UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

 

For the quarterly period ended June 30, 2007

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)

 

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 x No o

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

Large accelerated filer x              Accelerated filer o              Non-accelerated filer o

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

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 August 3, 2007
Common Stock, par value $.01 per share		86,450,284 (includes 380,000 shares of restricted stock)

 

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 Penn National Gaming, Inc. and its subsidiaries (collectively, the “Company”) believe that our expectations are based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from our expectations. Meaningful factors which could cause actual results to differ from expectations include, but are not limited to, risks related to the following: the possibility that the pending acquisition of the Company by certain funds managed by affiliates of Fortress Investment Group LLC and Centerbridge Partners, L.P. will not be consummated, or will be significantly delayed; the passage of state, federal or local legislation that would expand, restrict, further tax, prevent or negatively impact (such as a smoking ban at any of our facilities) operations in the jurisdictions in which we do business; the activities of our competitors; increases in the 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, the costs and risks involved in the pursuit of those acquisitions and our ability to integrate those acquisitions; our ability to maintain regulatory approvals for our existing businesses and to receive regulatory approvals for our new businesses; the maintenance of agreements with our horsemen, pari-mutuel clerks and other organized labor groups; our dependence on key personnel; the impact of terrorism and other international hostilities; the availability and cost of financing; and other factors as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the United States Securities and Exchange Commission. We do not intend to update publicly any forward-looking statements except as required by law.

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PENN NATIONAL GAMING, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION	4
ITEM 1.	FINANCIAL STATEMENTS	4
	Consolidated Balance Sheets — June 30, 2007 and December 31, 2006	4
	Consolidated Statements of Income — Three and Six Months Ended June 30, 2007 and 2006	5
	Consolidated Statements of Changes in Shareholders’ Equity — Six Months Ended June 30, 2007 and 2006	6
	Consolidated Statements of Cash Flows — Six Months Ended June 30, 2007 and 2006	7
	Notes to the Consolidated Financial Statements	8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (unaudited)	21
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	35
ITEM 4.	CONTROLS AND PROCEDURES	35
PART II.	OTHER INFORMATION	36
ITEM 1.	LEGAL PROCEEDINGS	36
ITEM 1A.	RISK FACTORS	36
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	37
ITEM 6.	EXHIBITS	37

 

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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)

		June 30,			December 31,
		2007			2006
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	159,594		$	168,515
Receivables, net of allowance for doubtful accounts of $3,672 and $3,698 at June 30, 2007 and December 31, 2006, respectively		41,237			53,829
Insurance receivable		—			100,000
Prepaid expenses and other current assets		37,009			57,432
Deferred income taxes		24,357			22,187
Total current assets		262,197			401,963
Property and equipment, net		1,497,653			1,365,871
Other assets
Investment in and advances to unconsolidated affiliate		16,481			16,138
Goodwill		2,010,169			1,869,444
Other intangible assets		778,137			726,126
Deferred financing costs, net of accumulated amortization of $22,060 and $16,438 at June 30, 2007 and December 31, 2006, respectively		51,764			57,386
Other assets		116,541			77,154
Total other assets		2,973,092			2,746,248
Total assets		$	4,732,942		$	4,514,082
Liabilities
Current liabilities
Current maturities of long-term debt		$	72,792		$	40,058
Accounts payable		20,017			37,928
Accrued expenses		95,322			130,877
Accrued interest		32,955			31,329
Accrued salaries and wages		55,269			60,164
Gaming, pari-mutuel, property, and other taxes		52,836			48,181
Income taxes payable		16,700			21,020
Insurance financing		414			19,336
Other current liabilities		33,394			26,778
Total current liabilities		379,699			415,671
Long-term liabilities
Long-term debt, net of current maturities		2,872,657			2,789,390
Deferred income taxes		390,624			387,615
Noncurrent tax liabilities		69,155			—
Other noncurrent liabilities		265			243
Total long-term liabilities		3,332,701			3,177,248
Shareholders’ equity
Preferred stock ($.01 par value, 1,000,000 shares authorized, none issued and outstanding at June 30, 2007 and December 31, 2006)		—			—
Common stock ($.01 par value, 200,000,000 shares authorized, 87,353,395 and 86,814,999 shares issued at June 30, 2007 and December 31, 2006, respectively)		874			868
Treasury stock (1,698,800 shares issued at June 30, 2007 and December 31, 2006)		(2,379		)	(2,379		)
Additional paid-in capital		276,981			251,943
Retained earnings		736,865			667,557
Accumulated other comprehensive income		8,201			3,174
Total shareholders’ equity		1,020,542			921,163
Total liabilities and shareholders’ equity		$	4,732,942		$	4,514,082

 

See accompanying notes to the consolidated financial statements.

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Penn National Gaming, Inc. and Subsidiaries

Consolidated Statements of Income

(in thousands, except per share data)

(unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Revenues
Gaming		$	570,281		$	490,804		$	1,119,374		$	994,254
Management service fee		4,341			4,921			7,815			9,308
Food, beverage and other		82,894			66,052			156,664			132,187
Gross revenues		657,516			561,777			1,283,853			1,135,749
Less promotional allowances		(32,272		)	(24,004		)	(62,351		)	(50,174		)
Net revenues		625,244			537,773			1,221,502			1,085,575
Operating expenses
Gaming		297,086			254,638			581,377			510,223
Food, beverage and other		63,123			54,980			121,453			108,652
General and administrative		98,993			78,590			192,492			158,516
Depreciation and amortization		37,622			27,728			72,980			57,446
Total operating expenses		496,824			415,936			968,302			834,837
Income from operations		128,420			121,837			253,200			250,738
Other income (expenses)
Interest expense		(51,302		)	(47,766		)	(99,649		)	(96,195		)
Interest income		1,289			867			2,165			1,770
Earnings from joint venture		325			574			365			987
Other		(5,476		)	184			(5,704		)	74
Loss on early extinguishment of debt		—			—			—			(10,022		)
Total other expenses		(55,164		)	(46,141		)	(102,823		)	(103,386		)
Income from operations before income taxes		73,256			75,696			150,377			147,352
Taxes on income		34,957			33,001			69,137			62,674
Net income		$	38,299		$	42,695		$	81,240		$	84,678
Basic earnings per share		$	0.45		$	0.51		$	0.96		$	1.01
Diluted earnings per share		$	0.43		$	0.49		$	0.93		$	0.98

 

See accompanying notes to the consolidated financial statements.

