Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

| **x** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|--------------------------------------------------------------------------------------------------------|

** **

**For thequarterly period ended September 30, 2008**

 

**OR**

** **

| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**For the transition period from                to                    **

 

**Commission File Number 000-50689**

 

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

(Exact Name of Registrant as Specified in its Charter)

 

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

 

**(702) 785-5555**

(Registrant’s Telephone Number, Including Area Code)

 

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Indicate by check mark whether the Registrant (1) has filed allreports required by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days.   Yes x    No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. (See definition of “accelerated filer,” “large accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act).

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

 

Indicate by check mark whether the Registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). 

Yes o  No x

 

 

 

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Tableof Contents

 

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

 

Index

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

 

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**PART I- FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

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

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(amounts in thousands)**

 
| ** **                                            | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                                  |       | **(unaudited)**              |       |                        |       |
| ASSETS                                                |       |                         |       |                        |       |
| Current assets:                                       |       |                         |       |                        |       |
| Cash and cash equivalents                             |       | $                            | 21,556     |                        | $          | 21,468 |   |
| Receivables, net                                      |       | 24,206                       |       | 26,920                      |       |
| Inventories                                           |       | 2,378                        |       | 1,729                       |       |
| Prepaid expenses                                      |       | 9,397                        |       | 7,487                       |       |
| Deposits and other current assets                     |       | 164                          |       | 216                         |       |
| Restricted cash and cash equivalents                  |       | 29,894                       |       | 32,008                      |       |
| Total current assets                                  |       | 87,595                       |       | 89,828                      |       |
|                                                  |       |                         |       |                        |       |
| Property and equipment, net                           |       | 581,424                      |       | 602,098                     |       |
| Restricted cash and cash equivalents                  |       | 14,062                       |       | 45,613                      |       |
| Land receivable                                       |       | 15,484                       |       | 19,728                      |       |
| Deferred income tax                                   |       | —                       |       | 172                         |       |
| Other assets, net                                     |       | 2,983                        |       | 9,629                       |       |
| Total assets                                          |       | $                            | 701,548    |                        | $          | 767,068 |   |
|                                                  |       |                         |       |                        |       |
| LIABILITIES  AND MEMBERS’ EQUITY (DEFICIT)       |       |                         |       |                        |       |
|                                                  |       |                         |       |                        |       |
| Current liabilities:                                  |       |                         |       |                        |       |
| Current portion of long-term debt                     |       | $                            | 1,944      |                        | $          | 1,785 |   |
| Accounts payable                                      |       | 4,180                        |       | 29,273                      |       |
| Accrued payroll and related                           |       | 12,936                       |       | 11,817                      |       |
| Accrued interest payable                              |       | 7,261                        |       | 8,182                       |       |
| Accrued taxes                                         |       | 2,835                        |       | 3,338                       |       |
| Accrued expenses                                      |       | 10,920                       |       | 9,422                       |       |
| Deposits                                              |       | 6,723                        |       | 6,476                       |       |
| Other current liabilities                             |       | 4,729                        |       | 6,493                       |       |
| Due to affiliates                                     |       | 1,961                        |       | 1,661                       |       |
| Total current liabilities                             |       | 53,489                       |       | 78,447                      |       |
|                                                  |       |                         |       |                        |       |
| Long-term debt, less current portion                  |       | 886,079                      |       | 887,545                     |       |
| Deferred income tax                                   |       | —                       |       | 172                         |       |
| Other long-term liabilities                           |       | 4,117                        |       | 4,117                       |       |
| Total liabilities                                     |       | 943,685                      |       | 970,281                     |       |
|                                                  |       |                         |       |                        |       |
| Commitments and contingencies                         |       |                         |       |                        |       |
|                                                  |       |                         |       |                        |       |
| Minority interest                                     |       | (22,111                      | )          | (16,272                     | )          |
|                                                  |       |                         |       |                        |       |
| Members’ equity (deficit):                       |       |                         |       |                        |       |
| Members’ equity                                  |       | 21,500                       |       | 21,500                      |       |
| Accumulated deficit                                   |       | (241,526                     | )          | (208,441                    | )          |
| Total members’ equity (deficit)                  |       | (220,026                     | )          | (186,941                    | )          |
| Total liabilities and members’ equity  (deficit) |       | $                            | 701,548    |                        | $          | 767,068 |   |

 

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

 

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

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(amounts in thousands)**

 
| ** **                          | ** ** | **Three Months  Ended  September 30,  2008** | ** ** | **Three Months  Ended  September 30,  2007** | ** ** |
|-------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
|                                |       |                                                   |       |                                                   |       |
| Operating revenues:                 |       |                                                   |       |                                                   |       |
| Casino                              |       | $                                                      | 31,054     |                                                   | $          | 26,373 |   |
| Hotel                               |       | 25,632                                                 |       | 22,113                                                 |       |
| Food and beverage                   |       | 13,187                                                 |       | 11,307                                                 |       |
| Other                               |       | 5,806                                                  |       | 2,228                                                  |       |
| Gross revenues                      |       | 75,679                                                 |       | 62,021                                                 |       |
| Promotional allowances              |       | (6,367                                                 | )          | (4,892                                                 | )          |
| Net revenues                        |       | 69,312                                                 |       | 57,129                                                 |       |
|                                |       |                                                   |       |                                                   |       |
| Operating costs and expenses:       |       |                                                   |       |                                                   |       |
| Casino                              |       | 19,463                                                 |       | 17,920                                                 |       |
| Hotel                               |       | 10,221                                                 |       | 10,263                                                 |       |
| Food and beverage                   |       | 9,530                                                  |       | 8,841                                                  |       |
| Other                               |       | 77                                                     |       | 307                                                    |       |
| Selling, general and administrative |       | 17,413                                                 |       | 21,745                                                 |       |
| Depreciation and amortization       |       | 8,971                                                  |       | 10,740                                                 |       |
|                                |       | 65,675                                                 |       | 69,816                                                 |       |
|                                |       |                                                   |       |                                                   |       |
| Operating income (loss)             |       | 3,637                                                  |       | (12,687                                                | )          |
|                                |       |                                                   |       |                                                   |       |
| Other income (expense):             |       |                                                   |       |                                                   |       |
| Interest expense, net               |       | (16,198                                                | )          | (18,881                                                | )          |
| Minority interest                   |       | 1,884                                                  |       | 4,735                                                  |       |
|                                |       | (14,314)                                               |       | (14,146                                                | )          |
|                                |       |                                                   |       |                                                   |       |
| Pre-tax loss                        |       | (10,677                                                | )          | (26,833                                                | )          |
| Provision for income taxes          |       | —                                                 |       | —                                                 |       |
| Net loss                            |       | $                                                      | (10,677    | )                                                      | $          | (26,833 | ) |

 

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

 

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

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(amounts in thousands)**

 
| ** **                          | ** ** | **Nine Months  Ended  September 30,  2008** | ** ** | **Nine Months  Ended  September 30,  2007** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
|                                |       |                                                  |       |                                                  |       |
| Operating revenues:                 |       |                                                  |       |                                                  |       |
| Casino                              |       | $                                                     | 94,367     |                                                  | $          | 76,636 |   |
| Hotel                               |       | 86,948                                                |       | 82,025                                                |       |
| Food and beverage                   |       | 41,225                                                |       | 35,787                                                |       |
| Other                               |       | 13,659                                                |       | 5,790                                                 |       |
| Gross revenues                      |       | 236,199                                               |       | 200,238                                               |       |
| Promotional allowances              |       | (20,668                                               | )          | (14,689                                               | )          |
| Net revenues                        |       | 215,531                                               |       | 185,549                                               |       |
|                                |       |                                                  |       |                                                  |       |
| Operating costs and expenses:       |       |                                                  |       |                                                  |       |
| Casino                              |       | 58,863                                                |       | 49,814                                                |       |
| Hotel                               |       | 31,551                                                |       | 32,616                                                |       |
| Food and beverage                   |       | 28,212                                                |       | 27,116                                                |       |
| Other                               |       | 1,125                                                 |       | 892                                                   |       |
| Selling, general and administrative |       | 57,425                                                |       | 61,434                                                |       |
| Depreciation and amortization       |       | 26,987                                                |       | 26,631                                                |       |
|                                |       | 204,163                                               |       | 198,503                                               |       |
|                                |       |                                                  |       |                                                  |       |
| Operating income (loss)             |       | 11,368                                                |       | (12,954                                               | )          |
|                                |       |                                                  |       |                                                  |       |
| Other income (expense):             |       |                                                  |       |                                                  |       |
| Interest expense, net               |       | (50,292                                               | )          | (54,317                                               | )          |
| Minority interest                   |       | 5,839                                                 |       | 10,093                                                |       |
|                                |       | (44,453                                               | )          | (44,224                                               | )          |
|                                |       |                                                  |       |                                                  |       |
| Pre-tax loss                        |       | (33,085                                               | )          | (57,178                                               | )          |
| Provision for income taxes          |       | —                                                |       | —                                                |       |
| Net loss                            |       | $                                                     | (33,085    | )                                                     | $          | (57,178 | ) |

 

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

 

