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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended March 31, 2004

 

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:  0-24206

 

PENN NATIONAL GAMING, INC.

(Exact name of registrant as specified in its charter)

 

Pennsylvania

 

23-2234473

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

825 Berkshire Blvd., Suite 200
Wyomissing, PA 19610

(Address of principal executive offices)

 

610-373-2400

(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  ý  No  o

 

Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  ý  No  o

 

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

 

Title

 

Outstanding as of May 5, 2004

Common Stock, par value $.01 per share

 

40,059,700

 

 



 

This report contains information that are not statements of historical fact, but merely reflect our intent, belief or expectations regarding the anticipated effect of events, circumstances and trends.  Such statements should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Although we believe that our expectations are based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from our expectations.  Meaningful factors which could cause actual results to differ from expectations include, but are not limited to, risks related to the following: the passage of state, federal or local legislation that would expand, restrict, further tax or prevent gaming operations in the jurisdictions in which we do business; the activities of our competitors; increases in our effective rate of taxation at any of our properties or at the corporate level; successful completion of capital projects at our gaming and pari-mutuel facilities; the existence of attractive acquisition candidates and the costs and risks involved in the pursuit of those acquisitions; our ability to maintain regulatory approvals for our existing businesses and to receive regulatory approvals for our new businesses; the maintenance of agreements with our horsemen and pari-mutuel clerks; our dependence on key personnel; the impact of terrorism and other international hostilities; the availability and cost of financing; and other factors as discussed in our other filings with the United States Securities and Exchange Commission.  We do not intend to update publicly any forward-looking statements except as required by law.

 

2



 

PENN NATIONAL GAMING, INC. AND SUBSIDIARIES
INDEX

 

PART I. FINANCIAL INFORMATION

4

 

ITEM 1.

FINANCIAL STATEMENTS

4

 

Penn National Gaming, Inc. and Subsidiaries Consolidated Balance Sheets
December 31, 2003 and March 31, 2004 (unaudited)

4

 

Penn National Gaming, Inc. and Subsidiaries Consolidated Statements of Income
(unaudited)
Three months Ended March 31, 2003 and 2004

5

 

Penn National Gaming, Inc. and Subsidiaries Consolidated Statements of Shareholders’
Equity and Comprehensive Income(unaudited)
Three months Ended March 31, 2004

6

 

Penn National Gaming, Inc. and Subsidiaries Consolidated Statements of Cash Flows
(Unaudited)
Three months Ended March 31, 2003 and 2004

7

 

Notes to Consolidated Financial Statements

8

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

16

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

24

 

ITEM 4.

CONTROLS AND PROCEDURES

24

PART II. OTHER INFORMATION

25

 

ITEM 1.

LEGAL PROCEEDINGS

25

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

25

 

ITEM 5.

OTHER INFORMATION

25

 

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

26

 

3



 

PART I. FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

Penn National Gaming, Inc. and Subsidiaries
Consolidated Balance Sheets

(In thousands, except share and per share data)

 

 

 

December 31, 2003

 

March 31, 2004

 

 

 

 

 

(unaudited)

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

106,969

 

$

118,361

 

Receivables

 

28,304

 

30,346

 

Prepaid income taxes

 

7,593

 

6,434

 

Prepaid expenses and other current assets

 

29,592

 

29,861

 

Deferred income taxes

 

17,285

 

17,477

 

Total current assets

 

189,743

 

202,479

 

 

 

 

 

 

 

Net property and equipment, at cost

 

740,507

 

734,107

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

Investment in and advances to unconsolidated affiliate

 

17,187

 

14,535

 

Excess of cost over fair market value of net assets acquired

 

603,470

 

604,982

 

Management service contract (net of amortization of $6,719 and $7,347, respectively)

 

19,027

 

18,399

 

Deferred financing costs, net

 

28,214

 

27,388

 

Miscellaneous

 

11,451

 

20,891

 

Total other assets

 

679,349

 

686,195

 

 

 

$

1,609,599

 

$

1,622,781

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current maturities of long-term debt

 

$

124,979

 

$

124,736

 

Accounts payable

 

28,155

 

21,331

 

Accrued Liabilities:

 

 

 

 

 

Expenses

 

46,117

 

51,383

 

Interest

 

36,516

 

38,446

 

Salaries and wages

 

29,925

 

23,125

 

Gaming, pari-mutuel, property and other taxes

 

11,624

 

20,948

 

Income taxes payable

 

 

7,397

 

Other current liabilities

 

9,722

 

13,308

 

Total current liabilities

 

287,038

 

300,674

 

 

 

 

 

 

 

Long term liabilities:

 

 

 

 

 

Long-term debt, net of current maturities

 

984,489

 

963,429

 

Deferred income taxes

 

27,791

 

28,850

 

Other liabilities

 

403

 

434

 

Total long-term liabilities

 

1,012,683

 

992,713

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, $.01 par value, 1,000,000 shares authorized, none issued

 

 

¾

 

Common stock, $.01 par value, 200,000,000 shares authorized; shares issued 40,621,350 and 40,839,350, respectively

 

409

 

411

 

Treasury stock, at cost 849,400 shares

 

(2,379

)

(2,379

)

Additional paid-in capital

 

162,442

 

165,372

 

Retained earnings

 

148,055

 

165,842

 

Accumulated other comprehensive income

 

1,351

 

148

 

Total shareholders’ equity

 

309,878

 

329,394

 

 

 

$

1,609,599

 

$

1,622,781

 

 

See accompanying notes to consolidated financial statements.

 

4



 

Penn National Gaming, Inc. and Subsidiaries
Consolidated Statements of Income

(In thousands, except per share data)
(Unaudited)

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

Revenues

 

 

 

 

 

Gaming

 

$

183,984

 

$

283,808

 

Racing

 

24,843

 

24,640

 

Management service fee

 

2,699

 

3,458

 

Food, beverage and other revenue

 

25,345

 

41,120

 

Gross revenues

 

236,871

 

353,026

 

Less: Promotional allowances.

 

 (11,737

)

(22,255

)

Net revenues

 

225,134

 

330,771

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Gaming

 

101,895

 

154,777

 

Racing

 

18,408

 

18,233

 

Food, beverage and other expenses

 

17,134

 

28,785

 

General and administrative

 

36,065

 

55,416

 

Depreciation and amortization

 

12,829

 

19,266

 

Total operating expenses

 

186,331

 

276,477

 

 

 

 

 

 

 

Income from operations

 

38,803

 

54,294

 

 

 

 

 

 

 

Other income (expenses)

 

 

 

 

 

Interest expense

 

(16,352

)

(25,698

)

Interest income

 

434

 

389

 

Earnings from joint venture

 

588

 

460

 

Other

 

(104

)

(1,078

)

Loss on change in fair values of interest rate swaps

 

(527

)

 

Loss on early extinguishment of debt

 

(1,310

)

 

Total other expenses

 

(17,271

)

(25,927

)

 

 

 

 

 

 

Income before income taxes

 

21,532

 

28,367

 

Taxes on income

 

8,345

 

10,580

 

Net income

 

$

13,187

 

$

17,787

 

 

 

 

 

 

 

Per share data

 

 

 

 

 

Basic net income

 

$

.34

 

$

.45

 

 

 

 

 

 

 

Diluted net income

 

$

.33

 

$

.43

 

 

 

 

 

 

 

Weighted shares outstanding

 

 

 

 

 

Basic

 

39,219

 

39,859

 

Diluted

 

40,280

 

41,112

 

 

See accompanying notes to consolidated financial statements.

