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MONARCH CASINO & RESORT : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

05/08/2015 | 01:43pm US/Eastern

Monarch Casino & Resort, Inc., through its direct and indirect wholly-owned subsidiaries, Golden Road Motor Inn, Inc. ("Golden Road"), Monarch Growth Inc. ("Monarch Growth"), Monarch Black Hawk, Inc. ("Monarch Black Hawk"), High Desert Sunshine, Inc. ("High Desert"), Golden North, Inc. ("Golden North") and Golden East, Inc. ("Golden East") owns and operates the Atlantis Casino Resort Spa, a hotel/casino facility in Reno, Nevada (the "Atlantis"), the Monarch Casino Black Hawk in Black Hawk, Colorado ("Monarch Black Hawk"), and certain real estate proximate to the Atlantis and Monarch Casino Black Hawk

Monarch's wholly owned subsidiary Monarch Interactive, Inc. ("Monarch Interactive") received approval from the Nevada Gaming Commission on August 23, 2012, which approval was extended three times, each for an additional six-month period, for a license as an operator of interactive gaming. The Company has decided to allow the current approval to lapse pending a change in market conditions that would support the Company's investment in this line of business. Monarch Interactive is not currently engaged in any operating activities. In Nevada, legal interactive gaming is currently limited to intrastate poker.

Unless otherwise indicated, "Monarch," "Company," "we," "our" and "us" refer to Monarch Casino & Resort, Inc. and its subsidiaries.



OPERATING RESULTS SUMMARY


Our operating results may be affected by, among other things, competitive factors, gaming tax increases, the commencement of new gaming operations, construction at our facilities, general public sentiment regarding travel, overall economic conditions and governmental policies affecting the disposable income of our patrons and weather conditions affecting our properties.

The following significant factors and trends should be considered in analyzing our operating performance:

Atlantis: Aggressive marketing programs by our competitors have posed challenges to us. In response our complimentaries expense has increased.

Monarch Black Hawk: Since the acquisition of Monarch Black Hawk in April 2012, our focus has been to maximize casino and food and beverage revenues. There is currently no hotel on the property. In September 2013, we opened a new buffet. In December 2013, we began a project to redesign and upgrade the casino. To minimize disruption, we staged the work in three equal phases. The first phase was completed and opened in August 2014. The second phase was completed and opened in March 2015. We estimate that the third and final phase of the redesign and upgrade work will be completed by the end of the third quarter 2015. The excavation and foundation work for the facility's new parking structure has been completed and the new parking structure is anticipated to be completed in late 2015 (see "Master Planned Expansion of the Monarch Casino Black Hawk" below). Monarch expects to begin construction of its new hotel tower and casino expansion in the second quarter of 2016. Once completed, the Monarch Black Hawk expansion will nearly double the casino space and will add a 23-story hotel tower with approximately 500 guest rooms and suites, an upscale spa and pool facility, three additional restaurants (increasing the total to four), additional bars, a new parking structure and associated support facilities. The planned nine story parking structure will increase total parking on site from approximately 500 spaces to approximately 1,500 spaces. Upon completion of the new parking structure, the existing parking structure will be demolished to make space for the hotel tower.

CAPITAL SPENDING AND DEVELOPMENT

We seek to continuously upgrade and maintain our facilities in order to present a fresh, high quality product to our guests.

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Capital expenditures totaled approximately $7.8 million and $5.0 million for the three month periods ended March 31, 2015 and 2014. During each of the three month periods ended March 31, 2015 and 2014, our capital expenditures related primarily to the redesign and upgrade of the Monarch Black Hawk facility as well as acquisition of gaming equipment to upgrade and replace existing equipment in the Atlantis and Monarch Casino Black Hawk. In December 2013, we started a three-phase casino floor remodel and upgrade project. The first phase was completed and opened in August 2014 and the second phase was completed and opened in March 2015.

