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 September 30, 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 November 3, 2004

 

Common Stock, par value $.01 per share

 

40,704,383

 

 

 



 

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Actual results may vary materially from expectations. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from the Company’s 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; our ability to successfully consummate the proposed sale of the Pocono Downs facility; 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 (including without limitation the Company’s proposed acquisition of Argosy Gaming Company); our ability to maintain regulatory approvals for our existing businesses and to receive regulatory approvals for our new businesses (including without limitation the issuance of final operators’ licenses in Maine and Pennsylvania); delays in the process of finalizing gaming regulations and the establishment of related governmental infrastructure in Pennsylvania and Maine; 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; the outcome and financial impact from the event of default under the indentures governing the Hollywood Casino Shreveport notes and other factors as discussed in the Company’s filings with the United States Securities and Exchange Commission.  The Company does not intend to update publicly any forward-looking statements except as required by law.

 

ii

 



 

PENN NATIONAL GAMING, INC. AND SUBSIDIARIES
INDEX

 

PART I. FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS

 

 

 

Consolidated Balance Sheets

 

 

 

Consolidated Statements of Income (unaudited) Nine months ended September 30, 2003 and 2004

2

 

 

Consolidated Statements of Income (unaudited) Three months ended September 30, 2003 and 2004

3

 

 

Consolidated Statements of Shareholders’ Equity and Comprehensive Income (unaudited)

4

 

 

Consolidated Statements of Cash Flows (unaudited)

5

 

 

Notes to Consolidated Financial Statements

6

 

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

17

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

33

 

ITEM 4. CONTROLS AND PROCEDURES

34

PART II. OTHER INFORMATION

34

 

ITEM 1. LEGAL PROCEEDINGS

34

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

34

 

ITEM 5. OTHER INFORMATION

36

 

ITEM 6. EXHIBITS

37

 

iii



 

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

 

September 30, 2004

 

 

 

 

 

(unaudited)

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

81,567

 

$

83,200

 

Receivables, net of allowance for doubtful accounts of $2,062 and $3,903, respectively

 

25,739

 

34,475

 

Prepaid income taxes

 

7,593

 

7,583

 

Prepaid expenses and other current assets

 

25,447

 

18,699

 

Deferred income taxes

 

17,284

 

17,568

 

Total current assets

 

157,630

 

161,525

 

 

 

 

 

 

 

Net property and equipment, at cost

 

594,152

 

593,933

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

Investment in and advances to unconsolidated affiliate

 

17,187

 

15,372

 

Excess of cost over fair market value of net assets acquired

 

586,969

 

587,757

 

Management service contract (net of amortization of $6,719 and $8,602, respectively)

 

19,027

 

17,143

 

Deferred financing costs, net

 

28,214

 

24,947

 

Miscellaneous

 

10,813

 

31,112

 

Assets held for sale

 

195,607

 

196,346

 

Total other assets

 

857,817

 

872,677

 

Total assets

 

$

1,609,599

 

$

1,628,135

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current maturities of long-term debt

 

$

5,634

 

$

4,906

 

Accounts payable

 

10,785

 

9,061

 

Accrued Liabilities:

 

 

 

 

 

Expenses

 

45,950

 

44,185

 

Interest

 

11,736

 

3,046

 

Salaries and wages

 

27,482

 

26,115

 

Gaming, pari-mutuel, property and other taxes

 

11,940

 

14,489

 

Income taxes payable

 

9,313

 

25,733

 

Other current liabilities

 

7,698

 

10,785

 

Total current liabilities

 

130,538

 

138,320

 

 

 

 

 

 

 

Long term liabilities:

 

 

 

 

 

Long-term debt, net of current maturities

 

984,489

 

904,888

 

Deferred income taxes

 

13,354

 

19,117

 

Liabilities held for sale

 

171,340

 

186,122

 

Total long-term liabilities

 

1,169,183

 

1,110,127

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

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

 

 

 

Common stock, $.01 par value, 200,000,000 shares authorized; shares issued 40,621,350 and 41,466,283, respectively

 

409

 

417

 

Restricted Stock, 80,000 shares issued

 

 

(2,234

)

Treasury stock, at cost 849,400 shares

 

(2,379

)

(2,379

)

Additional paid-in capital

 

162,442

 

178,233

 

Retained earnings

 

148,055

 

202,681

 

Accumulated other comprehensive income

 

1,351

 

2,970

 

Total shareholders’ equity

 

309,878

 

379,688

 

Total Liabilities and Shareholder’s Equity

 

$

1,609,599

 

$

1,628,135

 

 

See accompanying notes to consolidated financial statements.

 



 

Penn National Gaming, Inc. and Subsidiaries

Consolidated Statements of Income

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

 

 

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

Revenues

 

 

 

 

 

Gaming

 

$

648,248

 

$

751,165

 

Racing

 

40,093

 

38,359

 

Management service fee

 

9,869

 

11,950

 

Food, beverage and other revenue

 

98,144

 

111,935

 

Gross revenues

 

796,354

 

913,409

 

Less: Promotional allowances

 

(40,746

)

(49,408

)

Net revenues

 

755,608

 

864,001

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Gaming

 

353,753

 

411,814

 

Racing

 

32,093

 

30,047

 

Food, beverage and other expenses

 

69,475

 

73,155

 

General and administrative

 

123,792

 

135,689

 

Depreciation and amortization

 

41,551

 

49,413

 

Total operating expenses

 

620,664

 

700,118

 

 

 

 

 

 

 

Income from continuing operations

 

134,944

 

163,883

 

 

 

 

 

 

 

Other income (expenses)

 

 

 

 

 

Interest expense

 

(56,510

)

(57,590

)

Interest income

 

1,269

 

1,299

 

Earnings from joint venture

 

1,632

 

1,298

 

Other

 

(649

)

(796

)

Loss on change in fair values of interest rate swaps

 

(527

)

 

Loss on early extinguishment of debt

 

(1,310

)

 

Total other expenses, net

 

(56,095

)

(55,789

)

 

 

 

 

 

 

Income from continuing operations before income taxes

 

78,849

 

108,094

 

Taxes on income

 

29,724

 

39,550

 

Net income from continuing operations

 

49,125

 

68,544

 

(Loss) from discontinued operations, net of tax benefit of $3,652 and $7,444, respectively

 

(6,846

)

(13,918

)

Net income

 

$

42,279

 

$

54,626

 

 

 

 

 

 

 

Earnings per share — basic

 

 

 

 

 

Income from continuing operations

 

$

1.25

 

$

1.71

 

Discontinued operations, net of tax

 

(0.18

)

(0.35

)

Basic net income per share

 

$

1.07

 

$

1.36

 

 

 

 

 

 

 

Earnings per share — diluted

 

 

 

 

 

Income from continuing operations

 

$

1.21

 

$

1.65

 

Discontinued operations, net of tax

 

(0.17

)

(0.33

)

Diluted net income per share

 

$

1.04

 

$

1.32

 

 

 

 

 

 

 

Weighted shares outstanding

 

 

 

 

 

Basic

 

39,408

 

40,116

 

Diluted

 

40,525

 

41,520

 

 

See accompanying notes to consolidated financial statements.

 

2



 

Penn National Gaming, Inc. and Subsidiaries

Consolidated Statements of Income

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

 

 

 

 

Three Months Ended

September 30,

 

 

 

2003

 

2004

 

Revenues

 

 

 

 

 

Gaming

 

$

233,878

 

$

251,372

 

Racing

 

12,555

 

12,371

 

Management service fee

 

4,005

 

4,584

 

Food, beverage and other revenue

 

36,084

 

37,146

 

Gross revenues

 

286,522

 

305,473

 

Less: Promotional allowances

 

(15,505

)

(16,742

)

Net revenues

 

271,017

 

288,731

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Gaming

 

126,297

 

138,990

 

Racing

 

10,118

 

9,740

 

Food, beverage and other expenses

 

25,010

 

24,251

 

General and administrative

 

45,599

 

43,808

 

Depreciation and amortization

 

15,545

 

16,492

 

Total operating expenses

 

222,569

 

233,281

 

 

 

 

 

 

 

Income from continuing operations

 

48,448

 

55,450

 

 

 

 

 

 

 

Other income (expenses)

 

 

 

 

 

Interest expense

 

(21,166

)

(18,970

)

Interest income

 

403

 

483

 

Earnings from joint venture

 

327

 

205

 

Other

 

104

 

(186

)

Total other expenses, net

 

(20,332

)

(18,468

)

 

 

 

 

 

 

Income from continuing operations before income taxes

 

28,116

 

36,982

 

Taxes on income

 

10,263

 

13,410

 

Net income from continuing operations

 

17,853

 

23,572

 

(Loss) from discontinued operations, net of tax benefit of $1,891 and $3,419, respectively

 

(4,238

)

(6,382

)

Net income

 

$

13,615

 

$

17,190

 

 

 

 

 

 

 

Earnings per share — basic

 

 

 

 

 

Income from continuing operations

 

$

0.46

 

$

0.58

 

Discontinued operations, net of tax

 

(0.11

)

(0.15

)

Basic net income per share

 

$

0.35

 

$

0.43

 

 

 

 

 

 

 

Earnings per share — diluted

 

 

 

 

 

Income from continuing operations

 

$

0.44

 

$

0.56

 

Discontinued operations, net of tax

 

(0.10

)

(0.15

)

Diluted net income per share

 

$

0.34

 

$

0.41

 

 

 

 

 

 

 

Weighted shares outstanding

 

 

 

 

 

Basic

 

39,214

 

40,437

 

Diluted

 

40,388

 

41,926

 

 

See accompanying notes to consolidated financial statements.