 

5



 

Penn National Gaming, Inc. and Subsidiaries
Consolidated Statements of Shareholders’ Equity and Comprehensive Income

(Unaudited)
(In thousands, except share data)

 

 

 

 

 

Treasury
Stock

 

Additional
Paid-In
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Total

 

Comprehensive
Income

 

 

Common Stock

Shares

 

Amount

Balance, December 31, 2003

 

40,621,350

 

$

409

 

$

(2,379

)

$

162,442

 

$

148,055

 

$

1,351

 

$

309,878

 

$

 

Exercise of stock options including tax benefit of $1,707

 

218,000

 

2

 

 

2,930

 

 

 

2,932

 

 

Change in fair value of interest rate swap contracts, net of income tax benefit of $766

 

 

 

 

 

 

(1,191

)

(1,191

)

(1,191

)

Amortization of interest rate swap agreement, net of income taxes of $23

 

 

 

 

 

 

39

 

39

 

 

Foreign currency translation adjustment

 

 

 

 

 

 

(51

)

(51

)

(51

)

Net income for the period

 

 

 

 

 

17,787

 

 

17,787

 

17,787

 

Balance, March 31, 2004

 

40,839,350

 

$

411

 

$

(2,379

)

$

165,372

 

$

165,842

 

$

148

 

$

329,394

 

$

16,545

 

 

See accompanying notes to consolidated financial statements.

 

6



 

Penn National Gaming, Inc. and Subsidiaries
Consolidated Statements of Cash Flows

(In thousands)
(Unaudited
)

 

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

13,187

 

$

17,787

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

Depreciation and amortization

 

12,829

 

19,266

 

Amortization of deferred financing costs charged to interest expense

 

707

 

1,360

 

Amortization of the unrealized loss on interest rate swap contracts charged to interest expense

 

373

 

39

 

Loss on disposal of fixed assets

 

830

 

679

 

Earnings from joint venture

 

(588

)

(460

)

Loss relating to early extinguishment of debt

 

1,310

 

 

Deferred income taxes

 

2,319

 

867

 

Tax benefit from stock options exercised

 

342

 

1,707

 

Loss on change in value of interest rate swap contracts

 

527

 

¾

 

Decrease (increase), net of businesses acquired in:

 

 

 

 

 

Receivables

 

2,219

 

(2,773

)

Prepaid expenses and other current assets

 

(11,462

)

(4,329

)

Prepaid income taxes

 

6,415

 

1,159

 

Miscellaneous other assets

 

10,096

 

(6,119

)

Increase (decrease), net of businesses acquired in:

 

 

 

 

 

Accounts payable

 

21,649

 

(6,824

)

Accrued liabilities

 

(9,384

)

(756

)

Gaming, pari-mutuel, property and other taxes

 

2,760

 

9,321

 

Income taxes payable

 

5,678

 

7,400

 

Other current and non-current liabilities

 

(1,010

)

3,617

 

Net cash provided by operating activities

 

58,797

 

41,941

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Expenditures for property and equipment

 

(9,950

)

(13,107

)

Payments to terminate interest rate swap contract

 

(1,902

)

¾

 

Proceeds from sale of property and equipment

 

62

 

105

 

Acquisition of business, net of cash acquired

 

(264,081

)

¾

 

Cash in escrow

 

(401,612

)

¾

 

Distributions from joint venture

 

¾

 

3,112

 

Net cash (used in) investing activities

 

(677,483

)

(9,890

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Proceeds from exercise of options

 

321

 

1,229

 

Proceeds from credit facility

 

700,000

 

¾

 

Principal payments on long-term debt

 

¾

 

(21,303

)

(Increase) in unamortized financing cost

 

(18,829

)

(534

)

Net cash provided by (used in) financing activities

 

681,492

 

(20,608

)

Effect of exchange rate fluctuations on cash

 

125

 

(51

)

Net increase in cash and cash equivalents

 

62,931

 

11,392

 

Cash and cash equivalents, at beginning of period

 

55,121

 

106,969

 

Cash and cash equivalents, at end of period

 

$

118,052

 

$

118,361

 

 

See accompanying notes to consolidated financial statements.

 

7



 

Notes to Consolidated Financial Statements

 

1.                                      Basis of Presentation

 

The consolidated financial statements are unaudited and include the accounts of Penn National Gaming, Inc. (“Penn”) and its subsidiaries (collectively, the “Company”). Investment in and advances to an unconsolidated affiliate that is 50% owned are accounted for under the equity method.  All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to current year presentation.

 

In the opinion of management, all adjustments (consisting of normal recurring accruals) have been made that are necessary to present fairly the financial position of the Company as of March 31, 2004 and the results of its operations for the three month periods ended March 31, 2003 and 2004. The results of operations experienced for the three month period ended March 31, 2004 are not necessarily indicative of the results to be experienced for the fiscal year ending December 31, 2004.

 

The statements and related notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. The accompanying notes should therefore be read in conjunction with the Company’s December 31, 2003 annual consolidated financial statements filed on Form 10-K.

 

2.                                      Revenue Recognition

 

In accordance with gaming industry practice, the Company recognizes casino revenues as the net of gaming wins less losses.  Net revenues exclude the retail value of complimentary rooms, and food and beverage furnished gratuitously to customers.  These amounts, which are included in promotional allowances, were as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

 

 

(In thousands)

 

Rooms

 

$

1,334

 

$

3,010

 

Food and beverage

 

9,474

 

16,423

 

Other

 

929

 

2,822

 

Total promotional allowances

 

$

11,737

 

$

22,255

 

 

The estimated cost of providing such complimentary services, which is included in operating expenses, was as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

 

 

(In thousands)

 

Rooms

 

$

1,063

 

$

2,465

 

Food and beverage

 

6,314

 

12,572

 

Other

 

690

 

1,471

 

Total cost of complimentary services

 

$

8,067

 

$

16,508

 

 

Racing revenues include the Company’s share of pari-mutuel wagering on live races after payment of amounts returned as winning wagers, the Company’s share of wagering from import and export simulcasting, as well as its share of wagering from its OTWs.

 

8



 

Revenues from the management service contract the Company has with Casino Rama (the “Casino Rama Management Contract”) are recognized as those services are performed.

 

3.                                      Earnings Per Share

 

The weighted average number of shares of common stock and common stock equivalents used in the computation of basic and diluted earnings per share are set forth in the table below.  For the three month periods ended March 31, 2003 and 2004, the effect of all outstanding stock options have been included in the calculation of diluted earnings per share.

 

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

 

 

(In thousands)

 

Weighted average number of shares outstanding-Basic earnings per share

 

39,219

 

39,859

 

Dilutive effect of stock options

 

1,061

 

1,253

 

Weighted average number of shares outstanding-Diluted earnings per share

 

40,280

 

41,112

 

 

4.                                      Stock-Based Compensation

 

The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair market value of the shares at the date of grant.  The Company accounts for stock option grants using the intrinsic-value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations.  Under the intrinsic-value method, because the exercise price of the Company’s employee stock options is more than or equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

 

The Company accounts for the plan under the recognition and measurement principles of APB 25 and related Interpretations.  No stock-based employee compensation cost is reflected in net income for options granted since all options granted under the plan had an exercise price equal to the fair market value of the underlying common stock on the date of grant.  However, there are situations that may occur, such as the accelerated vesting of options that require a current charge to income.  The following table illustrates the affect on net income and earnings per share if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS 148”), to stock-based employee compensation.

 

9



 

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

 

 

(In thousands)

 

Net income, as reported

 

$

13,187

 

$

17,787

 

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

 

¾

 

¾

 

Deduct:  Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(571

)

(781

)

Pro forma net income

 

$

12,616

 

$

17,006

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic-as reported

 

$

.34

 

$

.45

 

Basic-pro forma

 

$

.32

 

$

.43

 

Diluted-as reported

 

$

.33

 

$

.43

 

Diluted-pro forma

 

$

.31

 

$

.41

 

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants:

 

Three months ended March 31,

 

2003

 

2004

 

Risk-free interest rate

 

3.0

%

3.0

%

Volatility

 

50.0

%

31.0

%

Dividend yield

 

0.0

%

0.0

%

Expected life (years)

 

5

 

6

 

 

The effects of applying SFAS 123 and SFAS 148 in the above pro forma disclosure are not indicative of future amounts.  SFAS 123 and SFAS 148 do not apply to awards prior to 1995.  Additional awards in future years are anticipated.

