PENN Entertainment, Inc. - Quarter Report: 2013 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended March 31, 2013

 

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) (Zip Code)

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

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

 

 

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

 

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

 

 

 

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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 that could cause actual results to differ from expectations include, but are not limited to, risks related to the following: the proposed separation of a newly formed publicly traded real estate investment trust which will be named Gaming and Leisure Properties, Inc. (“GLPI”) from the Company (the “Spin-Off”), including our ability to timely receive all necessary consents and approvals, the anticipated timing of the proposed separation, the expected tax treatment of the proposed transaction, the ability of each of the post-spin Company and GLPI to conduct and expand their respective businesses following the proposed Spin-Off, and the diversion of management’s attention from traditional business concerns; our ability to raise the capital necessary to finance the Spin-Off, including the redemption of our existing debt and preferred stock obligations, the anticipated cash portion of our special earnings and profit dividend and transaction costs; our ability to obtain timely regulatory approvals required to own, develop and/or operate our facilities, or other delays or impediments to completing our planned acquisitions or projects, including favorable resolution of any related litigation, including the ongoing appeal by the Ohio Roundtable addressing the legality of video lottery terminals in Ohio; our ability to secure state and local permits and approvals necessary for construction; construction factors, including delays, unexpected remediation costs, local opposition and increased cost of labor and materials; our ability to successfully integrate Harrah’s St. Louis into our existing business; our ability to reach agreements with the State of Ohio that memorialize our earlier Memorandum of Understanding; our ability to reach agreements with the thoroughbred and harness horseman in Ohio in connection with the proposed relocations and to otherwise maintain agreements with our horseman, pari-mutuel clerks and other organized labor groups; with respect to the proposed Jamul project, particular risks associated with securing financing, local opposition, and building a complex project on a relatively small parcel; the passage of state, federal or local legislation (including referenda) that would expand, restrict, further tax, prevent or negatively impact operations in or adjacent to the jurisdictions in which we do or seek to do business (such as a smoking ban at any of our facilities); the effects of local and national economic, credit, capital market, housing, and energy conditions on the economy in general and on the gaming and lodging industries in particular; the activities of our competitors and the rapid emergence of new competitors (traditional, internet based and sweepstakes based); increases in the effective rate of taxation at any of our properties or at the corporate level; our ability to identify attractive acquisition and development opportunities and to agree to terms with partners for such transactions; the costs and risks involved in the pursuit of such opportunities and our ability to complete the acquisition or development of, and achieve the expected returns from, such opportunities; our expectations for the continued availability and cost of capital; the outcome of pending legal proceedings; changes in accounting standards; our dependence on key personnel; the impact of terrorism and other international hostilities; the impact of weather; and other factors as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K as filed 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.

 

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PENN NATIONAL GAMING, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION		4
ITEM 1.	FINANCIAL STATEMENTS (Unaudited)		4
	Condensed Consolidated Balance Sheets — March 31, 2013 and December 31, 2012		4
	Condensed Consolidated Statements of Income — Three Months Ended March 31, 2013 and 2012		5
	Condensed Consolidated Statements of Comprehensive Income — Three Months Ended March 31, 2013 and 2012		6
	Condensed Consolidated Statements of Changes in Shareholders’ Equity — Three Months Ended March 31, 2013 and 2012		7
	Condensed Consolidated Statements of Cash Flows — Three Months Ended March 31, 2013 and 2012		8
	Notes to the Condensed Consolidated Financial Statements		9
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		21
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		33
ITEM 4.	CONTROLS AND PROCEDURES		33
PART II.	OTHER INFORMATION		34
ITEM 1.	LEGAL PROCEEDINGS		34
ITEM 1A.	RISK FACTORS		34
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		34
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES		34
ITEM 4.	MINE SAFETY DISCLOSURES		34
ITEM 5.	OTHER INFORMATION		34
ITEM 6.	EXHIBITS		34
SIGNATURES			35
EXHIBIT INDEX			36

 

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

 

		March 31,			December 31,
		2013			2012
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	247,702		$	260,467
Receivables, net of allowance for doubtful accounts of $3,909 and $3,901 at March 31, 2013 and December 31, 2012, respectively		56,888			53,720
Prepaid expenses		74,525			94,620
Deferred income taxes		36,863			39,793
Other current assets		11,480			38,540
Total current assets		427,458			487,140
Property and equipment, net		2,707,172			2,730,797
Other assets
Investment in and advances to unconsolidated affiliates		201,727			204,506
Goodwill		1,379,355			1,380,689
Other intangible assets		706,718			706,477
Debt issuance costs, net of accumulated amortization of $13,548 and $11,462 at March 31, 2013 and December 31, 2012, respectively		33,959			35,999
Other assets		109,187			98,449
Total other assets		2,430,946			2,426,120
Total assets		$	5,565,576		$	5,644,057
Liabilities
Current liabilities
Current maturities of long-term debt		$	88,368		$	81,497
Accounts payable		37,198			38,268
Accrued expenses		103,308			133,316
Accrued interest		14,882			21,872
Accrued salaries and wages		78,076			96,426
Gaming, pari-mutuel, property, and other taxes		61,313			55,610
Insurance financing		13,456			3,856
Other current liabilities		75,114			68,774
Total current liabilities		471,715			499,619
Long-term liabilities
Long-term debt, net of current maturities		2,525,316			2,649,073
Deferred income taxes		221,124			216,357
Noncurrent tax liabilities		21,757			20,393
Other noncurrent liabilities		7,050			7,686
Total long-term liabilities		2,775,247			2,893,509
Shareholders’ equity
Preferred stock ($.01 par value, 1,000,000 shares authorized, 12,050 and 12,275 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively)		—			—
Common stock ($.01 par value, 200,000,000 shares authorized, 78,175,181 and 77,446,601 shares issued at March 31, 2013 and December 31, 2012, respectively)		774			769
Additional paid-in capital		1,454,864			1,451,965
Retained earnings		860,444			795,173
Accumulated other comprehensive income		2,532			3,022
Total shareholders’ equity		2,318,614			2,250,929
Total liabilities and shareholders’ equity		$	5,565,576		$	5,644,057