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

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(amounts in thousands)**

 
| ** **                                                                   | ** ** | **Nine Months  Ended  September 30,  2008** | ** ** | **Nine Months  Ended  September 30,  2007** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
|                                                                         |       |                                                  |       |                                                  |       |
| Cash flows from operating activities:                                        |       |                                                  |       |                                                  |       |
| Net loss                                                                     |       | $                                                     | (33,085    | )                                                     | $          | (57,178 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                                  |       |                                                  |       |
| Depreciation and amortization                                                |       | 26,987                                                |       | 26,631                                                |       |
| Amortization of debt discount and issuance  costs                            |       | 6,343                                                 |       | 5,085                                                 |       |
| Minority interest                                                            |       | (5,839                                                | )          | (10,093                                               | )          |
| Changes in assets and liabilities:                                           |       |                                                  |       |                                                  |       |
| Restricted cash and cash equivalents                                         |       | 2,114                                                 |       | (10,408                                               | )          |
| Receivables, net                                                             |       | 2,714                                                 |       | 3,701                                                 |       |
| Inventories and prepaid expenses                                             |       | (2,559                                                | )          | (2                                                    | )          |
| Deposits and other current assets                                            |       | 52                                                    |       | 176                                                   |       |
| Due to affiliates                                                            |       | 300                                                   |       | 137                                                   |       |
| Accounts payable                                                             |       | (4,287                                                | )          | (1,223                                                | )          |
| Accrued payroll and related                                                  |       | 1,119                                                 |       | 2,475                                                 |       |
| Accrued expenses                                                             |       | 995                                                   |       | 2,122                                                 |       |
| Deposits and other current liabilities                                       |       | (1,517                                                | )          | (2,526                                                | )          |
| Accrued interest                                                             |       | (921                                                  | )          | 1,669                                                 |       |
| Long term deposits and other assets                                          |       | —                                                |       | 542                                                   |       |
| Long term receivable, land                                                   |       | 4,244                                                 |       | —                                                |       |
| Net cash used in operating activities                                        |       | (3,340                                                | )          | (38,892                                               | )          |
| Cash flows from investing activities:                                        |       |                                                  |       |                                                  |       |
| Purchases of property and equipment                                          |       | (26,673                                               | )          | (90,571                                               | )          |
| Restricted cash and cash equivalents                                         |       | 31,551                                                |       | 67,813                                                |       |
| Net cash provided by investing activities                                    |       | 4,878                                                 |       | (22,758                                               | )          |
| Cash flows from financing activities:                                        |       |                                                  |       |                                                  |       |
| Borrowings under Loan Agreement                                              |       | —                                                |       | 60,330                                                |       |
| Payments under CUP financing                                                 |       | (1,307                                                | )          | (1,166                                                | )          |
| Financing fees                                                               |       | (143                                                  | )          | —                                                |       |
| Net cash (used in) provided by financing  activities                         |       | (1,450                                                | )          | 59,164                                                |       |
| Cash and cash equivalents:                                                   |       |                                                  |       |                                                  |       |
| Increase (decrease) in cash and cash  equivalents                            |       | 88                                                    |       | (2,486                                                | )          |
| Balance, beginning of period                                                 |       | 21,468                                                |       | 25,640                                                |       |
| Balance, end of period                                                       |       | $                                                     | 21,556     |                                                  | $          | 23,154 |   |
|                                                                         |       |                                                  |       |                                                  |       |
| Supplemental cash flow disclosures:                                          |       |                                                  |       |                                                  |       |
| Cash paid for interest, net of capitalized  interest                         |       | $                                                     | 45,394     |                                                  | $          | 53,925 |   |
|                                                                         |       |                                                  |       |                                                  |       |
| Non-cash investing and financing  activities:                                |       |                                                  |       |                                                  |       |
| Sale of land to Westgate                                                     |       | $                                                     | —     |                                                  | $          | 29,500 |   |

 

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

 

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

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

##### ** **

##### **1.****                                      ORGANIZATION ANDBASIS 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 ownedindirectly by Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”).MezzCo, L.L.C. (“MezzCo”) is a wholly-owned subsidiary of EquityCo and each ofOpBiz, LLC (“OpBiz”) and PH Mezz II LLC (“PH Mezz II”) is a wholly ownedsubsidiary of MezzCo. PH Mezz I LLC (“PH Mezz I”), is a wholly owned subsidiaryof PH Mezz II. PH Fee Owner LLC (“PH Fee Owner”) is a wholly owned subsidiaryof PH Mezz I. TSP Owner LLC (“TSP Owner”) is a wholly owned subsidiary of PHFee Owner. PH Mezz II, PH Mezz I, PH Fee Owner and TSP Owner are Delawarelimited liability companies structured as bankruptcy remote special purposeentities which, together with OpBiz, own and operate the Planet HollywoodResort and Casino (the “PH Resort”). OpBiz is the licensed owner and operatorof the gaming assets and leases the casino space and hotel space together withall hotel assets from PH Fee Owner. TSP Owner was formed to hold the parcel ofland (the “Timeshare Parcel”) that was sold to Westgate Resorts, LLP, a Floridalimited partnership (“Westgate”) subject to the Timeshare Purchase Agreementbetween OpBiz and Westgate, dated December 10, 2004. 50% of BH/RE’s votingmembership interests are held by each of Robert Earl and Douglas P. Teitelbaum,and BH/RE’s equity membership interests are held 40.75% by BH Casino andHospitality LLC I (“BHCH I”), 18.50% by BH Casino and Hospitality LLC II (“BHCHII”) (together, “BHCH”) and 40.75% by OCS Consultants, Inc. (“OCS”).

 

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

 

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

 

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

######  

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

 

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

#####  

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

######  

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

 

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

 

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

######  

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

 

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

######  

The balance in current restricted cash and cash equivalentsat September 30, 2008 and December 31, 2007 was approximately $29.9million and $32.0 million, respectively, which consists of reserves requiredunder the Loan Agreement (as defined in Note 5 to the CondensedConsolidated Financial Statements) including a reserve for payment ofproperty taxes and insurance and a reserve for on-going furniture, fixture andequipment purchases or property improvements. Long-term restricted cash andcash equivalents consistof approximately $14.1 million and $45.6 million at September 30, 2008 andDecember 31, 2007, respectively, which includes a reserve for theremaining cash commitments for the on-going hotel room renovation project and areserve for interest shortfalls. The restricted cash related to the renovationincludes a contingency required by the Loan Agreement which will be released,in accordance with the terms of the Loan Agreement, upon completion of projectfunding.

 

###### *Accounts Receivable*

######  

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

 

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###### *Inventories*

######  

Inventories consist of food and beverage, retail merchandiseand operating supplies, and are stated at the lower of cost or market. Cost isdetermined by the first-in, first-out and specific identification methods.

 

###### *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 theCompany’s capitalization policy, are expensed as incurred. The Company hasestablished its capital expense policy to be reflective of its individualongoing repairs and maintenance programs. Gains or losses on dispositions ofproperty and equipment are included in the determination of income. Propertyand equipment are generally depreciated over the following estimated usefullives on a straight-line basis:

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

 

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

 

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

 

*DebtIssuance Costs*

 

Debt issuance costsincurred in connection with the issuance of long-term debt are capitalized andamortized to interest expense over the expected terms of the related debtagreements using the straight-line method, which approximates the effectiveinterest method, and are included in other assets on BH/RE’s consolidatedbalance sheets. Debt issuance costs, net of the related amortization,approximated $1.5 million and $7.7 million as of September 30, 2008 and December 31,2007, respectively.

 

*Intangible Assets*

 

In connection with thepurchase of the Aladdin, BH/RE recorded intangible assets, which consist of acustomer list and trade name. The customer list was valued at approximately$2.7 million at the time of purchase and at September 30, 2008 was fullyamortized. The trade name was valued at approximately $1.0 million at the timeof purchase and was fully amortized at September 30, 2008.   The customer list and trade name wereamortized using the straight-line method over a useful life of 4 years and 1.5years, respectively.  Amortizationexpense for the three months ended September 30, 2008 and 2007 wasapproximately $112,000 and $168,000, respectively.  Amortization expense for the nine monthsended September 30, 2008 and 2007 was approximately $447,000 and $503,000,respectively.

 

*Derivative Instruments and Hedging Activities*

 

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

 

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The terms of the LoanAgreement required the Company to enter into an interest rate cap agreement,which expires on November 30, 2008, to manage interest rate risk.  The Company is required to enter into a newinterest rate cap agreement when it exercises the first extension option of theLoan (see Note 5 – Long-Term Debt).  TheCompany did not apply cash flow hedge accounting to this instrument. Althoughthis derivative was not afforded cash flow hedge accounting, the Companyretained the instrument as protection against the interest rate risk associatedwith its long-term borrowings. The Company accounts for its derivative activityin accordance with SFAS No. 133 and accordingly, recognizes allderivatives on the balance sheet at fair value with any change in fair valuebeing recorded in interest income or expense in the accompanying consolidatedstatements of operations.

 

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

######  

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

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Rooms                                |       | $                                                    | 1,670      |                                                | $          | 1,087 |   | $ | 4,950 |   | $ | 2,967 |   |
| Food and Beverage                    |       | 2,138                                                |       | 2,429                                               |       | 6,731 |   | 6,731 |   |
| Other                                |       | 22                                                   |       | 9                                                   |       | 45 |   | 19 |   |
| Total cost of promotional allowances | ** ** | **$**                                                | **3,830**  | ** **                                          | **$**      | **3,525** | ** ** | **$** | **11,726** | ** ** | **$** | **9,717** | ** ** |

 

###### *Slot ClubProgram*

######  

The PH Resort’s slot clubmembers earn points based on gaming activity, which can be redeemed for cash. Aliability is recorded for the estimated cost of the outstanding points accruedunder the slot club program. The accrued slot club point liability wasapproximately $2.1 million and $1.8 million as of September 30, 2008 and December 31,2007, respectively.