 

5.                                      Certain Risks and Uncertainties

 

The Company’s operations are dependent on its continued licensing by state gaming and racing commissions.  The loss of a license, in any jurisdiction in which the Company operates, could have a material adverse affect on future results of operations.

 

The Company is dependent on each gaming and racing property’s local market for a significant number of its patrons and revenues.  If economic conditions in these areas deteriorate or additional gaming or racing licenses are awarded in these markets, the Company’s results of operations could be adversely affected.

 

The Company is also dependant upon a stable gaming and admission tax structure in the states that it operates in.  Any change in the tax structure could have a material adverse affect on future results of operations.

 

10



 

6.                                      Property and Equipment

 

Property and equipment consist of the following:

 

 

 

December 31,
2003

 

March 31,
2004

 

 

 

(In thousands)

 

Land and improvements

 

$

123,660

 

$

128,756

 

Building and improvements

 

530,845

 

531,817

 

Furniture, fixtures, and equipment

 

216,503

 

221,018

 

Transportation equipment

 

1,246

 

1,369

 

Leasehold improvements

 

14,495

 

14,533

 

Construction in progress

 

6,093

 

5,901

 

Total property and equipment

 

892,842

 

903,394

 

Less:  accumulated depreciation and amortization

 

152,335

 

169,287

 

Property and equipment, net

 

$

740,507

 

$

734,107

 

 

Interest capitalized in connection with major construction projects was $.3 million and $0 for the year ended December 31, 2003 and for the three months ended March 31, 2004, respectively.  Depreciation and amortization expense, for property and equipment, totaled $12.2 million and $18.6 million for the three months ended March 31, 2003 and 2004, respectively.

 

7.                                      Supplemental Disclosures of Cash Flow Information

 

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

 

 

(In thousands)

 

Cash payments of interest

 

$

23,493

 

$

24,317

 

Cash payments of income taxes

 

$

 

$

 

 

 

 

 

 

 

Acquisitions: Hollywood Casino Corporation Acquisition

 

 

 

 

 

Cash Paid

 

$

397,948

 

$

 

Fair value of assets acquired, including cash acquired of $133,867 in 2003

 

$

976,245

 

$

 

Fair value of liabilities assumed

 

$

578,297

 

$

 

 

11



 

 

8.                                      Long-term Debt

 

Long-term debt is as follows (in thousands):

 

 

 

December 31,
2003

 

March 31,
2004

 

Senior secured credit facility. This credit facility is secured by substantially all of the assets of the Company.

 

$

399,700

 

$

378,700

 

$200 million 11 1/8% senior subordinated notes.  These notes are general unsecured obligations of the Company.

 

200,000

 

200,000

 

$175 million 8 7/8% senior subordinated notes.  These notes are general unsecured obligations of the Company.

 

175,000

 

175,000

 

$200 million 6 7/8% senior subordinated notes.  These notes are general unsecured obligations of the Company.

 

200,000

 

200,000

 

Hollywood Casino Shreveport non-recourse debt

 

 

 

 

 

13% Shreveport First Mortgage Notes

 

150,000

 

150,000

 

13% Shreveport Senior Secured Notes, including bond premium of $686 and $623, respectively

 

39,686

 

39,623

 

Less: Bond valuation allowance

 

(70,348

)

(70,348

)

Capital leases

 

15,423

 

15,190

 

Other notes payable

 

7

 

 

 

 

1,109,468

 

1,088,165

 

Less: current maturities

 

124,979

 

124,736

 

 

 

$

984,489

 

$

963,429

 

 

The following is a schedule of future minimum repayments of long-term debt as of March 31, 2004 (in thousands):

 

2004 (9 months)

 

$

123,518

 

2005

 

5,591

 

2006

 

5,709

 

2007

 

370,346

 

2008

 

202,288

 

2009

 

2,015

 

Thereafter

 

378,698

 

Total minimum payments

 

$

1,088,165

 

 

At March 31, 2004, the Company was contingently obligated under letters of credit issued pursuant to the senior secured credit facility with face amounts aggregating $7.8 million.

 

The senior secured credit facility requires the Company, among other obligations, to maintain specified financial ratios and satisfy certain financial tests, including interest coverage and total leverage ratios. In addition, the senior secured credit facility restricts, among other things, the Company’s ability to incur additional indebtedness, incur guarantee obligations, amend debt instruments, pay dividends, create liens on assets, make investments, make acquisitions, engage in mergers or consolidations, make capital expenditures, or engage in certain transactions with subsidiaries and affiliates and otherwise restrict corporate activities. The terms of the senior subordinated notes contain similar restrictions. At March 31, 2004, the Company was in compliance with all required financial covenants.

 

9.                                      Segment Information

 

The Company currently operates in two segments: gaming and racing. The accounting policies for each segment are the same as those described in the “Summary of Significant Accounting Policies” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

12



 

The table below presents information about reported segments (in thousands):

 

As of and for the three months ended
March 31, 2004

 

Gaming

 

Racing

 

Eliminations

 

Total

 

Revenue

 

$

308,576

 

$

22,511

 

$

(316

)(2)

$

330,771

 

Income from operations

 

52,422

 

1,872

 

 

54,294

 

Depreciation and Amortization

 

18,484

 

782

 

 

19,266

 

Total Assets

 

2,720,753

 

100,959

 

(1,198,931

)(3)

1,622,781

 

 

As of and for the three months ended
March 31, 2003

 

Gaming(1)

 

Racing

 

Eliminations

 

Total

 

Revenue

 

$

202,079

 

$

23,402

 

$

(347

)(2)

$

225,134

 

Income from operations

 

36,523

 

2,280

 

 

38,803

 

Depreciation and Amortization

 

11,987

 

842

 

 

12,829

 

Total Assets

 

3,183,971

 

99,211

 

(1,223,835

)(3)

2,059,347

 

 


(1)                                 Reflects results of Hollywood Casino since the March 3, 2003 acquisition, which the Company accounts for as of March 1, 2003.

(2)                                 Primarily reflects intercompany transactions related to import/export simulcasting.

(3)                                  Primarily reflects elimination of intercompany investments, receivables and payables.

 

10.                               Litigation

 

Penn and its subsidiaries are subject to various legal and administrative proceedings relating to personal injuries, employment matters, commercial transactions and other matters arising in the normal course of business. The Company does not believe that the final outcome of these matters will have a material adverse effect on the Company’s consolidated financial position or results of operations. In addition, the Company maintains what it believes is adequate insurance coverage to further mitigate the risks of such proceedings. However, such proceedings can be costly, time consuming and unpredictable and, therefore, no assurance can be given that the final outcome of such proceedings may not materially impact the Company’s consolidated financial condition or results of operations. Further, no assurance can be given that the amount or scope of existing insurance coverage will be sufficient to cover losses arising from such matters.

 

The following proceedings could result in costs, settlements or damages that materially impact the Company’s consolidated financial condition or operating results. In each instance, the Company believes that it has meritorious defenses and/or counter-claims and intends to vigorously defend itself.

 

In August 2002, the lessor of the property on which Casino Rouge conducts a significant portion of its dockside operations filed a lawsuit against the Company in the 19th Judicial District Court for the Parish of East Baton Rouge, Louisiana seeking a declaratory judgment that the plaintiff is entitled to terminate the lease and/or void the Company’s option to renew the lease due to certain alleged defaults by the Company or its predecessors-in-interest. The term of the Company’s lease expired in January 2004 and the Company exercised its automatic right to renew for an additional five year term (which, as previously noted is being contested by the landlord). In September 2003 the court granted the Company a partial motion for summary judgment.  In February 2004, the Company filed another motion for partial judgment on most of the remaining issues.  A hearing date has been set for July 2004.  Further litigation on the remaining issues is anticipated.