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Penn National Gaming, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

(in thousands, except share data) (unaudited)

		Common Stock					Treasury			Additional Paid-In			Retained			Accumulated Other Comprehensive			Total Shareholders’			Comprehensive
		Shares		Amount			Stock			Capital			Earnings			Income			Equity			Income
Balance, December 31, 2005		85,064,886		$	850		$	(2,379	)	$	206,763		$	340,469		$	840		$	546,543
Stock option activity, including tax benefit of $9,259		990,838		11			—			28,094			—			—			28,105			$	—
Restricted stock		440,000		4			—			1,107			—			—			1,111			—
Change in fair value of interest rate swap contracts, net of income taxes of $9,075		—		—			—			—			—			15,788			15,788			15,788
Foreign currency translation adjustment		—		—			—			—			—			80			80			80
Net income		—		—			—			—			84,678			—			84,678			84,678
Balance, June 30, 2006		86,495,724		$	865		$	(2,379	)	$	235,964		$	425,147		$	16,708		$	676,305		$	100,546
Balance, December 31, 2006		86,814,999		$	868		$	(2,379	)	$	251,943		$	667,557		$	3,174		$	921,163
Stock option activity, including tax benefit of $4,861		598,396		6			—			24,063			—			—			24,069			$	—
Restricted stock		(60,000	)	—			—			975			—			—			975			—
Change in fair value of interest rate swap contracts, net of income taxes of $2,689		—		—			—			—			—			4,734			4,734			4,734
Foreign currency translation adjustment		—		—			—			—			—			293			293			293
Cumulative effect of adoption of FIN 48		—		—			—			—			(11,932		)	—			(11,932		)	—
Net income		—		—			—			—			81,240			—			81,240			81,240
Balance, June 30, 2007		87,353,395		$	874		$	(2,379	)	$	276,981		$	736,865		$	8,201		$	1,020,542		$	86,267

 

See accompanying notes to the consolidated financial statements.

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Penn National Gaming, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands) (unaudited)

Six Months Ended June 30,		2007			2006
Operating activities
Net income		$	81,240		$	84,678
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		72,980			57,446
Amortization of items charged to interest expense		6,511			5,740
Loss on sale of fixed assets		1,058			374
Earnings from joint venture		(365		)	(987		)
Loss relating to early extinguishment of debt		—			2,255
Deferred income taxes		4,433			(1,811		)
Charge for stock compensation		12,854			10,404
Decrease (increase), net of businesses acquired
Accounts receivable		13,022			(5,673		)
Insurance receivable		100,000			(21,116		)
Prepaid expenses and other current assets		28,173			4,331
Other assets		(6,348		)	1,079
(Decrease) increase, net of businesses acquired
Accounts payable		(25,687		)	(5,386		)
Accrued expenses		(35,102		)	(26,552		)
Accrued interest		1,626			(3,049		)
Accrued salaries and wages		(4,883		)	(2,779		)
Gaming, pari-mutuel, property and other taxes		4,586			(6,417		)
Income taxes payable		13,916			(13,992		)
Noncurrent tax liabilities		2,246			—
Other liabilities		6,637			(3,608		)
Operating cash flows from discontinued operations		—			(129		)
Net cash provided by operating activities		276,897			74,808
Investing activities
Expenditures for property and equipment		(155,102		)	(118,055		)
Proceeds from sale of property and equipment		13,881			840
Acquisition of businesses and licenses, net of cash acquired		(252,977		)	—
Distributions from joint venture		—			153
Net cash used in investing activities		(394,198		)	(117,062		)
Financing activities
Proceeds from exercise of options		7,329			9,553
Proceeds from issuance of long-term debt		307,000			205,028
Principal payments on long-term debt		(191,888		)	(183,852		)
Payments on insurance financing		(18,922		)	—
Increase in deferred financing cost		—			(36		)
Tax benefit from stock options exercised		4,861			9,259
Net cash provided by financing activities		108,380			39,952
Net decrease in cash and cash equivalents		(8,921		)	(2,302		)
Cash and cash equivalents at beginning of year		168,515			132,620
Cash and cash equivalents at end of period		$	159,594		$	130,318
Supplemental disclosure
Interest expense paid		$	96,320		$	97,488
Income taxes paid		$	50,446		$	68,500

 

See accompanying notes to the consolidated financial statements.

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Penn National Gaming, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

1.             Basis of Presentation

The accompanying unaudited consolidated financial statements of Penn National Gaming, Inc. (“Penn”) and subsidiaries (collectively, the “Company”) have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The notes to the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2006 should be read in conjunction with these consolidated financial statements. For purposes of comparability, certain prior year amounts have been reclassified to conform to the current year presentation. Operating results for the six months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

2.             Merger Announcement

On June 15, 2007, the Company, PNG Acquisition Company Inc. (“Parent”) and PNG Merger Sub Inc., a wholly- owned subsidiary of Parent (“Merger Sub”), announced that they had entered into an Agreement and Plan of Merger, dated as of June 15, 2007 (the “Merger Agreement”), that provides, among other things, for Merger Sub to be merged with and into the Company (the “Merger”), as a result of which the Company will continue as the surviving corporation and a wholly-owned subsidiary of Parent. Parent is owned by certain funds managed by affiliates of Fortress Investment Group LLC and Centerbridge Partners, L.P. (the “Funds”).

Pursuant to the Merger Agreement, at the effective time of the Merger, each outstanding share of common stock of the Company (the “Common Stock”), other than shares held by the Company as treasury stock or owned directly or indirectly by Parent or Merger Sub, will be cancelled and converted into the right to receive $67.00 in cash, without interest. In the event that the Merger shall not have occurred by June 15, 2008 (the “Adjustment Date”), the $67.00 cash amount per share of Common Stock shall be increased for each day after the Adjustment Date, through and including the closing date, by adding an amount equal to $0.0149 per day.

The Merger Agreement provides that, upon termination under specified circumstances generally related to a competing acquisition proposal, the Company would be required to pay a termination fee of up to $200 million to Parent and, under certain circumstances if the Company’s shareholders do not approve the Merger, the Company must reimburse Parent for an amount not to exceed $17.5 million for transaction expenses incurred by Parent and its affiliates. The Company’s reimbursement of Parent’s expenses would reduce the amount of any required termination fee that becomes payable by the Company. The Merger Agreement further provides that, upon termination under specified circumstances related to, among other things, Parent’s breach of the Merger Agreement, the failure to obtain financing or failure to obtain regulatory approval, Parent would be required to pay the Company a termination fee of $200 million. Affiliates of the Funds have agreed to fund Parent in the amount of the termination fee in the event it becomes payable.

