Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

** **

----

 

**FORM 10-Q**

 
| **(Mark One)**                                         | ** ** | ** **                                                                                              |
|--------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| **x**                                                  | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| ** **                                             | ** ** | ** **                                                                                              |
| **For the quarterly period ended June 30,  2008** |
|                                                   |       |                                                                                                    |
| **OR**                                                 |
|                                                   |       |                                                                                                    |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from              to             **

 

**Commission File Number 000-50689**

 

----

 

**BH/RE, L.L.C.**

(Exact Name ofRegistrant as Specified in its Charter)

 

| **NEVADA**                                | ** ** | **84-1622334**          |
|-------------------------------------------|------------|-------------------------|
| (State  or Other Jurisdiction             |       | (I.R.S.  Employer       |
| of  Incorporation or Organization)        |       | Identification  Number) |
|                                      |       |                    |
| **3667 Las Vegas Boulevard South**        | ** ** | ** **              |
| **Las Vegas, Nevada**                     | ** ** | **89109**               |
| (Address  of Principal Executive Offices) |       | (Zip  Code)             |

 

**(702) 785-5555**

(Registrant’sTelephone Number, Including Area Code)

 

----

 

Indicate by check markwhether the Registrant (1) has filed all reports required by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports) and (2) has been subject to such filing requirements for thepast 90 days. Yes xNo o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. (See definition of “accelerated filer,” “largeaccelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act).

 
| Large accelerated filer o |   | Accelerated  filer o |   | Non-accelerated filer x                        |   | Smaller reporting company o |
|---------------------------|--------|---------------------------|--------|------------------------------------------------|--------|----------------------------------|
|                      |   |                      |   | (Do not  check if a smaller reporting company) |

 

Indicate by check mark whether the Registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

 

 

----

Tableof Contents

 

BH/RE, L.L.C. AND SUBSIDIARIES

 

Index

 
| PART I —  FINANCIAL INFORMATION |       |
|-------------------------------------------|------------|
|                                      |       |   |   |
|                                      | ITEM 1.    | FINANCIAL STATEMENTS: |   |
|                                      |       |   |   |
|                                      |       | Condensed  Consolidated Balance Sheets (Unaudited) |
|                                      |       |   |   |
|                                      |       | Condensed  Consolidated Statements Of Operations (Unaudited) |
|                                      |       |   |   |
|                                      |       | Condensed  Consolidated Statements Of Cash Flows (Unaudited) |
|                                      |       |   |   |
|                                      |       | Notes To Condensed Consolidated Financial Statements  (Unaudited) |
|                                      |       |   |   |
|                                      | ITEM 2.    | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|                                      |       |   |   |
|                                      | ITEM 3.    | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
|                                      |       |   |   |
|                                      | ITEM 4T.   | CONTROLS AND  PROCEDURES |   |
|                                      |       |   |   |
| PART II  — OTHER INFORMATION:   |       |
|                                      |       |   |   |
|                                      | ITEM 6.    | EXHIBITS |   |
|                                      |       |   |   |
|                                      | SIGNATURES |   |

 

2

----

Tableof Contents

 

**PART I- FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**BH/RE,L.L.C. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(amounts inthousands)**

 
| ** **                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                            | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                |       |              |       |                  |       |
| Current assets:                                       |       |              |       |                  |       |
| Cash and cash equivalents                             |       | $                 | 19,627     |                  | $          | 21,468 |   |
| Receivables, net                                      |       | 26,164            |       | 26,920                |       |
| Inventories                                           |       | 2,577             |       | 1,729                 |       |
| Prepaid expenses                                      |       | 6,476             |       | 7,487                 |       |
| Deposits and other current assets                     |       | 164               |       | 216                   |       |
| Restricted cash and cash equivalents                  |       | 27,585            |       | 32,008                |       |
| Total current assets                                  |       | 82,593            |       | 89,828                |       |
|                                                  |       |              |       |                  |       |
| Property and equipment, net                           |       | 579,500           |       | 602,098               |       |
| Restricted cash and cash equivalents                  |       | 28,332            |       | 45,613                |       |
| Land receivable                                       |       | 17,484            |       | 19,728                |       |
| Deferred income tax                                   |       | 172               |       | 172                   |       |
| Other assets, net                                     |       | 5,113             |       | 9,629                 |       |
| Total assets                                          |       | $                 | 713,194    |                  | $          | 767,068 |   |
|                                                  |       |              |       |                  |       |
| LIABILITIES AND MEMBERS’ EQUITY (DEFICIT)        |       |              |       |                  |       |
|                                                  |       |              |       |                  |       |
| Current liabilities:                                  |       |              |       |                  |       |
| Current portion of long-term debt                     |       | $                 | 1,890      |                  | $          | 1,785 |   |
| Accounts payable                                      |       | 5,914             |       | 29,273                |       |
| Accrued payroll and related                           |       | 11,054            |       | 11,817                |       |
| Accrued interest payable                              |       | 6,882             |       | 8,182                 |       |
| Accrued taxes                                         |       | 3,091             |       | 3,338                 |       |
| Accrued expenses                                      |       | 8,476             |       | 9,422                 |       |
| Deposits                                              |       | 5,917             |       | 6,476                 |       |
| Other current liabilities                             |       | 6,434             |       | 6,493                 |       |
| Due to affiliates                                     |       | 2,243             |       | 1,661                 |       |
| Total current liabilities                             |       | 51,901            |       | 78,447                |       |
|                                                  |       |              |       |                  |       |
| Long-term debt, less current portion                  |       | 886,581           |       | 887,545               |       |
| Deferred income tax                                   |       | 172               |       | 172                   |       |
| Other long-term liabilities                           |       | 4,117             |       | 4,117                 |       |
| Total liabilities                                     |       | 942,771           |       | 970,281               |       |
|                                                  |       |              |       |                  |       |
| Commitments and contingencies                         |       |              |       |                  |       |
|                                                  |       |              |       |                  |       |
| Minority interest                                     |       | (20,227           | )          | (16,272               | )          |
|                                                  |       |              |       |                  |       |
| Members’ equity (deficit):                       |       |              |       |                  |       |
| Members’ equity                                  |       | 21,500            |       | 21,500                |       |
| Accumulated deficit                                   |       | (230,850          | )          | (208,441              | )          |
| Total members’ equity (deficit)                  |       | (209,350          | )          | (186,941              | )          |
| Total liabilities and members’ equity  (deficit) |       | $                 | 713,194    |                  | $          | 767,068 |   |

 

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

 

3

----

Tableof Contents

 

**BH/RE,L.L.C. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(amounts inthousands)**

 
| ** **                          | ** ** | **Three Months**       | ** ** | **Three Months**       | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | **Ended**                   | ** ** | **Ended**                   | ** ** |
| ** **                          | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
| ** **                          | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Operating revenues:                 |       |                        |       |                        |       |
| Casino                              |       | $                           | 30,965     |                        | $          | 26,405 |   |
| Hotel                               |       | 30,363                      |       | 29,054                      |       |
| Food and beverage                   |       | 13,781                      |       | 12,442                      |       |
| Other                               |       | 4,071                       |       | 1,863                       |       |
| Gross revenues                      |       | 79,180                      |       | 69,764                      |       |
| Promotional allowances              |       | (6,954                      | )          | (4,932                      | )          |
| Net revenues                        |       | 72,226                      |       | 64,832                      |       |
|                                |       |                        |       |                        |       |
| Operating costs and expenses:       |       |                        |       |                        |       |
| Casino                              |       | 18,980                      |       | 16,473                      |       |
| Hotel                               |       | 10,764                      |       | 11,353                      |       |
| Food and beverage                   |       | 9,614                       |       | 9,013                       |       |
| Other                               |       | 765                         |       | 311                         |       |
| Selling, general and administrative |       | 21,038                      |       | 20,356                      |       |
| Depreciation and amortization       |       | 9,215                       |       | 7,507                       |       |
|                                |       | 70,376                      |       | 65,013                      |       |
|                                |       |                        |       |                        |       |
| Operating income (loss)             |       | 1,850                       |       | (181                        | )          |
|                                |       |                        |       |                        |       |
| Other income (expense):             |       |                        |       |                        |       |
| Interest expense, net               |       | (16,203                     | )          | (17,687                     | )          |
| Minority interest                   |       | 2,153                       |       | 2,680                       |       |
| Loss on warrant valuation           |       | —                      |       | —                      |       |
|                                |       | (14,050                     | )          | (15,007                     | )          |
|                                |       |                        |       |                        |       |
| Pre-tax loss                        |       | (12,200                     | )          | (15,188                     | )          |
| Provision for income taxes          |       | —                      |       | —                      |       |
| Net loss                            |       | $                           | (12,200    | )                           | $          | (15,188 | ) |

 

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

 

4

----

Table of Contents

 

**BH/RE,L.L.C. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(amounts inthousands)**

 
| ** **                          | ** ** | **Six Months**         | ** ** | **Six Months**         | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | **Ended**                   | ** ** | **Ended**                   | ** ** |
| ** **                          | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|                                |       |                        |       |                        |       |
| Operating revenues:                 |       |                        |       |                        |       |
| Casino                              |       | $                           | 63,312     |                        | $          | 50,263 |   |
| Hotel                               |       | 61,316                      |       | 59,912                      |       |
| Food and beverage                   |       | 28,038                      |       | 24,481                      |       |
| Other                               |       | 7,853                       |       | 3,561                       |       |
| Gross revenues                      |       | 160,519                     |       | 138,217                     |       |
| Promotional allowances              |       | (14,300                     | )          | (9,796                      | )          |
| Net revenues                        |       | 146,219                     |       | 128,421                     |       |
|                                |       |                        |       |                        |       |
| Operating costs and expenses:       |       |                        |       |                        |       |
| Casino                              |       | 39,400                      |       | 31,894                      |       |
| Hotel                               |       | 21,330                      |       | 22,353                      |       |
| Food and beverage                   |       | 18,683                      |       | 18,275                      |       |
| Other                               |       | 1,048                       |       | 585                         |       |
| Selling, general and administrative |       | 40,012                      |       | 39,690                      |       |
| Depreciation and amortization       |       | 18,016                      |       | 15,891                      |       |
|                                |       | 138,489                     |       | 128,688                     |       |
|                                |       |                        |       |                        |       |
| Operating income (loss)             |       | 7,730                       |       | (267                        | )          |
|                                |       |                        |       |                        |       |
| Other income (expense):             |       |                        |       |                        |       |
| Interest expense, net               |       | (34,094                     | )          | (35,436                     | )          |
| Minority interest                   |       | 3,955                       |       | 5,358                       |       |
| Loss on warrant valuation           |       | —                      |       | —                      |       |
|                                |       | (30,139                     | )          | (30,078                     | )          |
|                                |       |                        |       |                        |       |
| Pre-tax loss                        |       | (22,409                     | )          | (30,345                     | )          |
| Provision for income taxes          |       | —                      |       | —                      |       |
| Net loss                            |       | $                           | (22,409    | )                           | $          | (30,345 | ) |

 

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

 

5

----

Tableof Contents

 

**BH/RE,L.L.C. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(amounts inthousands)**

 
| ** **                                                                   | ** ** | **Six Months**         | ** ** | **Six Months**         | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | **Ended**                   | ** ** | **Ended**                   | ** ** |
| ** **                                                                   | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|                                                                         |       |                        |       |                        |       |
| Cash flows from operating activities:                                        |       |                        |       |                        |       |
| Net loss                                                                     |       | $                           | (22,409    | )                           | $          | (30,345 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                        |       |                        |       |
| Depreciation and amortization                                                |       | 18,016                      |       | 15,891                      |       |
| Amortization of debt discount and issuance  costs                            |       | 4,181                       |       | 3,893                       |       |
| Minority interest                                                            |       | (3,955                      | )          | (5,358                      | )          |
| Changes in assets and liabilities:                                           |       |                        |       |                        |       |
| Restricted cash and cash equivalents                                         |       | 4,423                       |       | (4,976                      | )          |
| Receivables, net                                                             |       | 756                         |       | (502                        | )          |
| Inventories and prepaid expenses                                             |       | 163                         |       | 3,168                       |       |
| Deposits and other current assets                                            |       | 52                          |       | 660                         |       |
| Due to affiliates                                                            |       | 582                         |       | 450                         |       |
| Accounts payable                                                             |       | (2,552                      | )          | (2,383                      | )          |
| Accrued payroll and related                                                  |       | (763                        | )          | (185                        | )          |
| Accrued expenses                                                             |       | (1,196                      | )          | 1,259                       |       |
| Deposits and other current liabilities                                       |       | (618                        | )          | (1,788                      | )          |
| Accrued interest                                                             |       | (1,300                      | )          | 703                         |       |
| Long term receivable, land                                                   |       | 2,244                       |       | —                      |       |
| Net cash used in operating activities                                        |       | (2,376                      | )          | (19,513                     | )          |
| Cash flows from investing activities:                                        |       |                        |       |                        |       |
| Purchases of property and equipment                                          |       | (15,887                     | )          | (43,797                     | )          |
| Restricted cash and cash equivalents                                         |       | 17,281                      |       | 42,297                      |       |
| Net cash provided by (used in) investing  activities                         |       | 1,394                       |       | (1,500                      | )          |
| Cash flows from financing activities:                                        |       |                        |       |                        |       |
| Borrowings under Loan Agreement                                              |       | —                      |       | 23,466                      |       |
| Payments under CUP financing                                                 |       | (859                        | )          | (766                        | )          |
| Net cash (used in) provided by financing  activities                         |       | (859                        | )          | 22,700                      |       |
| Cash and cash equivalents:                                                   |       |                        |       |                        |       |
| (Decrease) increase in cash and cash  equivalents                            |       | (1,841                      | )          | 1,687                       |       |
| Balance, beginning of period                                                 |       | 21,468                      |       | 25,640                      |       |
| Balance, end of period                                                       |       | $                           | 19,627     |                        | $          | 27,327 |   |
|                                                                         |       |                        |       |                        |       |
| Supplemental cash flow disclosures:                                          |       |                        |       |                        |       |
| Cash paid for interest, net of capitalized  interest                         |       | $                           | 31,616     |                        | $          | 35,145 |   |

