**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
|           |   |   |
| ý         | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **For the quarterly period ended  March 31, 2006** |
|           |   |   |
| ** **     | ** ** | **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**

 

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

(Exact Name of Registrant as Specified in itsCharter)

 

| **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’s Telephone Number, IncludingArea Code)

 

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Indicateby check mark whether the Registrant (1) has filed all reports required bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.   Yes ý   No o

 

Indicateby check mark whether the Registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. (See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Securities Exchange Act of1934).   (Check one):
| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer  ý |
|---------------------------|--------|---------------------|--------|------------------------------------|

 

Indicateby check mark whether the Registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes o No ý

 

 

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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 4.    | CONTROLS AND PROCEDURES |   |
|                                    |       |   |   |
| PART II  — OTHER INFORMATION: |       |
|                                    |       |   |   |
|                                    | ITEM 6.    | EXHIBITS |   |
|                                    |       |   |   |
|                                    | SIGNATURES |   |

 

2

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**PART I -FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

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

**CONSOLIDATEDBALANCE SHEETS**

**(amounts inthousands)**

 
| ** **                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                            | ** ** | **2006**      | ** ** | **2005**         | ** ** |
| ASSETS                                                |       |          |       |             |       |
| Current assets:                                       |       |          |       |             |       |
| Cash and cash equivalents                             |       | $             | 47,475     |             | $          | 41,419 |   |
| Receivables, net                                      |       | 16,969        |       | 19,793           |       |
| Inventories                                           |       | 1,822         |       | 2,165            |       |
| Prepaid expenses                                      |       | 5,144         |       | 4,913            |       |
| Deposits and other current assets                     |       | 2,105         |       | 3,058            |       |
| Total current assets                                  |       | 73,515        |       | 71,348           |       |
|                                                  |       |          |       |             |       |
| Property and equipment, net                           |       | 487,543       |       | 485,746          |       |
| Restricted cash and cash equivalents                  |       | 81,682        |       | 87,787           |       |
| Other assets, net                                     |       | 8,824         |       | 9,614            |       |
| Total assets                                          |       | $             | 651,564    |             | $          | 654,495 |   |
|                                                  |       |          |       |             |       |
| LIABILITIES  AND MEMBERS’ EQUITY (DEFICIT)       |       |          |       |             |       |
|                                                  |       |          |       |             |       |
| Current liabilities:                                  |       |          |       |             |       |
| Current portion of long-term debt                     |       | $             | 3,962      |             | $          | 2,671 |   |
| Accounts payable                                      |       | 2,993         |       | 3,359            |       |
| Accrued payroll and related                           |       | 11,158        |       | 13,373           |       |
| Accrued interest payable                              |       | 8,172         |       | 6,896            |       |
| Accrued taxes                                         |       | 3,127         |       | 2,994            |       |
| Accrued expenses                                      |       | 5,317         |       | 6,183            |       |
| Deposits                                              |       | 5,030         |       | 4,563            |       |
| Other current liabilities                             |       | 6,016         |       | 6,159            |       |
| Due to affiliates                                     |       | 2,023         |       | 1,591            |       |
| Total current liabilities                             |       | 47,798        |       | 47,789           |       |
|                                                  |       |          |       |             |       |
| Long-term debt, less current portion                  |       | 608,371       |       | 604,877          |       |
| Other long-term liabilities                           |       | 4,224         |       | 4,229            |       |
| Total liabilities                                     |       | 660,393       |       | 656,895          |       |
|                                                  |       |          |       |             |       |
| Commitments and contingencies                         |       |          |       |             |       |
|                                                  |       |          |       |             |       |
| Minority interest                                     |       | 12,892        |       | 13,863           |       |
|                                                  |       |          |       |             |       |
| Members’ equity (deficit):                       |       |          |       |             |       |
| Member’s equity                                  |       | 21,500        |       | 21,500           |       |
| Accumulated deficit                                   |       | (43,221       | )          | (37,763          | )          |
| Total members’ equity (deficit)                  |       | (21,721       | )          | (16,263          | )          |
| Total liabilities and members’ equity  (deficit) |       | $             | 651,564    |             | $          | 654,495 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(amounts inthousands)**

 
| ** **                          | ** ** | **Three Months****Ended** | ** ** | **Three Months****Ended** | ** ** |
|-------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                          | ** ** | **March 31, 2006**        | ** ** | **March 31, 2005**        | ** ** |
|                                |       |                      |       |                      |       |
| Operating revenues:                 |       |                      |       |                      |       |
| Casino                              |       | $                         | 29,825     |                      | $          | 32,913 |   |
| Hotel                               |       | 29,194                    |       | 29,237                    |       |
| Food and beverage                   |       | 16,651                    |       | 19,319                    |       |
| Other                               |       | 4,144                     |       | 4,393                     |       |
| Gross revenues                      |       | 79,814                    |       | 85,862                    |       |
| Promotional allowances              |       | (6,333                    | )          | (6,643                    | )          |
| Net revenues                        |       | 73,481                    |       | 79,219                    |       |
|                                |       |                      |       |                      |       |
| Operating costs and expenses:       |       |                      |       |                      |       |
| Casino                              |       | 17,887                    |       | 17,458                    |       |
| Hotel                               |       | 9,915                     |       | 9,056                     |       |
| Food and beverage                   |       | 11,806                    |       | 12,939                    |       |
| Other                               |       | 2,324                     |       | 2,342                     |       |
| Selling, general and administrative |       | 17,645                    |       | 17,500                    |       |
| Depreciation and amortization       |       | 5,691                     |       | 5,870                     |       |
|                                |       | 65,268                    |       | 65,165                    |       |
|                                |       |                      |       |                      |       |
| Operating income (loss)             |       | 8,213                     |       | 14,054                    |       |
|                                |       |                      |       |                      |       |
| Other income (expense):             |       |                      |       |                      |       |
| Interest expense, net               |       | (14,646                   | )          | (13,635                   | )          |
| Minority interest in income (loss)  |       | 971                       |       | (63                       | )          |
| Loss on warrant valuation           |       | 4                         |       | —                    |       |
|                                |       | (13,671                   | )          | (13,698                   | )          |
|                                |       |                      |       |                      |       |
| Pre-tax income (loss)               |       | (5,458                    | )          | 356                       |       |
| Provision for income taxes          |       | —                    |       | —                    |       |
| Net income (loss)                   |       | $                         | (5,458     | )                         | $          | 356 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

4

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(amounts inthousands)**

 
| ** **                                                                                | ** ** | **Three Months****Ended** | ** ** | **Three Months****Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                | ** ** | **March 31, 2006**        | ** ** | **March 31, 2005**        | ** ** |
|                                                                                      |       |                      |       |                      |       |
| Cash flows from operating activities:                                                     |       |                      |       |                      |       |
| Net income (loss)                                                                         |       | $                         | (5,458     | )                         | $          | 356 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                      |       |                      |       |
| Depreciation and amortization                                                             |       | 5,691                     |       | 5,870                     |       |
| Amortization of debt discount and issuance  costs                                         |       | 1,695                     |       | 1,727                     |       |
| Minority interest in income (loss)                                                        |       | (971                      | )          | 63                        |       |
| Change in value of warrants                                                               |       | 102                       |       | (168                      | )          |
| Changes in assets and liabilities:                                                        |       |                      |       |                      |       |
| Receivables, net                                                                          |       | 2,824                     |       | (1,613                    | )          |
| Inventories and prepaid expenses                                                          |       | 112                       |       | 79                        |       |
| Other assets                                                                              |       | 1,097                     |       | (174                      | )          |
| Accounts payable                                                                          |       | (365                      | )          | 188                       |       |
| Accrued expenses and other current  liabilities                                           |       | (916                      | )          | 5,900                     |       |
| Net cash provided by operating activities                                                 |       | 3,811                     |       | 12,228                    |       |
| Cash flows from investing activities:                                                     |       |                      |       |                      |       |
| Purchases of property and equipment                                                       |       | (7,213                    | )          | (2,013                    | )          |
| Restricted cash and cash equivalents                                                      |       | 6,105                     |       | 1,657                     |       |
| Net cash used in investing activities                                                     |       | (1,108                    | )          | (356                      | )          |
| Cash flows from financing activities:                                                     |       |                      |       |                      |       |
| Payable-in-kind interest added to debt  principal                                         |       | 4,084                     |       | —                    |       |
| Payments under CUP financing                                                              |       | (337                      | )          | (403                      | )          |
| Payments under bank facility                                                              |       | (394                      | )          | —                    |       |
| Net cash provided by (used in) financing  activities                                      |       | 3,353                     |       | (403                      | )          |
| Cash and cash equivalents:                                                                |       |                      |       |                      |       |
| Increase in cash and cash equivalents                                                     |       | 6,056                     |       | 11,469                    |       |
| Balance, beginning of period                                                              |       | 41,419                    |       | 37,016                    |       |
| Balance, end of period                                                                    |       | $                         | 47,475     |                      | $          | 48,485 |   |
|                                                                                      |       |                      |       |                      |       |
| Supplemental cash flow disclosures:                                                       |       |                      |       |                      |       |
| Cash paid for interest                                                                    |       | $                         | 7,907      |                      | $          | 7,448 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

5

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

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

** **

##### **1.**             ORGANIZATIONAND BASIS OF PRESENTATION

##### ** **

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

###### *** ***

BH/RE,L.L.C. (“BH/RE” or “the Company”) is a holding company that owns 85% ofEquityCo, L.L.C. (“EquityCo”). The remaining 15% of EquityCo is owned by asubsidiary of Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”).MezzCo, L.L.C. (“MezzCo”) is a wholly owned subsidiary of EquityCo, and OpBiz,L.L.C. (“OpBiz”) is a wholly owned subsidiary of MezzCo. 50% of BH/RE’s voting membershipinterests are held by each of Robert Earl and Douglas P. Teitelbaum, and BH/RE’s equitymembership interests are held 40.75% by BH Casino and Hospitality LLC I (“BHCHI”), 18.50% by BH Casino and Hospitality LLC II (“BHCH II”) (collectively “BHCH”)and 40.75% by OCS Consultants, Inc. (“OCS”).