Master Planned Expansion of the Monarch Casino Black Hawk

In October 2012, we began an extensive renovation and upgrade of Monarch Casino Black Hawk. To-date, we have upgraded the property's food and beverage operations (including an all-new buffet) and completed the first two phases of a three-phase renovation and upgrade of the existing casino floor (including a new front entrance and cabaret lounge). We expect to complete phase three in the third quarter of 2015. Our plans also call for the exterior of the existing facilities to be refinished to match the master planned expansion. The remaining cost of the upgrade and renovation is expected to be approximately $16-$18 million, all of which is expected to be funded from operating cash flow.

In addition, we have begun work on our master plan to expand and convert the Monarch Casino Black Hawk into a full-scale casino resort. The excavation and foundation work for the facility's new parking structure has been completed. The 9-story parking structure will increase on-site parking from approximately 500 spaces to approximately 1,500 spaces and is anticipated to be completed in late 2015. Upon completion of the new parking structure, the existing parking structure will be razed to make room for the hotel tower. The remaining cost of the parking structure-related work is expected to be approximately $29-$32 million, which we expect to fund primarily from operating cash flow and, to a lesser extent, from our Credit Facility.

We expect to begin construction of the new hotel tower and casino expansion in the second quarter of 2016. The new 23-story tower will nearly double the existing casino space and will include approximately 500 hotel rooms, an upscale spa and pool facility, three additional restaurants and additional bars. Tower floors will be opened as they are finished beginning with the casino expansion and additional restaurants, with the expected opening of the entire tower in late 2017 at a total cost of approximately $229-$234 million. The cost is expected to be financed through a combination of operating cash flow and an expansion or replacement of our Credit Facility. The Company's current credit facility will mature in November 2016, and before that time, we expect to negotiate a new or amended Credit Facility with sufficient borrowing capacity to complete the expansion.

STATEMENT ON FORWARD-LOOKING INFORMATION

When used in this report and elsewhere by management from time to time, the words "believes", "anticipates" and "expects" and similar expressions are intended to identify forward-looking statements with respect to our financial condition, results of operations and our business including our expansion, construction timelines, development activities, legal proceedings and employee matters. Certain important factors, including but not limited to, competition from other gaming operations, factors affecting our ability to compete, acquisitions of gaming properties, legalization of additional gaming operations in our markets, leverage, construction risks, the inherent uncertainty and costs associated with litigation and governmental and regulatory investigations, and licensing and other regulatory risks, could cause our actual results to differ materially from those expressed in our forward-looking statements. Any changes in the law that would permit the establishment of gaming operations in or near Denver could materially impact Black Hawk operations and could alter, delay or cause us to reconsider our master development plan to expand our Black Hawk property. Further information on potential factors which could affect our financial condition, results of operations and business including, without limitation, our expansion, development activities, legal proceedings and employee matters are included in our filings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date thereof. We undertake no obligation to publicly release any revisions to such forward-looking statement to reflect events or circumstances after the date hereof.




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RESULTS OF OPERATIONS


Comparison of Operating Results for the Three-Month Periods Ended March 31, 2015 and 2014

For the three months ended March 31, 2015, our net income totaled $4.0 million, or $0.24 per diluted share, compared to net income of $3.3 million, or $0.19 per diluted share, reflecting a 23.4% increase in net income and a 26.3% increase in diluted earnings per share. Net revenues totaled $47.2 million in the current quarter, an increase of $1.7 million compared to the 2014 first quarter. Income from operations for the three months ended March 31, 2015 totaled $6.5 million compared to $5.3 million for the same period in 2014.

Casino revenues increased 3.9%, in the first quarter of 2015 compared to the first quarter of 2014. Casino operating expenses as a percentage of casino revenue increased to 43.6% in the first quarter of 2015, compared to 41.7% in the first quarter of 2014 primarily due to higher complimentaries expense combined with higher payroll and related benefits.

Food and beverage revenues for the first quarter of 2015 increased 6.8% over the first quarter of 2014, due to a 3.5% increase in average revenue per cover combined with a 3.3% increase in total covers served. Food and beverage operating expenses as a percentage of food and beverage revenues decreased slightly in the first quarter of 2015 to 39.8% compared to 40.5% for the prior year same period primarily as a result of the increase in revenue per cover partially offset by higher repair and maintenance expenses.