 

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

 

6

----

Table ofContents

 

**BH/RE,L.L.C. AND SUBSIDIARIES****NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

##### **1.****                                      ORGANIZATION ANDBASIS OF PRESENTATION**

#####  

###### ***Organization***

######  

 BH/RE, L.L.C. (“BH/RE”or the “Company”)  is a holdingcompany that owns 85% of EquityCo, L.L.C. (“EquityCo”). The remaining 15% ofEquityCo is owned indirectly by Starwood Hotels & Resorts Worldwide, Inc.(“Starwood”). MezzCo, L.L.C. (“MezzCo”) is a wholly-owned subsidiary ofEquityCo and each of OpBiz, LLC (“OpBiz”) and PH Mezz II LLC (“PH Mezz II”) isa wholly owned subsidiary of MezzCo. PH Mezz I LLC (“PH Mezz I”), is a whollyowned subsidiary of PH Mezz II. PH Fee Owner LLC (“PH Fee Owner”) is a whollyowned subsidiary of PH Mezz I. TSP Owner LLC (“TSP Owner”) is a wholly ownedsubsidiary of PH Fee Owner. PH Mezz II, PH Mezz I, PH Fee Owner and TSP Ownerare Delaware limited liability companies structured as bankruptcy remotespecial purpose entities which, together with OpBiz, own and operate the PlanetHollywood Resort and Casino (the “PH Resort”). OpBiz is the licensed owner andoperator of the gaming assets and leases the casino space and hotel spacetogether with all hotel assets from PH Fee Owner. TSP Owner was formed to holdthe parcel of land (the “Timeshare Parcel”) that was sold to Westgate Resorts,LLP, a Florida limited partnership (“Westgate”) subject to the TimesharePurchase Agreement between OpBiz and Westgate, dated December 10, 2004.50% of BH/RE’s voting membership interests are held by each of Robert Earl andDouglas P. Teitelbaum, and BH/RE’s equity membership interests are held 40.75%by BH Casino and Hospitality LLC I (“BHCH I”), 18.50% by BH Casino andHospitality LLC II (“BHCH II”) (together, “BHCH”) and 40.75% by OCS Consultants, Inc.(“OCS”).

 

BH/RE and its subsidiaries were formed to acquire, operateand renovate the Aladdin Resort and Casino (the “Aladdin”) located in LasVegas, Nevada. OpBiz, an indirect subsidiary of BH/RE, completed theacquisition of the Aladdin on September 1, 2004 and completed a renovationproject which transformed the Aladdin into the PH Resort at the end of 2007. Inconnection with the operation of the PH Resort, OpBiz has entered into anagreement with Planet Hollywood International, Inc. (“Planet Hollywood”)and certain of its subsidiaries to, among other things, license PlanetHollywood’s trademarks, memorabilia and other intellectual property. OpBiz hasalso entered into an agreement with Sheraton Operating Corporation (“Sheraton”),a subsidiary of Starwood, pursuant to which Sheraton provides hotel management,marketing and reservation services for the hotel (the “Hotel”) that comprises aportion of the PH Resort.

 

BH/RE is a Nevada limited liability company and wasorganized on March 31, 2003. BH/RE was formed by BHCH and OCS. BHCH iscontrolled by Douglas P. Teitelbaum, a managing principal of Bay HarbourManagement, L.C. (“Bay Harbour Management”). BHCH was formed by Mr. Teitelbaumfor the purpose of holding investments in BH/RE by funds managed by Bay HarbourManagement. Bay Harbour Management is an investment management firm. OCS iswholly owned and controlled by Robert Earl and holds Mr. Earl’s investmentin BH/RE. Mr. Earl is the founder, chairman and chief executive officer ofPlanet Hollywood and Mr. Teitelbaum is a director of Planet Hollywood.Collectively, Mr. Earl, a trust for the benefit of Mr. Earl’schildren and affiliates of Bay Harbour Management, own substantially all of theequity of Planet Hollywood. Mr. Earl disclaims beneficial ownership of anyequity of Planet Hollywood owned by the trust.

 

###### ***Interim Financial Statements(unaudited)***

######  

The accompanyingcondensed consolidated financial statements included herein have been preparedby the management of BH/RE, without audit, pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with U.S. generally accepted accounting principles have beencondensed or omitted pursuant to such rules and regulations. BH/REbelieves that the disclosures are adequate to make the information presentednot misleading. In the opinion of management, all adjustments (which includenormal recurring adjustments) necessary for a fair presentation of the resultsfor the interim periods have been made. The results for the three and sixmonths ended June 30, 2008, are not indicative of results to be expectedfor the full fiscal year. These unaudited financial statements should be readin conjunction with the audited financial statements and notes thereto for theyear ended December 31, 2007, included in BH/RE’s Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 28, 2008.

 

7

----

##### Table of Contents

 

##### **2.****                                      SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

#####  

###### ***Significant Accounting Policies and Estimates***

######  

The condensed consolidated financial statements areprepared in conformity with U.S. generally accepted accounting principles.Certain policies, including the determination of bad debt reserves, theestimated useful lives assigned to assets, asset impairment, insurance reservesand the calculation of liabilities require that management apply significantjudgment in defining the appropriate assumptions for calculating financialestimates. By their nature, these judgments are subject to an inherent degreeof uncertainty. Management’s judgments are based on historical experience,terms of existing contracts, observance of trends in the gaming industry andinformation available from other outside sources. There can be no assurancethat actual results will not differ from management’s estimates.

 

To providean understanding of the methodology management applies, BH/RE’s significantaccounting policies and basis of presentation are discussed below.

 

###### *Cash and Cash Equivalents*

######  

Cash and cash equivalents include cash on hand, as well asshort-term investments with original maturities not in excess of 90 days.

 

###### *Restricted Cash and Cash Equivalents*

######  

The balance in current restricted cash and cash equivalentsat June 30, 2008 and December 31, 2007 was approximately $27.6 millionand $32.0 million, respectively, which consists of reserves required under theLoan Agreement (as defined in Note 5 to the Condensed ConsolidatedFinancial Statements) including a reserve for payment of property taxesand insurance and a reserve for on-going furniture, fixture and equipmentpurchases or property improvements. Long-term restricted cash and cashequivalents consistof approximately $28.3 million and $45.6 million at June 30, 2008 and December 31,2007, respectively, which includes a reserve for the remaining cash commitmentsfor the renovations of the PH Resort and a reserve for interest shortfalls. Therestricted cash related to the renovation includes a contingency required bythe Loan Agreement which will be released, in accordance with the terms of theLoan Agreement, upon completion of project funding.

 

###### *Accounts Receivable*

######  

Accounts receivable, including casino and hotelreceivables, are typically non-interest bearing and are initially recorded atcost. An estimated allowance for doubtful accounts is maintained to reduce thereceivables to their carrying amount, which approximates fair value. BH/REestimates the allowance for doubtful accounts by applying standard reservepercentages, which are based on historical collections, to aged accountbalances under a specific dollar amount and specifically analyzes thecollectibility of each account with a balance over the specified dollar amount,based on the age of the account, the customer’s financial condition, collectionhistory and any other known information.

 

8

----

###### Table of Contents

 

###### *Inventories*

######  

Inventories consist of food and beverage, retailmerchandise and operating supplies, and are stated at the lower of cost ormarket. Cost is determined by the first-in, first-out and specificidentification methods.

 

###### *Propertyand Equipment*

######  

Property andequipment are stated at cost. Recurring repairs and maintenance costs,including items that are replaced routinely in the casino, hotel and food andbeverage departments which do not meet the Company’s capitalization policy, areexpensed as incurred. The Company has established its capital expense policy tobe reflective of its individual ongoing repairs and maintenance programs. Gainsor losses on dispositions of property and equipment are included in thedetermination of income. Property and equipment are generally depreciated overthe following estimated useful lives on a straight-line basis:

 

| Buildings                         |   | 40 years   |   |
|-----------------------------------|--------|-----------------|--------|
| Building improvements             |   | 15  to 40 years |   |
| Furniture, fixtures and equipment |   | 3  to 7 years   |   |

 

Property and equipmentand other long-lived assets are evaluated for impairment in accordance with theFinancial Accounting Standards Board’s (“FASB”) Statement of FinancialAccounting Standards (“SFAS”) No. 144, “*Accountingfor the Impairment or Disposal of Long-Lived Assets*.” For assets tobe disposed of, the asset to be sold is recognized at the lower of carryingvalue or fair value less costs of disposal. Fair value for assets to bedisposed of is estimated based on comparable asset sales, solicited offers or adiscounted cash flow model.

 

Property and equipmentare reviewed for impairment whenever indicators of impairment exist. If anindicator of impairment exists, the estimated future cash flows of the asset,on an undiscounted basis, are compared to the carrying value of the asset. Ifthe undiscounted cash flows exceed the carrying value, no impairment isindicated. If the undiscounted cash flows do not exceed the carrying value,then impairment is measured based on fair value compared to carrying value,with fair value typically based on a discounted cash flow model.

 

*DebtIssuance Costs*

 

Debt issuance costsincurred in connection with the issuance of long-term debt are capitalized andamortized to interest expense over the expected terms of the related debtagreements using the straight-line method, which approximates the effectiveinterest method, and are included in other assets on BH/RE’s consolidatedbalance sheets. Debt issuance costs, net of the related amortization,approximated $3.5 million and $7.7 million as of June 30, 2008 and December 31,2007, respectively.

 

*Intangible Assets*

 

In connection with thepurchase of the Aladdin and as a result of an independent appraisal of theassets purchased, BH/RE recorded intangible assets, which consist of a customerlist and trade name. The customer list was valued at approximately $2.7 millionat the time of purchase and at June 30, 2008, had a net book value ofapproximately $112,000. The trade name was valued at approximately $1.0 millionat the time of purchase and was fully amortized at June 30, 2008. Thecustomer list is being amortized using the straight-line method over a usefullife of 4 years. Amortization expense for the three months ended June 30,2008 and 2007 was approximately $170,000 for each of the three month periods.Amortization expense for the six months ended June 30, 2008 and 2007 wasapproximately $340,000 for each of the six month periods.

 

*Derivative Instruments and Hedging Activities*

 

 Pursuant to the refinancing of the SecuritiesPurchase Agreement and the terms of the Restructuring Agreement, theRestructuring Parties (each as defined in Note 5 to the CondensedConsolidated Financial Statements), agreed to amend the warrants issued byMezzCo to purchase 17.5% of the fully diluted equity in MezzCo. The warrantscontain a net cash settlement, and therefore are accounted for in accordancewith Emerging Issues Task Force (“EITF”) 00-19, “*Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.*” Both SFAS No. 133, *“Accountingfor Derivative Instruments and Hedging Activities”* andEITF 00-19 require that the warrants be recognized as liabilities, withchanges in fair value affecting net income. See “Note 5. Long-Term Debt.”

 

9

----

Tableof Contents

 

The terms of the LoanAgreement required the Company to enter into an interest rate cap agreement,which expires on November 30, 2008, to manage interest rate risk. TheCompany did not apply cash flow hedge accounting to this instrument. Althoughthis derivative was not afforded cash flow hedge accounting, the Companyretained the instrument as protection against the interest rate risk associatedwith its long-term borrowings. The Company accounts for its derivative activityin accordance with SFAS No. 133 and accordingly, recognizes allderivatives on the balance sheet at fair value with any change in fair valuebeing recorded in interest income or expense in the accompanying consolidatedstatements of operations.

