PENN Entertainment, Inc. - Quarter Report: 2016 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, 2016

 

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.

 

Large accelerated filer x		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

 

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.

 

Title		Outstanding as of April 30, 2016
Common Stock, par value $.01 per share		81,537,523 (includes 185,164 shares of restricted stock)

 

 

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Forward-looking Statements

 

This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements can be identified by the use of forward looking terminology such as “expects,” “believes,” “estimates,” “projects,” “intends,” “plans,” “seeks,” “may,” “will,” “should” or “anticipates” or the negative or other variations of these or similar words, or by discussions of future events, strategies or risks and uncertainties, including future plans, strategies, performance, developments, acquisitions, capital expenditures, and operating results.  Actual results may vary materially from expectations.  Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business, 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 assumptions included in our financial guidance; the ability of our operating teams to drive improved revenues and adjusted EBITDA margins; 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, our ability to secure federal, state and local permits and approvals necessary for our construction projects; construction factors, including delays, unexpected remediation costs, local opposition, organized labor, and increased cost of labor and materials; 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, sweepstakes based and taverns); 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 (especially in new business lines) and to agree to terms with, and maintain good relationships with partners/municipalities 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 ability to maintain market share in established markets and ramp up operations at our recently opened facilities; our expectations for the continued availability and cost of capital; the outcome of pending legal proceedings, for example, the ongoing litigation by the Ohio Roundtable addressing the legality of gaming in Ohio; changes in accounting standards; the impact of weather; with regard to our recent Restatement, risks relating the remediation of any material weaknesses and the costs to strengthen our internal control structure, potential investigations, litigation or other proceedings by governmental authorities, stockholders or other parties, and the risks related to the impact of the recent restatement of the Company’s financial statements on the Company’s reputation, development projects, joint ventures and other commercial contracts; the ability of the Company to generate sufficient future taxable income to realize its deferred tax assets; with respect to the proposed Jamul project near San Diego, California, particular risks associated with financing/refinancing a project of this type, sovereign immunity, local opposition (including several pending lawsuits), building a complex project on a relatively small parcel and the receipt of all necessary permits and licenses; with respect to our Massachusetts project, the ultimate location and timing of the other gaming facilities in the state and region; with respect to our social and other interactive gaming endeavors, risks related to ultimate profitability, cyber-security, data privacy, intellectual property and legal and regulatory challenges; with respect to Prairie State Gaming, risks relating to our ability to successfully compete in the video gaming terminal (“VGT”) market, our ability to retain existing customers and secure new customers, risks relating to municipal authorization of VGT operations and the implementation and the ultimate success of the products and services being offered; and other factors as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, each 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. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this press release may not occur.

 

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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, 2016 and December 31, 2015	4
		Condensed Consolidated Statements of Income — Three Months Ended March 31, 2016 and 2015	5
		Condensed Consolidated Statements of Comprehensive Income — Three Months Ended March 31, 2016 and 2015	6
		Condensed Consolidated Statements of Changes in Shareholders’ Deficit — Three Months Ended March 31, 2016 and 2015	7
		Condensed Consolidated Statements of Cash Flows — Three Months Ended March 31, 2016 and 2015	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	36
ITEM 4.		CONTROLS AND PROCEDURES	36
PART II.		OTHER INFORMATION	38
ITEM 1.		LEGAL PROCEEDINGS	38
ITEM 1A.		RISK FACTORS	38
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	38
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES	38
ITEM 4.		MINE SAFETY DISCLOSURES	38
ITEM 5.		OTHER INFORMATION	38
ITEM 6.		EXHIBITS	38
SIGNATURES			40
EXHIBIT INDEX			41

 

