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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended: March 31, 2010

OR

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

For the transition period from:                 to                

Commission file number:  333-71094

HERBST GAMING, INC.

(Exact name of registrant as specified in its charter)

(702) 889-7695

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES    x    NO    o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES   o    NO    o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Applicable Only to Issuers Involved in Bankruptcy Proceedings During the Preceding Five Years

Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by court. YES   o      NO   o      Not Applicable   x

Applicable Only to Corporate Issuers

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, no par value, 300 outstanding shares

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FORM 10-Q

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PART I — FINANCIAL INFORMATION

ITEM 1           FINANCIAL STATEMENTS

HERBST GAMING, INC. AND SUBSIDIARIES

(Debtor and Debtor-in-Possession as of March 22, 2009)

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

The accompanying notes are an integral part of these

unaudited condensed consolidated financial statements.

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HERBST GAMING, INC. AND SUBSIDIARIES

(Debtor and Debtor-in-Possession as of March 22, 2009)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

The accompanying notes are an integral part of these

unaudited condensed consolidated financial statements.

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HERBST GAMING, INC. AND SUBSIDIARIES

(Debtor and Debtor-in-Possession as of March 22, 2009)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of these

unaudited condensed consolidated financial statements.

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HERBST GAMING, INC. AND SUBSIDIARIES

(Debtor and Debtor-in-Possession as of March 22, 2009)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.                                      CHAPTER 11 REORGANIZATION AND GOING CONCERN

On March 22, 2009 (the “Petition Date”), Herbst Gaming, Inc. (“Herbst” or the “Company”) and certain of its subsidiaries (the “Subsidiary Guarantors”, and together with the Company, the “Debtors”) filed voluntary petitions for relief (the “Chapter 11 Cases”) under Chapter 11 of the United States Bankruptcy Code, 11 U.S.C. §§ 101-1532 (the “Bankruptcy Code”), in the United States Bankruptcy Court for the District of Nevada, Northern Division (the “Bankruptcy Court”) under case numbers 09-50746-gwz through 09-50763-gwz.  Pursuant to an order of the Bankruptcy Court, the Chapter 11 Cases are being jointly administered.  From the period commencing on the Petition Date up to and including the Effective Date (as defined below), the Debtors operated their businesses and managed their properties as debtors-in-possession subject to the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code.

On July 22, 2009, the Debtors filed with the Bankruptcy Court an amended joint plan of reorganization.  On January 22, 2010, the Bankruptcy Court issued an Amended Order Confirming Debtors’ First Amended Joint Plan of Reorganization (the “Order”), confirming the amended joint plan of reorganization, as modified by the Findings of Fact and Conclusions of Law in Support of Order Confirming Debtors’ First Amended Joint Plan of Reorganization (the “Findings of Fact “) entered contemporaneously with the Order (the amended joint plan of reorganization as modified by the Findings of Fact, the “Plan”).  The Plan became effective on February 5, 2010 (the “Effective Date”), but will not be fully implemented until the Substantial Consummation Date (as defined below).  Since the Effective Date, the Debtors have been operating as reorganized entities pursuant to the terms and provisions of the Plan and, except as otherwise specifically provided for in the Plan, outside the jurisdiction of the Bankruptcy Court.  Upon the Substantial Consummation Date, the Plan provides for the following restructuring (the “Restructuring”) of the Debtors to occur:

·            Conversion of all allowed claims under the Company’s $860.0 million senior credit facility (the “amended Credit Agreement”) into debt and equity of the Debtors, through ownership of a new holding company (“Reorganized Herbst Gaming”).

·            Termination of all outstanding obligations under our 8 1/8% senior subordinated notes due 2012 (the “8 1/8% Notes”) and our 7% senior subordinated notes due 2014 (the “7% Notes” and, collectively with the 8 1/8% Notes, the “Subordinated Notes”).

·            Cancellation of 100% of the existing equity in the Company.

Following the Substantial Consummation Date, Reorganized Herbst Gaming will hold all of the equity interests in the Reorganized Debtors (as defined below) and the Company will be dissolved.

The Plan generally will be fully implemented on the third business day following the satisfaction or waiver of all conditions to substantial consummation of the Plan (the “Substantial Consummation Date”), which are described in the paragraph below.  However, pursuant to the Plan certain payments were made on or shortly after the Effective Date, including payment of allowed priority claims, certain allowed secured claims and allowed general unsecured claims, in some cases with interest from the Petition Date, as described in the Plan and the Second Amended Disclosure Statement to Accompany the Plan filed with the Bankruptcy Court on August 7, 2009.

Additionally, under the Plan, between the Effective Date and the Substantial Consummation Date the Company will make adequate protection payments to the lenders under the amended Credit Agreement (the “Lenders”) in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured initially as of the end of the third full calendar month following the Effective Date, and then as of the end of every third full calendar month thereafter, and paid 30 days thereafter).

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The Plan will not be fully implemented until the Substantial Consummation Date.  The Substantial Consummation Date will not occur until the Restructuring and the individuals proposed as officers, directors and key employees of Reorganized Herbst Gaming and the Subsidiary Guarantors, as they will be reorganized (the “Reorganized Debtors”) have received all requisite governmental and regulatory approvals.  The Company has been advised by the representatives of the Lenders that the applications of Reorganized Herbst Gaming, as well as the equity holders of Reorganized Herbst Gaming and their principals, have been filed with the gaming authorities in Nevada, Missouri and Iowa, and that the applications of directors, officers and key employees required to submit to licensing are expected to be filed in those jurisdictions in the near future.  The Company has been advised by the representatives of the Lenders that the licensing process is expected to take nine to 12 months.

The Substantial Consummation Date is also subject to the satisfaction or waiver of the following conditions: (i) none of the Debtors and Lenders are in material breach of the Plan; and (ii) the Bankruptcy Court has authorized the assumption and rejection of certain contracts of the Debtors.  The Company currently expects that the Substantial Consummation Date will occur in the fourth quarter of 2010, although the Company cannot assure you that all conditions to the Substantial Consummation Date will be satisfied by that date or at all, or that the Company will be successful in implementing the Restructuring in the form contemplated by the Plan or at all.  The Plan provides that the Substantial Consummation Date must occur no later than February 5, 2011, the first anniversary of the Effective Date, unless extended by mutual agreement of the Debtors and Requisite Lenders (as defined below).  In the event that the Substantial Confirmation Date does not occur by that date, or such later date as may be agreed to by the Debtors and the Requisite Lenders, the confirmation of the Plan would be vacated and all claims (except for allowed priority claims, certain allowed secured claims unrelated to the Lenders or the Subordinated Notes, and allowed general unsecured claims) would be restored as though the Effective Date had never occurred.

On January 28, 2010, the Indenture Trustee, as defined in the Findings of Fact, filed a notice of appeal from the Order (the “Indenture Trustee Appeal”).  On January 29, 2010, the Debtors elected to have the Indenture Trustee Appeal heard by the U.S. District Court for the District of Nevada (the “District Court”) and not the U.S. Bankruptcy Appellate Panel for the Ninth Circuit Court of Appeals.  On April 2, 2010, the Indenture Trustee filed its opening brief in the Indenture Trustee Appeal and also filed a motion with the District Court requesting that the Order be stayed pending a decision on the merits of the Indenture Trustee Appeal.  On April 7, 2010, the Debtors and the Administrative Agent under the amended Credit Agreement filed their joint opposition to the Indenture Trustee’s request that the Order be stayed.  On April 21, 2010, the Debtors and the Administrative Agent under the amended Credit Agreement filed their respective answering briefs in the Indenture Trustee Appeal.  On May 4, 2010, the Indenture Trustee filed its reply brief, thereby completing the briefing on the Indenture Trustee Appeal.  As of May 11, 2010, the District Court has not ruled on the Indenture Trustee’s request for a stay pending appeal and has not entered a written order scheduling oral arguments in the Indenture Trustee Appeal.