 

3



 

Penn National Gaming, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity and Comprehensive Income

(Unaudited)
(In thousands, except share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

 

 

Common Stock

 

Restricted

 

Treasury

 

Paid-In

 

Retained

 

Comprehensive

 

 

 

Comprehensive

 

 

 

Shares

 

Amount

 

Stock

 

Stock

 

Capital

 

Earnings

 

Income (Loss)

 

Total

 

Income

 

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 $7,126

 

844,933

 

8

 

 

 

13,397

 

 

 

13,405

 

 

Restricted Stock Issue

 

 

 

(2,234

)

 

2,394

 

 

 

160

 

 

Change in fair value of interest rate swap contracts, net of income taxes of $918

 

 

 

 

 

 

 

1,502

 

1,502

 

1,502

 

Amortization of unrealized loss on interest rate contracts, net of income taxes of $44

 

 

 

 

 

 

 

82

 

82

 

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

35

 

35

 

35

 

Net income

 

 

 

 

 

 

54,626

 

 

54,626

 

54,626

 

Balance September 30, 2004

 

41,466,283

 

$

417

 

$

(2,234

)

$

(2,379

)

$

178,233

 

$

202,681

 

$

2,970

 

$

379,688

 

$

56,163

 

 

See accompanying notes to consolidated financial statements.

 

4



 

Penn National Gaming, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)
(Unaudited)

 

 

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

Cash flows from operating activities

 

 

 

 

 

Net income from operations

 

$

42,279

 

$

54,626

 

Loss from discontinued operations

 

6,846

 

13,918

 

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

 

 

 

 

 

Depreciation and amortization

 

41,551

 

49,413

 

Amortization of deferred financing costs charged to interest expense

 

3,055

 

4,032

 

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

 

1,161

 

81

 

Earnings from joint venture

 

(1,632

)

(1,298

)

Loss on sale of net assets

 

1,902

 

1,325

 

Loss relating to early extinguishment of debt, before income tax benefit

 

1,310

 

 

Deferred income taxes

 

4,141

 

5,479

 

Tax benefit from stock options exercised

 

2,338

 

7,126

 

Loss on change in value of interest rate swap contracts

 

527

 

 

Decrease (increase), net of businesses acquired

 

 

 

 

 

Accounts receivable

 

1,301

 

(8,735

)

Prepaid expenses and other current assets

 

(7,815

)

6,783

 

Prepaid income taxes

 

4,125

 

10

 

Miscellaneous other assets

 

10,566

 

(20,843

)

Increase (decrease), net of businesses acquired

 

 

 

 

 

Accounts payable

 

(1,834

)

(1,724

)

Accrued expenses

 

7,917

 

(1,765

)

Accrued interest

 

(23,712

)

(7,187

)

Accrued salaries and wages

 

(7,743

)

(1,367

)

Gaming, pari-mutuel, property and other taxes

 

(4,500

)

2,549

 

Income taxes payable

 

21,058

 

16,420

 

Other current liabilities

 

(2,935

)

3,087

 

Net cash provided by operating activities

 

99,906

 

121,930

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Expenditures for property and equipment

 

(47,133

)

(48,133

)

Payments to terminate interest rate swap contract

 

(1,902

)

 

Proceeds from sale of property and equipment

 

663

 

458

 

Acquisition of business, net of cash acquired

 

(276,415

)

(954

)

Cash in escrow

 

1,000

 

 

Distributions from joint venture

 

790

 

3,112

 

Net cash (used) in investing activities

 

(322,997

)

(45,517

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Proceeds from exercise of options

 

1,755

 

6,279

 

Proceeds from long term debt

 

700,000

 

146

 

Principal payments on long-term debt

 

(453,554

)

(80,475

)

Increase in unamortized financing cost

 

(19,027

)

(765

)

Net cash provided by (used in) financing activities

 

229,174

 

(74,815

)

 

 

 

 

 

 

Effect of exchange rate fluctuations on cash

 

290

 

35

 

Net increase in cash and cash equivalents

 

6,373

 

1,633

 

 

 

 

 

 

 

Cash and cash equivalents for beginning of period

 

54,535

 

81,567

 

Cash and cash equivalents for end of period

 

$

60,908

 

$

83,200

 

 

See accompanying notes to consolidated financial statements.

 

5



 

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 September 30, 2004 and the results of its continuing operations for the three and nine month periods ended September 30, 2003 and 2004. The results of continuing operations experienced for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results to be experienced for the fiscal year ending December 31, 2004.  The Company has classified the assets, liabilities and results of operations of Hollywood Casino Shreveport and The Downs Racing, Inc. and its subsidiaries, as assets and liabilities held for sale and discontinued operations at September 30, 2004.  (See Note 12).

 

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, as amended.

 

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

September 30,

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

2004

 

2004

 

 

 

(In thousands)

 

 

 

Rooms

 

$

1,978

 

$

2,040

 

$

4,698

 

$

5,848

 

Food and beverage

 

11,472

 

11,823

 

31,668

 

35,274

 

Other

 

2,055

 

2,879

 

4,380

 

8,286

 

Total promotional allowances

 

$

15,505

 

$

16,742

 

$

40,746

 

$

49,408

 

 

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

 

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

 

 

(In thousands)

 

(In thousands)

 

Rooms

 

$

1,884

 

$

1,962

 

$

4,467

 

$

5,611

 

Food and beverage

 

8,275

 

8,494

 

22,613

 

25,301

 

Other

 

834

 

968

 

2,143

 

2,559

 

Total cost of complimentary services

 

$

10,993

 

$

11,424

 

$

29,223

 

$

33,471

 

 

6



 

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.

 

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 and nine month periods ended September 30, 2003 and 2004, the effect of all outstanding stock options have been included in the calculation of diluted earnings per share.

 

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

 

 

(In thousands)

 

(In thousands)

 

Weighted average number of shares outstanding—Basic earnings per share

 

39,214

 

40,437

 

39,408

 

40,116

 

Dilutive effect of stock options

 

1,174

 

1,489

 

1,117

 

1,404

 

Weighted average number of shares outstanding—Diluted earnings per share

 

40,388

 

41,926

 

40,525

 

41,520

 

 

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 greater than or equal to 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 or the issuance of restricted stock 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.

 

7



 

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

 

 

(In thousands)

 

(In thousands)

 

Net income, as reported

 

$

13,615

 

$

17,190

 

$

42,279

 

$

54,626

 

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

 

 

76

 

 

101

 

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

 

769

 

2,639

 

2,233

 

4,685

 

Pro forma net income

 

$

12,846

 

$

14,627

 

$

40,046

 

$

50,042

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic-as reported

 

$

0.35

 

$

0.43

 

$

1.07

 

$

1.36

 

Basic-pro forma

 

$

0.33

 

$

0.36

 

$

1.02

 

$

1.25

 

Diluted-as reported

 

$

0.34

 

$

0.41

 

$

1.04

 

$

1.32

 

Diluted-pro forma

 

$

0.32

 

$

0.35

 

$

0.99

 

$

1.21

 

 

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:

 

Nine months ended September 30,

 

2003

 

2004

 

Risk-free interest rate

 

3.0

%

3.0

%

Volatility

 

43.0

%

31.0

%

Dividend yield

 

0.0

%

0.0

%

Expected life (years)

 

6

 

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 stable gaming and admission taxes in the states in which it operates.  Any change in such taxes could have a material adverse affect on future results of operations.

 

8



 

6.             Property and Equipment

 

Property and equipment consist of the following:

 

 

 

December 31,

2003

 

September 30,

2004

 

 

 

(In thousands)

 

Land and improvements

 

$

100,164

 

$

106,420

 

Building and improvements

 

416,710

 

429,310

 

Furniture, fixtures, and equipment

 

191,363

 

210,750

 

Transportation equipment

 

1,246

 

1,474

 

Leasehold improvements

 

11,005

 

12,075

 

Construction in progress

 

6,093

 

10,798

 

Total property and equipment

 

726,581

 

770,827

 

Less: accumulated depreciation and amortization

 

132,429

 

176,894

 

Property and equipment, net

 

$

594,152

 

$

593,933

 

 

Interest capitalized in connection with major construction projects was $.3 million for the year ended December 31, 2003 and for the nine months ended September 30, 2004, respectively.  Depreciation and amortization expense, for property and equipment, totaled $39.7 million and $47.5 million for the nine months ended September 30, 2003 and 2004, respectively.

 

7.             Supplemental Disclosures of Cash Flow Information

 

 

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

 

 

(In thousands)

 

Cash payments of interest

 

$

74,735

 

$

59,713

 

Cash payments of income taxes

 

$

 

$

13,079

 

 

 

 

 

 

 

Acquisitions: Hollywood Casino Corporation

 

 

 

 

 

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

 

$

 

 

9



 

8.             Long-term Debt

 

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

 

 

 

December 31,

2003

 

September 30,

2004

 

 

 

(In thousands)

 

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

 

$

399,700

 

$

320,000

 

$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

 

Capital leases

 

15,423

 

14,794

 

 

 

990,123

 

909,794

 

Less: current maturities

 

5,634

 

4,906

 

Total long-term debt

 

$

984,489

 

$

904,888

 

 

                The following is a schedule of future minimum repayments of long-term debt as of September 30, 2004 (in thousands):

 

2004 (3 months)

 

$

1,691

 

2005

 

4,992

 

2006

 

5,119

 

2007

 

314,815

 

2008

 

202,270

 

2009

 

1,997

 

Thereafter

 

378,910

 

Total minimum payments

 

$

909,794

 

 

At September 30, 2004, the Company had a contingent obligation under letters of credit issued pursuant to the senior secured credit facility with face amounts aggregating $6.8 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. Except for the defaults under the Hollywood Casino Shreveport notes, for which the Company (other than the Shreveport entities) is not liable, at September 30, 2004 the Company was in compliance with all required financial covenants.

 

9.             Segment Information

 

The Company views each property as an operating segment.  The Company has aggregated its gaming properties that are economically similar, offer similar types of products and services (table games and/or slot machines), cater to the same types of customers (local patronage) and are heavily regulated into one reporting segment called gaming.  The Company has aggregated its racing properties that are economically similar, offer similar products and services (live and simulcast racing), cater to the similar types of customers (local patronage) and are similarly regulated into one reporting segment called 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, as amended, for the year ended December 31, 2003.

