Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x

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

 

For the quarterly period ended June 30, 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)

 

Pennsylvania

 

23-2234473

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

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 July 26, 2013

Common Stock, par value $.01 per share

 

78,892,597 (includes 381,245 shares of restricted stock)

 

 

 



Table of Contents

 

This document 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 GLPI’s 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 and the exemption of casinos from the commercial activity tax 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 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, CA project, particular risks associated with securing financing, local opposition, and building a complex project on a relatively small parcel; with respect to the Tewksbury, MA project, particular risks associated with local opposition and local permitting, surrounding community agreements and a local ballot measure; 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.

 

2



Table of Contents

 

PENN NATIONAL GAMING, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

4

 

 

 

ITEM 1.

FINANCIAL STATEMENTS (Unaudited)

4

 

Condensed Consolidated Balance Sheets — June 30, 2013 and December 31, 2012

4

 

Condensed Consolidated Statements of Operations — Three and Six Months Ended June 30, 2013 and 2012

5

 

Condensed Consolidated Statements of Comprehensive Income — Three and Six Months Ended June 30, 2013 and 2012

6

 

Condensed Consolidated Statements of Changes in Shareholders’ Equity — Six Months Ended June 30, 2013 and 2012

7

 

Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 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

22

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

38

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

38

 

 

 

PART II.

OTHER INFORMATION

39

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

39

 

 

 

ITEM 1A.

RISK FACTORS

39

 

 

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

39

 

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

39

 

 

 

ITEM 4.

MINE SAFETY DISCLOSURES

39

 

 

 

ITEM 5.

OTHER INFORMATION

39

 

 

 

ITEM 6.

EXHIBITS

39

 

 

 

SIGNATURES

40

 

 

EXHIBIT INDEX

41

 

3



Table of Contents

 

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)

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

235,135

 

$

260,467

 

Receivables, net of allowance for doubtful accounts of $4,272 and $3,901 at June 30, 2013 and December 31, 2012, respectively

 

52,135

 

53,720

 

Insurance receivable

 

210

 

 

Prepaid expenses

 

65,482

 

94,620

 

Deferred income taxes

 

36,674

 

39,793

 

Other current assets

 

11,646

 

38,540

 

Total current assets

 

401,282

 

487,140

 

Property and equipment, net

 

2,678,003

 

2,730,797

 

Other assets

 

 

 

 

 

Investment in and advances to unconsolidated affiliates

 

201,547

 

204,506

 

Goodwill

 

1,309,413

 

1,380,689

 

Other intangible assets, net

 

698,467

 

706,477

 

Debt issuance costs, net of accumulated amortization of $15,636 and $11,462 at June 30, 2013 and December 31, 2012, respectively

 

31,761

 

35,999

 

Other assets

 

112,897

 

98,449

 

Total other assets

 

2,354,085

 

2,426,120

 

Total assets

 

$

5,433,370

 

$

5,644,057

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current maturities of long-term debt

 

$

82,594

 

$

81,497

 

Accounts payable

 

25,256

 

38,268

 

Accrued expenses

 

102,821

 

133,316

 

Accrued interest

 

19,831

 

21,872

 

Accrued salaries and wages

 

80,567

 

96,426

 

Gaming, pari-mutuel, property, and other taxes

 

65,857

 

55,610

 

Insurance financing

 

8,125

 

3,856

 

Other current liabilities

 

71,997

 

68,774

 

Total current liabilities

 

457,048

 

499,619

 

 

 

 

 

 

 

Long-term liabilities

 

 

 

 

 

Long-term debt, net of current maturities

 

2,393,606

 

2,649,073

 

Deferred income taxes

 

223,004

 

216,357

 

Noncurrent tax liabilities

 

23,044

 

20,393

 

Other noncurrent liabilities

 

7,050

 

7,686

 

Total long-term liabilities

 

2,646,704

 

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 June 30, 2013 and December 31, 2012, respectively)

 

 

 

Common stock ($.01 par value, 200,000,000 shares authorized, 78,854,790 and 77,446,601 shares issued at June 30, 2013 and December 31, 2012, respectively)

 

780

 

769

 

Additional paid-in capital

 

1,479,945

 

1,451,965

 

Retained earnings

 

848,264

 

795,173

 

Accumulated other comprehensive income

 

629

 

3,022

 

Total shareholders’ equity

 

2,329,618

 

2,250,929

 

Total liabilities and shareholders’ equity

 

$

5,433,370

 

$

5,644,057

 

 

See accompanying notes to the condensed consolidated financial statements.

