowings on the Company’s unsecured revolving line of credit.
The Company is exploring the possibility of an expansion to the Dover Downs Hotel and has hired architects, engineers and other professionals to prepare drawings and cost estimates. The total cost of this preliminary work is estimated at $1,750,000, of which approximately $125,000 was paid as of December 31, 2005, and is expected to be completed by the end of the first quarter of 2006.
Since our video lottery (slot) machine casino opened in 1995, we had been party to a management agreement with Caesars, under which Caesars was our agent to supervise, manage and operate our video lottery (slot) machine casino. Effective December 28, 2004, that management agreement expired and we opted not to renew the agreement. As a result, we are no longer required to pay to Caesars a management fee. We have not and do not expect to incur any material costs to replace functions for which Caesars had responsibility under this agreement. Caesars’ performance-based fees were $4,448,000 for the year ended December 31, 2004.
We have a $70,000,000 unsecured revolving line of credit agreement, as amended effective December 14, 2005. At December 31, 2005, $24,075,000 was outstanding under the facility. Based on current business trends, we believe that our cash flows from operations and the funds available pursuant to our revolving credit facility will be sufficient to meet our short and long-term cash needs. Any significant expansion of our hotel or gaming facility that we may decide to undertake, any significant acquisitions, or any material adverse change in our operations could cause the need for additional financing. The Company expects that its net cash flows from operating activities and funds available from its credit facility will be sufficient to provide for its working capital needs and capital spending requirements at least through the next twelve months, as well as any cash dividends the Company’s Board of Directors may declare. We expect cash flows from operating activities and funds available from our credit facility to also provide for long-term liquidity.
The introduction or expansion of gaming in and around our market area could have a material adverse effect on our cash flows and results of operations. See Part I, Item 1 - Business included elsewhere in this Annual Report on Form 10-K for further discussion.
Contractual Obligations
At December 31, 2005, the Company had the following contractual obligations:
We have a $70,000,000 unsecured revolving line of credit agreement. At December 31, 2005, $24,075,000 was outstanding under the facility.
At December 31, 2005, we have a purchase obligation related to the possible expansion of the Dover Downs Hotel. The Company has hired architects, engineers and other professionals to prepare drawings and cost estimates. The total cost of this preliminary work is estimated at $1,750,000, of which approximately $125,000 was paid as of December 31, 2005, and is expected to be completed by the end of the first quarter of 2006.
Related Party Transactions
See NOTE 9 - Related Party Transactions of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a full description of related party transactions.
Critical Accounting Policies
The accounting policies described below are those the Company considers critical in preparing its consolidated financial statements and/or include significant estimates made by management using information available at the time the estimates are made. However, as described below, these estimates could change materially if different information or assumptions were used.
Points Program
The Company currently has a point loyalty program for its video lottery customers which allows them to earn points based on the volume of their video lottery activity. Prior to December 2004, the points could be redeemed for various services and merchandise throughout the gaming facility; however, they were not redeemable for cash or casino play. Effective December 2004, the Company changed its policy relating to its point loyalty program to allow points earned by customers to be redeemed for cash under certain circumstances. As a result, all points earned by customers are now expensed in the period they are earned. The estimated amount of points redeemable for cash is recorded as a reduction of revenue and the estimated amount of points redeemable for services and merchandise is recorded as gaming expense. In determining the amount of the liability, which was $2,289,000 and $2,678,000, respectively, at December 31, 2005 and 2004, the Company estimates a redemption rate, a cost of rewards to be offered and the mix of cash, goods and services for which reward points will be redeemed. We use historical data to estimate those amounts.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided for financial reporting purposes using the straight-line method over estimated useful lives ranging from 5 to 10 years for furniture, fixtures and equipment and up to 40 years for facilities. These estimates require assumptions that are believed to be reasonable. The Company performs reviews for impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. No such events or changes in circumstances have occurred to date. An impairment loss would be measured as the amount by which the carrying amount of the asset exceeds its fair value. Generally, fair value will be determined using valuation techniques such as the present value of future cash flows.
Recent Accounting Pronouncements
See NOTE 2-Summary of Significant Accounting Policies of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.
Factors That May Affect Operating Results; Forward-Looking Statements
In addition to historical information, this Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, relating to our financial condition, profitability, liquidity, resources, business outlook, proposed acquisitions, market forces, corporate strategies, consumer preferences, contractual commitments, legal matters, capital requirements and other matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. To comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results and experience to differ substantially from the anticipated results or other expectations expressed in our forward-looking statements. When words and expressions such as: “believes,” “expects,” “anticipates,” “estimates,” “plans,” “intends,” “objectives,” “goals,” “aims,” “projects,” “forecasts,” “possible,” “seeks,” “may,” “could,” “should,” “might,” “likely,” “enable” or similar words or expressions are used in this document, as well as statements containing phrases such as “in our view,” “there can be no assurance,” “although no assurance can be given” or “there is no way to anticipate with certainty,” forward-looking statements are being made.
Various risks and uncertainties may affect the operation, performance, development and results of our business and could cause future outcomes to differ materially from those set forth in our forward-looking statements, including the following factors:
• success of any expansion to or renovation of our existing facilities or changes in our growth strategies;
• our development and potential acquisition of new facilities;
• anticipated trends in the gaming industry;
• patron demographics;
• general market and economic conditions, including consumer and corporate spending sentiment;
• our ability to finance future business requirements;
• our ability to effectively compete in the marketplace;
• the availability of adequate levels of insurance;
• our ability to successfully integrate acquired companies and businesses;
• management retention and development;
• changes in Federal, state, and local laws and regulations, including environmental, gaming license and tax legislation;
• the effect of weather conditions or travel on attendance at our facilities;
• military or other government actions; and
• national or local catastrophic events.
We undertake no obligation to publicly update or revise any forward-looking statements as a result of future developments, events or conditions. New risk factors emerge from time to time and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ significantly from those forecast in any forward-looking statements. Given these risks and uncertainties, stockholders should not overly rely or attach undue weight to our forward-looking statements as an indication of our actual future results.
Our Gaming Activities Compete Directly With Other Gaming Facilities And Other Entertainment Businesses
We compete in local and regional markets with horse tracks, off-track betting parlors, state run lotteries, casinos and other gaming facilities. We cannot be certain that we will maintain our market share or compete more effectively with our competitors. The introduction or expansion of gaming in neighboring jurisdictions, particularly Maryland, Virginia, Washington, D.C., Pennsylvania or New Jersey, or the legalization of additional gaming venues in Delaware, could have a material adverse effect on our cash flows and results of operations. From time to time legislation is proposed for adoption in these jurisdictions which if enacted, would further expand state gambling and wagering opportunities, including video lottery (slot) machines at racetracks. Enactment of such legislation could increase our competition and could adversely affect our business, financial condition and overall profitability. For example, in 2005, the Maryland Senate passed a bill providing for various gaming venues for the third straight year and for the third straight year could not reach any consensus with the Maryland House. Accordingly, no legislation was passed. Approximately 70% of our customers come from Maryland, Pennsylvania, Virginia and the District of Columbia. In July 2004, Pennsylvania adopted legislation which authorizes up to 61,000 slot machines at various existing and proposed venues throughout the state. It is difficult for us to predict the effect that such legislation will have on us, but we estimate that one or more facilities in Pennsylvania may begin operations in the latter half of 2006. Pennsylvania will have one of the highest effective tax rates on slot machine gaming in the country and will charge an up front $50,000,000 license fee to the horse racing and casino venues that are granted a gaming license. Management has estimated that slot win from Pennsylvania patrons represents approximately 6% of our total slot win.
