**UNITEDSTATES SECURITIES AND EXCHANGECOMMISSION****Washington, DC 20549**

**FORM 10-Q**

**x    QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**for thequarterly period ended April 1, 2007**

**OR**

**o    TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**for thetransition periodfrom           to           .**

**COMMISSIONFILE NUMBER:  333-135091-12**

**Palace Entertainment Holdings, Inc.**

**(Exactname of registrant as specified in its charter)**
| **DELAWARE**                                                  |   | **20-4503577**                                             |
|---------------------------------------------------------------|--------|------------------------------------------------------------|
| (State of  incorporation)                                     |   | (I.R.S. Employer  Identification No.)                      |
|                                                          |   |                                                       |
| **4590  MacArthur Boulevard, Suite 400**                      |   | ** **                                                 |
| **Newport  Beach, California 92660**                          |   | **(949) 797-9700**                                    |
| (Address of  Principal Executive Offices, including Zip Code) |   | (Registrant’s  Telephone Number, Including Area Code) |

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes x  No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated  filer o | Accelerated  filer o | Non-accelerated  filer x |
|---------------------------------|---------------------------|-------------------------------|

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).
|        | o Yes  x No |
|--------|---------------------------------|
|   |                            |

There were 100 shares of common stock with a par value of $0.01 pershare outstanding as of April 1, 2007.

 

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**TABLEOF CONTENTS**
| Safe Harbor Statement under  the Private Securities Litigation Reform Act of 1995                   | 3      |
|-----------------------------------------------------------------------------------------------------|--------|
|                                                                                                |   |
| PART  I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION                                               | 4      |
| Item  1. Financial Statements (unaudited)                                                           | 4      |
| Condensed Consolidated Balance Sheets as of March 31,  2007 and December 31, 2006                   | 4      |
| Condensed Consolidated Statements of Operations for  the three months ended March 31, 2007 and 2006 | 5      |
| Condensed Consolidated Statements of Cash Flows for  the three months ended March 31, 2007 and 2006 | 6      |
| Notes to Condensed Consolidated Financial Statements                                                | 8      |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 28     |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 | 33     |
| Item 4. Controls and Procedures                                                                     | 33     |
|                                                                                                |   |
| PART  II. OTHER INFORMATION                                                                         | 33     |
| Item  1. Legal Proceedings                                                                          | 33     |
| Item  1A. Risk Factors                                                                              | 34     |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                | 34     |
| Item 3. Defaults Upon Senior Securities                                                             | 34     |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        | 34     |
| Item  5. Other Information                                                                          | 34     |
| Item 6.  Exhibits                                                                                   | 34     |

 

2

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**CAUTIONARYNOTE REGARDINGFORWARD-LOOKING STATEMENTS AND RISK FACTORS**

**(Safe-HarborStatement Under the Private Securities Litigation Reform Act of 1995)**

This quarterly report on Form10-Q contains forward-looking statements. Forward-looking statements are statementsthat are not historical facts, including statements about our beliefs andexpectations or any statement that may predict, forecast, indicate or implyfuture results, performance, achievements or events. Forward-looking statementsinclude, but are not limited to, statements generally preceded by, followed byor that include the words “believe,” “expect,” “anticipate,” “plan,” “estimate,”“intend,” “project,” “targets,” “likely,” “would,” “could” or similarexpressions. These statements include, among others, statements regarding ourexpected business outlook, anticipated financial and operating results,strategies, contingencies, financing plans, working capital needs, sources ofliquidity, capital expenditures, amounts and timing of expenditures andcontemplated transactions.

Forward-looking statementsreflect our current expectations and are not guarantees of performance. Thesestatements are based on our management’s beliefs and assumptions, which in turnare based on currently available information. Important assumptions relating tothese forward-looking statements include, among others, assumptions regardingdemand for our water parks and family entertainment centers, expected pricinglevels, the timing and cost of planned capital expenditures, the estimatedoperational costs for each of our water parks and family entertainment centers,expected outcomes of pending litigation, competitive conditions and generaleconomic conditions. These assumptions could prove inaccurate. Forward-lookingstatements involve risks and uncertainties, which could cause actual results todiffer materially from those contained in any forward-looking statement. Manyof these factors are beyond our ability to control or predict. Such factors mayrelate to, among other things:

·                  adverseweather conditions and other natural phenomena;

·                  seasonaloperations of water parks;

·                  riskof in-park accidents and health risks;

·                  changesin consumer preferences;

·                  reductionsin consumer disposable income;

·                  ourability to compete successfully with other amusement parks and otherentertainment providers;

·                  governmentaland environmental requirements and changes in those requirements;

·                  increasesin general liability and workers compensation claims;

·                  discontinuationof our leases pursuant to termination or default provisions;

·                  acquisitionand retention of key personnel;

·                  ourlevel of indebtedness; and

·                  restrictionscontained in our debt agreements.

Youshould not place undue reliance on any forward-looking statements. Further,forward-looking statements speak only as of the date they are made, and weundertake no obligation to update them in light of new information or futureevents. These forward-looking statements reflect our current views with respectto future events and are based on assumptions and subject to risks anduncertainties that may cause actual results to differ materially from trends,plans or expectations set forth in the forward-looking statements which, as aresult, may adversely affect the value of, and our ability to make payments on,our 10 7/8% Senior Notes due 2014. These risks and uncertainties may includethose discussed in Part I, Item 2 and Part II, Item 1A of this report. Newrisks can emerge from time to time. It is not possible for us to assess all ofthese risks, nor can we assess the extent to which any factor, or combinationof factors, may cause actual results to differ from those contained in theforward-looking statements. Given such risks and uncertainties, we urge you toread this report completely with the understanding that actual future resultsmay be materially different from what we plan or expect.  The Company will not update anyforward-looking information to reflect actual results or changes in the factorsaffecting the forward-looking information.

3

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**PARTI.     FINANCIAL INFORMATION**

**Item  1. Financial Statements**

**PALACE ENTERTAINMENT HOLDINGS,INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (unaudited / in thousands except for per share amounts)AS OF MARCH 31, 2007 AND DECEMBER 31, 2006**
| ** **                                                                                  | ** ** | **March 31, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                                                                  | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| ASSETS                                                                                      | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| ** **                                                                                  | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| CURRENT ASSETS                                                                              |       |                         |       |                            |       |
| Cash and cash equivalents                                                                   |       | $                            | 2,577      |                            | $          | 2,090 |   |
| Inventories                                                                                 |       | 2,348                        |       | 2,124                           |       |
| Prepaid expenses and other current assets                                                   |       | 4,853                        |       | 5,316                           |       |
| Deferred income taxes                                                                       |       | 7,258                        |       | 1,171                           |       |
| Total current assets                                                                        |       | 17,036                       |       | 10,701                          |       |
|                                                                                        |       |                         |       |                            |       |
| Property and  equipment - net                                                               |       | 114,573                      |       | 114,150                         |       |
| Goodwill                                                                                    |       | 86,504                       |       | 86,504                          |       |
| Other intangible  assets - net                                                              |       | 18,808                       |       | 19,032                          |       |
| Other assets -  net                                                                         |       | 6,576                        |       | 7,307                           |       |
|                                                                                        |       |                         |       |                            |       |
| TOTAL                                                                                       |       | $                            | 243,497    |                            | $          | 237,694 |   |
|                                                                                        |       |                         |       |                            |       |
| **LIABILITIES  AND SHAREHOLDER’S EQUITY**                                              | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| ** **                                                                                  | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| CURRENT  LIABILITIES                                                                        |       |                         |       |                            |       |
| Accounts payable                                                                            |       | $                            | 3,770      |                            | $          | 1,791 |   |
| Accrued interest                                                                            |       | 7,694                        |       | 3,518                           |       |
| Accrued wages and payroll taxes                                                             |       | 2,212                        |       | 2,513                           |       |
| Other accrued liabilities                                                                   |       | 11,433                       |       | 10,170                          |       |
| Unearned revenue                                                                            |       | 2,167                        |       | 1,323                           |       |
| Current portion of long-term debt                                                           |       | 876                          |       | 848                             |       |
|                                                                                        |       |                         |       |                            |       |
| Total current liabilities                                                                   |       | 28,152                       |       | 20,163                          |       |
|                                                                                        |       |                         |       |                            |       |
| Long-Term Debt -  Less current portion                                                      |       | 157,336                      |       | 150,008                         |       |
| Deferred income  taxes                                                                      |       | 2,588                        |       | 2,032                           |       |
| Other long term  liabilities                                                                |       | 7,292                        |       | 7,296                           |       |
|                                                                                        |       |                         |       |                            |       |
| Total liabilities                                                                           |       | 195,368                      |       | 179,499                         |       |
|                                                                                        |       |                         |       |                            |       |
| COMMITMENTS AND  CONTINGENCIES                                                              |       |                         |       |                            |       |
|                                                                                        |       |                         |       |                            |       |
| SHAREHOLDER’S  EQUITY                                                                  |       |                         |       |                            |       |
| Common Stock, $.01 stated value, 1000 shares  authorized, 100 shares issued and outstanding |       |                         |       |                            |       |
| Additional Paid-in Capital                                                                  |       | 55,218                       |       | 54,633                          |       |
| Accumulated (deficit) earnings                                                              |       | (7,089                       | )          | 3,562                           |       |
|                                                                                        |       |                         |       |                            |       |
| Total  Shareholder’s equity                                                            |       | 48,129                       |       | 58,195                          |       |
|                                                                                        |       |                         |       |                            |       |
| TOTAL                                                                                       |       | $                            | 243,497    |                            | $          | 237,694 |   |

 

*See Notes to Condensed ConsolidatedFinancial Statements*

4

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**PALACEENTERTAINMENT HOLDINGS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (unaudited / in thousands)**

**FOR THETHREE MONTH PERIOD ENDED MARCH 31, 2007 AND MARCH 31, 2006**

 
| ** **                                                                | ** ** | **Successor**                    | ** ** | **Predecessor**                  | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                | ** ** | **For the three**      | ** ** | **For the three**      | ** ** |
| ** **                                                                | ** ** | **month period ended** | ** ** | **month period ended** | ** ** |
| ** **                                                                | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006**     | ** ** |
|                                                                      |       |                             |       |                             |       |
| REVENUES - net                                                            |       | $                                | 21,533     |                             | $          | 20,796 |   |
|                                                                      |       |                             |       |                             |       |
| OPERATING COSTS  AND EXPENSES                                             |       |                             |       |                             |       |
| Cost of revenue (exclusive of depreciation and  amortization shown below) |       | 23,729                           |       | 23,274                           |       |
| Selling, general and administrative                                       |       | 4,886                            |       | 3,811                            |       |
| Depreciation and amortization                                             |       | 4,724                            |       | 4,179                            |       |
| Gain on disposal of assets                                                |       | (40                              | )          | —                           |       |
|                                                                      |       |                             |       |                             |       |
| Total operating costs and expenses                                        |       | 33,299                           |       | 31,264                           |       |
|                                                                      |       |                             |       |                             |       |
| OPERATING LOSS                                                            |       | (11,766                          | )          | (10,468                          | )          |
|                                                                      |       |                             |       |                             |       |
| OTHER EXPENSE                                                             |       |                             |       |                             |       |
| Interest expense - net                                                    |       | 4,415                            |       | 6,004                            |       |
| Total other expense - net                                                 |       | 4,415                            |       | 6,004                            |       |
|                                                                      |       |                             |       |                             |       |
| LOSS FROM  OPERATIONS                                                     |       | (16,181                          | )          | (16,472                          | )          |
| BEFORE INCOME  TAXES                                                      |       |                             |       |                             |       |
|                                                                      |       |                             |       |                             |       |
| INCOME TAX  BENEFIT                                                       |       | (5,530                           | )          | —                           |       |
|                                                                      |       |                             |       |                             |       |
| NET LOSS                                                                  |       | $                                | (10,651    | )                                | $          | (16,472 | ) |

 

*See Notes to Condensed Consolidated Financial Statements*

5

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**PALACEENTERTAINMENT HOLDINGS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THE THREE MONTH PERIOD ENDEDMARCH 31, 2007 AND 2006  (unaudited / inthousands)**

 
| ** **                                                                       | ** ** | **Successor**                    | ** ** | **Predecessor**                  | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                       | ** ** | **For the three**      | ** ** | **For the three**      | ** ** |
| ** **                                                                       | ** ** | **month period ended** | ** ** | **month period ended** | ** ** |
| ** **                                                                       | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006**     | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                           |       |                             |       |                             |       |
| Net loss                                                                         |       | $                                | (10,651    | )                                | $          | (16,472 | ) |
| Adjustments to reconcile net loss to net cash provided  by operating activities: |       |                             |       |                             |       |
| Depreciation and amortization                                                    |       | 4,724                            |       | 4,179                            |       |
| Gain on disposal of assets                                                       |       | (40                              | )          |                             |       |
| Amortization of deferred financing costs                                         |       | 193                              |       | 720                              |       |
| Financed Interest Payments                                                       |       |                             |       | 3,386                            |       |
| Share based Compensation                                                         |       | 85                               |       |                             |       |
| Deferred rent expense                                                            |       | 59                               |       | 51                               |       |
| Deferred income taxes                                                            |       | (5,530                           | )          |                             |       |
|                                                                             |       |                             |       |                             |       |
| Changes in net operating assets and liabilities:                                 |       |                             |       |                             |       |
| Inventories                                                                      |       | (224                             | )          | (104                             | )          |
| Prepaid expenses and other current assets                                        |       | 479                              |       | 442                              |       |
| Other assets                                                                     |       | 523                              |       | 8                                |       |
| Accounts payable                                                                 |       | 1,883                            |       | (133                             | )          |
| Accrued interest                                                                 |       | 4,177                            |       | (11                              | )          |
| Accrued wages and payroll taxes                                                  |       | (301                             | )          | (61                              | )          |
| Other accrued liabilities                                                        |       | 1,256                            |       | (782                             | )          |
| Unearned revenue                                                                 |       | 844                              |       | 365                              |       |
| Other long-term liabilities                                                      |       | (6                               | )          |                             |       |
|                                                                             |       |                             |       |                             |       |
| Net cash used by operating activities                                            |       | (2,529                           | )          | (8,412                           | )          |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                           |       |                             |       |                             |       |
|                                                                             |       |                             |       |                             |       |
| Purchases of  property and equipment                                             |       | (4,799                           | )          | (3,403                           | )          |
| Proceeds from  disposal of assets                                                |       | 72                               |       |                             |       |
|                                                                             |       |                             |       |                             |       |
| Net cash used in  investing activities                                           |       | (4,727                           | )          | (3,403                           | )          |
|                                                                                  |            |                                  |            |                                  |            |  |  |