 

In October 2002, in response to the Company’s plans to relocate the river barge underlying the Boomtown Biloxi casino to an adjacent property, the lessor of the property on which the Boomtown Biloxi casino conducts a portion of its dockside operations, filed a lawsuit against the Company in the U.S. District Court for the Southern District of Mississippi seeking a declaratory judgment that (i) the Company must use the leased premises for a gaming use or, in the alternative, (ii) after the move, the Company will remain obligated to make the revenue based rent payments to plaintiff set forth in the lease. The plaintiff filed this suit immediately after the Mississippi Gaming Commission approved the Company’s request to relocate the barge. Since such approval, the Mississippi

 

13



 

Department of Marine Resources and the U.S. Army Corps of Engineers have also approved our plan to relocate the barge. The Company filed a motion for summary judgment in October 2003 and the plaintiff filed its own motion for summary judgment in January 2004.  In March 2004, the trial court ruled in favor of the Company on all counts.  The plaintiff has filed a motion for reconsideration, which has not yet been ruled on by the trial court.

 

In October 2003, the Company and one of its subsidiaries brought a declaratory action for coverage against Lexington Insurance Company and National Union Fire Insurance of Pittsburgh, Pennsylvania (“National Union”) in the Circuit Court of Jefferson County, West Virginia (“the West Virginia Action”). The case involves a dispute over coverage for punitive damage awards for claims arising in West Virginia. Subsequent to the filing of the West Virginia action, National Union brought an action against the Company and several of its subsidiaries in the Court of Common Pleas of Berks County, Pennsylvania denying coverage for punitive damage awards for claims arising in West Virginia.  The Company has resolved the underlying cases in West Virginia in which punitive damages have been plead, paid out the settlement amounts in the first quarter of 2004 (which amounts are included in miscellaneous assets) and is seeking reimbursement for the settlement amounts in the West Virginia action.

 

11.                               Subsidiary Guarantors

 

Under the terms of the senior secured credit facility, all of the Company’s domestic subsidiaries except for Onward Development, LLC, an inactive subsidiary, Tennessee Downs, Inc., an inactive subsidiary, HWCC-Louisiana, Inc., HWCC-Shreveport, Inc. HCS I, Inc, HCS II Inc., HCS-Golf Course, LLC, Hollywood Casino Shreveport and Shreveport Capital Corporation and their respective subsidiaries, if any, (“Subsidiary Non-Guarantors”), are guarantors under the agreement.  Summarized financial information as of and for the three months ended March 31, 2004 and 2003 for Penn, the Subsidiary Guarantors and Subsidiary Non-guarantors is as follows:

 

 

 

Penn

 

Subsidiary
Guarantors

 

Subsidiary Non-Guarantors

 

Eliminations

 

Consolidated

 

As of March 31, 2004

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Balance Sheet (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

$

36,097

 

$

119,671

 

$

45,789

 

$

922

 

$

202,479

 

Net property and equipment, at cost

 

4,503

 

621,020

 

108,584

 

 

734,107

 

Other assets

 

1,177,868

 

712,056

 

(3,876

)

(1,199,853

)

686,195

 

Total

 

$

1,218,468

 

$

1,452,747

 

$

150,497

 

$

(1,198,931

)

$

1,622,781

 

Current liabilities

 

$

43,415

 

$

78,634

 

$

174,732

 

$

3,893

 

$

300,674

 

Long-term liabilities

 

960,431

 

1,201,742

 

435

 

(1,169,895

)

992,713

 

Shareholder’s equity

 

214,622

 

172,371

 

(24,670

)

(32,929

)

329,394

 

Total

 

$

1,218,468

 

$

1,452,747

 

$

150,497

 

$

(1,198,931

)

$

1,622,781

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2004

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Statement of Income (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

290,726

 

$

40,361

 

$

(316

)

$

330,771

 

Total operating expenses

 

6,191

 

231,641

 

38,961

 

(316

)

276,477

 

Income (loss) from operations

 

(6,191

)

59,085

 

1,400

 

 

54,294

 

Other income (expense)

 

9,937

 

(28,738

)

(7,126

)

 

(25,927

)

Income (loss) before income taxes

 

3,746

 

30,347

 

(5,726

)

 

28,367

 

Taxes on income (loss)

 

3,007

 

7,530

 

43

 

 

10,580

 

Net income (loss)

 

$

739

 

$

22,817

 

$

(5,769

)

$

 

$

17,787

 

 

14



 

 

 

Penn

 

Subsidiary
Guarantors

 

Subsidiary Non-Guarantors

 

Eliminations

 

Consolidated

 

Three months ended March 31, 2004

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Statement of Cash Flows (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

6,421

 

$

31,488

 

$

4,032

 

$

 

$

41,941

 

Net cash used in investing activities

 

24,449

 

(34,072

)

(267

)

 

(9,890

)

Net cash provided by (used in)  financing activities

 

(20,303

)

103

 

(408

)

 

(20,608

)

Effect of exchange rate fluctuations on cash

 

 

(105

)

54

 

 

(51

)

Net increase (decrease) in cash and  cash equivalents

 

10,567

 

(2,586

)

3,411

 

 

11,392

 

Cash and cash equivalents at  beginning of period

 

11,212

 

68,819

 

26,938

 

 

106,969

 

Cash and cash equivalents at end of period

 

$

21,779

 

$

66,233

 

$

30,349

 

$

 

$

118,361

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2003

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Balance Sheet (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

$

1,153,015

 

$

124,220

 

$

46,231

 

$

(1,133,723

)

$

189,743

 

Net property and equipment, at cost

 

1,793

 

627,970

 

110,744

 

 

740,507

 

Other assets

 

70,634

 

679,152

 

1,150

 

(71,587

)

679,349

 

Total

 

$

1,225,442

 

$

1,431,342

 

$

158,125

 

$

(1,205,310

)

$

1,609,599

 

Current liabilities

 

$

55,944

 

$

64,489

 

$

162,708

 

$

3,897

 

$

287,038

 

Long-term liabilities

 

976,012

 

1,207,221

 

5,734

 

(1,176,284

)

1,012,683

 

Shareholder’s equity

 

193,486

 

159,632

 

(10,317

)

(32,923

)

309,878

 

Total

 

$

1,225,442

 

$

1,431,342

 

$

158,125

 

$

(1,205,310

)

$

1,609,599

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2003

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Statement of Income (Loss) (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

210,072

 

$

15,409

 

$

(347

)

$

225,134

 

Total operating expenses

 

4,598

 

168,892

 

13,188

 

(347

)

186,331

 

Income (loss) from operations

 

(4,598

)

41,180

 

2,221

 

 

38,803

 

Other income (expense)

 

9,926

 

(24,547

)

(2,650

)

 

(17,271

)

Income (loss) before income taxes (benefit)

 

5,328

 

16,633

 

(429

)

 

21,532

 

Taxes (benefit) on income (loss)

 

2,224

 

6,292

 

(171

)

 

8,345

 

Net income (loss)

 

$

3,104

 

$

10,341

 

$

(258

)

$

 

$

13,187

 

 

15



 

 

 

Penn

 

Subsidiary
Guarantors

 

Subsidiary Non-
Guarantors

 

Eliminations

 

Consolidated

 

Three months ended March 31,
2003

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Statement of Cash Flows (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

12,582

 

$

42,814

 

$

3,401

 

$

 

$

58,797

 

Net cash provided by (used in) investing activities

 

(690,953

)

13,534

 

(64

)

 

(677,483

)

Net cash provided by (used in)  financing activities

 

681,492

 

115

 

(115

)

 

681,492

 

Effect of exchange rate fluctuations on cash

 

125

 

 

 

 

125

 

Net increase in cash and  cash equivalents

 

3,246

 

56,463

 

3,222

 

 

62,931

 

Cash and cash equivalents at  beginning of period

 

3,339

 

38,430

 

13,352

 

 

55,121

 

Cash and cash equivalents at end of period

 

$

6,585

 

$

94,893

 