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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,
		2016			2015
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	214,238		$	237,009
Receivables, net of allowance for doubtful accounts of $2,434 and $2,428 at March 31, 2016 and December 31, 2015, respectively		47,029			45,186
Prepaid expenses		65,976			76,784
Other current assets		13,177			13,497
Total current assets		340,420			372,476
Property and equipment, net		2,935,270			2,980,068
Other assets
Investment in and advances to unconsolidated affiliates		165,356			168,149
Goodwill		911,942			911,942
Other intangible assets, net		391,149			391,442
Advances to the Jamul Tribe		246,792			197,722
Other assets		137,759			116,953
Total other assets		1,852,998			1,786,208
Total assets		$	5,128,688		$	5,138,752
Liabilities
Current liabilities
Current portion of financing obligation to GLPI		$	52,685		$	50,548
Current maturities of long-term debt		96,543			92,108
Accounts payable		68,059			72,816
Accrued expenses		94,318			93,666
Accrued interest		8,641			7,091
Accrued salaries and wages		76,451			98,671
Gaming, pari-mutuel, property, and other taxes		52,382			57,486
Insurance financing		8,534			3,125
Other current liabilities		72,661			82,263
Total current liabilities		530,274			557,774
Long-term liabilities
Long-term financing obligation to GLPI, net of current portion		3,499,295			3,514,080
Long-term debt, net of current maturities and debt issuance costs		1,597,870			1,618,851
Deferred income taxes		107,300			107,921
Other noncurrent liabilities		43,046			18,169
Total long-term liabilities		5,247,511			5,259,021
Shareholders’ equity (deficit)
Series B Preferred stock ($.01 par value, 1,000,000 shares authorized, 0 shares issued and outstanding at March 31, 2016 and December 31, 2015)		—			—
Series C Preferred stock ($.01 par value, 18,500 shares authorized, 8,624 shares issued and outstanding at March 31, 2016 and December 31, 2015)		—			—
Common stock ($.01 par value, 200,000,000 shares authorized, 83,451,574 and 83,056,668 shares issued and 81,284,181 and 80,889,275 shares outstanding, at March 31, 2016 and December 31, 2015, respectively)		834			830
Treasury stock, at cost (2,167,393 shares held at March 31, 2016 and December 31, 2015)		(28,414		)	(28,414		)
Additional paid-in capital		992,608			988,686
Retained deficit		(1,610,883		)	(1,634,591		)
Accumulated other comprehensive loss		(3,242		)	(4,554		)
Total shareholders’ equity (deficit)		(649,097		)	(678,043		)
Total liabilities and shareholders’ equity (deficit)		$	5,128,688		$	5,138,752

 

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,
		2016			2015
Revenues
Gaming		$	656,701		$	591,336
Food, beverage, hotel and other		137,848			108,763
Management service fee		2,473			1,927
Revenues		797,022			702,026
Less promotional allowances		(40,571		)	(37,888		)
Net revenues		756,451			664,138
Operating expenses
Gaming		335,317			294,895
Food, beverage, hotel and other		98,079			77,929
General and administrative		116,504			116,256
Depreciation and amortization		66,020			63,369
Total operating expenses		615,920			552,449
Income from operations		140,531			111,689
Other income (expenses)
Interest expense		(116,512		)	(108,346		)
Interest income		5,240			1,870
Income from unconsolidated affiliates		4,609			3,982
Other		(2,426		)	3,089
Total other expenses		(109,089		)	(99,405		)
Income from operations before income taxes		31,442			12,284
Income tax provision		7,734			10,415
Net income		$	23,708		$	1,869
Earnings per common share:
Basic earnings per common share		$	0.26		$	0.02
Diluted earnings per common share		$	0.26		$	0.02

 

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,
		2016			2015
Net income		$	23,708		$	1,869
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment during the period		1,312			(1,716		)
Other comprehensive income (loss)		1,312			(1,716		)
Comprehensive income		$	25,020		$	153

 

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’ Deficit

(in thousands, except share data) (unaudited)

 

		Preferred Stock					Common Stock					Treasury			Additional Paid-In			Retained			Accumulated Other Comprehensive			Total Shareholders’
		Shares		Amount			Shares		Amount			Stock			Capital			Deficit			Loss			Deficit
Balance, December 31, 2014		8,624		$	—		79,161,817		$	813		$	(28,414	)	$	956,146		$	(1,635,277	)	$	(1,282	)	$	(708,014	)
Share-based compensation arrangements, net of tax benefits of $6,379		—		—			543,816		5			—			11,228			—			—			11,233
Foreign currency translation adjustment		—		—			—		—			—			—			—			(1,716		)	(1,716		)
Net income		—		—			—		—			—			—			1,869			—			1,869
Balance, March 31, 2015		8,624		$	—		79,705,633		$	818		$	(28,414	)	$	967,374		$	(1,633,408	)	$	(2,998	)	$	(696,628	)
Balance, December 31, 2015		8,624		$	—		80,889,275		$	830		$	(28,414	)	$	988,686		$	(1,634,591	)	$	(4,554	)	$	(678,043	)
Share-based compensation arrangements, net of tax benefits of $689		—		—			394,906		4			—			3,922			—			—			3,926
Foreign currency translation adjustment		—		—			—		—			—			—			—			1,312			1,312
Net income		—		—			—		—			—			—			23,708			—			23,708
Balance, March 31, 2016		8,624		$	—		81,284,181		$	834		$	(28,414	)	$	992,608		$	(1,610,883	)	$	(3,242	)	$	(649,097	)