 

BH/RE andits subsidiaries were formed to acquire, operate and renovate the AladdinResort and Casino (the “Aladdin”) located in Las Vegas, Nevada. OpBiz,an indirect subsidiary of BH/RE, completed the acquisition of the Aladdin onSeptember 1, 2004 and has begun a renovation project which, when complete,will transform the Aladdin into the Planet Hollywood Resort and Casino (the “PHResort”). In connection with the renovation of the Aladdin, OpBiz has enteredinto an agreement with Planet Hollywood International, Inc. (“PlanetHollywood”) and certain of its subsidiaries to, among other things, licensePlanet Hollywood’s trademarks, memorabilia and other intellectual property.OpBiz has also 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 Nevadalimited liability company and was organized on March 31, 2003. BH/RE wasformed by BHCH and OCS. BHCH is controlled by Douglas P. Teitelbaum, a managingprincipal of Bay Harbour Management, L.C. (“Bay Harbour Management”). BHCH was formed byMr. Teitelbaum for the purpose of holding investments in BH/RE by fundsmanaged by Bay Harbour Management. Bay Harbour Management is an investmentmanagement firm. OCS is wholly owned and controlled by Robert Earl and holdsMr. Earl’s investment in BH/RE. Mr. Earl is the founder, chairman andchief executive officer of Planet Hollywood and Mr. Teitelbaum is adirector of Planet Hollywood. Collectively, Mr. Earl, a trust for thebenefit of Mr. Earl’s children and affiliates of Bay Harbour Management,own substantially all of the equity of Planet Hollywood. Mr. Earldisclaims beneficial ownership of any equity of Planet Hollywood owned by thetrust.

 

***Acquisition of theAladdin***

*** ***

Aladdin Gaming, L.L.C. (“Aladdin Gaming”), which was adebtor-in-possession under Chapter 11 of the United States Bankruptcy Code,commenced its bankruptcy case in the United States Bankruptcy Court for theDistrict of Nevada, Southern Division on September 28, 2001. OnApril 23, 2003, OpBiz and Aladdin Gaming entered into a purchase agreementpursuant to which OpBiz agreed to acquire the Aladdin. Under the purchaseagreement and pursuant to an order of the Bankruptcy Court, Aladdin Gamingconducted an auction to sell the Aladdin. On June 20, 2003, the BankruptcyCourt declared OpBiz the winner of that auction and, on August 29, 2003,the Bankruptcy Court entered an order confirming Aladdin Gaming’s plan ofreorganization and authorizing Aladdin Gaming to complete the sale of theAladdin to OpBiz under the purchase agreement. On September 1, 2004, OpBizacquired substantially all of the real and personal property owned or used byAladdin Gaming to operate the Aladdin, and received $15 million of workingcapital from Aladdin Gaming, including $25.7 million of cash. The acquisitionwas accounted for as a purchase and, accordingly, the purchase price andworking capital adjustments have been allocated to the underlying assetsacquired and liabilities assumed. The working capital adjustment was determinedbased on the closing balance sheet on August 31, 2004. OpBiz paid thepurchase price for the Aladdin by issuing new secured notes to Aladdin Gaming’ssecured creditors and assumed various contracts and leases entered into byAladdin Gaming in connection with its operation of the Aladdin and certain of AladdinGaming’s liabilities, including Aladdin Gaming’s energy service obligation tothe third party owner of the central utility plant that supplies hot and cold waterand emergency power to the Aladdin. At the time of purchase, the energy serviceobligation was $34.0 million. Upon the completion of the Aladdin acquisition,OpBiz issued $510 million of new secured notes to Aladdin Gaming’s securedcreditors under an Amended and Restated Loan and Facilities Agreement (the “CreditAgreement”) with a group of lenders and The Bank of New York, Asset SolutionsDivision, as administrative and collateral agent. OpBiz also simultaneouslymade a $14 million cash payment to those secured creditors, which reduced theprincipal amount of the notes to $496 million and obtained a release of thelien on a four-acre parcel of undeveloped property that OpBiz also acquiredfrom Aladdin Gaming (the “Timeshare Land”). On December 10, 2004, OpBizentered into a Timeshare Purchase Agreement with Westgate Resorts, LTD. (“Westgate”),whereby OpBiz agreed to sell approximately four acres of the Timeshare Land toWestgate, who plans to develop, market, manage and sell timeshare units on theland. The Credit Agreement also requires that OpBiz provide either cash or aletter of credit in the aggregate amount of $90 million to fund the costs ofthe planned renovations to the Aladdin. In August 2004, MezzCo issued $87million of senior secured notes to a group of purchasers. The net proceeds ofthis financing were used to make the $14 million payment described above, topay certain costs and expenses of BH/RE and its subsidiaries and affiliatesrelated to the acquisition of the Aladdin, and to provide OpBiz with a

 

6

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portion of the funds necessary to meet its obligationsregarding the planned renovations to the Aladdin.

 

The purchase agreement also provided that OpBiz assumesubstantially all of Aladdin Gaming’s pre-petition contracts and leases and anypost-petition contracts or leases to which OpBiz does not object. In addition,the purchase agreement provided that OpBiz offer employment to all of AladdinGaming’s employees, other than executive management, on terms and conditionssubstantially similar to their previous employment terms and conditions.

 

###### ***Plan of Operations***

###### *** ***

OpBiz iscurrently conducting a renovation project which, when complete, will transformthe Aladdin into the PH Resort. In connection with the renovation of theAladdin, OpBiz has entered into an agreement with Planet Hollywood and certainof its subsidiaries to, among other things, license Planet Hollywood’strademarks, memorabilia and other intellectual property. OpBiz has also enteredinto an agreement with Sheraton, a subsidiary of Starwood, pursuant to whichSheraton provides hotel management, marketing and reservation services for theHotel that comprises a portion of the PH Resort.

 

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

###### *** ***

The accompanying condensed consolidated financialstatements included herein have been prepared by the management of BH/RE,without audit, pursuant to the rules and regulations of the Securities andExchange Commission. Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with U.S. generally acceptedaccounting principles have been condensed or omitted pursuant to suchrules and regulations. BH/RE believes that the disclosures are adequate tomake the information presented not misleading. In the opinion of management,all adjustments (which include normal recurring adjustments) necessary for afair presentation of the results for the interim periods have been made. Theresults for the three months ended March 31, 2006, are not indicative ofresults to be expected for the full fiscal year. These unaudited financialstatements should be read in conjunction with the audited financial statementsand notes thereto for the year ended December 31, 2005, included in BH/RE’sAnnual Report on Form 10-K filed with the Securities and ExchangeCommission on March 31, 2006.

 

##### **2.**             SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

##### ** **

###### ***SignificantAccounting Policies and Estimates***

###### *** ***

Thecondensed consolidated financial statements are prepared in conformity withU.S. generally accepted accounting principles. Certain policies, including thedetermination of bad debt reserves, the estimated useful lives assigned toassets, asset impairment, insurance reserves and the calculation ofliabilities, require that management apply significant judgment in defining theappropriate assumptions for calculating financial estimates. By their nature,these judgments are subject to an inherent degree of uncertainty. Management’sjudgments 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 methodologymanagement applies, BH/RE’s significant accounting policies and basis of presentationare discussed below, as well as in the management’s discussion and analysis.

 

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

###### *** ***

Cash andcash equivalents include cash on hand, as well as short-term investments withoriginal maturities not in excess of 90 days.

 

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

###### *** ***

Restrictedcash and cash equivalents consist of approximately $81.7 million and $87.8million as of March 31, 2006 and December 31, 2005, respectively, themajority of which will be applied toward the remaining cash commitments for theplanned renovations to the Aladdin.

 

###### ***Accounts Receivable***

###### *** ***

Accountsreceivable, including casino and hotel receivables, are typically non-interestbearing and are initially recorded at cost. An estimated allowance for doubtfulaccounts is maintained to reduce the receivables to their carrying amount,which approximates fair value. BH/RE estimates the allowance for doubtfulaccounts by applying standard reserve percentages to aged account balancesunder a specific dollar amount and specifically analyzes the collectibility ofeach account with a balance over the specified dollar amount, based on the ageof the account, the customer’s financial condition, collection history and anyother known information.

 

7

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###### ***Inventories***

###### *** ***

Inventoriesconsist of food and beverage, retail merchandise and operating supplies, andare stated at the lower of cost or market. Cost is determined by the first-in,first-out and specific identification methods.

 

###### ***Property and Equipment***

###### *** ***

Property and equipment are stated at cost. Recurringrepairs and maintenance costs, including items that are replaced routinely inthe casino, hotel and food and beverage departments which do not meet theCompany’s capitalization policy of $10,000, are expensed as incurred. TheCompany has established its capital expense policy to be reflective of itsindividual 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 equipment and other long-lived assets areevaluated for impairment in accordance with the Financial Accounting StandardsBoard’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”)No. 144, “*Accounting for the Impairment or Disposal ofLong-Lived Assets*.” For assets to be disposed of, the asset to besold is recognized at the lower of carrying value or fair value less costs ofdisposal. Fair value for assets to be disposed of is estimated based oncomparable asset sales, solicited offers or a discounted cash flow model.

 

Property and equipment are reviewed for impairmentwhenever indicators of impairment exist. If an indicator of impairment exists,the estimated future cash flows of the asset, on an undiscounted basis, arecompared to the carrying value of the asset. If the undiscounted cash flowsexceed the carrying value, no impairment is indicated. If the undiscounted cashflows do not exceed the carrying value, then impairment is measured based onfair value compared to carrying value, with fair value typically based on adiscounted cash flow model.

 

The property and equipment and other long-lived assetsthat BH/RE obtained in the acquisition of the Aladdin were appraised by anindependent third party. Property and equipment and the related accumulateddepreciation amounts, as well as certain intangible assets recorded in theCompany’s condensed consolidated balance sheets as of March 31, 2006 andDecember 31, 2005, are based on the independent third party appraisal.

 

*DebtIssuance Costs*

 

Debt issuance costs incurred in connection with theissuance of long-term debt are capitalized and amortized to interest expenseover the expected terms of the related debt agreements using the effectiveinterest method and are included in other assets on BH/RE’s consolidatedbalance sheets. Debt issuance costs, net of the related amortization,approximated $6.7 million and $7.0 million as of March 31, 2006 andDecember 31, 2005, respectively.

 

*Intangible Assets*

 

In connection with the purchase of the Aladdin and asa result of an independent appraisal of the assets purchased, BH/RE recordedintangible assets, which consist of a customer list and trade name. Thecustomer list was valued at approximately $2.7 million at the time of purchaseand at March 31, 2006, had a net book value of approximately $1.6 million. Thetrade name was valued at approximately $1.0 million at the time of purchase andwas fully amortized at March 31, 2006. The customer list is being amortizedusing the straight-line method over a useful life of 4 years.