Parent has obtained equity and debt financing commitments for the transactions contemplated by the Merger Agreement, the proceeds of which will be used by Parent to pay the aggregate Merger consideration and related fees and expenses of the transactions contemplated by the Merger Agreement and to repay certain debt of the Company and its subsidiaries. Consummation of the Merger is not subject to a financing condition, but is subject to customary conditions to closing, including the approval of the Company’s shareholders and regulatory approvals.

3.             Summary of Significant Accounting Policies

Revenue Recognition and Promotional Allowances

Gaming revenue is the aggregate net difference between gaming wins and losses, with liabilities recognized for funds deposited by customers before gaming play occurs, for chips and “ticket-in, ticket-out” coupons in the customers’ possession and for accruals related to the anticipated payout of progressive jackpots.

Revenue from the management service contract for Casino Rama is based upon contracted terms, and is recognized when services are performed.

Food, beverage and other revenue, including racing revenue, is recognized as services are performed.  Racing

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revenue includes the Company’s share of pari-mutuel wagering on live races after payment of amounts returned as winning wagers, its share of wagering from import and export simulcasting, and its share of wagering from its off-track wagering facilities (“OTWs”).

Revenues are recognized net of certain sales incentives in accordance with the Emerging Issues Task Force (“EITF”) consensus on Issue 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s products)” (“EITF 01-9”). The consensus in EITF 01-9 requires that sales incentives and points earned in point-loyalty programs be recorded as a reduction of revenue. The Company recognizes incentives related to gaming play and points earned in point-loyalty programs as a direct reduction of gaming revenue.

The retail value of accommodations, food and beverage, and other services furnished to guests without charge is included in gross revenues and then deducted as promotional allowances. The estimated cost of providing such promotional allowances is primarily included in food, beverage and other expense. The amounts included in promotional allowances for the three and six months ended June 30, 2007 and 2006 are as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
		(in thousands)						(in thousands)
Rooms		$	3,982		$	2,804		$	7,238		$	5,580
Food and beverage		25,946			19,537			50,918			39,236
Other		2,344			1,663			4,195			5,358
Total promotional allowances		$	32,272		$	24,004		$	62,351		$	50,174

 

The estimated cost of providing such complimentary services for the three and six months ended June 30, 2007 and 2006 are as follows:

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
		(in thousands)						(in thousands)
Rooms		$	1,630		$	1,174		$	3,253		$	2,315
Food and beverage		18,451			13,644			35,006			27,585
Other		1,316			817			2,371			3,613
Total cost of complimentary services		$	21,397		$	15,635		$	40,630		$	33,513

 

Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing net income applicable to common stock by the weighted-average common shares outstanding during the period. Diluted EPS reflects the additional dilution for all potentially-dilutive securities such as stock options.

The following table reconciles the weighted-average common shares outstanding used in the calculation of basic earnings per share to the weighted-average common shares outstanding used in the calculation of diluted earnings per share.  Options to purchase 1,441,727 and 1,468,452 shares of common stock were outstanding during the three and six months ended June 30, 2007, respectively, but were not included in the computation of diluted earnings per share because they are antidilutive. Options to purchase 1,645,812 and 1,827,280 shares of common stock were outstanding during the three and six months ended June 30, 2006, respectively, but were not included in the computation of diluted earnings per share because they are antidilutive.

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		Three Months Ended June 30,				Six Months Ended June 30,
		2007		2006		2007		2006
		(in thousands)				(in thousands)
Determination of shares:
Weighted-average common shares outstanding		85,176		84,333		85,034		83,991
Assumed conversion of dilutive stock options		2,893		2,396		2,750		2,444
Diluted weighted-average common shares outstanding		88,069		86,729		87,784		86,435

 

Stock-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which requires the Company to expense the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. This expense must be recognized ratably over the requisite service period following the date of grant.

The Company elected the modified prospective application method for adoption, which results in the recognition of compensation expense using the provisions of SFAS 123(R) for all share-based awards granted or modified after December 31, 2005, and the recognition of compensation expense using the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”), with the exception of the method of recognizing forfeitures, for all unvested awards outstanding at the date of adoption. Under this transition method, the results of operations of prior periods were not restated.

The fair value for stock options was estimated at the date of grant using the Black-Scholes option-pricing model, which requires management to make certain assumptions. The risk-free interest rate was based on the U.S. Treasury spot rate with a remaining term equal to the expected life assumed at the date of grant. Expected volatility was estimated based on the historical volatility of the Company’s stock price over a period of 4.24 years, in order to match the expected life of the options at the grant date. There is no expected dividend yield since the Company has not paid any cash dividends on its common stock since its initial public offering in May 1994, and since the Company intends to retain all of its earnings to finance the development of its business for the foreseeable future. The weighted-average expected life was based on the contractual term of the stock option and expected employee exercise dates, which was based on the historical exercise behavior of the Company’s employees. Forfeitures are estimated at the date of grant based on historical experience. The following are the weighted-average assumptions used in the Black-Scholes option-pricing model at June 30, 2007 and 2006:

		Six Months Ended June 30,
		2007		2006
Risk-free interest rate		4.84	%	4.34	%
Expected volatility		38.72	%	46.98	%
Dividend yield		—		—
Weighted-average expected life (years)		4.24		4.52
Forfeiture rate		4.00	%	2.00	%

 

4.             New Accounting Pronouncement

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). Under SFAS 109, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities and are measured at the prevailing enacted tax rates that will be in effect when these differences are settled or realized. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.

The realizability of the deferred tax assets is evaluated quarterly by assessing the valuation allowance and by adjusting the amount of the allowance, if necessary. The factors used to assess the likelihood of realization are the forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. The Company has used tax-planning strategies to realize or renew net deferred tax assets in order to avoid the potential loss of future tax benefits.

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The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized a liability for unrecognized tax benefits of approximately $11.9 million, which was accounted for as a reduction to the January 1, 2007 retained earnings balance. The liability for unrecognized tax benefits is included in noncurrent tax liabilities within the consolidated balance sheet at June 30, 2007.