 

See accompanying notes to the condensed consolidated financial statements.

 

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Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(in thousands, except per share data)

(unaudited)

 

		Three Months Ended March 31,
		2013			2012
Revenues
Gaming		$	717,925		$	656,077
Food, beverage and other		121,860			112,908
Management service fee		3,047			3,443
Revenues		842,832			772,428
Less promotional allowances		(44,586		)	(36,369		)
Net revenues		798,246			736,059
Operating expenses
Gaming		362,018			340,169
Food, beverage and other		90,265			87,804
General and administrative		135,577			115,997
Depreciation and amortization		77,071			53,337
Insurance recoveries, net of deductible charges		—			(3,863		)
Total operating expenses		664,931			593,444
Income from operations		133,315			142,615
Other income (expenses)
Interest expense		(27,924		)	(18,043		)
Interest income		262			219
Gain from unconsolidated affiliates		1,721			1,685
Other		664			(1,003		)
Total other expenses		(25,277		)	(17,142		)
Income from operations before income taxes		108,038			125,473
Taxes on income		42,767			46,854
Net income		$	65,271		$	78,619
Earnings per common share:
Basic earnings per common share		$	0.68		$	0.83
Diluted earnings per common share		$	0.63		$	0.74

 

See accompanying notes to the condensed consolidated financial statements.

 

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Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(in thousands) (unaudited)

 

		Three Months Ended March 31,
		2013			2012
Net income		$	65,271		$	78,619
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustment during the period		(391		)	288
Unrealized holding losses on corporate debt securities arising during the period		(99		)	(70		)
Other comprehensive (loss) income		(490		)	218
Comprehensive income		$	64,781		$	78,837

 

See accompanying notes to the condensed consolidated financial statements.

 

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Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(in thousands, except share data) (unaudited)

 

		Preferred Stock					Common Stock					Additional Paid-In			Retained			Accumulated Other Comprehensive			Total Shareholders’
		Shares		Amount			Shares		Amount			Capital			Earnings			Income			Equity
Balance, December 31, 2011		12,275		$	—		76,213,126		$	756		$	1,385,355		$	583,202		$	2,318		$	1,971,631
Stock option activity, including tax benefit of $1,126		—		—			214,632		2			12,919			—			—			12,921
Restricted stock activity, including tax benefit of $353		—		—			(4,076	)	—			1,109			—			—			1,109
Change in fair value of corporate debt securities		—		—			—		—			—			—			(70		)	(70		)
Foreign currency translation adjustment		—		—			—		—			—			—			288			288
Net income		—		—			—		—			—			78,619			—			78,619
Balance, March 31, 2012		12,275		$	—		76,423,682		$	758		$	1,399,383		$	661,821		$	2,536		$	2,064,498
Balance, December 31, 2012		12,275		$	—		77,446,601		$	769		$	1,451,965		$	795,173		$	3,022		$	2,250,929
Repurchase of preferred stock		(225	)	—			—		—			(22,275		)	—			—			(22,275		)
Stock option activity, including tax benefit of $2,717		—		—			540,567		5			24,732			—			—			24,737
Restricted stock activity, including tax benefit of $749		—		—			188,013		—			442			—			—			442
Change in fair value of corporate debt securities		—		—			—		—			—			—			(99		)	(99		)
Foreign currency translation adjustment		—		—			—		—			—			—			(391		)	(391		)
Net income		—		—			—		—			—			65,271			—			65,271
Balance, March 31, 2013		12,050		$	—		78,175,181		$	774		$	1,454,864		$	860,444		$	2,532		$	2,318,614

 

See accompanying notes to the condensed consolidated financial statements.

 

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Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands) (unaudited)

 