 

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,		2016			2015
Operating activities
Net income		$	23,708		$	1,869
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		66,020			63,369
Amortization of items charged to interest expense		1,876			1,505
Change in contingent purchase price		(1,201		)	351
(Gain) loss on sale of property and equipment and assets held for sale		(1,101		)	153
Income from unconsolidated affiliates		(4,609		)	(3,982		)
Distributions from unconsolidated affiliates		7,400			8,000
Deferred income taxes		(740		)	18,648
Charge for stock-based compensation		1,455			2,084
(Increase) decrease,
Accounts receivable		(1,803		)	727
Prepaid expenses and other current assets		(11,579		)	(2,742		)
Other assets		3,039			6,400
(Decrease) increase,
Accounts payable		(1,951		)	2,887
Accrued expenses		648			4,931
Accrued interest		1,550			6,264
Accrued salaries and wages		(22,220		)	(14,363		)
Gaming, pari-mutuel, property and other taxes		(4,920		)	3,754
Income taxes		22,826			(11,738		)
Other current and noncurrent liabilities		(7,065		)	(10,081		)
Net cash provided by operating activities		71,333			78,036
Investing activities
Capital project expenditures		(6,496		)	(36,929		)
Capital maintenance expenditures		(14,873		)	(11,860		)
Advances to the Jamul Tribe		(51,781		)	(16,341		)
Proceeds from sale of property and equipment and assets held for sale		2,091			146
Investment in joint ventures		—			(328		)
Acquisition of other property and equipment		(148		)	—
Net cash used in investing activities		(71,207		)	(65,312		)
Financing activities
Proceeds from exercise of options		1,742			2,743
Principal payments on financing obligation with GLPI		(12,648		)	(12,475		)
Proceeds from issuance of long-term debt, net of issuance costs		12,214			45,000
Principal payments on long-term debt		(23,404		)	(21,886		)
Payments of other long-term obligations		(6,899		)	—
Proceeds from insurance financing		9,193			885
Payments on insurance financing		(3,784		)	(4,314		)
Tax benefit from stock options exercised		689			6,379
Net cash (used in) provided by financing activities		(22,897		)	16,332
Net (decrease) increase in cash and cash equivalents		(22,771		)	29,056
Cash and cash equivalents at beginning of year		237,009			208,673
Cash and cash equivalents at end of period		$	214,238		$	237,729
Supplemental disclosure
Interest expense paid, net of amounts capitalized		$	113,629		$	100,179
Income tax (refunds received)/taxes paid		$	(12,481	)	$	226

 

Non-cash transactions:  In January 2015, a repayment obligation for a hotel and event center near Hollywood Casino Lawrenceburg was assumed by a subsidiary of the Company, which was financed through a loan with the City of Lawrenceburg Department of Redevelopment. This non-cash transaction increased property and equipment, net and total debt by $15.3 million.

 

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 together with its subsidiaries (collectively, the “Company”) is a diversified, multi-jurisdictional owner and manager of gaming and racing facilities and video gaming terminal operations with a focus on slot machine entertainment. As of March 31, 2016, the Company owned, managed, or had ownership interests in twenty-seven facilities in the following seventeen jurisdictions: Florida, Illinois, Indiana, Kansas, Maine, Maryland, Massachusetts, Mississippi, Missouri, Nevada, New Jersey, New Mexico, Ohio, Pennsylvania, Texas, West Virginia and Ontario, Canada.

 

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, that do not meet the consolidation criteria of the authoritative guidance for voting interest, controlling interest or variable interest entities (“VIE”), 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.

 

Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. The notes to the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2015 should be read in conjunction with these condensed consolidated financial statements.  The December 31, 2015 financial information has been derived from the Company’s audited consolidated financial statements.

 

2.  Summary of Significant Accounting Policies

 

Revenue Recognition and Promotional Allowances

 

Gaming revenue consists mainly of slot and video lottery gaming machine revenue as well as to a lesser extent table game and poker revenue. 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 “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 increases. Table game revenue is the aggregate of table drop adjusted for the change in aggregate table chip inventory. Table drop is the total dollar amount of the currency, coins, chips, tokens and outstanding markers (credit instruments) that are removed from the live gaming tables.

 

Food, beverage, hotel 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.  Advance deposits on lodging are recorded as accrued liabilities until services are provided to the customer.

 

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 (“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.