 

*Advertising Costs*

 

Advertising costs are expensed as incurred and included in selling,general and administrative costs and expenses. Advertising costs totaledapproximately $1.4 million and $8.3 million for the three and nine months endedSeptember 30, 2008, respectively, and $2.0 million and $5.0 million forthe three and nine months ended September 30, 2007, respectively.

 

*IncomeTaxes*

 

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

 

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

 

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In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN48”) *“Accounting for Uncertainty in Income Taxes – aninterpretation of FASB No. 109”*, to clarify certain aspects ofaccounting for uncertain tax positions, including issues related to therecognition and measurement of those tax positions.  FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15,2006.  The Company adopted the provisionsof FIN 48 on January 1, 2007 as required. Further discussion regarding the adoption of FIN 48 can be found inNote 8 to the Condensed Consolidated Financial Statements.

 

*Membership Interests*

 

As of September 30, 2008, BH/RE’s membership interestshad not been unitized and BH/RE’s members do not presently intend to unitizethese membership interests. Accordingly, management of BH/RE has excludedearnings per share data required pursuant to SFAS No. 128, “*Earnings Per Share,*” because management believes that suchdisclosures would not be meaningful to the financial statement presentation.

 

*Reclassifications*

 

Certain reclassifications have been made to conform prior period datato the current presentation. These reclassifications had no effect on reportedincome.

 

*RecentlyIssued Accounting Pronouncements*

 

In September 2006, the FASB issued SFAS No. 157,*“Fair Value Measurements.”* SFAS 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements.  The provisions of SFAS 157 were effective forthe Company beginning January 1, 2008 for financial assets and liabilitiesand are effective January 1, 2009 for non-financial assets andliabilities.  The warrants the Companyhas issued to purchase 17.5% of the equity of MezzCo (see Note 5 – Long-TermDebt) qualify as a level three financial liability as there are no observablemarket inputs and there is no market activity for the instruments.  The changes in valuation of the warrants forthe period ended September 30, 2008 were not material to the Company’sfinancial position or operations.  Theinterest rate cap qualifies as a level two financial asset in accordance withSFAS 157.  The balance of the interestrate cap and changes in valuation for the period ended September 30, 2008were not material to the Company’s financial position or operations.

 

In February 2007, the FASB issued SFAS No. 159,*“The Fair Value Option for Financial Assets andFinancial Liabilities Including an Amendment of FASB Statement No. 115.”*SFAS No. 159 permits entities to choose to measure many financialinstruments and certain other items at fair value, with unrealized gains andlosses related to these financial instruments reported in earnings at eachsubsequent reporting date. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. The adoption of this statement on January 1,2008, did not have a material impact on the Company’s financial position,results of operations or cash flows.

 

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

 

In December 2007, the FASB issued SFAS No. 160,*“Noncontrolling Interest in Consolidated FinancialStatements, an amendment of ARB No. 51.”* This statementestablishes accounting and reporting standards for ownership interest insubsidiaries held by parties other than the parent and for the deconsolidationof a subsidiary. It also clarifies that a noncontrolling interest in asubsidiary is an ownership interest in the consolidated entity that should bereported as equity in the consolidated financial statements. SFAS No. 160changes the way the consolidated statement of operations is presented byrequiring consolidated net income to be reported at amounts that include theamount attributable to both the parent and the noncontrolling interests. Thestatement also establishes reporting requirements that provide sufficientdisclosures that clearly identify and distinguish between the interest of theparent and those of the noncontrolling owners. This statement is effective

 

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for fiscal years beginning on or after December 15, 2008. Theadoption of SFAS No. 160 is not expected to have a material impact on theCompany’s financial position, results of operations or cash flows.

 

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

 

In May 2008, FASB issued Statement No. 162, “*The Hierarchy of Generally Accepted Accounting Principles”*(“SFAS 162”). SFAS 162 identifies the sources of accountingprinciples and the framework for selecting the principles to be used in the preparationof financial statements of nongovernmental entities that are presented inconformity with GAAP (the GAAP hierarchy). SFAS 162 is effective60 days following the SEC’s approval of the Public Company AccountingOversight Board amendments to AU Section 411, The Meaning of PresentFairly in Conformity With Generally Accepted Accounting Principles. Theadoption of SFAS 162 is not expected to have a material impact on theCompany’s financial position, results of operations or cash flows.

 

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**3.****                                      RECEIVABLES**

 

Receivables consist of the following (in thousands):

 
| ** **                                 | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| Casino                                     |       | $                            | 13,611     |                        | $          | 18,322 |   |
| Hotel                                      |       | 8,562                        |       | 6,811                       |       |
| Land sale  receivable                      |       | 21,244                       |       | 25,373                      |       |
| Other                                      |       | 4,772                        |       | 3,248                       |       |
|                                       |       | 48,189                       |       | 53,754                      |       |
| Long-term portion  of land sale receivable |       | (15,484                      | )          | (19,728                     | )          |
| Allowance for  doubtful accounts           |       | (8,499                       | )          | (7,106                      | )          |
| Receivables, net                           |       | $                            | 24,206     |                        | $          | 26,920 |   |

 

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

 

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

 
| ** **                        | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| Land                              |       | $                            | 68,479     |                        | $          | 68,479 |   |
| Building and improvements         |       | 502,203                      |       | 502,584                     |       |
| Furniture, fixtures and equipment |       | 102,616                      |       | 104,253                     |       |
| Construction in progress          |       | 18,651                       |       | 10,767                      |       |
|                              |       | 691,949                      |       | 686,083                     |       |
| Accumulated depreciation          |       | (110,525                     | )          | (83,985                     | )          |
| Property and equipment, net       |       | $                            | 581,424    |                        | $          | 602,098 |   |

 

Depreciation expense wasapproximately $9.0 million and $27.0 million for the three and nine monthsended September 30, 2008, respectively, and $10.7 million and $26.6million for the three and nine months ended September 30, 2007,respectively.

 

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

 

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

 
| ** **                                        | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| $860 million Loan                                 |       | $                            | 860,000    |                        | $          | 860,000 |   |
| Northwind Aladdin obligation under capital  lease |       | 28,023                       |       | 29,330                      |       |
| Total long-term debt                              |       | 888,023                      |       | 889,330                     |       |
| Current portion of long-term debt                 |       | (1,944                       | )          | (1,785                      | )          |
| Total long-term debt, net                         |       | $                            | 886,079    |                        | $          | 887,545 |   |

 

***LoanAgreement***

* *

On November 30, 2006, OpBiz and PH FeeOwner (collectively the “Borrower”) entered into the Loan Agreement (the “LoanAgreement”) with Column Financial, Inc. (the “Lender”) for a mortgage loanin the principal amount of up to $820 million. The Loan Agreement providedfor an initial disbursement in the amount of $759.7 million and a futurefunding facility in the amount of up to $60.3 million. On July 17,2007, the Borrower and the Lender entered into an amendment (the “Amendment”)to the Loan Agreement. The Amendment provided for the immediate funding toBorrower of the balance of future funding that was available under the LoanAgreement and established an additional future funding facility in the amountof up to $40 million (“Future Funding Tranche B”). Future FundingTranche B has the same terms as the Loan Agreement for maturity andextension. The Loan Agreement, as amended by the Amendment, is referred to asthe Loan. The Loan is secured by a deed of trust on the PH Resort and a pledge,subject to approval by the Nevada gaming authorities, by MezzCo of itsmembership interest in OpBiz (as described below).

 

The initial maturity date of the Loan is December 9,2008 with three one year extension options available, subject to payment of afee and the Borrower’s compliance with the requirements for an extensionoutlined in the Loan Agreement. Interest on the Loan is payable monthly andaccrues at the 30 day LIBOR rate (2.488% for the September 30, 2008interest payment) plus 3.25% with a .25% ticking fee on available butun-advanced future funding. Interest on Future Funding Tranche B ispayable monthly and accrues at the 30 day LIBOR rate plus 7.50% with a 1.50%ticking fee on available but un-advanced funds. The Loan does not requireamortization during the initial term or, provided certain EBITDA thresholds aremet, during the extension periods. The Loan requires that the Borrowerestablish and maintain certain reserves including a reserve for completion ofthe renovation project, a reserve for projected interest shortfalls, a reservefor payment of property taxes and insurance and a reserve for on-goingfurniture, fixture and equipment purchases or property improvements. The Loanrestricts the Borrower’s ability to spend excess cash flow until certain debtservice coverage ratios are met.

 

The Borrower has given the Lender notice ofits intention to exercise the first of three available one year extensionoptions outlined in the Loan Agreement. In connection with the exercise of the extension options, the Borrowermust comply with certain requirements outlined in the Loan Agreement including (i) certificationthat there is no event of default (ii) replacement of the interest ratecap agreement expiring on November 30, 2008 (iii) payment of anextension fee (applicable to the second and third extension periods only) (iv) paymentof Lender’s reasonable out-of-pocket expenses associated with the extension and(v) deposit of additional funds into the interest shortfall reserve accountsufficient to result in a debt service coverage ratio for the extension term ofat least 1.10:1.00.  To the extent thatthe property generates excess cash flow (as defined in the Loan Agreement) anddoes not meet certain EBITDA thresholds during the extension periods, theexcess cash flow will be held in reserve for amortization of the Loan oradditional security for the Lender.  Theinterest reserve of $11 million is included in long-term restricted cash and cashequivalents in the accompanying financial statements and the Company does notanticipate the need to increase the amount of this reserve in connection withthe extension of the Loan.  Since theCompany intends to exercise the first extension option, The Loan is classifiedas a non-current liability in the accompanying financial statements.