A reconciliation of the beginning and ending amount for the liability for unrecognized tax benefits is as follows:

		Noncurrent tax liabilities
		(in thousands)
Balance at January 1, 2007		$	56,960
Additions based on current year tax positions		984
Additions based on prior year tax positions		3,223
Currency translation adjustments		7,988
Balance at June 30, 2007		$	69,155

 

Included in the liability for unrecognized tax benefits at June 30, 2007 were $32.8 million of tax positions that are indemnified by a third party.  The receivable for this indemnification is included in other assets within the consolidated balance sheet at June 30, 2007.

Included in the liability for unrecognized tax benefits at June 30, 2007 were $8.0 million of currency translation adjustments for foreign currency tax positions.

Included in the liability for unrecognized tax benefits at June 30, 2007 were $20.6 million of tax positions that, if reversed, would affect the effective tax rate.

During the three and six months ended June 30, 2007, as well as prior to January 1, 2007, the Company recognized interest and penalties accrued related to unrecognized tax benefits in taxes on income within the consolidated statements of income.

During the three and six months ended June 30, 2007, the Company recognized approximately $0.8 million and $1.5 million of interest and penalties, respectively. The Company has accrued approximately $34.8 million for the payment of interest and penalties at June 30, 2007. These accruals were included in noncurrent tax liabilities within the consolidated balance sheet at June 30, 2007.

As of January 1, 2007, the Company is subject to U.S. Federal income tax examinations for the tax years 2005 and 2006.  In addition, the Company is subject to state and local income tax examinations for various tax years in the taxing jurisdictions in which we operate.

5.             Acquisition

On April 16, 2007, pursuant to the Asset Purchase Agreement dated November 7, 2006 among Zia Partners, LLC (“Zia”), Zia Park LLC (the “Buyer”), a wholly-owned subsidiary of Penn, and (solely with respect to specified sections thereof which relate to the Company’s guarantee of the Buyer’s payment and performance) Penn, the Buyer completed the acquisition of the Black Gold Casino and Zia Park Racetrack and all related assets of Zia. Penn funded this purchase with additional borrowings under its existing $750 million revolving credit facility.

The Company accounted for the acquisition in accordance with SFAS No. 141, “Business Combinations”. As a result of the acquisition, the Company recorded goodwill of $143.7 million and other intangible assets of $4.6 million. The results of operations of the Black Gold Casino and Zia Park Racetrack have been included in the Company’s consolidated financial statements since the acquisition date. The acquisition of Black Gold Casino and Zia Park Racetrack was not significant to the Company’s results of operations for the three and six months ended June 30, 2007.

6.             Hurricane Katrina

As a result of Hurricane Katrina’s direct hit on the Mississippi Gulf Coast on August 29, 2005, two of the Company’s casinos, Hollywood Casino Bay St. Louis and Boomtown Biloxi, were significantly damaged, many employees

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were displaced and operations ceased at the two properties. Boomtown Biloxi reopened on June 29, 2006 and Hollywood Casino Bay St. Louis reopened on August 31, 2006.

During the year ended December 31, 2006, the Company’s financial results benefited from a settlement agreement with its property and business interruption insurance providers for a total of $225 million for Hurricane Katrina-related losses at its Hollywood Casino Bay St. Louis and Boomtown Biloxi properties, as well as minor proceeds related to its National Flood Insurance coverage and auto insurance claims.

The $100 million insurance receivable recorded at December 31, 2006 represented the portion of the $225 million settlement that was received in January 2007.

On August 8, 2006, the Company renewed its property insurance coverage in the amount of $200 million. The $200 million coverage is “all risk”, including “named windstorm”, flood and earthquake. Also, the Company purchased an additional $250 million of “all risk” coverage that is subject to certain exclusions including, among others, exclusions for “named windstorms,” floods and earthquakes. There is a $25 million deductible for “named windstorm” events, and lesser deductibles as they apply to other perils.

In June 2007, the Company renewed its first layer of property insurance coverage in the amount of $200 million. The $200 million coverage, which is effective from August 8, 2007 through December 31, 2010, is on an “all risk” basis, including, but not limited to, coverage for “named windstorm”, flood and earthquake.  Also, the Company purchased an additional $400 million of “all risk” coverage that is subject to certain exclusions including, among others, exclusions for “named windstorms,” floods and earthquakes. The additional $400 million coverage is effective from August 8, 2007 through June 1, 2008. There is a $25 million deductible for “named windstorm” events, and lesser deductibles as they apply to other perils. Both layers are subject to specific policy terms, conditions and exclusions.

7.             Property and Equipment

Property and equipment, net, consists of the following:

		June 30,			December 31,
		2007			2006
		(in thousands)
Land and improvements		$	180,245		$	190,002
Building and improvements		992,283			868,577
Furniture, fixtures and equipment		472,006			420,809
Transportation equipment		2,935			2,392
Leasehold improvements		16,004			15,005
Construction in progress		216,103			187,531
Total property and equipment		1,879,576			1,684,316
Less accumulated depreciation and amortization		(381,923		)	(318,445		)
Property and equipment, net		$	1,497,653		$	1,365,871

 

Depreciation expense for property and equipment totaled $35.7 million and $69.3 million for the three and six months ended June 30, 2007, respectively, as compared to $26.1 million and $54.2 million for the three and six months ended June 30, 2006, respectively. Interest capitalized in connection with major construction projects was $2.6 million and $5.7 million for the three and six months ended June 30, 2007, respectively, as compared to $2.0 and $3.3 million for the three and six months ended June 30, 2006, respectively.