On November 16, 2009, the Indenture Trustee filed its First Amended Complaint for Declaratory Judgment (the “Amended Complaint”) against the Debtors and the Administrative Agent under the amended Credit Agreement seeking, among other relief, a judgment of the Bankruptcy Court determining that the Subordinated Notes entitled to pari passu treatment with the obligations due under the amended Credit Agreement.  The Debtors and the Administrative Agent filed motions to dismiss the Amended Complaint.  On February 23, 2010, the Bankruptcy Court dismissed the Amended Complaint without prejudice to seek leave to re-file the Amended Complaint if the Order is set aside in the Indenture Trustee Appeal.

We cannot assure you that a stay pending appeal from the Order will not be granted during the pendency of the Indenture Trustee Appeal and prior to the Substantial Consummation Date.  We cannot assure you that the Order will not be overturned and the Plan set aside.  Finally, we cannot assure you of the timing of the District Court’s decision on either the request for a stay pending appeal or a decision on the merits of the appeal itself.

The Debtors and Lenders holding, in the aggregate, approximately 61% of all of the outstanding claims under the amended Credit Agreement are parties to an amended and restated lockup agreement (the “Lockup Agreement”).  Pursuant to the Lockup Agreement, the parties thereto are contractually obligated to use commercially reasonable efforts to successfully consummate the Restructuring and achieve the expeditious consummation of the Plan.  The Lockup Agreement will automatically terminate, pursuant to its terms, if the Substantial Consummation Date does not occur on or before February 5, 2011, the first anniversary of the Effective Date, unless such termination event is waived by Lenders party to the Lockup Agreement holding at least two-thirds in amount of the total claims held by all Lenders party to the Lockup Agreement (the “Requisite Lenders”) within five days of the occurrence of the termination event.  In the event that the Substantial Consummation Date does not occur by that date, and the Requisite Lenders do not waive the related termination event and the Lockup Agreement is terminated, the Lenders would no longer be obligated to support the Restructuring.

The Plan provides that, from the Effective Date through the Substantial Consummation Date, the Debtors will continue to be managed by the current officers and directors.

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The continuation of the Company as a going concern is contingent upon, among other things, the Debtors’ ability to (i) obtain substantial consummation of the Plan or another plan of reorganization under the Bankruptcy Code; (ii) return to profitability; (iii) generate sufficient cash flow from operations; and (iv) obtain financing sources to meet our future obligations.  These matters create uncertainty relating to our ability to continue as a going concern.  The accompanying condensed consolidated financial statements do not reflect any adjustments relating to the recoverability and classification of assets or liabilities that might result from the outcome of these uncertainties.  In addition, the Restructuring could materially change amounts reported in our consolidated financial statements, which do not give effect to any adjustments of the carrying value of assets and liabilities that may be necessary as a consequence of reorganization under Chapter 11 of the Bankruptcy Code.

Additionally, the Restructuring is subject to various regulatory approvals.  We cannot assure you that we will be successful in consummating the Plan.

Due to the occurrence and continuation of events of default, the amounts outstanding under the amended Credit Agreement and the indentures pursuant to which the Subordinated Notes were issued are immediately due and payable, subject to an automatic stay of any action to collect, assert or recover a claim against the Company under applicable bankruptcy law.  Based on the filing of the Chapter 11 Cases, the entire balance outstanding under the amended Credit Agreement and all of the amounts outstanding under the indentures pursuant to which the Subordinated Notes were issued are included in liabilities subject to compromise at March 31, 2010.  The Company classifies liabilities subject to compromise as a long-term liability.

The current outstanding balance under the amended Credit Agreement is $858 million.  The Plan provides, in part, that the Lenders will receive 100% of the equity of Reorganized Herbst Gaming, and that Reorganized Herbst Gaming and the Reorganized Debtors will borrow $350 million pursuant to a new senior secured bank loan.

Prior to the filing of the Chapter 11 Cases, interest accrued on borrowings under the amended Credit Agreement was based on a floating rate.  This floating rate was based upon a variable interest rate (a base rate or LIBOR, at our option) plus a leverage grid-based spread.  Our average floating rate on debt incurred under the amended Credit Agreement was 12.5% as of March 31, 2010.  However, based on the filing of the Chapter 11 Cases, after the Petition Date the Company did not make payments under the amended Credit Agreement, other than certain adequate protection payments, as provided in the Final Order Approving the Amended and Restated Stipulation Authorizing Use of Cash Collateral by Debtors and Granting Adequate Protection, which was entered by the Bankruptcy Court on May 21, 2009 and remained in effect until the Effective Date (the “Cash Collateral Order”).

The Cash Collateral Order provided for adequate protection payments to be made to the Lenders during the period commencing on the Petition Date and ending on the Effective Date in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured as of the last day of each fiscal quarter and to be paid on the 30th day thereafter) reduced by certain unpaid restructuring costs, as well as costs and expenses of the professionals retained by the administrative agent.  Based on the Company’s cash and cash equivalents as of December 31, 2009 and taking into account the required Effective Date payments described in this Note 1 of Notes to Condensed Consolidated Financial Statements (Unaudited), the Company made an adequate protection payment of $1.1 million on February 5, 2010.  Additionally, under the Plan, between the Effective Date and the Substantial Consummation Date the Company will make adequate protection payments to Lenders in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured initially as of the end of the third full calendar month following the Effective Date, and then as of the end of every third full calendar month thereafter, and paid 30 days thereafter).

2.                                      DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business and Principles of Consolidation—The accompanying condensed consolidated financial statements of Herbst Gaming, Inc. include the accounts of Herbst and its subsidiaries: E-T-T, Inc. and subsidiaries (“ETT”), Market Gaming, Inc. (“MGI”), E-T-T Enterprises L.L.C. (“E-T-T Enterprises”), Flamingo Paradise Gaming, LLC (“FPG”), HGI-Lakeside (“HGI-L”), HGI-St. Jo (“HGI-SJ”), HGI-Mark Twain (“HGI-MT”), The Sands Regent and subsidiaries (“The Sands Regent”) and The Primadonna Company LLC (“Primadonna”).  The financial statements of ETT are consolidated and include the following wholly-owned subsidiaries: Cardivan Company, Corral Coin, Inc. and Corral Country Coin, Inc.  The financial statements of The Sands Regent are consolidated and include the following direct and indirect wholly-owned subsidiaries: Zante, Inc., Last Chance, Inc., California Prospectors, Ltd. (which is a wholly owned subsidiary of Last Chance, Inc.), Plantation Investments, Inc. and Dayton Gaming, Inc.

All significant intercompany balances and transactions between and among Herbst, ETT, MGI, E-T-T Enterprises, FPG, HGI-L, HGI-SJ, HGI-MT, The Sands Regent and Primadonna have been eliminated in the condensed consolidated financial statements.  ETT and MGI conduct business in the gaming industry and generate revenue principally from gaming machine route operations and casino operations.  Gaming machine route operations involve the installation, operation and service of gaming machines owned by the Company that are located in licensed, leased or subleased space in retail stores (supermarkets, convenience stores, etc.), bars and restaurants throughout the State of Nevada.  The Company owns and operates Terrible’s Town Casino & Bowl in Henderson, Nevada, Terrible’s Searchlight Casino in Searchlight, Nevada and Terrible’s Town Casino and Terrible’s Lakeside Casino & RV Park, both of which are located in Pahrump, Nevada.  The operations of the subsidiaries of the Company are as follows:

·                  E-T-T Enterprises develops and leases real estate to ETT.