 

*Derivative Instruments and Hedging Activities*

 

 As further consideration to the lenders underthe Credit Agreement, BH/RE has issued warrants to purchase membershipinterests held by BH/RE in EquityCo. BH/RE accounts for the outstandingwarrants in EquityCo as embedded derivative instruments in accordance with SFASNo. 133, “*Accounting for Derivative Instruments andHedging Activities,*” and SFAS No. 138, *“Accountingfor Certain Derivative Instruments and Hedging Activities—an Amendment of FASBStatement No. 133*.*”*

 

Inconjunction with the Mezzanine Financing, MezzCo issued warrants to purchasemembership interests in the fully diluted equity of MezzCo which contain a netcash settlement, 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 and EITF 00-19 require that thewarrants be recognized as liabilities, with changes in fair value affecting netincome.

 

8

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###### ***Revenue Recognition and PromotionalAllowances***

###### *** ***

Casino revenues are recognized as the net win fromgaming activities, which is the difference between gaming wins and losses. Hotelrevenue recognition criteria are generally met at the time of occupancy. Foodand beverage revenue recognition criteria are generally met at the time ofservice. Deposits for future hotel occupancy or food and beverage services arerecorded as deferred income until revenue recognition criteria are met.Cancellation fees for hotel and food and beverage services are recognized uponcancellation by the customer as defined by a written contract entered into withthe customer. All other revenues are recognized as the service is provided.Revenues include the retail value of food, beverage, rooms, entertainment andmerchandise provided on a complimentary basis to customers. Such complimentaryamounts are then deducted from revenues as promotional allowances on BH/RE’sconsolidated statements of operations. The estimated departmental costs ofproviding such promotional allowances are included in casino costs and expensesand consist of the following (amounts in thousands).:

 
| ** **                           | ** ** | **Three Months  Ended  March 31,** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2006**                           | ** ** | **2005** | ** ** |
| Rooms                                |       | $                                  | 982        |   | $ | 857 |   |
| Food and Beverage                    |       | 2,525                              |       | 2,463 |   |
| Other                                |       | 337                                |       | 186 |   |
| Total cost of promotional allowances |       | $                                  | 3,844      |   | $ | 3,506 |   |

 

###### ***Slot Club Program***

###### *** ***

The Aladdin’s slot club members earn points based ongaming activity, which can be redeemed for cash. A liability is recorded forthe estimated cost of the outstanding points accrued under the slot clubprogram. The accrued slot club point liability was approximately $1.4 millionand $1.7 million as of March 31, 2006 and December 31, 2005, respectively.

 

*Advertising Costs*

 

Advertisingcosts are expensed as incurred and included in selling, general andadministrative costs and expenses. Advertising costs totaled approximately $1.2million and $1.0 million for the three months ended March 31, 2006 and 2005, respectively.

 

*Income Taxes*

 

The condensed consolidated financial statementsinclude the operations of BH/RE and its controlled subsidiaries: EquityCo,MezzCo, and OpBiz. BH/RE and EquityCo are limited liability companies and aretaxed as partnerships for federal income tax purposes. MezzCo has elected to betaxed as a corporation for federal income tax purposes. OpBiz, a wholly ownedsubsidiary of MezzCo, will be treated as a division of MezzCo for federalincome tax purposes, and accordingly, will also be subject to federal incometaxes.

 

MezzCo and OpBiz 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 futuretax benefits to the extent that realization of such benefits are more likelythan not. Otherwise, a valuation allowance is applied.

 

###### ***Membership Interests***

###### *** ***

As of March31, 2006, BH/RE’s membership interests had not been unitized and BH/RE’smembers do not presently intend to unitize these membership interests.Accordingly, management of BH/RE has excluded earnings per share data requiredpursuant to SFAS No. 128, “*Earnings Per Share,*”because management believes that such disclosures would not be meaningful tothe 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 entitiled to options topurchase between 0.2% and 5% of the equity of MezzCo.

 

9

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***Recently issued accounting pronouncements***

 

*SFAS No.123(R)*

 

On December 16,2004, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFASNo. 123(R)”), which is a revision to SFAS No. 123, “Accounting for Stock-BasedCompensation.”  SFAS No. 123(R)supersedes Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB No. 25”) and amends SFAS No. 95, “Statement of CashFlows.”  Among other items, SFAS No.123(R) requires the recognition of compensation expense in an amount equal tothe fair value of share-based payments, including employee stock options andrestricted stock, granted to employees.

 

The Companyadopted SFAS No. 123(R) on January 1, 2006 using the “modified prospective”method, in which compensation cost is recognized beginning with the effectivedate (a) based on the requirements of SFAS No. 123(R) for all share-basedpayments granted after the effective date and (b) based on the requirements ofSFAS No. 123 for all awards granted to employees prior to the effective date ofSFAS No. 123(R) that remain unvested on the effective date.

 

SFAS No. 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow. This requirement reduced net operating cash flows and increased netfinancing cash flows for the three months ended March 31, 2006.

 

*Accounting for stock-basedcompensation*

 

Effective January 1, 2006, the Company adopted the provisions of SFASNo. 123(R) requiring that compensation cost relating to share-based paymenttransactions be recognized in the operating expenses. The cost is measured atthe grant date, based on the calculated fair value of the award, and isrecognized as an expense over the employee’s requisite service period(generally the vesting period of the equity award). Prior to January 1, 2006,the Company accounted for share-based compensation to employees in accordancewith APB No. 25, and related interpretations. The Company also followed thedisclosure requirements of SFAS No. 123 as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure.”  The Company adopted SFAS No. 123(R) using themodified prospective method and, accordingly, financial statement amounts forprior periods presented in this Form 10-Q have not been restated to reflect thefair value method of recognizing compensation cost relating to non-qualifiedstock options.

 

There was $0.1 million of compensation cost related to non-qualifiedstock options recognized in operating results (included in selling, general andadministrative expenses) for the three months ended March 31, 2006.

 

The fair value of each option award is estimated on the date of grantusing the Black-Scholes-Merton option pricing model. Expected volatility isbased on historical volatility trends as well as implied future volatilityobservations as determined by independent third parties. In determining theexpected life of the option grants, the Company used historical data toestimate option exercise and employee termination behavior. The expected termrepresents an estimate of the time options are expected to remain outstanding. Therisk-free interest rate for periods within the contractual life of the optionis based on the U.S. treasury yield curve in effect at the time of grant. Thefollowing table sets forth the assumptions used to determine compensation costfor the Company’s non-qualified stock options consistent with the requirementsof SFAS No. 123(R).

 
| ** **                         | ** ** | **Three Months  Ended March 31,  2006** | ** ** |
|------------------------------------|------------|-----------------------------------------|------------|
| **Weighted-average  assumptions:** | ** ** | ** **                              | ** ** |
| Expected stock price volatility    |       | 36                                      | %          |
| Risk-free interest rate            |       | 3.76                                    | %          |
| Expected option life (years)       |       | 7                                       |       |
| Expected annual dividend yield     |       | —                                  | %          |

 

Under APB No. 25 there was no compensation cost recognized for theCompany’s non-qualified stock options awarded in the three months ended March31, 2005 as these non-qualified stock options had an exercise price equal tothe market value of the underlying stock at the grant date. The following tablesets forth pro forma information as if compensation cost had been determinedconsistent with the requirements of SFAS No. 123:

 

10

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| ** **                                                               | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                               | ** ** | **(Amounts in thousands)**             | ** ** |
| **Net income:**                                                          | ** ** | ** **                             | ** ** |
| As reported                                                              |       | $                                      | 356        |   |
| Deduct: compensation expense under fair  value-based method (net of tax) |       | (45                                    | )          |
| Pro forma                                                                |       | $                                      | 311        |   |

 

The following setsforth fair value per share information, including related assumptions, used todetermine compensation cost consistent with the requirements of SFAS No. 123:

 
| ** **                                                                                                                                                 | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                                 | ** ** | ** **                             | ** ** |
| **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     |   |
| ** **                                                                                                                                                 | ** ** | ** **                             | ** ** |
| **Weighted-average assumptions:**                                                                                                                          | ** ** | ** **                             | ** ** |
| Expected stock price volatility                                                                                                                            |       | 36                                     | %          |
| Risk-free interest rate                                                                                                                                    |       | 3.76                                   | %          |
| Expected option life (years)                                                                                                                               |       | 7                                      |       |
| Expected annual dividend yield                                                                                                                             |       | -                                      | %          |
|                                                                                                                                                            |            |                                        |            |  |

 

At March 31, 2006, there was $0.2 million of total unrecognizedcompensation cost related to nonvested non-qualified stock option awards, whichis expected to be recognized over a weighted-average period of two years. Thetotal fair value of options vested during the three months ended March 31, 2006was $0.1 million.

 

**3.****             RECEIVABLES**

 

Accountsreceivable consist of the following (in thousands):

 
| ** **                      | ** ** | **March 31   2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------|------------|---------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **(unaudited)**     | ** ** | ** **                  | ** ** |
| Casino                          |       | $                   | 9,775      |                        | $          | 12,173 |   |
| Hotel                           |       | 9,843               |       | 8,470                       |       |
| Other                           |       | 2,290               |       | 3,593                       |       |
|                            |       | 21,908              |       | 24,236                      |       |
| Allowance for doubtful accounts |       | (4,939              | )          | (4,443                      | )          |
| Receivables, net                |       | $                   | 16,969     |                        | $          | 19,793 |   |

 

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

 

Property and equipment and the related accumulateddepreciation consist of the following (in thousands):

 
| ** **                        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(unaudited)**          | ** ** | ** **                  | ** ** |
| Land                              |       | $                        | 97,979     |                        | $          | 97,979 |   |
| Building and improvements         |       | 367,234                  |       | 367,234                     |       |
| Furniture, fixtures and equipment |       | 34,431                   |       | 34,194                      |       |
| Construction in progress          |       | 21,661                   |       | 14,685                      |       |
|                              |       | 521,305                  |       | 514,092                     |       |
| Accumulated depreciation          |       | (33,762                  | )          | (28,346                     | )          |
| Property and equipment, net       |       | $                        | 487,543    |                        | $          | 485,746 |   |

 

The $98 million land value includes $29.5 million allocated to theTimeshare Land.