 

10



 

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

 

As of and for the nine months ended

 

 

 

 

 

 

 

 

 

September 30, 2004

 

Gaming

 

Racing

 

Eliminations

 

Total

 

Revenue

 

$

820,124

 

$

43,877

 

$

 

$

864,001

 

Income from operations

 

160,654

 

3,229

 

 

163,883

 

Depreciation and Amortization

 

48,204

 

1,209

 

 

49,413

 

Total Assets

 

2,670,005

 

93,812

 

(1,135,682

)(2)

1,628,135

 

 

 

 

 

 

 

 

 

 

 

As of and for the nine months ended

 

 

 

 

 

 

 

 

 

September 30, 2003

 

Gaming(1)

 

Racing

 

Eliminations

 

Total

 

Revenue

 

$

710,281

 

$

45,327

 

$

 

$

755,608

 

Income from operations

 

131,004

 

3,940

 

 

134,944

 

Depreciation and Amortization

 

40,386

 

1,165

 

 

41,551

 

Total Assets

 

2,720,336

 

93,710

 

(1,173,343

)(2)

1,640,703

 


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

 

(2)                                  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. Except as set forth below, the Company does not believe that the final outcome of these matters will have a material adverse affect 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 landlord 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.  On October 26, 2004, in ruling on a motion for summary judgment filed by the plaintiff, the court determined that the Company was in default of an obligation in the lease and that the lease is dissolved.  The Company plans to vigorously appeal this decision, which will suspend any effect of the October 26, 2004 order during the pendency of the appeal.  Depending on the outcome of the appeal, the Company may eventually choose from options which may include entering into a new lease with the plaintiff, purchasing the property from the plaintiff or relocating.

 

11



 

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 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’s subsequent motion for reconsideration was denied and plaintiff has appealed the decision to the Fifth Circuit.

 

On September 10, 2004, certain creditors of the Hollywood Casino Shreveport filed with the U.S. Bankruptcy Court, Western District of Louisiana, located in Shreveport, Louisiana, an involuntary petition against Hollywood Casino Shreveport for relief under chapter 11 of the U.S. Bankruptcy Code.  On October 30, 2004, the Bankruptcy Court entered an order for relief.  Hollywood Casino Shreveport will continue to manage its assets and business as a “debtor in possession” subject to the powers and supervision of the Bankruptcy Court pursuant to chapter 11.  In addition, on October 30, 2004, HCS I, Inc. and HCS II, Inc., the general partners of Hollywood Casino Shreveport, HWCC-Louisiana, Inc., the parent company of both HCS I, Inc. and HCS II, Inc., and Shreveport Capital Corporation commenced voluntary cases under chapter 11 in the U.S. Bankruptcy Court, Western District of Louisiana, which cases are pending.

 

11.          Subsidiary Guarantors

 

Under the terms of the senior subordinated notes, all of the Company’s domestic subsidiaries are guarantors under the agreement, except for HWCC-Argentina, Inc., an inactive subsidiary, and 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 (the “Subsidiary Non-Guarantors”).  The guarantees provided by our subsidiaries are full and unconditional, joint and several.  There are no significant restrictions in the indentures on the Company’s ability to obtain funds from its subsidiaries, except for the Subsidiary Non-Guarantors, by dividend or loan. However, we note that in certain jurisdictions, the gaming authorities may impose restrictions pursuant to the authority granted to them with regard to the Company’s ability to obtain funds from its subsidiaries.

 

Summarized financial information as of December 31, 2003 and September 30, 2004 and for the three and nine months ended September 30, 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 September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Balance Sheet (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

$

24,317

 

$

124,190

 

$

50,827

 

$

1,094

 

$

200,428

 

Net property and equipment, at cost

 

8,444

 

620,164

 

104,832

 

 

733,440

 

Other assets

 

1,175,034

 

660,949

 

(4,940

)

(1,136,776

)

694,267

 

Total

 

$

1,207,795

 

$

1,405,303

 

$

150,719

 

$

(1,135,682

)

$

1,628,135

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

$

48,769

 

$

59,454

 

$

194,933

 

$

4,308

 

$

307,464

 

Long-term liabilities

 

904,755

 

1,142,804

 

484

 

(1,107,060

)

940,983

 

Shareholder’s equity

 

254,271

 

203,045

 

(44,698

)

(32,930

)

379,688

 

Total

 

$

1,207,795

 

$

1,405,303

 

$

150,719

 

$

(1,135,682

)

$

1,628,135

 

 

12



 

 

 

Penn

 

Subsidiary

Guarantors

 

Subsidiary

Non-

Guarantors

 

Eliminations

 

Consolidated

 

Nine months ended September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

883,390

 

$

116,631

 

$

(1,169

)

$

998,852

 

 

Total operating expenses

 

17,480

 

698,907

 

116,392

 

(1,169

)

831,610

 

Income (loss) from operations

 

(17,480

)

184,483

 

239

 

 

167,242

 

Other income (expense)

 

27,854

 

(83,612

)

(24,749

)

(8

)

(80,515

)

Income (loss) before income taxes

 

10,374

 

100,871

 

(24,510

)

(8

)

86,727

 

Taxes on income (loss)

 

6,706

 

25,287

 

108

 

 

32,101

 

Net income (loss)

 

$

3,668

 

$

75,584

 

$

(24,618

)

$

(8

)

$

54,626

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

294,676

 

$

38,211

 

$

(410

)

$

332,477

 

Total operating expenses

 

5,348

 

233,031

 

38,517

 

(410

)

276,486

 

Income (loss) from operations

 

(5,348

)

61,645

 

(306

)

 

55,991

 

Other income (expense)

 

8,767

 

(27,068

)

(10,507

)

(8

)

(28,816

)

Income (loss) before income taxes

 

3,419

 

34,577

 

(10,813

)

(8

)

27,175

 

Taxes on income (loss)

 

1,444

 

8,508

 

33

 

 

9,985

 

Net income (loss)

 

$

1,975

 

$

26,069

 

$

(10,846

)

$

(8

)

$

17,190

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Statement of Cash Flows (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

44,408

 

$

81,095

 

$

4,350

 

$

 

$

129,853

 

 

Net cash provided by (used in) investing activities

 

33,723

 

(79,182

)

(1,372

)

 

(46,831

)

Net cash provided by (used in) financing activities

 

(74,026

)

(3,952

)

3,164

 

 

(74,814

)

Effect of exchange rate fluctuations on cash

 

 

54

 

(19

)

 

35

 

Net increase (decrease) in cash and cash equivalents

 

4,105

 

(1,985

)

6,123

 

 

8,243

 

Cash and cash equivalents at beginning of period

 

11,217

 

68,814

 

26,938

 

 

106,969

 

Less cash and cash equivalents from discontinued operations

 

 

 

(32,012

)

 

(32,012

)

Cash and cash equivalents at end of period

 

$

15,322

 

$

66,829

 

$

1,049

 

$

 

$

83,200

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

13



 

 

 

Penn

 

Subsidiary

Guarantors

 

Subsidiary

Non-

Guarantors

 

Eliminations

 

Consolidated

 

Nine months ended September 30, 2003

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

775,799

 

$

91,751

 

$

(1,262

)

$

866,288

 

Total operating expenses

 

14,953

 

623,266

 

88,038

 

(1,777

)

724,480

 

Income (loss) from operations

 

(14,953

)

152,533

 

3,713

 

515

 

141,808

 

Other income (expense)

 

25,702

 

(81,981

)

(17,198

)

10

 

(73,467

)

Income (loss) before income taxes (benefit)

 

10,749

 

70,552

 

(13,485

)

525

 

68,341

 

Taxes (benefit) on income (loss)

 

6,518

 

19,290

 

254

 

 

26,062

 

Net income (loss)

 

$

4,231

 

$

51,262

 

$

(13,739

)

$

525

 

$

42,279

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months ended September 30, 2003

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

277,176

 

$

39,417

 

$

(443

)

$

316,150

 

Total operating expenses

 

5,381

 

222,419

 

39,283

 

(564

)

266,519

 

Income (loss) from operations

 

(5,381

)

54,757

 

134

 

121

 

49,631

 

Other income (expense)

 

8,700

 

(29,026

)

(7,328

)

10

 

(27,644

)

Income (loss) before income taxes (benefit)

 

3,319

 

25,731

 

(7,194

)

131

 

21,987

 

Taxes (benefit) on income (loss)

 

1,671

 

6,788

 

185

 

(272

)

8,372

 

Net income (loss)

 

$

1,648

 

$

18,943

 

$

(7,379

)

$

403

 

$

13,615

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2003

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidating Statement of Cash Flows (In thousands)

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

50,096

 

$

47,763

 

$

10,984

 

$

 

$

108,843

 

Net cash provided by (used in) investing activities

 

(639,803

)

328,985

 

(252

)

 

(311,070

)

Net cash provided by (used in) financing activities

 

590,112

 

(360,158

)

(780

)

 

229,174

 

Effect of exchange rate fluctuations on cash

 

 

 

290

 

 

290

 

Net increase in cash and cash equivalents

 

405

 

16,590

 

10,242

 

 

27,237

 

Cash and cash equivalents at beginning of period

 

3,339

 

39,333

 

13,352

 

 

56,024

 

Less cash and cash equivalents from discontinued operations

 

 

 

(22,353

)

 

(22,353

)

Cash and cash equivalents at end of period

 

$

3,744

 

$

55,923

 

$

1,241

 

$

 

$

60,908

 

 

14



 

12.          Discontinued Operations

 

On January 30, 2004, the Board of Directors of HCS I, the managing general partner of Hollywood Casino Shreveport, approved a resolution to sell Hollywood Casino Shreveport and authorized their financial advisor, Libra Securities, LLC, to begin contacting potential acquirers.  The Board also authorized the creation of an independent committee of independent Board Members to oversee the sale process.  The Board created the independent committee in the event that Penn decided to participate as a bidder in the sales process.  A press release was issued on February 3, 2004 announcing the sale of the property.  Prospective bidders were invited to tour the property, perform diligence and prepare a bid.   Invitations to bid were mailed to all interested parties, including Penn, on May 4, 2004 and responses were due at Libra Securities, LLC in New York on June 4, 2004.  Oral presentations by the four highest bidders were presented to the ad hoc committee on June 15, 2004 and their revised bids were due on July 6, 2004.  Prior to June 30, 2004, Penn decided not to participate in the bid process.