 

Using the proceeds from the Loan, all amountsoutstanding under the Credit Agreement, dated August 31, 2004, amongOpBiz, the lenders named therein and The Bank of New York, Asset SolutionDivision (the “Senior Agent”) were paid in full. Pursuant to the terms of theCredit Agreement, upon repayment of all amounts due, the warrant to purchase2.5% of the equity in EquityCo issued to the lenders at the closing of theCredit Agreement became exercisable. The Company

 

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compensated the holders of all unexercised warrants in accordance withthe terms of a letter agreement between the parties and the warrants werecanceled.

 

In order to permit the Lender to foreclose onthe Hotel and Casino separately and to allow OpBiz to continue to operate theCasino after such a foreclosure (should the Lender choose to do so), title to thereal property comprising the Hotel and Casino (the “Property”) was transferredfrom OpBiz to PH Fee Owner. OpBiz and PH Fee Owner then entered into a leasepursuant to which OpBiz agreed to continue to operate the Hotel in the mannerit had been and to pay monthly rent of approximately $917,000. OpBiz and PH FeeOwner also entered into a lease pursuant to which OpBiz agreed to continue tooperate the Casino in the manner it had been and to pay monthly rent ofapproximately $1,167,000.

 

In connection with the Loan, the Lenderrequired that Trophy Hunter Investments, Ltd., Bay Harbour 90-1, Ltd.and Bay Harbour Master Ltd., which are affiliates of Bay HarbourManagement, execute and deliver a certain Guaranty (as defined below). Inexchange for Trophy Hunter Investments, Ltd., Bay Harbour 90-1 Ltd. andBay Harbour Master Ltd. (the “Guarantors”) executing the Guaranty, OpBizand PH Fee Owner agreed to pay to Trophy Hunter Investments, Ltd. and BayHarbour Master Ltd. a fee equal to $1,500,000 per year. The fee is accruedand only payable once OpBiz hits certain debt service coverage ratios definedin the Loan Agreement.

 

In connection with the Loan, the Guarantorsentered into a Guaranty, dated November 30, 2006 (the “Guaranty”),pursuant to which the Guarantors agreed to indemnify the Lender against lossesrelated to certain prohibited actions of the Borrower and guarantied fullrepayment of the Loan in the case of a voluntary or collusive bankruptcy of theBorrower, a transfer of the Property or interests in the Borrower in violationof the Loan Agreement and if the Borrower fails to maintain its status as abankruptcy remote entity and as a result sees its assets consolidated withthose of an affiliate in a bankruptcy. The liability of the Guarantors is cappedat $15,000,000 per entity and $30,000,000 in the aggregate, however this capdoes not apply to (i) liability arising from events, acts or circumstancesactually committed or brought about by the willful acts of any of theGuarantors and (ii) the extent of any benefit received by any of theGuarantors as a result of the acts giving rise to the liability under theGuaranty. Each of Douglas Teitelbaum and Robert Earl executed and deliveredguaranties substantially the same as that delivered by the Guarantors, howeverthe liability of each of them was limited to (i) liability arising fromevents, acts or circumstances actually committed or brought about by willfulacts by him and (ii) the extent of any benefit received by him as a resultof the acts giving rise to the liability under the Guaranty.

 

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

 

In addition, in connection with the LoanAgreement, MezzCo effected a refinancing of the Securities Purchase Agreement,dated August 9, 2004, among MezzCo and the Investors (the “RestructuringParties”), pursuant to which MezzCo issued to the Investors (i) 16% seniorsubordinated secured Notes in the original aggregate principal amount of$87 million, and (ii) Warrants for the purchase (subject to certainadjustments as provided for therein) of membership interests of MezzCo,representing 17.5% of its fully diluted equity. Loan proceeds were used toredeem in full the Notes.

 

In connection with the refinancing of theSecurities Purchase Agreement and redemption of the Notes, the RestructuringParties entered into the Restructuring Agreement, dated November 30, 2006,pursuant to which the Restructuring Parties terminated in full the SecuritiesPurchase Agreement, the Subordination Agreement, dated as of August 31,2004, among MezzCo, OpBiz, the Senior Agent and the Investors, the PledgeAgreement, dated August 9, 2006, among MezzCo and the Collateral Agent,and the Guaranty, dated August 9, 2004, made by OpBiz to the Investors,and amended certain other existing agreements, as described below.

 

In accordance with the terms of theRestructuring Agreement, the Investors and EquityCo, MezzCo and OpBiz enteredinto a Release, Consent and Waiver Agreement, pursuant to which the Investors (i) releasedOpBiz from its guaranteed obligations, under that certain Guaranty Agreement,dated as of August 9, 2004 and executed by OpBiz in favor of the Investorsand the Collateral Agent; (ii) released MezzCo from its pledge of thecollateral, under that certain Pledge Agreement, dated as of August 9,2004, and executed by MezzCo in favor of the Collateral Agent, the Investorsreleased their security interest, as defined in that certain SecurityAgreement, as amended by that certain Amendment to Security Agreement, in eachcase dated as of August 9, 2004 and executed by the Company in favor ofthe Collateral Agent; (iii) released and terminated the Deed of Trust,dated as of August 9, 2004 and executed by MezzCo in favor of the Trustee

 

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(as defined therein) for the benefit of the Collateral Agent; (iv) releasedand terminated the Investors’ security interest in the securities account,provided for that certain Securities Account Control Agreement, dated as of August 9,2004 and executed by the Company, the Collateral Agent and Wells Fargo Bank,N.A.

 

Additionally, MezzCo, EquityCo, and theInvestors entered into an Amended and Restated Investor Rights Agreement, datedNovember 30, 2006 (the “A&R Investor Rights Agreement”), to amend andrestate the original Investor Rights Agreements among the parties thereto,dated August 9, 2004.

 

Pursuant to the Restructuring Agreement, theRestructuring Parties agreed to amend the Warrants by issuing Amended andRestated Warrants to Purchase Membership Interests of MezzCo (the “A&RWarrants”) to the Investors upon approval by the Nevada gaming authorities. TheA&R Warrants will be 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 through the expiration date of December 9, 2012. Inaddition to customary anti-dilution protections, the number of unitsrepresenting MezzCo membership interests issuable upon exercise of the A&RWarrants may be increased from time to time upon the occurrence of certainevents as described in the A&R Warrants. Holders of the A&R Warrantsand any securities issued upon exercise thereof may require MezzCo to redeemsuch securities commencing on December 9, 2011 at a redemption price basedupon a formula set forth in the A&R Warrants. These rights expire uponcompletion of a public offering by MezzCo or OpBiz.

 

In connection with the RestructuringAgreement, EquityCo entered into a Guaranty Agreement, dated November 30,2006 (the “Guaranty Agreement”), in favor of the Investors and the CollateralAgent, pursuant to which EquityCo has guaranteed the obligation of MezzCo topay the redemption price under the A&R Warrants prior to expiration and anyindebtedness arising under the Put Note (as defined in the A&R Warrants).

 

EquityCo and the Collateral Agent alsoentered into a Pledge Agreement, dated November 30, 2006 (the “PledgeAgreement”), pursuant to which EquityCo has, subject to approval of the Nevadagaming authorities, pledged and granted a first priority security interest tothe Collateral Agent for the ratable benefit of the Investors in the membershipinterests of EquityCo in MezzCo. The Pledge Agreement, once approved, willsecure the full payment of the Put Right (as defined in the A&R Warrants),including any obligations under the Put Note.

 

On November 30, 2006, MezzCo enteredinto an Indemnification Agreement with the Investors, pursuant to which MezzCoagreed to indemnify the Investors for any losses caused by (i) lack ofgaming approvals for the issuance of the A&R Warrants, (ii) lack ofgaming approval for the granting of a lien by EquityCo in the equity interestsin MezzCo, as described in the Pledge Agreement, and (iii) the inabilityof the Investors to exercise the Warrants until July 1, 2007.

 

***Energy ServicesAgreement***

*** ***

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

 

**6.****             MEMBERSHIPINTERESTS**

 

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

 

BH/RE owns 85% of the membership interests in EquityCo and Starwoodowns 15%. MezzCo is a wholly owned

 

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subsidiary ofEquityCo, and OpBiz is a wholly owned subsidiary of MezzCo. BH/RE and Starwoodmade total equity contributions of $20 million each in EquityCo to fund aportion of the costs of the renovation of the property. Starwood’s equityinterest in EquityCo is reflected as minority interest in the accompanyingcondensed consolidated financial statements. BH/RE recorded minority interestincome related to the Starwood interests of approximately $1.9 million and $4.7million for the three months ended September 30, 2008 and 2007,respectively, and $5.8 million and $10.1 million for the nine months ended September 30,2008 and 2007, respectively.

 

BH/RE has the option to purchase all of Starwood’s membership interestsin EquityCo if OpBiz is entitled to terminate the hotel management contractbetween OpBiz and Sheraton as a result of a breach by Sheraton. Starwood canrequire EquityCo to purchase all of its membership interests in EquityCo if thehotel management contract is terminated for any reason other than in accordancewith its terms or as the result of a breach by Sheraton. In addition, BH/RE andStarwood entered into a registration rights agreement with respect to their membershipinterests in EquityCo.

 

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

 

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

 

There is $0.1 million of compensation cost,which approximated fair value, related to non-qualified stock optionsrecognized in operating results (included in selling, general andadministrative expenses) for each of the three and nine month periods ended September 30,2008 and 2007.