Three Months Ended March 31,		2013			2012
Operating activities
Net income		$	65,271		$	78,619
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		77,071			53,337
Amortization of items charged to interest expense		2,149			1,649
Loss (gain) on sale of fixed assets		2,390			(945		)
Gain from unconsolidated affiliates		(1,721		)	(1,685		)
Distributions of earnings from unconsolidated affiliates		5,000			—
Deferred income taxes		8,174			(3,143		)
Charge for stock-based compensation		6,251			7,911
(Increase) decrease, net of businesses acquired
Accounts receivable		(3,807		)	(114		)
Insurance receivable		—			1,072
Prepaid expenses and other current assets		21,878			3,459
Other assets		(11,544		)	(2,328		)
Increase (decrease), net of businesses acquired
Accounts payable		3,922			197
Accrued expenses		(30,503		)	(23,897		)
Accrued interest		(6,990		)	(7,711		)
Accrued salaries and wages		(18,096		)	(22,201		)
Gaming, pari-mutuel, property and other taxes		5,703			(219		)
Income taxes		—			31,434
Other current and noncurrent liabilities		6,669			5,465
Other noncurrent tax liabilities		1,971			1,724
Net cash provided by operating activities		133,788			122,624
Investing activities
Expenditures for property and equipment, net of reimbursements		(62,703		)	(119,659		)
Proceeds from sale of property and equipment		2,517			1,283
Investment in joint ventures		(500		)	(39,600		)
Decrease in cash in escrow		26,000			25,650
Acquisition of gaming licenses		(1,125		)	—
Net cash used in investing activities		(35,811		)	(132,326		)
Financing activities
Proceeds from exercise of options		15,461			4,640
Repurchase of preferred stock		(22,275		)	—
Proceeds from issuance of long-term debt, net of issuance costs		19,954			47,932
Principal payments on long-term debt		(136,949		)	(60,656		)
Proceeds from insurance financing		15,306			—
Payments on insurance financing		(5,706		)	(4,682		)
Tax benefit from stock options exercised		3,467			1,479
Net cash used in financing activities		(110,742		)	(11,287		)
Net decrease in cash and cash equivalents		(12,765		)	(20,989		)
Cash and cash equivalents at beginning of year		260,467			238,440
Cash and cash equivalents at end of period		$	247,702		$	217,451
Supplemental disclosure
Interest expense paid, net of amounts capitalized		$	32,673		$	24,007
Income taxes paid		$	1,124		$	15,353

 

See accompanying notes to the condensed consolidated financial statements.

 

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Penn National Gaming, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements

(Unaudited)

 

1.  Organization and Basis of Presentation

 

Penn National Gaming, Inc. (“Penn”) and subsidiaries (collectively, the “Company”) is a diversified, multi-jurisdictional owner and manager of gaming and pari-mutuel properties. As of March 31, 2013, the Company owned, managed, or had ownership interests in twenty-nine facilities in the following nineteen jurisdictions: Colorado, Florida, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Mississippi, Missouri, Nevada, New Jersey, New Mexico, Ohio, Pennsylvania, Texas, West Virginia, and Ontario.

 

The accompanying unaudited condensed consolidated financial statements of 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 condensed consolidated financial statements include the accounts of Penn and its subsidiaries. Investment in and advances to unconsolidated affiliates are accounted for under the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses for the reporting periods. Actual results could differ from those estimates.  For purposes of comparability, certain prior year amounts have been reclassified to conform to the current year presentation.

 

Operating results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The notes to the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2012 should be read in conjunction with these condensed consolidated financial statements.  The December 31, 2012 financial information has been derived from the Company’s audited consolidated financial statements.

 

2.                                      Proposed Spin-Off of Real Estate Assets through a Real Estate Investment Trust

 

On November 15, 2012, the Company announced that it intends to pursue a plan to separate the majority of its gaming operating assets and real property assets into two publicly traded companies including an operating entity, Penn National Gaming (“PNG”), and, through a tax-free spin-off of its real estate assets to holders of its common and preferred stock, a newly formed publicly traded real estate investment trust (“REIT”) that will be named Gaming and Leisure Properties, Inc. (“GLPI”), subject to required gaming regulatory body approvals and other contingencies noted below (the “Spin-Off”).

 

A REIT is not permitted to retain earnings and profits (“E&P”) accumulated during the years when the company or its predecessor was taxed as a regular C corporation. For GLPI to elect REIT status, GLPI must distribute to its shareholders its undistributed E&P attributable to taxable periods prior to its REIT election. The Company currently estimates that, if GLPI were to elect REIT status as of January 1, 2014, the aggregate amount of the special E&P taxable dividend would be approximately $1.1 billion. The dividend will be paid in a combination of cash and GLPI common stock, which will consist of at least 20% in cash with the remainder in GLPI common stock.

 

As a result of the proposed Spin-Off, GLPI will initially own substantially all of the real property assets and will lease back most of those assets to PNG for use by its subsidiaries, under a “triple net” 15 year Master Lease agreement (excluding four 5 year renewals, which are at PNG’s option) as well as own and operate Hollywood Casino Perryville and Hollywood Casino Baton Rouge through a taxable REIT subsidiary. PNG would hold the gaming licenses, operate the leased gaming facilities and own and operate other assets, including the Casino Rama casino management contract, the 50% joint venture interest in Hollywood Casino at Kansas Speedway, seven non-casino racetracks and gaming equipment.

 

The Company has received a private letter ruling from the Internal Revenue Service relating to the tax treatment of the separation and the qualification of GLPI as a REIT. The private letter ruling is subject to certain qualifications and based on certain representations and statements made by the Company. If such representations and statements are untrue or incomplete in any material

 

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respect (including as a result of a material change in the proposed transaction or other relevant facts), the Company may not be able to rely on the private letter ruling.

 

The completion of the proposed Spin-Off is contingent, among other things, on receipt of regulatory approvals, the receipt of final approval by Penn’s Board of Directors, execution of definitive documentation, the receipt of legal and accounting opinions, raising significant amounts of capital to finance the transaction, and other customary conditions. The Company may, at any time and for any reason until the proposed Spin-Off is complete, abandon the Spin-Off or modify or change the terms of the Spin-Off.