 

###### *RevenueRecognition and Promotional Allowances*

######  

Casino revenuesare recognized as the net win from gaming activities, which is the differencebetween gaming wins and losses. Hotel revenue recognition criteria aregenerally met at the time of occupancy. Food and beverage revenue recognition criteriaare generally met at the time of service. Deposits for future hotel occupancyor food and beverage services are recorded as deferred income until revenuerecognition criteria are met. Cancellation fees for hotel and food and beverageservices are recognized upon cancellation by the customer as defined by awritten contract entered into with the customer. All other revenues arerecognized as the service is provided. Revenues include the retail value offood, beverage, rooms, entertainment and merchandise provided on acomplimentary basis to customers. Such complimentary amounts are then deductedfrom revenues as promotional allowances on BH/RE’s consolidated statements ofoperations. The estimated departmental costs of providing such promotional allowancesare included in casino costs and expenses and consist of the following (amountsin thousands, unaudited):

 

| ** **                           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Rooms                                |       | $                                                   | 1,713      |                                              | $          | 924 |   | $ | 3,280 |   | $ | 1,880 |   |
| Food and Beverage                    |       | 2,164                                               |       | 2,340                                             |       | 4,593 |   | 4,302 |   |
| Other                                |       | 14                                                  |       | 5                                                 |       | 22 |   | 10 |   |
| Total cost of promotional allowances | ** ** | **$**                                               | **3,891**  | ** **                                        | **$**      | **3,269** | ** ** | **$** | **7,895** | ** ** | **$** | **6,192** | ** ** |

 

###### *Slot ClubProgram*

######  

The PH Resort’s slot clubmembers earn points based on gaming activity, which can be redeemed for cash. Aliability is recorded for the estimated cost of the outstanding points accruedunder the slot club program. The accrued slot club point liability wasapproximately $2.0 million and $1.8 million as of June 30, 2008 and December 31,2007, respectively.

 

*Advertising Costs*

 

Advertisingcosts are expensed as incurred and included in selling, general andadministrative costs and expenses. Advertising costs totaled approximately $4.5million and $6.9 million for the three and six months ended June 30, 2008,respectively, and $2.0 million and $3.0 million for the three and six monthsended June 30, 2007, respectively.

 

*IncomeTaxes*

 

The condensedconsolidated financial statements include the operations of BH/RE and itsmajority-owned subsidiaries: EquityCo, MezzCo, OpBiz, PH Mezz II, PH Mezz I, PHFee Owner and TSP Owner. BH/RE and EquityCo are limited liability companies andare taxed as partnerships for federal income tax purposes. However, MezzCo haselected to be taxed as a corporation for federal income tax purposes. OpBiz andPH Mezz II, wholly-owned subsidiaries of MezzCo, are treated as divisions ofMezzCo for federal income tax purposes, and accordingly, are also subject tofederal income taxes. Additionally, PH Mezz I, a wholly-owned subsidiary of PHMezz II, PH Fee Owner, a wholly owned subsidiary of PH Mezz I, and TSP Owner, awholly owned subsidiary of PH Fee Owner, are also subject to federal incometaxes.

 

MezzCo, OpBiz, PH MezzII, PH Mezz I, PH Fee Owner and TSP Owner account for income taxes inaccordance with SFAS No. 109, “*Accounting for IncomeTaxes*”. SFAS 109 requires the recognition of deferred income taxassets, net of applicable reserves, related to net operating loss carryforwardsand certain temporary differences. The standard requires recognition of afuture tax benefit to the extent that realization of such benefit is morelikely than not. Otherwise, a valuation allowance is applied.

 

InJuly 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”) *“Accounting for Uncertainty in Income Taxes –*

 

10

----

Table of Contents

 

*an interpretation of FASB No. 109”*, to clarify certain aspectsof accounting for uncertain tax positions, including issues related to therecognition and measurement of those tax positions.  FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interim periods,disclosures, and transition.  FIN 48is effective for fiscal years beginning after December 15, 2006.  The Company adopted the provisions of FIN 48on January 1, 2007 as required. Further discussion regarding the adoption of FIN 48 can be found inNote 8 to the Condensed Consolidated Financial Statements.

 

*Membership Interests*

 

As of June 30, 2008, BH/RE’s membership interests hadnot been unitized and BH/RE’s members do not presently intend to unitize thesemembership interests. Accordingly, management of BH/RE has excluded earningsper share data required pursuant to SFAS No. 128, “*Earnings PerShare,*” because management believes that such disclosures would notbe meaningful to the financial statement presentation.

 

*Reclassifications*

 

Certainreclassifications have been made to conform prior period data to the currentpresentation. These reclassifications had no effect on reported income.

 

*RecentlyIssued Accounting Pronouncements*

 

In December 2007, the FASB issued SFAS No. 141 (revised2007), *“Business Combinations.”* SFAS No. 141(revised) establishes principles and requirements for how an acquirerrecognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and noncontrolling interest in the acquireeand the goodwill acquired. The revision is intended to simplify existingguidance and converge rulemaking under U.S. generally accepted accountingprinciples with international accounting rules. This statement appliesprospectively to business combinations where the acquisition date is on or afterthe beginning of the first annual reporting period beginning on or after December 15,2008. The adoption of SFAS No. 141 (revised) is not expected to have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

In December 2007, the FASB issued SFAS No. 160, *“Noncontrolling Interest in Consolidated Financial Statements, anamendment of ARB No. 51.”* This statement establishes accountingand reporting standards for ownership interest in subsidiaries held by partiesother than the parent and for the deconsolidation of a subsidiary. It alsoclarifies that a noncontrolling interest in a subsidiary is an ownershipinterest in the consolidated entity that should be reported as equity in theconsolidated financial statements. SFAS No. 160 changes the way theconsolidated statement of operations is presented by requiring consolidated netincome to be reported at amounts that include the amount attributable to boththe parent and the noncontrolling interests. The statement also establishesreporting requirements that provide sufficient disclosures that clearlyidentify and distinguish between the interest of the parent and those of thenoncontrolling owners. This statement is effective for fiscal years beginningon or after December 15, 2008. The adoption of SFAS No. 160 is notexpected to have a material impact on the Company’s financial position, resultsof operations or cash flows.

 

In March 2008, theFASB issued SFAS No. 161, *“Disclosures AboutDerivative Instruments and Hedging Activities, an amendment of SFAS No. 133.”*SFAS No. 161 is intended to improve financial reporting about derivativeinstruments and hedging activities by requiring enhanced disclosures to enableinvestors to better understand their effects on an entity’s financial position,financial performance, and cash flows. This statement is effective for fiscalyears beginning after November 15, 2008. SFAS No. 161 is not expectedto have a material impact on the Company’s financial position, results ofoperations or cash flows.

 

In May 2008, FASB issued Statement No. 162, “*The Hierarchy of Generally Accepted AccountingPrinciples”*  (“SFAS 162”).SFAS 162 identifies the sources of accounting principles and the frameworkfor selecting the principles to be used in the preparation of financialstatements of nongovernmental entities that are presented in conformity withGAAP (the GAAP hierarchy). SFAS 162 is effective 60 days followingthe SEC’s approval of the Public Company Accounting Oversight Board amendmentsto AU Section 411, The Meaning of Present Fairly in Conformity WithGenerally Accepted Accounting Principles. The adoption of SFAS 162 is notexpected to have a material impact on the Company’s financial position, resultsof operations or cash flows.

 

11

----

Tableof Contents

 

**3.****                                      RECEIVABLES**

 

Receivables consist of the following (in thousands):

 

| ** **                                 | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Casino                                     |       | $                       | 16,567     |                        | $          | 18,322 |   |
| Hotel                                      |       | 8,103                   |       | 6,811                       |       |
| Land sale receivable                       |       | 22,764                  |       | 25,373                      |       |
| Other                                      |       | 4,025                   |       | 3,248                       |       |
|                                       |       | 51,459                  |       | 53,754                      |       |
| Long-term portion of land  sale receivable |       | (17,484                 | )          | (19,728                     | )          |
| Allowance for doubtful  accounts           |       | (7,811                  | )          | (7,106                      | )          |
| Receivables, net                           |       | $                       | 26,164     |                        | $          | 26,920 |   |

 

**4.****                                      PROPERTYAND EQUIPMENT**

 

Property andequipment and the related accumulated depreciation consist of the following (inthousands):

 

| ** **                        | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Land                              |       | $                       | 68,479     |                        | $          | 68,479 |   |
| Building and improvements         |       | 502,203                 |       | 502,584                     |       |
| Furniture, fixtures and equipment |       | 102,204                 |       | 104,253                     |       |
| Construction in progress          |       | 8,280                   |       | 10,767                      |       |
|                              |       | 681,166                 |       | 686,083                     |       |
| Accumulated depreciation          |       | (101,666                | )          | (83,985                     | )          |
| Property and equipment, net       |       | $                       | 579,500    |                        | $          | 602,098 |   |

 

Depreciation expense wasapproximately $9.2 million and $18.0 million for the three and six months endedJune 30, 2008, respectively, and $7.5 million and $15.9 million for thethree and six months ended June 30, 2007, respectively.

 

12

----

Tableof Contents

 

**5.****                                      LONG-TERMDEBT**

 

Long-term debt consistsof the following (in thousands):

 

| ** **                                       | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| $860 million Loan                                |       | $                       | 860,000    |                        | $          | 860,000 |   |
| Northwind Aladdin obligation under capital lease |       | 28,471                  |       | 29,330                      |       |
| Total long-term debt                             |       | 888,471                 |       | 889,330                     |       |
| Current portion of long-term debt                |       | (1,890                  | )          | (1,785                      | )          |
| Total long-term debt, net                        |       | $                       | 886,581    |                        | $          | 887,545 |   |

 

***LoanAgreement***

* *

On November 30, 2006, OpBiz and PH Fee Owner (collectively the “Borrower”)entered into the Loan Agreement (the “Loan Agreement”) with Column Financial, Inc.(the “Lender”) for a mortgage loan in the principal amount of up to$820 million. The Loan Agreement provided for an initial disbursement inthe amount of $759.7 million and a future funding facility in the amountof up to $60.3 million. On July 17, 2007, the Borrower and the Lenderentered into an amendment (the “Amendment”) to the Loan Agreement. TheAmendment provided for the immediate funding to Borrower of the balance offuture funding that was available under the Loan Agreement and established anadditional future funding facility in the amount of up to $40 million (“FutureFunding Tranche B”). Future Funding Tranche B has the same terms asthe Loan Agreement for maturity and extension. The Loan Agreement, as amendedby the Amendment, is referred to as the Loan. The Loan is secured by a deed oftrust on the PH Resort and a pledge, subject to approval by the Nevada gamingauthorities, by MezzCo of its membership interest in OpBiz (as describedbelow).

 

The Loan matures in November 2008 and has three one year extensionoptions subject to payment of a fee and the Borrower’s compliance with therequirements for an extension outlined in the Loan Agreement. As the Companyintends and has the ability to extend the maturity of the Loan, it isclassified as a non-current liability as of the latest balance sheet date.Interest on the Loan is payable monthly and accrues at a rate of LIBOR plus3.25% with a .25% ticking fee on available but un-advanced future funding.Interest on Future Funding Tranche B is payable monthly and accrues at arate of LIBOR plus 7.50% with a 1.50% ticking fee on available but un-advancedfunds. The Loan does not require amortization during the initial term or,provided certain EBITDA thresholds are met, during the extension periods. TheLoan requires that the Borrower establish and maintain certain reservesincluding a reserve for completion of the renovation project, a reserve forprojected interest shortfalls, a reserve for payment of property taxes andinsurance and a reserve for on-going furniture, fixture and equipment purchasesor property improvements. The Loan restricts the Borrower’s ability to spendexcess cash flow until certain debt service coverage ratios are met.

 

Using the proceeds from the Loan, all amounts outstanding under theCredit Agreement, dated August 31, 2004, among OpBiz, the lenders namedtherein and The Bank of New York, Asset Solution Division (the “Senior Agent”)were paid in full. Pursuant to the terms of the Credit Agreement, uponrepayment of all amounts due, the warrant to purchase 2.5% of the equity inEquityCo issued to the lenders at the closing of the Credit Agreement becameexercisable. The Company compensated the holders of all unexercised warrants inaccordance with the terms of a letter agreement between the parties and thewarrants were canceled.

 

In order to permit the Lender to foreclose on the Hotel and Casinoseparately and to allow OpBiz to continue to operate the Casino after such aforeclosure (should the Lender choose to do so), title to the real propertycomprising the Hotel and Casino (the “Property”) was transferred from OpBiz toPH Fee Owner. OpBiz and PH Fee Owner then entered into a lease pursuant towhich OpBiz agreed to continue to operate the Hotel in the manner it had beenand to pay monthly rent of approximately $916,000. OpBiz and PH Fee Owner alsoentered into a lease pursuant to which OpBiz agreed to continue to operate theCasino in the manner it had been and to pay monthly rent of approximately$1,160,000.

 

In connection with the Loan, the Lender required that Trophy HunterInvestments, Ltd., Bay Harbour 90-1, Ltd. and Bay HarbourMaster Ltd., which are affiliates of Bay Harbour Management, execute anddeliver a certain Guaranty (as described below). In exchange for Trophy HunterInvestments, Ltd., Bay Harbour 90-1 Ltd. and Bay Harbour Master Ltd.(the “Guarantors”) executing the Guaranty, OpBiz and PH Fee Owner agreed to payto Trophy Hunter Investments, Ltd. and Bay Harbour Master Ltd. a feeequal to $1,500,000 per year. The fee is accrued and only payable once OpBizhits certain debt service coverage ratios defined in the Loan Agreement.