 

Depreciation expense was approximately $5.7 millionand $5.9 million for the three months ended March 31, 2006 and 2005

 

11

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respectively.

 

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

 

Long-term debt consists of the following (inthousands):

 
| ** **                                                                                     | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                     | ** ** | **(unaudited)**          | ** ** | ** **                  | ** ** |
| Term Loan A - $500 million senior notes,  net of unamortized discount of $24,305 and $25,632   |       | $                        | 461,225    |                        | $          | 460,293 |   |
| Term Loan B - $10 million senior notes                                                         |       | 11,220                   |       | 10,985                      |       |
| Mezzanine senior secured subordinated  notes, net of unamortized discount of $3,774 and $3,880 |       | 107,911                  |       | 103,956                     |       |
| Northwind Aladdin obligation under capital  lease                                              |       | 31,977                   |       | 32,314                      |       |
| Total long-term debt                                                                           |       | 612,333                  |       | 607,548                     |       |
| Current portion of long-term debt                                                              |       | (3,962                   | )          | (2,671                      | )          |
| Total long-term debt, net                                                                      |       | $                        | 608,371    |                        | $          | 604,877 |   |

 

***Credit Agreement***

 

The Aladdin acquisition and the planned renovationswere funded by the issuance of $510 million of secured notes to Aladdin Gaming’ssecured creditors pursuant to a Credit Agreement. OpBiz’s obligations under theCredit Agreement are secured by liens on all of its assets, including amortgage on its real property, the Hotel, the Casino and the Theater for thePerforming Arts (“TPA”), and security interests in its accounts receivable,inventory, equipment and intangible assets, excluding the Timeshare Land. TheCredit Agreement is guaranteed by MezzCo and MezzCo secured its guarantee bypledging its membership interests in OpBiz to the lenders. The Credit Agreementmatures on August 31, 2010.

 

The loans under the Credit Agreement are evidenced by $500 million ofTerm Loan A notes and $10 million of Term Loan B notes. Upon issuance of thenotes, BH/RE simultaneously made a $14 million cash payment to the holders ofthe Term Loan A notes to reduce the principal amount of the Term Loan A notesto $486 million and obtained a release of the lien on the Timeshare Land.

 

The scheduled principal payments on the Term Loan A notes are asfollows:

 

•   $1.25 million on the first day of each fiscalquarter during the period beginning on August 31, 2006 and ending on August 31,2007;

 

•   $3.75 million on the first day of each fiscalquarter during the period beginning on August 31, 2007 and ending on August 31,2008;

 

•   $5.0 million on the first day of each fiscalquarter during the period beginning on August 31, 2008 and ending on August 31,2009;

 

•   $6.25 million on the first day of each fiscalquarter during the period beginning on August 31, 2009 and ending on August 31,2010;

 

•   the then unpaid balance amount of Term Loan Anotes on August 31, 2010.

 

OpBiz pays interest on the outstanding Term Loan A notes quarterly, incash, at the London Inter-Bank Offered Rate, or LIBOR, plus an applicablemargin that increases over time. Until the earlier of August 31, 2007 orOpBiz’s accumulation of certain permitted cash reserves, OpBiz’s interestpayment will not exceed its quarterly earnings before interest, taxes,depreciation and amortization (“EBITDA”), reduced by certain permittedreductions (as defined in the Credit Agreement), divided by a factor of 1.20.Interest on the Term Loan B notes will accrue at a rate of LIBOR plus 4% andwill be added quarterly to the outstanding principal amount of the Term Loan Bnotes and will be paid when OpBiz pays off the Term Loan B notes. OpBiz is alsorequired to pay an annual administrative fee and certain other fees andexpenses of the lender under the Credit Agreement.

 

OpBiz is required to prepay amounts outstanding under the CreditAgreement:

 

•   with excess cash flow (as defined inthe Credit Agreement) after certain permitted cash reserves are accumulated;

 

•   in scheduled quarterly amountsbeginning after August, 31, 2006;

 

•   with certain amounts received inconnection with the development of the Timeshare Land adjacent to the DesertPassage (as defined in the underlying agreement);

 

•   with an amount equal to the differencebetween what should have been spent on renovation capital expenditures and whatwas

 

12

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actually spent thereon if (i) an aggregate amount of $72.0 millionis not spent on renovation capital expenditures by August 31, 2006, or(ii) an aggregate amount of $81.0 million is not spent on renovationcapital expenditures by February 28, 2007 or (iii) an aggregateamount of $90.0 million is not spent on renovation capital expenditures byAugust 31, 2007; and

 

•   with the proceeds of certain assetsales.

 

In particular, after OpBiz accumulates certain permitted cash reserves,OpBiz is required to pay 100% of its excess cash flow (as defined in the CreditAgreement) from operations to the lenders under the Credit Agreement. Thatpercentage decreases to 75%, then 50%, if OpBiz meets certain targeted ratiosof total debt to EBITDA, or certain leverage ratios, for any two consecutivefiscal quarters.

 

The Credit Agreement includes covenants that, among other things,restrict OpBiz’s ability to sell assets, make distributions to its owners,other than distributions for taxes, incur or prepay additional indebtedness,enter into transactions with affiliates, incur liens, make investments, makecapital expenditures,****develop theTimeshare Land adjacent to the Desert Passage and enter into materialcontracts. In addition, OpBiz is required to maintain certain levels of EBITDAthat increase over time and, beginning August 31, 2007, maintain certainratios of EBITDA to interest expense that increase over time and maintaincertain leverage ratios that decrease over time.

 

The Credit Agreement contains customary events of default, including achange of control of OpBiz, the occurrence of a default under the terms of anyindebtedness of MezzCo, a default by OpBiz under the Hotel management contractor termination of Sheraton as the manager of the Hotel (unless OpBiz replacesSheraton with another approved manager within 30 days of such termination), adefault or termination of the Planet Hollywood license agreement and certaindefaults under the agreements with Boulevard Invest or Northwind Aladdin.

 

BH/REhas issued warrants to purchase 2.94% of its ownership interest in EquityCo tothe lenders under the Credit Agreement. The warrants can only be exercised uponthe occurrence of (i) a liquidity event or distribution (such as throughthe sale of the hotel/casino); (ii) a public sale of equity securities ofEquityCo, MezzCo or OpBiz; or (iii) payment in full of the obligationsunder the Credit Agreement. The warrants can either be settled in cash or inother membership interests upon exercise. The estimated fair value of thewarrants was approximately $0.1 million as of March 31, 2006. These warrantsare recorded separately from the related debt within other long-termliabilities.

 

***Mezzanine Financing***

 

In August 2004, MezzCo entered into a mezzanine financingtransaction (the “Mezzanine Financing”) with a group of purchasers. Pursuant tothe Mezzanine Financing, MezzCo issued $87 million of 16% Senior SecuredSubordinated Notes and warrants to purchase 17,500 of its units representingmembership interests equal to 17.5% of the fully diluted equity of MezzCo. Thegross offering proceeds of the Mezzanine Financing were deposited into anescrow account and, in conjunction with the closing of the Aladdin acquisition,were used to (i) pay approximately $16.1 million of fees and expensesrelated to the acquisition of the Aladdin, (ii) fund the $14 million lienrelease payment required under the Credit Agreement, and (iii) fund aportion of the planned renovations to the Aladdin. The notes mature inAugust 2011 and accrue interest at a rate of 16% per annum. Interest onthe notes is payable-in-kind or, at the option of MezzCo, in cash. The warrantsare 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 thereof.Currently, all of MezzCo’s voting membership interests are represented by unitsowned by EquityCo. In addition to customary anti-dilution protections, thenumber of units representing MezzCo membership interests issuable upon exerciseof the warrants may be increased from time to time upon the occurrence ofcertain events as described in the warrants. The maximum aggregate increase is24%, following which the warrants would represent rights to purchase 41.5% ofthe units representing the fully diluted equity of MezzCo. Holders of thewarrants and any securities issued upon exercise of the warrants may requireMezzCo to redeem such securities commencing in August 2011 at a redemptionprice based upon a formula set forth in the warrants. Starting in August 2008,in the event the Company fails to achieve certain operational thresholds, theholders of the MezzCo warrants, and securities issued upon exercise thereof,have the right to assume control of MezzCo and OpBiz and conduct a sale of theequity of, or all or substantially all of the assets of, either MezzCo or OpBizprovided that all Control Conditions (as defined in the Investor RightsAgreement) are met. These rights are subject to (i) repayment in full ofall indebtedness that is senior to the notes (including all indebtedness ofOpBiz under the Credit Agreement), (ii) certain covenants related to OpBiz’sability to achieve targeted levels of EBITDA and (iii) the prior approvalof the Nevada gaming authorities. These rights expire upon completion of apublic offering by MezzCo or OpBiz. In connection with the Mezzanine Financing,OpBiz’s obligation to make expenditures on renovations to the Aladdin wasincreased from $90 million, as required under the Credit Agreement, to $100million.

 

As of March 31, 2006, the MezzCo financing was recorded net of theunamortized balance of the put warrants of approximately $3.8 million. Theestimated fair value of the warrants was approximately $4.1 million at March 31,2006 and December 31, 2005, and is recorded separately from the relateddebt within other long-term liabilities.

 

13

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***Energy Services Agreement***

 

Northwind Aladdin (“Northwind”), a third party, ownsand operates a central utility plant on land leased from OpBiz. The plantsupplies hot and cold water and emergency power to the Aladdin under a contractbetween Aladdin Gaming and Northwind. OpBiz has assumed the energy serviceagreement, which expires in 2020. Under the agreement, OpBiz is required to payNorthwind a monthly consumption charge, a monthly operational charge, a monthlydebt service payment and a monthly return on equity payment. Payments under theNorthwind agreement total approximately $0.5 million per month.

 

**6.****             MEMBERSHIPINTERESTS**

 

The non-votinginterests in BH/RE are owned 40.75% by BHCH I, 18.50% by BHCH II and 40.75% byOCS and the voting interests are owned 50% by Douglas P. Teitelbaum and 50% byRobert Earl. BHCH is controlled by Mr. Teitelbaum, managing principal ofBay Harbour Management, an investment management firm. BHCH was formed byMr. Teitelbaum for the purpose of holding investments in BH/RE by fundsmanaged by Bay Harbour Management. OCS is wholly-owned and controlled byMr. Earl and holds Mr. Earl’s investment in BH/RE. Mr. Earl isthe founder, chairman and chief executive officer of Planet Hollywood andMr. Teitelbaum is a director of Planet Hollywood. Collectively,Mr. Earl, a trust for the benefit of Mr. Earl’s children andaffiliates of Bay Harbour Management, own substantially all of the equity ofPlanet Hollywood.