·                  FPG owns and operates Terrible’s Hotel & Casino (“Terrible’s Casino”) in Las Vegas, Nevada, which began operations

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in December 2000.

·                  HGI-L owns and operates Terrible’s Lakeside Casino (“Lakeside Iowa”), as well as a hotel, gas station and convenience store, all located in Osceola, Iowa, which were acquired in February 2005.

·                  HGI-SJ owns and operates Terrible’s St. Jo Frontier Casino (“St. Jo”) in St. Joseph, Missouri, which was acquired in February 2005.

·                  HGI-MT owns and operates Terrible’s Mark Twain Casino in La Grange, Missouri, which was acquired in February 2005.

·                  The Sands Regent and its direct and indirect wholly-owned subsidiaries, which were acquired on January 3, 2007, own and operate Terrible’s Rail City Casino in Sparks, Nevada, the Sands Regency Casino Hotel in Reno, Nevada, the Terrible’s Gold Ranch Casino and RV Resort in Verdi, Nevada and Terrible’s Dayton Casino in Dayton, Nevada (all such properties acquired pursuant to the Sands Regent Acquisition, together the “Sands Casinos”).

·                  Primadonna, which was acquired on April 10, 2007, owns and operates Whiskey Pete’s Hotel and Casino (“Whiskey Pete’s”), Buffalo Bill’s Hotel and Casino (“Buffalo Bill’s”), Primm Valley Resort and Casino (“Primm Valley,” and together with Whiskey Pete’s and Buffalo Bill’s, together the “Primm Casinos”), a California lottery station located on the Nevada/California border, three gasoline stations and the Primm Travel Center (such properties, together with the Primm Casinos, the “Primm Properties”), all of which are located in Primm, Nevada.

We have elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code of 1986.  Under those provisions, the owners of the Company pay income taxes on its taxable income.  Accordingly, a provision for income taxes is not included in our financial statements.

The gaming industry in the States of Nevada, Iowa, and Missouri is subject to extensive state and local government regulation. The Company’s gaming operations are subject to the licensing and regulatory control of the Nevada Gaming Commission, the Nevada Gaming Control Board, the Iowa Race and Gaming Commission, the Missouri Gaming Commission as well as local jurisdictions.

Basis of Presentation—The condensed consolidated financial statements of Herbst Gaming, Inc. as of March 31, 2010, and for the three months ended March 31, 2010 and 2009 are unaudited, but, in the opinion of management, include all adjustments necessary for a fair presentation of the financial results for the interim periods.  Our results of operations for the three months ended March 31, 2010 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2010.  These interim statements should be read in conjunction with the audited financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”).

In accordance with GAAP, the Company has applied ASC 852, Reorganizations — Other Presentation Matters (“ASC 852”), in preparing the consolidated financial statements.  ASC 852 requires that the financial statements, for periods subsequent to the Chapter 11 filing, distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business.  Accordingly, certain expenses (including professional fees), are recorded in reorganization items in the accompanying consolidated statement of operations.  In addition, pre-petition obligations that may be impacted by the bankruptcy reorganization process have been classified in the consolidated balance sheet at March 31, 2010 as liabilities subject to compromise.  These liabilities are reported at the amounts expected pursuant to the Plan, although we can provide no assurance that the Plan will be fully implemented. (see Note 5 of Notes to Condensed Consolidated Financial Statements (Unaudited)).

Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Significant estimates incorporated into the Company’s condensed consolidated financial statements include the estimated useful lives for depreciable and amortizable assets, the estimated allowance for doubtful accounts receivable and the estimated cash flows in assessing the recoverability of long-lived assets as well as estimated fair values of certain assets related to write downs and impairments, contingencies and litigation, and claims and assessments. Actual results could differ from those estimates.

Accounts Receivable—Receivables consist primarily of amounts due from customers as a result of normal business operations.  The Company periodically performs credit evaluations of its customers.  The Company reviews accounts receivable balances in order to determine an allowance for potential credit losses based on our collections experience and the age of the receivables.  At December 31, 2009 and March 31, 2010, the allowance for potential credit losses was approximately $808,000 and $848,500, respectively.

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Goodwill—The Company has approximately $3,255,000 in goodwill as of March 31, 2010.  We evaluate our goodwill and indefinite-lived intangible assets in accordance with the applications of ASC Topic 350, “Intangibles-Goodwill and Other” (“ASC Topic 350”). Goodwill and indefinite-lived intangible assets are not subject to amortization, but they are subject to an annual impairment test in the fourth quarter of each year and between annual test dates in certain circumstances.

Restructuring Costs—Restructuring costs are comprised of expenses related to the evaluation of financial and strategic alternatives and include special legal and other advisor fees associated with the Company’s reorganization efforts prior to the Petition Date, including preparation for the bankruptcy filing.

Reorganization Items—Reorganization items are comprised of expenses incurred after the Petition Date.  Reorganization items include legal, advisory and trustee fees incurred in connection with the Restructuring and the Chapter 11 Cases.

Recently Issued Accounting Standards

In January 2010, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2010-06, Fair Value Measurements and Disclosures, which adds new disclosure requirements for transfers into and out of Levels 1 and 2 in the fair value hierarchy and additional disclosures about purchases, sales, issuances, and settlements relating to Level 3 fair value measurements. This ASU also clarifies existing fair value disclosures about the level of disaggregation about inputs and valuation techniques used to measure fair value. The ASU is effective for the first reporting period beginning after December 15, 2009, except for the requirement to provide the Level 3 activity on a gross basis, which is effective for fiscal year ends beginning after December 15, 2010 and interim periods within those years. The adoption did not have a material effect on our financial condition or results of operations.

3.                                      LONG-TERM DEBT

The Company is in default under the amended Credit Agreement and the indentures pursuant to which the Subordinated Notes were issued.  The current outstanding balance under the amended Credit Agreement is $858 million.  The Plan provides, in part, that the Lenders will receive 100% of the equity of Reorganized Herbst Gaming, and that Reorganized Herbst Gaming will borrow $350 million pursuant to a new senior secured bank loan.

Due to the occurrence and continuation of events of default, the amounts outstanding under the amended Credit Agreement and the indentures pursuant to which the Subordinated Notes were issued are immediately due and payable, subject to an automatic stay of any action to collect, assert or recover a claim against the Company under applicable bankruptcy law.  Based on the filing of the Chapter 11 Cases, the entire balance outstanding under the amended Credit Agreement and all of the amounts outstanding under the indentures pursuant to which the Subordinated Notes were issued are included in liabilities subject to compromise at March 31, 2010.  The Company classifies liabilities subject to compromise as a long-term liability.

Interest accrued on borrowings under the amended Credit Agreement was based on a floating rate until the Petition Date.  This floating rate was based upon a variable interest rate (a base rate or LIBOR, at our option) plus a leverage grid-based spread.  Our average floating rate on debt incurred under the amended Credit Agreement was 12.5% at March 31, 2010.  However, based on the filing of the Chapter 11 Cases, after the Petition Date the Company did not make payments under the amended Credit Agreement, other than certain adequate protection payments, as provided in the Final Order Approving the Amended and Restated Stipulation Authorizing Use of Cash Collateral by Debtors and Granting Adequate Protection, which was entered by the Bankruptcy Court on May 21, 2009 and remained in effect until the Effective Date (the “Cash Collateral Order”).