 

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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, 2016 and 2015 are as follows:

 

		Three Months Ended March 31,
		2016			2015
		(in thousands)
Rooms		$	9,122		$	8,336
Food and beverage		29,521			27,448
Other		1,928			2,104
Total promotional allowances		$	40,571		$	37,888

 

The estimated cost of providing such complimentary services for the three months ended March 31, 2016 and 2015 are as follows:

 

		Three Months Ended March 31,
		2016			2015
		(in thousands)
Rooms		$	1,197		$	936
Food and beverage		11,523			10,833
Other		745			832
Total cost of complimentary services		$	13,465		$	12,601

 

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 horse races run at the Company’s racetracks in the period in which wagering occurs. For the three months ended March 31, 2016, these expenses, which are recorded primarily within gaming expense in the condensed consolidated statements of income, were $256.4 million, as compared to $227.0 million for the three months ended March 31, 2015.

 

Long-term asset related to the Jamul Tribe

 

On April 5, 2013, the Company announced that, subject to final National Indian Gaming Commission approval, it and the Jamul Indian Village of California (the “Tribe”) had entered into definitive agreements to jointly develop a Hollywood Casino-branded casino on the Tribe’s trust land in San Diego County, California. The definitive agreements were entered into to: (i) secure the development, management, and branding services of the Company to assist the Tribe during the pre-development and entitlement phase of the project; (ii) set forth the terms and conditions under which the Company will provide a loan or loans to the Tribe to fund certain development costs; and (iii) create an exclusive arrangement between the parties.

 

The Tribe is a federally recognized Indian Tribe holding a government-to-government relationship with the U.S. through the U.S. Department of the Interior’s Bureau of Indian Affairs and possessing certain inherent powers of self-government. The Tribe is the beneficial owner of approximately six acres of reservation land located within the exterior boundaries of the State of California held by the U.S. in trust for the Tribe (the “Property”). The Tribe exercises jurisdiction over the Property pursuant to its powers of self-government and consistent with the resolutions and ordinances of the Tribe. The arrangement between the Tribe and the Company provides the Tribe with the expertise, knowledge and capacity of a proven developer and operator of gaming facilities and provides the Company with the exclusive right to administer and oversee planning, designing, development, construction management, and coordination during the development and construction of the project as well as the management of a gaming facility on the Property.

 

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The proposed $390 million development project will include a three-story gaming and entertainment facility of approximately 200,000 square feet featuring over 1,700 slot machines, 43 live table games, including poker, multiple restaurants, bars and lounges and a partially enclosed parking structure with over 1,800 spaces. In mid-January 2014, the Company commenced construction activities at the site and it is anticipated that the facility will open in mid-summer this year. The Company currently provides financing to the Tribe in connection with the project and, upon opening, will manage and provide branding for the casino. The Company has a conditional loan commitment to the Tribe (that can be terminated under certain circumstances) for up to $400 million and anticipates it will fund approximately $390 million related to this development.

 

The Company is accounting for the development agreement and related loan commitment letter with the Tribe as a loan (the “Senior Loans”) with accrued interest in accordance with ASC 310, “Receivables.” The Senior Loans represent advances made by the Company to the Tribe for the development and construction of a gaming facility for the Tribe on reservation land. As such, the Tribe will own the casino and its related assets and liabilities. San Diego Gaming Ventures, LLC (a wholly-owned subsidiary of the Company) is a separate legal entity established to account for the Senior Loans and, upon completion of the project and subsequent commencement of gaming operations on the Property, will be the Penn entity which receives management and licensing fees from the Tribe. The Company’s Senior Loans with the Tribe totaled $246.8 million and $197.7 million, which includes accrued interest of $18.9 million, and $13.9 million, at March 31, 2016 and December 31, 2015, respectively. Collectability of the Senior Loans will be derived from the revenues of the casino operations once the project is completed. Based on the Company’s current progress with this project, the Company believes collectability of the Senior Loans is highly certain. However, in the event that the Company’s internal projections related to the profitability of this project and/or the timing of the opening are inaccurate, the Company may be required to record a reserve related to the collectability of the Senior Loans.

 

The Company considered whether the arrangement with the Tribe represents a variable interest that should be accounted for pursuant to the VIE subsections of ASC 810. The Company noted that the scope and scope exceptions of ASC 810-10-15-12(e) states that a reporting entity shall not consolidate a government organization or financing entity established by a government organization (other than certain financing entities established to circumvent the provisions of the VIE subsections of ASC 810). Based on the status of the Tribe as a government organization, the Company believes its arrangement with the Tribe is not within the scope defined by ASC 810.