 

13

----

Table ofContents

 

In connection with the Loan, the Guarantors entered into a Guaranty,dated November 30, 2006 (the “Guaranty”), pursuant to which the Guarantorsagreed to indemnify the Lender against losses related to certain prohibitedactions of the Borrower and guarantied full repayment of the Loan in the caseof a voluntary or collusive bankruptcy of the Borrower, a transfer of theProperty or interests in the Borrower in violation of the Loan Agreement and ifthe Borrower fails to maintain its status as a bankruptcy remote entity and asa result sees its assets consolidated with those of an affiliate in abankruptcy. The liability of the Guarantors is capped at $15,000,000 per entityand $30,000,000 in the aggregate, however this cap does not apply to (i) liabilityarising from events, acts or circumstances actually committed or brought aboutby the willful acts of any of the Guarantors and (ii) the extent of anybenefit received by any of the Guarantors as a result of the acts giving riseto the liability under the Guaranty. Each of Douglas Teitelbaum and Robert Earlexecuted and delivered guaranties substantially the same as that delivered bythe Guarantors, however the liability of each of them was limited to (i) liabilityarising from events, acts or circumstances actually committed or brought aboutby willful acts by him and (ii) the extent of any benefit received by himas a result of the acts giving rise to the liability under the Guaranty.

 

In connection with the Loan, the Guarantors and Robert Earl executedand delivered a Completion Guaranty, dated November 30, 2006, pursuant towhich they jointly and severally guarantied the completion of the renovation ofthe Property and payment of all costs associated therewith. The liability underthe Completion Guaranty is capped at the greater of (a) $35,000,000 and (b) onlyin the case that cost overruns for the renovation exceed $15,000,000, 24% ofthe then unpaid costs of the completion of the renovation.

 

In addition, in connection with the Loan Agreement, MezzCo effected arefinancing of the Securities Purchase Agreement, dated August 9, 2004,among MezzCo and the Investors (the “Restructuring Parties”), pursuant to whichMezzCo issued to the Investors (i) 16% senior subordinated secured Notesin the original aggregate principal amount of $87 million, and (ii) Warrantsfor the purchase (subject to certain adjustments as provided for therein) ofmembership interests of MezzCo, representing 17.5% of its fully diluted equity.Loan proceeds were used to redeem in full the Notes.

 

In connection with the refinancing of the Securities Purchase Agreementand redemption of the Notes, the Restructuring Parties entered into theRestructuring Agreement, dated November 30, 2006, pursuant to which theRestructuring Parties terminated in full the Securities Purchase Agreement, theSubordination Agreement, dated as of August 31, 2004, among MezzCo, OpBiz,the Senior Agent and the Investors, the Pledge Agreement, dated August 9,2006, among MezzCo and the Collateral Agent, and the Guaranty, dated August 9,2004, made by OpBiz to the Investors, and amended certain other existingagreements, as described below.

 

In accordance with the terms of the Restructuring Agreement, theInvestors and EquityCo, MezzCo and OpBiz entered into a Release, Consent andWaiver Agreement, pursuant to which the Investors (i) released OpBiz fromits guaranteed obligations, under that certain Guaranty Agreement, dated as of August 9,2004 and executed by OpBiz in favor of the Investors and the Collateral Agent; (ii) releasedMezzCo from its pledge of the collateral, under that certain Pledge Agreement,dated as of August 9, 2004, and executed by MezzCo in favor of theCollateral Agent, the Investors released their security interest, as defined inthat certain Security Agreement, as amended by that certain Amendment toSecurity Agreement, in each case dated as of August 9, 2004 and executedby the Company in favor of the Collateral Agent; (iii) released andterminated the Deed of Trust, dated as of August 9, 2004 and executed byMezzCo in favor of the Trustee (as defined therein) for the benefit of theCollateral Agent; (iv) released and terminated the Investors’ securityinterest in the securities account, provided for that certain SecuritiesAccount Control Agreement, dated as of August 9, 2004 and executed by theCompany, the Collateral Agent and Wells Fargo Bank, N.A.

 

Additionally, MezzCo, EquityCo, and the Investors entered into anAmended and Restated Investor Rights Agreement, dated November 30, 2006(the “A&R Investor Rights Agreement”), to amend and restate the originalInvestor Rights Agreements among the parties thereto, dated August 9,2004.

 

Pursuant to the Restructuring Agreement, the Restructuring Partiesagreed to amend the Warrants by issuing Amended and Restated Warrants toPurchase Membership Interests of MezzCo (the “A&R Warrants”) to theInvestors upon approval by the Nevada gaming authorities. The A&R Warrantswill be exercisable at any time, subject to the approval of the Nevada gamingauthorities, at a purchase price of $0.01 per unit. Subject to the approval ofthe Nevada gaming authorities, the warrants may be exercised to purchase eithervoting or non-voting membership interests of MezzCo or a combination thereofthrough the expiration date of December 9, 2012. In addition to customaryanti-dilution protections, the number of units representing MezzCo membershipinterests issuable upon exercise of the A&R Warrants may be increased fromtime to 

 

14

----

Table ofContents

 

time upon the occurrence ofcertain events as described in the A&R Warrants. Holders of the A&RWarrants and any securities issued upon exercise thereof may require MezzCo toredeem such securities commencing on December 9, 2011 at a redemptionprice based upon a formula set forth in the A&R Warrants. These rightsexpire upon completion of a public offering by MezzCo or OpBiz.

 

In connection with the Restructuring Agreement, EquityCo entered into aGuaranty Agreement, dated November 30, 2006 (the “Guaranty Agreement”), infavor of the Investors and the Collateral Agent, pursuant to which EquityCo hasguaranteed the obligation of MezzCo to pay the redemption price under theA&R Warrants prior to expiration and any indebtedness arising under the PutNote (as defined in the A&R Warrants).

 

EquityCo and the Collateral Agent also entered into a Pledge Agreement,dated November 30, 2006 (the “Pledge Agreement”), pursuant to whichEquityCo has, subject to approval of the Nevada gaming authorities, pledged andgranted a first priority security interest to the Collateral Agent for theratable benefit of the Investors in the membership interests of EquityCo inMezzCo. The Pledge Agreement, once approved, will secure the full payment ofthe Put Right (as defined in the A&R Warrants), including any obligationsunder the Put Note.

 

On November 30, 2006, MezzCo entered into an IndemnificationAgreement with the Investors, pursuant to which MezzCo agreed to indemnify theInvestors for any losses caused by (i) lack of gaming approvals for theissuance of the A&R Warrants, (ii) lack of gaming approval for thegranting of a lien by EquityCo in the equity interests in MezzCo, as describedin the Pledge Agreement, and (iii) the inability of the Investors toexercise the Warrants until July 1, 2007.

 

***Energy ServicesAgreement***

*** ***

Northwind Aladdin (“Northwind”),a third party, owns and operates a central utility plant on land leased fromOpBiz. The plant supplies hot and cold water and emergency power to the PHResort under an energy service agreement, which expires in 2018. Under theagreement, OpBiz is required to pay Northwind a monthly consumption charge, amonthly operational charge, a monthly debt service payment and a monthly returnon equity payment. Payments under the Northwind agreement total approximately$0.4 million per month.

 

**6.****             MEMBERSHIPINTERESTS**

 

Thenon-voting interests in BH/RE are owned 40.75% by BHCH I, 18.50% by BHCH II and40.75% by OCS and the voting interests are owned 50% by Douglas P. Teitelbaumand 50% by Robert Earl. BHCH is controlled by Mr. Teitelbaum, managingprincipal of Bay Harbour Management, an investment management firm. BHCH wasformed by Mr. Teitelbaum for the purpose of holding investments in BH/REby funds managed by Bay Harbour Management. OCS is wholly-owned and controlledby Mr. Earl and holds Mr. Earl’s investment in BH/RE. Mr. Earlis the founder, chairman and chief executive officer of Planet Hollywood and Mr. Teitelbaumis a director of Planet Hollywood. Collectively, Mr. Earl, a trust for thebenefit of Mr. Earl’s children, and affiliates of Bay Harbour Managementown substantially all of the equity of Planet Hollywood.

 

BH/REowns 85% of the membership interests in EquityCo and Starwood owns 15%. MezzCois a wholly owned subsidiary of EquityCo, and OpBiz is a wholly ownedsubsidiary of MezzCo. BH/RE and Starwood made total equity contributions of $20million each in EquityCo to fund a portion of the costs of the renovation ofthe property. Starwood’s equity interest in EquityCo is reflected as minorityinterest in the accompanying condensed consolidated financial statements. BH/RErecorded minority interest income related to the Starwood interests ofapproximately $2.2 million and $2.7 million for the three months ended June 30,2008 and 2007, respectively, and $4.0 million and $5.4 million for the sixmonths ended June 30, 2008 and 2007, respectively.

 

BH/REhas the option to purchase all of Starwood’s membership interests in EquityCoif OpBiz is entitled to terminate the hotel management contract between OpBizand Sheraton as a result of a breach by Sheraton. Starwood can require EquityCoto purchase all of its membership interests in EquityCo if the hotel managementcontract is terminated for any reason other than in accordance with its termsor as the result of a breach by Sheraton. In addition, BH/RE and Starwoodentered into a registration rights agreement with respect to their membershipinterests in EquityCo.

 

The Company has entered into various employment agreements,as amended, with several executives. The employment agreements have initialterms of two to five years. The employment agreements provide that theexecutives will receive a 

 

15

----

Tableof Contents

 

base salary with either mandatoryincreases or annual adjustments and annual bonus payments. In addition,depending on the terms of the employment agreements, these executives areentitled to options to purchase between 0.2% and 3% of the equity of MezzCo.

 

Effective January 1, 2006, the Company adoptedthe provisions of SFAS No. 123(R) “*Share BasedPayment”* requiring that compensation cost relating to share-basedpayment transactions be recognized in the operating expenses. The cost ismeasured at the grant date, based on the calculated fair value of the award,and is recognized as an expense over the employee’s estimated requisite serviceperiod (generally the vesting period of the equity award) on a straight-linebasis. Estimates are revised if subsequent information indicates thatforfeitures will differ from previous estimates, and the cumulative effect oncompensation cost of a change in the estimated forfeitures is recognized in theperiod of the change. Prior to January 1, 2006, the Company accounted forshare-based compensation to employees in accordance with APB No. 25, andrelated interpretations. The Company also followed the disclosure requirementsof SFAS No. 123 as amended by SFAS No. 148, *“Accountingfor Stock-Based Compensation-Transition and Disclosure.”*

 

There is $0.1 million of compensation cost, whichapproximated fair value, related to non-qualified stock options recognized inoperating results (included in selling, general and administrative expenses)for each of the three and six month periods ended June 30, 2008 and 2007.

 

The fair value of each option award is estimated onthe date of grant using the Black-Scholes-Merton option pricing model. Expectedvolatility is based on historical volatility trends as well as implied futurevolatility observations as determined by independent third parties. Indetermining the expected life of the option grants, the Company used historicaldata to estimate option exercise and employee termination behavior. Theexpected term represents an estimate of the time options are expected to remainoutstanding. The risk-free interest rate for periods within the contractuallife of the option is based on the U.S. treasury yield curve in effect at thetime of grant. The following table sets forth the assumptions used to determinecompensation cost for the Company’s non-qualified stock options consistent withthe requirements of SFAS No. 123(R).

 
|                                                                                                                                                   | ** ** | **Three and Six  Months  Ended  June 30, 2008** | ** ** | **Three and Six  Months  Ended  June 30, 2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                                                                                             | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Weighted-average fair value per share of options granted during the  period (estimated on grant date using Black-Scholes-Merton option-pricing  model) |       | $                                                                   | 235.28     |                                                                | $          | 235.28 |   |
| Weighted-average assumptions:                                                                                                                          |       |                                                                |       |                                                                |       |
| Expected stock price volatility                                                                                                                        |       | 36                                                                  | %          | 36                                                                  | %          |
| Risk-free interest rate                                                                                                                                |       | 3.76                                                                | %          | 3.76                                                                | %          |
| Expected option life (years)                                                                                                                           |       | 7                                                                   |       | 7                                                                   |       |
| Expected annual dividend yield                                                                                                                         |       | —                                                              | %          | —                                                              | %          |
|                                                                                                                                                        |            |                                                                     |            |                                                                     |            |  |  |

 

**7.****                                      RELATEDPARTY TRANSACTIONS**

 

***Planet HollywoodLicensing Agreement***

*** ***

OpBiz, Planet Hollywoodand certain of Planet Hollywood’s subsidiaries have entered into a licensingagreement pursuant to which OpBiz received a non-exclusive, irrevocable licenseto use various “Planet Hollywood” trademarks and service marks. Under thelicensing agreement, OpBiz also has the right, but not the obligation, to opena Planet Hollywood restaurant and one or more Planet Hollywood retail shopsunder a  separate restaurant agreementwith Planet Hollywood. OpBiz pays Planet Hollywood a quarterly licensing fee of1.75% of OpBiz’s non-casino revenues. The initial term of the licensingagreement will expire in 2028. OpBiz can renew the licensing agreement forthree successive 10-year terms. The property officially began operation as thePH Resort on April 17, 2007 and began paying fees pursuant to thelicensing agreement as of that date. Licensing fees paid to Planet Hollywoodtotaled approximately $0.8 million and $1.6 million for the three and sixmonths ended June 30, 2008, respectively, and $0.6 million for the threeand six months ended June 30, 2007.