The Cash Collateral Order provided for adequate protection payments to be made to the Lenders during the period commencing on the Petition Date and ending on the Effective Date in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured as of the last day of each fiscal quarter and to be paid on the 30th day thereafter) reduced by certain unpaid restructuring costs, as well as costs and expenses of the professionals retained by the administrative agent.  Based on the Company’s cash and cash equivalents as of December 31, 2009 and taking into account the required Effective Date payments described in Note 1 of Notes to Condensed Consolidated Financial Statements (Unaudited), the Company made an adequate protection payment of $1.1 million on February 5, 2010.  Additionally, under the Plan, between the Effective Date and the Substantial Consummation Date the Company will make adequate protection payments to the lenders under the amended Credit Agreement (the “Lenders”) in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured initially as of the end of the third full calendar month following the Effective Date, and then as of the end of every third full calendar month thereafter, and paid 30 days thereafter).

Pursuant to the Plan, all outstanding obligations under the Subordinated Notes will be terminated on the Substantial Consummation Date.

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Subject to the automatic stay associated with the Chapter 11 Cases, long-term debt included in “liabilities subject to compromise,” is expected to mature as follows (dollars in thousands):

The following table provides the fair value measurement information about our long-term debt at March 31, 2010.  For additional information regarding ASC Topic 820, “Fair Value Measurements and Disclosures” and the fair value hierarchy, see Note 2 of Notes to Condensed Consolidated Financial Statements (Unaudited).

The estimated fair value of our bank credit facility is based on bid prices on or about March 31, 2010.  The estimated fair values of our senior subordinated notes are based on quoted market prices as of March 31, 2010.

4.                                      REORGANIZATION ITEMS

Reorganization items represent expense incurred as a result of the Chapter 11 proceedings and are presented separately in the Condensed Consolidated Statements of Operations (Unaudited) (dollars in thousands).

In the three months ended March 31, 2010, the Company incurred $471,000 in reorganization items.  Of this amount, $190,000 was for statutorily mandated United States Trustee fees and $281,000 was for professional fees, which include financial advisory, legal, real estate and valuation services directly attributed to the reorganization process. Any professional fees incurred from the bankruptcy filing on March 22, 2009 through the Effective Date of February 5, 2010 were subject to bankruptcy court approval.

5.                                      LIABILITIES SUBJECT TO COMPROMISE

Liabilities subject to compromise refer to both secured and unsecured obligations that will be accounted for under a plan of reorganization.  Generally, actions to enforce or otherwise effect payment of pre-Chapter 11 liabilities are stayed.  ASC Topic 852-10-45 requires pre-petition liabilities that are subject to compromise to be reported at the amounts expected to be allowed, even if they may be settled for lesser amounts.  These liabilities represent the estimated amount expected to be allowed on known or potential claims to be resolved through the Chapter 11 process, and remain subject to future adjustments arising from negotiated settlements, actions of the applicable bankruptcy court, rejection of executory contracts and unexpired leases, the determination as to the value of collateral securing the claims, proofs of claim, or other events.  Liabilities subject to compromise also include certain items that may be assumed under the plan of reorganization, and as such, may be subsequently reclassified to liabilities not subject to compromise.  The Company has included the amounts due under the amended Credit Agreement and indentures pursuant to which the Subordinated Notes were issued as liabilities subject to compromise.  Although the Plan has been confirmed, the Plan will not be fully implemented until the Substantial Consummation Date.  The Substantial Consummation Date will not occur until certain conditions, including certain approvals of gaming authorities in Nevada, Iowa and Missouri, have been obtained.  See Note 1 of Notes to Condensed Consolidated Financial Statements (Unaudited).  We cannot assure you that all conditions to the Substantial Consummation Date will be satisfied or that we will be successful in fully implementing the Plan or any other plan of reorganization.

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6.                                      BUSINESS SEGMENTS

The Company operates through two business segments:  slot route operations and casino operations. The slot route operations involve the installation, operation and service of slot machines at strategic, high traffic, non-casino locations, such as grocery stores, drug stores, convenience stores, bars, and restaurants. Casino operations consist of two geographic areas, Nevada and other states.  The Nevada locations include: Terrible’s Town Casino (Henderson) in Henderson, Nevada, Terrible’s Searchlight Casino in Searchlight, Nevada, Terrible’s Town Casino and Terrible’s Lakeside Casino, both of which are located in Pahrump, Nevada, Terrible’s Hotel & Casino in Las Vegas, Nevada, Rail City Casino in Sparks, Nevada, the Sands Regency Casino Hotel in Reno, Nevada, Terrible’s Gold Ranch Casino and RV Resort in Verdi, Nevada, Terrible’s Dayton Casino in Dayton, Nevada, and Buffalo Bill’s Hotel and Casino, Primm Valley Resort and Casino and Whiskey Pete’s Hotel and Casino, all located in Primm, Nevada.  Casinos located in other states are Terrible’s Lakeside Casino in Osceola, Iowa, Terrible’s St. Jo Frontier Casino in St. Joseph, Missouri and Terrible’s Mark Twain Casino in La Grange, Missouri. These segment results are regularly provided to the Office of the CEO of the Company, the members of which are the chief operating decision makers of the Company.

Net revenues, income from operations, depreciation and amortization and segment EBITDA for these segments are as set forth in the table below (dollars in thousands).  Route and Casino segment EBITDA are non-GAAP measures but are used by management to measure segment profits and losses in accordance with ASC Topic 280, “Segment Reporting” (“ASC Topic 280”).  Route and Casino segment EBITDA have certain limitations in that they do not take into account the impact of certain expenses, including allocation of overhead.  The Company endeavors to compensate for the limitations of the non-GAAP measures presented by also providing the comparable GAAP measure with equal or greater prominence, financial statements prepared in accordance with generally accepted accounting principles, and descriptions of the reconciling items, including quantifying such items, to derive the non-GAAP measures.  Accordingly, the following table also contains a reconciliation of Segment EBITDA to net income (loss) (in thousands).

(1)                    Represents non-gaming revenues, general and administrative expenses, interest income and restructuring expense.

(2)                    Segment EBITDA is used by management to measure segment profits and losses and consists of income from segment operations plus depreciation and amortization and is calculated before allocation of overhead.

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7.                           COMMITMENTS AND CONTINGENCIES

On February 17, 2006, the Clark County District Court entered judgment of a jury verdict delivered on January 14, 2006 against ETT for $4.1 million in compensatory damages and $10.1 million in punitive damages.  The jury verdict was delivered in connection with an action brought by the family of an individual that alleged that ETT had negligently retained and negligently supervised a temporary employee who in 2001 stole a truck from ETT and, while drunk, hit and killed the individual.  The punitive damage award was subsequently lowered to $4.1 million in a post-trial ruling.  The Company appealed this decision, and on April 29, 2010, the Supreme Court of Nevada, sitting in a three-member panel, affirmed the judgment in a split-decision.  ETT is currently evaluating whether to file a petition for rehearing before the three-member panel that issued the April 29 ruling.  In the event ETT seeks a rehearing and the petition is denied, the Company has the right to seek en banc reconsideration before the entire seven-member panel of the Nevada Supreme Court.  Based on a review of the legal opinions and facts available to the Company at this time, the Company believes it is adequately reserved for any potential liability related to this incident. 