 

On August 27, 2004, Hollywood Casino Shreveport, acting by and through its managing general partner, HCS I, Inc., entered into an agreement with Eldorado Resorts, LLC (“Eldorado”) providing for the acquisition of Hollywood Casino Shreveport by certain affiliates of Eldorado.  On October 18, 2004, Hollywood Casino Shreveport, acting by and through its managing general partner, HCS I, Inc., entered into a definitive Investment Agreement (the “Agreement”) with Eldorado, Eldorado Shreveport #1, LLC (“Investor 1”) and Eldorado Shreveport #2, LLC (“Investor II”, and together with Investor I, the “Investors”) providing for the acquisition of the reorganized Hollywood Casino Shreveport by the Investors.  The Investors are each an affiliate of Eldorado.  The Agreement contemplates a financial restructuring of Hollywood Casino Shreveport that will significantly reduce outstanding secured debt obligations and annual cash interest payments.  Hollywood Casino Shreveport intends to effectuate the sale and related financial restructuring transaction through a Chapter 11 bankruptcy reorganization.  The Agreement remains subject to filing with and approval by the Bankruptcy Court, Louisiana Gaming Control Board approval and certain other conditions.

 

The Company has reflected the results of this transaction by classifying the assets, liabilities and results of operations of Hollywood Casino Shreveport as assets and liabilities held for sale and discontinued operations in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.  A gain or loss on this transaction has not been recorded or recognized at this time since the sale has not yet been completed and is subject to various approvals.  Financial information for Hollywood Casino Shreveport was previously reported as part of the gaming reporting segment.

 

Summarized financial information as of and for the three and nine month periods ended September 30, 2004 for Hollywood Casino Shreveport is as follows:

 

HWCC-Louisiana, Inc. And Subsidiaries
Consolidated Balance Sheets
(In thousands)

 

 

 

December 31,

2003

 

September 30,

2004

 

 

 

 

 

(Unaudited)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

$

30,828

 

$

37,855

 

Property and equipment, net

 

110,743

 

104,831

 

Other assets

 

1,266

 

1,379

 

Total assets held for sale

 

$

142,837

 

$

144,065

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

$

151,046

 

$

164,357

 

Other noncurrent liabilities

 

5,732

 

7,693

 

Total liabilities held for sale

 

$

156,778

 

$

172,050

 

 

15



 

HWCC-Louisiana, Inc. And Subsidiaries
Consolidated Statements Of Operations
(In thousands)
(Unaudited)

 

 

 

Three Months Ended

September 30,

 

March 1, 2003—

September 30,

 

Nine Months

Ended

September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

Net revenues

 

$

35,412

 

$

33,627

 

$

81,881

 

$

104,681

 

Income (loss) from operations

 

$

452

 

$

(247

)

$

3,832

 

$

906

 

Net (loss)

 

$

(4,919

)

$

(7,097

)

$

(8,963

)

$

(16,121

)

 

On October 15, 2004, the Company announced that it has entered into an agreement whereby a subsidiary of the Company will sell The Downs Racing, Inc., which does business as Pocono Downs, and its subsidiaries, to the Mohegan Tribal Gaming Authority (MTGA).  The transaction, which contemplates a $280 million purchase price before adjustments, fees, taxes and other costs, is expected to close prior to December 31, 2004 and is subject to customary closing conditions and regulatory approvals including approvals from the Pennsylvania Harness Racing Commission.  The agreement also provides MTGA with both pre- and post-closing termination rights in the event of certain materially adverse legislative or regulatory events. The Company expects to use the net proceeds of approximately $175 million for debt reduction.

 

The Company is divesting Pocono Downs to satisfy a condition of Pennsylvania’s new slot machine legislation that restricts ownership to 100% of one licensed operation and no more than 33% ownership in a second operation.  In addition to Pocono Downs, the Company owns Penn National Race Course in Grantville, Pennsylvania, for which it has announced plans to develop a slot machine facility.

 

The Company has reflected the results of this transaction by classifying the assets, liabilities and results of operations of The Downs Racing, Inc. and its subsidiaries as assets and liabilities held for sale and discontinued operations in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.  A gain or loss on this transaction has not been recorded or recognized at this time since the sale has not yet been completed and is subject to various approvals.  Financial information for The Downs Racing, Inc. and its subsidiaries was previously reported as part of the racing reporting segment.

 

Summarized financial information as of and for the three and nine month periods ended September 30, 2004 for The Downs Racing, Inc. and its subsidiaries is as follows:

 

The Downs Racing, Inc. And Subsidiaries
Consolidated Balance Sheets
(In thousands)

 

 

 

December 31,

2003

 

September 30,

2004

 

 

 

 

 

(Unaudited)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

$

603

 

$

1,048

 

Property and equipment, net

 

35,610

 

34,676

 

Other assets

 

16,557

 

16,557

 

Total assets held for sale

 

$

52,770

 

$

52,281

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

$

5,453

 

$

4,788

 

Other noncurrent liabilities

 

9,109

 

9,284

 

Total liabilities held for sale

 

$

14,562

 

$

14,072

 

 

16



 

The Downs Racing, Inc. And Subsidiaries
Consolidated Statements Of Operations
(In thousands)
(Unaudited)

 

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

Net revenues

 

$

9,721

 

$

10,119

 

$

28,797

 

$

30,169

 

Income from operations

 

$

1,062

 

$

1,113

 

$

3,284

 

$

3,447

 

Net income

 

$

681

 

$

715

 

$

2,117

 

$

2,203

 

 

13.          Commitments and Contingencies

 

Employment Agreements

 

On May 26, 2004, the Company entered into employment agreements with the Chairman and Chief Executive Officer and the President and Chief Operating Officer for an initial term of five years and three years, respectively, renewable thereafter for additional terms.  Each agreement includes a base compensation and bonus provision, a severance clause, a change of control provision and provides for other employee benefits.

 

14.          Subsequent Events

 

On November 3, 2004, the Company and Argosy Gaming Company  announced that their boards of directors unanimously approved a definitive merger agreement under which the Company will acquire all of the outstanding shares of Argosy Gaming for $47.00 per share in cash.  The transaction is valued at approximately $2.2 billion, including approximately $805 million of long-term debt of Argosy Gaming and its subsidiaries.  Upon closing, the transaction is expected to be immediately accretive to the Company earnings per share.

 

The transaction is subject to approval by the Argosy Gaming stockholders and by each company’s respective state regulatory bodies, and to certain other necessary regulatory approvals and other customary closing conditions contained in the merger agreement.  The Company has received a $2.9 billion senior secured underwritten commitment to finance the transaction.  The transaction is not conditioned on financing and is expected to close in the second half of 2005.

 

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 currently own and operate two racetracks and eleven OTWs in Pennsylvania, one racetrack in West Virginia, through a joint venture, own and operate a racetrack in New Jersey, and a racetrack in Maine.  We operate in two reporting segments, gaming and racing, 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.

 

17



 

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.  Racing 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

                                          Racing 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.  Certain technology improvements may result in lower operating costs for slot products.

                                          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.

 

18



 

Three Months ended September 30, 2003 compared to three months ended September 30, 2004

The results of continuing operations by property level for the three months ended September 30, 2003 and 2004 are summarized below (in thousands):

 

 

Revenues(1)

 

Income from operations

 

Gaming Segment

 

2003

 

2004

 

2003

 

2004

 

Charles Town Entertainment Complex

 

$

90,088

 

$

104,503

 

$

20,378

 

$

25,809

 

Hollywood Casino Aurora (2)

 

54,481

 

58,509

 

15,714

 

15,358

 

Casino Rouge

 

25,990

 

26,022

 

5,319

 

5,766

 

Casino Magic-Bay St. Louis

 

27,256

 

25,507

 

3,444

 

1,528

 

Hollywood Casino Tunica (2)

 

29,501

 

30,306

 

3,184

 

5,122

 

Boomtown Biloxi

 

18,314

 

16,816

 

2,469

 

1,611

 

Bullwhackers

 

7,187

 

8,289

 

701

 

1,101

 

Casino Rama Management Contract

 

4,005

 

4,584

 

3,340

 

4,252

 

Corporate overhead

 

 

 

(6,839

)

(5,987

)

Total Gaming Segment

 

256,822

 

274,536

 

47,710

 

54,560

 

Racing Segment

 

 

 

 

 

 

 

 

 

Penn National Race Course and OTWs

 

14,195

 

13,632

 

738

 

996

 

Bangor Historic Track (3)

 

 

563

 

 

(106

)

Total Racing Segment

 

14,195

 

14,195

 

738

 

890

 

Total

 

$

271,017

 

$

288,731

 

$

48,448

 

$

55,450

 

 

 

 

 

 

 

 

 

 

 


(1)          Net revenues are net of promotional allowances.

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

(3)          Reflects results since February 12, 2004 acquisition.

 

Revenues

Net revenues, three months ended September 30, 2004

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

251,372

 

$

 

$

251,372

 

Racing

 

 

12,371

 

12,371

 

Management service fee

 

4,584

 

 

4,584

 

Food, beverage and other revenue

 

35,322

 

1,824

 

37,146

 

Gross revenue

 

291,278

 

14,195

 

305,473

 

Less: Promotional allowances

 

(16,742

)

 

(16,742

)

Net revenues.

 

$

274,536

 

$

14,195

 

$

288,731

 

 

 

 

 

 

 

 

 

Net revenues, three months ended September 30, 2003

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

233,878

 

$

 

$

233,878

 

Racing

 

 

12,555

 

12,555

 

Management service fee

 

4,005

 

 

4,005

 

Food, beverage and other revenue

 

34,444

 

1,640

 

36,084

 

Gross revenue

 

272,327

 

14,195

 

286,522

 

Less: Promotional allowances

 

(15,505

)

 

(15,505

)

Net revenues.