 

In addition to being amanager of BH/RE, Mr. Earl is the chief executive officer and chairman ofthe board of directors of Planet Hollywood. Similarly, Mr. Teitelbaum is amanager of BH/RE and a director of Planet Hollywood. Together, Mr. Earl, atrust for the benefit of Mr. Earl’s children and affiliates of Bay HarbourManagement, own substantially all of the equity of Planet Hollywood. Mr. Earldisclaims beneficial ownership of any equity of Planet Hollywood owned by thetrust.

 

16

----

***Tableof Contents***

*** ***

***Sheraton HotelManagement Contract***

*** ***

OpBiz and Sheraton haveentered into a management contract pursuant to which Sheraton provides hotelmanagement services to OpBiz, assists OpBiz in the management, operation andpromotion of the Hotel and permits OpBiz to use the Sheraton brand andtrademarks in the promotion of the Hotel. OpBiz pays Sheraton a monthly fee of4% of gross hotel revenue and certain food and beverage outlet revenues and 2%of rental income from third-party leases in the hotel. The management contracthas a 20-year term commencing on the completion of the Aladdin acquisition andis subject to certain termination provisions by either OpBiz or Sheraton.Sheraton is a wholly owned subsidiary of Starwood, which has a 15% equityinterest in EquityCo and has the right to appoint two members to the EquityCo boardof managers. Management fees paid to Starwood totaled approximately $2.6million and $2.5 million for the three months ended June 30, 2008 and2007, respectively, and $5.2 million and $5.1 million for the six months ended June 30,2008 and 2007, respectively.

 

***Planet Hollywood(LV) LLC Lease Agreement***

*** ***

OpBiz and PlanetHollywood (LV) LLC (“Planet Hollywood LV”) have entered into a lease agreementpursuant to which Planet Hollywood LV, as tenant, operates a new concept it hasdeveloped for an upscale 24-hour diner named “Planet Dailies” withinapproximately 11,500 square feet of space located on the premises owned byOpBiz. Planet Hollywood LV pays OpBiz base rent in the amount of $500,000 peryear (subject to annual increase adjustments), in addition to percentage rentof up to 12% based on annual gross sales (to the extent such percentage rentexceeds base rent). The initial term of the lease agreement will expire in2017. Planet Hollywood LV can renew the lease agreement for two successive5-year terms.  The Company believes thatthe provisions of this lease agreement reflect arm’s length market terms andthat it is comparable to other lease agreements OpBiz has entered into withthird-party restaurant operators.  PlanetDailies began operation on April 1, 2007 and began paying rent pursuant tothe lease agreement as of that date. Rent received from Planet Dailies totaledapproximately $0.1 million and $0.2 million for the three and six months ended June 30,2008, and $0.1 million for the three and six months ended June 30, 2007.

 

17

----

Tableof Contents

 

Planet Hollywood LV iswholly owned by, and a subsidiary of, Planet Hollywood International, Inc.Together, Mr. Earl, a trust for the benefit of Mr. Earl’s childrenand affiliates of Bay Harbour Management, own substantially all of the equityof Planet Hollywood International, Inc. Mr. Earl disclaims beneficialownership of any equity of Planet Hollywood International Inc. owned by thetrust.

 

***Earl of Sandwich(Las Vegas), LLC Lease Agreement***

*** ***

OpBiz and Earl ofSandwich (Las Vegas), LLC (“Earl of Sandwich”) have entered into a leaseagreement pursuant to which Earl of Sandwich, as tenant, operates a restaurantnamed “Earl of Sandwich” within approximately 3,030 square feet of spacelocated on the premises owned by OpBiz. Earl of Sandwich pays OpBiz base rentin the amount of $161,600 per year (subject to annual increase adjustments), inaddition to percentage rent of up to 12% based on annual gross sales (to theextent such percentage rent exceeds base rent). The initial term of the leaseagreement will expire in 2017. Earl of Sandwich can renew the lease agreementfor two successive 5-year terms. Earl of Sandwich began operation in September 2007and began paying rent pursuant to the lease agreement as of that date. Rentreceived from Earl of Sandwich totaled approximately $100,000 and $200,000 forthe three and six months ended June 30, 2008. The Company believes thatthe provisions of this lease agreement reflect arm’s length market terms andthat it is comparable to other lease agreements OpBiz has entered into withthird-party restaurant operators.

 

Earl of Sandwich iswholly and indirectly owned by a trust for the benefit of Mr. Earl’schildren. Mr. Earl disclaims beneficial ownership of any equity of Earl ofSandwich owned by the trust.

 

***Guaranty Agreement***

*** ***

In connection with the Loan, the Lender requiredthat Trophy Hunter Investments, Ltd., Bay Harbour 90-1, Ltd. and Bay HarbourMaster Ltd., which are affiliates of Bay Harbour Management, execute anddeliver a certain Guaranty (see Note 5.—Long-Term Debt). In exchange forexecuting the Guaranty, OpBiz and PH Fee Owner agreed to pay Trophy HunterInvestments, Ltd. and Bay Harbour Master Ltd. a fee equal to $1,500,000 peryear. The fee is accrued and only payable once OpBiz achieves certain debtservice coverage ratios defined in the Loan Agreement.

 

***Aircraft Charter Arrangements***

 

In the ordinary course from time to time the Companyutilizes the services of private aircrafts for charter.  The Company currently utilizes severaldifferent third party aircraft management/charter vendors for the provision ofcharter flights depending upon aircraft size, availability and location.  One or more affiliates of BH/RE has placed anowned aircraft in service with one such vendor. From time to time, the Company may utilize the services of this vendorwhich may involve the affiliates’ owned aircraft provided that the rate chargedfor that aircraft shall be at arms length and fair market for similar aircraft.

 

**8.****                                      INCOMETAXES**

 

The condensedconsolidated financial statements include the operations of BH/RE and itsmajority-owned subsidiaries: EquityCo, MezzCo, OpBiz, PH Mezz II, PH Mezz I, PHFee Owner and TSP Owner. BH/RE and EquityCo are limited liability companies andare taxed as partnerships for federal income tax purposes. However, MezzCo haselected to be taxed as a corporation for federal income tax purposes. OpBiz andPH Mezz II,  wholly-owned subsidiaries ofMezzCo, will be treated as divisions of MezzCo for federal income tax purposes,and accordingly, will also be subject to federal income taxes. Additionally, PHMezz I, a wholly-owned subsidiary of PH Mezz II, PH Fee Owner, a wholly ownedsubsidiary of PH Mezz I and TSP Owner, a wholly owned subsidiary of PH FeeOwner will also be subject to federal income taxes.

 

MezzCo, OpBiz, PH MezzII, PH Mezz I, PH Fee Owner and TSP Owner account for income taxes inaccordance with SFAS No. 109, “*Accounting for IncomeTaxes*”. SFAS 109 requires the recognition of deferred income taxassets, net of applicable reserves, related to net operating loss carryforwardsand certain temporary differences. The standard requires recognition of afuture tax benefit to the extent that realization of such benefit is morelikely than not. Otherwise, a valuation allowance is applied.

 

Management believes it ismore likely than not that its net deferred tax asset will not be realized andhas therefore recorded a valuation allowance against this net deferred taxasset.

 

18

----

Table ofContents

 

As of December 31,2007, MezzCo has federal net operating losses of $232.7 million which begin toexpire after 2024. MezzCo has general business credit carryforwards at December 31,2007 of $1.6 million which begin to expire after 2024 and a minimum tax creditcarryforward of $7,000.

 

As discussed in Note 2 tothe Condensed Consolidated Financial Statements, the Company adopted theprovisions of FIN 48 effective January 1, 2007.  Upon the adoption of FIN 48, the Companyreclassified the uncertain tax benefits as required and reclassified a portionof the existing allowance. Accordingly, there has been no adjustment toretained earnings recorded as a result of the FIN 48 reclassifications.The Company had uncertain tax benefits of $2.2 million and $1.8 million as of June 30,2008 and December 31, 2007, respectively.  The Company recognizes penalties and interest as a component of incometax expense.  Management does not expectany penalty assessment associated with our adoption of FIN 48.  The Company is no longer subject to U.S.federal tax examinations by tax authorities for tax years before 2004.

 

**9.****                                      COMMITMENTSAND CONTINGENCIES**

 

###### ***Litigation***

######  

In the normal course of business, the Company is subject tovarious litigation claims and assessments. The Company is not currently a party to any material legal proceedings.

 

***Employment Agreements***

*** ***

The Company has entered into various employment agreements,as amended, with several executives. The employment agreements have initialterms of two to five years. The employment agreements provide that theexecutives will receive a base salary with either mandatory increases or annualadjustments and annual bonus payments. In addition, depending on the terms ofthe employment agreements, these executives are entitled to options to purchasebetween 0.2% and 3% of the equity of MezzCo.

 

19

----

## Table of Contents

 

## **ITEM 2.****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

##  

###### ***Overview of Management’sDiscussion and Analysis of Financial Condition and Results of Operations***

######  

Set forth below is adiscussion of the financial condition and results of operations of BH/RE andits subsidiaries for the periods covered in this report. The discussion ofoperations herein focuses on events and the revenues and expenses during thethree and six months ended June 30, 2008, as compared to the three and sixmonths ended June 30, 2007.

 

The following management’sdiscussion and analysis of financial condition and results of operations shouldbe read in conjunction with the consolidated financial statements and therelated notes to the consolidated financial statements of BH/RE included inBH/RE’s Annual Report on Form 10-K filed with the Securities and ExchangeCommission on March 28, 2008, and the unaudited condensed consolidatedfinancial statements and notes hereto included in Part I, Item 1 of thisreport.

 

###### ***Critical Accounting Policiesand Estimates***

######  

###### *Significant Accounting Policies and Estimates*

######  

Our unaudited condensed consolidated financial statementsare prepared in conformity with U.S. generally accepted accounting principles.Certain policies, including the determination of bad debt reserves, theestimated useful lives assigned to assets, asset impairment, insurance reservesand the calculation of liabilities, require that we apply significant judgmentin defining the appropriate assumptions for calculating financial estimates. Bytheir nature, these judgments are subject to an inherent degree of uncertainty.Our judgments are based on historical experience, terms of existing contracts,observance of trends in the gaming industry and information available fromother outside sources. There can be no assurance that actual results will notdiffer from our estimates. To provide an understanding of the methodology weapply, our significant accounting policies and basis of presentation arediscussed below, as well as, where appropriate, in the notes to the condensedconsolidated financial statements.

 

###### *Propertyand Equipment*

######  

Property and equipmentare stated at cost. Recurring repairs and maintenance costs, including itemsthat are replaced routinely in the casino, hotel and food and beveragedepartments which do not meet our capitalization policy are expensed asincurred. We have established our capital expense policy to be reflective ofour individual ongoing repairs and maintenance programs. Gains or losses ondispositions of property and equipment are included in the determination ofincome. Property and equipment are generally depreciated over the followingestimated useful lives on a straight-line basis:

 

| Buildings                         |   | 40 years       |
|-----------------------------------|--------|----------------|
| Building improvements             |   | 15 to 40 years |
| Furniture, fixtures and equipment |   | 3 to 7 years   |

 

Property and equipmentand other long-lived assets are evaluated for impairment in accordance with theFinancial Accounting Standards Board’s (“FASB”) Statement of FinancialAccounting Standards (“SFAS”) No. 144, “*Accountingfor the Impairment or Disposal of Long-Lived Assets*.” For assets tobe disposed of, the asset to be sold is recognized at the lower of carryingvalue or fair value less costs of disposal. Fair value for assets to bedisposed of is estimated based on comparable asset sales, solicited offers or adiscounted cash flow model.

 

Property and equipmentare reviewed for impairment whenever indicators of impairment exist. If anindicator of impairment exists, the estimated future cash flows of the asset,on an undiscounted basis, are compared to the carrying value of the asset. Ifthe undiscounted cash flows exceed the carrying value, no impairment isindicated. If the undiscounted cash flows do not exceed the carrying value,then impairment is measured based on fair value compared to carrying value,with fair value typically based on a discounted cash flow model.

 

20

----

Tableof Contents

 

*Derivative Instruments andHedging Activities*

 

 Pursuant to the refinancing of the SecuritiesPurchase Agreement and the terms of the Restructuring Agreement (each asdefined in Note 5 to the Condensed Consolidated Financial Statements), theRestructuring Parties agreed to amend the warrants issued by MezzCo to purchase17.5% of the fully diluted equity in MezzCo. The warrants contain a net cashsettlement, and therefore are accounted for in accordance with Emerging IssuesTask Force (“EITF”) 00-19, “*Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock*”. Both SFAS No. 133 *“Accounting for DerivativeInstruments and Hedging Activities”* and EITF 00-19 require thatthe warrants be recognized as liabilities, with changes in fair value affectingnet income.