 

The fair value of each option award isestimated on the date of grant using the Black-Scholes-Merton option pricingmodel. Expected volatility is based on historical volatility trends as well asimplied future volatility observations. In determining the expected life of theoption grants, the Company used historical data to estimate option exercise andemployee termination behavior. The expected term represents an estimate of thetime options are expected to remain outstanding. The risk-free interest ratefor periods within the contractual life of the option is based on the U.S.treasury yield curve in effect at the time of grant. The following table setsforth the assumptions used to determine compensation cost for the Company’snon-qualified stock options consistent with the requirements of SFAS No. 123(R).

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

 

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

 

***Planet HollywoodLicensing Agreement***

*** ***

OpBiz, Planet Hollywoodand certain of Planet Hollywood’s subsidiaries have entered into a licensingagreement pursuant to which OpBiz received a non-exclusive, irrevocable licenseto use various “Planet Hollywood” trademarks and service marks. Under thelicensing agreement, OpBiz also has the right, but not the obligation, to opena Planet Hollywood restaurant and one or more Planet Hollywood retail shopsunder a  separate restaurant agreementwith Planet Hollywood. OpBiz pays Planet Hollywood a quarterly licensing fee of1.75% of OpBiz’s non-casino revenues. The initial term of the licensingagreement will expire in 2028. OpBiz can renew the licensing agreement forthree successive 10-year terms. The property officially began operation as thePH Resort on April 17, 2007 and began paying fees pursuant to thelicensing agreement as of that date. Licensing fees paid to Planet Hollywoodtotaled approximately $0.7 million and $2.3 million for the three and ninemonths ended September 30, 2008, respectively, and $0.6 million and $1.2million for the three and nine months ended September 30, 2007.

 

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

 

***Sheraton HotelManagement Contract***

*** ***

OpBiz and Sheraton haveentered into a management contract pursuant to which Sheraton provides hotel managementservices to OpBiz, assists OpBiz in the management, operation and promotion ofthe 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 commencing on the completion of the Aladdin acquisition and is subject tocertain 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. Management fees paid to Starwood totaled approximately $2.2 millionand $2.0 million for the three months ended September 30, 2008 and 2007,respectively, and $7.4 million and $7.1 million for the nine months ended September 30,2008 and 2007, respectively.

 

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

*** ***

OpBiz and PlanetHollywood (LV) LLC (“Planet Hollywood LV”) have entered into a lease agreementpursuant to which Planet Hollywood LV, as tenant, operates a new concept it hasdeveloped for an upscale 24-hour diner named “Planet Dailies” withinapproximately 11,500 square feet of space located on the premises owned byOpBiz. Planet Hollywood LV pays OpBiz base rent in the amount of $500,000 peryear (subject to annual increase adjustments), in addition to percentage rentof up to 12% based on annual gross sales (to the extent such percentage rentexceeds base rent). The initial term of the lease agreement will expire in2017. Planet Hollywood LV can renew the lease agreement for two successive5-year terms.  Planet Dailies began operationon April 1, 2007 and began paying rent pursuant to the lease agreement asof that date. Rent received from Planet Dailies totaled approximately $0.1million and $0.3 million for the three and nine months ended September 30,2008, and $0.1 million for the three and nine months ended September 30,2007.

 

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

 

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

*** ***

OpBiz and Earl ofSandwich (Las Vegas), LLC (“Earl of Sandwich”) have entered into a leaseagreement pursuant to which Earl of Sandwich, as tenant, operates a restaurantnamed “Earl of Sandwich” within approximately 3,030 square feet of spacelocated on the premises owned by OpBiz. Earl of Sandwich pays OpBiz base rentin the amount of $161,600 per year (subject to annual increase adjustments), inaddition to percentage rent of up to 12% based on annual gross sales (to theextent such percentage rent exceeds base rent). The initial term of the leaseagreement will expire in 2017. Earl of Sandwich can renew the lease agreementfor two successive 5-year terms. Earl of Sandwich began operation in September 2007and began paying rent pursuant to the lease agreement as of that date. Rentreceived from Earl of Sandwich totaled approximately $100,000 and $300,000 forthe three and nine months ended September 30, 2008, and $5,000 for themonth of September 2007.

 

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

 

***Guaranty Agreement***

*** ***

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

 

***Aircraft Charter Arrangements***

 

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

 

**8.****                                      INCOMETAXES**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

######  

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

 

***Employment Agreements***

*** ***

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

 

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## **ITEM 2.****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

##  

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

######  

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

 

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

 

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

######  

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

######  

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

 

###### *Propertyand Equipment*

######  

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

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

 

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

 

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

 

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*Derivative Instruments andHedging Activities*

 

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

 

The terms of the LoanAgreement required the Company to enter into an interest rate cap agreement,which expires on November 30, 2008, to manage interest rate risk. TheCompany is required to enter into a new interest rate cap agreement when itexercises the first extension option of the Loan. The Company did not apply cashflow hedge accounting to this instrument. Although this derivative was notafforded cash flow hedge accounting, the Company retained the instrument asprotection against the interest rate risk associated with its long-termborrowings. The Company accounts for its derivative activity in accordance withSFAS No. 133 and accordingly, recognizes all derivatives on the balancesheet at fair value with any change in fair value being recorded in interestincome or expense in the accompanying consolidated statements of operations.

 

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

######  

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

 

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

 

*Income Taxes*

 

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

 

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

 

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

 

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*Membership Interests*

 

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

 

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

 

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

 

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

######  

In September 2006, the FASB issued SFAS No. 157,*“Fair Value Measurements.”* SFAS 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements.  The provisions of SFAS 157 were effective forthe Company beginning January 1, 2008 for financial assets and liabilitiesand are effective January 1, 2009 for non-financial assets andliabilities.  The warrants the Companyissued to purchase 17.5% of the equity of MezzCo (see Note 5 – Long-Term Debt)qualify as a level three financial liability as there are no observable marketinputs and there is no market activity for the instruments.  The changes in valuation of the warrants forthe period ended September 30, 2008 were not material to the Company’sfinancial position or operations.  Theinterest rate cap qualifies as a level two financial asset in accordance withSFAS 157.  The balance of the interestrate cap and changes in valuation for the period ended September 30, 2008were not material to the Company’s financial position or operations.

 

In February 2007, the FASB issued SFAS No. 159,*“The Fair Value Option for Financial Assets andFinancial Liabilities Including an Amendment of FASB Statement No. 115.”*SFAS No. 159 permits entities to choose to measure many financialinstruments and certain other items at fair value, with unrealized gains andlosses related to these financial instruments reported in earnings at eachsubsequent reporting date. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. The adoption of this statement on January 1,2008, did not have a material impact on the Company’s financial position,results of operations or cash flows.

 

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

 

In December 2007, the FASB issued SFAS No. 160,*“Noncontrolling Interest in Consolidated FinancialStatements, an amendment of ARB No. 51.”* This statementestablishes accounting and reporting standards for ownership interest insubsidiaries held by parties other than the parent and for the deconsolidationof a subsidiary. It also clarifies that a noncontrolling interest in asubsidiary is an ownership interest in the consolidated entity that should bereported as equity in the consolidated financial statements. SFAS No. 160changes the way the consolidated statement of operations is presented byrequiring consolidated net income to be reported at amounts that include theamount attributable to both the parent and the

 

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noncontrolling interests. The statement also establishes reportingrequirements that provide sufficient disclosures that clearly identify anddistinguish between the interest of the parent and those of the noncontrollingowners. This statement is effective for fiscal years beginning on or after December 15,2008. The adoption of SFAS No. 160 is not expected to have a materialimpact on the Company’s financial position, results of operations or cashflows.

 

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

######  

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

 

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

######  

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

 
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Percent** | ** ** | **Nine Months Ended  September 30,** | ** ** | **Percent** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-------------|------------|-----------------------------------------------------|------------|-------------|------------|
| ** **                         | ** ** | **2008**                                             | ** ** | **2007**    | ** ** | **Change**                                          | ** ** | **2008**    | ** ** | **2007** | ** ** | **Change** | ** ** |
| Net Revenues                       |       | $                                                    | 69,312     |        | $          | 57,129                                              |       | 21.3        | %          | $ | 215,531 |   | $ | 185,549 |   | 16.2 | % |
| Operating Expenses:                |       |                                                 |       |        |       |                                                |       |        |       |   |   |   |   |
| Casino                             |       | 19,463                                               |       | 17,920      |       | 8.6                                                 | %          | 58,863      |       | 49,814 |   | 18.2 | % |
| Hotel                              |       | 10,221                                               |       | 10,263      |       | (0.4                                                | )%         | 31,551      |       | 32,616 |   | (3.3 | )% |
| Food and Beverage                  |       | 9,530                                                |       | 8,841       |       | 7.8                                                 | %          | 28,212      |       | 27,116 |   | 4.0 | % |
| Other                              |       | 77                                                   |       | 307         |       | (74.9                                               | )%         | 1,125       |       | 892 |   | 26.1 | % |
| Selling, general and adminstrative |       | 17,413                                               |       | 21,745      |       | (19.9                                               | )%         | 57,425      |       | 61,434 |   | (6.5 | )% |
| Depreciation and amortization      |       | 8,971                                                |       | 10,740      |       | (16.5                                               | )%         | 26,987      |       | 26,631 |   | 1.3 | % |
| Operating (Loss) Income            |       | $                                                    | 3,637      |        | $          | (12,687                                             | )          | 128.7       | %          | $ | 11,368 |   | $ | (12,954 | ) | 187.7 | % |

 

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Net revenues for thethree and nine months ended September 30, 2008 increased when compared tothe three and nine months ended September 30, 2007. The property was underrenovation until late 2007 so when comparing the three and nine month periodsended September 30, 2008 to the same three and nine month periods in 2007,revenues and operating income have increased in all divisions.  While the operating results have improved asa result of the completion of the renovation, we also believe that our revenuesfor the three and nine months ended September 30, 2008 have beennegatively impacted by the weakened United States economy. Disruptions in thehousing and stock markets, high travel costs, along with declines in the LasVegas market due to decreased visitor volume and lower customer spending pertrip have and may continue to adversely impact our revenues.  We have and will continue to aggressivelymonitor and reduce expenses to maintain and improve operating margins during2008.