 

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. Progressive slot machines, which contain base jackpots that increase at a progressive rate based on the number of coins played, are charged to revenue as the amount of the jackpots increase.

 

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

 

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

 

Revenues are recognized net of certain sales incentives in accordance with Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 605-50, “Revenue Recognition—Customer Payments and Incentives.” The Company records certain sales incentives and points earned in point-loyalty programs as a reduction of 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 months ended March 31, 2013 and 2012 are as follows:

 

		Three Months Ended March 31,
		2013			2012
		(in thousands)
Rooms		$	9,319		$	6,294
Food and beverage		32,490			27,479
Other		2,777			2,596
Total promotional allowances		$	44,586		$	36,369

 

The estimated cost of providing such complimentary services for the three months ended March 31, 2013 and 2012 are as follows:

 

		Three Months Ended March 31,
		2013			2012
		(in thousands)
Rooms		$	3,239		$	2,356
Food and beverage		21,979			18,480
Other		1,644			1,522
Total cost of complimentary services		$	26,862		$	22,358

 

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Gaming and Racing Taxes

 

The Company is subject to gaming and pari-mutuel taxes based on gross gaming revenue and pari-mutuel revenue in the jurisdictions in which it operates. The Company primarily recognizes gaming and pari-mutuel tax expense based on the statutorily required percentage of revenue that is required to be paid to state and local jurisdictions in the states where or in which wagering occurs. In certain states in which the Company operates, gaming taxes are based on graduated rates. The Company records gaming tax expense at the Company’s estimated effective gaming tax rate for the year, considering estimated taxable gaming revenue and the applicable rates. Such estimates are adjusted each interim period. If gaming tax rates change during the year, such changes are applied prospectively in the determination of gaming tax expense in future interim periods. Finally, the Company recognizes purse expense based on the statutorily required percentage of revenue that is required to be paid out in the form of purses to the winning owners of horseraces run at the Company’s racetracks in the period in which wagering occurs. For the three months ended March 31, 2013, these expenses, which are recorded primarily within gaming expense in the condensed consolidated statements of income, were $282.0 million, as compared to $276.9 million for the three months ended March 31, 2012.

 

Earnings Per Share

 

The Company calculates earnings per share (“EPS”) in accordance with ASC 260, “Earnings Per Share” (“ASC 260”). Basic EPS is computed by dividing net income applicable to common stock, excluding net income attributable to noncontrolling interests, by the weighted-average number of common shares outstanding during the period. Diluted EPS reflects the additional dilution for all potentially-dilutive securities such as stock options and unvested restricted shares.

 

At March 31, 2013, the Company had outstanding 12,050 shares of Series B Redeemable Preferred Stock (the “Preferred Stock”), which the Company determined qualified as a participating security as defined in ASC 260. Under ASC 260, a security is considered a participating security if the security may participate in undistributed earnings with common stock, whether that participation is conditioned upon the occurrence of a specified event or not. In accordance with ASC 260, a company is required to use the two-class method when computing EPS when a company has a security that qualifies as a “participating security.” The two-class method is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is included in the computation of basic EPS using the two-class method. Under the two-class method, basic EPS for the Company’s common stock is computed by dividing net income applicable to common stock by the weighted-average common shares outstanding during the period. Diluted EPS for the Company’s common stock is computed using the more dilutive of the two-class method or the if-converted method.

 

The following table sets forth the allocation of net income for the three months ended March 31, 2013 and 2012 under the two-class method:

 

		Three Months Ended March 31,
		2013			2012
		(in thousands)
Net income		$	65,271		$	78,619
Net income applicable to preferred stock		12,358			15,272
Net income applicable to common stock		$	52,913		$	63,347

 

The following table reconciles the weighted-average common shares outstanding used in the calculation of basic EPS to the weighted-average common shares outstanding used in the calculation of diluted EPS for the three months ended March 31, 2013 and 2012:

 

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		Three Months Ended March 31,
		2013		2012
		(in thousands)
Determination of shares:
Weighted-average common shares outstanding		77,553		75,994
Assumed conversion of dilutive employee stock-based awards		2,940		2,222
Assumed conversion of restricted stock		99		138
Assumed conversion of preferred stock		22,295		27,278
Diluted weighted-average common shares outstanding		102,887		105,632

 

The Company is required to adjust its diluted weighted-average common shares outstanding for the purpose of calculating diluted EPS as follows: 1) when the average price of the Company’s common stock at the end of the reporting period is less than $45, the diluted weighted-average common shares outstanding is increased by 26,777,778 shares (regardless of how much the stock price is below $45); 2) when the average price of the Company’s common stock at the end of the reporting period is between $45 and $67, the diluted weighted-average common shares outstanding is increased by an amount which can be calculated by dividing $1.205 billion (face value) by the current price per share of the Company’s common stock, which will result in an increase in the diluted weighted-average common shares outstanding of between 17,985,075 shares and 26,777,778 shares; and 3) when the average price of the Company’s common stock at the end of the reporting period is above $67, the diluted weighted- average common shares outstanding is increased by 17,985,075 shares (regardless of how much the stock price exceeds $67). See Note 9 for discussion of the proposed Spin-Off’s potential future impact on the calculation of diluted weighted-average common shares outstanding.