 

The terms of the LoanAgreement required the Company to enter into an interest rate cap agreement,which expires on November 30, 2008, to manage interest rate risk. TheCompany did not apply cash flow hedge accounting to this instrument. Althoughthis derivative was not afforded cash flow hedge accounting, the Companyretained the instrument as protection against the interest rate risk associatedwith its long-term borrowings. The Company accounts for its derivative activityin accordance with SFAS No. 133 and accordingly, recognizes allderivatives on the balance sheet at fair value with any change in fair valuebeing recorded in interest income or expense in the accompanying consolidatedstatements of operations.

 

###### *RevenueRecognition and Promotional Allowances*

######  

Casino revenues arerecognized as the net win from gaming activities, which is the differencebetween gaming wins and losses. All other revenues are recognized as theservice is provided. Revenues include the retail value of food, beverage,rooms, entertainment and merchandise provided on a complimentary basis tocustomers. Such complimentary amounts are then deducted from revenues aspromotional allowances on our condensed consolidated statements of operations.The estimated departmental costs of providing such promotional allowances areincluded in casino costs and expenses.

 

Hotel revenue recognitioncriteria are generally met at the time of occupancy. Food and beverage revenuerecognition criteria are generally met at the time of service. Deposits forfuture hotel occupancy or food and beverage services are recorded as deferredincome until revenue recognition criteria are met. Cancellation fees for hoteland food and beverage services are recognized upon cancellation by the customeras defined by a written contract entered into with the customer.

 

*Income Taxes*

 

The condensedconsolidated financial statements include the operations of BH/RE and itsmajority-owned subsidiaries: EquityCo, MezzCo, OpBiz, PH Mezz II, PH Mezz I, PHFee Owner and TSP Owner. BH/RE and EquityCo are limited liability companies andare taxed as partnerships for federal income tax purposes. However, MezzCo haselected to be taxed as a corporation for federal income tax purposes. OpBiz andPH Mezz II,  wholly-owned subsidiaries ofMezzCo, will be treated as divisions of MezzCo for federal income tax purposes,and accordingly, will also be subject to federal income taxes. Additionally, PHMezz I, a wholly-owned subsidiary of PH Mezz II, PH Fee Owner, a wholly ownedsubsidiary of PH Mezz I and TSP Owner, a wholly owned subsidiary of PH FeeOwner will also be subject to federal income taxes.

 

MezzCo, OpBiz, PH MezzII, PH Mezz I, PH Fee Owner and TSP Owner account for income taxes inaccordance with SFAS No. 109, “*Accounting for IncomeTaxes*”. SFAS 109 requires the recognition of deferred income taxassets, net of applicable reserves, related to net operating loss carryforwardsand certain temporary differences. The standard requires recognition of afuture tax benefit to the extent that realization of such benefit is morelikely than not. Otherwise, a valuation allowance is applied.

 

In July 2006, theFASB issued FASB Interpretation No. 48 (“FIN 48”) *“Accountingfor Uncertainty in Income Taxes — an interpretation of FASB No. 109”,*to clarify certain aspects of accounting for uncertain tax positions, includingissues related to the recognition and measurement of those tax positions.  FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15,2006.  The Company adopted the provisionsof FIN 48 on January 1, 2007.

 

21

----

Tableof Contents

 

*Membership Interests*

 

As of June 30, 2008, our membership interests had notbeen unitized and our members do not presently intend to unitize thesemembership interests. Accordingly, we have excluded earnings per membershipunit data required pursuant to SFAS No. 128, “*Earnings PerShare,*” because we believe that such disclosures would not bemeaningful to the financial statement presentation.

 

The Company has entered into various employment agreements,as amended, with several executives. The employment agreements have initialterms of two to five years. The employment agreements provide that theexecutives will receive a base salary with either mandatory increases or annualadjustments and annual bonus payments. In addition, depending on the terms ofthe employment agreements, these executives are entitled to options to purchasebetween 0.2% and 3% of the equity of MezzCo.

 

Effective January 1, 2006, the Company adoptedthe provisions of SFAS No. 123(R) requiring that compensation costrelating to share-based payment transactions be recognized in the operatingexpenses. The cost is measured at the grant date, based on the calculated fairvalue of the award, and is recognized as an expense over the employee’sestimated requisite service period (generally the vesting period of the equityaward) on a straight-line basis. Estimates are revised if subsequentinformation indicates that forfeitures will differ from previous estimates, andthe cumulative effect on compensation cost of a change in the estimatedforfeitures is recognized in the period of the change. Prior to January 1,2006, the Company accounted for share-based compensation to employees inaccordance with APB No. 25, and related interpretations. The Company alsofollowed the disclosure requirements of SFAS No. 123 as amended by SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure.”

 

###### *Recently Issued Accounting Pronouncements*

######  

In December 2007, the FASB issued SFAS No. 141 (revised2007), *“Business Combinations.”* SFAS No. 141(revised) establishes principles and requirements for how an acquirerrecognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and noncontrolling interest in the acquireeand the goodwill acquired. The revision is intended to simplify existingguidance and converge rulemaking under U.S. generally accepted accountingprinciples with international accounting rules. This statement appliesprospectively to business combinations where the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008. The adoption of SFAS No. 141 (revised) is not expected to have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

In December 2007, the FASB issued SFAS No. 160, *“Noncontrolling Interest in Consolidated Financial Statements, anamendment of ARB No. 51.”* This statement establishes accountingand reporting standards for ownership interest in subsidiaries held by partiesother than the parent and for the deconsolidation of a subsidiary. It alsoclarifies that a noncontrolling interest in a subsidiary is an ownershipinterest in the consolidated entity that should be reported as equity in theconsolidated financial statements. SFAS No. 160 changes the way theconsolidated statement of operations is presented by requiring consolidated netincome to be reported at amounts that include the amount attributable to boththe parent and the noncontrolling interests. The statement also establishesreporting requirements that provide sufficient disclosures that clearlyidentify and distinguish between the interest of the parent and those of thenoncontrolling owners. This statement is effective for fiscal years beginningon or after December 15, 2008. The adoption of SFAS No. 160 is notexpected to have a material impact on the Company’s financial position, resultsof operations or cash flows.

 

###### In March 2008, the FASB issued SFAS No. 161,*“Disclosures About Derivative Instruments andHedging Activities, an amendment of SFAS No. 133”.* SFAS No. 161is intended to improve financial reporting about derivative instruments andhedging activities by requiring enhanced disclosures to enable investors tobetter understand their effects on an entity’s financial position, financialperformance, and cash flows. This statement is effective for fiscal yearsbeginning after November 15, 2008. SFAS No. 161 is not expected tohave a material impact on the Company’s financial position, results ofoperations or cash flows.

######  

In May 2008, FASB issued Statement No. 162, “*The Hierarchy of Generally Accepted AccountingPrinciples”*  (“SFAS 162”).SFAS 162 identifies the sources of accounting principles and the frameworkfor selecting the principles to be used in the preparation of financial statementsof nongovernmental entities that are presented in conformity with GAAP (theGAAP hierarchy). SFAS 162 is effective 60 days following the SEC’sapproval of the Public Company Accounting Oversight Board amendments to AU Section 411,The Meaning of Present Fairly in Conformity With Generally Accepted 

 

22

----

Table ofContents

 

Accounting Principles. The adoption of SFAS 162 is not expected tohave a material impact on the Company’s financial position, results ofoperations or cash flows.

 

###### ***Results of Operations***

######  

The following tablehighlights the results of operations for the three and six months ended June 30,2008 and 2007, respectively (dollars in thousands, unaudited).

 
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | **Percent** | ** ** | **Six Months Ended June 30,** | ** ** | **Percent** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|-------------|------------|---------------------------------------------------|------------|-------------|------------|
| ** **                         | ** ** | **2008**                                            | ** ** | **2007**    | ** ** | **Change**                                        | ** ** | **2008**    | ** ** | **2007** | ** ** | **Change** | ** ** |
| Net Revenues                       |       | $                                                   | 72,226     |        | $          | 64,832                                            |       | 11.4        | %          | $ | 146,219 |   | $ | 128,421 |   | 13.9 | % |
| Operating Expenses:                |       |                                                |       |        |       |                                              |       |        |       |   |   |   |   |
| Casino                             |       | 18,980                                              |       | 16,473      |       | 15.2                                              | %          | 39,400      |       | 31,894 |   | 23.5 | % |
| Hotel                              |       | 10,764                                              |       | 11,353      |       | (5.2                                              | )%         | 21,330      |       | 22,353 |   | (4.6 | )% |
| Food and Beverage                  |       | 9,614                                               |       | 9,013       |       | 6.7                                               | %          | 18,683      |       | 18,275 |   | 2.2 | % |
| Other                              |       | 765                                                 |       | 311         |       | 146.0                                             | %          | 1,048       |       | 585 |   | 79.1 | % |
| Selling, general and adminstrative |       | 21,038                                              |       | 20,356      |       | 3.4                                               | %          | 40,012      |       | 39,690 |   | 0.8 | % |
| Depreciation and amortization      |       | 9,215                                               |       | 7,507       | ** ** | 22.8                                              | %          | 18,016      |       | 15,891 | ** ** | 13.4 | % |
| Operating (Loss) Income            | ** ** | **$**                                               | **1,850**  | ** **  | **$**      | **(181**                                          | **)**      | (1,122.1    | )%         | **$** | **7,730** | ** ** | **$** | **(267** | **)** | (2,995.1 | )% |

 

23

----

Tableof Contents

 

Net revenues for thethree and six months ended June 30, 2008 increased when compared to thethree and six months ended June 30, 2007. The renovation project wascompleted late 2007 and all public areas and guest rooms were fully operationalat the beginning of 2008. The property was under renovation during the threeand six months ended June 30, 2007 so when comparing the three and sixmonth periods, revenues and operating income have increased in all divisions.

 

The following table highlights the various sourcesof our revenues and expenses for the three and six months ended June 30,2008 and 2007, respectively (dollars in thousands, unaudited).

 
| ** **                                   | ** ** | **Three months ended** | ** ** | ** **  | ** ** | **Six months ended** | ** ** | ** **  | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|-------------|------------|--------------------------------|------------|-------------|------------|
| ** **                                   | ** ** | **June 30,**                | ** ** | **Percent** | ** ** | **June 30,**              | ** ** | **Percent** | ** ** |
| ** **                                   | ** ** | **2008**                         | ** ** | **2007**    | ** ** | **Change**                     | ** ** | **2008**    | ** ** | **2007** | ** ** | **Change** | ** ** |
| Casino revenues                              |       | $                                | 30,965     |        | $          | 26,405                         |       | 17.3        | %          | $ | 63,312 |   | $ | 50,263 |   | 26.0 | % |
| Casino expenses                              |       | 18,980                           |       | 16,473      |       | 15.2                           | %          | 39,400      |       | 31,894 |   | 23.5 | % |
| *Margin*                                     | * *   | *38.7*                           | *%*        | *37.6*      | *%*        | * *                       | * *   | *37.8*      | *%*        | *36.5* | *%* | * * | * * |
| Hotel revenues                               |       | $                                | 30,363     |        | $          | 29,054                         |       | 4.5         | %          | $ | 61,316 |   | $ | 59,912 |   | 2.3 | % |
| Hotel expenses                               |       | 10,764                           |       | 11,353      |       | (5.2                           | )%         | 21,330      |       | 22,353 |   | (4.6 | )% |
| *Margin*                                     | * *   | *64.5*                           | *%*        | *60.9*      | *%*        | * *                       | * *   | *65.2*      | *%*        | *62.7* | *%* | * * | * * |
| Food and beverage revenues                   |       | $                                | 13,781     |        | $          | 12,442                         |       | 10.8        | %          | $ | 28,038 |   | $ | 24,481 |   | 14.5 | % |
| Food and beverage expenses                   |       | 9,614                            |       | 9,013       |       | 6.7                            | %          | 18,683      |       | 18,275 |   | 2.2 | % |
| *Margin*                                     | * *   | *30.2*                           | *%*        | *27.6*      | *%*        | * *                       | * *   | *33.4*      | *%*        | *25.4* | *%* | * * | * * |
| Other revenues                               |       | $                                | 4,071      |        | $          | 1,863                          |       | 118.5       | %          | $ | 7,853 |   | $ | 3,561 |   | 120.5 | % |
| Other expenses                               |       | 765                              |       | 311         |       | 146.0                          | %          | 1,048       |       | 585 |   | 79.1 | % |
| *Margin*                                     | * *   | *81.2*                           | *%*        | *83.3*      | *%*        | * *                       | * *   | *86.7*      | *%*        | *83.6* | *%* | * * | * * |
| Selling, general and administrative expenses |       | $                                | 21,038     |        | $          | 20,356                         |       | 3.4         | %          | $ | 40,012 |   | $ | 39,690 |   | 0.8 | % |
| *% of revenue*                               | * *   | *26.6*                           | *%*        | *29.2*      | *%*        | * *                       | * *   | *24.9*      | *%*        | *28.7* | *%* | * * | * * |

 

*Casino*

 

Casino revenue is derivedprimarily from patrons wagering on slot machines, table games and other gamingactivities. Table games generally include blackjack or twenty one, craps,baccarat and roulette. Other gaming activities include the race and sportsbooks, poker and keno. Casino revenue is defined as the win from gamingactivities, computed as the difference between gaming wins and losses.