All Of Our Facilities Are In One Location
Our facilities are located adjacent to one another at a single location in Dover, Delaware. Any prolonged disruption of operations at these facilities due to destruction of or material damage to the facilities or other reasons could adversely affect our financial condition and results of operations. We maintain property and business interruption insurance to protect against such types of disruption, but there can be no assurance that the proceeds of such insurance would be adequate to repair or rebuild our facilities in such event or to compensate us for lost profit during the period of any such disruption.
The Revocation, Suspension Or Modification Of Our Gaming Licenses Would Adversely Affect Our Gaming Business
The Delaware State Lottery Office and the Delaware Harness Racing Commission regulate our gaming operations. Our license from the Commission must be renewed on an annual basis. To keep our license for video lottery (slot) machine gaming, we must remain licensed for harness horse racing by the Commission and conduct at least 80 live race days each racing season, subject to the availability of harness race horses. The Commission has broad discretion to reject any application for a license or suspend or revoke a license once it is issued. The Director of the Delaware State Lottery Office has broad discretion to revoke, suspend or modify the terms of a video lottery license. Any modification or termination of existing licensing regulations or any revocation, suspension or modification of our licenses could adversely affect our business, financial condition and overall profitability.
Our Gaming Activities Are Subject To Extensive Government Regulation And Any Additional Government Regulation Or Taxation Of Gaming Activities Could Substantially Reduce Our Revenue Or Profit
Video lottery (slot) machine gaming, harness horse racing and pari-mutuel wagering are subject to extensive government regulation. Delaware law regulates the win we are entitled to retain and the percentage of commission we are entitled to receive from our gaming revenues, which comprises a significant portion of our overall revenues. The State granted us a license to conduct video lottery (slot) machine operations and a license to conduct harness
horse races and pari-mutuel wagering. The laws under which these licenses are granted could be modified or repealed at any time and we could be required to terminate our gaming operations. If we are required to terminate our gaming operations or if the amount of the commission we receive from the State for conducting our gaming operations is decreased, our business operations and overall profitability would be significantly impaired.
We believe that the prospect of significant additional tax revenue is one of the primary reasons why jurisdictions have legalized gaming. As a result, gaming operators are typically subject to significant taxes and fees in addition to normal federal and state corporate income taxes. These taxes and fees are subject to increase at any time. We pay substantial taxes and fees with respect to our operations and will likely incur similar burdens in any other jurisdiction in which we may conduct gaming operations in the future. Any material increase in taxes or fees, or the adoption of additional taxes or fees, may have a material adverse effect on our future financial results.
We are subject to various federal, state and local laws and regulations in addition to gaming regulations. These laws and regulations include, but are not limited to, restrictions and conditions concerning alcoholic beverages, environmental matters, employees, currency transactions, taxation, zoning and building codes, and marketing and advertising. Such laws and regulations are always subject to change, can be interpreted differently in the future, and new laws and regulations may be enacted which could adversely affect the tax, regulatory, operational or other aspects of the gaming industry and our Company. Furthermore, noncompliance with one or more of these laws and regulations could result in the imposition of substantial penalties against us.
We Do Not Own Or Lease Our Video Lottery (Slot) Machines And Related Technology
We do not own or lease the video lottery (slot) machines or computer systems used by the State in connection with our video lottery gaming operations. The Lottery Director enters into contracts directly with the providers of the video lottery (slot) machines and computer systems. The State purchases or leases all equipment and the Lottery Director licenses all technology providers. Our operations could be disrupted if a licensed technology provider violates its agreement with the State or ceases to be licensed for any reason. Such an event would be outside of our control and could adversely affect our gaming revenues.
Item 7A.
Item 7A. Quantitative And Qualitative Disclosure About Market Risk
The Company does not utilize financial instruments for trading purposes and holds no derivative financial instruments which could expose it to market risk. Our exposure to market risks related to fluctuations in interest rates is limited to our variable rate borrowings of $24,075,000 at December 31, 2005 under our revolving credit facility. A change in interest rates of one percent on the balance outstanding at December 31, 2005 would cause a change in total annual interest costs of $241,000. The carrying values of these borrowings approximate their fair values at December 31, 2005.
Item 8.
Item 8. Financial Statements And Supplementary Data
Gaming & Entertainment’s consolidated financial statements and the Report of Independent Registered Public Accounting Firm included in this report are shown on the Index to Consolidated Financial Statements on page 31.
Item 9.
Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify the Company’s financial reports and to other members of senior management and the Board of Directors.
Based on their evaluation as of December 31, 2005, the Chief Executive Officer and Chief Financial Officer of the Company have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
(b) Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2005 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
(c) Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation, management of the Company concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005. Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.
(d) Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Dover Downs Gaming & Entertainment, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A(c)), that Dover Downs Gaming & Entertainment, Inc. (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Dover Downs Gaming & Entertainment, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Dover Downs Gaming & Entertainment, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Dover Downs Gaming & Entertainment, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of earnings and comprehensive earnings and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 9, 2006 expressed an unqualified opinion on those consolidated financial statements.
KPMG LLP
Philadelphia, Pennsylvania
March 9, 2006
Item 9B.
Item 9B. Other Information
None.
Part III
Item 10.
Item 10. Directors And Executive Officers Of The Registrant
Except as presented below, biographical information relating to the Company’s directors and executive officers, information regarding the Company’s audit committee financial experts and information on Section 16(a) Beneficial Ownership Reporting Compliance called for by this Item 10 are incorporated by reference to the Gaming & Entertainment Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Stockholders to be held on April 26, 2006.
The Company has adopted a Code of Business Conduct applicable to the Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Controller and other employees performing similar functions as designated by the Company’s Chief Executive Officer. A copy of the Code of Business Conduct is available on the Company’s website at http://www.doverdowns.com. The Company will post on its website any amendments to, or waivers from, its Code of Business Conduct as required by law.
Executive Officers of the Registrant. As of December 31, 2005, the executive officers of the registrant were:
Our Chairman of the Board, Henry B. Tippie, is a non-employee director and, therefore, not an executive officer of the Company. Mr. Tippie has served the Company in that capacity, or as Vice Chairman of the Board, for over 9 years. Mr. Tippie also serves as Chairman of the Board to DVD as a non-employee director.
Denis McGlynn has served as the Company’s President and CEO for 26 years. Mr. McGlynn also serves as President and Chief Executive Officer to DVD.