 

The following table highlights the varioussources of our revenues and expenses for the three and nine months ended September 30,2008 and 2007, respectively (dollars in thousands, unaudited).

 
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Percent** | ** ** | **Nine months ended  September 30,** | ** ** | **Percent** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------|------------|-----------------------------------------------------|------------|-------------|------------|
| ** **                                    | ** ** | **2008**                                             | ** ** | **2007**    | ** ** | **Change**                                          | ** ** | **2008**    | ** ** | **2007** | ** ** | **Change** | ** ** |
| Casino revenues                               |       | $                                                    | 31,054     |        | $          | 26,373                                              |       | 17.7        | %          | $ | 94,367 |   | $ | 76,636 |   | 23.1 | % |
| Casino expenses                               |       | 19,463                                               |       | 17,920      |       | 8.6                                                 | %          | 58,863      |       | 49,814 |   | 18.2 | % |
| *Margin*                                      | * *   | *37.3*                                               | *%*        | *32.1*      | *%*        | * *                                            | * *   | *37.6*      | *%*        | *35.0* | *%* | * * | * * |
| Hotel revenues                                |       | $                                                    | 25,632     |        | $          | 22,113                                              |       | 15.9        | %          | $ | 86,948 |   | $ | 82,025 |   | 6.0 | % |
| Hotel expenses                                |       | 10,221                                               |       | 10,263      |       | (0.4                                                | )%         | 31,551      |       | 32,616 |   | (3.3 | )% |
| *Margin*                                      | * *   | *60.1*                                               | *%*        | *53.6*      | *%*        | * *                                            | * *   | *63.7*      | *%*        | *60.2* | *%* | * * | * * |
| Food and beverage revenues                    |       | $                                                    | 13,187     |        | $          | 11,307                                              |       | 16.6        | %          | $ | 41,225 |   | $ | 35,787 |   | 15.2 | % |
| Food and beverage expenses                    |       | 9,530                                                |       | 8,841       |       | 7.8                                                 | %          | 28,212      |       | 27,116 |   | 4.0 | % |
| *Margin*                                      | * *   | *27.7*                                               | *%*        | *21.8*      | *%*        | * *                                            | * *   | *31.6*      | *%*        | *24.2* | *%* | * * | * * |
| Other revenues                                |       | $                                                    | 5,806      |        | $          | 2,228                                               |       | 160.6       | %          | $ | 13,659 |   | $ | 5,790 |   | 135.9 | % |
| Other expenses                                |       | 77                                                   |       | 307         |       | (74.9                                               | )%         | 1,125       |       | 892 |   | 26.1 | % |
| *Margin*                                      | * *   | *98.7*                                               | *%*        | *86.2*      | *%*        | * *                                            | * *   | *91.8*      | *%*        | *84.6* | *%* | * * | * * |
| Selling, general and administrative  expenses |       | $                                                    | 17,413     |        | $          | 21,745                                              |       | (19.9       | )%         | $ | 57,425 |   | $ | 61,434 |   | (6.5 | )% |
| *% of revenue*                                | * *   | *23.0*                                               | *%*        | *35.1*      | *%*        | * *                                            | * *   | *24.3*      | *%*        | *30.7* | *%* | * * | * * |

 

*Casino*

 

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

 

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

 

Casino revenues increased 17.7% to $31.1million for the three months ended September 30, 2008, as compared to$26.4 million for the three months ended September 30, 2007. Table gamesrevenue for the three months ended September 30, 2008 increased byapproximately $2.1 million as compared to the three months ended September 30,2007. Table drop for the three months ended September 30, 2008 increased$15.2 million or 28.2% when compared to the same three month period in theprior year, which is attributable to the completion of the renovation projectand addition of amenities to attract casino customers.  Table win percentage for the three monthsended September 30, 2008 was approximately 2.5% lower than the same threemonth period in the prior year. Slot revenue for the three months ended September 30,2008 increased approximately $4.2 million when compared to the same three monthperiod in the prior year. Slot handle for the three months ended September 30,2008 increased $15.6 million or 6.6% when compared to the same three monthperiod in the prior year. With the renovation project complete, all entrywaysto the casino are open and the number of slots on the floor has increased by anaverage of 170 machines when compared to the three months ended September 30,2007.  Combined revenues from the raceand sports book, poker and keno for the three months ended September 30,2008 increased by $0.2 million or 22.3% when compared to the three month periodended September 30, 2007.

 

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Casino expenses increased 8.6% to $19.5million for the three months ended September 30, 2008, as compared to$17.9 million for the three months ended September 30, 2007. Operatingmargin increased 5.2% when comparing the same three month periods. Expensesincreased commensurate with the revenue increases in the casino while operatingmargins improved over prior year.

 

Casino revenues increased 23.1% to $94.4million for the nine months ended September 30, 2008, as compared to $76.6million for the nine months ended September 30, 2007.  Table games revenue for the nine months endedSeptember 30, 2008 increased by approximately $7.7 million as compared tothe nine months ended September 30, 2007. Table games drop increasedapproximately 42.9% for the nine month period ended September 30, 2008when compared to the same nine month period in prior year. Overall table winpercentage decreased by 2.5% when compared to the same nine month period inprior year. Slot revenue for the nine months ended September 30, 2008increased approximately $12.1 million when compared to the same nine monthperiod in prior year. Slot handle increased approximately 19.0% for the ninemonth period ended September 30, 2008 when compared to the same nine monthperiod in prior year. The renovation project was complete at the end of 2007and the average number of slot machines on the floor has increased 280 deviceswhen comparing this year to last. Combined revenues from the race and sports book, poker and kenoincreased by $0.7 million or 28.9% when compared to the nine month period endedSeptember 30, 2007. The increases in casino revenue is attributed to thecompletion of the renovation project and the improvement of entryways from LasVegas Boulevard and the mall.  The gamingfloor is now fully operational with a full compliment of amenities.

 

Casino expenses increased 18.2% to $58.9million for the nine months ended September 30, 2008, as compared to $49.8million for the nine months ended September 30, 2007. Operating marginincreased 2.6% when comparing the same nine month periods.

 

*Hotel*

 

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

 

Hotel revenues of $25.6 million for the threemonths ended September 30, 2008 were 15.9% higher than the three monthsended September 30, 2007. Hotel occupancy decreased 1.6% to 95.0% whencompared to the same three month period in the prior year. Average daily roomrates increased to $123 for the three months ended September 30, 2008compared to $114 for the three months ended September 30, 2007.  The final phase of the room renovation isunderway which is the primary driver of the reduction in occupancy.

 

Hotel expenses decreased 0.4% to $10.2million for the three months ended September 30, 2008, as compared to$10.3 million for the three months ended September 30, 2007. Operatingmargin increased 6.5% for the three month period ended September 30, 2008when compared to the same three month period in the previous year.

 

Hotel revenues of $87.0 million for the ninemonths ended September 30, 2008, were 6.0% higher than the nine monthsended September 30, 2007. Hotel occupancy percentage was 95.5% for thenine months ended September 30, 2008, as compared to 97.6% for the ninemonths ended September 30, 2007. Average daily room rates increased to$136 for the nine months ended September 30, 2008, as compared to $127 forthe nine months ended September 30, 2007.

 

Hotel expenses decreased 3.3% to $31.6million for the nine months ended September 30, 2008, as compared to $32.6million for the nine months ended September 30, 2007. Operating marginincreased 3.5 percentage points over the same nine month period.

 

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*Food and Beverage*

 

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

 

Food and beverage revenues increased 16.6% to$13.2 million for the three months ended September 30, 2008, as comparedto $11.3 million for the three months ended September 30, 2007. Foodrevenue increased $0.8 million when compared to the same three month period inthe previous year.  The PH Resortoperates Starbucks, the buffet, room service, the pool cafe and banquets withall remaining food outlets leased to third party operators.  Beverage revenue increased $0.8 million whencompared to the same three month period in the previous year due to thecompletion of the renovation project and all beverage outlets being fullyoperational in 2008.

 

Food and beverage expenses increased 7.8% to$9.5 million for the three months ended September 30, 2008, as compared to$8.8 million for the three months ended September 30, 2007. Operatingmargin increased 5.9% when compared to the same three month period in previousyear. The expense increase and operating margin increase is consistent with thetransition from in-house food operations to leased outlets operated by thirdparties.

 

Food and beverage revenues increased 15.2% to$41.2 million for the nine months ended September 30, 2008, as compared tothe $35.8 million for the nine months ended September 30, 2007.

 

Food and beverage expenses increased 4.0% to$28.2 million for the nine months ended September 30, 2008, as compared to$27.1 million for the nine months ended September 30, 2007. Food andbeverage margins increased 7.4 percentage points in comparing the same ninemonth periods.