$

16,574

 

$

 

$

118,052

 

 

12.                               Unaudited Pro Forma Financial Information

 

Unaudited pro forma financial information for the three months ended March 31, 2003 and 2004, as though the Hollywood Casino acquisition had occurred on January 1, 2003, is as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2003

 

2004

 

 

 

(In thousands)

 

Revenues

 

$

306,457

 

$

330,771

 

Net income

 

$

16,987

 

$

17,787

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

Basic

 

$

.43

 

$

.45

 

Diluted

 

$

.42

 

$

.43

 

 

 

 

 

 

 

Weighted shares outstanding

 

 

 

 

 

Basic

 

39,219

 

39,859

 

Diluted

 

40,280

 

41,112

 

 

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

 

Our Operations

 

We are a leading, diversified, multi-jurisdictional owner and operator of gaming properties, as well as horse racetracks and associated off-track wagering facilities, or OTWs. We own or operate nine gaming properties located in Colorado, Illinois, Louisiana, Mississippi, Ontario and West Virginia that are focused primarily on serving customers within driving distance of the properties. We also own two racetracks and eleven OTWs in Pennsylvania, one racetrack in West Virginia, and through a joint venture, own and operate a racetrack in New Jersey. We operate in two segments, gaming and pari-mutuel operations, and derive substantially all of our revenues from such operations. We believe that our portfolio of assets provides us with a diversified cash flow from operations.

 

16



 

We intend to continue to expand our gaming operations through the implementation of a disciplined capital expenditure program at our existing properties and the continued pursuit of strategic acquisitions of gaming properties particularly in attractive regional markets.

 

Gaming revenues are derived primarily from gaming on slot machines and table games. Pari-mutuel revenues are derived from wagering on our live races, wagering on import simulcasts at our racetracks and OTWs and through telephone account wagering, and fees from wagering on export simulcasting our races at out-of-state locations. Other revenues are derived from hotel, dining, retail, admissions, program sales, concessions and certain other ancillary activities.

 

Key performance indicators related to revenues are:

 

                                          Gaming revenue indicators—slot handle (volume indicator), table game drop (volume indicator) and “win” or “hold” percentages, which are not fully controllable by us. Our typical slot win percentage is in the range of 5% to 9% of slot handle and our typical table games win percentage is in the range of 15% to 21% of table game drop; and

 

                                          Pari-mutuel revenue indicators—pari-mutuel wagering commissions (volume indicator) earned on wagering on our live races, wagering on import simulcasts at our racetracks and OTWs and through telephone account wagering, and fees from wagering on export simulcasting our races at out-of-state locations.

 

Our properties generate significant operating cash flow since most of our revenue is cash-based from slot machines and pari-mutuel wagering. Our business is capital intensive and we rely on cash flow from our properties to generate operating cash to repay debt, fund maintenance capital expenditures, fund new capital projects at existing properties and provide excess cash for future development and acquisitions.

 

Results of Operations

 

The following are the most important factors and trends that contribute to our operating performance:

 

                                          The continued emphasis on slot revenue at our properties, which revenue is the consistently profitable segment of the gaming industry.

 

                                          The continued expansion and revenue gains at our Charles Town Entertainment Complex.

 

                                          Recent economic conditions could intensify the efforts of state and local governments to raise revenues through increases in gaming taxes, as illustrated by our experience in Illinois in 2003.

 

                                          A number of states are currently considering legislation to legalize or expand gaming. Such legislation presents both potential opportunities to establish new properties (for instance in Pennsylvania and Maine) and potential competitive threats to business at our existing properties (such as Maryland and Texas). The timing and occurrence of these events remain uncertain. Legalized gaming from casinos located on Native American lands could also have a significant competitive effect.

 

17



 

The results of operations by property level for the three months ended March 31, 2003 and 2004 are summarized below (in thousands):

 

 

 

Revenues(1)

 

Income from operations

 

 

 

2003

 

2004

 

2003

 

2004

 

Charles Town Entertainment Complex

 

$

70,483

 

$

94,052

 

$

15,192

 

$

20,272

 

Hollywood Casino Aurora (2)

 

24,791

 

58,869

 

6,571

 

14,608

 

Casino Rouge

 

29,070

 

28,455

 

7,518

 

7,301

 

Casino Magic-Bay St. Louis

 

26,665

 

28,601

 

3,491

 

3,853

 

Hollywood Casino Tunica (2)

 

10,548

 

30,888

 

1,640

 

5,215

 

Boomtown Biloxi

 

18,917

 

19,595

 

3,011

 

2,951

 

Hollywood Casino Shreveport (2)

 

12,710

 

36,901

 

1,988

 

1,390

 

Bullwhackers

 

6,198

 

7,758

 

194

 

810

 

Casino Rama Management Contract

 

2,699

 

3,458

 

2,494

 

3,200

 

Pennsylvania Racing Operations

 

23,400

 

22,510

 

2,051

 

1,613

 

Corporate eliminations (3)

 

(347

)

(316

)

 

 

Corporate overhead

 

 

 

(5,347

)

(6,919

)

Total

 

$

225,134

 

$

330,771

 

$

38,803

 

$

54,294

 

 


(1)                             Net revenues are net of promotional allowances.

(2)                             Reflects results since March 3, 2003 acquisition.

(3)                             Primarily reflects intracompany transactions related to import/export simulcast wagering.

 

Revenues

 

Revenues for the three month period ended March 31, 2004 increased by $105.6 million, or 46.9%, to $330.7 million from $225.1 million in 2003. The three new Hollywood Casino properties contributed $78.6 million of the increase in revenue.  The increase for the Hollywood Casino properties was a result of comparing a three month period of operations in 2004 to a one month period of operations in 2003. For the properties we owned prior to the acquisition of the Hollywood Casino properties, revenues increased by $27.0 million, or 15.3%.  Revenues at the Charles Town Entertainment Complex increased by $23.6 million, or 33.4%, over the same period from last year due to the opening of an additional 38,000 square feet of gaming space with 700 new slot machines in July of 2003. At Casino-Magic-Bay St. Louis revenues increased by $1.9 million.  The primary driver in the revenue increase was a higher occupancy rate at the 291-room Bay Tower Hotel and Conference Center.  The occupancy rate for the three months ended March 31, 2004 was 87.3% compared to 72.6% in 2003 and was the result of a marketing program that focused on better utilization of the hotel and increased play on the gaming floor.  Revenues at Bullwhackers increased by $1.5 million, or 25.2%, due to the introduction of penny machines that were part of the facility renovations completed in 2003 and a more aggressive marketing program that is focused on the “locals” market.

 

Operating Expenses

 

Operating expenses for the three month period ended March 31, 2004 increased by $90.1 million, or 48.4%, to $276.4 million from $186.3 million in 2003. The three new Hollywood Casino properties were responsible for $67.6 million of the increase in operating expenses. The increase was a result of comparing a three month period of operations in 2004 to a one month period of operations in 2003. For the properties we owned prior to the acquisition of the Hollywood Casino properties, expenses increased by $22.5 million, or 15.1%. At the Charles Town Entertainment Complex expenses increased by $18.5 million, or 33.4%, over the same period from last year due to the opening of an additional 38,000 square feet of gaming space with 700 new slot machines in July of 2003.  At Casino Magic—Bay St. Louis expenses increased by $1.6 million and included higher gaming taxes and slot machine participation fees that increased with revenues, additional hotel expenses that increased with occupancy rates and higher marketing expenses for entertainment and players’ club promotions.  Expenses at

 

18



 

Bullwhackers increased by $.9 million, or 15.7%, primarily as a result of the higher gaming taxes associated with higher revenues and increased marketing expenses for advertising and players’ club promotions.