Edward J. Sutor joined the Company in March 1999. Prior to joining the Company, Mr. Sutor served as Senior Vice President of Finance at Caesars Atlantic City from 1983 until 1999. Mr. Sutor previously served as Executive Vice President to DVD, a position he held from 1999 to 2002.
Timothy R. Horne joined the Company in November 1996. Mr. Horne previously served as Vice President-Finance and Chief Financial Officer to DVD, a position he held for over 5 years.
Klaus M. Belohoubek has been Vice President-General Counsel and Secretary since 1999 and has provided legal representation to the Company in various capacities since 1990. Mr. Belohoubek also serves as Sr. Vice President-General Counsel and Secretary to DVD.
Item 11.
Item 11. Executive Compensation
The information called for by this Item 11 is incorporated by reference to the Gaming & Entertainment Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Stockholders to be held on April 26, 2006.
Item 12.
Item 12. Security Ownership Of Certain Beneficial Owners And Management And Related Stockholder Matters
The information called for by this Item 12 is incorporated by reference to the Gaming & Entertainment Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Stockholders to be held on April 26, 2006.
Item 13.
Item 13. Certain Relationships And Related Transactions
The information called for by this Item 13 is incorporated by reference to the Gaming & Entertainment Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Stockholders to be held on April 26, 2006.
Item 14.
Item 14. Principal Accounting Fees And Services
The information called for by this Item 14 is incorporated by reference to the Gaming & Entertainment Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Stockholders to be held on April 26, 2006.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)(1)
Financial Statements - See accompanying Index to Consolidated Financial Statements on page 31.
(2)
Financial Statement Schedules - None.
(3)
Exhibits:
2.1
Amended and Restated Agreement Regarding Distribution and Plan of Reorganization, dated as of February 15, 2002, by and between Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) and Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit 2.1 to the Form 10 filed on February 26, 2002, which was declared effective on March 7, 2002).
3.1
Certificate of Incorporation of Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit 3.1 to the Form 10 filed on November 21, 2001, which was declared effective on March 7, 2002).
3.2
Amended and Restated By-laws of Dover Downs Gaming & Entertainment, Inc. dated March 1, 2002 (incorporated herein by reference to Exhibit 3.2 to the Form 10 filed on March 7, 2002).
4.1
Form of Common Stock Certificate of Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit 4.1 to the Form 10 filed on November 21, 2001, which was declared effective on March 7, 2002).
4.2
Rights Agreement dated as of January 2, 2002 between Dover Downs Gaming & Entertainment, Inc. and Mellon Investor Services, as Rights Agent (incorporated herein by reference to Exhibit 4.2 to the Form 10 filed on January 16, 2002, which was declared effective on March 7, 2002).
10.1
Employee Benefits Agreement, dated as of January 15, 2002, by and between Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) and Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit 10.2 to the Form 10 filed on January 16, 2002, which was declared effective on March 7, 2002).
10.2
Transition Support Services Agreement, dated as of January 15, 2002, by and between Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) and Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit 10.3 to the Form 10 filed on January 16, 2002, which was declared effective on March 7, 2002).
10.3
Tax Sharing Agreement, dated as of January 15, 2002, by and between Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) and Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit 10.4 to the Form 10 filed on January 16, 2002, which was declared effective on March 7, 2002).
10.4
Real Property Agreement dated as of January 15, 2002, by and between Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) and Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit 10.5 to the Form 10 filed on January 16, 2002, which was declared effective on March 7, 2002).
10.5
Agreement between Dover Downs, Inc. and Delaware Standardbred Owners Association, Inc. dated October 22, 2003 (incorporated herein by reference to Exhibit 10.9 to the Form 10-K filed on March 9, 2004).
10.6
Credit Agreement among Dover Downs Gaming & Entertainment, Inc. and Wilmington Trust Company, dated as of January 15, 2002 (incorporated herein by reference to Exhibit 10.10 to the Form 10 filed on January 16, 2002, which was declared effective on March 7, 2002).
10.7
Amended and Restated Credit Agreement among Dover Downs Gaming & Entertainment, Inc. and Wilmington Trust Company, as agent, dated as of March 25, 2002 (incorporated herein by reference to Exhibit 10.6 to the Form 10-Q filed on May 10, 2002).
10.8
Amended and Restated Guaranty and Suretyship Agreement by and between Dover Downs, Inc. and Wilmington Trust Company, as agent, dated as of March 25, 2002 (incorporated herein by reference to Exhibit 10.7 to the Form 10-Q filed on May 10, 2002).
10.9
Amendment to Amended and Restated Credit Agreement among Dover Downs Gaming & Entertainment, Inc. and Wilmington Trust Company, as agent, dated as of August 12, 2002 (incorporated herein by reference to Exhibit 10.1 to the Form 10-Q filed on November 4, 2002).
10.10
Second Amendment to Amended and Restated Credit Agreement among Dover Downs Gaming & Entertainment, Inc. and Wilmington Trust Company, as agent, dated as of February 19, 2004 (incorporated herein by reference to Exhibit 10.14 to the Form 10-K filed on March 9, 2004).
10.11
Third Amendment to Amended and Restated Credit Agreement among Dover Downs Gaming & Entertainment, Inc. and Wilmington Trust Company, as agent, dated as of November 5, 2004 (incorporated herein by reference to Exhibit 10.14 to the Form 10-K filed on March 10, 2005).
10.12
Fourth Amendment to Amended and Restated Credit Agreement among Dover Downs Gaming & Entertainment, Inc. and Wilmington Trust Company, as agent, dated as of December 14, 2005 (incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed on December 16, 2005).
10.13
Amended and Restated Employment and Non-Compete Agreement between Dover Downs Gaming & Entertainment, Inc. and Denis McGlynn dated February 13, 2006 (incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed on February 17, 2006).
10.14
Amended and Restated Employment and Non-Compete Agreement between Dover Downs Gaming & Entertainment, Inc. and Edward J. Sutor dated February 13, 2006 (incorporated herein by reference to Exhibit 10.2 to the Form 8-K filed on February 17, 2006).
10.15
Amended and Restated Employment and Non-Compete Agreement between Dover Downs Gaming & Entertainment, Inc. and Timothy R. Horne dated February 13, 2006 (incorporated herein by reference to Exhibit 10.3 to the Form 8-K filed on February 17, 2006).
10.16
Amended and Restated Employment and Non-Compete Agreement between Dover Downs Gaming & Entertainment, Inc. and Klaus M. Belohoubek dated February 13, 2006 (incorporated herein by reference to Exhibit 10.4 to the Form 8-K filed on February 17, 2006).
10.17
Amended and Restated Non-Compete Agreement between Dover Downs Gaming & Entertainment, Inc. and Patrick J. Bagley dated February 13, 2006 (incorporated herein by reference to Exhibit 10.5 to the Form 8-K filed on February 17, 2006).