 

BH/RE owns 85%of the membership interests in EquityCo and Starwood owns 15%. MezzCo is awholly owned subsidiary of EquityCo, and OpBiz is a wholly owned subsidiary ofMezzCo. BH/RE and Starwood made total equity contributions of $20 million eachin EquityCo to fund the costs of the planned renovations to the Aladdin.Starwood’s equity interest in EquityCo is reflected as minority interest in theaccompanying condensed consolidated financial statements. BH/RE recordedminority interest income (loss) related to the Starwood interests ofapproximately $1.0 million and $(0.1) million for the three months ended March31, 2006 and 2005, respectively.

 

BH/RE has theoption to purchase all of Starwood’s membership interests in EquityCo if OpBizis entitled to terminate the hotel management contract between OpBiz andSheraton as a result of a breach by Sheraton. Starwood can require EquityCo topurchase 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.

 

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

 

***Mr. Jess Ravich***

*** ***

Jess Ravich, a Manager of OpBiz, is CEO and indirectcontrolling shareholder of Libra Securities, LLC, an investment banking firm (“LibraSecurities”). Libra Securities acted as placement agent for MezzCo, L.L.C. inthe placement of the Mezzanine Financing and was paid a placement fee of$4,350,000.

 

Mr. Ravichholds a note convertible into 25% of the equity in PDS Gaming, a leasing andfinance company specializing in gaming equipment. Conversion of the note issubject to approval of appropriate gaming regulators in the jurisdictions inwhich PDS Gaming does business. PDS Gaming entered into a gaming equipmentlease with OpBiz on December 22, 2004, for a 48-month term with payments ofapproximately $137,500 per month. Libra Securities raised financing for PDSGaming to allow it to purchase the equipment underlying the lease and receiveda placement fee for its services.

 

***Planet Hollywood Licensing Agreement***

 

OpBiz, PlanetHollywood and certain of Planet Hollywood’s subsidiaries have entered into alicensing agreement pursuant to which OpBiz received a non-exclusive,irrevocable license to use various “Planet Hollywood” trademarks and servicemarks. Under the licensing agreement, OpBiz also has the right, but not theobligation, to open a Planet Hollywood restaurant and one or more PlanetHollywood retail shops under a separate restaurant agreement with PlanetHollywood. OpBiz will pay Planet Hollywood a quarterly licensing fee of 1.75%of OpBiz’s non-casino revenues. If OpBiz opens an attraction with paidadmission using the Planet Hollywood marks or memorabilia prior to beginningoperations as the PH Resort, it will pay Planet Hollywood a quarterly licensingfee of 1.75% of the revenues of the attraction until OpBiz begins operating asthe PH Resort. The initial term of the licensing agreement will expire in 2028.OpBiz can renew the licensing agreement for three successive 10-year terms.

 

In addition tobeing a manager of BH/RE, Mr. Earl is the chief executive officer andchairman of the board of directors of Planet Hollywood. Similarly,Mr. Teitelbaum is a manager of BH/RE and 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.

 

14

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***Sheraton Hotel Management Contract***

 

OpBiz and Sheraton have entered into amanagement contract pursuant to which Sheraton provides hotel managementservices to the Hotel, assists OpBiz in the management, operation and promotionof the Hotel and permits OpBiz to use the Sheraton brand and trademarks in thepromotion of the Hotel. OpBiz pays Sheraton a monthly fee of 4% of gross Hotelrevenue and certain food and beverage outlet revenues and 2% of rental incomefrom third-party leases in the Hotel. The management contract has a 20-yearterm that commenced on the completion of the Aladdin acquisition and is subjectto certain termination provisions by either OpBiz or Sheraton. Sheraton is awholly owned subsidiary of Starwood, which has a 15% equity interest inEquityCo and has the right to appoint two members to the EquityCo board ofmanagers. Starwood management fees totaled approximately $2.6 million and $3.1million for the three months ended March 31, 2006 and 2005 respectively.

 

**8.****             INCOMETAXES**

 

The condensedconsolidated financial statements include the operations of BH/RE and itscontrolled subsidiaries: EquityCo, MezzCo, and OpBiz. BH/RE and EquityCo arelimited liability companies and are taxed as partnerships for federal incometax purposes. MezzCo has elected to be taxed as a corporation for federalincome tax purposes. OpBiz, a wholly owned subsidiary of MezzCo, will betreated as a division of MezzCo for federal income tax purposes, andaccordingly, will also be subject to federal income taxes.

 

MezzCo and OpBiz accountfor income taxes in accordance with SFAS No. 109, “*Accountingfor Income Taxes*”. SFAS 109 requires the recognition of deferredincome tax assets, net of applicable reserves, related to net operating losscarryforwards and certain temporary differences. The standard requiresrecognition of future tax benefits to the extent that realization of suchbenefits are more likely than not. Otherwise, a valuation allowance is applied.

 

Management believes itis more likely than not that its net deferred tax asset will not be realizedand has therefore recorded a valuation allowance against this net deferred taxasset.

 

The payable in-kindinterest associated with the Mezzanine Financing is subject to the provisionsof Internal Revenue Code Section 163(e)(5) as a high yield debt obligation withdisqualified OID. As a result, a portion of the interest expense associatedwith the Mezzanine Financing is permanently non-deductible for tax purposes andthe balance of the interest expense is only deductible when paid in cash. Thedeferred tax asset associated with the Mezzanine Financing remains fullyreserved.

 

At December 31,2005, OpBiz had a general business credit carryforward of approximately $0.7million that expires in 2025 and a minimum tax credit carryforward ofapproximately $0.1 million. MezzCo and OpBiz have a valuation allowance atDecember 31, 2005 and 2004 recorded against tax benefits that are more likelythan not unrealizable. The current tax receivable of $134,000 at March 31, 2006represents recoverable taxes paid in a carryback period.

 

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

 

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

###### *** ***

BH/RE isnot currently a party to any material legal proceedings.

 

***Employment Agreements***

*** ***

The Companyhas entered into various employment agreements, as amended, with severalexecutives. The employment agreements have initial terms of two to five years. Theemployment agreements provide that the executives will receive a base salarywith either mandatory increases or annual adjustments and annual bonus payments.In addition, depending on the terms of the employment agreements, theseexecutives are entitiled to options to purchase between 0.2% and 5% of theequity of MezzCo.

 

***Timeshare Purchase Agreement***

*** ***

OnDecember 10, 2004, OpBiz entered into a Timeshare Purchase Agreement withWestgate Resorts, LTD. (“Westgate”), a Florida limited partnership, wherebyOpBiz has agreed to sell approximately 4 acres of land adjacent to the Aladdinto Westgate, who plans to develop, market, manage and sell timeshare units onthe land. Under the Timeshare Purchase Agreement, OpBiz will receive fees eachyear based on sales of timeshare units until the timeshare units are onehundred percent sold out.

 

***Theater Lease***

*** ***

OnDecember 16, 2004, OpBiz entered into a long-term lease agreement wherebyCC Entertainment Theatrical-LV, LLC, succesor-in-interest to SFX Entertainment,Inc. pursuant to an assignment dated September 26, 2005 (“CCE”) will berenovating and leasing certain theaters and related areas located at the Aladdin.CCE will have the exclusive right to use, reconfigure, adapt, change

 

15

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and operatethe leased premises.

 

## **ITEM 2.** MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

## ** **

###### ***Overview of Management’s Discussion and Analysis ofFinancial Condition and Results of Operations***

###### *** ***

Set forth below is a discussion of the financialcondition and results of operations of BH/RE and its subsidiaries for theperiods covered in this report. The discussion of operations herein focuses onevents and the revenues and expenses during the three months ended March 31,2006, as compared to the three months ended March 31, 2005.

 

The following management’s discussion and analysis offinancial condition and results of operations should be read in conjunctionwith the consolidated financial statements and the related notes to theconsolidated financial statements of BH/RE included in BH/RE’s Annual Report onForm 10-K filed with the Securities and Exchange Commission on March 31,2006, and the unaudited condensed consolidated financial statements and noteshereto included in Part I, Item 1 of this report.

 

###### ***Critical Accounting Policies and Estimates***

###### *** ***

###### ***Significant Accounting Policies andEstimates***

###### *** ***

Our unauditedcondensed consolidated financial statements are prepared in conformity withU.S. generally accepted accounting principles. Certain policies, including thedetermination of bad debt reserves, the estimated useful lives assigned toassets, asset impairment, insurance reserves and the calculation ofliabilities, require that we apply significant judgment in defining theappropriate assumptions for calculating financial estimates. By their nature,these judgments are subject to an inherent degree of uncertainty. Our judgmentsare based on historical experience, terms of existing contracts, observance oftrends in the gaming industry and information available from other outsidesources. There can be no assurance that actual results will not differ from ourestimates. To provide an understanding of the methodology we apply, oursignificant accounting policies and basis of presentation are discussed below,as well as, where appropriate, in the notes to the condensed consolidatedfinancial statements.

 

###### ***Propertyand Equipment***

###### *** ***

Property and equipment are stated at cost. Recurringrepairs and maintenance costs, including items that are replaced routinely inthe casino, hotel and food and beverage departments which do not meet ourcapitalization policy of $10,000, are expensed as incurred. We have establishedour capital expense policy to be reflective of our individual ongoing repairsand maintenance programs. Gains or losses on dispositions of property andequipment are included in the determination of income. Property and equipmentare generally depreciated over the following estimated useful lives on astraight-line basis:

 

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

 

Property and equipment and other long-lived assets areevaluated for impairment in accordance with the Financial Accounting StandardsBoard’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”)No. 144, “*Accounting for the Impairment or Disposal ofLong-Lived Assets*.” For assets to be disposed of, the asset to besold is recognized at the lower of carrying value or fair value less costs ofdisposal. Fair value for assets to be disposed of is estimated based oncomparable asset sales, solicited offers or a discounted cash flow model.