 

*Other*

 

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

 

Other revenues increased 160.6% to $5.8million for the three months ended September 30, 2008, as compared to $2.2million for the three months ended September 30, 2007, and increased135.9% to $13.7 million for the nine months ended September 30, 2008, ascompared to $5.8 million for the nine months ended September 30, 2007. Theincrease in other revenue is primarily due to the increase in the amountreceived from Westgate based on sales of timeshare units. Westgate pays OpBiz9% of total timeshare sales on a monthly basis with 50% of the proceedsrecorded as tenant income and the remaining 50% recorded against landreceivable.

 

Other expenses decreased 74.9% to $0.1million for the three months ended September 30, 2008, as compared to $0.3million for the three months ended September 30, 2007 and increased 26.1%to $1.1 million for the nine months ended September 30, 2008, as comparedto $0.9 million for the nine months ended September 30, 2007.

 

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

 

SG&A expenses decreased 19.9% to $17.4million for the three months ended September 30, 2008, as compared to$21.7 million for the three months ended September 30, 2007.  As a percentage of revenue, SG&A expensesdecreased to 23.0% for the three months ended September 30, 2008 ascompared to 35.1% for the three months ended September 30, 2007. SG&Aexpenses decreased 6.5% to $57.4 million for the nine months ended September 30,2008, as compared to $61.4 million for the nine months ended September 30,2007. SG&A expenses as a percentage of revenues decreased 6.4% for the ninemonths ended September 30, 2008. The primary driver of SG&A expensesis marketing which is focused on brand recognition during our first year ofpost-renovation operation.

 

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*Depreciation and Amortization*

 

Depreciation and amortization expense of $9.0million for the three months ended September 30, 2008 decreased whencompared to $10.7 million in expense for the three months ended September 30,2007. Depreciation and amortization expense of $27.0 million for the ninemonths ended September 30, 2008 increased when compared to $26.6 millionin expense for the nine months ended September 30, 2007. The increase indepreciation expense is a direct result of the additional assets placed inservice once the renovation was complete.

 

*Net Interest Expense*

 

Net interest expense decreased to $16.2million for the three months ended September 30, 2008, as compared to$18.9 million for the three months ended September 30, 2007.  Net interest expense decreased to $50.3million for the nine months ended September 30, 2008, as compared to $54.3million for the nine months ended September 30, 2007.  The decrease in interest expense is directlyrelated to the reduction in the interest rates.

 

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

######  

During the nine monthsended September 30, 2008, we utilized cash flows from operating activitiesof approximately $3.3 million and had a balance of $21.6 million in cash andcash equivalents as of September 30, 2008. We also had current restrictedcash and cash equivalents of approximately $29.9 million and long-termrestricted cash and cash equivalents of approximately $14.1 million at September 30,2008. The current restricted cash and cash equivalents are primarily reserveaccounts that have been established under the Loan Agreement to guaranteepayment of property taxes, insurance and furniture, fixtures and equipmentreplacement. Current restricted cash also includes the balance in the cashmanagement account. Under the terms of the Loan Agreement, all cash receiptsare deposited into a cash management account under Lender control which is usedto fund reserves and operating expenses. The long-term restricted cash and cashequivalents include funds designated for the remaining costs associated withthe renovation of hotel rooms and the interest reserve account which will bereleased once certain debt service coverage ratios are achieved. See “Descriptionof Certain Indebtedness” below.

 

Our primary remainingcash requirements for the remainder of 2008 are expected to include (i)  approximately$2.2 million for maintenance capital expenditures or replacement furniture,fixtures and equipment and (ii) up to approximately $16.1 million ininterest payments on our debt.

 

The expected continuationof challenging economic conditions in the Las Vegas market leads us to estimatethe need for a working capital contribution to OpBiz of $13.5 million for the liquidityneeds of the PH Resort for the next twelve months.  In order to fund the $13.5 millioncontribution, EquityCo has requested that its members make an additionalcapital contribution of $13.5 million (the “Capital Contribution”) on a prorata basis in accordance with their relative ownership interests inEquityCo.  BH/RE currently owns 85% ofEquityCo and Starwood owns the remaining 15%. Starwood, however, has declined to contribute its portion of the CapitalContribution.  As a result, theprincipals of BH/RE have orally agreed to contribute the entire CapitalContribution. Each of the equity owners of BH/RE (BHCH, which holds a combined59.25% equity membership interest, and OCS, which holds a 40.75% equitymembership interest), will contribute their proportionate share of the CapitalContribution to BH/RE, BH/RE will then contribute the capital to EquityCo,which in turn will contribute the capital to MezzCo, which in turn willcontribute the capital to OpBiz.  As of November 14,2008, BHCH and OCS have each contributed $1,039,000 of the CapitalContribution.  We have estimated that theremaining $11.4 million of the Capital Contribution will be paid by January 2009,at which point BH/RE’s ownership interest in EquityCo will have increased from85% to 89% and Starwood’s ownership interest in EquityCo will be reduced from15% to 11%.  This transaction is exemptfrom registration under Section 4(2) of the Securities Act of 1933,as amended.  There can be no assurancethat we have accurately estimated our liquidity needs, or that we will notexperience unforeseen events that may materially increase our need for liquidityto fund our operations or capital expenditure programs or decrease the amountof cash generated from our operations.

 

As discussed under “Descriptionof Certain Indebtedness” below, the Company also has an obligation under theterms of the Loan to maintain reserves for, among other items, projectedinterest shortfalls.  In connection withthe extension of the Loan, we are required to project interest expense for theupcoming twelve months and increase the interest reserve, which is currentlyestablished at $11 million, for any projected shortfalls.  The interest reserve test (as fully definedin the Loan), essentially compares the annualized operating results based onthe previous six months of operation to the expected interest

 

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payments for the upcoming twelve months using thetwelve month forward curve for the thirty-day LIBOR rate plus the applicablespread.  At this time, we do notanticipate a need to increase the established interest reserve.

 

***Descriptionof Certain Indebtedness***

 

*Loan Agreement*

* *

On November 30, 2006, OpBiz and PH FeeOwner (collectively the “Borrower”) entered into the Loan Agreement (the “LoanAgreement”) with Column Financial, Inc. (the “Lender”) for a mortgage loanin the principal amount of up to $820 million. The Loan Agreement providedfor an initial disbursement in the amount of $759.7 million and a futurefunding facility in the amount of up to $60.3 million. On July 17,2007, the Borrower and the Lender entered into an amendment (the “Amendment”)to the Loan Agreement. The Amendment provided for the immediate funding toBorrower of the balance of future funding that was available under the LoanAgreement and established an additional future funding facility in the amountof up to $40 million (“Future Funding Tranche B”). Future FundingTranche B has the same terms as the Loan Agreement for maturity andextension. The Loan Agreement, as amended by the Amendment, is referred to asthe Loan. The Loan is secured by a deed of trust on the PH Resort and a pledge,subject to approval by the Nevada gaming authorities, by MezzCo of itsmembership interest in OpBiz (as described below).

 

The initial maturity date of the Loan is December 9,2008 with three one year extension options available, subject to payment of afee and the Borrower’s compliance with the requirements for an extensionoutlined in the Loan Agreement. Interest on the Loan is payable monthly andaccrues at the 30 day LIBOR rate (2.488% for the September 30, 2008interest payment) plus 3.25% with a .25% ticking fee on available butun-advanced future funding. Interest on Future Funding Tranche B ispayable monthly and accrues at the 30 day LIBOR rate plus 7.50% with a 1.50%ticking fee on available but un-advanced funds. The Loan does not requireamortization during the initial term or, provided certain EBITDA thresholds aremet, during the extension periods. The Loan requires that the Borrowerestablish and maintain certain reserves including a reserve for completion ofthe renovation project, a reserve for projected interest shortfalls, a reservefor payment of property taxes and insurance and a reserve for on-goingfurniture, fixture and equipment purchases or property improvements. The Loanrestricts the Borrower’s ability to spend excess cash flow until certain debtservice coverage ratios are met.

 

The Borrower has given the Lender notice ofits intention to exercise the first of three available one year extensionoptions outlined in the Loan Agreement. In connection with the exercise of the extension options, the Borrowermust comply with certain requirements outlined in the Loan Agreement including (i) certificationthat there is no event of default (ii) replacement of the interest ratecap agreement expiring on November 30, 2008 (iii) payment of anextension fee (applicable to the second and third extension periods only) (iv) paymentof Lender’s reasonable out-of-pocket expenses associated with the extension and(v) deposit of additional funds into the interest shortfall reserveaccount sufficient to result in a debt service coverage ratio for the extensionterm of at least 1.10:1.00.  To theextent that the property generates excess cash flow (as defined in the LoanAgreement) and does not meet certain EBITDA thresholds during the extensionperiods, the excess cash flow will be held in reserve for amortization of theLoan or additional security for the Lender. The interest reserve of $11 million is included in long-term restrictedcash and cash equivalents in the accompanying financial statements and theCompany does not anticipate the need to increase the amount of this reserve inconnection with the extension of the Loan. Since the Company intends to exercise the first extension option, TheLoan is classified as a non-current liability in the accompanying financialstatements.

 

Using the proceeds from the Loan, all amountsoutstanding under the Credit Agreement, dated August 31, 2004, amongOpBiz, the lenders named therein and The Bank of New York, Asset SolutionDivision (the “Senior Agent”) were paid in full. Pursuant to the terms of theCredit Agreement, upon repayment of all amounts due, the warrant to purchase2.5% of the equity in EquityCo issued to the lenders at the closing of theCredit Agreement became exercisable. The Company compensated the holders of allunexercised warrants in accordance with the terms of a letter agreement betweenthe parties and the warrants were canceled.