 

Options to purchase 235,125 shares and 3,122,903 shares were outstanding during the three months ended March 31, 2013 and 2012, respectively, but were not included in the computation of diluted EPS because they were antidilutive.

 

The following table presents the calculation of basic and diluted EPS for the Company’s common stock:

 

		Three Months Ended March 31,
		2013			2012
		(in thousands, except per share data)
Calculation of basic EPS:
Net income applicable to common stock		$	52,913		$	63,347
Weighted-average common shares outstanding		77,553			75,994
Basic EPS		$	0.68		$	0.83
Calculation of diluted EPS:
Net income		$	65,271		$	78,619
Diluted weighted-average common shares outstanding		102,887			105,632
Diluted EPS		$	0.63		$	0.74

 

Stock-Based Compensation

 

The Company accounts for stock compensation under ASC 718, “Compensation-Stock Compensation,” 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. Stock based compensation expense for the three months ended March 31, 2013 was $6.3 million, as compared to $7.9 million for the three months ended March 31, 2012.  This expense is recognized ratably over the requisite service period following the date of grant.

 

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 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 6.57 years, in order to match the expected life of the options at the grant date. Historically, at the grant date, there has been no expected dividend yield assumption 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 and expected exercise behavior of the

 

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Company’s employees. Forfeitures are estimated at the date of grant based on historical experience.  No stock options were granted by the Company during the three months ended March 31, 2013.

 

The Company has also issued cash-settled phantom stock unit awards, which vest over a period of four to five years.  Cash-settled phantom stock unit awards entitle employees and directors to receive cash based on the fair value of the Company’s common stock on the vesting date. These phantom stock unit awards are accounted for as liability awards and are re-measured at fair value each reporting period until they become vested with compensation expense being recognized over the requisite service period in accordance with ASC 718-30, “Compensation—Stock Compensation, Awards Classified as Liabilities.” As of March 31, 2013, there was $27.6 million of total unrecognized compensation cost that will be recognized over the grants remaining weighted average vesting period of 3.29 years. For the three months ended March 31, 2013, the Company recognized $2.8 million of compensation expense associated with these awards, as compared to $1.2 million for the three months ended March 31, 2012.

 

Additionally, the Company has issued stock appreciation rights to certain employees, which vest over a period of four years.  The Company’s stock appreciation rights are accounted for as liability awards since they will be settled in cash. The fair value of these awards is calculated during each reporting period and estimated using the Black-Scholes option pricing model based on the various inputs discussed below. As of March 31, 2013, there was $12.1 million of total unrecognized compensation cost that will be recognized over the awards remaining weighted average vesting period of 2.51 years. For the three months ended March 31, 2013, the Company recognized $2.8 million of compensation expense associated with these awards, as compared to $1.4 million for the three months ended March 31, 2012.

 

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model at March 31, 2013 and 2012:

 

		2013		2012
Risk-free interest rate		1.08	%	1.04	%
Expected volatility		46.27	%	47.60	%
Dividend yield		—		—
Weighted-average expected life (years)		6.57		5.82
Forfeiture rate		5.00	%	5.00	%

 

4.  New Accounting Pronouncements

 

In February 2013, the FASB finalized the disclosure requirements on how entities should present financial information about reclassification adjustments from accumulated other comprehensive income. The standard requires that companies present either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. If a component is not required to be reclassified to net income in its entirety, companies would instead cross reference to the related footnote for additional information. The disclosures required by this amendment are effective for public entities for annual and interim reporting periods beginning after December 15, 2012. The Company adopted the guidance as of January 1, 2013. Other than the additional disclosure requirements shown below, the adoption of this guidance did not have an impact on the Company’s financial statements.

 

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The net of tax changes in accumulated other comprehensive income by component were as follows:

 

		Foreign Currency			Available for sale securities			Total
Balance at December 31, 2011		$	1,202		$	1,116		$	2,318
Other comprehensive (loss) income:
Foreign currency translation adjustment		288			—			288
Unrealized holding losses on corporate debt securities		—			(70		)	(70		)
Ending balance at March 31, 2012		$	1,490		$	1,046		$	2,536
Balance at December 31, 2012		$	1,628		$	1,394		$	3,022
Other comprehensive (loss) income:
Foreign currency translation adjustment		(391		)	—			(391		)
Unrealized holding losses on corporate debt securities		—			(99		)	(99		)
Ending balance at March 31, 2013		$	1,237		$	1,295		$	2,532

 

5.  Property and Equipment

 

Property and equipment, net, consists of the following:

 

		March 31,			December 31,
		2013			2012
		(in thousands)
Land and improvements		$	438,378		$	442,882
Building and improvements		2,295,878			2,283,230
Furniture, fixtures, and equipment		1,275,140			1,240,898
Leasehold improvements		17,188			17,229
Construction in progress		37,267			30,531
Total property and equipment		4,063,851			4,014,770
Less accumulated depreciation		(1,356,679		)	(1,283,973		)
Property and equipment, net		$	2,707,172		$	2,730,797

 

Depreciation expense, for property and equipment, totaled $76.2 million for the three months ended March 31, 2013, as compared to $53.2 million for the three months ended March 31, 2012.  Interest capitalized in connection with major construction projects was $0.1 million for the three months ended March 31, 2013, as compared to $2.9 million for the three months ended March 31, 2012.