 

*SeeNotes to Condensed Consolidated Financial Statements*

6

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| ** **                                                                | ** ** | **Successor**                    | ** ** | **Predecessor**                  | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                | ** ** | **For the three**      | ** ** | **For the three**      | ** ** |
| ** **                                                                | ** ** | **month period ended** | ** ** | **month period ended** | ** ** |
| ** **                                                                | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006**     | ** ** |
|                                                                      |       |                             |       |                             |       |
| Issuance of  common stock                                                 |       | 500                              |       |                             |       |
| Proceeds from long-term  debt                                             |       | 7,250                            |       | 13,100                           |       |
| Payments on  long-term debt                                               |       |                             |       | (842                             | )          |
| Payments on  capital leases                                               |       | (7                               | )          | (2                               | )          |
| Distributions to  member                                                  |       |                             |       | (56                              | )          |
| Net cash provided by financing activities                                 |       | 7,743                            |       | 12,200                           |       |
|                                                                      |       |                             |       |                             |       |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                |       | 487                              |       | 385                              |       |
|                                                                      |       |                             |       |                             |       |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                           |       | 2,090                            |       | 5,240                            |       |
|                                                                      |       |                             |       |                             |       |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                 |       | $                                | 2,577      |                             | $          | 5,625 |   |
|                                                                      |       |                             |       |                             |       |
| Supplemental  Disclosures of Cash Flow Information:                       |       |                             |       |                             |       |
| Cash Paid For  Interest                                                   |       | $                                | 35         |                             | $          | 1,941 |   |
|                                                                      |       |                             |       |                             |       |
| Supplemental  Disclosures of Non Cash Investing and Financing Activities: |       |                             |       |                             |       |
| Property and  Equipment included in Accounts Payable                      |       | $                                | 358        |                             | $          | 360 |   |
| Increase in Capital  Lease Obligation for Property and Equipment          |       | $                                | 113        |                             | $          | — |   |

 

*See Notes to Condensed Consolidated Financial Statements*

 

7

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**PALACE ENTERTAINMENTHOLDINGS, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(unaudited, $ in thousands)**

**1.**                      ORGANIZATION

**Organization**

On April 12, 2006, PalaceEntertainment Holdings, Inc. (the “Company”), a Delaware corporation, acquiredFestival Fun Parks, LLC (“FFP”).  TheCompany is a 100% owned subsidiary of Palace Holdings Group, LLC (“Holdings”),which is primarily owned by MidOcean Partners, LP (“MidOcean Partners”), a NewYork and London based private equity firm. FFP is a Delaware limited liability company formed on June 23,1998, with Palace Entertainment, Inc. (“PAL”) being the sole member prior tothe acquisition. The Company was established to purchase and operate familyentertainment centers (“FECs”) and water parks (“WPs”).

On March 8, 2007, the Company purchased certain water park assetslocated in Sacramento, California from Premier Waterworld Sacramento, Inc. (“Premier”),an affiliate of Six Flags Theme Parks, Inc., and the lease between Premier andthe State of California was assigned to the Company.  The Company is renaming the WP Raging WatersSacramento.

At March 31, 2007, theCompany owned and operated 33 FECs and WPs (“Parks”). Of the 33 Parksowned at March 31, 2007, seventeen are located in California, five are locatedin Florida, four are located in Texas, and two each are located in Georgia andNew York, and one in North Carolina, New Jersey, and New Hampshire. Revenueearned from the Parks located in California represents approximately 52%, inthe aggregate, of the Company’s revenues for the three month period ended March31, 2007 and 2006. Nine of the Parks are WPs featuring such attractions aswater slides, flumes, and pools and one is a nature theme park. The other23 FECs generally feature such attractions as miniature golf, battingcages, kiddy parks, go-carts, and video arcades.

For financial reportingpurposes, the Company uses a 52- or 53-week fiscal year. The fiscal periodspresented, which ended April 1, 2007 and April 2, 2006, comprised of 13weeks, or one quarter of the fiscal year. The fiscal period ends on the Sundaynearest to March 31. For simplicity of presentation, the Company refers tothe 13-week period as ended on March 31.

**2.**                      SUMMARYOF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

**Basis of Presentation**

The acquisition of FFP bythe Company (“Acquisition”) (See Footnote 3) was accounted for under thepurchase method of accounting, as required by Statement of Financial AccountingStandards (“SFAS”) No.141, *Business Combinations*.  The purchase price has been “pushed-down” andallocated to the assets and liabilities of FFP. Accordingly, the post-acquisition Condensed Consolidated FinancialStatements reflect a new basis of accounting. The Company’s Condensed Consolidated Statements of Operations and CashFlows for the three month period ended March 31, 2006 reflect the operations ofthe Company prior to the Acquisition.

We prepared theaccompanying Condensed Consolidated Financial Statements pursuant to the rulesand regulations of the Securities and Exchange Commission (the “SEC”). The information reflects the required adjustments that in the opinion of theCompany’s management are necessary for a fair presentation of the financialposition of the Company, its results of operations and cash flows for theinterim period presented.

The accompanyingunaudited condensed consolidated financial statements of our company, PalaceEntertainment Holdings, Inc., have been prepared in accordance with generallyaccepted accounting principles in the United States for interim financialinformation and in accordance with the rules and regulations of the UnitedStates Securities and Exchange Commission. Accordingly, they do not include allof the information and notes required by generally accepted accountingprinciples in the United States for annual financial statements as permittedunder applicable rules and regulations. The condensed consolidated balancesheet at December 31, 2006 was derived from the audited financialstatements at that date but may not include all disclosures required byaccounting principles generally accepted in the United States.

These CondensedConsolidated Financial Statements should be read in conjunction with theConsolidated Financial Statements included in the Company’s annual report onForm 10K for the fiscal year ended December 31, 2006.  The results of operations for the three monthperiod ended March 31, 2007 are not indicative of the expected full yearresults.  Our WP operations contribute asignificant amount of the Company’s annual revenue from May through Labor Dayeach year while certain expenses are incurred year round.

The Condensed ConsolidatedFinancial Statements include the accounts of the Company and its wholly ownedsubsidiaries. All intercompany transactions and balances have been eliminatedin consolidation.

8

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**Property and Equipment**

Property and equipment is stated at cost and isdepreciated using the straight-line method over the following estimated lives:
|                                       | ** ** | **Life**         |
|---------------------------------------|------------|------------------|
| Buildings and  leasehold improvements |       | 20–38 years |
| Land  improvements                    |       | 7–10 years  |
| Equipment and  fixtures               |       | 1–10 years  |
| Rides and  attractions                |       | 5–15 years  |
| Games                                 |       | 1–3 years   |

 

Property and equipmentinclude assets recorded under capital leases presented with the comparablecategories for owned assets. The charge to income resulting from amortizationof assets recorded under capital leases is included in depreciation expense inthe Condensed Consolidated Statement of Operations. Leasehold improvements areamortized over the shorter of the lease term or their useful lives.

Ordinary repairs andmaintenance are expensed as incurred; major replacements and betterments arecapitalized.

**Long-LivedAssets**

Long-lived assets arecarried at cost less accumulated depreciation. Long-lived assets are evaluatedfor potential impairment in accordance with SFAS No. 144 (“SFAS No. 144”) *Accounting for Impairment or Disposal of Long Lived Assets*at least annually or whenever events or changes in circumstances indicate thattheir carrying amounts may not be recoverable. In the event that periodicassessments reflect that the carrying amount of a long-lived asset exceeds thesum of the undiscounted cash flows (excluding interest) that are expected toresult from the use and eventual disposition of the long-lived asset, theCompany recognizes an impairment loss to the extent the carrying amount exceedsthe fair value of the long-lived asset. The Company estimates the fair valueusing available market information or other industry valuation techniques, suchas present-value calculations. The Company has recorded no impairment lossesfor the three month period ended March 31, 2007 and 2006. In conjunction withthe purchase of the Company long-lived assets were revalued at fair marketvalue. (See Footnote 3)

**Goodwill**

Goodwill is tested for impairment annually, or when a possibleimpairment is indicated, using the fair value-based test prescribed by SFAS No.142 (“SFAS No. 142”), *Goodwill and OtherIntangible Assets*. The goodwill impairment test prescribed by SFASNo. 142 requires the Company to identify reporting units and to determineestimates of the fair value of the Company’s reporting units as of the date ofthe test for impairment. The goodwill impairment test is a two-step process.First, the fair value of the reporting unit is compared with its carrying valueincluding goodwill. If the reporting unit’s carrying value exceeds its fairvalue, an impairment loss is to be recorded to the extent that the carryingvalue of the goodwill exceeds its implied fair value. The second stepdetermines the fair value of a reporting unit for the amount for which the unitas a whole could be bought or sold in a current transaction between willingparties. The Company estimates the fair value of its reporting units usingdiscounted cash flow valuation models. The Company estimates these amounts byevaluating historical trends, current budgets, operating plans, and industrydata. Determining the fair value of reporting units and goodwill includessignificant judgment by management and different judgments could yielddifferent results.  The Company testsgoodwill annually for impairment and in interim periods if certain events occurindicating that the carrying value of goodwill may be impaired. We evaluategoodwill on a separate reporting unit basis to assess recoverability andimpairment, if any, are recognized in earnings. Goodwill was allocated to ourreporting units based on the original purchase price allocation.

The Company recorded nogoodwill impairment losses for the three month period ended March 31, 2007 and2006.

9

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**Intangibles**

Trademarksare amortized over their estimated useful lives of 20 years and property leasesare amortized over the terms of the related leases.  The amortization expense relating totrademarks recorded for the three month period ended March 31, 2007 was $167.

**FinancingCosts**

Financing costs, whichare included in other assets, are deferred and amortized using thestraight-line method, which approximates the effective interest method, overthe term of the respective loan agreements. At March 31, 2007 and December 31,2006, deferred financing costs were $5,138 and $5,331, respectively, net ofaccumulated amortization of $746 and $553, respectively. Amortization ofdeferred financing costs for the three month period March 31, 2007 and March31, 2006 was $193 and $720, respectively. All debt outstanding as of the Acquisition date was repaid and therelated discounts were written off. Additionally, discount on loans is beingamortized using the effective interest method over the term of the respectiveloan agreement.

**Stock-BasedCompensation**

The former parent of theCompany issued stock options to the Company’s employees in 2002. Outstandingoptions and the related potential compensation amounts were immaterial, andwere terminated in April 2006 in connection with the sale of the Company.Following the acquisition, Holdings adopted a new stock compensation plan andthe Company adopted SFAS No. 123(R), “*Share-Based Payment*”to account for the incentive units granted during the quarter. All awardsgranted, modified, or settled after the date of adoption will be accounted forusing the measurement, recognition, and attribution provisions ofSFAS No.123(R). Under the fair value recognition provision of thisstatement, share based compensation costs are measured at the grant date basedupon the fair value of the award. The Company elected to recognize the expenseon a straight-line basis over the requisite period that is the vestingperiod.  See Footnote 9 for a furtherdescription of the plan.

**RevenueRecognition**

The Company recognizesrevenue net of sales tax at the point of sale to a customer or over the periodthat receives the benefit.

**Use ofEstimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

**Concentration of Credit Risk**

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist primarily of cash and cash equivalents. At various times duringthe three months ended March 31, 2007 and 2006, the Company maintained cashbalances in its general cash accounts in excess of Federal Deposit InsuranceCorporation insurable limits; however, the Company places its cash with highcredit quality financial institutions.

**FairValue of Financial Instruments**

The carrying values ofcash and cash equivalents, accounts receivable, and accounts payableapproximate fair values due to the relatively short maturities of suchinstruments. For the fair value of long-term debt, see Footnote 7.

**RecentAccounting Pronouncements**

In February 2007,the FASB issued Statement of Financial Accounting Standards No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities*– *includingan amendment of FASB Statement No. 115* (SFAS 159). SFAS 159 givesthe Company the irrevocable option to carry most financial assets andliabilities at fair value, with changes in fair value recognized in earnings.SFAS 159 is effective for the Company’s 2009 fiscal year, although earlyadoption is permitted. The Company is currently assessing the potential effectof SFAS 159 on its financial statements.

10

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InSeptember 2006, the FASB issued SFAS No. 157, *“Fair ValueMeasurements.”* SFAS No. 157 establishes a framework for measuringfair value in generally accepted accounting principles (“GAAP”), and expandsdisclosures about fair value measurements. This Statement is effective forfinancial statements issued for fiscal years beginning after November 15, 2007,and interim periods within those fiscal years. The Company is in the process ofevaluating the impact of adopting SFAS No. 157.