 

Property and equipment are reviewed for impairmentwhenever indicators of impairment exist. If an indicator of impairment exists,the estimated future cash flows of the asset, on an undiscounted basis, arecompared to the carrying value of the asset. If the undiscounted cash flowsexceed the carrying value, no impairment is indicated. If the undiscounted cashflows do not exceed the carrying value, then impairment is measured based onfair value compared to carrying value, with fair value typically based on adiscounted cash flow model.

 

*Derivative Instruments and Hedging Activities*

 

BH/RE has issued warrants to provide further consideration to theholders of the Senior Notes and Mezzanine Financing. BH/RE accounts for thesenior note warrants in EquityCo as embedded derivative instruments inaccordance with SFAS No. 133, “*Accounting for DerivativeInstruments and Hedging Activities,*” and SFAS No. 138, “*Accounting for Certain Derivative Instruments and Hedging Activities —an Amendment of FASB Statement No. 133*”. The warrants issued inconjunction with the Mezzanine Financing contain a

 

16

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net cash settlement, and therefore are accounted for in accordance withEmerging Issues Task Force (“EITF”) 00-19, “*Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock*”. Both SFAS No. 133 and EITF 00-19 require that thewarrants be recognized as liabilities, with changes in fair value affecting netincome.

 

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

###### *** ***

Casino revenues are recognized as the net win fromgaming activities, which is the difference between gaming wins and losses. Allother revenues are recognized as the service is provided. Revenues include the retailvalue of food, beverage, rooms, entertainment and merchandise provided on acomplimentary basis to customers. Such complimentary amounts are then deductedfrom revenues as promotional allowances on our condensed consolidatedstatements of operations. The estimated departmental costs of providing suchpromotional allowances are included in casino costs and expenses.

 

Hotel revenue recognition criteria are generally metat the time of occupancy. Food and beverage revenue recognition criteria aregenerally met at the time of service. Deposits for future hotel occupancy orfood 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.

 

*IncomeTaxes*

 

The condensed consolidated financial statementsinclude the operations of BH/RE and its controlled subsidiaries: EquityCo,MezzCo, and OpBiz. BH/RE and EquityCo are limited liability companies and aretaxed as partnerships for federal income tax purposes. MezzCo has elected to betaxed as a corporation for federal income tax purposes. OpBiz, a wholly ownedsubsidiary of MezzCo, will be treated as a division of MezzCo for federalincome tax purposes, and accordingly, will also be subject to federal incometaxes.

 

MezzCo and OpBiz 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 futuretax benefits to the extent that realization of such benefits are more likely thannot. Otherwise, a valuation allowance is applied.

 

###### ***MembershipInterests***

###### *** ***

As of March31, 2006, our membership interests had not been unitized and our members do notpresently intend to unitize these membership interests. Accordingly, we haveexcluded earnings per membership unit data required pursuant to SFASNo. 128, “*Earnings Per Share,*” because webelieve that such disclosures would not be meaningful to the financialstatement 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 entitiled to options topurchase between 0.2% and 5% of the equity of MezzCo.

 

***Recently issued accounting pronouncements***

 

*SFAS No.123(R)*

 

On December 16,2004, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFASNo. 123(R)”), which is a revision to SFAS No. 123, “Accounting for Stock-BasedCompensation.”  SFAS No. 123(R)supersedes Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB No. 25”) and amends SFAS No. 95, “Statement of CashFlows.”  Among other items, SFAS No.123(R) requires the recognition of compensation expense in an amount equal tothe fair value of share-based payments, including employee stock options andrestricted stock, granted to employees.

 

TheCompany adopted SFAS No. 123(R) on January 1, 2006 using the “modifiedprospective” method, in which compensation cost is recognized beginning withthe effective date (a) based on the requirements of SFAS No. 123(R) for allshare-based payments granted after the effective date and (b) based on therequirements of SFAS No. 123 for all awards granted to employees prior to theeffective date of SFAS No. 123(R) that remain unvested on the effective date.

 

17

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SFAS No. 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow. This requirement reduced net operating cash flows and increased netfinancing cash flows for the three months ended March 31, 2006.

 

*Accounting for stock-basedcompensation*

 

Effective January 1, 2006, the Company adopted the provisions of SFASNo. 123(R) requiring that compensation cost relating to share-based paymenttransactions be recognized in operating expenses. The cost is measured at thegrant date, based on the calculated fair value of the award, and is recognizedas an expense over the employee’s requisite service period (generally thevesting period of the equity award). Prior to January 1, 2006, the Companyaccounted for share-based compensation to employees in accordance with APB No.25, and related interpretations. The Company also followed the disclosurerequirements of SFAS No. 123 as amended by SFAS No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure.”  The Company adopted SFAS No. 123(R) using themodified prospective method and, accordingly, financial statement amounts forprior periods presented in this Form 10-Q have not been restated to reflect thefair value method of recognizing compensation cost relating to non-qualifiedstock options.

 

There was $0.1 million of compensation cost related to non-qualifiedstock options recognized in operating results (included in selling, general andadministrative expenses) for the three months ended March 31, 2006.

 

The fair value of each option award is estimated on the date of grantusing the Black-Scholes-Merton option pricing model. Expected volatility isbased on historical volatility trends as well as implied future volatilityobservations as determined by independent third parties. In determining the expectedlife of the option grants, the Company used historical data to estimate optionexercise and employee termination behavior. The expected term represents anestimate of the time options are expected to remain outstanding. The risk-freeinterest rate for periods within the contractual life of the option is based onthe U.S. treasury yield curve in effect at the time of grant. The followingtable sets forth the assumptions used to determine compensation cost for theCompany’s non-qualified stock options consistent with the requirements of SFASNo. 123(R):

 
| ** **                         | ** ** | **Three Months  Ended March 31,  2006** | ** ** |
|------------------------------------|------------|-----------------------------------------|------------|
| **Weighted-average  assumptions:** | ** ** | ** **                              | ** ** |
| Expected stock price volatility    |       | 36                                      | %          |
| Risk-free interest rate            |       | 3.79                                    | %          |
| Expected option life (years)       |       | 7                                       |       |
| Expected annual dividend yield     |       | —                                  | %          |

 

Under APB No. 25 there was no compensation cost recognized for theCompany’s non-qualified stock options awarded in the three months ended March31, 2005 as these non-qualified stock options had an exercise price equal tothe market value of the underlying stock at the grant date. The following tablesets forth pro forma information as if compensation cost had been determinedconsistent with the requirements of SFAS No. 123.

 
| ** **                                                               | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                               | ** ** | **(Amounts in thousands)**             | ** ** |
| **Net income:**                                                          | ** ** | ** **                             | ** ** |
| As reported                                                              |       | $                                      | 356        |   |
| Deduct: compensation expense under fair  value-based method (net of tax) |       | (45                                    | )          |
| Pro forma                                                                |       | $                                      | 311        |   |

 

Thefollowing sets forth fair value per share information, including relatedassumptions, used to determine compensation cost consistent with therequirements of SFAS No. 123:

 

18

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| ** **                                                                                                                                                 | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                                 | ** ** | ** **                             | ** ** |
| **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     |   |
| ** **                                                                                                                                                 | ** ** | ** **                             | ** ** |
| **Weighted-average assumptions:**                                                                                                                          | ** ** | ** **                             | ** ** |
| Expected stock price volatility                                                                                                                            |       | 36                                     | %          |
| Risk-free interest rate                                                                                                                                    |       | 3.79                                   | %          |
| Expected option life (years)                                                                                                                               |       | 7                                      |       |
| Expected annual dividend yield                                                                                                                             |       | —                                 | %          |
|                                                                                                                                                            |            |                                        |            |  |

 

At March 31, 2006, there was $0.2 million of total unrecognizedcompensation cost related to nonvested non-qualified stock option awards, whichis expected to be recognized over a weighted-average period of two years. Thetotal fair value of options vested during the three months ended March 31, 2006was $0.1 million.

 

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

###### *** ***

The following table highlights the results ofoperations of the Aladdin for the three months ended March 31, 2006 and 2005,respectively (dollars in thousands, unaudited).

 
| ** **                          | ** ** | **Three months ended  March 31,** | ** ** | **Percent** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|-------------|------------|
| ** **                          | ** ** | **2006**                               | ** ** | **2005**    | ** ** | **Change** | ** ** |
|                                |       |                                   |       |        |       |   |   |
| Net revenues                        |       | $                                      | 73,481     |        | $          | 79,219 |   | (7.2 | )% |
| Operating expenses:                 |       |                                   |       |        |       |   |   |
| Casino                              |       | 17,887                                 |       | 17,458      |       | 2.5 | % |
| Hotel                               |       | 9,915                                  |       | 9,056       |       | 9.5 | % |
| Food and beverage                   |       | 11,806                                 |       | 12,939      |       | 8.8 | % |
| Other                               |       | 2,324                                  |       | 2,342       |       | (0.8 | )% |
| Selling, general and administrative |       | 17,645                                 |       | 17,500      |       | 0.8 | % |
| Depreciation and amortization       |       | 5,691                                  |       | 5,870       |       | (3.0 | )% |
| Operating income                    |       | $                                      | 8,213      |        | $          | 14,054 |   | (41.6 | )% |

 

Net revenues for the three months ended March 31, 2006declined when compared to the three months ended March 31, 2005. The renovationproject, which is currently underway, was the primary reason for the decline inrevenues throughout the property. Operating income and operating margin alsodeclined as a result of the renovation project due to the level of disruption weare experiencing while the structural phase of the construction is underway.

 

The following table highlights the various sources of our revenues andexpenses for the three months ended March 31, 2006 and 2005, respectively(dollars in thousands, unaudited).