 

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 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, 2016 and 2015, the Company had outstanding 8,624 shares of Series C Convertible Preferred Stock. The Company determined that the preferred stock qualified as a participating security as defined in ASC 260 since these securities participate in dividends with the Company’s common stock. 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, 2016 and 2015 under the two-class method:

 

		Three Months Ended March 31,
		2016			2015
		(in thousands)
Net income		$	23,708		$	1,869
Net income applicable to preferred stock		2,282			183
Net income applicable to common stock		$	21,426		$	1,686

 

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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, 2016 and 2015:

 

		Three Months Ended March 31,
		2016		2015
		(in thousands)
Determination of shares:
Weighted-average common shares outstanding		80,968		79,400
Assumed conversion of dilutive employee stock-based awards		1,448		2,296
Assumed conversion of restricted stock		51		72
Diluted weighted-average common shares outstanding before participating security		82,467		81,768
Assumed conversion of preferred stock		8,624		8,624
Diluted weighted-average common shares outstanding		91,091		90,392

 

Options to purchase 2,574,719 shares and 1,561,562 shares were outstanding during the three months ended March 31, 2016 and 2015, respectively, but were not included in the computation of diluted EPS because they were antidilutive.

 

The following tables present the calculation of basic and diluted EPS for the Company’s common stock for the three months ended March 31, 2016 and 2015 (in thousands, except per share data):

 

		Three Months Ended March 31,
		2016			2015
Calculation of basic EPS:
Net income applicable to common stock		$	21,426		$	1,686
Weighted-average common shares outstanding		80,968			79,400
Basic EPS		$	0.26		$	0.02
Calculation of diluted EPS using two-class method:
Net income applicable to common stock		$	21,426		$	1,686
Diluted weighted-average common shares outstanding before participating security		82,467			81,768
Diluted EPS		$	0.26		$	0.02

 

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. 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 5.40 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 Company’s employees.  The Company granted 1,535,823 stock options during the three months ended March 31, 2016.

 

Stock-based compensation expense for the three months ended March 31, 2016 was $1.5 million, as compared to $2.1 million for the three months ended March 31, 2015, and is included within the condensed consolidated statements of income under general and administrative expense.

 

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The Company’s cash-settled phantom stock unit awards (“PSUs”), which vest over a period of three to four years, entitle employees and directors to receive cash based on the fair value of the Company’s common stock on the vesting date.  The PSUs 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.” The Company had a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its PSUs of $5.7 million and $7.8 million at March 31, 2016 and December 31, 2015, respectively. For PSUs held by Penn employees, there was $16.4 million of total unrecognized compensation cost at March 31, 2016 that will be recognized over the grants remaining weighted average vesting period of 1.79 years. For the three months ended March 31, 2016, the Company recognized $3.0 million of compensation expense associated with these awards, as compared to $4.5 million for the three months ended March 31, 2015.  The decrease was primarily due to changes in stock price year-over-year for both Penn and GLPI awards held by Penn employees.  Amounts paid by the Company for the three months ended March 31, 2016 on these cash-settled awards totaled $4.4 million, as compared to $5.2 million for the three months ended March 31, 2015.

 

For the Company’s stock appreciation rights (“SARs”), the fair value of the SARs is calculated during each reporting period and estimated using the Black-Scholes option pricing model based on the various inputs discussed below. The Company’s SARs, which vest over a period of four years, are accounted for as liability awards since they will be settled in cash. The Company had a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its SARs of $9.1 million and $8.0 million at March 31, 2016 and December 31, 2015, respectively. For SARs held by Penn employees, there was $9.8 million of total unrecognized compensation cost at March 31, 2016 that will be recognized over the awards remaining weighted average vesting period of 3.06 years. For the three months ended March 31, 2016, the Company recognized $1.9 million of compensation expense associated with these awards, as compared to $4.6 million for the three months ended March 31, 2015. The decrease was primarily due to changes in stock price year-over-year for both Penn and GLPI awards held by Penn employees.  Amounts paid by the Company for the three months ended March 31, 2016 on these cash-settled awards totaled $0.4 million, as compared to $1.8 million for the three months ended March 31, 2015.