In July 2006, the FASBissued FASB Interpretation No. 48 (“FIN No. 48”), *Accountingfor Uncertainty in Income Taxes,* which prescribes a recognitionthreshold and measurement process for recording in the financial statementsuncertain tax positions taken or expected to be taken in a tax return.Additionally, FIN No. 48 provides guidance on derecognition, classification,interest and penalties, accounting in interim periods and disclosurerequirements for uncertain tax positions. The accounting provisions of FIN No.48 are effective for reporting periods beginning after December 15, 2006.  The Company adopted the provisions of FIN No.48, on January 1, 2007. The Company did not have any unrecognized tax benefitsand there was no effect on our financial condition or results of operations asa result of implementing FIN No. 48.

In July 2006, the FASBissued EITF 06-3, How Taxes Collected from Customers and Remitted toGovernmental Authorities Should Be Presented in the Income Statement (That Is,Gross versus Net Presentation) that requires disclosure of the accountingpolicy related to any tax assessed by a government authority in a revenueproducing transaction (either gross or net) and the amount of such taxes inboth interim and annual financial statements if the amounts aresignificant.  This EITF becomes effectivefor reporting periods beginning after December 15, 2006. The Company hasadopted EITF 06-3 and the Condensed Consolidated financial statements conformto its requirements. The Company’s policy is to present the taxes collectedfrom the customers and remitted to governmental authorities on a net basis.

**3.****                                     ****ACQUISITION**

In accordance with a definitive agreement dated February 21, 2006, theCompany acquired FFP on April 12, 2006. The aggregate purchase price of $212,175 was primarily funded by the$53,500 equity contribution by Holdings, issuance of $150,000 in aggregateprincipal amount of 10 7/8% Senior Notes (“Notes”) due in 2014 and a draw of$12,000 against the Company’s senior secured revolving credit facility (“Revolver”)(See Footnote 6).   Proceeds from theissuance of the Notes was used to payoff all outstanding term debt in theamount of $173,177 as of April 12, 2006, less the remaining capital leaseobligations of $1,635, to pay transaction related fees and costs, and to fundinitial working capital for the Company.

The final aggregate purchase price allocation is reflected on theaccompanying condensed consolidated balance sheet as of March 31, 2007 andthere was no change in the purchase price allocation from December 31,2006.  The following table summarizes theestimated fair values of the assets acquired and liabilities assumed as ofApril 12, 2006 based upon management’s estimates and with the support of anindependent appraiser.
| Current assets                                                 |   | $       | 7,303   |   |
|----------------------------------------------------------------|--------|---------|---------|--------|
| Property and  equipment – net                             |   | 118,963 |    |
| Goodwill                                                       |   | 86,504  |    |
| Other intangible  assets – net                            |   | 19,674  |    |
| Other assets –  net                                       |   | 6,395   |    |
| Current  liabilities                                           |   | (18,569 | )       |
| Other long term  liabilities                                   |   | (8,095  | )       |
| Allocated purchase  price, including related acquisition costs |   | $       | 212,175 |   |

 

The excess of the adjusted purchase price over the fair value of thenet assets acquired or goodwill has been assigned to our WPs and FECs in theamounts of $51,902 and $34,602 respectively. The goodwill is not amortized and is subject to an annual impairmenttest in accordance with SFAS No.142, *Goodwill and OtherIntangible Assets*.  For incometax purposes, the Company amortizes goodwill and other intangible assets.

The trademarks are being amortized using a 20-year useful life whichare included in other intangible assets. The intangible asset related to the property leases advantage and thedeferred credit related to property leases disadvantage are being amortizedover the related lease terms on straight-line basis over the individualremaining lease terms.

11

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The following condensed consolidated pro forma income statementinformation covers the three month period ended March 31, 2006.  The pro forma adjustments reflect thepurchase of the Company, the extinguishment of the prior debt and itsreplacement with the Notes and the revolver. The pro-forma also adjusts interest expense based upon the terms of theagreements governing the Notes and the revolver.  The financial information below alsosubstitutes the Windward management fee with the MidOcean Partners advisory feeand adjusts for the effect of the directors/officers andrepresentations/warranties insurance policies issued in connection with thesale transaction.

We have also adjusted depreciation and amortization for property andequipment, trademarks and leases based on the purchase price allocation.

Palace Entertainment Holdings Inc.

Consolidated andCondensed Proforma Income Statement

Three Month Period EndedMarch 31, 2006

(Unaudited)
|                                  | ** ** | **March 31, 2006** | ** ** |
|----------------------------------|------------|------------------------------|------------|
|                             |       |                         |       |
| REVENUES – NET              |       | $                            | 20,796     |   |
|                             |       |                         |       |
| LOSS FROM  CONTINUING OPERATIONS |       | (15,771                      | )          |
|                             |       |                         |       |
| NET LOSS                         |       | $                            | (15,771    | ) |

 

**On a pro-forma basis for the threemonths ended March 31, 2006, the Company had no tax expense and a 0% effectivetax rate due**to the net losses and full valuationreserves on a proforma basis.

On March 8, 2007, the Company purchased certain water park assetslocated in Sacramento, California from Premier. The asset purchase was recorded at its fair value for a cash amount of$950.  The Company did not record anyintangible assets, trademarks or other assets*.*    In addition, there were no liabilitiesassumed as a result of the transaction.  The majority of the assets purchased relate to rides and attractions andwere recorded to property and equipment at fair value.

**4.**                                      PREPAIDEXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consist ofthe following:
|                        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **             | ** ** | **2007**           | ** ** | **2006**              | ** ** |
|                   |       |               |       |                  |       |
| Prepaid  insurance     |       | $                  | 963        |                  | $          | 1,261 |   |
| Prepaid rent           |       | 1,098              |       | 1,090                 |       |
| Accounts  Receivable   |       | 625                |       | 780                   |       |
| Income Tax  Receivable |       | 560                |       | 560                   |       |
| Other current  assets  |       | 1,607              |       | 1,625                 |       |
|                   |       |               |       |                  |       |
| Total                  |       | $                  | 4,853      |                  | $          | 5,316 |   |

 

 

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**5.**                      PROPERTYAND EQUIPMENT

Property andequipment consist of the following:
|                                                 | ** ** | **March 31** | ** ** | **December 31** | ** ** |
|-------------------------------------------------|------------|--------------|------------|-----------------|------------|
| ** **                                      | ** ** | **2007**     | ** ** | **2006**        | ** ** |
|                                            |       |         |       |            |       |
| Land                                            |       | $            | 158        |            | $          | 158 |   |
| Buildings and leasehold  improvements           |       | 56,693       |       | 56,338          |       |
| Equipment and fixtures                          |       | 14,587       |       | 14,234          |       |
| Games                                           |       | 3,987        |       | 3,772           |       |
| Rides and attractions                           |       | 53,468       |       | 51,476          |       |
|                                            |       |         |       |            |       |
| Total                                           |       | 128,893      |       | 125,978         |       |
|                                            |       |         |       |            |       |
| Less accumulated  depreciation and amortization |       | 16,991       |       | 12,439          |       |
|                                            |       |         |       |            |       |
| Add construction in  progress                   |       | 2,671        |       | 611             |       |
|                                            |       |         |       |            |       |
| Total                                           |       | $            | 114,573    |            | $          | 114,150 |   |

 

**6.**                      OTHER INTANGIBLE ASSETS - NET

The following are the gross carrying amounts andaccumulated amortization of the other intangible assets as of March 31, 2007and December 31, 2006:

March 31, 2007
| ** **              | ** **                 | **Gross Carrying** | ** ** | **Accumulated**  | ** ** | **Net Book** | ** ** |
|-------------------------|----------------------------|-------------------------|------------|------------------|------------|-------------------|------------|
| ** **              | ** **                 | **Amount**              | ** ** | **Amortization** | ** ** | **Value**         | ** ** |
|                    |                       |                    |       |             |       |              |       |
| Other intangible assets |                       |                    |       |             |       |              |       |
|                    | Trademarks                 |                    | $          | 13,328           |       | $                 | 643        |   | $ | 12,685 |   |
|                    | Property leases  advantage |                    | 6,346      |             | 223        |              | 6,123      |   |
|                    | Total                      |                    | $          | 19,674           |       | $                 | 866        |   | $ | 18,808 |   |

 

December 31, 2006
| ** **              | ** **                 | **Gross Carrying** | ** ** | **Accumulated**  | ** ** | **Net Book** | ** ** |
|-------------------------|----------------------------|-------------------------|------------|------------------|------------|-------------------|------------|
| ** **              | ** **                 | **Amount**              | ** ** | **Amortization** | ** ** | **Value**         | ** ** |
|                    |                       |                    |       |             |       |              |       |
| Other intangible assets |                       |                    |       |             |       |              |       |
|                    | Trademarks                 |                    | $          | 13,328           |       | $                 | 476        |   | $ | 12,852 |   |
|                    | Property leases  advantage |                    | 6,346      |             | 166        |              | 6,180      |   |
|                    | Total                      |                    | $          | 19,674           |       | $                 | 642        |   | $ | 19,032 |   |

 

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The futureamortization on trademarks and property leases advantage as of March 31, 2007are as follows:
| **Year Ending**  | ** ** | ** **     | ** ** | **Property**              | ** ** | ** ** | ** ** |
|-----------------------|------------|----------------|------------|---------------------------|------------|------------|------------|
| **December 31,** | ** ** | **Trademarks** | ** ** | **Leases Advantage** | ** ** | **Total**  | ** ** |
|                  |       |           |       |                      |       |       |       |
| 2007 (9 months)       |       | $              | 500        |                      | $          | 173        |       | $ | 673 |   |
|                  |       |           |       |                      |       |       |       |
| 2008                  |       | 666            |       | 231                       |       | 897        |       |
|                  |       |           |       |                      |       |       |       |
| 2009                  |       | 666            |       | 231                       |       | 897        |       |
|                  |       |           |       |                      |       |       |       |
| 2010                  |       | 666            |       | 231                       |       | 897        |       |
|                  |       |           |       |                      |       |       |       |
| 2011                  |       | 666            |       | 231                       |       | 897        |       |
|                  |       |           |       |                      |       |       |       |
| Thereafter            |       | 9,521          |       | 5,026                     |       | 14,547     |       |
|                  |       |           |       |                      |       |       |       |
| Total                 |       | $              | 12,685     |                      | $          | 6,123      |       | $ | 18,808 |   |

 

The amortization of trademarks is recorded to amortizationexpense.   However, the amortization ofproperty leases advantage is recorded as additional rent expense in order tonormalize rent expense.

The amortization of property lease disadvantage isrecorded as an offset to rent expense. The amortization relating to propertyleases disadvantage for the three month period ended March 31, 2007 was $35. Thefuture amortization of property leases disadvantage recorded in other long termliabilities as of March 31, 2007 is as follows:
| Year Ending      | ** ** | **Poperty Leases** | ** ** |
|-----------------------|------------|-------------------------|------------|
| **December 31,** | ** ** | **Disadvantage**        | ** ** |
|                  |       |                    |       |
| 2007 (9 months)       |       | $                       | (106       | ) |
|                  |       |                    |       |
| 2008                  |       | (141                    | )          |
|                  |       |                    |       |
| 2009                  |       | (141                    | )          |
|                  |       |                    |       |
| 2010                  |       | (141                    | )          |
|                  |       |                    |       |
| 2011                  |       | (141                    | )          |
|                  |       |                    |       |
| Thereafter            |       | (3,121                  | )          |
|                  |       |                    |       |
| Total                 |       | $                       | (3,791     | ) |

 

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**7.****                                      LONG-TERMDEBT**

Long-term debt atMarch 31, 2007 and December 31, 2006 consists of the following:

|                                                  | ** ** | **March 31** | ** ** | **December 31** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **2007**          | ** ** | **2006**             | ** ** |
|                                             |       |              |       |                 |       |
| 10 7/8% Senior  Notes (1)                        |       | $                 | 150,000    |                 | $          | 150,000 |   |
| Revolving line  of credit - GE Capital (2)       |       | 7,250             |       |                 |       |
| Capital lease  obligations (3)                   |       | 962               |       | 856                  |       |
|                                             |       |              |       |                 |       |
| Total                                            |       | 158,212           |       | 150,856              |       |
|                                             |       |              |       |                 |       |
| Less current  portion (capital lease obligation) |       | 876               |       | 848                  |       |
|                                             |       |              |       |                 |       |
| Total long-term debt                             |       | $                 | 157,336    |                 | $          | 150,008 |   |

 

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**(1)**                                 **10 7/8% Senior Notes**

In connection withthe Acquisition, FFP issued its 10 7/8% Senior Notes, Series A, due April 12,2014, which are fully and unconditionally guaranteed by the Company.  Interest is payable in semi-annualinstallments on October 15 and April 15 of each successive year.  The first payment was made on October 16,2006 and the second payment was made on April 16, 2007.  The fair value of the Notes were $154,500 and$151,500 as of March 31, 2007 and December 31, 2006, respectively.  The Company was in compliance with itscovenant requirements as of March 31, 2007.

**(2)**                                 **Revolving line of credit – GE Capital**

Revolving line ofcredit up to a maximum of $40,000, maturing no later than April 12, 2012.  Interest is payable periodically at the primerate plus a margin of 1.75% or the London Inter Bank Offered Rate (“LIBOR”)plus a margin of 2.75% based upon the Company’s election.  The outstanding balance was $7,250 which hada weighted average interest rate of 8.14% as of March 31, 2007.  The margin can vary based on the Company’sdebt to earnings ratio.  Under thisrevolving line of credit, the Company had certain letters of credit outstandingto secure its workers compensation and general liability insurancepolicies.  Letters of credit outstandingat March 31, 2007 and December 31, 2006 was $4,325.  The fair value of the outstanding balance onthe revolver approximates its carrying value.