 

In order to permit the Lender to foreclose onthe Hotel and Casino separately and to allow OpBiz to continue to operate theCasino after such a foreclosure (should the Lender choose to do so), title tothe real property comprising the Hotel and Casino (the “Property”) wastransferred from OpBiz to PH Fee Owner. OpBiz and PH Fee Owner then enteredinto a lease pursuant to which OpBiz agreed to continue to operate the Hotel inthe manner it had been and to pay monthly rent of approximately $917,000. OpBizand PH Fee Owner also entered into a lease pursuant to which OpBiz agreed tocontinue to operate the Casino in the manner it had been and to pay monthlyrent of approximately $1,167,000.

 

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In connection with the Loan, the Lenderrequired that Trophy Hunter Investments, Ltd., Bay Harbour 90-1, Ltd.and Bay Harbour Master Ltd., which are affiliates of Bay HarbourManagement, execute and deliver a certain Guaranty (as defined below). Inexchange for Trophy Hunter Investments, Ltd., Bay Harbour 90-1 Ltd. andBay Harbour Master Ltd. (the “Guarantors”) executing the Guaranty, OpBizand PH Fee Owner agreed to pay to Trophy Hunter Investments, Ltd. and BayHarbour Master Ltd. a fee equal to $1,500,000 per year. The fee is accruedand only payable once OpBiz hits certain debt service coverage ratios definedin the Loan Agreement.

 

In connection with the Loan, the Guarantorsentered into a Guaranty, dated November 30, 2006 (the “Guaranty”),pursuant to which the Guarantors agreed to indemnify the Lender against lossesrelated to certain prohibited actions of the Borrower and guarantied fullrepayment of the Loan in the case of a voluntary or collusive bankruptcy of theBorrower, a transfer of the Property or interests in the Borrower in violationof the Loan Agreement and if the Borrower fails to maintain its status as abankruptcy remote entity and as a result sees its assets consolidated withthose of an affiliate in a bankruptcy. The liability of the Guarantors iscapped at $15,000,000 per entity and $30,000,000 in the aggregate, however thiscap does not apply to (i) liability arising from events, acts orcircumstances actually committed or brought about by the willful acts of any ofthe Guarantors and (ii) the extent of any benefit received by any of theGuarantors as a result of the acts giving rise to the liability under theGuaranty. Each of Douglas Teitelbaum and Robert Earl executed and deliveredguaranties substantially the same as that delivered by the Guarantors, howeverthe liability of each of them was limited to (i) liability arising fromevents, acts or circumstances actually committed or brought about by willfulacts by him and (ii) the extent of any benefit received by him as a resultof the acts giving rise to the liability under the Guaranty.

 

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

 

In addition, in connection with the LoanAgreement, MezzCo effected a refinancing of the Securities Purchase Agreement,dated August 9, 2004, among MezzCo and the Investors (the “RestructuringParties”), pursuant to which MezzCo issued to the Investors (i) 16% seniorsubordinated secured Notes in the original aggregate principal amount of$87 million, and (ii) Warrants for the purchase (subject to certainadjustments as provided for therein) of membership interests of MezzCo,representing 17.5% of its fully diluted equity. Loan proceeds were used toredeem in full the Notes.

 

In connection with the refinancing of theSecurities Purchase Agreement and redemption of the Notes, the RestructuringParties entered into the Restructuring Agreement, dated November 30, 2006,pursuant to which the Restructuring Parties terminated in full the SecuritiesPurchase Agreement, the Subordination Agreement, dated as of August 31,2004, among MezzCo, OpBiz, the Senior Agent and the Investors, the PledgeAgreement, dated August 9, 2006, among MezzCo and the Collateral Agent,and the Guaranty, dated August 9, 2004, made by OpBiz to the Investors,and amended certain other existing agreements, as described below.

 

In accordance with the terms of theRestructuring Agreement, the Investors and EquityCo, MezzCo and OpBiz enteredinto a Release, Consent and Waiver Agreement, pursuant to which the Investors (i) releasedOpBiz from its guaranteed obligations, under that certain Guaranty Agreement,dated as of August 9, 2004 and executed by OpBiz in favor of the Investorsand the Collateral Agent; (ii) released MezzCo from its pledge of the collateral,under that certain Pledge Agreement, dated as of August 9, 2004, andexecuted by MezzCo in favor of the Collateral Agent, the Investors releasedtheir security interest, as defined in that certain Security Agreement, asamended by that certain Amendment to Security Agreement, in each case dated asof August 9, 2004 and executed by the Company in favor of the CollateralAgent; (iii) released and terminated the Deed of Trust, dated as of August 9,2004 and executed by MezzCo in favor of the Trustee (as defined therein) forthe benefit of the Collateral Agent; (iv) released and terminated theInvestors’ security interest in the securities account, provided for thatcertain Securities Account Control Agreement, dated as of August 9, 2004and executed by the Company, the Collateral Agent and Wells Fargo Bank, N.A.

 

Additionally, MezzCo, EquityCo, and theInvestors entered into an Amended and Restated Investor Rights Agreement, datedNovember 30, 2006 (the “A&R Investor Rights Agreement”), to amend andrestate the original Investor Rights Agreements among the parties thereto,dated August 9, 2004.

 

Pursuant to the Restructuring Agreement, theRestructuring Parties agreed to amend the Warrants by issuing Amended andRestated Warrants to Purchase Membership Interests of MezzCo (the “A&RWarrants”) to the Investors upon

 

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

 

In connection with the RestructuringAgreement, EquityCo entered into a Guaranty Agreement, dated November 30,2006 (the “Guaranty Agreement”), in favor of the Investors and the CollateralAgent, pursuant to which EquityCo has guaranteed the obligation of MezzCo topay the redemption price under the A&R Warrants prior to expiration and anyindebtedness arising under the Put Note (as defined in the A&R Warrants).

 

EquityCo and the Collateral Agent alsoentered into a Pledge Agreement, dated November 30, 2006 (the “PledgeAgreement”), pursuant to which EquityCo has, subject to approval of the Nevadagaming authorities, pledged and granted a first priority security interest tothe Collateral Agent for the ratable benefit of the Investors in the membershipinterests of EquityCo in MezzCo. The Pledge Agreement, once approved, willsecure the full payment of the Put Right (as defined in the A&R Warrants),including any obligations under the Put Note.

 

On November 30, 2006, MezzCo enteredinto an Indemnification Agreement with the Investors, pursuant to which MezzCoagreed to indemnify the Investors for any losses caused by (i) lack ofgaming approvals for the issuance of the A&R Warrants, (ii) lack ofgaming approval for the granting of a lien by EquityCo in the equity interestsin MezzCo, as described in the Pledge Agreement, and (iii) the inabilityof the Investors to exercise the Warrants until July 1, 2007.

 

*Energy Services Agreement*

 

Northwind owns andoperates a central utility plant on land leased from us. The plant supplies hotand cold water and emergency power to the PH Resort under an energy serviceagreement, which expires in 2018. Under the agreement, we are 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 $400,000 per month.

 

***ForwardLooking Statements***

 

This quarterly report on Form 10-Qcontains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. When used in this report and elsewhere bymanagement from time to time, the words “believe”, “anticipate”, “expect”, “intend”,“estimate”, “plan”, “may”, “seek”, “will”, and similar expressions are intendedto identify forward-looking statements with respect to our financial condition,results of operations and our business including our planned and possibleexpansion plans, legal proceedings and employee matters. Certain importantfactors, including but not limited to, competition from other gamingoperations, risks surrounding a weakened economy including reduced visitorvolume, construction risks, the inherent uncertainty and costs associated withlitigation and governmental and regulatory investigations, and licensing andother regulatory risks, could cause our actual results to differ materiallyfrom those expressed in or implied by our forward-looking statements. Furtherinformation on potential factors which could affect our financial condition,results of operations and business including, without limitation, theexpansion, development and acquisition projects, legal proceedings and employeematters are included in “Item 1A—Risk Factors” of BH/RE’s Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 28, 2008.Readers are cautioned not to place undue reliance on any forward-lookingstatements, which speak only as of the date thereof. We undertake no obligationto publicly release any revisions to such forward-looking statements to reflectevents or circumstances after the date hereof.

 

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

##  

Market risk is the riskof loss arising from adverse changes in market rates and prices, such asinterest rates, foreign currency exchange rates and commodity prices. Ourprimary exposure to market risk is interest rate risk associated with our

 

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long-term debt. We pay interest on the amountoutstanding under the Loan Agreement monthly, in cash, at the London Inter-BankOffered Rate, or LIBOR, plus 3.25% with a .25% ticking fee on available butun-advanced Future Funding. Interest on Future Funding Tranche B is payablemonthly, in cash, at LIBOR plus 7.50% with a 1.50% ticking fee on available butun-advanced funds.  An increase of onepercentage point in the average interest rate applicable to the variable ratedebt outstanding at September 30, 2008 would increase the annual interestcost by approximately $8.6 million.

 

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

##  

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

 

There has been no change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and15-d-15(f) under the Exchange Act) that occurred during our fiscal quarterended September 30, 2008, that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

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# **PART II — OTHER INFORMATION**

#  

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

Information regarding the unregistered sale of equity securities anduse of proceeds is included in Part I, Item 2 of this Quarterly Report on Form 10-Qunder the caption *Liquidity and Capital Resources*,which information is incorporated herein by reference.

 

## **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 requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

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

 

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**EXHIBITINDEX**

 
| 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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