 

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| ** **                                    | ** ** | **Three months ended  March 31,** | ** ** | **Percent** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|-------------|------------|
| ** **                                    | ** ** | **2006**                          | ** ** | **2005**    | ** ** | **Change** | ** ** |
|                                          |       |                              |       |        |       |   |   |
| Casino revenues                               |       | $                                 | 29,825     |        | $          | 32,913 |   | (9.4 | )% |
| Casino expenses                               |       | 17,887                            |       | 17,458      |       | 2.5 | % |
| *Margin*                                      | * *   | *40.0*                            | *%*        | *47.0*      | *%*        | * * | * * |
|                                          |       |                              |       |        |       |   |   |
| Hotel revenues                                |       | $                                 | 29,194     |        | $          | 29,237 |   | (0.1 | )% |
| Hotel expenses                                |       | 9,915                             |       | 9,056       |       | 9.5 | % |
| *Margin*                                      | * *   | *66.0*                            | *%*        | *69.0*      | *%*        | * * | * * |
|                                          |       |                              |       |        |       |   |   |
| Food and beverage revenues                    |       | $                                 | 16,651     |        | $          | 19,319 |   | (13.8 | )% |
| Food and beverage expenses                    |       | 11,806                            |       | 12,939      |       | (8.8 | )% |
| *Margin*                                      | * *   | *29.1*                            | *%*        | *33.0*      | *%*        | * * | * * |
|                                          |       |                              |       |        |       |   |   |
| Other revenues                                |       | $                                 | 4,144      |        | $          | 4,393 |   | (5.7 | )% |
| Other expenses                                |       | 2,324                             |       | 2,342       |       | (0.8 | )% |
| *Margin*                                      | * *   | *43.9*                            | *%*        | *46.7*      | *%*        | * * | * * |
|                                          |       |                              |       |        |       |   |   |
| Selling, general and administrative  expenses |       | $                                 | 17,645     |        | $          | 17,500 |   | 0.8 | % |
| *Percent of net revenues*                     | * *   | *24.0*                            | *%*        | *22.1*      | *%*        | * * | * * |

 

*Casino*

 

Casino revenue is derived primarily from patronswagering on slot machines, table games and other gaming activities. Table gamesgenerally include blackjack or twenty one, craps, baccarat and roulette. Othergaming activities include the race and sports books, poker and keno. Casinorevenue is defined as the win from gaming activities, computed as thedifference between gaming wins and losses.

 

Casino revenues vary from time-to-time due to general economicconditions, competition, popularity of entertainment offerings, table gamehold, slot machine hold and occupancy percentages in the Hotel. Casino revenuesalso vary depending upon the amount of gaming activity, as well as variationsin the odds for different games of chance. Casino revenue is recognized at theend of each gaming day.

 

Casino revenues decreased 9.4% to $29.8 million for the three monthsended March 31, 2006, as compared to $32.9 million for the three months ended March31, 2005. Table games revenue for the three months ended March 31, 2006, decreasedby approximately $1.5 million as compared to the three months ended March 31,2005. The number of operational table units decreased 11% in connection withthe renovation project with a resulting decrease in drop of 6%. Overall winpercentage was comparable to prior year. Slot revenue for the three monthsended March 31, 2006 decreased approximately $0.3 million when compared to thesame three month period in prior year. Number of slot units on the floordecreased 19% with a resulting decrease in slot handle of 14%. Win per unitincreased 19% offsetting the decrease in handle and resulting in an overalldecrease in revenue of 1.5%. Combined revenues from the race and sports book,poker and keno decreased by $0.9 million or 44% when compared to the threemonth period ended March 31, 2005 primarily due to a decrease in race andsports book revenue driven by losses on the NFL finals and a decrease in revenuefrom the Superbowl when compared to previous year.

 

Casino expenses increased 2.5% to $17.9 million for the three monthsended March 31, 2006, as compared to $17.5 million for the three months ended March31, 2005. Operating margin declined 7% when comparing the same three monthperiods. The increase in casino expenses and decline in operating margin weremainly attributable to the addition of promotional offers and events intendedto maintain revenue during the renovation period. We expect that continued focuson events and promotional offers will help us drive traffic throughout therenovation and that we will experience a resulting decline in operating marginwhen compared to prior year.

 

*Hotel*

 

Hotel revenue is derived from rooms and suites rentedto guests. “average daily rate” is an industry specific term used to define theaverage amount of revenue per rented room per day. “occupancy percentage”defines the total percentage of rooms occupied and is computed by dividing thenumber of rooms occupied by the total number of rooms available. Hotel revenueis recognized at the time the room is provided to the guest.

 

Hotel revenues of $29.2 million for the three months ended March 31,2006 were comparable to the three months ended March 31, 2005. Hotel occupancyincreased 1.6% to 95.7% when compared to the same three month period in prioryear. An offsetting decline in average daily rate to $131 compared to $133 forthe three months ended March 31, 2005 resulted in consistent revenues. We wereable to maintain hotel revenues during the renovation period due to continuedstrong demand for rooms in the Las Vegas market and the improved marketingchannels of Starwood.

 

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Hotel expenses increased 9.5% to $9.9 million for the three monthsended March 31, 2006, as compared to $9.1 million for the three months endedMarch 31, 2005. Operating margin declined 3% for the three month period endedMarch 31, 2006 when compared to the same three month period in previous year. Theincrease in expenses and resulting decline in operating margin were mainlyattributable to an increase in payroll and benefit costs due to theimplementation of the culinary union contract in October 2005.

 

*Food and Beverage*

 

Food and beverage revenues are derived from food andbeverage sales in the restaurants, bars, room service, banquets andentertainment outlets. Food and beverage revenue is recognized at the time thefood and/or beverage is provided to the guest.

 

Food and beverage revenues decreased 13.8% to $16.7 million for thethree months ended March 31, 2006, as compared to $19.3 million for the threemonths ended March 31, 2005. The decline in food revenue was the result of coverdeclines in all outlets due to construction disruption. Beverage revenuedeclines were directly attributed the closing of outlets for the construction. Thoseclosed beverage outlets were replaced by portable casino bars that did not pickup the lost revenue.

 

Food and beverage expenses decreased 8.8% to $11.8 million for thethree months ended March 31, 2006, as compared to $12.9 million for the threemonths ended March 31, 2005. Operating margin declined 4% when compared to thesame three month period in previous year. Food and beverage payroll expenseswere also impacted by the addition of the culinary union contract in October2005 but expense increases were more than offset by expense control measuresincluding flexible staffing based on cover and revenue reductions during therenovation period.

 

*Other*

 

Other revenue includes entertainment sales, retailsales, telephone and other miscellaneous income and is recognized at the timethe goods or services are provided to the guest.

 

Other revenues decreased 5.7% to $4.1 million for the three monthsended March 31, 2006, as compared to $4.4 million for the three months endedMarch 31, 2005. The decline in other revenue is primarily due to the loss ofrevenue from the showroom that was fully operational during the three monthsended March 31, 2005. The showroom was closed for renovation in April 2005.

 

Other expenses remained consistent when comparing the same three monthperiods resulting in a decline in operating margin of 2.7%. Expenses related tothe operation of a temporary casino lounge including a nightly band were absorbedto offset the loss of entertainment due to the showroom closing.

 

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

 

SG&A expenses were consistent for the three months ended March 31,2006, when compared to the three months ended March 31, 2005 at $17.6 millionand $17.5 million respectively. As a percentage of net revenue, SG&Aexpenses increased to 24% for the three months ended March 31, 2006 as comparedto 22% for the three months ended March 31, 2005. The increase in SG&Aexpenses as a percentage of net revenue was mainly due to maintenance ofmarketing and fixed administrative expenses on a greater than anticipatedreduction in revenue. In reaction to the additional reduction in revenue, wehave taken steps to reduce the level of marketing and fixed admin expenses forthe remainder of 2006.

 

*Depreciation and Amortization*

 

Depreciation and amortization expense of $5.7 million for the threemonths ended March 31, 2006 declined when compared to $5.9 million in expensefor the three months ended March 31, 2005. Asset additions resulting from therenovation project will not begin depreciating until construction is completeand they are placed in service.

 

*Net Interest Expense*

 

Net interest expense increased to $14.6 million for the three monthsended March 31, 2006, as compared to $13.6 million for the three months endedMarch 31, 2005. The increase in net interest expense is directly attributed to theincrease in LIBOR for the comparable three month periods, which is used tocalculate interest expense on the Credit Facility.

 

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

###### *** ***

The following liquidity and capital resources discussion containscertain forward-looking statements with respect to our business, financialcondition, results of operations, dispositions, acquisitions, expansionprojects and our subsidiaries, which involve risks and uncertainties thatcannot be predicted or quantified, and consequently, actual results may differmaterially from those expressed or implied herein. Such risks and uncertaintiesinclude, but are not limited to, financial market risks, the ability tomaintain existing management, integration of acquisitions, competition withinthe gaming industry, the cyclical nature of the hotel business and gamingbusiness, economic conditions, regulatory matters and litigation and otherrisks described in our filings with the Securities and Exchange Commission. Allforward-looking statements are based on our current expectations andprojections about future events.

 

During the three months ended March 31, 2006, we generated cash flowsfrom operating activities of approximately $3.8 million. We also had restrictedcash and cash equivalents of approximately $81.7 million, which is designatedto be used for costs associated with the renovation and retheming of theAladdin into the PH Resort.

 

Our primary cash requirements for the remainder of 2006 are expected toinclude (i) up to approximately $81.7 million in capital expendituresrelated to the renovation project, (ii) approximately $16.5 million formaintenance capital expenditures and (iii) up to approximately $30.6million in interest payments on our debt.

 

We believe that cash generated from operations, thecapital invested in OpBiz in connection with our acquisition of the Aladdin andavailable working capital, including the cash that we acquired from AladdinGaming under the purchase agreement, will be adequate to meet the anticipatedworking capital, capital expenditure, renovation and debt service obligationsof OpBiz for at least the next 12 months of operations. We may have otherliquidity needs, such as tax distributions to the members of EquityCo andBH/RE, and we believe that we will have adequate cash to meet these needs ifthey should arise. The Credit Agreement allows OpBiz to make tax distributions.

 

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 orcapital expenditure programs or decrease the amount of cash generated from ouroperations. We expect to experience a reduction in cash generated by ouroperations during our planned renovations to the Aladdin and have negotiatedthe terms of the Credit Agreement to address those anticipated reductions. Forexample, the covenant in the Credit Agreement requiring OpBiz to achievespecified levels of earnings before interest, taxes, depreciation andamortization (“EBITDA”) during the first two years of the Credit Agreement issignificantly below the Aladdin’s current EBITDA levels. Also, the interestrate during the first three years of the term of the Credit Agreement is lowerthan the interest rate in the last three years.

 

***Description of Certain Indebtedness***

 

*Credit Agreement*

 

The Aladdin acquisition and the planned renovationswere funded by the issuance of $510 million of secured notes to Aladdin Gaming’ssecured creditors pursuant to a Credit Agreement. OpBiz’s obligations under theCredit Agreement are secured by liens on all of its assets, including amortgage on its real property, the Hotel, the Casino and the TPA, and securityinterests in our accounts receivable, inventory, equipment and intangibleassets, excluding the Timeshare Land. The Credit Agreement is guaranteed byMezzCo and MezzCo secured its guarantee by pledging its membership interests inOpBiz to the lenders. The Credit Agreement matures on August 31, 2010.