8.             Goodwill and Other Intangible Assets

The Company’s goodwill and intangible assets had a gross carrying value of $2.8 billion and $2.6 billion at June 30, 2007 and December 31, 2006, respectively, and accumulated amortization of $23.1 million and $19.4 million at June 30, 2007 and December 31, 2006, respectively.  The table below presents the gross carrying value, accumulated amortization, and net book value of each major class of goodwill and intangible asset at June 30, 2007 and December 31, 2006:

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		June 30,									December 31,
		2007									2006
		(in thousands)
		Gross Carrying Value			Accumulated Amortization			Net Book Value			Gross Carrying Value			Accumulated Amortization			Net Book Value
Goodwill		$	2,010,169		$	—		$	2,010,169		$	1,869,444		$	—		$	1,869,444
Gaming license and trademarks		751,966			—			751,966			700,434			—			700,434
Other intangible assets		49,316			23,145			26,171			45,126			19,434			25,692
Total		$	2,811,451		$	23,145		$	2,788,306		$	2,615,004		$	19,434		$	2,595,570

 

During the six months ended June 30, 2007, goodwill increased by $140.7 million, primarily due to goodwill recorded as part of the completion of the Black Gold Casino and Zia Park Racetrack acquisition in April 2007, offset by deferred tax adjustments relating to litigation accruals.  In addition, gaming license and trademarks increased by $51.5 million during the six months ended June 30, 2007, due to the Black Gold Casino and Zia Park Racetrack acquisition and payment for the Category 1 slot machine license for the placement of slot machines at the Company’s planned Hollywood Casino at Penn National Race Course.

The Company’s intangible asset amortization expense was $1.9 million and $3.7 million for the three and six months ended June 30, 2007, respectively, as compared to $1.7 million and $3.3 million for the three and six months ended June 30, 2006, respectively.

The following table presents expected intangible asset amortization expense based on existing intangible assets at June 30, 2007 (in thousands):

2007 (6 months)		$	3,897
2008		7,626
2009		6,626
2010		5,757
2011		2,080
Thereafter		185
Total		$	26,171

 

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9.             Long-term Debt

Long-term debt, net of current maturities, is as follows:

		June 30,			December 31,
		2007			2006
		(in thousands)
Senior secured credit facility		$	2,459,625		$	2,343,875
$200 million 6 7¤8% senior subordinated notes		200,000			200,000
$250 million 6 ¾% senior subordinated notes		250,000			250,000
Other long-term obligations		25,930			25,041
Capital leases		9,894			10,532
		2,945,449			2,829,448
Less current maturities of long-term debt		(72,792		)	(40,058		)
		$	2,872,657		$	2,789,390

 

The following is a schedule of future minimum repayments of long-term debt at June 30, 2007 (in thousands):

Within one year			$	72,792
1-3 years			206,605
3-5 years			2,026,343
Over 5 years			639,709
Total minimum payments			$	2,945,449

 

At June 30, 2007, the Company was contingently obligated under letters of credit issued pursuant to the $2.725 billion senior secured credit facility with face amounts aggregating $32.6 million.

Senior Secured Credit Facility

On October 3, 2005, the Company entered into a $2.725 billion senior secured credit facility to fund the Company’s acquisition of Argosy Gaming Company (“Argosy”), including payment for all of Argosy’s outstanding shares, the retirement of certain long-term debt of Argosy and its subsidiaries, the payment of related transaction costs, and to provide additional working capital. The $2.725 billion senior secured credit facility consists of three credit facilities comprised of a $750 million revolving credit facility (of which $513.5 million was drawn at June 30, 2007), a $325 million Term Loan A facility and a $1.65 billion Term Loan B facility. The $2.725 billion senior secured credit facility also allows the Company to raise an additional $300 million in senior secured credit for project development and property expansion.

The $2.725 billion senior secured credit facility is secured by substantially all of the assets of the Company.

Interest Rate Swap Contracts

The Company has a policy designed to manage interest rate risk associated with its current and anticipated future borrowings. This policy enables the Company to use any combination of interest rate swaps, futures, options, caps and similar instruments. To the extent the Company employs such financial instruments pursuant to this policy, they are generally accounted for as hedging instruments. In order to qualify for hedge accounting, the underlying hedged item must expose the Company to risks associated with market fluctuations and the financial instrument used must be designated as a hedge and must reduce the Company’s exposure to market 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. Net settlements pursuant to the financial instrument are included as interest expense in the period.

In accordance with the terms of its $2.725 billion senior secured credit facility, the Company was required to enter into interest rate swap agreements in an amount equal to 50% of the outstanding term loan balances within 100 days of the closing date of the $2.725 billion senior secured credit facility.  On October 27, 2005, the Company entered into four interest rate swap contracts with terms from three to five years, notional amounts of $224 million, $274 million, $225 million, and

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$237 million, for a total of $960 million, and fixed interest rates ranging from 4.678% to 4.753%.  The annual weighted-average interest rate of the four contracts is 4.71%. On May 8, 2006, the Company entered into three interest rate swap contracts with a term of five years and notional amounts of $100 million each, for a total of $300 million and fixed interest rates ranging from 5.263% to 5.266%. The annual weighted-average interest rate of the three contracts is 5.26%. Under all of these contracts, the Company pays a fixed interest rate against a variable interest rate based on the 90-day LIBOR rate. The 90-day LIBOR rate relating to these contracts as of June 30, 2007 was 5.36% for both the $960 million swaps and the $300 million swaps.

Redemption of 87¤8% Senior Subordinated Notes

In February 2006, the Company called for the redemption of its $175 million 87¤8% senior subordinated notes. The redemption price was $1,044.38 per $1,000 principal amount, plus accrued and unpaid interest and was made on March 15, 2006. The Company recorded a $10.0 million loss on early extinguishment of debt during the six months ended June 30, 2006 for the call premium and the write-off of the associated deferred financing fees. The Company funded the redemption of the notes from available cash and borrowings under its revolving credit facility.

67¤8% Senior Subordinated Notes

On December 4, 2003, the Company completed an offering of $200 million of 67¤8% senior subordinated notes that mature on December 1, 2011. Interest on the notes is payable on June 1 and December 1 of each year, beginning June 1, 2004.

The Company may redeem all or part of the notes on or after December 1, 2007 at certain specified redemption prices.

The 67¤8% notes are general unsecured obligations and are guaranteed on a senior subordinated basis by certain of the Company’s current and future wholly-owned domestic subsidiaries. The 67¤8% notes rank equally with the Company’s future senior subordinated debt and junior to its senior debt, including debt under the Company’s $2.725 billion senior secured credit facility. In addition, the 67¤8% notes will be effectively junior to any indebtedness of Penn’s non-U.S. unrestricted subsidiaries.

The 67¤8% notes and guarantees were originally issued in a private placement pursuant to an exemption from the registration requirements of the Securities Act of 1933 (the “Securities Act”). On August 27, 2004, the Company completed an offer to exchange the notes and guarantees for notes and guarantees registered under the Securities Act having substantially identical terms.