The revolvingcredit facility is secured by substantially all of the Company’s assets.   The Company was in compliance with itscovenant requirements as of March 31, 2007.

**(3)****                                 CapitalLease Obligations**

Capital leaseobligations secured by applicable equipment with a net book value of $676 and$648 at March 31, 2007 and December 31, 2006, respectively, payable in periodicinstallments.

15

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**8.**                                      RELATED-PARTYTRANSACTIONS

A professional servicesagreement was in effect between the Company and MidOcean Partners as of March31, 2007. The agreement provides for quarterly payments of $250. These fees aremade quarterly and included in selling, general and administrative expenses inthe Condensed Consolidated Statement of Operations.  The term of this agreement is through April12, 2016. Additionally, MidOcean Partners is entitled to reimbursement ofexpenses. As of March 31, 2007 and December 31, 2006, the Company had a prepaidbalance of $81 relating to the services agreement.

**9.**                                      STOCKCOMPENSATION PLANS

The former parent of the Company issued stock optionsto Company employees in 2002.  Outstanding options and the relatedpotential compensation were immaterial and were terminated as of April 12, 2006pursuant to the sale of FFP.

Holdings has adopted a share-based compensation planfor certain management employees and directors of the Company. The Company hasaccounted for the fair value of these grants under this Plan in accordance withSFAS No. 123(R).   Holdings issued grantsin March 2007 and June 2006.

Under the Incentive Equity Unit Plan, Holdings maygrant incentive units (“grants”) to selected management personnel and directorsof the Company. Units are granted at the discretion of the Board of Directors.The Class B units vest in equal 1/20th amounts at the end of each fullquarter following the grant date and the Class C units fully vest at the dateof the grant. Vesting on the Class B units is accelerated in the event of aliquidating event, such as; the approved sale of the Company, including mergeror consolidation as well as the sale of publicly traded securities of theCompany. The accelerated vesting is subject to the achievement of specifiedinternal rate of return and return on investment hurdles based on MidOceanPartners’ initial investment. Should those hurdles not be met at the time ofthe liquidating event, the shares will continue to vest quarterly over the restof the original five year service period, with the exception of the B-2 unitswhich will be forfeited on the date of the liquidating event if the hurdles arenot met.

The Board of Directors at its sole discretion mayrepurchase the vested portion of the incentive units from terminated employeesunder certain conditions at the fair market value for the units.  In March 2005, the SEC issued SAB No. 107 *Share Based Payments,* which provides guidance on theimplementation of SFAS No. 123(R). The Company applied the principles of SABNo. 107 in conjunction with its adoption of SFAS No. 123(R).

The volatility assumption used by the Company of30.23% and 41.01% for the March 2007 and June 2006 grants, respectively, wasdetermined by weighting the volatility of public companies with comparablebusiness lines and product lines because the Company does not have historicalstock prices for direct comparison. The volatility weighting was based on theimplied volatility, the most recent 1-year volatility, and the median of therolling 5-year volatilities. The risk-free interest rate of 4.5% and 4.9% forthe March 2007 and June 2006 grants, respectively, that was used in the MonteCarlo Simulation model is based on the risk free rate of return that is equalto the yield of a five-year zero-coupon U.S. Treasury note as of March 2007 andJune 2006 for the March 2007 and June 2006 grants, respectively. Managementuses an expected dividend yield of zero for the March 2007 and June 2006 grantsin the Monte Carlo Simulation model, as it has no intention to pay any cashdividends in the foreseeable future. SFAS No. 123(R) requires management toestimate forfeitures at the time of grant and revise those estimates insubsequent periods if actual forfeitures differ from those estimates.Management uses an estimated forfeiture rate based on the weighted average ofdifferent scenarios as historical data is not available and records stock-basedcompensation expense only for those awards that are expected to vest. Adiscount has also been calculated into the fair value of the units to accountfor the market requirement inherent in the units.

16

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The compensation cost that has been charged againstincome for that Plan was $85 for the three months ended March 31, 2007. As ofMarch 31, 2007, there was $2,937 of total unrecognized compensation costrelated to unvested stock-based compensation that is expected to be recognizedover a weighted-average period of 4.7 years. Based on currently outstandingequity incentive units, total stock-based compensation expense for fiscal year2007 is expected to be approximately $569.

A summary of the units granted during the period andoutstanding as of March 31, 2007 is presented below:

***Amountsare reported in whole numbers below***
|                                                        | ** ** | ** **        | ** ** | **Weighted**        | ** ** | ** **        | ** ** | **Weighted**        | ** ** | ** **        | ** ** | **Weighted**        | ** ** | ** **        | ** ** | **Weighted**        | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|---------------------|------------|-------------------|------------|---------------------|------------|-------------------|------------|---------------------|------------|-------------------|------------|---------------------|------------|
| ** **                                             | ** ** | **Number**        | ** ** | **Average**         | ** ** | **Number**        | ** ** | **Average**         | ** ** | **Number**        | ** ** | **Average**         | ** ** | **Number**        | ** ** | **Average**         | ** ** |
| ** **                                             | ** ** | **of units** | ** ** | **Fair Value** | ** ** | **of units** | ** ** | **Fair Value** | ** ** | **of units** | ** ** | **Fair Value** | ** ** | **of Units** | ** ** | **Fair Value** | ** ** |
| ** **                                             | ** ** | **B1**            | ** ** | ** **          | ** ** | **B2**            | ** ** | ** **          | ** ** | **B3**            | ** ** | ** **          | ** ** | **C**             | ** ** | ** **          | ** ** |
|                                                   |       |              |       |                |       |              |       |                |       |              |       |                |       |              |       |                |       |
| Equity incentive  units outstanding at January 1, 2007 |       | 3,673             |       | $                   | 482        |              | 6,122      |                | $          | 308               |       | 2,449               |       | $                 | 201        |                | 415        |   | $ | 1,000 |   |
| Granted                                                |       | 2,428             |       | $                   | 414        |              | 4,047      |                | $          | 193               |       | 1,619               |       | $                 | 82         |                | —     |   | — |   |
| Repurchased                                            |       | (257              | )          | $                   | 482        |              | (428       | )                   | $          | 308               |       | (171                | )          | $                 | 201        |                | —     |   | — |   |
| Forfeited                                              |       | (2,314            | )          | $                   | 482        |              | (3,857     | )                   | $          | 308               |       | (1,543              | )          | $                 | 201        |                | —     |   | — |   |
| Equity incentive  units outstanding at March 31, 2007  |       | 3,530             |       | $                   | 435        |              | 5,884      |                | $          | 229               |       | 2,354               |       | $                 | 119        |                | 415        |   | $ | 1,000 |   |
|                                                   |       |              |       |                |       |              |       |                |       |              |       |                |       |              |       |                |       |
| Vested Number of  Units as of March 31, 2007           |       | 165               |       |                |       | 275               |       |                |       | 110               |       |                |       | 415               |       |                |       |
| Unvested Number of Units  as of March 31, 2007         |       | 3,365             |       |                |       | 5,609             |       |                |       | 2,244             |       |                |       | 0                 |       |                |       |

 

**10.**                               COMMITMENTSAND CONTINGENCIES

**LeaseExpense**

As of March 31, 2007, theCompany leases the land for all 33 Parks. Of the 33 Parks, 30 lease theland from third parties under noncancelable operating leases that expire onvarious dates through 2041 and two lease the land from third parties underoperating leases with a termination option by the respective landlords. Theground leases for certain of the Parks require the Company to pay minimummonthly or annual rentals, which are adjusted periodically based on changes inthe Consumer Price Index or a percentage of sales method. The ground leases forcertain of the Parks require monthly rentals based on a percentage of grossrevenues derived from the operations of the premises, as defined. In addition,the ground leases require the payment of property taxes and certain leasesrequire the payment of common area expenses. Certain of the leases provide theCompany with options to renew for various periods of time. In addition, certainof the leases provide the Company with options to purchase the leased premisesin accordance with the terms of those lease agreements, and certain otherleases provide the Company with the right of first refusal in the event thatthe lessors decide to sell the land during the term of the leases.

In addition, the Companyleases its corporate office facilities from an unaffiliated third party under anon-cancelable operating lease, which expires in 2009.

For the three monthperiod ended March 31, 2007 and 2006, rent expense charged to cost of revenuein the Condensed Consolidated Statement of Operations, excluding propertytaxes, amounted to $3,641 and $3,667, respectively.

17

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The future minimum lease payments required undernoncancelable Park leases and office leases as of March 31, 2007, are asfollows:
| Year Ending      | ** ** | ** **           | ** ** | ** **                           | ** ** |
|-----------------------|------------|----------------------|------------|--------------------------------------|------------|
| **December 31,** | ** ** | **Park Leases** | ** ** | **Corporate Office Lease** | ** ** |
|                  |       |                 |       |                                 |       |
| 2007 (9 months)       |       | $                    | 9,942      |                                 | $          | 312 |   |
| 2008                  |       | 13,360               |       | 426                                  |       |
| 2009                  |       | 13,281               |       | —                               |       |
| 2010                  |       | 12,879               |       | —                               |       |
| 2011                  |       | 13,054               |       | —                               |       |
| Thereafter            |       | 218,732              |       | —                               |       |
| Total                 |       | $                    | 281,248    |                                 | $          | 738 |   |

 

**Litigation**

From time to time, the Company is involved in litigation relating toclaims arising out of its operations in the normal course of business. As ofMarch 31, 2007, the Company is not a party to any legal proceedings, theadverse outcome of which, in management’s opinion, individually or in theaggregate, would have a materially adverse effect on the Company’s consolidatedfinancial position or results of operations.

The Company received written notice in December 2004 concerning theTexas Department of Transportation’s intention to seize, through the eminentdomain process, a portion of the real property leased by the Company at itsDallas SpeedZone® FEC in connection with the widening of Interstate 35 E. TheCompany is currently in negotiations with its landlord on a global resolution ofthe issue, and is close to an agreement whereby the Landlord will sell thesubject portion of the property to the State and then pay to modify the Company’sfacilities to conform to the new property line.   In addition, thecity of Riverside, California is currently in the process of seizing a portionof roadside property at the Company’s Castle Park FEC under the doctrine ofeminent domain in connection with the construction of a freeway access ramp.The portion of land at issue is unimproved dirt, and the Company has reached anagreement with its landlord of a reduction in rent in exchange for concedingthe issue and not litigating.  The Company believes that the new accessramp will not impair any of the attractions at this FEC, and will likely improvevisibility and access to the park.

The Company and MidOceanPartners have been named as defendants in a lawsuit alleging, among otherthings, breach of a finder’s fee agreement and tortuous interference with suchagreement in connection with the Acquisition.  The agreement at issue isbetween two individuals and a company that are separate and distinct from boththe Company and MidOcean Partners.  Theplaintiff, Steven Crowley (“Crowley”), asserts five claims in his AmendedComplaint dated January 5, 2007.  Crowleypurports to hold the Company responsible for the alleged breach of finder’sagreement between Crowley (and another individual who is not a plaintiff) andVisionMaker, LLC (“VisionMaker”). Crowley claims that the Company is thesuccessor in interest to VisionMaker.  As such, although the lawsuit seeksaggregate damages in excess of $3.2 million, the Company has filed a motion todismiss, which is currently pending in the United States District Court for theSouthern District of New York.

**11.**                               INCOMETAXES

The Company and its subsidiaries file a consolidated federal income taxreturn and various state income and franchise tax returns.   The Company uses the estimated effective taxrate for the year to determine the provision for income taxes for interimperiods.  The Company recorded an incometax benefit of $5,530 for the three months ended March 31, 2007.  The Company has recorded no valuationallowance.  The Company believes it ismore likely than not that the tax benefit will be used in subsequent periodswhen profitability is expected due to the seasonality of the business.

The Company adopted the provisions of FASB Interpretation No. 48,*Accounting for Uncertainty in Income Taxes*- anInterpretation of FASB Statement No. 109, or FIN 48, on January 1, 2007. TheCompany did not have any unrecognized tax benefits and there was no effect onour financial condition or results of operations as a result of implementingFIN No. 48.

18

----

The Company files income tax returns in the U.S. federal jurisdictionand various state jurisdictions. The Company does not believe there will be anymaterial changes in our unrecognized tax positions over the next 12 months.

Our policy is that we recognize interest and penalties accrued on anyunrecognized tax benefits as a component of income tax expense. As of the dateof adoption of FIN 48, we did not have any accrued interest or penaltiesassociated with any unrecognized tax benefits, nor was any interest expenserecognized during the quarter. Our effective tax rate differs from the federalstatutory rate primarily due to state tax and non-deductible expenses.

**12.**                               SEGMENTINFORMATION DISCLOSURE

The Company hasoperations in two business segments and, as a result, has adopted SFASNo. 131, *Disclosures about Segments ofan Enterprise and Related Information.* SFAS No. 131 establishesstandards for reporting information about operating segments in annualfinancial statements. Operating segments are defined as components of anenterprise about which separate financial information is available and isevaluated on a regular basis by the chief operating decision maker or decisionmaking group, in deciding how to allocate resources to an individual segmentand in assessing performance of the segment. The Company has identified these segmentsbased on the nature of business conducted by each.

TheCompany has two reportable segments: FECs and WPs. FECs primarily offerminiature golf, batting cages, kiddie parks, go-carts, and video arcades. WPsfeature water slides, flumes, and pools as their primary attractions. Theaccounting policies of the segments are the same as those described inNote 2. Operating income (loss) of segments does not include interestincome or expense and provision for income taxes and also excludes corporate items,such as general and administrative expenses and corporate depreciation expense.Identifiable assets are those used in the Company’s operations in each segment.Corporate assets consist primarily of deferred financing costs, deposits,property and equipment, and cash and cash equivalents.