 

6.  Long-term Debt

 

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

 

			March 31,			December 31,
			2013			2012
			(in thousands)
Senior secured credit facility			$	2,278,050		$	2,394,963
$	325 million 8 ¾% senior subordinated notes due August 2019		325,000			325,000
Other long-term obligations			10,000			10,000
Capital leases			2,076			2,111
			2,615,126			2,732,074
Less current maturities of long-term debt			(88,368		)	(81,497		)
Less discount on senior secured credit facility Term Loan B			(1,442		)	(1,504		)
			$	2,525,316		$	2,649,073

 

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The following is a schedule of future minimum repayments of long-term debt as of March 31, 2013 (in thousands) (which does not contemplate the redemption of debt obligations that are anticipated to occur in connection with the proposed Spin-Off):

 

Within one year		$	88,368
1-3 years		238,633
3-5 years		775,543
Over 5 years		1,512,582
Total minimum payments		$	2,615,126

 

Senior Secured Credit Facility

 

The Company’s senior secured credit facility had a gross outstanding balance of $2,278.1 million at March 31, 2013, consisting of a $1,028.8 million Term Loan A facility and a $1,249.3 million Term Loan B facility.  No balances were outstanding on the revolving credit facility at March 31, 2013.  Additionally, at March 31, 2013, the Company was contingently obligated under letters of credit issued pursuant to the senior secured credit facility with face amounts aggregating $73.2 million, resulting in $711.8 million of available borrowing capacity as of March 31, 2013 under the revolving credit facility.

 

Covenants

 

The Company’s senior secured credit facility and $325 million 83/4% senior subordinated notes require it, among other obligations, to maintain specified financial ratios and to satisfy certain financial tests, including fixed charge coverage, interest coverage, senior leverage and total leverage ratios. In addition, the Company’s senior secured credit facility and $325 million 83/4% 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, engage in mergers or consolidations, and otherwise restrict corporate activities.

 

At March 31, 2013, the Company was in compliance with all required financial covenants.

 

7.  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. The Company believes that it has meritorious defenses, claims and/or counter-claims, and intends to vigorously defend itself or pursue its claims.

 

Gaming licenses in Iowa are typically issued jointly to a gaming operator and a local charitable organization known as a QSO. The agreement between the Company’s gaming operator subsidiary in Iowa, Belle of Sioux City, L.P. (“Belle”), and its QSO, Missouri River Historical Development, Inc. (“MRHD”), expired in early July 2012. On July 12, 2012, when presented with an extension of the Company’s QSO/operating agreement for the Sioux City facility through March 2015, the Iowa Racing and Gaming Commission (“IRGC”) failed to approve the extension and urged a shorter extension. In mid-August 2012, MRHD offered a revised contract to the Company that would require a yearly renewal from the IRGC and stated that MHRD would be able to continue searching for an operator for a new land-based casino. The Company rejected this contract offer and at the August 23, 2012 IRGC meeting urged the IRGC to reconsider the original extension offer through March 2015. The IRGC did not act on this request and, concluded that the casino can continue to operate without an effective operating agreement. The IRGC also announced at the July 12, 2012 meeting the schedule for requests for proposals for a new land-based Woodbury County casino. Applications and financing proposals were due by November 5, 2012. The Company submitted two proposals for a new gaming and entertainment destination in Woodbury County for the IRGC’s consideration. On April 18, 2013, the IRGC awarded the license to another gaming operator. The IRGC has indicated that it intends to permit the Company to continue operations at its Sioux City facility until such time as the new

 

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casino opens to the public, but not beyond. The Company is currently reviewing all of its options and will maintain an open dialogue with members of the IRGC, Sioux City officials, and its employees regarding the IRGC’s decision. However, in light of this decision, the Company believes that the fair value of its Sioux City reporting unit will be less than its carrying amount and expects to record a goodwill and other intangible impairment charge of between $65 million and $80 million in its results in the second quarter of 2013.  The exact amount of the charge will be determined after the Company completes its analysis of the estimated future expected cash flows  it anticipates receiving from the operations of its Sioux City facility. Argosy Casino Sioux City had remaining goodwill and other intangible assets of $92.8 million at March 31, 2013, and had net revenues and income from operations of $14.0 million and $3.7 million, respectively, for the three months ended March 31, 2013, which represented 1.8% and 2.8% of the Company’s consolidated results. The Belle has filed three lawsuits against the IRGC’s recent actions, namely refusing to consider the Belle’s request to replace MRHD with another non-profit partner and opening up the gaming license to bidding for a land-based casino, its failure to approve the 2015 extension agreement and any extension, and announcing a process would be instituted to revoke the Belle’s license. In addition, the Belle filed suit against MRHD for a breach of contract and seeking to enjoin MRHD from disavowing the 2015 extension agreement it signed and the exclusivity obligations in the agreement. The injunction request was denied on October 29, 2012.  A trial has been scheduled to begin in April 2014.