Separate from the Nevada Supreme Court proceedings, ETT is also pursuing an appeal from the decision of the Bankruptcy Court contained in the order confirming the Plan approving the treatment of the $4.1 million punitive damages award as an unsecured claim.  Through this appeal, ETT is seeking the categorical subordination of the $4.1 million punitive damages award through the separate classification and disparate subordinated treatment of the punitive damages from the other general unsecured claims in the Plan.  This appeal, which is pending before the U.S. District Court for the District of Nevada, is currently being briefed and has not yet been submitted for decision. 

The Company was party to an arbitration in 2008 in Las Vegas, Nevada involving the termination of an employee.  The former employee alleged he was terminated without cause and was therefore due amounts pursuant to his employment agreement.  On March 10, 2009, the Company received an interim award from the arbitrator that awarded the former employee $1.3 million as a result of this arbitration.  On November 6, 2009, the Company filed a Motion to Vacate Arbitration Award with the Eighth Judicial District Court to overturn the arbitrator’s findings.  The Eighth Judicial District Court granted this motion on April 26, 2010.  On May 5, 2010, the former employee appealed the decision of the Eighth Judicial District Court.  The Company fully recognized the award and approximately $0.2 million for attorneys fees in fiscal year 2008.   If the Company prevails in any appeal or new arbitration it will record a gain on the previously expensed $1.5 million.

The Company is a party to certain other claims, legal actions, and complaints arising in the ordinary course of business or asserted by way of defense or counterclaim in actions filed by the Company. Management believes that its defenses are substantial in each of these matters and that the Company’s legal position can be successfully defended without material adverse effect on its consolidated financial statements.

Nevada Use Tax Refund Claims

On March 27, 2008, the Nevada Supreme Court issued a decision in Sparks Nugget, Inc. vs. The State of Nevada Department of Taxation (the “Department”), holding that food purchased for subsequent use in the provision of complimentary and/or employee meals was exempt from both sales and use tax.  On April 24, 2008, the Department filed a Petition for Rehearing (the “Petition”) on the decision.  On July 17, 2008, the Nevada Supreme Court denied the Department’s Petition.  We have been paying use tax on food purchased for subsequent use as complimentary and employee meals at our Nevada casino properties and are in the process of quantifying the amount of our potential refund, which we estimate to be approximately $1.8 million, excluding interest, from July 1, 2001 through January 1, 2008.  Based on the denial of the petition, as of January 1, 2008, the Company no longer accrues for these taxes, but due to the uncertainty regarding the method for reimbursement to the Company of taxes paid to date, we will not record any gain from previous tax years until the tax refund is realized.

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OVERVIEW

We are a diversified gaming company that focuses on two business lines: slot route operations and casino operations.  Our route operations involve the exclusive installation and operation of approximately 6,100 slot machines as of March 31, 2010 in strategic, high traffic, non-casino locations, such as grocery stores, drug stores, convenience stores, bars and restaurants.  Our casino operations consist of sixteen casinos located in Nevada, Iowa and Missouri.  Other than the Sands and the Primm Casinos, our casinos are operated under the “Terrible’s” brand

We generally enter into two types of route contracts.  With chain store customers, such as Albertsons, Vons, Safeway, SavOn, Smith’s, and Terrible Herbst , we pay a fixed monthly fee for each location in which we place slot machines.  With our street accounts, such as bars, restaurants and non-chain convenience stores, we share in the revenues on a percentage basis with the location owner.  Revenues from street accounts are recorded gross of amounts share.

Our revenues are primarily derived from gaming revenues, which include revenues from slot machines and table games.  Gaming revenues are generally defined as gaming wins less gaming losses.  Our largest component of revenues is from our slot machines.  Promotional allowances consist primarily of food and beverages furnished gratuitously to customers.  The retail value of such services is included in the respective revenue classifications and is then deducted as promotional allowances.  We calculate income from operations as net revenues less total operating costs and expenses.  Income from operations represents only those amounts that relate to our operations and excludes interest income, interest expense and other non-operating income and expenses.  Segment EBITDA consists of income from segment operations plus depreciation and amortization, and is calculated before an allocation of overhead.

We have elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code of 1986.  Under those provisions, the owners of our Company pay income taxes on our taxable income.  Accordingly, a provision for income taxes is not included in our financial statements.

Full implementation of the Plan on the Substantial Consummation Date is subject to various regulatory approvals.  We cannot assure you that we will be successful in consummating the Plan.  Please refer to our discussion under “Liquidity and Capital Resources—Cash Flows; Restructuring” for a more detailed discussion of the Chapter 11 Cases and the Restructuring.

THREE MONTHS ENDED MARCH 31, 2009 COMPARED TO THREE MONTHS ENDED MARCH 31, 2010

Route Operations

Route operations accounted for 28% of total revenues during each of the three months ended March 31, 2010 and 2009.  Total revenues from route operations were $48.2 million for the three months ended March 31, 2010, a decrease of $5.7 million, or 11%, from $53.9 million for the three months ended March 31, 2009.  This decrease is due primarily to the continued general economic weakness in Nevada.

Route operating costs were $44.7 million, or 93% of route revenues, for the three months ended March 31, 2010.  This compares to $47.7 million, or 89% of route revenues for the same period in 2009.  The decrease in route operating expenses was primarily associated with various cost controls and lower revenues at our participation locations, which are based on operating contracts that provide for a decrease in revenue share costs in proportion to revenue decline.  The increase in the expenses as a percentage of route revenues is due to the fixed nature of many of the route costs.

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Primarily as a result of the factors discussed above, route EBITDA for the three months ended March 31, 2010 was $3.4 million, a decrease of $2.7 million, or 44%, from $6.1 million for the three months ended March 31, 2009.

Casino Operations

Casino operations accounted for 60% of total revenues for the three month period ended March 31, 2010 and 62% of total revenues for the three months ended March 31, 2009.  Total revenues derived from casino operations were $105.0 million for the three months ended March 31, 2010, a decrease of $12.1 million, or 10%, from $117.1 million for the three months ended March 31, 2009.  The decrease is due primarily to the combined general economic weakness in Nevada and the impact of severe weather on our Midwest casino operations.

Casino promotional spending was down $2.5 million, or 14%, due to reduced complimentary expenses in connection with lower revenues.  Promotional allowances decreased from 15% of revenues for the three months ended March 31, 2009 to 14% of revenues for the three months ended March 31, 2010.  This decrease is attributable to increased efficiencies in managing promotional spending.

Casino operating costs were $71.6 million, or 68% of revenues, for the three months ended March 31, 2010, compared to $84.5 million, or 72% of revenues, for the three months ended March 31, 2009.  This decrease was primarily due to reductions of $3.7 million in variable costs of sales, $1.1 million in taxes and $6.4 million in payroll and related expenses.  The $6.4 million reduction in payroll and related expenses is a result of targeted labor reductions implemented in the fourth quarter of 2009.

Casino EBITDA was $18.4 million for the three months ended March 31, 2010, an increase of $3.4 million, or 23%, from $15.0 million from the three months ended March 31, 2009.  The increase in casino EBITDA was primarily due to the factors discussed above, most notably the reductions in casino operating costs during the three months ended March 31, 2010.

The following paragraphs describe the results from our casino operations geographically between casinos in Nevada and those in other states.

Casino Operations — Nevada

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Revenues derived from Nevada casino operations were $70.8 million for the three months ended March 31, 2010, a decrease of $10.2 million, or 13%, from $81.0 million for the three months ended March 31, 2009.  This decrease is primarily attributable to the continued economic downturn in the Nevada market.  The revenue at our casinos located in Southern Nevada declined approximately 16.3%, or $10.3 million, to $53.1 million in first quarter of 2010 from $63.5 million during the first quarter of 2009.  The Primm Casinos accounted for $9.5 million of the revenue decline.  The Northern Nevada casinos had a slight increase in revenues of $0.2 million or 1%, from $17.5 million during the first quarter of 2009 to $17.7 million in the first quarter of 2010.