 

Casino revenues vary from time-to-time due togeneral economic conditions, competition, popularity of entertainmentofferings, table game hold, slot machine hold and occupancy percentages in theHotel. Casino revenues also vary depending upon the amount of gaming activity,as well as variations in the odds for different games of chance. Casino revenueis recognized at the end of each gaming day.

 

Casino revenues increased 17.3% to $31.0 million forthe three months ended June 30, 2008, as compared to $26.4 million for thethree months ended June 30, 2007. Table games revenue for the three monthsended June 30, 2008 increased by approximately $1.6 million as compared tothe three months ended June 30, 2007. Table drop for the three monthsended June 30, 2008 increased $50.0 million or 45.9% when compared to thesame three month period in the prior year, which is attributable to thecompletion of the renovation project and addition of amenities to attractcasino customers.  Table win percentagefor the three months ended June 30, 2008 was approximately 3.9% lower thanthe same three month period in the prior year. Slot revenue for the threemonths ended June 30, 2008 increased approximately $2.6 million whencompared to the same three month period in the prior year. Slot handle for thethree months ended June 30, 2008 increased $33.1 million or 15.0% whencompared to the same three month period in the prior year. With the renovationproject complete, all entryways to the casino are open and the number of slotson the floor has increased by an average of 158 machines when compared to thequarter ended June 30, 2007. Combined revenues from the race and sports book, poker and keno for thethree months ended June 30, 2008 increased by $0.5 million or 70.3% whencompared to the three month period ended June 30, 2007 primarily due to anincrease in race and sports book revenue driven by the completion of therenovation project.

 

Casino expenses increased 15.2% to $19.0 million forthe three months ended June 30, 2008, as compared to $16.5 million for thethree months ended June 30, 2007. Operating margin increased 1.1% whencomparing the same three month periods. Expenses increased commensurate withthe revenue increases in the casino while operating margins improved over prioryear.

 

24

----

Table ofContents

 

Casino revenues increased 26.0% to $63.3 million forthe six months ended June 30, 2008, as compared to $50.3 million for thesix months ended June 30, 2007. Table games revenue for the six months ended June 30, 2008increased by approximately $5.6 million as compared to the six months ended June 30,2007. Table games drop increased approximately 50.7% for the six month periodended June 30, 2008 when compared to the same six month period in prioryear. Overall table win percentage decreased by 2.7% when compared to the samesix month period in prior year. Slot revenue for the six months ended June 30,2008 increased approximately $7.9 million when compared to the same six monthperiod in prior year. Slot handle increased approximately 26.0% for the sixmonth period ended June 30, 2008 when compared to the same six monthperiod in prior year. The renovation project was complete at the end of 2007and the average number of slot machines on the floor has increased 335 deviceswhen comparing this year to last. Combined revenues from the race and sports book, poker and kenoincreased by $0.6 million or 31.8% when compared to the six month period ended June 30,2007. The increases in casino revenue is attributed to the completion of therenovation project and the improvement of entryways from Las Vegas Boulevardand the mall.  The gaming floor is nowfully operational with a full compliment of amenities.

 

Casino expenses increased 23.5% to $39.4 million forthe six months ended June 30, 2008, as compared to $31.9 million for thesix months ended June 30, 2007. Operating margin increased 1.3% whencomparing the same six month periods.

 

*Hotel*

 

Hotel revenue is derivedfrom rooms and suites rented to guests. “Average daily rate” is an industryspecific term used to define the average amount of revenue per rented room perday. “Occupancy percentage” defines the total percentage of rooms occupied andis computed by dividing the number of rooms occupied by the total number ofrooms available. Hotel revenue is recognized at the time the room is providedto the guest.

 

Hotel revenues of $30.4 million for the three monthsended June 30, 2008 were 4.5% higher than the three months ended June 30,2007. Hotel occupancy decreased 1.5% to 97.0% when compared to the same threemonth period in the prior year. Average daily room rates increased to $141 forthe three months ended June 30, 2008 compared to $130 for the three monthsended June 30, 2007.  The roomrenovation is on-going which is the primary driver of the reduction inoccupancy.

 

Hotel expenses decreased 5.2% to $10.8 million forthe three months ended June 30, 2008, as compared to $11.4 million for thethree months ended June 30, 2007. Operating margin increased 3.6% for thethree month period ended June 30, 2008 when compared to the same threemonth period in the previous year.

 

Hotel revenues of $61.3 million for the six monthsended June 30, 2008, were 2.3% higher than the six months ended June 30,2007. Hotel occupancy percentage was 95.8% for the six months ended June 30,2008, as compared to 98.1% for the six months ended June 30, 2007. Averagedaily room rates increased to $142 for the six months ended June 30, 2008,as compared to $133 for the six months ended June 30, 2007.

 

Hotel expenses decreased 4.6% to $21.3 million forthe six months ended June 30, 2008, as compared to $22.4 million for thesix months ended June 30, 2007. Operating margin increased 2.5 percentagepoints over the same six month period.

 

25

----

Table ofContents

 

*Food and Beverage*

 

Food and beveragerevenues are derived from food and beverage sales in the restaurants, bars,room service, banquets and entertainment outlets. Food and beverage revenue isrecognized at the time the food and/or beverage is provided to the guest.

 

Food and beverage revenues increased 10.8% to $13.8million for the three months ended June 30, 2008, as compared to $12.4million for the three months ended June 30, 2007. Food revenue declined$0.1 million when compared to the same three month period in the previousyear.  The PH Resort operates Starbucks,the buffet, room service, the pool cafe and banquets with all remaining foodoutlets leased to third party operators. Beverage revenue increased $1.3 million when compared to the same threemonth period in the previous year due to the completion of the renovationproject and all beverage outlets being fully operational in 2008.

 

Food and beverage expenses increased 6.7% to $9.6million for the three months ended June 30, 2008, as compared to $9.0million for the three months ended June 30, 2007. Operating marginincreased 2.6% when compared to the same three month period in previous year.The expense increase and operating margin increase is consistent with thetransition from in-house food operations to leased outlets operated by thirdparties.

 

Food and beverage revenues increased 14.5% to $28.0million for the six months ended June 30, 2008, as compared to the $24.5million for the six months ended June 30, 2007.

 

Food and beverage expenses increased 2.2% to $18.7million for the six months ended June 30, 2008, as compared to $18.3million for the six months ended June 30, 2007. Food and beverage marginsincreased 8.0 percentage points in comparing the same six month periods.

 

*Other*

 

Other revenue includestelephone, marketing fees received from Westgate based on sales of timeshareunits and other miscellaneous income and is recognized at the time the goods orservices are provided to the guest.

 

Other revenues increased 118.5% to $4.1 million forthe three months ended June 30, 2008, as compared to $1.9 million for thethree months ended June 30, 2007 and increased 120.5% to $7.9 million forthe six months ended June 30, 2008, as compared to $3.6 million for thesix months ended June 30, 2007. The increase in other revenue is primarilydue to the increase in the amount received from Westgate based on sales oftimeshare units. Westgate pays OpBiz 9% of total timeshare sales on a monthlybasis with 50% of the proceeds recorded as tenant income and the remaining 50%recorded against land receivable.

 

Other expenses increased 146.0% to $.8 million forthe three months ended June 30, 2008, as compared to $0.3 million for thethree months ended June 30, 2007 and increased 79.1% to $1.0 million forthe six months ended June 30, 2008, as compared to $0.6 million for thesix months ended June 30, 2007.

 

*Selling, General and Administrative (“SG&A”)*

 

SG&A expenses increased 3.4% to $21.0 millionfor the three months ended June 30, 2008, as compared to $20.4 million forthe three months ended June 30, 2007. As a percentage of revenue, SG&A expenses decreased to 26.6% for thethree months ended June 30, 2008 as compared to 29.2% for the three monthsended June 30, 2007. SG&A expenses increased 0.8% to $40.0 million forthe six months ended June 30, 2008, as compared to $39.7 million for the sixmonths ended June 30, 2007. SG&A expenses as a percentage of revenuesdecreased 3.8% for the six months ended June 30, 2008. The primary driverof SG&A expenses is marketing which is focused on brand recognition duringour first year of post-renovation operation.

 

26

----

Table of Contents

 

*Depreciation and Amortization*

 

Depreciation and amortization expense of $9.2 million for the threemonths ended June 30, 2008 increased when compared to $7.5 million inexpense for the three months ended June 30, 2007. Depreciation andamortization expense of $18.0 million for the six months ended June 30,2008 increased when compared to $15.9 million in expense for the six monthsended June 30, 2007. The increase in depreciation expense is a directresult of the additional assets placed in service once the renovation wascomplete.

 

*Net Interest Expense*

 

Net interest expense decreased to $16.2 million for the three monthsended June 30, 2008, as compared to $17.7 million for the three monthsended June 30, 2007.  Net interestexpense decreased to $34.1 million for the six months ended June 30, 2008,as compared to $35.4 million for the six months ended June 30, 2007.  The decrease in interest expense is directlyrelated to the reduction in the interest rates.

 

###### ***Liquidity and Capital Resources***

######  

During the six months ended June 30, 2008, weutilized cash flows from operating activities of approximately $4.6 million andhad a balance of $19.6 million in cash and cash equivalents as of June 30,2008. We also had current restricted cash and cash equivalents of approximately$27.6 million and long-term restricted cash and cash equivalents ofapproximately $28.3 million at June 30, 2008. The current restricted cashand cash equivalents are primarily reserve accounts that have been establishedunder the Loan Agreement to guarantee payment of property taxes, insurance andfurniture, fixtures and equipment replacement. Current restricted cash alsoincludes the balance in the cash management account. Under the terms of theLoan Agreement, all cash receipts are deposited into a cash management accountunder Lender control which is used to fund reserves and operating expenses. Thelong-term restricted cash and cash equivalents include funds designated for theremaining costs associated with the renovation of hotel rooms and the interestreserve account which will be released once certain debt service coverageratios are achieved. See “Description of Certain Indebtedness” below.

 

Our primary remaining cash requirements for theremainder of 2008 are expected to include (i)  approximately $5.0 millionfor maintenance capital expenditures or replacement furniture, fixtures andequipment and (ii) up to approximately $25.6 million in interest paymentson our debt.

 

We believe that cash generated from operations andcash held in reserve by the lenders under the Loan Agreement will be adequateto meet the anticipated working capital, capital expenditure and debt serviceobligations of OpBiz for at least the next twelve months of operations.

 

There can be no assurance that we have accuratelyestimated our liquidity needs, or that we will not experience unforeseen eventsthat may materially increase our need for liquidity to fund our operations or capitalexpenditure programs or decrease the amount of cash generated from ouroperations.

 

***Description of CertainIndebtedness***

 

*Loan Agreement*

* *

 On November 30, 2006, OpBizand PH Fee Owner (collectively the “Borrower”) entered into the Loan Agreement(the “Loan Agreement”) with Column Financial, Inc. (the “Lender”) for amortgage loan in the principal amount of up to $820 million. The LoanAgreement provided for an initial disbursement in the amount of$759.7 million and a future funding facility in the amount of up to$60.3 million. On July 17, 2007, the Borrower and the Lender enteredinto an amendment (the “Amendment”) to the Loan Agreement. The Amendmentprovided for the immediate funding to Borrower of the balance of future fundingthat was available under the Loan Agreement and established an additionalfuture funding facility in the amount of up to $40 million (“FutureFunding Tranche B”). Future Funding Tranche B has the same terms asthe Loan Agreement for maturity and extension. The Loan Agreement, as amendedby the Amendment, is referred to as the Loan. The Loan is secured by a deed oftrust on the PH Resort and a pledge, subject to approval by the Nevada gamingauthorities, by MezzCo of its membership interest in OpBiz (as describedbelow).

 

The Loan matures in November 2008 and has three one year extensionoptions subject to payment of a fee and the Borrower’s compliance with therequirements for an extension outlined in the Loan Agreement. As the Companyintends and 

 

27

----

Tableof Contents

 

has theability to extend the maturity of the Loan, it is classified as a non-currentliability as of the latest balance sheet date. Interest on the Loan is payablemonthly and accrues at a rate of LIBOR plus 3.25% with a .25% ticking fee onavailable but un-advanced future funding. Interest on Future FundingTranche B is payable monthly and accrues at a rate of LIBOR plus 7.50% witha 1.50% ticking fee on available but un-advanced funds. The Loan does notrequire amortization during the initial term or, provided certain EBITDAthresholds are met, during the extension periods. The Loan requires that theBorrower establish and maintain certain reserves including a reserve forcompletion of the renovation project, a reserve for projected interestshortfalls, a reserve for payment of property taxes and insurance and a reservefor on-going furniture, fixture and equipment purchases or propertyimprovements. The Loan restricts the Borrower’s ability to spend excess cashflow until certain debt service coverage ratios are met.