 

On September 11, 2008, the Board of County Commissioners of Cherokee County, Kansas (the “County”) filed suit against Kansas Penn Gaming, LLC (“KPG,” a wholly owned subsidiary of Penn created to pursue a development project in Cherokee County, Kansas) and the Company in the District Court of Shawnee County, Kansas. The petition alleged that KPG breached its pre-development agreement with the County when KPG withdrew its application to manage a lottery gaming facility in Cherokee County and sought in excess of $50 million in damages. In connection with their petition, the County obtained an ex-parte order attaching the $25 million privilege fee (which was included in current assets at December 31, 2012) paid to the Kansas Lottery Commission in conjunction with the gaming application for the Cherokee County zone. The defendants filed motions to dissolve and reduce the attachment. Those motions were denied. Following discovery, both parties filed dispositive motions and the motions were argued on April 20, 2012. In September 2012, the judge ruled in favor of the County on its motion for summary judgment.  At December 31, 2012, the Company accrued $6.4 million which was included in accrued expenses within the consolidated balance sheet, based on settlement discussions that took place in January 2013.  In February 2013, the Company finalized the settlement with the County and the $25 million privilege fee was returned to the Company, net of the amount previously accrued.

 

8.  Income Taxes

 

A reconciliation of the liability for unrecognized tax benefits is as follows:

 

		Noncurrent tax liabilities
		(in thousands)
Balance at January 1, 2013		$	20,393
Additions based on current year positions		280
Additions based on prior year positions		1,691
Currency translation adjustments		(607		)
Balance at March 31, 2013		$	21,757

 

The increase in the Company’s liability for unrecognized tax benefits during the three months ended March 31, 2013 was primarily due to recording interest expense accruals for previously recorded unrecognized tax benefits.

 

The Company’s effective tax rate (income taxes as a percentage of income from operations before income taxes) increased to 39.6% for the three months ended March 31, 2013, as compared to 37.3% for the three months ended March 31, 2012. During the three months ended March 31, 2013, the Company recorded a $1.1 million valuation allowance against the tax benefit associated with capital losses incurred within the quarter that the Company does not believe it will be able to utilize prior to their expiration.

 

At March 31, 2013 and December 31, 2012, prepaid expenses within the condensed consolidated balance sheets include prepaid income taxes of $33.6 million and $68.4 million, respectively.

 

9.                                      Shareholders’ Equity

 

Impact of Proposed Spin-Off on Preferred Equity Investment

 

As part of the proposed Spin-Off transaction described further in Note 2, the Company entered into an agreement (the “Exchange Agreement”) with FIF V PFD LLC, an affiliate of Fortress Investment Group LLC (“Fortress”), providing for the potential

 

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exchange of shares of the Company’s Preferred Stock for shares of a new class of preferred stock, Series C Convertible Preferred Stock (“Series C”), in contemplation of the potential Spin-Off.

 

The Exchange Agreement provides Fortress with the right to exchange its 9,750 shares of Preferred Stock for fractional shares of Series C at an exchange ratio that treats each such fractional share (and therefore each share of common stock into which such fractional share is convertible) as worth $67 per share, which is the “ceiling price” at which the shares of preferred stock are redeemable by the Company at maturity. Each fractional share of Series C will automatically convert into a share of common stock upon sale to a third party not affiliated with Fortress. Any shares of Series B not exchanged for shares of Series C prior to the second business day before the record date established for the distribution of GLPI common stock in the Spin-Off shall automatically be exchanged for shares of Series C on such date. Subsequently, the Company will have the right to purchase from Fortress, prior to the record date for the Spin-Off, a number of shares of Series C, at a price of $67 per fractional share of Series C, such that, immediately following the consummation of the Spin-Off, Fortress will own not more than 9.9% of GLPI’s common stock. The Company may terminate the Exchange Agreement at any time prior to the Spin-Off if it determines, in its sole discretion, to abandon the Spin-Off, provided that Fortress would keep any shares of Series C it received in exchange for preferred stock prior to termination.

 

Under the terms of the Statement with Respect to Shares of Series C Convertible Preferred Stock of the Company (the “Series C Designation”), the Series C is nonvoting stock, provided, however, that the Series C Designation cannot be altered or amended so as to adversely affect any right or privilege held by the holders of Series C shares without the consent of a majority of the shares of Series C then outstanding. Holders of Series C will participate in dividends paid to the holders of common stock of the Company on an as-converted basis. Each fractional share of Series C will automatically convert into a share of common stock upon sale to a third party not affiliated with the original holder.

 

The Company, Fortress and certain other holders of preferred stock are party to an Investor Rights Agreement, dated July 3, 2008 (the “Investor Rights Agreement”), that grants those holders certain rights with respect to the Company. In connection with the Exchange Agreement, Fortress and the Company entered into the Supplementary Investor Rights Agreement, which provides that, as between Fortress and the Company, the Series C shares will be governed by the Investor Rights Agreement, and modifies certain other existing arrangements between the Company and Fortress. The Supplementary Investor Rights Agreement provides Fortress with additional registration rights, beyond those currently set forth in the Investor Rights Agreement, including additional opportunities to sell shares of Series C stock in a registered offering, the right to select the managing underwriter in an underwritten offering prior to the Spin-Off and an increase in the registration expenses borne by the Company. The Supplementary Investor Rights Agreement also provides that, following the completion of the Spin-Off, the following rights and obligations under the Investor Rights Agreement would be eliminated: Fortress’s right to nominate a director, the obligation of Fortress to vote its shares of common stock in accordance with the recommendations of the Company’s Board of Directors, the restriction on hedging activities and certain information rights.