Goodwill for WPs and FECswas $51,902 and $34,602 respectively, as of March 31, 2007 and December 31,2006.

**SEGMENT DATA:**

**Successor**

**For the three monthperiod ended March 31, 2007**

 
|                                | ** ** | ** **   | ** ** | **Segment Loss**    | ** ** | ** **       | ** ** | ** **       | ** ** |
|--------------------------------|------------|--------------|------------|--------------------------|------------|------------------|------------|------------------|------------|
| ** **                     | ** ** | ** **   | ** ** | **Before Interest** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                     | ** ** | ** **   | ** ** | **Taxes,**               | ** ** | **Depreciation** | ** ** | ** **       | ** ** |
| ** **                     | ** ** | **Revenues** | ** ** | **Depreciation**         | ** ** | **and**          | ** ** | **Capital**      | ** ** |
| ** **                     | ** ** | **Net**      | ** ** | **and Amortization**     | ** ** | **Amortization** | ** ** | **Expenditures** | ** ** |
|                           |       |         |       |                     |       |             |       |             |       |
| FEC                            |       | $            | 18,597     |                     | $          | 2,897            |       | $                | 2,724      |   | $ | 1,595 |   |
| WP                             |       | 2,936        |       | (6,209                   | )          | 1,610            |       | 3,407            |       |
|                           |       |         |       |                     |       |             |       |             |       |
| Total Operations               |       | 21,533       |       | (3,312                   | )          | 4,334            |       | 5,002            |       |
| Corporate                      |       |         |       |                     |       | 390              |       | 5                |       |
|                           |       |         |       |                     |       |             |       |             |       |
| Total                          |       | $            | 21,533     |                     |       |             | $          | 4,724            |       | $ | 5,007 |   |
|                           |       |         |       |                     |       |             |       |             |       |
| Reconciliation  to Net Loss:   |       |         |       |                     |       |             |       |             |       |
|                           |       |         |       |                     |       |             |       |             |       |
| Corporate  Expenses            |       |         |       | (3,770                   | )          |             |       |             |       |
| Interest Expense  - Net        |       |         |       | (4,415                   | )          |             |       |             |       |
| Depreciation and  Amortization |       |         |       | (4,724                   | )          |             |       |             |       |
| Gain on disposal  of assets    |       |         |       | 40                       |       |             |       |             |       |
| Income tax  benefit            |       |         |       | 5,530                    |       |             |       |             |       |
| Net Loss                       |       |         |       | $                        | (10,651    | )                |       |             |       |   |

 

19

----

 

**SEGMENT DATA:**

**Predecessor**

**For the three month period ended March 31, 2006**

 
|                                | ** ** | ** **   | ** ** | **Segment Earnings (Loss)** | ** ** | ** **       | ** ** | ** **       | ** ** |
|--------------------------------|------------|--------------|------------|---------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                     | ** ** | ** **   | ** ** | **Before Interest**              | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                     | ** ** | ** **   | ** ** | **Taxes,**                            | ** ** | **Depreciation** | ** ** | ** **       | ** ** |
| ** **                     | ** ** | **Revenues** | ** ** | **Depreciation**                      | ** ** | **and**          | ** ** | **Capital**      | ** ** |
| ** **                     | ** ** | **Net**      | ** ** | **and Amortization**             | ** ** | **Amortization** | ** ** | **Expenditures** | ** ** |
|                           |       |         |       |                                  |       |             |       |             |       |
| FEC                            |       | $            | 17,104     |                                  | $          | 1,623            |       | $                | 1,901      |   | $ | 1,072 |   |
| WP                             |       | 3,692        |       | (5,134                                | )          | 2,136            |       | 2,659            |       |
|                           |       |         |       |                                  |       |             |       |             |       |
| Total Operations               |       | 20,796       |       | (3,511                                | )          | 4,037            |       | 3,731            |       |
| Corporate                      |       |         |       |                                  |       | 142              |       | 47               |       |
|                           |       |         |       |                                  |       |             |       |             |       |
| Total                          |       | $            | 20,796     |                                  |       |             | $          | 4,179            |       | $ | 3,778 |   |
|                           |       |         |       |                                  |       |             |       |             |       |
| Reconciliation  to Net Loss:   |       |         |       |                                  |       |             |       |             |       |
|                           |       |         |       |                                  |       |             |       |             |       |
| Corporate  Expenses            |       |         |       | (2,778                                | )          |             |       |             |       |
| Interest expense  - net        |       |         |       | (6,004                                | )          |             |       |             |       |
| Depreciation and  Amortization |       |         |       | (4,179                                | )          |             |       |             |       |
| Income tax  benefit            |       |         |       | —                                |       |             |       |             |       |
| Net Loss                       |       |         |       | $                                     | (16,472    | )                |       |             |       |   |

 

**13.****                               SEPARATEFINANCIAL INFORMATION OF SUSIDIARY GUARANTORS OF INDEBTEDNESS**

As described in Footnotes3 and 7 above, FFP issued $150,000 in aggregate principal amount of 10 7/8%Senior Notes, Series A, due in 2014.  TheNotes are guaranteed on a senior unsecured basis by the Company and certain ofthe Company’s subsidiaries.  Thefollowing disclosures reflect the Company’s condensed consolidated financialinformation for the periods presented. The Condensed Consolidated financial information for the Company and theCompany’s guarantor subsidiaries for the periods presented as outlined belowhave been prepared from the books and records maintained by the Company and theguarantor subsidiaries.  The condensedfinancial information may not necessarily be indicative of the results ofoperations or financial position had the Company and the guarantor subsidiariesoperated as independent entities.  Allintercompany amounts included in the subsidiary records are eliminated inconsolidation.  As a result of thisactivity, an amount due to / due from related companies will exist at any time.

20

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Palace Entertainment Holdings, Inc. 

Condensed Consolidated Balance Sheet as of March 31, 2007 ( inthousands)

 
| ** **                                 | ** ** | ** **   | ** ** | ** **            | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|--------------------------------------------|------------|--------------|------------|-----------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                 | ** ** | ** **   | ** ** | **Festival Fun** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | **Holdings**     | ** ** |
| ** **                                 | ** ** | **Holdings** | ** ** | **Parks**             | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                 | ** ** | ** **   | ** ** | ** **            | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ASSETS                                     |       |         |       |                  |       |             |       |             |       |             |       |
| CURRENT ASSETS                             |       |         |       |                  |       |             |       |             |       |             |       |
| Cash and cash  equivalents                 |       | $            | —     |                  | $          | 2,453            |       | $                | 124        |             | $          | — |   | $ | 2,577 |   |
| Inventories                                |       |         |       | 1,052                 |       | 1,296            |       |             |       | 2,348            |       |
| Prepaid Expenses  and Other Current Assets |       |         |       | 4,310                 |       | 543              |       |             |       | 4,853            |       |
| Deferred Income  Taxes                     |       |         |       | 7,258                 |       | 0                |       |             |       | 7,258            |       |
| Total Current  Assets                      |       |         |       | 15,073                |       | 1,963            |       |             |       | 17,036           |       |
|                                       |       |         |       |                  |       |             |       |             |       |             |       |
| PROPERTY AND  EQUIPMENT-NET                |       |         |       | 55,428                |       | 59,145           |       |             |       | 114,573          |       |
| GOODWILL                                   |       |         |       | 86,504                |       | —           |       |             |       | 86,504           |       |
| INTANGIBLE ASSETS - Net                    |       |         |       | 11,598                |       | 7,210            |       |             |       | 18,808           |       |
| OTHER ASSETS-NET                           |       |         |       | 6,434                 |       | 142              |       |             |       | 6,576            |       |
| DUE FROM SUBSIDIARIES                      |       |         |       | 61,347                |       |             |       | (61,347          | )          |             |       |
| INVESTMENT IN  SUBSIDIARIES                |       | 48,129       |       | 4,422                 |       |             |       | (52,551          | )          | 0                |       |
| TOTAL                                      |       | $            | 48,129     |                  | $          | 240,806          |       | $                | 68,460     |             | $          | (113,898 | ) | $ | 243,497 |   |
|                                       |       |         |       |                  |       |             |       |             |       |             |       |
| LIABILITIES AND MEMBERS  INTEREST          |       |         |       |                  |       |             |       |             |       |             |       |
| CURRENT LIABILITIES                        |       |         |       |                  |       |             |       |             |       |             |       |
| Accounts Payable                           |       | $            | —     |                  | $          | 3,770            |       | $                | —     |             | $          | — |   | $ | 3,770 |   |
| Accrued Interest                           |       |         |       | 7,694                 |       | —           |       |             |       | 7,694            |       |
| Accrued Wages  and Payroll Taxes           |       |         |       | 2,212                 |       | 0                |       |             |       | 2,212            |       |
| Other accrued  liabilities                 |       |         |       | 11,179                |       | 254              |       |             |       | 11,433           |       |
| Unearned Revenue                           |       |         |       | 568                   |       | 1,599            |       |             |       | 2,167            |       |
| Current portion  of long term debt         |       |         |       | 38                    |       | 838              |       |             |       | 876              |       |
| Total Current  Liabilities                 |       |         |       | 25,461                |       | 2,691            |       |             |       | 28,152           |       |
|                                       |       |         |       |                  |       |             |       |             |       |             |       |
| LONG TERM DEBT-Less  Current Portion       |       |         |       | 157,336               |       | 0                |       |             |       | 157,336          |       |
| DEFERRED INCOME TAXES                      |       |         |       | 2,588                 |       | 0                |       |             |       | 2,588            |       |
| OTHER LONG TERM  LIABILITIES               |       |         |       | 7,292                 |       | 0                |       |             |       | 7,292            |       |
| Total  Liabilities                         |       |         |       | 192,677               |       | 2,691            |       |             |       | 195,368          |       |
|                                       |       |         |       |                  |       |             |       |             |       |             |       |
| DUE TO PARENT                              |       |         |       |                  |       | 61,347           |       | (61,347          | )          | 0                |       |
| SHAREHOLDER'S EQUITY                       |       | 48,129       |       | 48,129                |       | 4,422            |       | (52,551          | )          | 48,129           |       |
| TOTAL                                      |       | $            | 48,129     |                  | $          | 240,806          |       | $                | 68,460     |             | $          | (113,898 | ) | $ | 243,497 |   |

 

21

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PalaceEntertainment Holdings, Inc.

CondensedConsolidated Balance Sheet As Of December 31, 2006 ( in thousands)

 
| ** **                                | ** ** | ** **   | ** ** | ** **         | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------|------------|--------------|------------|--------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                | ** ** | ** **   | ** ** | **Festival**       | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | **Holdings**     | ** ** |
| ** **                                | ** ** | **Holdings** | ** ** | **Fun Parks** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| ASSETS                                    |       |         |       |               |       |             |       |             |       |             |       |
| CURRENT ASSETS                            |       |         |       |               |       |             |       |             |       |             |       |
| Cash and cash equivalents                 |       | $            | —     |               | $          | 1,966            |       | $                | 124        |             | $          | — |   | $ | 2,090 |   |
| Inventories                               |       |         |       | 896                |       | 1,228            |       |             |       | 2,124            |       |
| Prepaid Expenses and Other Current Assets |       |         |       | 4,538              |       | 778              |       |             |       | 5,316            |       |
| Deferred Income Taxes                     |       |         |       | 1,171              |       | 0                |       |             |       | 1,171            |       |
| Total Current Assets                      |       |         |       | 8,571              |       | 2,130            |       |             |       | 10,701           |       |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| PROPERTY AND  EQUIPMENT-NET               |       |         |       | 54,309             |       | 59,841           |       |             |       | 114,150          |       |
| GOODWILL                                  |       |         |       | 86,504             |       | —           |       |             |       | 86,504           |       |
| OTHER INTANGIBLE  ASSETS - Net            |       |         |       | 11,734             |       | 7,298            |       |             |       | 19,032           |       |
| OTHER ASSETS-NET                          |       |         |       | 7,163              |       | 144              |       |             |       | 7,307            |       |
| DUE FROM  SUBSIDAIREIS                    |       |         |       | 57,340             |       |             |       | (57,340          | )          |             |       |
| INVESTMENT IN  SUBSIDIARIES               |       | 58,195       |       | 9,523              |       |             |       | (67,718          | )          | —           |       |
| TOTAL                                     |       | $            | 58,195     |               | $          | 235,144          |       | $                | 69,413     |             | $          | (125,058 | ) | $ | 237,694 |   |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| LIABILITIES AND  MEMBERS INTEREST         |       |         |       |               |       |             |       |             |       |             |       |
| CURRENT  LIABILITIES                      |       |         |       |               |       |             |       |             |       |             |       |
| Accounts Payable                          |       | $            | —     |               | $          | 1,791            |       | $                | —     |             | $          | — |   | $ | 1,791 |   |
| Accrued Interest                          |       |         |       | 3,518              |       | —           |       |             |       | 3,518            |       |
| Accrued Wages and Payroll Taxes           |       |         |       | 2,513              |       | —           |       |             |       | 2,513            |       |
| Other accrued liabilities                 |       |         |       | 9,640              |       | 530              |       |             |       | 10,170           |       |
| Unearned Revenue                          |       |         |       | 141                |       | 1,182            |       |             |       | 1,323            |       |
| Current portion of long term debt         |       |         |       | 11                 |       | 837              |       |             |       | 848              |       |
| Total Current Liabilities                 |       |         |       | 17,614             |       | 2,549            |       |             |       | 20,163           |       |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| LONG TERM  DEBT-Less Current Portion      |       |         |       | 150,007            |       | 1                |       |             |       | 150,008          |       |
| DEFERRED INCOME  TAXES                    |       |         |       | 2,032              |       | 0                |       |             |       | 2,032            |       |
| DUE TO PARENT                             |       |         |       |               |       | 57,340           |       | (57,340          | )          | —           |       |
| OTHER LONG TERM  LIABILITIES              |       |         |       | 7,296              |       | 0                |       |             |       | 7,296            |       |
| Total Liabilities                         |       |         |       | 176,949            |       | 59,890           |       | (57,340          | )          | 179,499          |       |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| SHAREHOLDER'S  EQUITY                     |       | 58,195       |       | 58,195             |       | 9,523            |       | (67,718          | )          | 58,195           |       |
| TOTAL                                     |       | $            | 58,195     |               | $          | 235,144          |       | $                | 69,413     |             | $          | (125,058 | ) | $ | 237,694 |   |

 

22

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Successor

Palace Entertainment Holdings, Inc. 