 

$

256,822

 

$

14,195

 

$

271,017

 

 

19



Net revenues for the three-month period ended September 30, 2004 increased by $17.7 million, or 6.5%, to $288.7 million from $271.0 million in 2003.  The properties with the largest revenue changes this quarter were Charles Town Entertainment Complex with a net revenue increase of $14.4 million, due to the addition of gaming space and slot machines in July of 2003, and Hollywood Casino Aurora, with a net revenue increase of $4.0 million that resulted from changes in operations that were made to maintain operating margins and offset the impact of the new gaming tax rate structure that went into effect on July 1, 2003, in Illinois.

Gaming revenues

Gaming revenue increased in 2004 by $17.5 million, or 7.4%, to $251.4 million from $233.9 million in 2003.  Of this total, Charles Town Entertainment Complex increased gaming revenue by $15.0 million, or 18.5%, over the same period last year due to the addition of 265 new slot machines since May of 2004 and an increase in the average win per machine.  The average number of gaming machines in play increased to 3,765 in 2004 from 3,448 in 2003 with the average win per machine of $278 and $256 per day, respectively.  At Hollywood Casino Aurora, gaming revenue increased by $3.8 million, or 7.3%, to $56.3 million from $52.5 million in 2003.  The revenue increase was a result of a change in mix between table games and slot machines, less emphasis on table play and a marketing program that is focused on the more profitable players.  This is the first quarter that meaningful comparisons can be made since the Illinois gaming tax increase became effective on July 1, 2003.

On the Gulf Coast, Casino Magic-Bay St. Louis and Boomtown Biloxi experienced gaming revenue decreases of $1.5 million and $1.2 million, respectively.  We believe the primary reasons for the decline in revenue were aggressive marketing by our competitors and a hurricane hitting the Gulf Coast, that caused all of the casinos in the area to close for three days.

Gaming revenue at Bullwhackers increased by $1.0 million, or 13.6%, 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.  These efforts resulted in an increase in patronage and a 15.6% increase in win per unit per day.

Management service fees from Casino Rama increased by $.6 million, or 14.5%, to $4.6 million from $4.0 million in 2003.  The increase in management service fees is a result of marketing programs that focus on trip generation, recent visitors, the hotel and convention center and the concert program.  These programs have increased slot play in the casino.

Food, beverage and other revenue increased in 2004 by $.8 million, or 2.95%, to $35.3 million from $34.4 million in 2003.  Hollywood Casino Aurora increased its food, beverage and other revenue by $1.1 million primarily as a result of the admission charge that was implemented in August of 2003.  Other properties had insignificant increase or decreases.

Promotional allowances increased in 2004 by $1.2 million to $16.7 million from $15.5 million in 2003.  Of the $1.2 million, approximately $.5 million of the increase was attributed to Charles Town because of the expansion of the facility.  At Hollywood Casino Aurora, promotional allowances increased by $.8 million as a result of providing complimentary admissions to our higher-value players’ club members.

Racing revenues

Net racing revenues at our Penn National Race Course and its OTW facilities and the Bangor Historic Track declined by $.2 million, or 1.5%, to $12.4 million from $12.6 million in 2003.

Penn National Race Course and its OTW facilities had a slight decline in racing revenues that was partially offset by the revenue from the Bangor Historic Track harness meet run as part of the Company for the first time.

There were no significant changes in food, beverage and other revenues at our racing properties.

 

20



 

Operating Expenses

Operating expenses, three months ended September 30, 2004

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

138,990

 

$

 

$

138,990

 

Racing

 

 

9,740

 

9,740

 

Food, beverage and other expenses

 

23,143

 

1,108

 

24,251

 

General and administrative

 

41,738

 

2,070

 

43,808

 

Depreciation and amortization

 

16,101

 

391

 

16,492

 

Total operating expenses

 

$

219,972

 

$

13,309

 

$

233,281

 

 

 

Operating expenses, three months ended September 30, 2003

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

126,297

 

$

 

$

126,297

 

Racing

 

 

10,118

 

10,118

 

Food, beverage and other expenses

 

23,832

 

1,178

 

25,010

 

General and administrative

 

43,794

 

1,805

 

45,599

 

Depreciation and amortization

 

15,173

 

372

 

15,545

 

Total operating expenses

 

$

209,096

 

$

13,473

 

$

222,569

 

 

Operating expenses for the three month period ended September 30, 2004 increased by $10.7 million, or 4.8%, to $233.3 million from $222.6 million in 2003.  Our largest increases in operating expenses occurred at Charles Town and Aurora.

Gaming operating expenses

Gaming expenses increased in 2004 by $12.7 million, or 10.0%, to $139.0 million from $126.3 million in 2003.  At the Charles Town Entertainment Complex, gaming expenses increased by $9.0 million, or 17.6%, over the same period from last year due to the addition of 265 new slot machines since May of 2004.  Of this total, gaming taxes increased by $8.5 million, which was a result of the increase in gaming revenues and horsemen’s purses.  Gaming expenses at Hollywood Casino Aurora increased by $4.7 million primarily due to the higher gaming tax rates that became effective July 1, 2003 and an increase in gaming revenue.  As a result of the gaming tax increase, our effective tax rate increased to 42.1% from 36.6% in 2003.  At Boomtown Biloxi we had a decrease in gaming expenses of $.6 million as a result of a decrease in marketing expenses for cash coupons, lower direct costs related to lower gaming revenue and a three day shut-down due to the hurricane.

Food, beverage and other expenses decreased in 2004 by $.7 million to $23.1 million from $23.9 million in 2003.  Most of the decrease is attributed to Hollywood Casino Tunica and was a direct result of lower cost of sales and improved staffing in the food and beverage area.

General and administrative expenses decreased by $2.1 million to $41.7 million in 2004 from $43.8 million in 2003.  General and administrative expenses at the properties includes facility maintenance, utilities, property and liability insurance, housekeeping, and all administration departments such as accounting, purchasing, human resources, legal and internal audit.  Most of our properties reduced their general and administration costs by approximately $.1 million to $.3 million each, as expenses were lower for property and general liability insurance, health insurance and outside services.  Corporate overhead expenses decreased by $.9 million for the three months ended September 30, 2004 as compared to 2003.  Most of the savings was a result of cost reductions from Hollywood Casino Corporation overhead that was eliminated in 2004.

Depreciation and amortization expense increased by $.9 million, or 6.1%, to $16.1 million in 2004 from $15.2 million in 2003.  The increase 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.

 

21



Racing operating expenses

Total racing expenses at Penn National Race Course and its OTW facilities and Bangor Historic Track decreased in 2004 by $.2 million, or 1.4%, to $13.3 million from $13.5 million in 2003.

Racing expenses that have a direct relationship to racing revenue such as purse expense, pari-mutuel taxes, simulcast fees and totalisator expense all decreased along with the decrease in racing revenues at our Penn National Race Course and its OTW facilities, but were partially offset by the additional racing expenses at Bangor Historic Track.

Other racing related expenses such as food, beverage and other expenses, general and administrative expenses have increased as a result of the Bangor Historic Track expenses and depreciation expenses decreased slightly due to the age of the facilities and equipment.

Income from operations

Operating income increased by $7.0 million, or 14.4%, to $55.4 million for the three months ended September 30, 2004 from $48.4 million in 2003.  The primary drivers, as discussed above, were the growth of income from operations at Charles Town, which accounted for $5.4 million and Hollywood Casino Tunica, which accounted for $1.9 million of the change.  These increases plus positive results at Casino Rouge and Bullwhackers offset the decrease in income from operations at Boomtown Biloxi and Casino Magic-Bay St. Louis.

Other income (expense)

Other income (expense) summary (in thousands):

 

 

 

 

 

 

Three Months Ended September 30,

 

2003

 

2004

 

Interest expense

 

$

(21,166

)

$

(18,970

)

Interest income

 

403

 

483

 

Earnings from joint venture

 

327

 

205

 

Other

 

104

 

(186

)

Total other expenses, net

 

$

(20,332

)

$

(18,468

)

 

Interest expense decreased by $2.2 million for the three months ended September 30, 2004 compared to 2003 as a result of reducing our debt by $88.8 million since September 30, 2003.  Subject to the availability of attractive acquisition or project opportunities, we expect to continue to accelerate our principal payments as free cash flow allows.

 

22



Nine Months ended September 30, 2003 compared to nine months ended September 30, 2004

The results of continuing operations by property level for the nine months ended September 30, 2003 and 2004 are summarized below (in thousands): 

 

 

Revenues(1) s

 

Income from operations

 

Gaming Segment

 

2003

 

2004

 

2003

 

2004

 

Charles Town Entertainment Complex

 

$

245,345

 

$

300,079

 

$

55,611

 

$

70,745

 

Hollywood Casino Aurora (2)

 

148,418

 

174,853

 

38,856

 

44,591

 

Casino Rouge

 

81,319

 

81,980

 

18,288

 

20,178

 

Casino Magic-Bay St. Louis

 

80,591

 

82,165

 

10,159

 

8,652

 

Hollywood Casino Tunica (2)

 

68,963

 

91,059

 

7,905

 

15,335

 

Boomtown Biloxi

 

55,852

 

53,784

 

8,150

 

6,694

 

Bullwhackers

 

19,924

 

24,254

 

1,495

 

2,769

 

Casino Rama Management Contract

 

9,869

 

11,950

 

8,764

 

11,074

 

Corporate overhead

 

 

 

(18,224

)

(19,384

)

Total Gaming Segment

 

710,281

 

820,124

 

131,004

 

160,654

 

Racing Segment

 

 

 

 

 

 

 

 

 

Penn National Race Course and OTWs

 

45,327

 

42,931

 

3,940

 

3,500

 

Bangor Historic Track (3)

 

 

946

 

 

(271

)

Total Racing Segment

 

45,327

 

43,877

 

3,940

 

3,229

 

Total

 

$

755,608

 

$

864,001

 

$

134,944

 

$

163,883

 


(1)          Net revenues are net of promotional allowances.