Hotel revenue increased 2.0% due to a slightly higher average daily room rate ("ADR") of $68.43 in the first quarter of 2015 compared to $67.86 in first quarter of 2014 and slightly higher hotel occupancy of 84.4% during first quarter of 2015 compared to 83.5% during first quarter of 2014. Revenue per Available Room ("REVPAR"), calculated by dividing total room revenue (less service charges, if any) by total rooms available was $63.88 and $62.63 for the three months ended March 31, 2015 and 2014, respectively. Hotel operating expenses as a percentage of hotel revenues increased to 32.1% in first quarter of 2015 as compared to 29.8% for the comparable prior year period due to higher repair and maintenance expenses and higher payroll and related expenses.

Promotional allowances as a percentage of gross revenues increased to 18.5% during the first quarter of 2015 compared to 17.9% in the comparable 2014 quarter. This increase was primarily due to the increase in complimentary expenses driven by our competitive gaming markets.

Other revenues increased 4.9% in the first quarter of 2015 compared to the first quarter of 2014 driven primarily by increased arcade, retail and spa revenues.

Selling, General and Administrative ("SG&A") expense decreased to $12.6 million in the first quarter of 2015 from $13.2 million in the first quarter of 2014 primarily due to lower marketing expense and lower salaries, wages and benefits expenses. As a percentage of net revenue, SG&A expense decreased to 26.7% in the first quarter of 2015 from 29.1% in the first quarter of 2014.

Depreciation and amortization expense decreased to $4.1 million for the three months ended March 31, 2015 as compared to $4.7 million for the three months ended March 31, 2014 primarily as a result of a decrease in monthly depreciation expense of the existing parking structure following the revision in the expected date of early removal of the parking structure from service in relation to the Monarch Black Hawk expansion project.

During the first quarter, the Company paid down the principal balance on its credit facility by $4.3 million, which decreased the outstanding balance of the credit facility to $42.0 million at March 31, 2015 from $46.3 million at December 31, 2014. Interest expense, net of amounts capitalized decreased to $0.2 million in the first quarter of 2015 from $0.3 million in the first quarter of 2014 as a result of lower average outstanding borrowings in 2015 first quarter compared to the 2014 first quarter.

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LIQUIDITY AND CAPITAL RESOURCES

For the three months ended March 31, 2015, net cash provided by operating activities totaled $8.2 million, an increase of approximately $0.4 million or 5.0% compared to the same period in the prior year. This increase was primarily the result of an increase in net income by $0.8 million and an increase in income tax payable by $0.4 million partially offset by a decrease in depreciation expense by $0.6 million and a decrease in the ordinary working capital.

Net cash used in investing activities totaled $7.3 million and $3.8 million for the three months ended March 31, 2015 and 2014, respectively. Net cash used in investing activities during first quarters of 2015 and 2014 consisted primarily of net cash used for redesigning and upgrading of the Monarch Casino Black Hawk property and for acquisition of gaming equipment and general upgrades at the Atlantis property.

Net cash used in financing activities during first quarter of 2015 was $4.0 million and represented $4.3 million of payments made on the Credit Facility offset by $0.3 million in proceeds resulting from stock options exercises. Net cash used in financing activities during first quarter of 2014 of $6.3 million represented $4.9 million of payments made on the Credit Facility and $0.5 million in proceeds resulting from stock options exercises net of $2.0 million in income taxes paid to satisfy minimum tax withholdings.

As of March 31, 2015, we had $88.0 million maximum principal available under the Credit Facility, of which $42.0 million was drawn. The proceeds from the Credit Facility were utilized to finance the acquisition of Monarch Black Hawk and may also be used for working capital needs, general corporate purposes and for ongoing capital expenditure requirements. We had $46.0 million remaining credit available on the Credit Facility as of March 31, 2015.