 

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model for stock option awards granted during the three month period ended March 31, 2016 and 2015, respectively:

 

		2016		2015
Risk-free interest rate		1.20	%	1.54	%
Expected volatility		31.22	%	36.93	%
Dividend yield		—		—
Weighted-average expected life (years)		5.40		5.45

 

Segment Information

 

The Company’s Chief Executive Officer and President, who is the Company’s Chief Operating Decision Maker, as that term is defined in ASC 280, “Segment Reporting” (“ASC 280”), measures and assesses the Company’s business performance based on regional operations of various properties grouped together based primarily on their geographic locations. The Company’s reportable segments are: (i) East/Midwest, (ii) West, and (iii) Southern Plains.

 

The East/Midwest reportable segment consists of the following properties: Hollywood Casino at Charles Town Races, Hollywood Casino Bangor, Hollywood Casino at Penn National Race Course, Hollywood Casino Lawrenceburg, Hollywood Casino Toledo, Hollywood Casino Columbus, Hollywood Gaming at Dayton Raceway, Hollywood Gaming at Mahoning Valley Race Course, and Plainridge Park Casino, which opened on June 24, 2015. It also includes the Company’s Casino Rama management service contract.

 

The West reportable segment consists of the following properties: Zia Park Casino, M Resort, and Tropicana Las Vegas, which was acquired on August 25, 2015, as well as the Hollywood Casino Jamul—San Diego project with the Tribe, which the Company anticipates completing in mid-summer this year.

 

The Southern Plains reportable segment consists of the following properties: Hollywood Casino Aurora, Hollywood Casino Joliet, Argosy Casino Alton, Argosy Casino Riverside, Hollywood Casino Tunica, Hollywood Casino Gulf Coast, Boomtown Biloxi, Hollywood Casino St. Louis, and Prairie State Gaming, which the Company acquired on September 1, 2015, and includes the Company’s 50% investment in Kansas Entertainment, LLC (“Kansas Entertainment”), which owns the Hollywood Casino at Kansas Speedway.

 

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The Other category consists of the Company’s standalone racing operations, namely 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 and Penn Interactive Ventures, LLC, the Company’s wholly-owned subsidiary which represents its social online gaming initiatives and would meet the definition of an operating segment under ASC 280, but is currently immaterial to the Company’s operations.

 

Management uses adjusted EBITDA as the primary measure of the operating performance of its segments, including the evaluation of operating personnel and believes it is especially relevant in evaluating large, long lived casino projects because they provide a perspective on the current effects of operating decisions separated from the substantial non-operational depreciation charges and financing costs of such projects. The Company defines adjusted EBITDA as earnings before interest, taxes, stock compensation, debt extinguishment charges, impairment charges, insurance recoveries and deductible charges, depreciation and amortization, changes in the estimated fair value of contingent purchase price to the previous owners of Plainridge Racecourse, gain or loss on disposal of assets, and other income or expenses. Adjusted EBITDA is also inclusive of income or loss from unconsolidated affiliates, with the Company’s share of non-operating items (such as depreciation and amortization) added back for its joint venture in Kansas Entertainment. Adjusted EBITDA excludes payments associated with our Master Lease agreement with GLPI as the transaction is accounted for as a financing obligation. Adjusted EBITDA should not be construed as an alternative to operating income, as an indicator of the Company’s operating performance, as an alternative to cash flows from operating activities, as a measure of liquidity, or as any other measure of performance determined in accordance with GAAP. The Company has significant uses of cash flows, including capital expenditures, interest payments, taxes and debt principal repayments, which are not reflected in adjusted EBITDA.

 

The Company recently announced a realignment of its reporting structure that will result in certain changes to our reportable segments.  We plan on finalizing these changes to our internal management reporting system in the second quarter, which will result in the following three geographic regions:  Northeast, Midwest and South/West.  The changes in the segment reporting have no effect on the Company’s previously reported consolidated operating results. See Part I, Item 2:  “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional details.

 

See Note 7 for further information with respect to the Company’s segments.

 

Other Comprehensive Income

 

The Company accounts for comprehensive income in accordance with ASC 220, “Comprehensive Income,” which establishes standards for the reporting and presentation of comprehensive income in the consolidated financial statements. The Company presents comprehensive income in two separate but consecutive statements. For the three months ended March 31, 2016 and 2015, the only component of accumulated other comprehensive income was foreign currency translation adjustments.