6 ¾% Senior Subordinated Notes

On March 9, 2005, the Company completed an offering of $250 million of 63¤4% senior subordinated notes that mature on March 1, 2015. Interest on the notes is payable on March 1 and September 1 of each year, beginning September 1, 2005.  The 63¤4% notes are general unsecured obligations and are not guaranteed by the Company’s subsidiaries.  The 63¤4% notes were issued in a private placement pursuant to an exemption from the registration requirements of the Securities Act.

Other Long-Term Obligations

On October 15, 2004, the Company announced the sale of The Downs Racing, Inc. and its subsidiaries to the Mohegan Tribal Gaming Authority (the “MTGA”). Under the terms of the agreement, the MTGA acquired The Downs Racing, Inc. and its subsidiaries, including Pocono Downs (a standardbred horse racing facility located on 400 acres in Wilkes-Barre, Pennsylvania) and five Pennsylvania off-track wagering facilities located in Carbondale, East Stroudsburg, Erie, Hazelton and the Lehigh Valley (Allentown). The sale agreement also provided the MTGA with certain post-closing termination rights in the event of certain materially adverse legislative or regulatory events. In January 2005, the Company received $280 million from the MTGA and transferred the operations of The Downs Racing, Inc. and its subsidiaries to the MTGA. The sale was not considered final for accounting purposes until the third quarter of 2006, as the MTGA had certain post-closing termination rights that remained outstanding. On August 7, 2006, the Company entered into the Second Amendment to the Purchase Agreement and Release of Claims (“Amendment and Release”) with the MTGA pertaining to the October 14, 2004 Purchase Agreement (the “Purchase Agreement”) and agreed to pay the MTGA an aggregate of $30 million over five years, beginning on the first anniversary of the commencement of slot operations at Mohegan Sun at Pocono Downs, in exchange for the MTGA’s agreement to release various claims it raised against the Company under the Purchase Agreement and the MTGA’s surrender of all post-closing termination rights it might have had under the Purchase Agreement. The Company recorded the present value of the $30 million liability within debt, as the amount due to the MTGA is payable over five years, with the first payment to occur in November 2007.

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Covenants

The Company’s $2.725 billion senior secured credit facility, $200 million 67/8% and $250 million 63¤4% senior subordinated notes require it, among other obligations, to maintain specified financial ratios and to satisfy certain financial tests, including fixed charge coverage, senior leverage and total leverage ratios. In addition, the Company’s $2.725 billion senior secured credit facility, $200 million 67/8% and $250 million 63¤4% senior subordinated notes restrict, 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 restricts corporate activities.

At June 30, 2007, the Company was in compliance with all required covenants.

10.          Commitments and Contingencies

Litigation

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

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

In November 2005, Capital Seven, LLC and Shawn A. Scott (collectively, “Capital Seven”), the sellers of Bangor Historic Track, Inc. (“BHT”), filed a demand for arbitration with the American Arbitration Association seeking $30 million plus interest and other damages. Capital Seven alleges a breach of contract by the Company based on the Company’s payment of a $51 million purchase price for the purchase of BHT instead of an alleged $81 million purchase price Capital Seven claims is due under the purchase agreement. The parties had agreed that the purchase price of BHT would be determined, in part, by the applicable gaming taxes imposed by Maine on the Company’s operations, and currently are disputing the effective tax rate. Pursuant to the dispute resolution procedures, the Company deposited $30 million in escrow, pending a resolution. This amount is included in other assets within the consolidated balance sheets at June 30, 2007 and December 31, 2006. The parties have commenced discovery.

In conjunction with the Company’s acquisition of Argosy, and subsequent disposition of the Argosy Casino Baton Rouge property, the Company became responsible for litigation initiated over eight years ago related to the Baton Rouge property formerly owned by Argosy. On November 26, 1997, Capitol House filed an amended petition in the Nineteenth Judicial District Court for East Baton Rouge Parish, State of Louisiana, amending its previously filed but unserved suit against Richard Perryman, the person selected by the Louisiana Gaming Division to evaluate and rank the applicants seeking a gaming license for East Baton Rouge Parish, and adding state law claims against Jazz Enterprises, Inc., the former Jazz Enterprises, Inc. shareholders, Argosy, Argosy of Louisiana, Inc. and Catfish Queen Partnership in Commendam, d/b/a the Belle of Baton Rouge Casino. This suit alleges that these parties violated the Louisiana Unfair Trade Practices Act in connection with obtaining the gaming license that was issued to Jazz Enterprises, Inc./Catfish Queen Partnership in Commendam. The plaintiff, an applicant for a gaming license whose application was denied by the Louisiana Gaming Division, seeks to prove that the gaming license was invalidly issued and seeks to recover lost gaming revenues that the plaintiff contends it could have earned if the gaming license had been properly issued to the plaintiff.  On October 2, 2006, the Company prevailed on a partial summary judgment motion which limited plaintiff’s damages to its out-of-pocket costs in seeking its gaming license, thereby eliminating any recovery for potential lost gaming profits. On February 6, 2007, the jury returned a verdict of $3.8 million (exclusive of statutory interest and attorney fees) against Jazz Enterprises, Inc. and Argosy. The Court subsequently entered judgment in the amount of $6.9 million, which includes attorney fees and interest. The Company has established an appropriate reserve, and has filed post-trial motions which seek to overturn the verdict. The plaintiffs have challenged the calculation of the judgment, and are requesting a new trial. The motions are scheduled for a September 10, 2007 hearing. The Company has the right to seek indemnification from two of the former Jazz Enterprises, Inc. shareholders for any liability suffered as a result of such cause of action, however, there can be no assurance that the former Jazz Enterprises, Inc. shareholders will have assets sufficient to satisfy any claim in excess of Argosy’s recoupment rights.

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In May 2006, the Illinois Legislature passed into law House Bill 1918, effective May 26, 2006, which singled out four of the nine Illinois casinos, including the Company’s Empress Casino Hotel and Hollywood Casino Aurora, for a 3% tax surcharge to subsidize local horse racing interests. On May 30, 2006, Empress Casino Hotel and Hollywood Casino Aurora joined with the two other riverboats affected by the law, Harrah’s Joliet and the Grand Victoria Casino in Elgin, and filed suit in the Circuit Court of the Twelfth Judicial District in Will County, Illinois (the “Court”), asking the Court to declare the law unconstitutional.  The casinos began paying the 3% tax surcharge into a protest fund which accrues interest during the pendency of the lawsuit.  The accumulated funds will be returned to the casinos if they ultimately prevail in the lawsuit.  In two orders dated March 29, 2007 and April 20, 2007, the Court declared the law unconstitutional under the Uniformity Clause of the Illinois Constitution and enjoined the collection of this tax surcharge.  The State of Illinois requested, and was granted, a stay of this ruling.  As a result, the casinos will continue paying the 3% tax surcharge into the protest fund until a final order has been entered in the case.  The State of Illinois has filed its notice of appeal of the ruling to the Illinois Supreme Court.  The Company anticipates the appeal will take several months before a final ruling is reached on this matter.