Condensed Consolidated Statement of Operations For The ThreeMonths Ended March 31, 2007 ( in thousands)

 
| ** **                                | ** ** | ** **   | ** ** | ** **         | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------|------------|--------------|------------|--------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                | ** ** | ** **   | ** ** | **Festival**       | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | **Holdings**     | ** ** |
| ** **                                | ** ** | **Holdings** | ** ** | **Fun Parks** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| REVENUES - net                            |       | $            | —     |               | $          | 16,966           |       | $                | 4,567      |             | $          | — |   | $ | 21,533 |   |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| OPERATING COSTS  AND EXPENSES             |       |         |       |               |       |             |       |             |       |             |       |
| Cost of revenue                           |       |         |       | 16,387             |       | 7,342            |       |             |       | 23,729           |       |
| Selling, general and administrative       |       |         |       | 4,279              |       | 607              |       |             |       | 4,886            |       |
| Depreciation and amortization             |       |         |       | 3,005              |       | 1,719            |       |             |       | 4,724            |       |
| Gain on disposal of assets                |       |         |       | (40                | )          | —           |       |             |       | (40              | )          |
| Total operating costs and expenses        |       | —       |       | 23,631             |       | 9,668            |       | —           |       | 33,299           |       |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| OPERATING LOSS                            |       | —       |       | (6,665             | )          | (5,101           | )          | —           |       | (11,766          | )          |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| Equity loss in  earnings of subsidiaries  |       | (16,181      | )          | (5,101             | )          | —           |       | 21,282           |       | —           |       |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| OTHER EXPENSE                             |       |         |       |               |       |             |       |             |       |             |       |
| Interest expense - net                    |       | —       |       | 4,415              |       | —           |       | —           |       | 4,415            |       |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| Loss from  operations before income taxes |       | (16,181      | )          | (16,181            | )          | (5,101           | )          | 21,282           |       | (16,181          | )          |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| Income tax  benefit                       |       | (5,530       | )          |               |       | —           |       | —           |       | (5,530           | )          |
|                                      |       |         |       |               |       |             |       |             |       |             |       |
| Net loss                                  |       | $            | (10,651    | )                  | $          | (16,181          | )          | $                | (5,101     | )                | $          | 21,282 |   | $ | (10,651 | ) |

 

23

----

Predecessor

Festival Fun Parks LLC

Condensed Consolidated Statement of Operations 

For The Three Months Ended March 31, 2006 ( in thousands )

 
| ** **                                | ** ** | ** **            | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **                | ** ** |
|-------------------------------------------|------------|-----------------------|------------|------------------|------------|------------------|------------|---------------------------|------------|
| ** **                                | ** ** | **Festival Fun** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **                | ** ** |
| ** **                                | ** ** | **Parks**             | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **FFP Consolidated** | ** ** |
|                                      |       |                  |       |             |       |             |       |                      |       |
| REVENUES - net                            |       | $                     | 15,722     |             | $          | 5,074            |       | $                         | —     |   | $ | 20,796 |   |
|                                      |       |                  |       |             |       |             |       |                      |       |
| OPERATING COSTS  AND EXPENSES             |       |                  |       |             |       |             |       |                      |       |
| Cost of revenue                           |       | 16,013                |       | 7,261            |       |             |       | 23,274                    |       |
| Selling, general and administrative       |       | 2,780                 |       | 1,031            |       |             |       | 3,811                     |       |
| Depreciation and amortization             |       | 2,493                 |       | 1,686            |       |             |       | 4,179                     |       |
| Gain on disposal of assets                |       |                  |       |             |       |             |       |                      |       |
| Total operating costs and expenses        |       | 21,286                |       | 9,978            |       |             |       | 31,264                    |       |
|                                      |       |                  |       |             |       |             |       |                      |       |
| OPERATING LOSS                            |       | (5,564                | )          | (4,904           | )          | —           |       | (10,468                   | )          |
|                                      |       |                  |       |             |       |             |       |                      |       |
| Equity loss in  earnings of subsidiaries  |       | (4,904                | )          | —           |       | 4,904            |       | —                    |       |
|                                      |       |                  |       |             |       |             |       |                      |       |
| OTHER EXPENSE                             |       |                  |       |             |       |             |       |                      |       |
| Interest expense - net                    |       | 6,004                 |       | —           |       |             |       | 6,004                     |       |
|                                      |       |                  |       |             |       |             |       |                      |       |
| Loss from  operations before income taxes |       | (16,472               | )          | (4,904           | )          | 4,904            |       | (16,472                   | )          |
|                                      |       |                  |       |             |       |             |       |                      |       |
| Net loss                                  |       | $                     | (16,472    | )                | $          | (4,904           | )          | $                         | 4,904      |   | $ | (16,472 | ) |

 

24

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SUCCESSOR

PALACE ENTERTAINMENT HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2007  ( in thousands)

 
| ** **                                                                             | ** ** | ** **   | ** ** | ** **            | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------|------------|-----------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                             | ** ** | ** **   | ** ** | **Festival Fun** | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | **Holdings**     | ** ** |
| ** **                                                                             | ** ** | **Holdings** | ** ** | **Parks**             | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                 |       |         |       |                  |       |             |       |             |       |             |       |
|  Net Loss                                                                         |       | $            | (10,651    | )                     | $          | (16,181          | )          | $                | (5,101     | )                | $          | 21,282 |   | $ | (10,651 | ) |
|  Adjustments  to reconcile net loss to net cash provided by operating activities: |       |         |       |                  |       |             |       |             |       |             |       |
| Depreciation and amortization                                                          |       |         |       | 3,005                 |       | 1,719            |       |             |       | 4,724            |       |
| Equity in earnings of subsidiaries                                                     |       | 16,181       |       | 5,101                 |       |             |       | (21,282          | )          |             |       |
| Gain on disposition                                                                    |       |         |       | (40                   | )          |             |       |             |       | (40              | )          |
| Amortization of deferred financing costs and  discount accretion                       |       |         |       | 193                   |       |             |       |             |       | 193              |       |
| Share based compensation                                                               |       |         |       | 85                    |       |             |       |             |       | 85               |       |
| Deferred rent expense                                                                  |       |         |       | 59                    |       |             |       |             |       | 59               |       |
| Deferred income tax                                                                    |       | (5,530       | )          |                  |       |             |       |             |       | (5,530           | )          |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| Changes in net operating assets and liabilities:                                       |       |         |       |                  |       |             |       |             |       |             |       |
| Inventories                                                                            |       |         |       | (156                  | )          | (68              | )          |             |       | (224             | )          |
| Prepaid expenses and other current assets                                              |       |         |       | 244                   |       | 235              |       |             |       | 479              |       |
| Other assets                                                                           |       |         |       | 521                   |       | 2                |       |             |       | 523              |       |
| Accounts payable                                                                       |       |         |       | 1,883                 |       | —           |       |             |       | 1,883            |       |
| Accrued interest                                                                       |       |         |       | 4,177                 |       | —           |       |             |       | 4,177            |       |
| Accrued wages and payroll taxes                                                        |       |         |       | (301                  | )          | —           |       |             |       | (301             | )          |
| Other accrued liabilities                                                              |       |         |       | 1,532                 |       | (276             | )          |             |       | 1,256            |       |
| Unearned revenue                                                                       |       |         |       | 427                   |       | 417              |       |             |       | 844              |       |
| Other long-term liabilities                                                            |       |         |       | (6                    | )          | —           |       |             |       | (6               | )          |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| Net cash used by operating activities                                                  |       | (0           | )          | 543                   |       | (3,072           | )          | (0               | )          | (2,529           | )          |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                 |       |         |       |                  |       |             |       |             |       |             |       |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| Purchases of  property and equipment                                                   |       |         |       | (3,765                | )          | (1,034           | )          |             |       | (4,799           | )          |
| Proceeds from  disposal of assets                                                      |       |         |       | 72                    |       |             |       |             |       | 72               |       |
| Net cash used in investing activities                                                  |       | —       |       | (3,693                | )          | (1,034           | )          | —           |       | (4,727           | )          |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                 |       |         |       |                  |       |             |       |             |       |             |       |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| Issuance of  common stock                                                              |       | 500          |       |                  |       |             |       |             |       | 500              |       |
| Proceeds from  issuance of long-term debt                                              |       | 7,250        |       |                  |       |             |       |             |       | 7,250            |       |
| Advances to  related party                                                             |       | (7,750       | )          | 3,643                 |       |             |       | 4,107            |       |             |       |
| Advances from  related party                                                           |       |         |       |                  |       | 4,107            |       | (4,107           | )          |             |       |
| Payments on  capital leases                                                            |       |         |       | (6                    | )          | (1               | )          |             |       | (7               | )          |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| Net cash provided by financing activities                                              |       | —       |       | 3,637                 |       | 4,106            |       | —           |       | 7,743            |       |
|                                                                                   |       |         |       |                  |       |             |       |             |       |             |       |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                             |       | (0           | )          | 487                   |       | 0                |       | (0               | )          | 487              |       |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                        |       |         |       | 1,966                 |       | 124              |       |             |       | 2,090            |       |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                              |       | $            | —     |                  | $          | 2,453            |       | $                | 124        |             | $          | — |   | $ | 2,577 |   |

 

25

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Predecessor

Festival Fun Parks LLC

Consolidated Statement of Cash Flows 

For the three month period ended Mach 31, 2006 (in thousands)

 
| ** **                                        | ** ** | ** **            | ** ** | **Combined**     | ** ** | ** **      | ** ** | ** **       | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                                        | ** ** | **Festival Fun** | ** ** | **Guarantor**    | ** ** | ** **      | ** ** | **FFP**          | ** ** |
| ** **                                        | ** ** | **Parks**             | ** ** | **Subsidiaries** | ** ** | **Elimination** | ** ** | **Consolidated** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES             |       |                  |       |             |       |            |       |             |       |
| Net (Loss)  Income                                |       | $                     | (16,472    | )                | $          | (4,904          | )          | $                | 4,904      |   | $ | (16,472 | ) |
| Depreciation and Amortization                     |       | 2,493                 |       | 1,686            |       |            |       | 4,179            |       |
| Equity in Earnings of Subsidiaries                |       | 4,904                 |       |             |       | (4,904          | )          |             |       |
| Amortization of Deferred financing costs          |       | 720                   |       |             |       |            |       | 720              |       |
| Financed Interest payments                        |       | 3,386                 |       |             |       |            |       | 3,386            |       |
| Deferred Rent expense                             |       | 51                    |       |             |       |            |       | 51               |       |
|                                              |       |                  |       |             |       |            |       |             |       |
| Changes in Net  Operating Assets and Liabilities: |       |                  |       |             |       |            |       |             |       |
| Inventories                                       |       | (54                   | )          | (50              | )          |            |       | (104             | )          |
| Prepaid Expenses and Other Current Assets         |       | 516                   |       | (74              | )          |            |       | 442              |       |
| Other Assets                                      |       | 8                     |       |             |       |            |       | 8                |       |
| Accounts Payable                                  |       | (133                  | )          |             |       |            |       | (133             | )          |
| Accrued Interest                                  |       | (11                   | )          |             |       |            |       | (11              | )          |
| Accrued Wages and Payroll Taxes                   |       | (61                   | )          |             |       |            |       | (61              | )          |
| Unearned Revenue                                  |       | 367                   |       | (2               | )          |            |       | 365              |       |
| Other Accrued Liabilities                         |       | (782                  | )          |             |       |            |       | (782             | )          |
| Net Cash Used by Operating Activities             |       | (5,068                | )          | (3,344           | )          |            |       | (8,412           | )          |
|                                              |       |                  |       |             |       |            |       |             |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES             |       |                  |       |             |       |            |       |             |       |
| Purchase of Property and Equipment                |       | (721                  | )          | (2,682           | )          |            |       | (3,403           | )          |
|                                              |       |                  |       |             |       |            |       |             |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES             |       |                  |       |             |       |            |       |             |       |
| Proceeds from Issuance of debt                    |       | 13,100                |       |             |       |            |       | 13,100           |       |
| Distribution to Members                           |       | (56                   | )          |             |       |            |       | (56              | )          |
| Advances to related company                       |       | (6,027                | )          |             |       | 6,027           |       |             |       |
| Advances from related company                     |       |                  |       | 6,027            |       | (6,027          | )          |             |       |
| Payments on Long-term Debt                        |       | (842                  | )          | 0                |       |            |       | (842             | )          |
| Payments on Capital Leases                        |       |                  |       | (2               | )          |            |       | (2               | )          |
| Net Cash Provided by Financing Activities         |       | 6,175                 |       | 6,025            |       |            |       | 12,200           |       |
|                                              |       |                  |       |             |       |            |       |             |       |
| NET INCREASE  (DECREASE) IN CASH                  |       | 386                   |       | (1               | )          |            |       | 385              |       |
|                                              |       |                  |       |             |       |            |       |             |       |
| CASH AND  EQUIVALENTS - BEGINNING OF PERIOD       |       | 5,125                 |       | 115              |       |            |       | 5,240            |       |
|                                              |       |                  |       |             |       |            |       |             |       |
| CASH AND EQUIVALENTS -  END OF PERIOD             |       | $                     | 5,511      |             | $          | 114             |       | $                | —     |   | $ | 5,625 |   |

 

26

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**14.         SUBSEQUENT EVENTS**

Effective May 1, 2007,the Company appointed Cynthia Kellogg as Senior Vice President and ChiefFinancial Officer. 