10.18
Non-Compete Agreement between Dover Downs Gaming & Entertainment, Inc. and Henry B. Tippie dated June 16, 2004 (incorporated herein by reference to Exhibit 10.7 to the Form 10-Q filed on August 6, 2004).
10.19
Dover Downs Gaming & Entertainment, Inc. 2002 Stock Incentive Plan, as Amended and Restated (incorporated herein by reference to Exhibit A to the Company’s Proxy Statement filed on March 29, 2004).
10.20
Form of Incentive Stock Option Agreement Used with Dover Downs Gaming & Entertainment, Inc. 2002 Stock Incentive Plan, as Amended and Restated (incorporated herein by reference to Exhibit 10.1 to the Form 10-Q filed on November 3, 2004).
10.21
Form of Restricted Stock Grant Agreement Used with Dover Downs Gaming & Entertainment, Inc. 2002 Stock Incentive Plan, as Amended and Restated (incorporated herein by reference to Exhibit 10.2 to the Form 10-Q filed on November 3, 2004).
21.1
List of Subsidiaries of Dover Downs Gaming & Entertainment, Inc.
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Sec. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Sec. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1
Information Statement dated as of March 7, 2002 (incorporated herein by reference to Exhibit 99.1 to the Form 10 filed on March 7, 2002).
99.2
Audit Committee Charter of Dover Downs Gaming & Entertainment, Inc. (incorporated herein by reference to Exhibit B to the Company’s Proxy Statement filed on March 29, 2004).
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
/s/ Timothy R. Horne
Sr. Vice President-Finance,
March 9,
Timothy R. Horne
Treasurer and Chief Financial Officer
/s/ Henry B. Tippie
Chairman of the Board
March 9,
Henry B. Tippie
/s/ Kenneth K. Chalmers
Director and Chairman
March 9,
Kenneth K. Chalmers
of the Audit Committee
/s/ R. Randall Rollins
Director
March 9,
R. Randall Rollins
/s/ Patrick J. Bagley
Director
March 9,
Patrick J. Bagley
/s/ John W. Rollins, Jr.
Director
March 9,
John W. Rollins, Jr.
/s/ Jeffrey W. Rollins
Director
March 9,
Jeffrey W. Rollins
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Statement of Management Responsibility
Report of Independent Registered Public Accounting Firm
Consolidated Statement of Earnings and Comprehensive Earnings for the years ended December 31, 2005, 2004 and 2003
Consolidated Balance Sheet at December 31, 2005 and 2004
Consolidated Statement of Cash Flows for the years ended December 31, 2005, 2004 and 2003
Notes to the Consolidated Financial Statements
STATEMENT OF MANAGEMENT RESPONSIBILITY
Dover Downs Gaming & Entertainment, Inc. and subsidiaries’ (the “Company”) management is responsible for the preparation, integrity and objectivity of the consolidated financial statements and other financial information included in the Company’s 2005 Annual Report on Form 10-K. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles and reflect the effects of certain estimates and judgments made by management.
The Company’s management also is responsible for establishing and maintaining a system of internal controls designed to provide reasonable assurance that assets are safeguarded and transactions are properly recorded and executed in accordance with management’s authorization. The system is regularly monitored by direct management review and by internal auditors who conduct an extensive program of audits throughout the Company. The Director of Internal Audit reports directly to the Audit Committee of the Board of Directors. We have confidence in our financial reporting, the underlying system of internal controls, and our people, who are objective in their responsibilities and operate under the Company’s Code of Business Conduct and with the highest level of ethical standards. These standards are a key element of the Company’s control system.
The Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation, management of the Company concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005.
The Audit Committee of the Board of Directors, which is comprised entirely of independent directors, has direct and private access to and meets regularly with management, the internal auditors and the independent registered public accounting firm to review accounting, reporting, auditing and internal control matters.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Dover Downs Gaming & Entertainment, Inc.:
We have audited the accompanying consolidated balance sheets of Dover Downs Gaming & Entertainment, Inc. and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of earnings and comprehensive earnings and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Dover Downs Gaming & Entertainment, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Dover Downs Gaming & Entertainment, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 9, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
KPMG LLP
Philadelphia, Pennsylvania
March 9, 2006
DOVER DOWNS GAMING & ENTERTAINMENT, INC.
CONSOLIDATED STATEMENT OF EARNINGS
AND COMPREHENSIVE EARNINGS
The Notes to the Consolidated Financial Statements are an integral part of these consolidated statements.
DOVER DOWNS GAMING & ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEET
The Notes to the Consolidated Financial Statements are an integral part of these consolidated statements.
DOVER DOWNS GAMING & ENTERTAINMENT, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
The Notes to the Consolidated Financial Statements are an integral part of these consolidated statements.
DOVER DOWNS GAMING & ENTERTAINMENT, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-Business Operations
References in this document to “the Company,” “Gaming & Entertainment,” “we,” “us” and “our” mean Dover Downs Gaming & Entertainment, Inc. and/or its wholly owned subsidiaries, as appropriate.
Dover Downs Gaming & Entertainment, Inc. is a diversified gaming and entertainment company whose operations consist of Dover Downs Slots - a 91,000 square foot video lottery (slots) casino complex; the Dover Downs Hotel - featuring luxury accommodations with conference, banquet, fine dining, ballroom and concert hall facilities; and Dover Downs Raceway - a harness racing track with pari-mutuel wagering on live and simulcast horse races.
Gaming & Entertainment is a public holding company that has two wholly owned subsidiaries: Dover Downs, Inc. and Dover Downs Management Corp. Dover Downs, Inc. was incorporated in 1967 and began motorsports and harness racing operations in 1969. In June of 1994, legislation authorizing video lottery operations in the State of Delaware (the “State”) was adopted. The Company’s video lottery (slots) casino operations began on December 29, 1995. As a result of several restructurings, Dover Downs, Inc. became a wholly owned subsidiary of Dover Motorsports, Inc. (f/k/a Dover Downs Entertainment, Inc.) (“DVD”), and became the operating entity for all of DVD’s gaming operations.
Dover Downs Gaming & Entertainment, Inc. was incorporated in the State in December of 2001 as a wholly owned subsidiary of DVD. Effective March 31, 2002, DVD completed a tax-free spin-off of its gaming operations by contributing 100% of the issued and outstanding common stock of Dover Downs, Inc. to the Company, and subsequently distributing 100% of the issued and outstanding common stock of the Company to DVD stockholders. Immediately following the spin-off, Dover Downs Gaming & Entertainment, Inc. became an independent public company.
The Company is authorized to conduct video lottery operations as a “Licensed Agent” under the Delaware State Lottery Code. Pursuant to Delaware’s Horse Racing Redevelopment Act, enacted in 1994, the Delaware State Lottery Office administers and controls the operation of the video lottery.
The Company’s license from the Delaware Harness Racing Commission (the “Commission”) to hold harness race meetings on our premises and to offer pari-mutuel wagering on live and simulcast horse races must be renewed on an annual basis. In order to maintain its license to conduct video lottery operations, the Company is required to maintain its harness horse racing license. The Company has received an annual license from the Commission for the past 37 consecutive years and management believes that its relationship with the Commission remains good.