The maximum principal available under the Credit Facility is reduced by 1.5% per quarter beginning July 1, 2013. We may permanently reduce the maximum principal available at any time so long as the amount of such reduction is at least $0.5 million and a multiple of $50,000. Maturities of the borrowings for each of the next three years and thereafter as of March 31, 2015 are as follows (in millions):



Year   Maturities
2015   $         -
2016          42.0
       $      42.0



The maturity date of the Credit Facility is November 15, 2016. Borrowings are secured by liens on substantially all of our real and personal property.

The Credit Facility contains customary covenants for a facility of this nature, including, but not limited to, covenants requiring the preservation and maintenance of the Company's assets and covenants restricting our ability to merge, transfer ownership of Monarch, incur additional indebtedness, encumber assets and make certain investments. Management does not consider the covenants to restrict normal functioning of day-to-day operations.

We may prepay borrowings under the Credit Facility without penalty (subject to certain charges applicable to the prepayment of LIBOR borrowings prior to the end of the applicable interest period). Amounts prepaid may be borrowed so long as the total borrowings outstanding do not exceed the maximum principal available.

We believe that our existing cash balances, cash flow from operations and borrowings available under the Credit Facility will provide us with sufficient resources to fund our operations, meet our debt obligations, and fulfill our capital expenditure plans over the next twelve months; however, our operations are subject to financial, economic, competitive, regulatory, and other factors, many of which are beyond our control. If we are unable to generate sufficient cash flow, we could be required to adopt one or more alternatives, such as reducing, delaying or eliminating planned capital expenditures, selling assets, restructuring debt or obtaining additional equity capital.

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OFF BALANCE SHEET ARRANGEMENTS

A driveway was completed and opened on September 30, 2004, that is being shared between the Atlantis and a shopping center (the "Shopping Center") directly adjacent to the Atlantis. The Shopping Center is controlled by an entity whose owners include our controlling stockholders. As part of this project, in January 2004, we leased a 37,368 square-foot corner section of the Shopping Center for a minimum lease term of 15 years at an annual rent of $300 thousand, subject to increase every year beginning in the 61st month based on the Consumer Price Index. We also use part of the common area of the Shopping Center and pay our proportional share of the common area expense of the Shopping Center. We have the option to renew the lease for three individual five-year terms, and at the end of the extension periods, we have the option to purchase the leased section of the Shopping Center at a price to be determined based on an MAI Appraisal. The leased space is being used by us for pedestrian and vehicle access to the Atlantis, and we may use a portion of the parking spaces at the Shopping Center. The total cost of the project was $2.0 million; we were responsible for two thirds of the total cost, or $1.35 million. The cost of the new driveway is being depreciated over the initial 15-year lease term; some components of the new driveway are being depreciated over a shorter period of time. We paid approximately $94 thousand in lease payments for the leased driveway space at the Shopping Center during the three-month period ended March 31, 2015.

CRITICAL ACCOUNTING POLICIES

A description of our critical accounting policies and estimates can be found in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Form 10-K for the year ended December 31, 2014 ("2014 Form 10-K"). For a more extensive discussion of our accounting policies, see Note 1, Summary of Significant Accounting Policies, in the Notes to the Consolidated Financial Statements in our 2014 Form 10-K filed on March 13, 2015.

OTHER FACTORS AFFECTING CURRENT AND FUTURE RESULTS

Negative economic developments in Northern Nevada, the Denver metropolitan area, and our feeder markets, could adversely impact discretionary incomes of our target customers, which, in turn could adversely impact our business as our target customers might curtail discretionary spending for leisure activities and businesses may reduce spending for conventions and meetings, both of which would adversely impact our business. Management continues to monitor economic trends and intends, as appropriate, to adopt operating strategies to attempt to mitigate the effects of such adverse conditions. We can make no assurances that such strategies will be effective should negative economic developments in our markets occur.