Effective May 1, 2007,James A. Burk, who formerly served as Chief Financial Officer, has agreed toremain with the Company as Chief Accounting Officer on an interim basis inorder to assist with the transition, serving at the discretion of the ChiefExecutive Officer in this capacity for a period ending not later than June 30,2007.  Pursuant to the terms of Mr. Burk’s separation agreement, when histenure as Chief Accounting Officer ends he will receive 14 months of severancebenefits. 

27

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**ITEM 2. MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

OVERVIEW

We are one of the largest operators of water parks (“WPs”)and family entertainment centers (“FECs”) in the United States, based on thenumber of Parks operated. As of March 31, 2007, we operated a geographicallydiverse portfolio of 33 Parks in eight states with an attendance that weestimate to be in excess of 10 million guests in 2007. Each of our Parksis a well-established business with a long operating history, with our WPs andour FECs having been in operation for an average of over 24 years and19 years, respectively. We operate our Parks under several establishedbrand names such as Wet ’N Wild®, Splish SplashÔ, Raging Waters®, Malibu Grand Prix®, MountasiaÔ, SpeedZone®, Big Kahuna’s®, Silver Springs® andBoomers!®.

Our typical WP offers 15 to 25 rides and attractionsincluding variable depth pools, water slides, wave pools, action and “lazy”rivers, tube rides and water-themed adventure areas, as well as interactivechildren’s play areas. We generate revenue in our WPs from general admissionticket sales, the sales of food, beverages, souvenir items, strollers, lockerrentals and parking.

With locations in California, Florida, Georgia, New Yorkand Texas, our FECs offer a variety of attractions, including some or all ofthe following: miniature golf courses, go-karts, bumper boats, thrill rides,state-of-the-art arcade games, redemption games, batting cages, rock walls,laser tag and kiddie rides. Two of our FECs offer dragster racing on six racingtracks. Our FECs typically do not charge a general admission fee; guests onlypay for those games they wish to utilize. Additionally, under certainpromotions, we offer bundled pricing and group packages. Our FECs generaterevenues from attractions and the sales of food, beverages and merchandise.

Attendance at our Parks is the key driver of our revenuesand profitability. Adverse weather conditions significantly reduce our guests’attendance. In addition, our Parks also are subject to changing consumertastes, preferences and demands, which directly affect attendance and revenueper guest. In general, we compete indirectly with all phases of theentertainment and recreation industry within our primary markets, includingmovie theaters, bowling alleys, skating rinks, sporting events, restaurants,zoos, museums, carnivals, aquariums, resorts, natural and historicalattractions and playgrounds.

In order to anticipate and adapt to changing consumerpreferences and maintain and increase attendance, we must invest in new rides,amusements, arcade games and attractions.

Our operating costs and expenses consist of thefollowing: cost of revenue, which primarily includes costs of products soldlike food and beverage, arcade redemption prizes and merchandise; salaries andbenefits, which include the costs of our park level fulltime and part timeemployees; operating and maintenance, which include outside services, supplies,spare parts, and utilities; rent (a portion of which are percentage rents) andproperty taxes, which includes all park level rent and property tax expenses(offset by rental income earned from the sublease of building space and/orland); selling, general and administrative expenses, which includes allcorporate overhead including corporate salaries, office rent, insurance costsand fees to outside professional service providers, other operating costs whichinclude all advertising, promotion and marketing program expenses (includingtelevision, radio and print advertising); and depreciation and amortization,which is primarily related to our leasehold improvements, equipment andtrademarks. All of our facilities are on leased property. Certain of our expensesare relatively fixed, and costs for full-time employees, outside services,maintenance, utilities, insurance, depreciation and amortization and occupancycosts do not vary significantly with attendance. We add significant numbers ofseasonal employees during the warmer months of the year, primarily fromMemorial Day to Labor Day. Our workforce consists of high-school aged youngadults and teachers who work on an hourly basis during our operating season forour WPs and year-round with peak summer employment for our FECs. A significantnumber of our hourly personnel at our facilities are paid at rates related tothe federal minimum wage. Under federal and state child labor laws, we areregulated in the number of hours, the times and the types of jobs that youthsup to the age of 18 are permitted to work.

Our nine WPs and one nature park have gated entrances,which allow us to track admissions and per capita spending for these Parks. Wegenerally do not track attendance and per capita spending for our 23 non-gatedFECs.

Our business is highly seasonal. Typically, our WPsoperate on an approximate 110-day operating season, generally from Memorial Daythrough Labor Day, and though our FECs are open year-round, there is alsosignificantly greater attendance at our FECs during this period and otherperiods when children are out of school. More than 75% of our revenues are generated during the second and thirdcalendar quarters of each year.  Webelieve that the spending at our FECs varies widely among our customers basedon age and other demographic factors, and the location and nature of theattractions of the park.

28

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Our business is concentrated geographically and by thesize of our Parks. Seventeen of our Parks are located in California andaccounted for 52%****of our revenue for the threemonth period ended March 31, 2007.

**Comparison of Three Months Ended March31, 2007 and 2006**

Our combined net loss was $10.6 million and $16.5 millionfor the three month period ended March 31, 2007 and 2006, respectively. The followingtable sets forth statement of operations data and other data for the periodsindicated:
| ** **                              | ** ** | **For the three months ended March 31,** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                                               | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)**                                   | ** ** |
| ** **                              |       |                                                                   |       |   |   |
| **Statement  of operations:**           |       |                                                                   |       |   |   |
|                                    |       |                                                                   |       |   |   |
| **Revenues**                            |       |                                                                   |       |   |   |
| FECs                                    |       | $                                                                      | 18,597     |   | $ | 17,104 |   |
| WPs                                     |       | 2,936                                                                  |       | 3,692 |   |
| Total revenues                          |       | 21,533                                                                 |       | 20,796 |   |
| **Operating  costs and expenses**       |       |                                                                   |       |   |   |
| Cost of revenues                        |       | 23,729                                                                 |       | 23,274 |   |
| % of revenues                           |       | 110.2                                                                  | %          | 111.9 | % |
| Selling, general and administrative     |       | 4,886                                                                  |       | 3,811 |   |
| % of revenues                           |       | 22.7                                                                   | %          | 18.3 | % |
| Depreciation and amortization           |       | 4,724                                                                  |       | 4.179 |   |
| Gain on disposal of assets              |       | (40                                                                    | )          | — |   |
| **Total  operating costs and expenses** |       | 33,299                                                                 |       | 31,264 |   |
| Operating loss                          |       | (11,766                                                                | )          | (10,468 | ) |
| Interest expense, net                   |       | 4,415                                                                  |       | 6,004 |   |
| **Net  loss from operations**           |       | (16,181                                                                | )          | (16,472 | ) |
| **Income  tax benefit**                 |       | (5,530                                                                 | )          | — |   |
|                                    |       |                                                                   |       |   |   |
| **Net loss**                            |       | $                                                                      | (10,651    | ) | $ | (16,472 | ) |

 

29

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We have two reportable segments, FECs and WPs. The accounting policiesof the segments are the same as those described in critical accounting policiesbelow. Net Income (loss) of the segments does not include interest income orexpense and provision for income taxes. The following table sets forth certainstatement of operations data by segment and other data for the periodsindicated:

 
| ** **                           | ** ** | **For the three months ended** | ** ** | **For the three months ended** | ** ** |
|--------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                           | ** ** | **March 31,**                                 | ** ** | **March 31,**                                 | ** ** |
| ** **                           | ** ** | **WPs**                                            | ** ** | **FECs**                                           | ** ** |
| ** **                           | ** ** | **2007**                                           | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |                                               |       |                                               |       |   |   |   |   |
| Revenues, net                        |       | $                                                  | 2,936      |                                               | $          | 3,692 |   | $ | 18,597 |   | $ | 17,104 |   |
| Segment-level  net income (loss) (1) |       | (7,819                                             | )          | (7,270                                             | )          | 173 |   | (278 | ) |
| Segment-level capital  expenditures  |       | 3,407                                              |       | 2,659                                              |       | 1,595 |   | 1,072 |   |
|                                      |            |                                                    |            |                                                    |            |  |  |  |  |  |  |  |  |

 

----

(1) *SegmentInformation Disclosure,*in the “Notes to the Condensed ConsolidatedFinancial Statements” for the reconciliation between segment-level earnings(loss) and the Company’s net income (loss). 
|                                  | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| **WP operating data:** | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
|                             |       |                                                 |       |   |   |
| WP attendance                    |       | 129,017                                              |       | 175,563 |   |
|                             |       |                                                 |       |   |   |
| Revenue per guest                |       | $                                                    | 22.75      |   | $ | 21.02 |   |
|                                  |            |                                                      |            |  |  |  |  |

 

**Threemonths ended March 31, 2007 and 2006**

*Revenue.*  Revenuefor the three months ended March 31, 2007 totaled $21.5 million comparedto $20.8 million for the three months ended March 31, 2006, an increase of$0.7 million or 3.3%.  FEC revenuesincreased $1.49 million or 8.8% over the same period in 2006.  This was achieved despite unfavorable weatherin Texas that adversely effected four FEC locations.  Good weather in California and the southeastlocations combined with pricing initiatives implemented in 2006, increasedcapital spending in 2006 and early in 2007 and last year’s initiatives toimprove the park appearances and the quality of the guest service contributedto this revenue increase.  Partialrevenue increase can also be attributed to Easter break occurring earlierduring 2007 versus 2006.  Offsetting theFEC revenue increase was a decrease in attendance and revenues at the SilverSprings nature park. A reduction in the number of concerts combined with aweaker concert lineup than in 2006 contributed to the revenue decrease.  In addition, a pricing increase in season passesadopted in late 2006 resulted in lower season pass sales adversely impactingattendance during the quarter.  In March2007, the Company lowered the season pass prices which resulted in a $0.3 millionincrease in season pass sales for the month of March 2007 compared to the sameperiod in 2006. 

*Cost ofrevenue.*  Our park level operating expenses totaled$23.7 million for the three months ended March 31, 2007 compared to $23.3million for the same period in 2006, an increase of $0.4 million or 1.7%.Operating expenses as a percentage of revenue, however, decreased from 111.9%in 2006 to 110.2%.  The primary driversin each expense category were as follows:

·                  Cost of products sold increased $0.05 million or2.8% for the three month period ended March 31, 2007 compared to the sameperiod in 2006 primarily due to revenue driven incremental food, beverage andmerchandise costs. Food and beverage costs as a percentage of related revenueswere consistent with the prior period.  

 ·               Salaries and benefits decreased $0.1 million or1.4% for the three month period ended March 31, 2007 compared to the sameperiod in 2006.  Rate increasesattributable to the minimum wage increase as of January 1, 2007, were partiallyoffset by salaried labor reductions and a reduction in hourly labor hours. Inaddition, accrued vacations costs were lower by $0.3 million as a result of thechange in the Company’s vacation policy as of January 1, 2007 to accrue asearned instead of earning 100% entitlement as of the beginning of the year.

30

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·                  Operating and maintenance costs increased $0.6 million or 8.8% for the three month period ended March 31, 2007 comparedto the same period in 2006 primarily resulting from higher revenues, a $0.3million increase in general liability self insurance reserve and $0.2 millionincrease in insurance premiums.

·                  Rent and property taxes decreased $0.1 million or2% for the three month period ended March 31, 2007 compared to the same periodin 2006 as a result of lower common area charges.   Theimproved liquidity of the Company allowed for earlier payments resulting indiscounts on tax assessments. 

*Selling,general and administrative expenses.*  Selling, general and administrativeexpenses totaled $4.9 million for the three month period ended March 31, 2007compared to $3.8 million for the same period in 2006, an increase of $1.1 millionor 28.2%.  The increase was primarily drivenby a $0.8 million increase in severance related costs associated with thecorporate reorganization at the beginning of 2007 and increased professionalaudit and legal fees attributable to being a public company.

*Depreciationand amortization. *Depreciation andamortization expenses increased $0.5 million or 13% for the three month periodended March 31, 2007 compared to the same period in 2006.   The increase was due to higher depreciation and amortization in 2007as a result of increasing property and equipment and intangibles to fair marketvalue and adjusting their economic useful lives in connection with theAcquisition.

*Interest expense,net*.  Interest expense, net totaled$4.4 million for the three monthperiod ended March 31, 2007 comparedto $6 million during the same period in 2006, a decrease of $1.6 million or26.6%.  The decrease in interest expense wasprimarily due to the lower debt levels and lower interest rates that resultedfrom the new capital structure implemented at the time of the Acquisition.  The debt extinguishment fees relating to theloans repaid as of the Acquisition date were recorded to goodwill. 