 

Additionally, the Exchange Agreement provides that, following the Spin-Off, GLPI and Fortress will enter into an investor rights agreement on similar terms to the Investor Rights Agreement as modified by the Supplemental Investor Rights Agreement.

 

Finally, in January 2013, the Company signed an agreement with Centerbridge Partners, L.P. pursuant to which the Company will repurchase their 2,300 shares of Preferred Stock at par in advance of the Spin-Off and in February 2013, the Company repurchased 225 shares of Preferred Stock from WF Investment Holdings, LLC at a slight discount to par.

 

10.  Segment Information

 

The Company has aggregated its properties into three reportable segments: (i) Midwest, (ii) East/West, and (iii) Southern Plains, which is consistent with how the Company’s Chief Operating Decision Maker reviews and assesses the Company’s financial performance.

 

The Midwest reportable segment consists of the following properties: Hollywood Casino Lawrenceburg, Hollywood Casino Aurora, Hollywood Casino Joliet, Argosy Casino Alton, Hollywood Casino Toledo, which opened on May 29, 2012, and Hollywood Casino Columbus, which opened on October 8, 2012. It also includes the Company’s Casino Rama management service contract and the Mahoning Valley and Dayton Raceway projects in Ohio which the Company anticipates completing in 2014.

 

The East/West reportable segment consists of the following properties: Hollywood Casino at Charles Town Races, Hollywood Casino Perryville, Hollywood Casino Bangor, Hollywood Casino at Penn National Race Course, Zia Park Casino, and the M Resort.

 

The Southern Plains reportable segment consists of the following properties: Argosy Casino Riverside, Argosy Casino Sioux City, Hollywood Casino Baton Rouge, Hollywood Casino Tunica, Hollywood Casino Bay St. Louis, Boomtown Biloxi, Hollywood

 

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Casino St. Louis (formerly Harrah’s St. Louis which was acquired from Caesars Entertainment on November 2, 2012), and includes the Company’s 50% investment in Kansas Entertainment, which owns the Hollywood Casino at Kansas Speedway that opened on February 3, 2012.

 

The Other category consists of the Company’s standalone racing operations, namely Beulah Park, Raceway Park, Rosecroft Raceway, Sanford-Orlando Kennel Club, and the Company’s joint venture interests in Sam Houston Race Park, Valley Race Park and Freehold Raceway. If the Company is successful in obtaining gaming operations at these locations, they would be assigned to one of the Company’s regional executives and reported in their respective reportable segment. The Other category also includes the Company’s corporate overhead operations which does not meet the definition of an operating segment under ASC 280, “Segment Reporting,” and the Bullwhackers property.

 

The following tables present certain information with respect to the Company’s segments. Intersegment revenues between the Company’s segments were not material in any of the periods presented below.

 

		Midwest			East/West			Southern Plains			Other			Total
		(in thousands)
Three months ended March 31, 2013
Net revenues		$	287,312		$	317,048		$	184,684		$	9,202		$	798,246
Income (loss) from operations		63,796			69,107			37,009			(36,597		)	133,315
Depreciation and amortization		32,257			20,833			19,888			4,093			77,071
Gain (loss) from unconsolidated affiliates		—			—			1,737			(16		)	1,721
Capital expenditures		33,830			7,071			19,027			2,775			62,703
Three months ended March 31, 2012
Net revenues		205,110			370,629			149,720			10,600			736,059
Income (loss) from operations		46,281			83,891			44,712			(32,269		)	142,615
Depreciation and amortization		17,552			22,241			11,388			2,156			53,337
Gain from unconsolidated affiliates		—			—			1,678			7			1,685
Capital expenditures		101,880			10,659			3,932			3,188			119,659
Balance sheet at March 31, 2013
Total assets		2,300,768			1,188,482			1,673,197			403,129			5,565,576
Investment in and advances to unconsolidated affiliates		—			87			135,251			66,389			201,727
Goodwill and other intangible assets, net		1,025,295			226,047			778,913			55,818			2,086,073
Balance sheet at December 31, 2012
Total assets		2,318,283			1,198,391			1,680,773			446,610			5,644,057
Investment in and advances to unconsolidated affiliates		—			87			138,514			65,905			204,506
Goodwill and other intangible assets, net		1,025,505			226,047			779,787			55,827			2,087,166

 

11.  Fair Value of Financial Instruments

 

The following methods and assumptions are used to estimate the fair value of each class of financial instruments for which it is practicable to estimate:

 

Cash and Cash Equivalents

 

The fair value of the Company’s cash and cash equivalents approximates the carrying value of the Company’s cash and cash equivalents, due to the short maturity of the cash equivalents.

 

Investment in Corporate Debt Securities

 

The fair value of the investment in corporate debt securities is estimated based on a third party broker quote. The investment in corporate debt securities is measured at fair value on a recurring basis.

 

Long-term Debt

 

The fair value of the Company’s Term Loan B component of the senior secured credit facility and senior subordinated notes is estimated based on quoted prices in active markets and as such is a Level 1 measurement (see Note 12). The fair value of the remainder of the Company’s senior secured credit facility approximates its carrying value as it is variable rate debt. The fair value of the Company’s other long-term obligations approximates its carrying value.

 

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