 

The loans under the Credit Agreement are evidenced by $500 million ofTerm Loan A notes and $10 million of Term Loan B notes. Upon issuance of thenotes, BH/RE simultaneously made a $14 million cash payment to the holders ofthe Term Loan A notes to reduce the principal amount of the Term Loan A notesto $486 million and obtained a release of their lien on the Timeshare Land.

 

The scheduled principal payments on the Term Loan A notes are asfollows:

 

•   $1.25 million on the first day of eachfiscal quarter during the period beginning on August 31, 2006 and endingon August 31, 2007;

 

•   $3.75 million on the first day of eachfiscal quarter during the period beginning on August 31, 2007 and endingon August 31, 2008;

 

•   $5.0 million on the first day of eachfiscal quarter during the period beginning on August 31, 2008 and endingon August 31, 2009;

 

•   $6.25 million on the first day of eachfiscal quarter during the period beginning on August 31, 2009 and endingon August 31, 2010;

 

•   the then unpaid balance amount of TermLoan A notes on August 31, 2010.

 

OpBiz pays interest on the outstanding Term Loan A notes quarterly, incash, at the London Inter-Bank Offered Rate, or LIBOR,

 

22

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plus an applicable margin that increases over time. Until the earlierof August 31, 2007 or OpBiz’s accumulation of certain permitted cashreserves, OpBiz’s interest payment will not exceed its quarterly EBITDA,reduced by certain permitted deductions (as defined in the Credit Agreement),divided by a factor of 1.20. Interest on the Term Loan B notes will accrue at arate of LIBOR plus 4% and will be added quarterly to the outstanding principalamount of the Term Loan B notes and will be paid when OpBiz pays off the TermLoan B notes. OpBiz is also required to pay an annual administrative fee andcertain other fees and expenses of the lender under the Credit Agreement.

 

OpBiz is required to prepay amounts outstanding under the CreditAgreement:

 

•   with excess cash flow (as defined inthe Credit Agreement) after certain permitted cash reserves are accumulated;

 

•   in scheduled quarterly amountsbeginning after August, 31, 2006;

 

•   with certain amounts received inconnection with the development of the Timeshare Land adjacent to the DesertPassage (as defined in the underlying agreement);

 

•   with an amount equal to the differencebetween what should have been spent on renovation capital expenditures and whatwas actually spent thereon if (i) an aggregate amount of $72.0 million isnot spent on renovation capital expenditures by August 31, 2006, or (ii) anaggregate amount of $81.0 million is not spent on renovation capitalexpenditures by February 28, 2007 or (iii) an aggregate amount of$90.0 million is not spent on renovation capital expenditures byAugust 31, 2007; and

 

•   with the proceeds of certain assetsales.

 

In particular, after OpBiz accumulates certain permitted cash reserves,OpBiz is required to pay 100% of its excess cash flow (as defined in the CreditAgreement) from operations to the lenders under the Credit Agreement. Thatpercentage decreases to 75%, then 50%, if OpBiz meets certain targeted ratiosof total debt to EBITDA, or certain leverage ratios, for any two consecutivefiscal quarters.

 

The Credit Agreement includes covenants that, among other things,restrict OpBiz’s ability to sell assets, make distributions to its owners,other than distributions for taxes, incur or prepay additional indebtedness,enter into transactions with affiliates, incur liens, make investments, makecapital expenditures,****develop theTimeshare Land adjacent to the Desert Passage and enter into materialcontracts. In addition, OpBiz is required to maintain certain levels of EBITDAthat increase over time and, beginning August 31, 2007, maintain certainratios of EBITDA to interest expense that increase over time and maintaincertain leverage ratios that decrease over time.

 

The Credit Agreement contains customary events of default, including achange of control of OpBiz, the occurrence of a default under the terms of anyindebtedness of MezzCo, a default by OpBiz under the Hotel management contractor termination of Sheraton as the manager of the Hotel (unless OpBiz replacesSheraton with another approved manager within 30 days of such termination), adefault or termination of the Planet Hollywood license agreement and certaindefaults under the agreements with Boulevard Invest or Northwind Aladdin.

 

BH/REhas issued warrants to purchase 2.94% of its ownership interest in EquityCo tothe lenders under the Credit Agreement. The warrants can only be exercised uponthe occurrence of a (i) liquidity event or distribution (such as throughthe sale of the hotel/casino); (ii) a public sale of equity securities ofEquityCo, MezzCo or OpBiz; or (iii) payment in full of the obligationsunder the Credit Agreement. The warrants can either be settled in cash or inother membership interests upon exercise. The estimated fair value of thewarrants was approximately $0.1 million as of March 31, 2006. These warrantsare recorded separately from the related debt within other long-termliabilities.

 

*MezzanineFinancing*

 

In August 2004, MezzCo entered into the Mezzanine Financing with agroup of purchasers. Pursuant to the Mezzanine Financing, MezzCo issued $87million of 16% Senior Secured Subordinated Notes and warrants to purchase17,500 of its units representing membership interests equal to 17.5% of thefully diluted equity of MezzCo. The gross offering proceeds of the MezzanineFinancing were deposited into an escrow account and, in conjunction with theclosing of the Aladdin acquisition, were used to (i) pay approximately$16.1 million of fees and expenses related to the acquisition of the Aladdin,(ii) fund the $14 million lien release payment required under the CreditAgreement, and (iii) fund a portion of the planned renovations to theAladdin. The notes mature in August 2011 and accrue interest at a rate of16% per annum. Interest on the notes is payable-in-kind or, at the option ofMezzCo, in cash.

 

The warrants are exercisable at any time, subject to the approval ofthe Nevada gaming authorities, at a purchase price of $0.01 per unit. Subjectto the approval of the Nevada gaming authorities, the warrants may be exercisedto purchase either voting or non-voting membership interests of MezzCo or acombination thereof. Currently, all of MezzCo’s voting membership interests arerepresented by units owned by EquityCo. In addition to customary anti-dilutionprotections, the number of units representing MezzCo membership interestsissuable upon exercise of the warrants may be increased from time-to-time uponthe occurrence of certain events

 

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as described in the warrants. The maximum aggregate increase is 24%,following which the warrants would represent rights to purchase 41.5% of theunits representing the fully diluted equity of MezzCo. Holders of the warrantsand any securities issued upon exercise of the warrants may require MezzCo toredeem such securities commencing in August 2011 at a redemption pricebased upon a formula set forth in the warrants. Starting in August 2008, in theevent the Company fails to achieve certain operational thresholds, the holdersof the MezzCo warrants, and securities issued upon exercise thereof, have theright to assume control of MezzCo and OpBiz and conduct a sale of the equityof, or all or substantially all of the assets of, either MezzCo or OpBizprovided that all Control Conditions (as defined in the Investor RightsAgreement) are met. These rights are subject to (i) repayment in full ofall indebtedness that is senior to the notes (including all indebtedness ofOpBiz under the Credit Agreement), (ii) certain covenants related to OpBiz’sability to achieve targeted levels of EBITDA and (iii) the prior approvalof the Nevada gaming authorities. These rights expire upon completion of apublic offering by MezzCo or OpBiz. In connection with the Mezzanine Financing,our obligation to make expenditures on renovations to the Aladdin was increasedfrom $90 million, as required under the Credit Agreement, to $100 million.

 

As of March 31, 2006, the MezzCo financing was recorded net of theunamortized balance of the warrants of approximately $3.8 million. Theestimated fair value of the warrants was approximately $4.1 million at March31, 2006 and December 31, 2005, and is recorded separately from therelated debt within other long-term liabilities.

 

*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 Aladdin under a contract between Aladdin Gaming and Northwind. We haveassumed the energy service agreement, which expires in 2020. Under theagreement, we are 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$0.5 million per month.

 

***Forward Looking Statements***

 

When used in this report and elsewhere by management from time-to-time,the words “believes”, “anticipates” and “expects” and similar expressions areintended to identify forward-looking statements with respect to our financialcondition, results of operations and our business including our expansion,legal proceedings and employee matters. Certain important factors, includingbut not limited to, competition from other gaming operations, factors affectingour ability 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 our forward-looking statements. Further information onpotential factors which could affect our financial condition, results ofoperations and business including, without limitation, the expansion,development and acquisition projects, legal proceedings and employee mattersare included in our filings with the Securities and Exchange Commission. Pleaserefer to the discussion of  Risk Factorsin Item 1A of BH/RE’s Annual Report on Form 10-K, filed with the Securities andExchange Commission on March 31, 2006. Readers are cautioned not to place unduereliance on any forward-looking statements, which speak only as of the datethereof. We undertake no obligation to update information contained inforward-looking statements.

 

## **ITEM 3.** QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

## ** **

Market risk is the risk of loss arising from adverse changes in marketrates and prices, such as interest rates, foreign currency exchange rates andcommodity prices. Our primary exposure to market risk is interest rate riskassociated with our long-term debt. We pay interest on the outstanding TermLoan A notes quarterly, in cash, at the London Inter-Bank Offered Rate, orLIBOR, plus an applicable margin that increases over time. Interest on the TermLoan B notes will accrue at a rate of LIBOR plus 4% and will be added quarterlyto the outstanding principal amount of the Term Loan B notes and will be paidwhen we pay off the Term Loan B notes. An increase of one percentage point inthe average interest rate applicable to the variable rate debt outstanding at March31, 2006, would increase our annual interest expense for the remainder of 2006 byapproximately $3.8 million.

 

## **ITEM 4.** CONTROLS AND PROCEDURES

## ** **

Our management, with theparticipation of our principal executive and chief financial officer, hasevaluated 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 March 31, 2006.Based on their evaluation, our principal executive and principal financial officersconcluded that our disclosure controls and procedures were effective as of March 31,2006.

 

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 March 31, 2006,that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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# **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.    |

 

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**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.                         |
|--------------------|----------------------------------------|
|               |                                   |
|               |                                   |
| May 15,  2006 | By:                                    | /S/  Donna Lehmann |   |
|               | Donna  Lehmann                         |
|               | Treasurer  and Chief Financial Officer |

 

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**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.    |

 

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