In October 2002, in response to the Company’s plans to relocate the river barge underlying the Boomtown Biloxi casino to an adjacent property, Raphael Skrmetta, 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. The Mississippi Department of Marine Resources and the U.S. Army Corps of Engineers have also approved the Company’s plan to relocate the barge. In March 2004, the trial court ruled in favor of the Company on all counts. The plaintiff appealed the decision to the Fifth Circuit, which upheld the tenant’s right to relocate but remanded the case to the trial court because there was insufficient evidence in the record to determine whether the casino barge would be relocated to a place which would trigger the increased rent obligation under the lease. Mr. Skrmetta has since transferred his interest in the property to Skrmetta MS, LLC. On March 23, 2007, BTN, Inc. (“BTN”), one of the Company’s wholly-owned subsidiaries, entered into an amended and restated ground lease (the “Amended Lease”) with Skrmetta MS, LLC.  The lease amends the prior ground lease, dated October 19, 1993.  The Amended Lease requires BTN to maintain a minimum gaming operation on the leased premises and to pay rent equal to 5% of adjusted gaming win after gaming taxes have been deducted.  The term of the Amended Lease expires on January 1, 2093.  The lessor has purchased property owned by BTN and certain other of the Company’s wholly-owned subsidiaries in the vicinity of Boomtown Biloxi casino for $12.8 million. As a result of the execution of the Amended Lease, all litigation between the lessor and BTN has been settled and dismissed.

Operating Lease Commitments

The Company is liable under numerous operating leases for airplanes, automobiles, land for the property on which some of its casinos operate, other equipment and buildings, which expire at various dates through 2093. Total rental expense under these agreements was $7.7 million and $15.8 million for the three and six months ended June 30, 2007, respectively, as compared to $7.1 million and $13.0 million for the three and six months ended June 30, 2006, respectively.

The leases for land consist of annual base lease rent payments, plus a percentage rent based on a percent of adjusted gaming wins, as described in the respective leases.

The Company has an operating lease with the City of Bangor for a permanent facility which the Company expects to open in the third quarter of 2008, at a budgeted cost of $131 million.  This permanent facility, which will be called Hollywood Slots Hotel and Raceway, is subject to a percentage rent equaling 3% of gross slot revenue. The lease is for an initial term of fifteen years, with three ten-year renewal options.  The initial term begins with the opening of the permanent facility. An agreement with the City of Bangor calls for a two-year rent moratorium for 2006 and 2007.

On March 23, 2007, BTN, one of the Company’s wholly-owned subsidiaries, entered into an Amended Lease with Skrmetta MS, LLC.  The lease amends the prior ground lease, dated October 19, 1993.  The Amended Lease requires BTN to maintain a minimum gaming operation on the leased premises and to pay rent equal to 5% of adjusted gaming win after gaming taxes have been deducted.  The term of the Amended Lease expires on January 1, 2093.

The future minimum lease commitments relating to the base lease rent portion of noncancelable operating leases at June 30, 2007 are as follows (in thousands):

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Capital Expenditure Commitments

At June 30, 2007, the Company is contractually committed to spend approximately $174.4 million in capital expenditures for projects in progress.

11.          Stock-Based Compensation

In April 1994, the Company’s Board of Directors and shareholders adopted and approved the 1994 Stock Option Plan (the “1994 Plan”). The 1994 Plan permitted the grant of options to purchase up to 12,000,000 shares of Common Stock, subject to antidilution adjustments, at a price per share no less than 100% of the fair market value of the Common Stock on the date an option is granted with respect to incentive stock options only. The price would be no less than 110% of fair market value in the case of an incentive stock option granted to any individual who owns more than 10% of the total combined voting power of all classes of outstanding stock. The 1994 Plan provided for the granting of both incentive stock options intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended, and nonqualified stock options, which do not so qualify. The 1994 Plan terminated in April 2004, but options granted prior to the 1994 Plan’s termination remain outstanding.

On April 16, 2003, the Company’s Board of Directors adopted and approved the 2003 Long Term Incentive Compensation Plan (the “2003 Plan”). On May 22, 2003, the Company’s shareholders approved the 2003 Plan. The 2003 Plan was effective June 1, 2003 and permits the grant of options to purchase Common Stock and other market-based and performance-based awards. Up to 12,000,000 shares of Common Stock are available for awards under the 2003 Plan. The 2003 Plan provides for the granting of both incentive stock options intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended, and nonqualified stock options, which do not so qualify. The exercise price per share may be no less than (i) 100% of the fair market value of the Common Stock on the date an option is granted for incentive stock options and (ii) 85% of the fair market value of the Common Stock on the date an option is granted for nonqualified stock options. Unless this plan is extended, no awards shall be granted or exchanges effected under this plan after May 31, 2013. At June 30, 2007 and December 31, 2006, there were 3,215,225 and 4,182,600 options available for future grants under the 2003 Plan, respectively.

Stock options that expire between January 2, 2008 and January 2, 2017 have been granted to officers, directors and employees to purchase Common Stock at prices ranging from $2.58 to $61.60 per share. All options were granted at the fair market value of the Common Stock on the date the options were granted.