 

Corporate overhead expenses increased by $1.6 million for the three months ended March 31, 2004 as compared to 2003. We continue to incur expenses for lobbying and site development expenses in connection with Pennsylvania slot legislation and Maine slot legislation.  Other corporate expenses such as payroll and employee benefits, legal, outside services and travel have increased as a result of the Hollywood Casino acquisition in March of 2003.  Notably, our corporate overhead as a percentage of our net revenues has decreased to 2.1% in 2004 compared to 2.4% in 2003.

 

Depreciation and amortization expense increased by $6.4 million to $19.2 million in 2003 from $12.8 million in 2002. The addition of the Hollywood Casino properties increased depreciation and amortization expense by $4.6 million. The remaining increase of $1.8 million was primarily a result of the expansion at Charles Town for additional gaming space and the parking structure and the purchase of new slot machines at many of our properties.

 

Income from operations

 

Operating income increased by $15.5 million, or 39.9%, to $54.3 million for the three months ended March 31, 2004 from $38.8 million in 2003. The primary drivers, as discussed above, in the growth of income from operations were the three Hollywood Casino properties, which accounted for $11.0 million of the increase, and Charles Town, which accounted for $5.1 million.

 

Other income (expense)

 

Other income (expense) summary (in thousands):

 

Three Months Ended March 31,

 

2003

 

2004

 

Other income (expense):

 

 

 

 

 

Interest expense

 

$

(16,352

)

$

(25,698

)

Interest income

 

434

 

389

 

Earnings from joint venture

 

588

 

460

 

Other

 

(104

)

(1,078

)

Loss on change in fair values of interest rate swaps

 

(527

)

 

Loss on early extinguishment of debt

 

(1,310

)

 

Total other expense

 

$

(17,271

)

$

(25,927

)

 

Interest expense increased by $9.3 million for the three months ended March 31, 2004 compared to 2003 as a result of borrowing an additional $700 million for the acquisition of Hollywood Casino Corporation and the interest expense associated with the Hollywood Casino Shreveport notes. During the first quarter of 2004, we made principal payments of $21.3 million on our senior secured credit facility, including an accelerated payment of $20 million on March 31, 2004.  Subject to the availability of attractive acquisition or project opportunities, we expect to continue to accelerate our principal payments as free cash flow allows.

 

During the first quarter of 2004, we incurred other non-recurring expenses of $1.1 million. These expenses are primarily attributable to costs for debt negotiations relative to, and the proposed sale of, Hollywood Casino Shreveport.

 

Liquidity and Capital Resources

 

Historically, our primary sources of liquidity and capital resources have been cash flow from operations, borrowings from banks and proceeds from the issuance of debt and equity securities.

 

19



 

Net cash provided by operating activities was $40.7 million for the three months ended March 31, 2004. This consisted of net income of $17.8 million, non-cash reconciling items of $23.4 million and net decreases in current liability accounts along with net decreases in current asset accounts of $.5 million, net of assets and liabilities acquired in the Hollywood Casino Corporation acquisition.

 

Cash flows used in investing activities totaled $9.9 million for the three months ended March 31, 2004. Expenditures for property, plant, and equipment totaled $13.1 million and included $2.0 million at Charles Town for the Phase III expansion project, $3.5 million for a land purchase at Boomtown and $7.6 million in maintenance capital expenditures including new slot machines. We also received a $3.1 million cash distribution from our New Jersey joint venture.

 

Cash used in financing activities was $20.6 million for the three months ended March 31, 2004. Principal payments on long-term debt included $21.3 million in payments under our credit facility. Net proceeds from the exercise of stock options totaled $1.2 million.

 

Outlook

 

Based on our current level of operations, and anticipated revenue growth, we believe that cash generated from operations and amounts available under our credit facility will be adequate to meet our anticipated debt service requirements, capital expenditures and working capital needs for the foreseeable future. We cannot assure you, however, that our business will generate sufficient cash flow from operations, that our anticipated revenue growth will be realized, or that future borrowings will be available under our credit facility or otherwise will be available to enable us to service our indebtedness, including the credit facility and the notes, to retire or redeem the notes when required or to make anticipated capital expenditures. In addition, if we consummate significant acquisitions in the future, our cash requirements may increase significantly. We may need to refinance all or a portion of our debt on or before maturity. Our future operating performance and our ability to service or refinance our debt will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control.

 

Capital Expenditures

 

The following table summarizes our budgeted capital expenditures, other than maintenance capital expenditures, by property for the fiscal year ended December 31, 2004 and actual expenditures during the first quarter of 2004 (in thousands):

 

Property

 

Budget for
Year Ended
December 31,
2004

 

Expenditures
Through
March 31,
2004

 

Balance to
Expend

 

Charles Town Entertainment Complex

 

$

34,200

 

$

2,034

 

$

32,166

 

Boomtown Biloxi

 

5,460

 

3,481

 

1,979

 

Totals

 

$

39,660

 

$

5,515

 

$

34,145

 

 

The Charles Town Entertainment Complex has started the design work for Phase III of the facility expansion. Phase III includes the expansion of the parking garage by approximately 1,050 spaces, adding an additional 300 slot machines and related equipment and infrastructure improvements, including a loading dock, dry storage area, offices and a maintenance shop. The parking garage should be completed by the third quarter of 2004 and the new gaming area should be open by the fourth quarter of 2004.  At Boomtown Biloxi, we signed an option to purchase approximately 4 acres of land adjacent to our Boomtown Biloxi property in January 2002. This purchase was completed in January 2004 at a cost of $3.7 million and is part of our 2004 budget. We expect to use the land for additional parking and to develop the property in the event that we move the casino barge. The decision to move the casino barge is contingent upon the outcome of the lawsuit filed by our landlord that goes to

 

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trial in 2004. Moving the casino barge is estimated to cost approximately $20.0 million.  Due to the ongoing litigation with our landlord at the Boomtown Biloxi property, we have elected not to budget for any additional project-related capital expenditures in 2004 other than the acquisition of the land. In the event that this dispute can be resolved, we may elect to revisit the decision.

 

During 2003, we began expanding our corporate offices to provide additional workstations and office space for our employees. The first part of this project was completed in the second quarter of 2003. Additional office space expansion is planned for 2004.

 

During the quarter, we spent approximately $7.6 million for maintenance capital expenditures at our properties.

 

For 2004, we expect to spend approximately $53.7 million for maintenance capital expenditures at our properties. Of this total, approximately $11.1 million will be spent on slot machines and ticket-in, ticket-out slot technology at our facilities in states where the new technology is approved.

 

Cash generated from operations funded our capital expenditures and maintenance capital expenditures.

 

Senior Secured Credit Facility

 

At March 31, 2004, we had an outstanding balance of $378.7 million on the Term Loan D facility and $92.2 million available to borrow under the revolving credit facility after giving effect to outstanding letters of credit of $7.8 million. The weighted average interest rate on the Term D facility is 3.63% at March 31, 2004, excluding swaps and deferred finance fees.

 

Covenants

 

Our senior secured credit facility requires us, among other obligations, to maintain specified financial ratios and satisfy certain financial tests, including interest coverage and total leverage ratios. In addition, our senior secured credit facility restricts, among other things, our ability to incur additional indebtedness, incur guarantee obligations, amend debt instruments, pay dividends, create liens on assets, make investments, make acquisitions, engage in mergers or consolidations, make capital expenditures, or engage in certain transactions with subsidiaries and affiliates and otherwise restrict corporate activities. The terms of our senior subordinated notes contain similar restrictions. At March 31, 2004, we were in compliance with all required financial covenants.