Promotional allowances for Nevada casinos decreased from 16.4% for the three months ended March 31, 2009 to 15.1% for the three months ended March 31, 2010.  This percentage decrease is attributable to increased efficiencies in managing promotional spending.

Nevada casino operating costs for the three months ended March 31, 2010 were $51.5 million, down $11.2 million, or 18%, from $62.7 million during the first quarter of 2009.  This decrease was primarily due to reductions of $3.2 million in variable costs of sales, $0.6 million in taxes and $5.9 million in payroll and related expenses.  The $5.9 million reduction in payroll and related expenses is a result of targeted labor reductions implemented in the fourth quarter of 2009.

Nevada casino EBITDA was $8.6 million for the three months ended March 31, 2010 compared to $5.1 million for the three months ended March 31, 2009.  Despite the revenue reduction at the Nevada casinos, EBITDA increased approximately $3.5 million or 69%, in total, primarily due to the cost reduction program implemented in the fourth quarter of 2009.  Of this $3.5 million increase, $1.8 million is attributable to the Primm Casinos and $1.7 million is attributable to the other Nevada Casinos.

Depreciation and amortization expense was $7.4 for the three months ended March 31, 2010, consistent with $7.3 million for the three months ended March 31, 2009.

The following paragraphs describe the results from our casino operations geographically between casinos in Nevada and those in other states.

Casino Operations — Other states

Casino operations in other states accounted for 20% of total revenues for each of the three months ended March 31, 2010 and 2009.  Total revenues derived from casino operations located in states other than Nevada were $34.2 million for the three months ended March 31, 2010, a decrease of $1.9 million, or 5%, from $36.1 million for the three months ended March 31, 2009.  Approximately $1.3 million of the decrease in revenue was at Lakeside Iowa, which experienced reduced revenues as a result of severe weather during January and February of 2010.

Although promotional allowances were $4.3 million for each of the three months ended March 31, 2010 and 2009, more agressive slot promotions were employed to minimize declines in revenue for the three months ended March 31, 2010.

Other state casino operating costs were $20.1 million, or 59% of revenues, for the three months ended March 31, 2010, a decrease of $1.8 million from $21.9 million, or 61% of revenues, for the three months ended March 31, 2009.  This decrease was primarily due to reductions to variable costs, such as payroll and taxes, in connection with decreased revenue.

Other state casino EBITDA was $9.8 million for the three months ended March 31, 2010, a slight decrease from $10.0 million for the three months ended March 31, 2009, as declines in revenue were offset by declines in direct expenses.

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Depreciation and amortization expense was $2.4 million for the three months ended March 31, 2010, a decrease of $0.3 million from $2.7 million for the three months ended March 31, 2009.

Other Operations

Revenue from other operations consists of revenue from sources such as gasoline and convenience store sales, ATM fees, pay phone charges, rental income and other miscellaneous items unrelated to route and casino operations.  Our gas station operations include our gas station and convenience store located in Osceola, Iowa, the Gold Ranch and the three gas stations in Primm, Nevada.  Revenues from other operations were $21.0 million for the three months ended March 31, 2010 compared to $18.3 million for the three months ended March 31, 2009, an increase of $2.7 million, primarily as a result of an increase in gasoline prices.

Promotional Allowances

Promotional allowances were $15.1 million, or 8.6% of total revenues, for the three months ended March 31, 2010, a decrease of $2.5 million, or 14%, from $17.6 million, or 9.3% of total revenues, for the three months ended March 31, 2009.  This decrease is attributable to increased efficiencies in managing promotional spending in the first quarter of 2010.

Costs of Revenues

The costs represented in “other operations” consist primarily of costs related to the gasoline service station and convenience store operations at Osceola, Iowa, the gas station and lottery at Verdi, Nevada, the gas stations at Primm, Nevada and lottery operations at Stateline, California.  Costs of other operations increased by $3.0 million to $16.4 million in the first quarter of 2010, compared to $13.4 million in the first quarter of 2009, primarily as a result of increased gasoline prices.

General and administrative (“G&A”) expenses were $5.0 million for the three months ended March 31, 2010, which is $0.1 million higher than $4.9 million for the three months ended March 31, 2009.  Although costs remained relatively stable, due to decreased revenue in the first quarter of 2010, G&A expenses as a percentage of revenue were 2.9% for the first quarter of 2010 compared to 2.6% for the first quarter of 2009.

Depreciation and amortization expense was $13.1 million for the three months ended March 31, 2010, a decrease of $1.1 million, from $14.2 million for the three months ended March 31, 2009.  This decrease was due to lower route operations depreciation as certain assets were fully depreciated.

The Company’s restructuring costs, primarily advisory and legal fees, associated with the Restructuring and the Chapter 11 Cases incurred prior to the filing of the Chapter 11 Cases are included under Restructuring Costs.  These expenses ceased to be accrued on March 21, 2009, the date of the filing of the Chapter 11 Cases.

Income/(Loss) from Operations

The Company’s income from operations was $8.4 million for the three months ended March 31, 2010, an increase of $11.4 million from a $3.0 million loss from operations for the three months ended March 31, 2009.   This is primarily due to the factors discussed above, most notably the lack of restructuring costs in the first quarter of 2010 compared to $10.1 million in restructuring costs in the first quarter of 2009.  Additionally, cost controls implemented during the fourth quarter of 2009 helped to offset an 8% decline in revenue.

Other Expenses

Our interest costs decreased from $29.5 million during the three months ended March 31, 2009 to zero during the three months ended March 31, 2010.  As a result of the filing of the Chapter 11 Cases, the Company no longer incurs contractual interest costs and instead makes certain adequate protection payments.

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Costs associated with the Restructuring incurred after the filing of the Chapter 11 Cases are included in Reorganization Items.  Reorganization Items for the three months ended March 31, 2010 were $0.5 million, an increase of $0.2 million, from $0.3 million for the three months ended March 31, 2009.  Reorganization Items did not begin to accrue in 2009 until the Petition Date.

Net Income/(Loss)

Net income for the three months ended March 31, 2010 was $8.0 million compared to a net loss of $32.8 million for the three months ended March 31, 2009.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows Restructuring

We are currently operating as reorganized debtors under Chapter 11 of the Bankruptcy Code and pursuant to the Plan, which became effective on the Effective Date.  The Plan will not be fully implemented until the Substantial Consummation Date.  Upon the Substantial Consummation Date, the Plan provides for the following restructuring (the “Restructuring”) of the Debtors to occur:

·                  Conversion of all allowed claims under the Company’s $860.0 million senior credit facility (the “amended Credit Agreement”) into debt and equity of the Debtors, through ownership of a new holding company (“Reorganized Herbst Gaming”).

·                  Termination of all outstanding obligations under our 8 1/8% senior subordinated notes due 2012 (the “8 1/8% Notes”) and our 7% senior subordinated notes due 2014 (the “7% Notes” and, collectively with the 8 1/8% Notes, the “Subordinated Notes”).

·                  Cancellation of 100% of the existing equity in the Company

The Plan generally will be fully implemented on the third business day following the satisfaction or waiver of all conditions to substantial consummation of the Plan (the “Substantial Consummation Date”), which are described in the paragraph below.  However, pursuant to the Plan certain payments were made on or shortly after the Effective Date, including payment of allowed priority claims, certain allowed secured claims and allowed general unsecured claims, in some cases with interest from the Petition Date, as described in the Plan and the Second Amended Disclosure Statement to Accompany the Plan filed with the Bankruptcy Court on August 7, 2009.