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

(3)          Reflects results since February 12, 2004 acquisition.

 

Revenues

Net revenues, nine months ended September 30, 2004

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

751,165

 

$

 

$

751,165

 

Racing

 

 

38,359

 

38,359

 

Management service fee

 

11,950

 

 

11,950

 

Food, beverage and other revenue

 

106,417

 

5,518

 

111,935

 

Gross revenue

 

869,532

 

43,877

 

913,409

 

Less: Promotional allowances

 

(49,408

)

 

(49,408

)

Net revenues.

 

$

820,124

 

$

43,877

 

$

864,001

 

 

 

 

 

 

 

 

 

Net revenues, nine months ended September 30, 2003

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

648,248

 

$

 

$

648,248

 

Racing

 

 

40,093

 

40,093

 

Management service fee

 

9,869

 

 

9,869

 

Food, beverage and other revenue

 

92,910

 

5,234

 

98,144

 

Gross revenue

 

751,027

 

45,327

 

796,354

 

Less: Promotional allowances

 

(40,746

)

 

(40,746

)

Net revenues.

 

$

710,281

 

$

45,327

 

$

755,608

 

 

23



Net revenues for the nine-month period ended September 30, 2004 increased by $108.4 million, or 14.3%, to $864.0 million from $755.6 million in 2003.  The two Hollywood Casino properties contributed $48.5 million of the increase in revenue.  The revenue increase for the two Hollywood Casino properties was a result of comparing a nine-month period of operations in 2004 to a seven-month period of operations in 2003.  For the properties we owned prior to the acquisition of the Hollywood Casino properties, revenues increased by $59.9 million, or 11.1%.  The properties with the largest revenue increase this period were Charles Town Entertainment Complex with a net revenue increase of $54.7 million, Casino Magic-Bay St. Louis with an increase of $1.6 million and Bullwhackers Casinos with an increase of $4.3 million.

Gaming revenues

Gaming revenue increased in 2004 by $102.9 million, or 15.9%, to $751.1 million from $648.2 million in 2003.  The two Hollywood Casino properties contributed $44.9 million of the increase and the properties we owned prior to the acquisition contributed $58.0 million.  Of this total, Charles Town Entertainment Complex increased gaming revenue by $53.5 million, or 24.3%, over the same period 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 and the addition of 265 new slot machines since May of 2004.  The average number of gaming machines in play increased to 3,614 in 2004 from 2,954 in 2003 with the average win per machine of $277 and $273 per day, respectively.  Gaming revenue at Bullwhackers increased by $3.9 million, or 19.8%, 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.  These efforts resulted in an increase in patronage and a 20.3% increase in win per unit per day.

Management service fees from Casino Rama increased by $2.0 million, or 20.2%, to $11.9 million from $9.9 million in 2003.  The increase in management service fees is a result of mild winter weather in the first quarter and marketing programs that focus on trip generation, recent visitors, the hotel and convention center and the concert program.  These programs have increased slot play in the casino.

Food, beverage and other revenue increased in 2004 by $13.5 million, or 14.5%, to $106.4 million from $92.9 million in 2003.  The two Hollywood Casino properties contributed $10.4 million of the increase and the properties we owned prior to the acquisition contributed $3.1 million.  Charles Town increased its food, beverage and other revenue by $2.2 million as a result of the increased attendance.  At Casino Magic-Bay St. Louis, food, beverage and other revenue, including hotel revenues, increased by $1.1 million as a result of marketing programs that were implemented to increase hotel occupancy and feature our dining outlets.  Bullwhackers had an increase in revenue of $.7 million as a result of adding a bakery and deli on the casino floor.  These gains offset the revenue declines at our other properties due to higher cost of sales and lower attendance.

Promotional allowances increased in 2004 by $8.7 million to $49.4 million from $40.7 million in 2003.  The two Hollywood Casino properties accounted for $6.8 million of the increase and the properties we owned prior to the acquisition increased by $1.9 million.  Of the $1.9 million, approximately $1.0 million of the increase was attributed to Charles Town because of the expansion of the facility and $1.2 million was attributable to the marketing of the hotel and convention center at Casino Magic-Bay St. Louis.  Promotional allowances decreased at Boomtown Biloxi and Casino Rouge due to changes made to the marketing programs during the year.

Racing revenues

Total racing revenues for our Penn National Race Course and its OTW facilities and the Bangor Historic Track decreased by $1.4 million, or 3.0%, to $43.9 million in 2004 from $45.3 million in 2003.

Racing revenues at Penn National Race Course and its OTW facilities decreased in 2004 by $2.4 million, or 5.2%, to $42.9 million from $45.3 million in 2003.  Adverse winter weather conditions during the first quarter were a factor as we had a number of race day cancellations and lower attendance on a number of other days.  The Bangor Historic Track had racing revenues for their 27 days of racing of $.9 million.

There were no significant changes in food, beverage and other revenues at our racing properties.

 

24



 

Operating Expenses

Operating expenses, nine months ended September 30, 2004

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

411,814

 

$

 

$

411,814

 

Racing

 

 

30,047

 

30,047

 

Food, beverage and other expenses

 

69,583

 

3,572

 

73,155

 

General and administrative

 

129,866

 

5,823

 

135,689

 

Depreciation and amortization

 

48,204

 

1,209

 

49,413

 

Total operating expenses

 

$

659,467

 

$

40,651

 

$

700,118

 

 

 

 

 

 

 

 

 

Operating expenses, nine months ended September 30, 2003

 

 

 

Gaming

 

Racing

 

Total

 

Gaming

 

$

353,753

 

$

 

$

353,753

 

Racing

 

 

32,093

 

32,093

 

Food, beverage and other expenses

 

65,987

 

3,488

 

69,475

 

General and administrative

 

119,136

 

4,656

 

123,792

 

Depreciation and amortization

 

40,386

 

1,165

 

41,551

 

Total operating expenses

 

$

579,262

 

$

41,402

 

$

620,664

 

 

Total operating expenses for the nine-month period ended September 30, 2004 increased by $79.4 million, or 12.7%, to $700.1 million from $620.7 million in 2003.  The two Hollywood Casino properties were responsible for $35.3 million of the increase in operating expenses.  The increase was a result of comparing a nine-month period of operations in 2004 to a seven-month period of operations in 2003.  For the properties we owned prior to the acquisition of the Hollywood Casino properties, expenses increased by $44.1 million, or 9.8%.   Our largest increases in operating expenses occurred at Charles Town, Casino Magic-Bay St. Louis and Bullwhackers Casino.

Gaming operating expenses

Gaming expenses increased in 2004 by $58.1 million, or 16.4%, to $411.8 million from $353.7 million in 2003.  The two Hollywood Casino properties accounted for $22.1 million of the increase and the properties we owned prior to the acquisition increased by $36.0 million.  At the Charles Town Entertainment Complex, gaming expenses increased by $33.4 million, or 24.1%, 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 and the addition of 265 new slot machines since May of 2004.  For the period we paid an additional $33.1 million in gaming taxes as a result of the higher gaming revenues.  At Casino Magic - Bay St. Louis, gaming expenses increased by $3.0 million and included higher gaming taxes and slot machine participation fees that increased with revenues and higher marketing expenses for entertainment and players’ club promotions.  Gaming expenses at Bullwhackers increased by $2.6 million primarily as a result of the higher gaming taxes associated with higher revenues and increased marketing expenses for advertising and players’ club promotions.  Boomtown Biloxi had lower gaming expenses as a result of lower gaming revenues and a decrease in marketing expenses.  At Casino Rouge, we reduced gaming expenses by replacing leased slot machines with new ticket-in, ticket-out slot machines.  This change enabled us to reduce slot participation fees and labor costs.

Food, beverage and other expenses increased in 2004 by $3.6 million to $69.6 million from $66.0 million in 2003.  The two Hollywood Casino properties accounted for $2.0 million of the increase and the properties we owned prior to the acquisition increased by $1.6 million.  Most of the increase occurred at Charles Town which had significant gains in attendance during the period compared to last year as a result of the gaming space expansion in July of 2003 and had increased staffing costs to properly service our customers and increased cost of sales due to increased food and beverage revenues.

 

25



General and administrative expenses increased by $10.8 million to $129.9 million in 2004 from $119.1 million in 2003.  The addition of the two Hollywood Casino properties increased general and administrative expenses by $8.1 million, the properties we owned prior to acquisition had an increase in general and administrative expenses of $1.5 million and corporate overhead increased by $1.2 million.  General and administrative expenses at the properties includes facility maintenance, utilities, property and liability insurance, housekeeping, and all administration departments such as accounting, purchasing, human resources, legal and internal audit.  At the properties, general and administrative expenses increased at Charles Town by $2.9 million primarily as a result of the expansion project that added new gaming space.  At Casino Rouge, expenses decreased by $1.0 million due to reductions in insurance premiums, outside services and labor costs in several support departments.  The other properties did not have any significant changes in these expenses.  Corporate overhead expenses increased by $1.2 million for the nine months ended September 30, 2004 as compared to 2003.  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 2.2% in 2004 compared to 2.4% in 2003.

Depreciation and amortization expense increased by $7.8 million, or 19.3%, to $48.2 million in 2004 from $40.4 million in 2003.  The addition of the two Hollywood Casino properties increased depreciation and amortization expense by $3.1 million.  The remaining increase of $4.7 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.

                Racing operating expenses

Total racing expenses for Penn National Race Course and its OTW facilities and the Bangor Historic Track decreased in 2004 by $.8 million, or 1.9%, to $40.6 million from $41.4 million in 2003.  The Bangor Historic Track had racing expenses of $.7 million for the 27 days of racing.