Our entertainment complex is located in Dover, the capital of the State of Delaware. Approximately 70% of our customers come from Maryland, Pennsylvania, Virginia and the District of Columbia. In July 2004, Pennsylvania adopted legislation which authorizes up to 61,000 slot machines at various existing and proposed venues throughout the state. It is difficult for us to predict the effect that such legislation will have on us, but we estimate that one or more facilities in Pennsylvania may begin operations in the latter half of 2006. Management has estimated that slot win from Pennsylvania patrons represents approximately 6% of our total slot win.
Due to the nature of the Company’s business activities, it is subject to various federal, state and local regulations.
NOTE 2-Summary of Significant Accounting Policies
Basis of consolidation-The consolidated financial statements include the accounts of Gaming & Entertainment and its wholly owned subsidiaries. Intercompany transactions and balances have been eliminated.
Inventories-Inventories, consisting primarily of food and beverage items, are stated at the lower of cost or market with cost being determined on the first-in, first-out basis.
Property and equipment-Property and equipment is stated at cost. Depreciation is provided for financial reporting purposes using the straight-line method over the following estimated useful lives:
The Company performs reviews for impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. No such events or changes in circumstances have occurred to date. An impairment loss would be measured as the amount by which the carrying amount of the asset exceeds its fair value. Generally, fair value will be determined using valuation techniques such as the present value of future cash flows.
Interest capitalization-Interest is capitalized in connection with the construction of major facilities. The capitalized interest is amortized over the estimated useful life of the asset to which it relates. During the year ended December 31, 2005, the Company incurred $1,875,000 of interest cost, none of which was capitalized. During the year ended December 31, 2004, the Company incurred $779,000 of interest cost, of which $17,000 was capitalized. During the year ended December 31, 2003, the Company incurred $842,000 of interest cost, none of which was capitalized.
Income taxes-Deferred income taxes are provided in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Statement No. 109, Accounting for Income Taxes, on all differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements based upon enacted statutory tax rates in effect at the balance sheet date.
Point loyalty program-The Company currently has a point loyalty program for its video lottery customers which allows them to earn points based on the volume of their video lottery activity. Prior to December 2004, the points could be redeemed for various services and merchandise throughout the gaming facility; however, they were not redeemable for cash or casino play. Effective December 2004, the Company changed its policy relating to its point loyalty program to allow points earned by customers to be redeemed for cash under certain circumstances. As a result, the Company recorded a non-recurring charge of $2,250,000 in the fourth quarter of 2004 to record the net impact of the program change. All reward points earned by customers are now expensed in the period they are earned. The estimated amount of points redeemable for cash is recorded as a reduction of revenue and the estimated amount of points redeemable for services and merchandise is recorded as gaming expense. In determining the amount of the liability, which was $2,289,000 and $2,678,000, respectively, at December 31, 2005 and 2004, the Company estimates a redemption rate, a cost of rewards to be offered and the mix of cash, goods and services for which reward points will be redeemed. We use historical data to estimate those amounts.
Revenue and expense recognition-Gaming revenues represent (i) the net win from video lottery (slot) machine wins and losses and (ii) commissions from pari-mutuel wagering. Other operating revenues consist of hotel rooms revenue, food and beverage sales and other miscellaneous income. Revenues do not include the retail amount of hotel rooms, food and beverage and other miscellaneous goods and services provided without charge to customers as promotional items of $15,103,000, $19,973,000 and $18,667,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The estimated direct cost of providing these items has been charged to the casino through interdepartmental allocations and is included in gaming expenses in the consolidated statement of earnings.
For the video lottery operations, which account for at least 90% of revenues for all periods presented, the difference between the amount wagered by bettors and the amount paid out to bettors is referred to as the win. The win is included in the amount recorded in the Company’s consolidated financial statements as gaming revenue. The Delaware State Lottery Office sweeps the win from the video lottery operations, collects the State’s share of the win and the amount due to the vendors under contract with the State who provide the video lottery (slot)
machines and associated computer systems, collects the amount allocable to purses for harness horse racing and remits the remainder to the Company as its commission for acting as a Licensed Agent. Gaming expenses include the amounts collected by the State (i) for the State’s share of the win, (ii) for remittance to the providers of the video lottery (slot) machines and associated computer systems, and (iii) for harness horse racing purses. The Company recognizes revenues from pari-mutuel commissions earned from live harness horse racing and importing of simulcast signals from other race tracks when the race occurs. Revenues from hotel rooms, food and beverage sales and other miscellaneous income are recognized at the time the service is provided.
Advertising costs-The cost of general advertising is charged to operations as incurred.
Earnings per share-Basic and diluted earnings per share (“EPS”) are calculated in accordance with FASB Statement No. 128, Earnings Per Share. Weighted average shares used in computing basic and diluted EPS are as follows:
Dilutive securities include stock options and unvested restricted stock awards.
For the years ended December 31, 2005, 2004 and 2003, options to purchase 15,000, 280,180 and 667,960 shares of common stock, respectively, were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common stock during the period.
Accounting for stock-based compensation-The Company has a stock incentive plan which provides for the grant of stock options and/or restricted stock to officers and key employees. The Company accounts for stock options in accordance with FASB Statement No. 123, Accounting for Stock-Based Compensation, as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123. Statement No. 123 defines a fair-value based method of accounting for stock-based compensation plans; however, it allows the continued use of the intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The Company has elected to continue to use the intrinsic value method and based on this method did not record any stock-based compensation expense related to its stock options during the years ended December 31, 2005, 2004 and 2003. The Company’s restricted stock vests based on continued employment with the Company. Restricted stock awards result in compensation expense as discussed in NOTE 8 - Stockholders’ Equity.
The following table illustrates the effect on net earnings and net earnings per common share if the Company had applied the fair-value recognition provisions of Statement No. 123 to stock-based employee compensation related to its stock options and awards:
For disclosure purposes, the Company determined compensation expense for its stock options based upon the fair value at the grant date using the Black-Scholes option-pricing model with the following assumptions:
The fair value of restricted stock awards granted during the years ended December 31, 2005 and 2004 was $12.91 and $11.62 per share, respectively. No stock options were granted during the years ended December 31, 2005 and 2004. The weighted-average fair value of options granted during the year ended December 31, 2003 was $4.02.
Use of estimates-The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fair value of financial instruments-The carrying amounts reported in the balance sheet for current assets and current liabilities approximates their fair values because of the short maturity of these instruments. The carrying value of long-term debt at December 31, 2005 and 2004 approximates its fair value based on the interest rates available on similar borrowings.
Reclassifications-Certain reclassifications have been made to the prior period consolidated financial statements to conform to the current period presentation. These reclassifications had no effect on consolidated financial condition, results of operations or cash flows.