*Income tax benefit. * The Company recorded an income tax benefit of $5,530for the three month period ended March 31, 2007 compared to $0 for the threemonth period ended March 31, 2006, since the entity was not previously subject totaxes prior to the Acquisition.  TheCompany recorded an income tax benefit since it had loss from operations forthe three month period ended March 31, 2007. The Company has recorded no valuation allowance.  The Company believes it is more likely thannot that the tax benefit will be used in subsequent periods when profitabilityis expected due to the seasonality of the business.

**Liquidity andcapital resources**

During the three month periodended March 31, 2007 and 2006, net cash used by operating activities was $2.5million and $8.4 million, respectively. An increase in unearned revenues and favorable timing movements in theaccounts payable and accrued    expensesaccounted for the improved net use of cash in 2007.  Because our business is seasonal and involvessignificant levels of cash transactions, factors impacting our net operatingcash flows are the same as those impacting our cash-based revenues and expensesdiscussed above.

Net cash used in investingactivities was $4.7 million and $3.4 million for the three month period ended March31, 2007 and 2006, respectively, primarily driven by increased purchases ofproperty and equipment. 

Net cash provided by financingactivities for the three month period ended March 31, 2007 was $7.7 millioncompared to $12.2 million during the same period in 2006.    The net cash provided in 2007 was primarilydriven by the proceeds received from our new senior secured revolving creditfacility to fund working capital requirements. 

In connection with the Acquisition,we incurred substantial amounts of debt, including amounts outstanding underthe Notes and our senior secured revolving credit facility (“Revolver”).Interest payments on this indebtedness significantly reduce our cash flow fromoperations. However, as a result of the refinancing of our debt in connectionwith the Transactions from the proceeds of the Equity Contribution and the Notes,our annual interest expense has significantly decreased and we are no longer besubject to annual debt amortization payments. As of March 31, 2007, the $150 million of Notes are outstanding and theprincipal is due April 12, 2014.  Therewere no interest payments paid or due during the three months ending, March 31,2007 relating to our Notes. 

Our senior secured revolvingcredit facility consists of a $40.0 million revolving credit facility. Due tothe seasonal nature of our business, we are dependent upon our revolving creditfacility to fund off-season expenses with seasonal borrowings typically peakingduring our fiscal second quarter. Our ability to borrow under the revolvingcredit facility is dependent upon compliance with certain conditions, includingsatisfying certain financial ratios and the absence of any material adversechange.   As of March 31, 2007, there was$7.2 million outstanding on our revolving credit facility and $4.3 million ofissued but undrawn letters of credit.

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The degree to which we areleveraged could adversely affect our liquidity. Our liquidity could also beadversely affected by unfavorable weather, accidents or the occurrence of anevent or condition, including negative publicity or significant localcompetitive events that significantly reduce paid attendance and, therefore,revenue at any of our Parks. In addition, our anticipated cash flows could bematerially adversely affected by the occurrence of certain of the risksdescribed in “Risk Factors.” In that case, we would need to seek additionalfinancing.

We believe, based on historicaland anticipated operating results, that cash flows from operations, availablecash and available amounts under the new senior secured revolving creditfacility will be adequate to meet our future liquidity needs, includinganticipated requirements for working capital, capital expenditures andscheduled debt requirements for the foreseeable future.

**Off balancesheet arrangements**

We have no off-balance sheetarrangements.

**Contractual Obligations**

The following table summarizesthe timing of our required payments due under various contractual obligationsas of March 31, 2007:
|                                     | ** ** | **Less**                | ** ** | **One**           | ** ** | **Three**         | ** ** | ** **     | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-------------------|------------|-------------------|------------|----------------|------------|------------|------------|
| ** **                          | ** ** | **than**                | ** ** | **Year**          | ** ** | **Years to** | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **One**                 | ** ** | **to Three** | ** ** | **Five**          | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **Year**                | ** ** | **Years**         | ** ** | **Years**         | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| ** **                          | ** ** | **(in thousands)** | ** ** |
| As of March 31,  2007:              |       |                    |       |              |       |              |       |           |       |       |       |
| Long term Notes  including interest |       | 16,312                  |       | 32,624            |       | 32,624            |       | 190,780        |       | 272,340    |       |
| Revolver (1)                        |       | 598                     |       | 1,794             |       | 1,794             |       | 7,250          |       | 11,436     |       |
| Capital lease  obligations          |       | 876                     |       | 86                |       | —            |       | —         |       | 962        |       |
| Park and office  leases (2)         |       | 10,254                  |       | 27,067            |       | 25,933            |       | 218,732        |       | 281,986    |       |
| **Total**                           |       | 28,040                  |       | 61,571            |       | 60,351            |       | 416,762        |       | 566,724    |       |

 

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(1) The revolver principal balance of$7,250 is not contractually due until 2012. The above reflects what amount of interest would be due if the principalbalance is paid in 2012.  Since theinterest rate is variable, the Company has assumed a variable interest rate of8.25% per year.  The contractual due datedoes not indicate when the revolver is expected to be repaid.  Due to the seasonality of the business, therevolver balance will fluctuate throughout the year.

(2) Does not include annual rent escalations associated with theconsumer price index or any percentage rent in excess of minimum levels. 

 

**Recently issued accountingpronouncements**

In February 2007,the FASB issued Statement of Financial Accounting Standards No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities*– *includingan amendment of FASB Statement No. 115* (SFAS 159). SFAS 159 givesthe Company the irrevocable option to carry most financial assets andliabilities at fair value, with changes in fair value recognized in earnings.SFAS 159 is effective for the Company’s 2009 fiscal year, although earlyadoption is permitted. The Company is currently assessing the potential effectof SFAS 159 on its financial statements. 

InSeptember 2006, the FASB issued SFAS No. 157, *“Fair ValueMeasurements.”* SFAS No. 157 establishes a framework for measuringfair value in generally accepted accounting principles (“GAAP”), and expandsdisclosures about fair value measurements. This Statement is effective forfinancial statements issued for fiscal years beginning after November 15, 2007,and interim periods within those fiscal years. The Company is in the process ofevaluating the impact of adopting SFAS No. 157.

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In July 2006, the FASBissued FASB Interpretation No. 48 (“FIN No. 48”), *Accountingfor Uncertainty in Income Taxes,* which prescribes a recognitionthreshold and measurement process for recording in the financial statementsuncertain tax positions taken or expected to be taken in a tax return.Additionally, FIN No. 48 provides guidance on derecognition, classification,interest and penalties, accounting in interim periods and disclosurerequirements for uncertain tax positions. The accounting provisions of FIN No. 48are effective for reporting periods beginning after December 15, 2006.  The Company adopted the provisions of FIN No.48, on January 1, 2007. The Company did not have any unrecognized tax benefitsand there was no effect on our financial condition or results of operations asa result of implementing FIN No. 48.

In July 2006, the FASBissued EITF 06-3, How Taxes Collected from Customers and Remitted toGovernmental Authorities Should Be Presented in the Income Statement (That Is,Gross versus Net Presentation) that requires disclosure of the accountingpolicy related to any tax assessed by a government authority in a revenueproducing transaction (either gross or net) and the amount of such taxes inboth interim and annual financial statements if the amounts aresignificant.  This EITF becomes effectivefor reporting periods beginning after December 15, 2006. The Company hasadopted EITF 06-3 and the Condensed Consolidated financial statements conformto its requirements. The Company’s policy is to present the taxes collectedfrom the customers and remitted to governmental authorities on a net basis. 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK

*InterestRates.*  Our marketrisks relate primarily to changes in interest rates. Our new senior securedrevolving credit facility carries floating interest rates that are tied to theLIBOR rate and the Prime rate and therefore, the consolidated financialstatements will be exposed to changes in interest rates. A 1.0% interest rateincrease would increase interest expenses between $0 and $0.4 million annually,depending on the average carrying balance of the facility which could vary from$0 to $40 million. We historically have not engaged in interest rate hedgingactivities.

*CurrencyExchange Rates.*  We arenot exposed to currency exchange rate risks.

Item 4. CONTROLS AND PROCEDURES

The Company’s management,with the participation of the Company’s Chief Executive Officer and ChiefFinancial Officer, has evaluated the effectiveness of the Company’s disclosurecontrols and procedures as of March 31, 2007. Based on that evaluation, the Company’s Chief Executive Officer andChief Financial Officer concluded that the Company’s disclosure controls andprocedures were effective as of March 31, 2007. The Company is not required to comply with Section 404 of the Sarbanes-OxleyAct of 2002, as amended, until December 31, 2007, but has initiated significantefforts to further ensure the adequacy and effectiveness of its internalcontrols.  There were no material changesin the Company’s internal control over financial reporting during the firstquarter.

 

**PART II.OTHER INFORMATION**

Item 1. LEGAL PROCEEDINGS

From time to time,the Company is involved in litigation relating to claims arising out of itsoperations in the normal course of business. As of March 31, 2007, the Companyis not a party to any legal proceedings, the adverse outcome of which, inmanagement’s opinion, individually or in the aggregate, would have a materiallyadverse effect on the Company’s consolidated financial position or results ofoperations.   The Company recordsreserves pursuant to Financial Accounting Standards Board Statement No 5, *Accounting for Contingencies.*

The Company receivedwritten notice in December 2004 concerning the Texas Department ofTransportation’s intention to seize, through the eminent domain process, aportion of the real property leased by the Company at its Dallas SpeedZone® FECin connection with the widening of Interstate 35 E. The Company is currently innegotiations with its landlord on a global resolution of the issue, and isclose to an agreement whereby the landlord will sell the subject portion of theproperty to the State and then pay to modify the Company’s facilities toconform to the new property line.   In addition, the city ofRiverside, California is currently in the process of seizing a portion ofroadside property at the Company’s Castle Park FEC under the doctrine ofeminent domain in connection with the construction of a freeway access ramp.The portion of land at issue is unimproved dirt, and the Company has reached anagreement with its landlord of a reduction in rent in exchange for concedingthe issue and not litigating.  The Company believes that the new accessramp will not impair any of the attractions at this FEC, and will likelyimprove visibility and access to the park.

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The Company andMidOcean Partners have been named as defendants in a lawsuit alleging, amongother things, breach of a finder’s fee agreement and tortuous interference withsuch agreement in connection with the Acquisition.  The agreement at issueis between two individuals and a company that are each separate and distinctfrom both the Company and MidOcean Partners.  The plaintiff, StevenCrowley (“Crowley”), asserts five claims in his Amended Complaint dated January5, 2007.  Crowley purports to hold theCompany responsible for the alleged breach of a finder’s agreement betweenCrowley (and another individual who is not a plaintiff) and VisionMaker, LLC(“VisionMaker”).  Crowley claims that theCompany is the successor in interest to VisionMaker.  As such, although the lawsuit seeks aggregatedamages in excess of $3.2 million, the Company has filed a motion to dismiss,which is currently pending in the United States District Court for the SouthernDistrict of New York.  

Item 1A. RISK FACTORS

**Risks related toour business**

There have been no material changes from the Risk Factorsdisclosed under the heading in Part I, Item 1A of our Annual Report on Form 10-K for the quarter ended March 31, 2007.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On March 1, 2007, Alexander Weber, Jr.purchased 500 membership units (Class A) of Holdings for $500,000 in cash.  Such shares were issued pursuant to theexemption from registration contained in Section 4(2) of the Securities Act asthey were sold to a sophisticated and accredited individual. 

 

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

See Exhibit Index

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|        |   | Palace Entertainment Holdings, Inc.                            |
|--------|--------|----------------------------------------------------------------|
|   |   |                                                           |
|   |   | /s/ Alexander Weber, Jr.                                       |
|   |   | By: Alexander Weber, Jr.                                       |
|   |   | Chief Executive Officer and President                          |
|   |   | (Principal  Executive Officer)                                 |
|   |   | Dated: May 14, 2007                                            |
|   |   |                                                           |
|   |   |                                                           |
|   |   | Palace Entertainment Holdings, Inc.                            |
|   |   |                                                           |
|   |   | /s/ James A. Burk                                              |
|   |   | By: James A. Burk                                              |
|   |   | Chief Accounting Officer                                       |
|   |   |       (Principal Accounting Officer)  |
|   |   |                                                           |
|   |   | Dated: May 14, 2007                                            |

 

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**EXHIBIT INDEX**
| Exhibit No. | ** ** | **Description of Document**                                                                                                                                                                                                                                 |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                        |
| 10.1        |       | Restated Assignment Agreement,  dated as of March 8, 2007, by and between Palace Entertainment Holdings, Inc.  and California Exposition & State Fair.                                                                                                  |
| 10.2        |       | Employment Agreement  effective as of May 1, 2007, among Festival Fun Parks, LLC, Palace  Entertainment Holdings, Inc. and Cynthia P. Kellogg (incorporated by  reference to the Current Report on Form 8-K filed May 3, 2007, File No.****333-135091-12).* |
| 31.1        |       | Rule  13a-14(a)/15d-14(a) Certification by the Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                           |
| 31.2        |       | Rule 13a-14(a)/15d-14(a)  Certification by the Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                           |
| 32.1        |       | Section 1350  Certification of Periodic Report by the Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002†                                                                                                              |
| 32.2        |       | Section 1350  Certification of Periodic Report by the Chief Financial Officer pursuant to  Section 906 of the  Sarbanes-Oxley Act  of 2002†                                                                                                       |

 

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| *      | Denotes management  contract or compensatory plan or arrangement.                                                                                                                                                                                                                                                                                                                                                                   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| † | This certification will  not be deemed “filed” for purposes of Section 18 of the Securities Exchange  Act of 1934 (15 U.S.C. 78r), or otherwise subject to the liability of that  section. Such certification will not be deemed to be incorporated by  reference into any filing under the Securities Act or Securities Exchange  Act, except to the extent that the Company specifically incorporates it by  reference. |

 

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