Racing expenses that have a direct relationship to racing revenue such as purse expense, pari-mutuel taxes, simulcast fees and totalisator expense all decreased along with the decrease in racing revenues at our Pennsylvania facilities.  The decrease in racing expenses at Penn National Race Course and its OTW facilities was partially offset by the addition of the Bangor Historic Track racing expenses.

Other racing related expenses such as food, beverage and other expenses, general and administrative expenses have increased as a result of the Bangor Historic Track expenses and depreciation expenses decreased slightly due to the age of the facilities and equipment.

Income from operations

Operating income increased by $29.0 million, or 21.4%, to $163.9 million for the nine months ended September 30, 2004 from $134.9 million in 2003.  The primary drivers, as discussed above, in the growth of income from operations were the two Hollywood Casino properties, which accounted for $13.1 million of the increase, and Charles Town, which accounted for $15.1 million.

 

26



Other income (expense)

Other income (expense) summary (in thousands):

 

 

 

 

 

 

Nine Months Ended September 30,

 

2003

 

2004

 

Interest expense

 

$

(56,510

)

$

(57,590

)

Interest income

 

1,269

 

1,299

 

Earnings from joint venture

 

1,632

 

1,298

 

Other

 

(649

)

(796

)

Loss on change in fair values of interest rate swaps

 

(527

)

 

Loss on early extinguishment of debt

 

(1,310

)

 

Total other expenses, net

 

$

(56,095

)

$

(55,789

)

 

Interest expense increased by $1.1 million for the nine months ended September 30, 2004 compared to 2003 as a result of borrowing an additional $700 million for the acquisition of Hollywood Casino Corporation.  During 2004, we made principal payments of $79.7 million on our senior secured credit facility.  Subject to the availability of attractive acquisition or project opportunities, we expect to continue to accelerate our principal payments as free cash flow allows.

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.

Net cash provided by continuing operating activities was $121.9 million for the nine months ended September 30, 2004.  This consisted of net income of $68.5 million, non-cash reconciling items of $66.2 million and net decreases in current liability accounts along with net decreases in current asset accounts of $12.8 million.

Cash flows used in continuing investing activities totaled $45.5 million for the nine months ended September 30, 2004.  Expenditures for property, plant, and equipment totaled $48.1 million and included $17.8 million at Charles Town for the Phase III expansion project, $3.6 million for a land purchase at Boomtown Biloxi and $26.7 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 continuing financing activities was $74.8 million for the nine months ended September 30, 2004.  Principal payments on long-term debt included $80.5 million in payments under our credit facility.  Net proceeds from the exercise of stock options totaled $6.3 million.

Outlook

Based on our current level of continuing 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.

 

27



Capital Expenditures

Capital expenditures are budgeted and accounted for as either capital project or capital maintenance (replacement) expenditures.  Capital project expenditures are for fixed asset additions that expand an existing facility.  Capital maintenance (replacement) expenditures are expenditures to replace existing fixed assets with a useful life greater than one year that are obsolete, worn out or it is no longer cost effective to repair.

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

Property

 

Expected for

Year Ended

December 31,

2004

 

Expenditures

Through

September 30,
2004

 

Balance to

Expend

 

Charles Town Entertainment Complex

 

$

24,000

 

$

17,854

 

$

6,146

 

Boomtown Biloxi

 

5,500

 

3,595

 

1,905

 

Totals

 

$

29,500

 

$

21,449

 

$

8,051

 


                The Charles Town Entertainment Complex has started the work on Phase III of the facility expansion.  Phase III includes the expansion of the parking garage by approximately 1,050 spaces, adding an additional 500 slot machines and related equipment, a new buffet area with seating for approximately 500 people and infrastructure improvements, including a loading dock, dry storage area, offices and a maintenance shop.  The parking garage expansion was completed and opened on July 1, 2004.  We have installed 300 slot machines and the new gaming area with an additional 200 slot machines should be open by the third quarter 2005.

At Boomtown Biloxi, we signed an option to purchase approximately 4 acres of land adjacent to our property in January 2002.  The 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.  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 the nine months ended September 30, 2004, we spent approximately $26.7 million for maintenance capital expenditures at our properties.

For 2004, we expect to spend approximately $39.1 million for maintenance capital expenditures at our properties.  Of this total, approximately $8.8 million will be spent on 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.

Debt

—Senior Secured Credit Facility

At September 30, 2004, we had an outstanding balance of $320.0 million on the Term Loan D facility and $93.2 million available to borrow under the revolving credit facility after giving effect to outstanding letters of credit of $6.8 million.  The weighted average interest rate on the Term D facility is 4.48% at September 30, 2004, excluding swaps and deferred finance fees.

 

28



—Hollywood Casino Shreveport Notes, Liabilities Held for Sale

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 had initiated a process that it hoped would 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 had decided 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 had been reached with the ad hoc committee regarding the sale process, HCS anticipated that it would consult with the ad hoc committee throughout the process.  Subsequently, we decided not to participate in the bidding 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, the February 1, 2004 and August 1, 2004 interest payments, aggregating $36.9 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.  The Hollywood Casino Shreveport notes are classified as liabilities held for sale at September 30, 2004.

On August 27, 2004, HCS, acting by and through its managing general partner, HCS I, Inc., entered into an agreement with Eldorado Resorts, LLC (“Eldorado”) providing for the acquisition of Hollywood Casino Shreveport by certain affiliates of Eldorado.  On October 18, 2004, HCS, acting by and through its managing general partner, HCS I, Inc., entered into a definitive Investment Agreement (the “Agreement”) with Eldorado, Eldorado Shreveport #1, LLC (“Investor 1”) and Eldorado Shreveport #2, LLC (“Investor II”, and together with Investor I, the “Investors”) providing for the acquisition of the reorganized HCS by the Investors.  The Investors are each an affiliate of Eldorado.  The Agreement contemplates a financial restructuring of HCS that will significantly reduce outstanding secured debt obligations and annual cash interest payments.   Under the proposed restructuring, holders of HCS’s existing secured notes are to receive $140 million of new first mortgage notes, and interest in a corporation that will hold a $20 million preferred equity interest, and a 25% non-voting equity interest in the reorganized Hollywood Casino Shreveport, and cash in an amount to be determined, in exchange for existing secured notes in the principal face amount of $189 million plus accrued interest.  The Investors would acquire a 75% voting equity interest in the reorganized HCS.  HCS intends to effectuate the sale and related financial restructuring transaction through a Chapter 11 bankruptcy reorganization.  The Agreement remains subject to filing with and approval by the Bankruptcy Court, Louisiana Gaming Control Board approval and certain other conditions.

 

29



On September 10, 2004, certain creditors of the HCS filed an involuntary petition against HCS for relief under chapter 11 of the U.S. Bankruptcy Code.  The petition was filed with the U. S. Bankruptcy Court, Western District of Louisiana, located in Shreveport, Louisiana.    On October 30, 2004, the Bankruptcy Court entered an order for relief in the involuntary bankruptcy proceeding.  Hollywood Casino Shreveport will continue to manage its assets and business as a “debtor in possession” subject to the powers and supervision of the Bankruptcy Court pursuant to Chapter 11.  In addition, on October 30, 2004, HCS I, Inc. and HCS II, Inc., the general partners of Hollywood Casino Shreveport, HWCC-Louisiana, Inc., the parent company of both HCS I, Inc. and HCS II, Inc., and Shreveport Capital Corporation commenced voluntary cases under chapter 11 in the Bankruptcy Court, which cases are pending.

—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.  Except for the defaults under the Hollywood Casino Shreveport notes, for which the Company (other than the Shreveport entities) is not liable, at September 30, 2004, we were in compliance with all required financial covenants.

 

30



Commitments and Contingencies

—Contractual Cash Obligations

The following table presents our contractual cash obligations as of September 30, 2004:

 

 

 

 

 

 

Payments Due By Period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

2004

 

2005 - 2006

 

2007 - 2008

 

2009 and After

 

 

 

(In thousands)

 

Senior secured credit facility(1)

 

$

320,000

 

$

806

 

$

6,450

 

$

312,744

 

$

 

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

 

 

 

 

 

 

 

 

 

 

 

Principal

 

200,000

 

 

 

200,000

 

 

Interest

 

77,875

 

 

44,500

 

33,375

 

 

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

 

 

 

 

 

 

 

 

 

 

 

Principal

 

175,000

 

 

 

 

175,000

 

Interest

 

85,422

 

 

31,063

 

31,063

 

23,296

 

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

 

 

 

 

 

 

 

 

 

 

 

Principal

 

200,000

 

 

 

 

200,000

 

Interest

 

103,125

 

6,875

 

27,500

 

27,500

 

41,250

 

Purchase obligations

 

23,584

 

7,637

 

12,203

 

2,664

 

1,080

 

Construction commitments

 

9,490

 

9,490

 

 

 

 

Capital Leases

 

14,795

 

885

 

3,662

 

4,341

 

5,907

 

Operating Leases

 

22,437

 

1,552

 

9,411

 

6,885

 

4,589

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,231,728

 

$

27,245

 

$

134,789

 

$

618,572

 

$

451,122

 

 

 

 

 

 

 

 

 

 

 

 

 


(1)           As of September 30, 2004 there was no indebtedness outstanding under the credit facility and there was approximately $93.2 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 September 1 and December 1 until December 1, 2011.

 

31



 

—Other Commercial Commitments

The following table presents our material commercial commitments as of September 30, 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)

 

6,848

 

4,419

 

2,429

 

 

 

Guarantees of New Jersey Joint Venture Obligations(2)

 

8,241

 

192

 

1,533

 

1,533

 

4,983

 

Total

 

$

15,089

 

$

4,611

 

$

3,962

 

$

1,533

 

$

4,983

 

 

 

 

 

 

 

 

 

 

 

 

 


(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 $16.5 million term loan.  Our obligation as of September 30, 2004 under this guarantee is approximately $8.2 million.

—Interest Rate Swap Agreements

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

Accounting Pronouncements Issued or Adopted in 2004

There are no accounting standards issued before September 30, 2004 but effective after December 31, 2003 which are expected to have a material impact on our financial reporting.