Segment information-The Company accounts for its operating segment in accordance with FASB Statement No. 131, Disclosures About Segments of an Enterprise and Related Information. Statement No. 131 establishes guidelines for public companies in determining operating segments based on those used for internal reporting to management. Based on these guidelines, the Company reports information under a single gaming and entertainment segment.
Recent accounting pronouncements-In May 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections, which supersedes APB Opinion No. 20, Accounting Changes and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. Statement No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The correction of an error in previously issued financial statements is not an accounting change. However, the reporting of an error correction involves adjustments to previously issued financial statements similar to those generally applicable to reporting an accounting change retroactively. Therefore, the reporting of an error correction by restating previously issued financial statements is also addressed by the statement. Statement No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of Statement No. 154 to have an impact on our consolidated results of operations or financial condition.
In December 2004, the FASB issued Statement No. 123 (Revised 2004) Share-Based Payment. Statement No. 123R addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. It will require companies to recognize in the statement of earnings the grant-date fair value of stock options and other equity-based compensation issued to employees, but expresses no preference for a type of valuation model. The statement eliminates the intrinsic value-based method prescribed by APB Opinion No. 25 and related interpretations that the Company currently uses. The Company would have been required to adopt Statement No. 123R beginning in the third quarter of 2005; however, on April 14, 2005 the United States Securities and Exchange Commission (“SEC”) announced that adoption of Statement No. 123R would be delayed until the first quarter of 2006 for calendar year companies. The Company
has estimated that its earnings per diluted share will be negatively impacted by approximately $0.02 in 2006 as a result of applying the various provisions of Statement No. 123R.
NOTE 3-Property and Equipment
Property and equipment consists of the following as of December 31:
Depreciation expense was $6,998,000, $6,791,000 and $6,287,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
On December 28, 2005, the Company’s wholly owned subsidiary, Dover Downs, Inc., closed on the sale of a shopping center it owned in Dover, Delaware. The shopping center consisted of approximately 7.7 acres of real property with a one-story building of approximately 95,700 square feet. The sales price was $12,450,000 and the Company recognized a gain on the sale of $5,837,000.
At December 31, 2004, the Company had a $1,195,000 purchase obligation related to the installation of a state-of-the-art customer management and slot data system. Installation was completed in the first quarter of 2004, though payments for the system extended into 2005. Capital expenditures and the change in accounts payable in the Company’s consolidated statement of cash flows for the year ended December 31, 2004 have been adjusted accordingly.
NOTE 4-Accrued Liabilities
Accrued liabilities consist of the following as of December 31:
NOTE 5-Indebtedness
The Company has a $70,000,000 credit facility, as amended effective December 14, 2005, that expires on January 1, 2008. Interest is based, at the Company’s option, upon (i) LIBOR plus 0.75% or (ii) the base rate (the greater of the prime rate or the federal funds rate plus 0.5%) minus 1%. The terms of the credit facility contain, among others, minimum net worth, interest coverage and maximum leverage covenant requirements. Material adverse changes in the Company’s results of operations could impact its ability to maintain financial ratios necessary to satisfy these requirements. The facility is for seasonal funding needs, capital improvements and other general corporate purposes. At December 31, 2005, the Company was in compliance with all terms of the facility and there was $24,075,000 outstanding at a weighted average interest rate of 5.32%. At December 31, 2005, $45,925,000 was available pursuant to the facility.
On December 19, 2005, the Company commenced a tender offer to purchase up to 1,063,937 shares of its common stock and up to 1,325,468 shares of its Class A common stock at a fixed price of $14.50 per share. The offer expired on January 19, 2006. The Company purchased 1,063,937 shares of its common stock and 1,325,000 shares of its Class A common stock for $35,006,000, including expenses, in connection with the tender offer. The tender offer was funded with borrowings on the Company’s unsecured revolving line of credit.
NOTE 6-Income Taxes
The current and deferred income tax provisions are as follows:
A reconciliation of the effective income tax rate with the applicable statutory federal income tax rate is as follows:
The components of deferred income tax assets and liabilities are as follows as of December 31:
Prior to the spin-off from DVD, the Company was included as part of DVD’s consolidated federal income tax return; however, the income tax expense presented in the consolidated financial statements for the periods prior to the spin-off was computed on a separate return basis. The Company and DVD have entered into a Tax Sharing Agreement to reflect each company’s rights and obligations relating to payments and refunds of taxes that are attributable to periods beginning before and including the date of the spin-off described in NOTE 1-Business
Operations. The agreement provides for payments between the companies to reflect tax liabilities that may arise before, after and because of the spin-off.
For the year ended December 31, 2003, DVD reported a net operating loss for federal income tax purposes. The loss was carried back to 2001, a period prior to the spin-off, which generated an alternative minimum tax credit carryforward, a portion of which was required to be paid to DVD under the Tax Sharing Agreement; therefore, during the fourth quarter of 2003 Gaming & Entertainment recorded a $330,000 payable to DVD for the Company’s portion of the carryforward. Gaming & Entertainment paid the amount in the first quarter of 2004.
NOTE 7-Pension Plans
The Company maintains a non-contributory, tax qualified defined benefit pension plan. All of Gaming & Entertainment’s full time employees are eligible to participate in this qualified pension plan. Benefits provided by the Gaming & Entertainment qualified pension plan are based on years of service and employees’ remuneration over their term of employment. Pension costs are funded in accordance with the provisions of the Internal Revenue Code. The Company also maintains a non-qualified, non-contributory defined benefit pension plan for certain employees. This excess plan provides benefits that would otherwise be provided under the qualified pension plan but for maximum benefit and compensation limits applicable under federal tax law. The cost associated with the excess plan is determined using the same actuarial methods and assumptions as those used for the Company’s qualified pension plan.
The following table sets forth the plans’ funded status and amounts recognized in the Company’s consolidated balance sheet as of December 31:
The liabilities recognized in the Company’s consolidated balance sheet as of December 31, 2005 and 2004 were $1,706,000 and $1,603,000, respectively.
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were $7,055,000, $5,483,000 and $3,795,000 respectively, as of December 31, 2005, and $5,307,000, $4,048,000 and $2,747,000, respectively, as of December 31, 2004.
The Company plans to contribute approximately $1,000,000 to its pension plans in 2006.
Benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:
The Company was required to record a minimum pension liability in its consolidated balance sheet at December 31, 2002, which is required when the actuarial present value of accumulated benefits exceeds plan assets and accrued pension liabilities. The effect of this adjustment was to increase pension liabilities by $300,000, increase intangible assets by $85,000, increase deferred income tax assets by $88,000 and recognize other comprehensive loss of $127,000. In 2003, the Company was required to reverse this minimum pension liability. Because these adjustments had no cash impact, the effect has been excluded from the accompanying consolidated statement of cash flows.