The Plan will not be fully implemented until the Substantial Consummation Date.  The Substantial Consummation Date will not occur until the Restructuring and the individuals proposed as officers, directors and key employees of the Reorganized Debtors have received all requisite governmental and regulatory approvals.  The Company has been advised by the representatives of the Lenders that the applications of Reorganized Herbst Gaming, as well as the equity holders of Reorganized Herbst Gaming and their principals, have been filed with the gaming authorities in Nevada, Missouri and Iowa, and that the applications of directors, officers and key employees required to submit to licensing are expected to be filed in those jurisdictions in the near future.  The Company has been advised by the representatives of the Lenders that the licensing process is expected to take nine to 12 months.

The Substantial Consummation Date is also subject to the satisfaction or waiver of the following conditions: (i) none of the Debtors and Lenders are in material breach of the Plan; and (ii) the Bankruptcy Court has authorized the assumption and rejection of certain contracts of the Debtors.  The Company currently expects that the Substantial Consummation Date will occur in the fourth quarter of 2010, although the Company cannot assure you that all conditions to the Substantial Consummation Date will be satisfied by that date or at all, or that the Company will be successful in implementing the Restructuring in the form contemplated by the Plan or at all.  The Plan provides that the Substantial Consummation Date must occur no later than February 5, 2011, the first anniversary of the Effective Date, unless extended by mutual agreement of the Debtors and Requisite Lenders.  In the event that the Substantial Confirmation Date does not occur by that date, or such later date as may be agreed to by the Debtors and the Requisite Lenders, the confirmation of the Plan would be vacated and all claims (except for allowed priority claims, certain allowed secured claims unrelated to the Lenders or the Subordinated Notes, and allowed general unsecured claims) would be restored as though the Effective Date had never occurred.

The Plan provides that, from the Effective Date through the Substantial Consummation Date, the Debtors will continue to be managed by the current officers and directors.

Due to the occurrence and continuation of events of default, the amounts outstanding under the amended Credit Agreement and the indentures pursuant to which the Subordinated Notes were issued are immediately due and payable, subject to an automatic stay of any action to collect, assert or recover a claim against the Company under applicable bankruptcy law.  Based on the filing of the Chapter 11 Cases, the entire balance outstanding under the amended Credit Agreement and all of the amounts outstanding under the indentures pursuant to which the Subordinated Notes were issued are included in liabilities subject to compromise at March 31, 2010.  The Company classifies liabilities subject to compromise as a long-term liability.

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The current outstanding balance under the amended Credit Agreement is $858 million.  The Plan provides, in part, that the Lenders will receive 100% of the equity of Reorganized Herbst Gaming, and that Reorganized Herbst Gaming and the Reorganized Debtors will borrow $350 million pursuant to a new senior secured bank loan.

Prior to the filing of the Chapter 11 Cases, interest accrued on borrowings under the amended Credit Agreement was based on a floating rate.  This floating rate was based upon a variable interest rate (a base rate or LIBOR, at our option) plus a leverage grid-based spread.  Our average floating rate on debt incurred under the amended Credit Agreement was 12.5% as of March 31, 2010.  However, based on the filing of the Chapter 11 Cases, after the Petition Date the Company did not make payments under the amended Credit Agreement, other than certain adequate protection payments, as provided in the Final Order Approving the Amended and Restated Stipulation Authorizing Use of Cash Collateral by Debtors and Granting Adequate Protection, which was entered by the Bankruptcy Court on May 21, 2009 and remained in effect until the Effective Date (the “Cash Collateral Order”).

The Cash Collateral Order provided for adequate protection payments to be made to the Lenders during the period commencing on the Petition Date and ending on the Effective Date in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured as of the last day of each fiscal quarter and to be paid on the 30th day thereafter) reduced by certain unpaid restructuring costs, as well as costs and expenses of the professionals retained by the administrative agent.  Based on the Company’s cash and cash equivalents as of December 31, 2009 and taking into account the required Effective Date payments described in Note 1 of Notes to Condensed Consolidated Financial Statements (Unaudited), the Company made an adequate protection payment of $1.1 million on February 5, 2010.  Additionally, under the Plan, between the Effective Date and the Substantial Consummation Date the Company will make adequate protection payments to the Lenders in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured initially as of the end of the third full calendar month following the Effective Date, and then as of the end of every third full calendar month thereafter, and paid 30 days thereafter).

We expect to fund our existing operations and capital needs during the Restructuring from operating cash flow and cash on hand, although that may be insufficient.  In the quarter ending March 31, 2010, we monitored carefully our capital expenditures, and delayed incurring capital expenditures where possible in order to conserve cash.  We cannot assure you that our cash flow will be adequate to meet our anticipated working capital requirements and capital expenditures for existing operations.

Operating Activities

For the three months ended March 31, 2010, operating activities provided $18.0 million in cash flows on $8.0 million in net income compared to $0.4 million in cash flows on $32.8 million in net loss for the three months ended March 31, 2009.  The increase in cash flows resulted from a decline in operating costs in both of our operating segments as well as a decrease in cash required related to restructuring expenses and cash interest paid as a result of the Chapter 11 Cases.  Based on the filing of the Chapter 11 Cases, the Company does not make payments under the amended Credit Agreement.  Instead, the Company made an adequate protection payment of $1.1 million on February 5, 2010, as noted below in the discussion of Financing Activities, pursuant to the Cash Collateral Order, which remained in effect until the Effective Date.

Investing Activities and Capital Expenditures

For the three months ended March 31, 2010, we used net cash of $4.1 million for investing activities primarily related to the capital expenditures of $4.2 million.

Capital expenditures for the remainder of the year are anticipated to be approximately $24 million, consisting of maintenance capital expenditures.  However, to the extent that our results of operations do not provide sufficient cash, we may elect to delay some of the capital expenditures in order to preserve short-term liquidity.

Financing Activities

For the three months ended March 31, 2010, we used net cash of $1.1 million for financing activities related to adequate protection payments required by the Cash Collateral Order.  There were no cash flows provided by or used in financing activities in the first three months of 2009.

From the Petition Date to the Effective Date the Company was subject to the Cash Collateral Order that called for periodic sweeps of its cash in excess of $100 million to be paid to the Lenders.  Based on the Company’s cash and cash equivalents as of December 31, 2009 and taking into account the required Effective Date payments described in Note 1 of Notes to Condensed Consolidated Financial Statements (Unaudited), the Company made an adequate protection payment of $1.1 million on February 5, 2010.  Additionally, under the Plan, between the Effective Date and the Substantial Consummation Date the Company will make adequate protection payments to the Lenders in the amount of the Debtors’ cash and cash equivalents in excess of $100 million (measured initially as of the end of the third full calendar month following the Effective Date, and then as of the end of every third full calendar month thereafter, and paid 30 days thereafter).

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At March 31, 2010, our liabilities subject to compromise included approximately $160.0 million of outstanding principal amount of our 8 1/8% Notes and $170.0 million of outstanding principal amount of our 7% Notes.  After giving effect to indebtedness under our Subordinated Notes and borrowings under our amended Credit Agreement, our total liabilities subject to compromise were approximately $1.2 billion at March 31, 2010.

There were no distributions to stockholders in the first quarter of 2010.  The Company does not expect to make cash payments for stockholder distributions for the remainder of the 2010.

CRITICAL ACCOUNTING POLICIES

A description of our critical accounting policies can be found in our 2009 Form 10-K.  There have been no material changes to our critical accounting polices during the three months ended March 31, 2010.