 

32



 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The table below provides information as of September 30, 2004, about our financial instruments that are sensitive to changes in interest rates, including debt obligations and interest rate swaps.  For debt obligations, the table presents notional amounts and weighted average interest rates by maturity dates.  For interest rate swaps, the table presents notional amounts and weighted average interest rates by contractual maturity dates.  Notional amounts are used to calculate the contractual payments to be exchanged under the contract and the weighted average variable rates are based on implied forward rates in the yield curve as of September 30, 2004.

 

 

2004

 

2005

 

2006

 

2007

 

2008

 

Thereafter

 

Total

 

Long-term debt:

 

(In thousands)

 

Variable rate

 

$

806

 

$

3,225

 

$

3,225

 

$

312,744

 

$

 

$

 

$

320,000

 

Average interest rate

 

4.48

%

4.48

%

4.48

%

4.48

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Leases

 

$

885

 

$

1,767

 

$

1,895

 

$

2,071

 

$

2,270

 

$

5,907

 

$

14,795

 

Average interest rate(1)

 

6.73

%

6.73

%

6.73

%

6.73

%

6.73

%

6.73

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable to fixed

 

$

 

$

120,000

 

$

200,000

 

$

 

$

 

$

 

$

320,000

 

Average pay rate

 

 

 

1.92

%

2.48

%

 

 

 

 

 

 

 

 

Average receive rate (2)

 

 

 

1.95

%

1.95

%

 

 

 

 

 

 

 

 

 


(1)           Interest payable is based on the Nine Month London Interbank Offer Rate (LIBOR) plus a spread.

 

(2)           Interest payable is based on the Nine Month London Interbank Offer Rate (LIBOR).

 

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 million in accordance with the terms of the $800 million senior secured credit facility.  There are six 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 six six-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.  On September 3, 2004, we terminated $65 million of our two-year swap contracts in conjunction with our debt reduction payment.  At September 30, 2004, the 90-day LIBOR rate was 2.00%.

 

33



 

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 September 30, 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 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, February 1, 2004 and August 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.

 

34



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.  Further, an event of default under the indentures for the Hollywood Casino Shreveport notes does not cause an event of default under the Company’s senior secured credit facility or senior subordinated notes.  The Hollywood Casino Shreveport notes have been in default under the terms of their respective note indentures since May 2003.  The Hollywood Casino Shreveport notes are classified as liabilities held for sale at September 30, 2004.

On October 18, 2004, Hollywood Casino Shreveport, acting by and through its managing general partner, HCS I, Inc., entered into a definitive Investment Agreement (the “Agreement”) with Eldorado Resorts, LLC (“Eldorado”), Eldorado Shreveport #1, LLC (“Investor 1”) and Eldorado Shreveport #2, LLC (“Investor II”, and together with Investor I, the “Investors”) providing for the acquisition of the reorganized Hollywood Casino Shreveport by the Investors.  The Investors are each an affiliate of Eldorado.  The Agreement contemplates a financial restructuring of Hollywood Casino Shreveport that will significantly reduce outstanding secured debt obligations and annual cash interest payments.  Under the proposed restructuring, holders of Hollywood Casino Shreveport’s existing secured notes are to receive $140 million of new first mortgage notes, and interest in a corporation that will hold a $20 million preferred equity interest and a 25% non-voting equity interest in the reorganized Hollywood Casino Shreveport, and cash in an amount to be determined, in exchange for existing secured notes in the principal face amount of $189 million plus accrued interest.  The Investors would acquire a 75% voting equity interest in the reorganized Hollywood Casino Shreveport.  Hollywood Casino Shreveport intends to effectuate the sale and related financial restructuring transaction through a Chapter 11 bankruptcy reorganization.  The Agreement remains subject to filing with and approval by the Bankruptcy Court, Louisiana Gaming Control Board approval and certain other conditions.

On September 10, 2004, certain creditors of the Hollywood Casino Shreveport filed an involuntary petition against Hollywood Casino Shreveport for relief under chapter 11 of the U.S. Bankruptcy Code.  The petition was filed with the U. S. Bankruptcy Court, Western District of Louisiana, located in Shreveport, Louisiana.   On October 30, 2004, the Bankruptcy Court entered an order for relief in the involuntary bankruptcy proceeding.  Hollywood Casino Shreveport will continue to manage its assets and business as a “debtor in possession” subject to the powers and supervision of the Bankruptcy Court pursuant to Chapter 11.  In addition, on October 30, 2004, HCS I, Inc. and HCS II, Inc., the general partners of Hollywood Casino Shreveport, HWCC-Louisiana, Inc., the parent company of both HCS I, Inc. and HCS II, Inc., and Shreveport Capital Corporation commenced voluntary cases under chapter 11 in the Bankruptcy Court, which cases are pending.

 

35



ITEM 5.  OTHER INFORMATION

Recent Developments

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

Pocono Downs

On July 5, 2004, Pennsylvania Governor Edward G. Rendell signed into law the Pennsylvania Race Horse Development and Gaming Act.  Under this new law, we are entitled to one category 1 slot machine license per facility.  The law provides that a single company and its affiliates may own only one slot machine license and not more than a one third interest in another slot machine license.  Given these ownership restrictions, our plan is to develop a slots facility at our Penn National Race Course in Grantville, Pennsylvania.  Under this plan, we expect to open in a permanent facility with 2,000 slot machines in early 2006 and expand to up to 5,000 machines based on demand.  With respect to Pocono Downs, we announced on October 15, 2004 that we entered into an agreement with the Mohegan Tribal Gaming Authority to sell Pocono Downs and its affiliated off-track wagering facilities (see Note 12).

Bangor Historic Track

We announced on October 19, 2004 that the Maine Harness Racing Commission granted Bangor Historic Track, Inc. an unconditional racing license for 2004.  The annual license represents the first regulatory approval necessary for Bangor Historic Track to proceed with the proposed $74 million development project at the track including the construction of the State’s first and only gaming facility where we intend to place up to 1,500 slot machines.  In October, we also submitted our licensing application to the state’s Gambling Control Board for a slot operator’s license.  On November 4, 2004, the Maine Gambling Control Board granted us a conditional slot operator license.  The license is conditioned on us not commencing gaming operations while the Board and the Department of Public Safety pursue legislation to protect confidential corporate and personal information in the same manner as other U.S. gaming and racing jurisdictions, and until we have submitted such information to the Board.  We anticipate this issue will be presented to the legislature in the first half of 2005.  Until such time, we intend to continue to move forward with developing our plans for construction of a state-of-the-art racing and gaming facility in Bangor with expected ground breaking in May 2005 and a projected budget of $75 million.

Argosy

On November 3, 2004, Penn National Gaming, Inc. and Argosy Gaming Company announced that their boards of directors unanimously approved a definitive merger agreement under which we will acquire all of the outstanding shares of Argosy Gaming for $47.00 per share in cash. The transaction is valued at approximately $2.2 billion, including approximately $805 million of long-term debt of Argosy Gaming and its subsidiaries.  Upon closing, the transaction is expected to be immediately accretive to our earnings per share.

The combined company will be the third largest operator of gaming properties in the U.S. with annual revenue in excess of $2 billion, over 20,000 slot machines, and approximately 700,000 square feet of casino space.  Upon completion of the transaction, and reflecting previously announced divestitures, acquisitions and projects under development, we will own thirteen gaming facilities; four pari-mutuel horse racing facilities and seven off-track wagering sites; a 50% interest in a fifth pari-mutuel horse racing facility; and hold a management contract for a casino in Canada.

The transaction is subject to approval by the Argosy Gaming stockholders and by each company’s respective state regulatory bodies, and to certain other necessary regulatory approvals and other customary closing conditions contained in the merger agreement.  We have received a $2.9 billion senior secured underwritten commitment to finance the transaction.  The transaction is not conditioned on financing and is expected to close in the second half of 2005.

 

36



ITEM 6.  EXHIBITS

Exhibit

 

Description of Exhibit

 

 

 

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

 

 

37



 

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.

 

 

 

 

 

 

 

 

 

November 8, 2004

By:

/s/ William J. Clifford

 

 

 

William J. Clifford

 

 

 

Senior Vice President-Finance and Chief Financial Officer

 

38


Exhibit 31.1

 

CERTIFICATION PURSUANT TO RULE 13a-14(a) AND 15d-14(a) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

I, Peter M. Carlino, certify that:

 

1.             I have reviewed this quarterly report on Form 10-Q of Penn National Gaming, Inc.;

2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.             The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)                                  designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)                                 evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c)                                  disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.             The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)                                  all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)                                 any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  November 8, 2004

 

 

/s/       Peter M. Carlino

 

Peter M. Carlino

 

Chairman and Chief Executive Officer

 

 


 

Exhibit 31.2

 

CERTIFICATION PURSUANT TO RULE 13a-14(a) AND 15d-14(a) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

I, William J. Clifford, certify that:

 

1.             I have reviewed this quarterly report on Form 10-Q of Penn National Gaming, Inc.;

2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.             The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)                                  designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)                                 evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c)                                  disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.             The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)                                  all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)                                 any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: November 8, 2004

 

 

/s/ William J. Clifford

 

William J. Clifford

 

Senior Vice President-Finance and

 Chief Financial Officer

 


 

 

Exhibit 32.1

 

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Penn National Gaming, Inc. (the “Company”) on Form 10-Q for the quarter ended September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Peter M. Carlino, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that:

(1)           The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

 

By:

/s/ Peter M. Carlino

 

 

Peter M. Carlino

 

 

Chairman and Chief Executive Officer

 

 

November 8, 2004

 

 


 

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Penn National Gaming, Inc. (the “Company”) on Form 10-Q for the quarter ended September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, William J. Clifford, Senior Vice President-Finance and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that:

(1)           The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

 

By:

/s/ William J. Clifford

 

 

William J. Clifford

 

 

Senior Vice President-Finance and Chief Financial Officer

 

 

November 8, 2004