 

Using the proceeds from the Loan, all amounts outstanding under theCredit Agreement, dated August 31, 2004, among OpBiz, the lenders namedtherein and The Bank of New York, Asset Solution Division (the “Senior Agent”)were paid in full. Pursuant to the terms of the Credit Agreement, uponrepayment of all amounts due, the warrant to purchase 2.5% of the equity inEquityCo issued to the lenders at the closing of the Credit Agreement becameexercisable. The Company compensated the holders of all unexercised warrants inaccordance with the terms of a letter agreement between the parties and thewarrants were canceled.

 

In order to permit the Lender to foreclose on the Hotel and Casinoseparately and to allow OpBiz to continue to operate the Casino after such aforeclosure (should the Lender choose to do so), title to the real propertycomprising the Hotel and Casino (the “Property”) was transferred from OpBiz toPH Fee Owner. OpBiz and PH Fee Owner then entered into a lease pursuant towhich OpBiz agreed to continue to operate the Hotel in the manner it had beenand to pay monthly rent of approximately $916,000. OpBiz and PH Fee Owner alsoentered into a lease pursuant to which OpBiz agreed to continue to operate theCasino in the manner it had been and to pay monthly rent of approximately$1,160,000.

 

In connection with the Loan, the Lender required that Trophy HunterInvestments, Ltd., Bay Harbour 90-1, Ltd. and Bay HarbourMaster Ltd., which are affiliates of Bay Harbour Management, execute anddeliver a certain Guaranty (as described below). In exchange for Trophy HunterInvestments, Ltd., Bay Harbour 90-1 Ltd. and Bay Harbour Master Ltd.(the “Guarantors”) executing the Guaranty, OpBiz and PH Fee Owner agreed to payto Trophy Hunter Investments, Ltd. and Bay Harbour Master Ltd. a feeequal to $1,500,000 per year. The fee is accrued and only payable once OpBizhits certain debt service coverage ratios defined in the Loan Agreement.

 

In connection with the Loan, the Guarantors entered into a Guaranty,dated November 30, 2006 (the “Guaranty”), pursuant to which the Guarantorsagreed to indemnify the Lender against losses related to certain prohibitedactions of the Borrower and guarantied full repayment of the Loan in the caseof a voluntary or collusive bankruptcy of the Borrower, a transfer of theProperty or interests in the Borrower in violation of the Loan Agreement and ifthe Borrower fails to maintain its status as a bankruptcy remote entity and asa result sees its assets consolidated with those of an affiliate in abankruptcy. The liability of the Guarantors is capped at $15,000,000 per entityand $30,000,000 in the aggregate, however this cap does not apply to (i) liabilityarising from events, acts or circumstances actually committed or brought aboutby the willful acts of any of the Guarantors and (ii) the extent of anybenefit received by any of the Guarantors as a result of the acts giving riseto the liability under the Guaranty. Each of Douglas Teitelbaum and Robert Earlexecuted and delivered guaranties substantially the same as that delivered bythe Guarantors, however the liability of each of them was limited to (i) liabilityarising from events, acts or circumstances actually committed or brought aboutby willful acts by him and (ii) the extent of any benefit received by himas a result of the acts giving rise to the liability under the Guaranty.

 

In connection with the Loan, the Guarantors and Robert Earl executedand delivered a Completion Guaranty, dated November 30, 2006, pursuant towhich they jointly and severally guarantied the completion of the renovation ofthe Property and payment of all costs associated therewith. The liability underthe Completion Guaranty is capped at the greater of (a) $35,000,000 and (b) onlyin the case that cost overruns for the renovation exceed $15,000,000, 24% ofthe then unpaid costs of the completion of the renovation.

 

In addition, in connection with the Loan Agreement, MezzCo effected arefinancing of the Securities Purchase Agreement, dated August 9, 2004,among MezzCo and the Investors (the “Restructuring Parties”), pursuant to whichMezzCo issued to the Investors (i) 16% senior subordinated secured Notesin the original aggregate principal amount of $87 million, and (ii) Warrantsfor the purchase (subject to certain adjustments as provided for therein) ofmembership interests of MezzCo, representing 17.5% of its fully diluted equity.Loan proceeds were used to redeem in full the Notes.

 

In connection with the refinancing of the Securities Purchase Agreementand redemption of the Notes, the Restructuring Parties entered into theRestructuring Agreement, dated November 30, 2006, pursuant to which the 

 

28

----

Tableof Contents

 

RestructuringParties terminated in full the Securities Purchase Agreement, the SubordinationAgreement, dated as of August 31, 2004, among MezzCo, OpBiz, the SeniorAgent and the Investors, the Pledge Agreement, dated August 9, 2006, amongMezzCo and the Collateral Agent, and the Guaranty, dated August 9, 2004,made by OpBiz to the Investors, and amended certain other existing agreements,as described below.

 

In accordance with the terms of the Restructuring Agreement, theInvestors and EquityCo, MezzCo and OpBiz entered into a Release, Consent andWaiver Agreement, pursuant to which the Investors (i) released OpBiz fromits guaranteed obligations, under that certain Guaranty Agreement, dated as of August 9,2004 and executed by OpBiz in favor of the Investors and the Collateral Agent; (ii) releasedMezzCo from its pledge of the collateral, under that certain Pledge Agreement,dated as of August 9, 2004, and executed by MezzCo in favor of theCollateral Agent, the Investors released their security interest, as defined inthat certain Security Agreement, as amended by that certain Amendment to SecurityAgreement, in each case dated as of August 9, 2004 and executed by theCompany in favor of the Collateral Agent; (iii) released and terminatedthe Deed of Trust, dated as of August 9, 2004 and executed by MezzCo infavor of the Trustee (as defined therein) for the benefit of the CollateralAgent; (iv) released and terminated the Investors’ security interest inthe securities account, provided for that certain Securities Account ControlAgreement, dated as of August 9, 2004 and executed by the Company, theCollateral Agent and Wells Fargo Bank, N.A.

 

Additionally, MezzCo, EquityCo, and the Investors entered into anAmended and Restated Investor Rights Agreement, dated November 30, 2006(the “A&R Investor Rights Agreement”), to amend and restate the originalInvestor Rights Agreements among the parties thereto, dated August 9,2004.

 

Pursuant to the Restructuring Agreement, the Restructuring Partiesagreed to amend the Warrants by issuing Amended and Restated Warrants toPurchase Membership Interests of MezzCo (the “A&R Warrants”) to theInvestors upon approval by the Nevada gaming authorities. The A&R Warrantswill be exercisable at any time, subject to the approval of the Nevada gamingauthorities, at a purchase price of $0.01 per unit. Subject to the approval ofthe Nevada gaming authorities, the warrants may be exercised to purchase eithervoting or non-voting membership interests of MezzCo or a combination thereofthrough the expiration date of December 9, 2012. In addition to customaryanti-dilution protections, the number of units representing MezzCo membershipinterests issuable upon exercise of the A&R Warrants may be increased fromtime to time upon the occurrence of certain events as described in the A&RWarrants. Holders of the A&R Warrants and any securities issued uponexercise thereof may require MezzCo to redeem such securities commencing on December 9,2011 at a redemption price based upon a formula set forth in the A&RWarrants. These rights expire upon completion of a public offering by MezzCo orOpBiz.

 

In connection with the Restructuring Agreement, EquityCo entered into aGuaranty Agreement, dated November 30, 2006 (the “Guaranty Agreement”), infavor of the Investors and the Collateral Agent, pursuant to which EquityCo hasguaranteed the obligation of MezzCo to pay the redemption price under theA&R Warrants prior to expiration and any indebtedness arising under the PutNote (as defined in the A&R Warrants).

 

EquityCo and the Collateral Agent also entered into a Pledge Agreement,dated November 30, 2006 (the “Pledge Agreement”), pursuant to whichEquityCo has, subject to approval of the Nevada gaming authorities, pledged andgranted a first priority security interest to the Collateral Agent for theratable benefit of the Investors in the membership interests of EquityCo inMezzCo. The Pledge Agreement, once approved, will secure the full payment ofthe Put Right (as defined in the A&R Warrants), including any obligationsunder the Put Note.

 

On November 30, 2006, MezzCo entered into an IndemnificationAgreement with the Investors, pursuant to which MezzCo agreed to indemnify theInvestors for any losses caused by (i) lack of gaming approvals for theissuance of the A&R Warrants, (ii) lack of gaming approval for thegranting of a lien by EquityCo in the equity interests in MezzCo, as describedin the Pledge Agreement, and (iii) the inability of the Investors toexercise the Warrants until July 1, 2007.

 

*Energy Services Agreement*

 

Northwind owns and operates a central utility plant onland leased from us. The plant supplies hot and cold water and emergency powerto the PH Resort under an energy service agreement, which expires in 2018.Under the agreement, we are required to pay Northwind a monthly consumptioncharge, a monthly operational charge, a monthly debt service payment and amonthly return on equity payment. Payments under the Northwind agreement totalapproximately $400,000 per month.

 

29

----

Tableof Contents

 

***Forward Looking Statements***

 

This quarterly report on Form 10-Q contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. When used in this report and elsewhere by management from time totime, the words “believe”, “anticipate”, “expect”, “intend”, “estimate”, “plan”,“may”, “seek”, “will”, and similar expressions are intended to identify forward-lookingstatements with respect to our financial condition, results of operations andour business including our planned and possible expansion plans, legalproceedings and employee matters. Certain important factors, including but notlimited to, competition from other gaming operations, factors affecting ourability to complete acquisitions and dispositions of gaming properties,leverage, construction risks, the inherent uncertainty and costs associatedwith litigation and governmental and regulatory investigations, and licensingand other regulatory risks, could cause our actual results to differ materiallyfrom those expressed in or implied by our forward-looking statements. Furtherinformation on potential factors which could affect our financial condition,results of operations and business including, without limitation, theexpansion, development and acquisition projects, legal proceedings and employeematters are included in “Item 1A—Risk Factors” of BH/RE’s Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 28, 2008.Readers are cautioned not to place undue reliance on any forward-lookingstatements, which speak only as of the date thereof. We undertake no obligationto publicly release any revisions to such forward-looking statements to reflectevents or circumstances after the date hereof.

 

## **ITEM 3.****QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

##  

Market risk is the risk of loss arising from adversechanges in market rates and prices, such as interest rates, foreign currencyexchange rates and commodity prices. Our primary exposure to market risk isinterest rate risk associated with our long-term debt. We pay interest on theamount outstanding under the Loan Agreement monthly, in cash, at the London Inter-BankOffered Rate, or LIBOR, plus 3.25% with a .25% ticking fee on available butun-advanced Future Funding. Interest on Future Funding Tranche B is payablemonthly, in cash, at LIBOR plus 7.50% with a 1.50% ticking fee on available butun-advanced funds.  An increase of onepercentage point in the average interest rate applicable to the variable ratedebt outstanding at June 30, 2008 would increase the annual interest costby approximately $8.6 million.

 

## **ITEM 4T.****CONTROLS ANDPROCEDURES**

##  

Our management, with theparticipation of our principal executive and principal financial officers,evaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)), as of June 30,2008. Based on their evaluation, our principal executive and principalfinancial officers concluded that our disclosure controls and procedures wereeffective as of June 30, 2008.

 

There has been no change in our internal control over financialreporting (as defined in Rules 13a-15(f) and 15-d-15(f) underthe Exchange Act) that occurred during our fiscal quarter ended June 30,2008, that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

30

----

# Table of Contents

 

# **PART II  — OTHER INFORMATION**

#  

## **ITEM 6.****EXHIBITS**

 
| 31.1   |   | Certification pursuant  to §302 of the Sarbanes-Oxley Act of 2002, Michael V. Mecca. |
|--------|--------|-------------------------------------------------------------------------------------------|
|   |   |                                                                                      |
| 31.2   |   | Certification pursuant  to §302 of the Sarbanes-Oxley Act of 2002, Donna Lehmann.    |
|   |   |                                                                                      |
| 32.1   |   | Certification pursuant  to §906 of the Sarbanes-Oxley Act of 2002, Michael V. Mecca. |
|   |   |                                                                                      |
| 32.2   |   | Certification pursuant  to §906 of the Sarbanes-Oxley Act of 2002, Donna Lehmann.    |

 

31

----

Tableof Contents

 

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                      |   | BH/RE, L.L.C. |
|----------------------|--------|---------------|
|                 |   |          |
|                 |   |          |
| August 14, 2008 |   | By:           |  /S/ Donna Lehmann |
|                 |   |          | Donna Lehmann |
|                 |   |          | Treasurer and Chief  Financial Officer |

 

32

----

Tableof Contents

 

**EXHIBIT INDEX**

 
| Exhibit No. | ** ** | **Description**                                                                           |
|------------------|------------|-------------------------------------------------------------------------------------------|
| 31.1             |       | Certification pursuant  to §302 of the Sarbanes-Oxley Act of 2002, Michael V. Mecca. |
|             |       |                                                                                      |
| 31.2             |       | Certification pursuant  to §302 of the Sarbanes-Oxley Act of 2002, Donna Lehmann.    |
|             |       |                                                                                      |
| 32.1             |       | Certification pursuant  to §906 of the Sarbanes-Oxley Act of 2002, Michael V. Mecca. |
|             |       |                                                                                      |
| 32.2             |       | Certification pursuant  to §906 of the Sarbanes-Oxley Act of 2002, Donna Lehmann.    |

 

33

----