The following table contains information on stock options issued under the plans for the six months ended June 30, 2007 and 2006:

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		Number of Option Shares		Weighted-Average Exercise Price			Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2005		7,733,814		$	17.09		5.34		$	122,844
Granted		1,446,500		33.19
Exercised		(990,838	)	9.64
Canceled		(52,500	)	20.28
Outstanding at June 30, 2006		8,136,976		$	20.84		5.32		$	145,976
Exercisable at June 30, 2006		2,842,226		$	13.43		4.06		$	72,040
Outstanding at December 31, 2006		8,110,601		$	21.87		4.97		$	160,225
Granted		1,431,750		41.89
Exercised		(598,396	)	12.25
Canceled		(475,375	)	28.22
Outstanding at June 30, 2007		8,468,580		$	25.57		5.03		$	290,621
Exercisable at June 30, 2007		3,989,180		$	17.98		3.98		$	167,181

 

Included in the above are common stock options that were issued in 2003 to the Company’s Chairman outside of the 1994 Plan and the 2003 Plan. These options were issued at $7.95 per share, and are exercisable through February 6, 2013. At June 30, 2007 and December 31, 2006, the number of these common stock options that were outstanding was 23,750. In addition, the Company issued 160,000 restricted stock awards in 2004, which fully vest in May 2009, and issued 280,000 restricted stock awards in 2006, which fully vest by 2011. The restricted stock grants in 2004 and 2006 were made pursuant to the 2003 Plan. Due to the departure of one of the Company’s senior executives, 60,000 of these awards were forfeited. The weighted-average grant-date fair value of options granted during the three and six months ended June 30, 2007 was $18.74 and $15.95, respectively, as compared to $16.49 and $14.68 during the three and six months ended June 30, 2006, respectively.

The aggregate intrinsic value of stock options exercised during the three and six months ended June 30, 2007 was $7.7 million and $21.1 million, respectively, as compared to $1.3 million and $28.1 million during the three and six months ended June 30, 2006, respectively.

The following table summarizes information about stock options outstanding at June 30, 2007:

		Exercise Price Range									Total
		$2.58 to $14.67			$14.75 to $33.12			$33.17 to $61.60			$2.58 to $61.60
Outstanding options
Number outstanding		2,831,062			3,765,665			1,871,853			8,468,580
Weighted-average remaining contractual life (years)		3.17			5.53			6.85			5.03
Weighted-average exercise price		$	10.09		$	29.99		$	40.09		$	25.57
Exercisable options
Number outstanding		2,339,562			1,617,415			32,203			3,989,180
Weighted-average exercise price		$	9.74		$	29.55		$	35.50		$	17.98

 

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Compensation costs related to stock-based compensation for the three and six months ended June 30, 2007 totaled $6.3 million pre-tax ($4.5 million after-tax) and $12.9 million pre-tax ($9.3 million after-tax), respectively, as compared to $5.5 million pre-tax ($3.3 million after-tax) and $10.4 million pre-tax ($6.8 million after-tax) for the three and six months ended June 30, 2006, respectively.  These are included within the consolidated statements of income under general and administrative expense.

At June 30, 2007 and December 31, 2006, the total compensation cost related to nonvested awards not yet recognized equaled $53.5 million and $45.2 million, respectively, including $47.2 million and $38.0 million for stock options, respectively, and $6.3 million and $7.2 million for restricted stock, respectively. This cost is expected to be recognized over the remaining vesting periods, which will not exceed five years.

12.          Subsidiary Guarantors

Under the terms of the $2.725 billion senior secured credit facility, all of Penn’s subsidiaries are guarantors under the agreement, with the exception of several minor subsidiaries with total assets of $111.1 million (approximately 2% of total assets at June 30, 2007). Each of the subsidiary guarantors is 100% owned by Penn. In addition, the guarantees provided by Penn’s subsidiaries under the terms of the $2.725 billion senior secured credit facility are full and unconditional, joint and several, and Penn has no significant independent assets and no independent operations at, and for the three and six months ended, June 30, 2007. There are no significant restrictions within the $2.725 billion senior secured credit facility on the Company’s ability to obtain funds from its subsidiaries by dividend or loan. However, in certain jurisdictions, the gaming authorities may impose restrictions pursuant to the authority granted to them with regard to Penn’s  ability to obtain funds from its subsidiaries.

With regard to the $2.725 billion senior secured credit facility, the Company has not presented condensed consolidating balance sheets, condensed consolidating statements of income and condensed consolidating statements of cash flows at, and for the three and six months ended, June 30, 2007 and 2006, as Penn had no significant independent assets and no independent operations at, and for the three and six months ended, June 30, 2007, the guarantees are full and unconditional and joint and several, and any subsidiaries of Penn other than the subsidiary guarantors are considered minor.

Under the terms of the $200 million 67/8% senior subordinated notes, all of Penn’s subsidiaries are guarantors under the agreement, with the exception of several minor subsidiaries with total assets of $102.8 million (approximately 2% of total assets at June 30, 2007). Each of the subsidiary guarantors is 100% owned by Penn. In addition, the guarantees provided by Penn’s subsidiaries under the terms of the $200 million 67/8% senior subordinated notes are full and unconditional, joint and several, and Penn had no significant independent assets and no independent operations at, and for the three and six months ended June 30, 2007. There are no significant restrictions within the $200 million 67/8% senior subordinated notes on the Company’s ability to obtain funds from its subsidiaries by dividend or loan. However, in certain jurisdictions, the gaming authorities may impose restrictions pursuant to the authority granted to them with regard to Penn’s ability to obtain funds from its subsidiaries.

With regard to the $200 million 67/8% senior subordinated notes, the Company has not presented condensed consolidating balance sheets, condensed consolidating statements of income and condensed consolidating statements of cash flows at, and for the three and six months ended, June 30, 2007 and 2006, as Penn had no significant independent assets and no independent operations at, and for the three and six months ended, June 30, 2007, the guarantees are full and unconditional and joint and several, and any subsidiaries of Penn other than the subsidiary guarantors are considered minor.

13.          Subsequent Event

On July 5, 2007, the Company announced that it had entered into a definitive agreement to purchase the Sanford-Orlando Kennel Club in Longwood, Florida from Sanford-Orlando Kennel Club, Inc. and Collins & Collins. In connection with the purchase agreement, the Company also secured a right of first refusal with respect to a majority stake in the Sarasota Kennel Club in Sarasota, Florida from Jack G. Collins, Sr. and members of his family. The purchase of the Sanford-Orlando Kennel Club is expected to close in the fourth quarter of 2007, and is subject to several customary conditions, including approval by Florida’s Department of Business and Professional Regulation. The purchase price for the Sanford-Orlando Kennel Club contemplates additional consideration to be paid by the Company based upon certain future regulatory developments. Located on approximately 26 acres in Longwood, Florida, the Sanford-Orlando Kennel Club features year-round greyhound racing, a simulcast wagering facility, a clubhouse lounge and two dining areas.

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