 

3.  New Accounting Pronouncements

 

In April and March 2016, the FASB issued ASU 2016-10 and ASU 2016-08, Revenue from Contract with Customers (Topic 606).  The amendments of ASU 2016-10 clarify the following two aspects of Topic 606: (a) identifying performance obligations; and (b) the licensing implementation guidance.  The amendments of ASU 2016-08 relate to when another party, along with the entity, is involved in providing a good or service to a customer.  The amendments are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations.  The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in Topic 606.  Public entities should apply the amendments for annual reporting periods beginning after December 31, 2017, including interim reporting periods therein (i.e., January 1, 2018, for a calendar year entity).  Management is currently assessing the impact of the new revenue recognition guidance will have on the consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718).  The amendments are intended to improve the accounting for employee share-based payments and affect all organizations that issue share-based payment awards to their employees.  Several aspects of the accounting for share-based payment award transactions are simplified, including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows.  For public companies, the amendments are effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods.  Early adoption is permitted for any organization in any interim or annual period.  Management plans to implement this change in accounting principle in 2017 and does not anticipate a material impact from this new guidance.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). This ASU primarily provides new guidance for lessees on the accounting treatment of operating leases. Under the new guidance, lessees are required to recognize

 

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assets and liabilities arising from operating leases on the balance sheet. ASU 2016-02 also aligns lessor accounting with the revenue recognition guidance in Topic 606 of the Accounting Standards Codification. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018 and is required to be adopted on a modified retrospective basis, meaning the new leasing model will be applied to the earliest year presented in the financial statements and thereafter. The Company is evaluating the impact of adopting this new accounting standard on its financial statements.

 

In February 2015, the FASB issued ASU 2015-02 with new consolidation guidance which modifies the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The main provisions of the new guidance include modifying the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, the evaluation of fees paid to a decision maker or a service provider as a variable interest, and the effect of fee arrangements and related parties on the primary beneficiary determination, as well as provides a scope exception for certain investment funds. The new guidance is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the new guidance using a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. A reporting entity also may apply the new guidance retrospectively. The adoption of this pronouncement had no impact to the Company’s financial statements.

 

4.  Property and Equipment

 

Property and equipment, net, consists of the following:

 

		March 31,			December 31,
		2016			2015
		(in thousands)
Property and equipment - non-leased
Land and improvements		$	289,030		$	288,910
Building and improvements		396,593			396,497
Furniture, fixtures, and equipment		1,308,387			1,303,153
Leasehold improvements		131,760			129,012
Construction in progress		17,700			9,175
		2,143,470			2,126,747
Less accumulated depreciation		(1,131,767		)	(1,093,115		)
		1,011,703			1,033,632
Property and equipment - master lease
Land and improvements		382,246			382,246
Building and improvements		2,219,018			2,219,018
		2,601,264			2,601,264
Less accumulated depreciation		(677,697		)	(654,828		)
		1,923,567			1,946,436
Property and equipment, net		$	2,935,270		$	2,980,068

 

Property and equipment, net decreased by $44.8 million for the three months ended March 31, 2016 primarily due to depreciation expense, which is partially offset by improvements at Tropicana Las Vegas, and normal capital maintenance expenditures for the three months ended March 31, 2016.

 

Depreciation expense, for property and equipment including assets under capital leases, totaled $65.6 million and $63.4 million for the three months ended March 31, 2016 and March 31, 2015, respectively, of which $22.9 million, $23.2 million related to assets under the Master Lease, respectively. No interest was capitalized in connection with major construction projects for the three months ended March 31, 2016 compared to $0.6 million for the three months ended March 31, 2015.

 

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5.  Long-term Debt

 

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

 

		March 31,			December 31,
		2016			2015
		(in thousands)
Senior secured credit facility		$	1,248,766		$	1,259,740
$300 million 5.875% senior unsecured notes due November 1, 2021		300,000			300,000
Other long term obligations		139,759			146,992
Capital leases		28,036			28,466
		1,716,561			1,735,198
Less current maturities of long-term debt		(96,543		)	(92,108		)
Less net discounts		(669		)	(686		)
Less debt issuance costs, net of accumulated amortization of $15.1 million and $13.3 million, respectively		(21,479		)	(23,553		)
		$	1,597,870		$	1,618,851

 

The following is a schedule of future minimum repayments of long-term debt as of March 31, 2016 (in thousands):

 

Within one year		$	96,433
1-3 years		986,625
3-5 years		269,340
Over 5 years		364,163
Total minimum payments		$	1,716,561

 

Senior Secured Credit Facility

 

On April 28, 2015, the Company entered into an agreement to amend its senior secured credit facility.   In August 2015, the amendment to the senior secured credit facility went into effect increasing the capacity under an existing five year revolver from $500 million to $633.2 million and increased the existing five year $500 million Term Loan A facility by $146.7 million.  The seven year $250 million Term Loan B facility remained unchanged.  At March 31, 2016, the Company’s senior secured credit facility had a gross outstanding balance of $1,248.8 million, consisting of a $580.4 million Term Loan A facility, a $244.4 million Term Loan B facility, and $424.0 million outstanding on the revolving credit facility.  Additionally, at March 31, 2016, the Company had conditional obligations under letters of credit issued pursuant to the senior secured credit facility with face amounts aggregating $23.5 million, resulting in $185.7 million of available borrowing capacity as of March 31, 2016 under the revolving credit facility.