The expansion of Native American casinos in California has had an impact on casino revenues in Nevada, in general, and many analysts have continued to predict the impact will be more significant on the Reno-Lake Tahoe market. If other Reno-area casinos continue to suffer business losses due to increased pressure from California Native American casinos, such casinos may intensify their marketing efforts to northern Nevada residents as well, greatly increasing competitive activities for our local customers.

Higher fuel costs may deter California, Denver area, and other drive-in customers from coming to the Atlantis or the Monarch Black Hawk Casino.

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We also believe that unlimited land-based casino gaming in or near any major metropolitan area in the Atlantis' key feeder market areas, such as San Francisco or Sacramento, or in other areas near Denver, Colorado, the Black Hawk key feeder markets, could have a material adverse effect on our business.

We rely on information technology and other systems to maintain and transmit customer financial information, credit card settlements, credit card funds transmissions, mailing lists and reservations information. The systems and processes we have implemented to protect customers, employees and company information are subject to the ever-changing risk of compromised security. These risks include cyber and physical security breaches, system failure, computer viruses, and negligent or intentional misuse by customers, company employees, or employees of third party vendors. The steps we take to deter and mitigate these risks may not be successful and our insurance coverage for protecting against cybersecurity risks may not be sufficient. Any disruption, compromise or loss of data or systems that results from a cybersecurity attack or breach could materially adversely impact operations or regulatory compliance and could result in remedial expenses, fines, litigation, and loss of reputation, potentially impacting our financial results.



COMMITMENTS AND CONTINGENCIES


Our contractual cash obligations as of March 31, 2015 and the next five years and thereafter are as follows (in millions):



                                              Payment due by period (1)
                                                    Less
                                                   than 1    1 to 3     3 to 5
                                        Total       year      years     years
Operating Leases (2)                   $    1.9    $   0.5   $   0.8   $    0.6
Purchase Obligations (3)                    7.5        7.5         -          -
Construction Contracts (4)                 31.2       25.0       6.2          -

Borrowings Under Credit Facility (5) 42.0 - 42.0 - Total Contractual Cash Obligations $ 82.6 $ 33.0 $ 49.0 $ 0.6

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(1) Because interest payments under our credit facility are subject to factors that in our judgment vary materially, the amount of future interest payments is not presently determinable. These factors include: i) future short-term interest rates; ii) our future leverage ratio which varies with Adjusted EBITDA and our borrowing levels; and iii) the speed with which we deploy capital and other spending which in turn impacts the level of future borrowings. The interest rate under our credit facility is LIBOR, or a base rate (as defined in the credit facility agreement), plus an interest rate margin ranging from 1.25% to 2.50% depending on our leverage ratio. The interest rate is adjusted quarterly based on our leverage ratio which is calculated using operating results over the previous four quarters and borrowings at the end of the most recent quarter. Based on our leverage ratio, at March 31, 2015 pricing was LIBOR plus 1.5% and will be adjusted in subsequent quarters in accordance with our leverage ratio. At March 31, 2015, the one-month LIBOR rate was 0.18%.

(2) Operating leases include leased driveway usage and executive housing in Colorado.

(3) Purchase obligations represent approximately $2.5 million of commitments related to capital projects and approximately $5.0 million of materials and supplies used in the normal operation of our business. Of the total purchase order and construction commitments, approximately $7.5 million are cancelable by us upon providing a 30-day notice.

(4) Construction contracts obligations represent commitments related to remodel and expansion projects in Monarch Casino Black Hawk. $28.6 million of the commitment relates to construction of the new parking garage structure, $0.6 million relates to construction of the new parking garage foundation and $2.0 million relates to the remodel of the casino floor of the existing facility.

(5) The amount represents outstanding draws against the Credit Facility as of March 31, 2015.

As described in the "CAPITAL SPENDING AND DEVELOPMENT" section above, we have begun commencement of a substantial expansion of our Monarch Casino Black Hawk facility which started in 2014. While we have disclosed the estimated cost of that expansion, we have not entered into contracts for substantial portions of the work. For this reason, we have included in the table above only the amounts for which we have contractual commitments.

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