The components of net periodic pension cost are as follows:
The principal assumptions used to determine the net periodic pension cost for the years ended December 31, 2005, 2004 and 2003, and the actuarial value of the projected benefit obligation at December 31, 2005 and 2004 (the measurement dates) for the Company’s pension plans are as follows:
For 2005, the Company assumed a long-term rate of return on plan assets of 9%. In developing the 9% expected long-term rate of return assumption, the Company reviewed asset class return expectations and long-term inflation assumptions and considered its post spin-off and DVD’s pre spin-off historical compounded return, which was consistent with our long-term rate of return assumption.
The Company’s pension plan asset allocation at December 31, 2005 and 2004, and target allocation for 2006 are as follows:
The Company’s investment goals are to maximize returns subject to specific risk management policies. Its risk management policies permit investments in mutual funds, and prohibit direct investments in debt and equity securities and derivative financial instruments. The Company addresses diversification by the use of mutual fund
investments whose underlying investments are in domestic and international equity and fixed income securities. These mutual funds are readily marketable and can be sold to fund benefit payment obligations as they become payable.
The Company maintains a defined contribution 401(k) plan which permits participation by substantially all employees. The Company’s matching contributions to the 401(k) plan were approximately $64,000 for the year ended December 31, 2005 and $50,000 for each of the years ended December 31, 2004 and 2003.
NOTE 8-Stockholders’ Equity
Changes in the components of stockholders’ equity are as follows (in thousands, except per share data):
Gaming & Entertainment has 125,000,000 shares of authorized capital stock which consists of 74,000,000 shares of common stock, par value $.10 per share; 50,000,000 shares of Class A common stock, par value $.10 per share; and 1,000,000 shares of preferred stock, par value $.10 per share.
The holders of common stock are entitled to one vote per share and the holders of our Class A common stock are entitled to 10 votes per share. There is no cumulative voting. Shares of Class A common stock are convertible at any time into our shares of common stock on a one-for-one basis at the option of the stockholder. Subject to rights of any preferred stockholder, holders of our common stock and Class A common stock are entitled to receive on a pro rata basis such dividends, if any, as may be declared from time to time by the Board of Directors out of funds
legally available for that purpose. At the discretion of the Company’s Board of Directors, it may pay to the holders of common stock a cash dividend greater than the dividend, if any, paid to the holders of Class A common stock.
Under Delaware law, a change of ownership of a Licensed Agent will automatically terminate its license 90 days after the change of ownership occurs, unless the Director of the Delaware State Lottery Office determines after application to issue a new license to the new owners. Change of ownership may occur if any new individual or entity acquires, directly or indirectly, 10% or more of the Licensed Agent or if more than 20% of the legal or beneficial interest in the Licensed Agent is transferred, whether by direct or indirect means. The Commission may require extensive background investigations of any new owner acquiring a 10% or greater interest in a Licensed Agent, including criminal background checks. Accordingly, the Company has a restrictive legend on its shares of common stock which require that (a) any holders of common stock found to be disqualified or unsuitable or not possessing the qualifications required by any appropriate gaming authority could be required to dispose of such stock and (b) any holder of common stock intending to acquire 10% or more of the outstanding common stock of the Company must first obtain prior written approval from the Delaware State Lottery Office.
The Company adopted a stockholder rights plan in 2002 prior to the effective date of the spin-off from DVD. The rights are attached to and trade in tandem with our common stock and Class A common stock. Each right entitles the registered holder to purchase from the Company one share of common stock at a purchase price of $200 per share. The rights, unless earlier redeemed by our Board of Directors, will detach and trade separately from our common stock upon the occurrence of certain events such as the unsolicited acquisition by a third party of beneficial ownership of 10% or more of our outstanding combined common stock and Class A common stock or the announcement by a third party of the intent to commence a tender or exchange offer for 10% or more of our outstanding combined common stock and Class A common stock. After the rights have detached, the holders of such rights would generally have the ability to purchase such number of either shares of our common stock or stock of an acquirer of the Company having a market value equal to twice the exercise price of the right being exercised, thereby causing substantial dilution to a person or group of persons attempting to acquire control of the Company. The rights may serve as a significant deterrent to unsolicited attempts to acquire control of Gaming & Entertainment, including transactions involving a premium to the market price of our stock. The rights expire on January 1, 2012, unless earlier redeemed.
On January 25, 2006, the Company’s Board of Directors declared a quarterly cash dividend on both classes of common stock of $.06 per share. The dividend is payable on March 10, 2006 to stockholders of record at the close of business on February 10, 2006.
On October 23, 2002, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s outstanding common stock. The purchases may be made in the open market or in privately negotiated transactions as conditions warrant. The repurchase authorization does not obligate the Company to acquire any specific number of shares and may be suspended at any time. No purchases of the Company’s equity securities were made during the year ended December 31, 2005. During the year ended December 31, 2004, Gaming & Entertainment purchased and retired 50,900 shares of its outstanding common stock pursuant to this plan at an average purchase price of $9.95 per share, not including nominal brokerage commissions. During the year ended December 31, 2003, the Company purchased and retired 169,945 shares of its outstanding common stock pursuant to this plan at an average purchase price of $8.90 per share, not including nominal brokerage commissions. At December 31, 2005, the Company had remaining repurchase authority of 1,779,155 shares.
On November 10, 2004, the Company commenced a tender offer to purchase up to 1,040,421 shares of its common stock and up to 1,607,506 shares of its Class A common stock at a fixed price of $12.00 per share. The offer expired on December 10, 2004. The Company purchased 1,040,421 shares of its common stock and 1,600,000 shares of its Class A common stock for $32,045,000, including expenses, in connection with the tender offer.
On December 19, 2005, the Company commenced a tender offer to purchase up to 1,063,937 shares of its common stock and up to 1,325,468 shares of its Class A common stock at a fixed price of $14.50 per share. The offer expired on January 19, 2006. The Company purchased 1,063,937 shares of its common stock and 1,325,000 shares of its Class A common stock for $35,006,000, including expenses, in connection with the tender offer.
The Company has a stock incentive plan which provides for the grant of up to 1,500,000 shares of common stock to our officers and key employees through stock options and/or awards valued in whole or in part by reference to our common stock, such as restricted stock awards. Under the plan, option grants must have an exercise price of not less than 100% of the fair market value of the underlying shares of common stock at the date of the grant. The stock options have eight-year terms and generally vest equally over a period of six years from the date of grant. The restricted stock vests an aggregate of twenty percent each year beginning on the second anniversary date of the grant. During the year ended December 31, 2005, the Company granted 65,000 shares of restricted stock to certain officers and key employees at a fair-market value of $12.91 per share on the grant date and 10,000 shares were forfeited. During the year ended December 31, 2004, the Company granted 52,000 shares of restricted stock to certain officers and key employees at a fair-market value of $11.62 per share on the grant date and no shares were forfeited. The aggregate market value of the restricted stock at the date of issuance has been recorded as deferred compensation, a separate component of stockholders’ equity, and is being amortized on a straight-line basis over the six-year service period.
Option activity was as follows:
As of December 31, 2005, 2004 and 2003, there were 697,252, 680,129 and 626,859 shares, respectively, available under the stock incentive plan for granting options or stock awards.