 

Covenants

 

The Company’s senior secured credit facility and $300 million 5.875% senior unsecured 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 $300 million 5.875% senior unsecured notes restrict, among other things, its 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, 2016, the Company was in compliance with all required financial covenants.

 

6.  Master Lease Financing Obligation

 

The Company’s Master Lease with GLPI is accounted for as a financing obligation. The obligation was calculated at the inception of the transaction based on the future minimum lease payments due to GLPI under the Master Lease discounted at 9.70%, which represents the estimated incremental borrowing rate over the lease term, including renewal options that were reasonably assured

 

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of being exercised and the funded construction of certain leased real estate assets in development at the date of the Spin-Off. Total payments under the Master Lease were $111.4 million and $108.8 million for the three months ended March 31, 2016 and 2015, respectively, of which $98.7 million and $96.4 million, respectively, were recognized as interest expense.

 

7.  Segment Information

 

The following tables (in thousands) 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.  The income (loss) from operations by segment presented below does not include allocations for corporate overhead costs or expenses associated with utilizing property subject to the Master Lease.

 

Three months ended March 31, 2016		East/Midwest			West			Southern Plains			Other (1)			Total
Income (loss) from operations		$	111,140		$	13,833		$	60,158		$	(44,600	)	$	140,531
Charge for stock compensation		—			—			—			1,455			1,455
Depreciation and amortization		24,840			6,205			10,281			24,694			66,020
Plainridge contingent purchase price		(1,201		)	—			—			—			(1,201		)
Loss (gain) on disposal of assets		19			17			(33		)	(1,104		)	(1,101		)
Income from unconsolidated affiliates		—			—			4,718			(109		)	4,609
Non-operating items for Kansas JV		—			—			2,570			—			2,570
Adjusted EBITDA		$	134,798		$	20,055		$	77,694		$	(19,664	)	$	212,883

 

Three months ended March 31, 2015		East/Midwest			West			Southern Plains			Other (1)			Total
Income (loss) from operations		$	90,863		$	15,526		$	55,385		$	(50,085	)	$	111,689
Charge for stock compensation		—			—			—			2,084			2,084
Depreciation and amortization		25,385			2,172			10,782			25,030			63,369
Plainridge contingent purchase price		351			—			—			—			351
(Gain) loss on disposal of assets		(122		)	181			100			(6		)	153
Income from unconsolidated affiliates		—			—			3,788			194			3,982
Non-operating items for Kansas JV		—			—			2,751			—			2,751
Adjusted EBITDA		$	116,477		$	17,879		$	72,806		$	(22,783	)	$	184,379

 

		East/Midwest			West			Southern Plains			Other (1)			Total
Three months ended March 31, 2016
Net revenues		$	437,457		$	87,559		$	225,235		$	6,200		$	756,451
Capital expenditures		7,843			6,823			6,020			683			21,369
Three months ended March 31, 2015
Net revenues		$	386,544		$	62,585		$	210,269		$	4,740		$	664,138
Capital expenditures		38,574			2,851			6,448			916			48,789
Balance sheet at March 31, 2016
Total assets		1,000,352			893,898			1,081,411			2,153,027			5,128,688
Investment in and advances to unconsolidated affiliates		83			—			100,926			64,347			165,356
Goodwill and other intangible assets, net		387,474			158,339			752,954			4,324			1,303,091
Balance sheet at December 31, 2015
Total assets		1,036,940			842,712			1,098,306			2,160,794			5,138,752
Investment in and advances to unconsolidated affiliates		84			—			103,608			64,457			168,149
Goodwill and other intangible assets, net		387,474			158,339			753,345			4,226			1,303,384

 

(1) Includes depreciation expense associated with the real property assets under the Master Lease with GLPI.  In addition, total assets include these assets.  The interest expense associated with the financing obligation is reflected in the other category.  Net revenues and income (loss) from unconsolidated affiliates relate to the Company’s stand-alone racing operations, namely Rosecroft Raceway, Sanford Orlando Kennel Club and the Company’s Texas and New Jersey joint ventures which do not have gaming operations.

 

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