 

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Commitments and Contingencies

 

—Contractual Cash Obligations

 

The following table presents our contractual cash obligations as of March 31, 2004:

 

 

 

Payments Due By Period

 

 

 

Total

 

2004

 

2005 - 2006

 

2007 – 2008

 

2009
and
After

 

 

 

(In thousands)

 

Senior secured credit facility(1)

 

$

378,700

 

$

2,847

 

$

7,594

 

$

368,259

 

$

 

11 1/8% senior subordinated notes due 2008(2)

 

 

 

 

 

 

 

 

 

 

 

Principal

 

200,000

 

 

 

200,000

 

 

Interest

 

89,000

 

11,125

 

44,500

 

33,375

 

 

8 7/8% senior subordinated notes due 2010(3)

 

 

 

 

 

 

 

 

 

 

 

Principal

 

175,000

 

 

 

 

175,000

 

Interest

 

93,188

 

7,766

 

31,063

 

31,062

 

23,297

 

6 7/8% senior subordinated notes due 2011(4)

 

 

 

 

 

 

 

 

 

 

 

Principal

 

200,000

 

 

 

 

200,000

 

Interest

 

109,885

 

13,635

 

27,500

 

27,500

 

41,250

 

13% Hollywood Casino Shreveport notes(5)

 

 

 

 

 

 

 

 

 

 

 

Principal

 

189,000

 

189,000

 

 

 

 

Interest

 

18,468

 

18,468

 

 

 

 

Purchase obligations

 

14,242

 

10,062

 

3,172

 

975

 

33

 

Construction commitments

 

10,085

 

10,085

 

 

 

 

Capital Leases

 

15,190

 

1,392

 

3,695

 

4,375

 

5,728

 

Operating Leases

 

23,947

 

6,156

 

6,416

 

3,287

 

8,088

 

Total

 

$

1,516,705

 

$

270,536

 

$

123,940

 

$

668,833

 

$

453,396

 

 


(1)                                  As of March 31, 2004 there was no indebtedness outstanding under the credit facility and there was approximately $92.2 million available for borrowing under the revolving credit portion of the credit facility.

 

(2)                                  The $200.0 million aggregate principal amount of 11 1/8% notes matures on March 1, 2008. Interest payments of approximately $11.1 million are due on each March 1 and September 1 until March 1, 2008.

 

(3)                                  The $175.0 million aggregate principal amount of 8 7/8% notes matures on March 15, 2010. Interest payments of approximately $7.8 million are due on each March 15 and September 15 until March 15, 2010.

 

(4)                                  The $200.0 million aggregate principal amount of 6 7/8% notes matures on December 1, 2011. Interest payments of approximately $6.8 million are due on each June 1 and December 1 until December 1, 2011.

 

(5)                                  The $150.0 million aggregate principal amount of 13% senior secured notes matures August 1, 2006 and the $39.0 million aggregate principal amount of 13% first mortgage notes matures August 1, 2006. Interest payments of approximately $12.3 million are due on the notes each August 1 and February 1 until August 1, 2006. The Hollywood Casino Shreveport notes are non-recourse to us and our subsidiaries (other than HCS, Shreveport Capital Corporation, HCS I, Inc., HCS II, Inc. and HWCC-Louisiana, Inc.). The Hollywood Casino Shreveport notes have been in default under the terms of their respective note indentures since May 2003, and accordingly are classified as current obligations at March 31, 2004.

 

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—Other Commercial Commitments

 

The following table presents our material commercial commitments as of March 31, 2004 for the following future periods: 

 

 

 

 

 

Amount of Commitment Expiration Per Period

 

 

 

Total
Amounts
Committed

 

2004

 

2005 – 2006

 

2007 2008

 

2009 and
After

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Revolving Credit Facility(1)

 

$

 

$

 

$

 

$

 

$

 

Letters of Credit(1)

 

7,809

 

7,809

 

 

 

 

Guarantees of New Jersey Joint Venture Obligations(2)

 

8,625

 

8,625

 

 

 

 

Total

 

$

16,434

 

$

16,434

 

$

 

$

 

$

 

 


(1)                                  The available balance under the revolving portion of the $100 million senior secured credit facility is diminished by outstanding letters of credit.

 

(2)                                  In connection with our 50% ownership interest in Pennwood Racing, Inc., our joint venture in New Jersey, we have entered into a debt service maintenance agreement with Pennwood’s lender to guarantee up to 50% of Pennwood’s $17.2 million term loan. Our obligation as of March 31, 2004 under this guarantee is approximately $8.6 million.

 

—Interest Rate Swap Agreements

 

See Item 3, “Quantitative and Qualitative Disclosures About Market Risk” below.

 

Hollywood Casino Shreveport Notes

 

Hollywood Casino Shreveport and Shreveport Capital Corporation are co-issuers of $150 million aggregate principal amount of 13% senior secured notes due 2006 and $39 million aggregate principal amount of 13% first mortgage notes due 2006, which we refer to collectively in this document as the Hollywood Casino Shreveport notes. Hollywood Casino Shreveport is a general partnership that owns the casino operations. Shreveport Capital Corporation is a wholly-owned subsidiary of Hollywood Casino Shreveport formed solely for the purpose of being a co-issuer of the Hollywood Casino Shreveport notes.

 

The Hollywood Casino Shreveport notes are non-recourse to us and our subsidiaries (other than Hollywood Casino Shreveport, Shreveport Capital Corporation, HCS I, Inc., HCS II, Inc. and HWCC-Louisiana, Inc., which we refer to as the Shreveport entities) and are secured by substantially all of the assets of the casino, and the partnership interests held by HCS I, Inc. and HCS II, Inc. and the stock held by HWCC-Louisiana, Inc.

 

On February 3, 2004, our indirect subsidiary, HCS I, Inc., the managing general partner of Hollywood Casino Shreveport general partnership, or HCS, announced that its Board of Directors has initiated a process that it hopes will result in the sale or other disposition of the riverboat casino/hotel complex of HCS located in Shreveport, Louisiana. The announcement followed action by the Board authorizing HCS’s financial advisor, Libra Securities LLC, to begin contacting potential acquirers. The Board also authorized the creation of an independent committee to oversee the sale process. The Board created the independent committee in case we seek to participate as a bidder in the sale process. The Board took action after consultation with an ad hoc committee of holders of the Hollywood Casino Shreveport notes.  Although no formal agreement has been reached with the ad hoc committee regarding the sale process, HCS anticipates that it will consult with the ad hoc committee

 

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throughout the process.  There can be no assurance that the process will result in the sale or other disposition of the riverboat casino/hotel complex or that, if it does, the sale proceeds will be adequate to pay the Hollywood Casino Shreveport notes in full.  Further, the holders of the Hollywood Casino Shreveport notes might pursue all rights and remedies that they may have under the indentures as a result of the event of default.  Any such action on the part of the note holders may prompt HCS to seek the protection of the bankruptcy laws or other similar remedies. HCS currently anticipates that any transaction would be effected through a federal bankruptcy proceeding. HCS did not make the August 1, 2003 and the February 1, 2004 interest payments, aggregating $24.6 million, due on the Hollywood Casino Shreveport notes. The Hollywood Casino Shreveport notes have been in default under the terms of their respective note indentures since May 2003, and accordingly are classified as current obligations at March 31, 2004.

 

Accounting Pronouncements Issued or Adopted in 2004

 

There are no accounting standards issued before March 31, 2004 but effective after December 31, 2003 which are expected to have a material impact on our financial reporting.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

On December 20, 2000, we entered into an interest rate swap with a notional amount of $100 million and a termination date of December 22, 2003.  Under this agreement, we pay a fixed rate of 5.835% against a variable interest rate based on the 90-day LIBOR rate.  On August 3, 2001, we entered into an interest rate swap with a notional amount of $36 million with a termination date of June 30, 2004.  Under this agreement, we paid a fixed rate of 4.8125% against a variable interest rate based on the 90-day LIBOR rate.  On March 3, 2003, we terminated our $36 million notional amount interest rate swap originally scheduled to expire in June 2004.  We paid $1.9 million to terminate the swap agreement.

 

We have a policy designed to manage interest rate risk associated with our current and anticipated future borrowings.  This policy enables us to use any combination of interest rate swaps, futures, options, caps and similar instruments.  To the extent we employ such financial instruments pursuant to this policy, they are accounted for as hedging instruments.  In order to qualify for hedge accounting, the underlying hedged item must expose us to risks associated with market fluctuations and the financial instrument used must be designated as a hedge and must reduce our exposure to the market in fluctuations throughout the hedge period.  If these criteria are not met, a change in the market value of the financial instrument is recognized as a gain or loss in the period of change.  Interest paid or received pursuant to the financial instrument is included as interest expense in the period.