As of December 31, 2005, the range of exercise prices and the weighted average remaining contractual life of outstanding options was $8.98-$13.31 and 3.72 years, respectively.
NOTE 9-Related Party Transactions
During the years ended December 31, 2005, 2004 and 2003, Gaming & Entertainment allocated costs of $1,613,000, $1,241,000 and $1,969,000, respectively, to DVD for certain administrative and operating services. Additionally, DVD allocated costs of $113,000 and $116,000 to Gaming & Entertainment for the years ended December 31, 2005 and 2004, respectively. The allocations were based on an analysis of each company’s share of the costs. In connection with DVD’s 2005, 2004 and 2003 NASCAR event weekends at Dover International Speedway, Gaming & Entertainment provided certain catering services for which DVD was invoiced $938,000, $933,000 and $443,000, respectively. Additionally, DVD invoiced Gaming & Entertainment $113,000, $238,000 and $206,000, respectively, for tickets and other services related to the 2005, 2004 and 2003 Dover events. As of December 31, 2005 and 2004, Gaming & Entertainment’s consolidated balance sheet includes a $15,000 and $2,000 receivable from DVD, respectively, for the aforementioned items. The Company received payment for the $15,000 receivable in the first quarter of 2006. The net costs incurred by each company for these services are not necessarily indicative of the costs that would have been incurred if the companies had been unrelated entities and/or had otherwise independently managed these functions; however, management believes that these costs are reasonable.
For the year ended December 31, 2003, DVD reported a net operating loss for federal income tax purposes. The loss was carried back to 2001, a period prior to the spin-off, which generated an alternative minimum tax credit carryforward, a portion of which was required to be paid to DVD under the Tax Sharing Agreement (see below);
therefore, during the fourth quarter of 2003 Gaming & Entertainment recorded a $330,000 payable to DVD for the Company’s portion of the carryforward. Gaming & Entertainment paid the amount in the first quarter of 2004.
The Company’s use of DVD’s 5/8-mile harness racing track is pursuant to an easement granted to the Company by DVD which does not require the payment of any rent. Under the terms of the easement, the Company has exclusive use of the harness track during the period beginning November 1 of each year and ending April 30 of the following year, together with set up and tear down rights for the two weeks before and after such period. The harness track is located on property owned by DVD and is on the inside of DVD’s motorsports superspeedway. The Company’s indoor grandstands are used by DVD at no charge in connection with its motorsports events. DVD also leases its principal office space from the Company. Various easements and agreements relative to access, utilities and parking have also been entered into between DVD and the Company relative to their respective Dover, Delaware facilities.
In conjunction with the spin-off from DVD, the Company and DVD entered into various agreements that addressed the allocation of assets and liabilities between the two companies and that define the companies’ relationship after the separation. Among these are the Real Property Agreement, the Transition Support Services Agreement and the Tax Sharing Agreement.
The Real Property Agreement governs certain real property transfers, leases and easements affecting the Company’s Dover, Delaware facility.
The Transition Support Services Agreement provides for each of the Company and DVD to provide each other with certain administrative and operational services. The party receiving the services is required to pay for them within 30 business days after receipt of an invoice at rates agreed upon by the Company and DVD. The agreement may be terminated in whole or in part 90 days after the request of the party receiving the services or 180 days after the request of the party providing the services.
The Tax Sharing Agreement provides for, among other things, the treatment of income tax matters for periods beginning before and including the date of the spin-off and any taxes resulting from transactions effected in connection with the spin-off. With respect to any period ending on or before the spin-off or any tax period in which the spin-off occurs, DVD:
• continues to be the sole and exclusive agent for the Company in all matters relating to the income, franchise, property, sales and use tax liabilities of the Company;
• subject to the Company’s obligation to pay for items relating to its gaming business, bears any costs relating to tax audits, including tax assessments and any related interest and penalties and any legal, litigation, accounting or consulting expenses;
• continues to have the sole and exclusive responsibility for the preparation and filing of consolidated federal and consolidated state income tax returns; and
• subject to the right and authority of the Company to direct DVD in the defense or prosecution of the portion of a tax contest directly and exclusively related to any Gaming & Entertainment tax adjustment, generally has the powers, in DVD’s sole discretion, to contest or compromise any claim or refund on the Company’s behalf.
Henry B. Tippie, the Chairman of the Company’s Board of Directors, controls in excess of fifty percent of the voting power of the Company. This means that Mr. Tippie has the ability to determine the outcome of the election of directors at the Company and to determine the outcome of many significant corporate transactions, many of which only require the approval of a majority of the Company’s voting power.
Mr. Tippie’s voting control with respect to the Company emanates from his direct and indirect holdings of Common Stock and Class A Common Stock, from his status as executor of the estate of John W. Rollins, the Company’s largest stockholder, and from certain shares as to which he has voting rights pursuant to a voting agreement with another one of our directors. As of December 31, 2005, Mr. Tippie has control over approximately 55.9% of the voting power of the Company.
Patrick J. Bagley, Kenneth K. Chalmers, Denis McGlynn, Jeffrey W. Rollins, John W. Rollins, Jr., R. Randall Rollins and Henry B. Tippie are all Directors of the Company and DVD. Denis McGlynn is the President and Chief Executive Officer of both companies, Klaus M. Belohoubek is the Senior Vice President - General Counsel and Secretary of both companies and Patrick J. Bagley is the Senior Vice President - Finance and Chief Financial Officer of DVD. Mr. Tippie controls in excess of fifty percent of the voting power of DVD.
NOTE 10-Commitments and Contingencies
In May 1995, Dover Downs, Inc., a subsidiary of the Company, entered into a long-term management agreement with Caesars World Gaming Development Corporation (“Caesars”) to act as our agent to manage our video lottery casino for which Caesars was paid a management fee based on the operating results of the casino. Effective December 28, 2004, that management agreement expired and the Company opted not to renew the agreement. These performance-based fees were $4,448,000 and $5,042,000 for the years ended December 31, 2004 and 2003, respectively.
The Company is a party to ordinary routine litigation incidental to its business. Management does not believe that the resolution of any of these matters is likely to have a serious adverse effect on our results of operations, financial condition or cash flows.
The Company has employment, severance and noncompete agreements with certain of its officers and directors under which certain change of control, severance and noncompete payments and benefits might become payable in the event of a change in control of the Company, defined to include a tender offer or the closing of a merger or similar corporate transactions. In the event of such a change in control of the Company and the subsequent termination of employment of all employees covered under these agreements, the maximum contingent liability would be approximately $6,029,000.
NOTE 11-Quarterly Results (unaudited)
(a) Included in the Company’s 2005 fourth quarter result is a gain on the sale of a shopping center of $5,837,000.
Included in the Company’s 2004 fourth quarter results is a net, non-recurring charge of $2,250,000 relating to the change in the Company’s point loyalty program.
Per share data amounts for the quarters have each been calculated separately. Accordingly, quarterly amounts may not add to the annual amounts because of differences in the average common shares outstanding during each period.