CERTAIN FORWARD-LOOKING STATEMENTS

We make statements in this report that relate to matters that are not historical facts that we refer to as “forward-looking statements” regarding, among other things, our business strategy, our prospects and our financial position.  These statements may be identified by the use of forward-looking terminology such as “believes,” “estimates,” “expects,” “intends,” “may,” “will,” “should” or “anticipates” or the negative or other variation of these or similar words, or by discussions of strategy or risks and uncertainties.  Forward-looking statements in this report include, among other things, statements concerning:

·                  projections of future results of operations or financial condition;

·                  expectations for our route operations and our casino properties;

·                  expectations of the continued availability of capital resources; and

·                  expectations regarding our restructuring efforts.

Any forward-looking statement made by us necessarily is based upon a number of estimates and assumptions that, while considered reasonable by us, is inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control, and are subject to change.  Actual results of our operations may vary materially from any forward-looking statement made by or on our behalf.  Forward-looking statements should not be regarded as a representation by us or any other person that the forward-looking statements will be achieved.  Undue reliance should not be placed on any forward-looking statements.  Some of the contingencies and uncertainties to which any forward-looking statement contained herein is subject include, but are not limited to, the following:

·                  Although the Plan has been confirmed, it will not be fully implemented until the Substantial Consummation Date.  Implementation of the Plan is subject to a number of conditions, including no stay being entered in the Appeal, the Appeal not being successful, as well as obtaining certain regulatory approvals.  It is uncertain whether we will emerge from bankruptcy.  Even if successful, the consummation of the Plan may adversely affect our business, including our relationships with our customers and suppliers.  We may lose valuable contracts in the process of carrying out the Plan.

·                  The recession, and in particular the economic downturn in Southern Nevada and Southern California (two of our primary markets), has adversely affected our business and is expected to continue to do so.

·                  Our business relies heavily on certain markets that have been impacted by significant economic downturns.  Prolonged economic downturns in these markets could have further material adverse effects on our results.

·                  If the economic downturn does not improve, there will continue to be an adverse impact on the Company’s operations and therefore the Company’s liquidity.

·                  Our substantial indebtedness contemplated by the Plan could adversely affect our financial health and prevent us from fulfilling our obligations under the debt instruments to be used upon the Substantial Consummation Date.

·                  We will require a significant amount of cash to service our indebtedness.  Our ability to generate cash depends on many factors beyond our control.

·                  The success of our route operations is dependent on our ability to renew our contracts.

·                  Our indebtedness imposes restrictive covenants on us.

·                  We may experience a loss of market share due to intense competition.

·                  We face extensive regulation from gaming and other government authorities.

·                  Changes to applicable tax laws could have a material adverse effect on our financial condition.

·                  We depend upon our key employees and certain members of our management.

·                  Until the Substantial Consummation Date, certain of our executive officers and members of our board of directors own 100% of the Company, which could lead to conflicts of interest.

For additional contingencies and uncertainties, see “Item 1A. Risk Factors.”

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We have no material changes to the disclosure on this matter made in the 2009 Form 10-K.

We maintain “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Nevertheless, there can be no assurance that either this evaluation process or our existing disclosure controls and procedures will prevent or detect all errors and all fraud, if any, or result in accurate and reliable disclosure.  A control system can provide only reasonable and not absolute assurance that the objectives of the control system are met.  Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.  Additionally, judgments in decision-making can be faulty and breakdowns in internal control can occur because of simple errors or mistakes that are not detected on a timely basis.

As of the end of the period covered by this report (the “Evaluation Date”), an evaluation was carried out by management, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based on this evaluation, the Company’s management concluded that our disclosure controls and procedures are effective as of March 31, 2010.

There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II — OTHER INFORMATION

On February 17, 2006, the Clark County District Court entered judgment of a jury verdict delivered on January 14, 2006 against ETT for $4.1 million in compensatory damages and $10.1 million in punitive damages.  The jury verdict was delivered in connection with an action brought by the family of an individual that alleged that ETT had negligently retained and negligently supervised a temporary employee who in 2001 stole a truck from ETT and, while drunk, hit and killed the individual.  The punitive damage award was subsequently lowered to $4.1 million in a post-trial ruling.  The Company appealed this decision, and on April 29, 2010, the Supreme Court of Nevada, sitting in a three-member panel, affirmed the judgment in a split-decision.  ETT is currently evaluating whether to file a petition for rehearing before the three-member panel that issued the April 29 ruling.  In the event ETT seeks a rehearing and the petition is denied, the Company has the right to seek en banc reconsideration before the entire seven-member panel of the Nevada Supreme Court.  Based on a review of the legal opinions and facts available to the Company at this time, the Company believes it is adequately reserved for any potential liability related to this incident.

Separate from the Nevada Supreme Court proceedings, ETT is also pursuing an appeal from the decision of the Bankruptcy Court contained in the order confirming the Plan approving the treatment of the $4.1 million punitive damages award as an unsecured claim.  Through this appeal, ETT is seeking the categorical subordination of the $4.1 million punitive damages award through the separate classification and disparate subordinated treatment of the punitive damages from the other general unsecured claims in the Plan.  This appeal, which is pending before the U.S. District Court for the District of Nevada, is currently being briefed and has not yet been submitted for decision. 

The Company was party to an arbitration in 2008 in Las Vegas, Nevada involving the termination of an employee.  The former employee alleged he was terminated without cause and was therefore due amounts pursuant to his employment agreement.  On March 10, 2009, the Company received an interim award from the arbitrator that awarded the former employee $1.3 million as a result of this arbitration.  On November 6, 2009, the Company filed a Motion to Vacate Arbitration Award with the Eighth Judicial District Court to overturn the arbitrator’s findings.  The Eighth Judicial District Court granted this motion on April 26, 2010.  On May 5, 2010, the former employee appealed the decision of the Eighth Judicial District Court.  The Company fully recognized the award and approximately $0.2 million for attorneys fees in fiscal year 2008.   If the Company prevails in any appeal or new arbitration it will record a gain on the previously expensed $1.5 million.

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In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the 2009 Form 10-K, which could materially affect our business, financial condition or future results. The risks described in the 2009 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

None.

The Company is in default under the amended Credit Agreement and the indentures pursuant to which the Subordinated Notes were issued.  The current outstanding balance under the amended Credit Agreement is $858 million.  The Plan provides, in part, that the Lenders will receive 100% of the equity of Reorganized Herbst Gaming, and that Reorganized Herbst Gaming will borrow $350 million pursuant to a new senior secured bank loan.  Please refer to our discussion under “Liquidity and Capital Resources—Cash Flows; Restructuring” for a discussion of the Restructuring and the Plan.

Amendments to Executive Employment Agreements

On May 12, 2010, the Company entered into amendments to the executive employment agreements with each of Troy D. Herbst, Chief Executive Officer; Ferenc B. Szony, President; Mary E. Higgins, Chief Financial Officer; and Sean T. Higgins, General Counsel, for purposes of compliance with Section 409A of the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder.

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(a)           Exhibits.

In reviewing the agreements included as exhibits to this quarterly report, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about the Company or the other parties to the agreements.  The agreements contain representations and warranties by each of the parties to the applicable agreement.  These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:

·            Should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;

·            Have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;

·            May apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and

·            Were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.

Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time.  Additional information about the Company may be found elsewhere in this quarterly report and the Company’s other public filings, which are available without charge through the SEC’s website at http://www.sec.gov and the Company’s website at http://www.herbstgaming.com.

The following exhibits are filed as part of this Form 10-Q:

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

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EXHIBIT INDEX

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