 

On March 27, 2003, we entered into forward interest rate swap agreements with a total notional amount of $375.0 million in accordance with the terms of the $800 million senior secured credit facility.  There are three two-year swap contracts totaling $175 million with an effective date of March 27, 2003 and a termination date of March 27, 2005.  Under these contracts, we pay a fixed rate of 1.92% against a variable rate based on the 90-day LIBOR rate.  We also entered into three three-year swap contracts totaling $200 million with a termination date of March 27, 2006.  Under these contracts, we pay a fixed rate of 2.48% to 2.49% against a variable rate based on the 90-day LIBOR rate.  The difference between amounts received and amounts paid under such agreements, as well as any costs or fees, is recorded as reduction of, or addition to, interest expense as incurred over the life of the swap or similar financial instrument.  At March 31, 2004, the 90-day LIBOR rate was 1.14%.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Our management, under the supervision and with the participation of the principal executive officer and principal financial officer, have evaluated the effectiveness of our controls and procedures related to our reporting and disclosure obligations as of March 31, 2004, which is the end of the period covered by this Quarterly Report on Form 10-Q.  In designing and evaluating the disclosure controls and procedures, management recognized 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 necessarily was required to apply its judgment in

 

24



 

evaluating the cost-benefit relationship of possible controls and procedures.  Based on that evaluation, the principal executive officer and principal financial officer have concluded that these disclosure controls and procedures are sufficient to provide that (a) material information relating to us, including our consolidated subsidiaries, is made known to these officers by other employees of us and our consolidated subsidiaries, particularly material information related to the period for which this periodic report is being prepared; and (b) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms of the Securities and Exchange Commission.

 

There were no changes that occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonable likely to materially affect, our internal controls over financial reporting.

 

PART II.  OTHER INFORMATION

 

ITEM 1.     LEGAL PROCEEDINGS

 

Information in response to this Item is incorporated by reference to the information set forth in “Note 10. Litigation” in the Notes to Consolidated Financial Statements in Part I of this Quarterly Report on Form 10-Q.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

 

As discussed in the Liquidity and Capital Resources Section of Management’s Discussion and Analysis of Financial Condition and Results of Operations, following the March 3, 2003 consummation of the merger of our wholly-owned subsidiary with and into Hollywood Casino Corporation, HCS and Shreveport Capital Corporation were required under the indentures governing the Hollywood Casino Shreveport notes, of which there were aggregate of $189 million outstanding, to make an offer to purchase the Hollywood Casino Shreveport notes.  On March 14, 2003, the HCS and Shreveport Capital Corporation were notified by an ad hoc committee of holders of the Hollywood Shreveport notes that they have 60 days from receipt of the notice to cure the failure to offer to purchase the Hollywood Casino Shreveport notes or an event of default will have occurred under the indentures.  Neither HCS nor Shreveport Capital Corporation made a Change of Control offer to purchase the Hollywood Casino Shreveport notes within the 60 days and, as a result, a default occurred.

 

On February 3, 2004, our indirect subsidiary, HCS I, Inc., the managing general partner of HCS, announced that its Board of Directors has initiated a process that it hopes will result in the sale or other disposition of the riverboat casino/hotel complex of HCS located in Shreveport, Louisiana.  We anticipate that any transaction may be effected through a federal bankruptcy proceeding.  There can be no assurance that the process will result in the sale or other disposition of the riverboat casino/hotel complex or that, if it does, the sale proceeds will be adequate to pay the Hollywood Casino Shreveport notes in full.  Further, the holders of the Hollywood Casino Shreveport notes might pursue all rights and remedies that they may have under the indentures as a result of the event of default.  Any such action on the part of the note holders may prompt HCS to seek the protection of the bankruptcy laws or other similar remedies.  On August 1, 2003 and February 1, 2004, interest payments of $12.3 million each became due on the Hollywood Casino Shreveport notes.  The managing general partner of Hollywood Casino Shreveport did not make those payments.

 

The Hollywood Casino Shreveport notes are non-recourse to Penn and its subsidiaries (other than Hollywood Casino Shreveport, Shreveport Capital Corporation, HCS I, Inc., HCS II, Inc. and HWCC-Louisiana, Inc.) and are secured by substantially all of the assets of the casino, and the partnership interests held by HCS I, Inc. and HCS II, Inc. and the stock held by HWCC-Louisiana, Inc.

 

ITEM 5.  OTHER INFORMATION

 

Recent Developments

 

Since the filing of our last Annual Report on Form 10-K, several developments have occurred with respect to certain matters noted in our annual report.

 

Development activity in Maine

 

In April 2004, in the litigation brought by certain special interest groups challenging the grant of the conditional racing license to Bangor Historic Track, Inc., the trial court dismissed the petitioners' appeals from the Maine Harness Racing Commission decision granting a conditional license.  No appeal of the court's decision has been taken and the time to file such appeals has expired.  There is still pending before the trial court an independent count requesting declaratory judgment regarding the initial gaming legislation adopted in Maine; however that legislation has since been repealed and replaced.  It is unclear at this time whether the plaintiffs intend to pursue this count.

 

In May 2004, the governor of Maine signed into law a bill providing for increased taxation and additional regulation of slot machine gaming as well as for the creation of a gambling control board.  The law takes effect on July 29, 2004.  Nomination and appointment of the members of the new gambling control board is currently expected to be completed by the close of the third quarter of 2004.  The governor also signed an executive order creating a gambling advisory council that is tasked with immediately commencing work on the creation and implementation of the State’s regulatory structure.

 

While we are preparing to move forward with this project, no assurance can be given that we will be able to complete this project or the transaction contemplated by the purchase agreement relating to this project. There remain several conditions and contingencies regarding the consummation of the purchase transaction, and both the regulatory and legislative environments continue to remain subject to uncertainty, including, without limitation, the process of adopting rules and regulations necessary to allow for the issuance of gaming related licenses.

 

Hollywood Casino Shreveport

 

In May 2004, our indirect subsidiary, HCS I, Inc., the managing general partner of Hollywood Casino Shreveport general partnership, or HCS, distributed formal requests for bids from certain qualified bidders recommended by its independent financial advisor.  There can be no assurance that the process will result in the sale or other disposition of the riverboat casino/hotel complex or that, if it does, the sale proceeds will be adequate to pay the HCS notes in full.  HCS currently anticipates that any transaction would be effected through a federal bankruptcy proceeding.

 

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ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                  Exhibits

 

Exhibit

 

Description of Exhibit

 

 

 

10.1

 

Agreement, effective January 15, 2004, between The Downs Racing, Inc. and the Pennsylvania Harness Horsemen’s Association, Inc.

 

 

 

10.2

 

Amendment dated March 30, 2004 to Live Racing Agreement dated March 23, 2003 among Penn National Turf Club, Inc., Mountainview Thoroughbred Racing Association and the Pennsylvania Horsemen’s Benevolent and Protective Association, Inc.

 

 

 

31.1

 

CEO Certification pursuant to rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934

 

 

 

31.2

 

CFO Certification pursuant to rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934

 

 

 

32.1

 

CEO Certification pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

 

 

 

32.2

 

CFO Certification pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

 

(b) Reports on Form 8-K

 

Report

 

Item(s) No.

 

Date of Report

 

Date Filed or Furnished

Form 8-K

 

5, 7 and 12

 

February 3, 2003

 

Filed February 6, 2004

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

PENN NATIONAL GAMING, INC.

 

 

 

 

 

 

 

 

By:

 

 

May 10, 2004

 

 

/s/ William J. Clifford

 

 

 

 

 

William J. Clifford

 

 

 

 

Senior Vice President-Finance
and Chief Financial Officer

 

27