 

4



Table of Contents

 

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

Gaming

 

$

679,829

 

$

634,846

 

$

1,397,754

 

$

1,290,923

 

Food, beverage and other

 

121,044

 

109,955

 

242,904

 

222,863

 

Management service fee

 

3,667

 

3,614

 

6,714

 

7,057

 

Revenues

 

804,540

 

748,415

 

1,647,372

 

1,520,843

 

Less promotional allowances

 

(43,169

)

(35,864

)

(87,755

)

(72,233

)

Net revenues

 

761,371

 

712,551

 

1,559,617

 

1,448,610

 

Operating expenses

 

 

 

 

 

 

 

 

 

Gaming

 

341,889

 

330,875

 

703,907

 

671,044

 

Food, beverage and other

 

88,910

 

84,985

 

179,175

 

172,789

 

General and administrative

 

128,730

 

115,251

 

264,307

 

231,248

 

Depreciation and amortization

 

80,615

 

56,791

 

157,686

 

110,128

 

Impairment losses

 

71,846

 

 

71,846

 

 

Insurance deductible charges, net of recoveries

 

2,500

 

(3,366

)

2,500

 

(7,229

)

Total operating expenses

 

714,490

 

584,536

 

1,379,421

 

1,177,980

 

Income from operations

 

46,881

 

128,015

 

180,196

 

270,630

 

 

 

 

 

 

 

 

 

 

 

Other income (expenses)

 

 

 

 

 

 

 

 

 

Interest expense

 

(27,060

)

(17,823

)

(54,984

)

(35,866

)

Interest income

 

343

 

246

 

605

 

465

 

Gain from unconsolidated affiliates

 

3,821

 

1,054

 

5,542

 

2,739

 

Other

 

2,402

 

1,474

 

3,066

 

471

 

Total other expenses

 

(20,494

)

(15,049

)

(45,771

)

(32,191

)

 

 

 

 

 

 

 

 

 

 

Income from operations before income taxes

 

26,387

 

112,966

 

134,425

 

238,439

 

Taxes on income

 

38,567

 

46,299

 

81,334

 

93,153

 

Net (loss) income

 

$

(12,180

)

$

66,667

 

$

53,091

 

$

145,286

 

 

 

 

 

 

 

 

 

 

 

(Loss) earnings per common share:

 

 

 

 

 

 

 

 

 

Basic (loss) earnings per common share

 

$

(0.16

)

$

0.70

 

$

0.55

 

$

1.54

 

Diluted (loss) earnings per common share

 

$

(0.16

)

$

0.63

 

$

0.51

 

$

1.37

 

 

See accompanying notes to the condensed consolidated financial statements.

 

5



Table of Contents

 

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(in thousands) (unaudited)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(12,180

)

$

66,667

 

$

53,091

 

$

145,286

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment during the period

 

(608

)

(455

)

(999

)

(167

)

Change in fair value of corporate debt securities

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) on corporate debt securities arising during the period

 

 

155

 

(98

)

85

 

Less: Reclassification adjustments for gains included in net income

 

(1,296

)

 

(1,296

)

 

Change in fair value of corporate debt securities, net

 

(1,296

)

155

 

(1,394

)

85

 

Other comprehensive loss

 

(1,904

)

(300

)

(2,393

)

(82

)

Comprehensive (loss) income

 

$

(14,084

)

$

66,367

 

$

50,698

 

$

145,204

 

 

See accompanying notes to the condensed consolidated financial statements.

 

6



Table of Contents

 

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 $2,096

 

 

 

380,576

 

4

 

24,085

 

 

 

24,089

 

Restricted stock activity, including tax benefit of $382

 

 

 

(4,076

)

 

2,230

 

 

 

2,230

 

Change in fair value of corporate debt securities

 

 

 

 

 

 

 

85

 

85

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

(167

)

(167

)

Net income

 

 

 

 

 

 

145,286

 

 

145,286

 

Balance, June 30, 2012

 

12,275

 

$

 

76,589,626

 

$

760

 

$

1,411,670

 

$

728,488

 

$

2,236

 

$

2,143,154

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 $4,920

 

 

 

1,159,426

 

11

 

48,563

 

 

 

48,574

 

Restricted stock activity, including tax benefit of $840

 

 

 

248,763

 

 

1,692

 

 

 

1,692

 

Change in fair value of corporate debt securities

 

 

 

 

 

 

 

(1,394

)

(1,394

)

Foreign currency translation adjustment

 

 

 

 

 

 

 

(999

)

(999

)

Net income

 

 

 

 

 

 

53,091

 

 

53,091

 

Balance, June 30, 2013

 

12,050

 

$

 

78,854,790

 

$

780

 

$

1,479,945

 

$

848,264

 

$

629

 

$

2,329,618

 

 

See accompanying notes to the condensed consolidated financial statements.

 

7



Table of Contents

 

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands) (unaudited)

 

Six Months Ended June 30, 

 

2013

 

2012

 

Operating activities

 

 

 

 

 

Net income

 

$

53,091

 

$

145,286

 

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

 

 

 

 

 

Depreciation and amortization

 

157,686

 

110,128

 

Amortization of items charged to interest expense

 

4,300

 

3,290

 

Accretion of settlement value on long term obligation

 

1,217

 

 

Loss (gain) on sale of fixed assets

 

2,675

 

(1,037

)

Hollywood St. Louis tornado deductible charges

 

2,500

 

 

Gain from unconsolidated affiliates

 

(5,542

)

(2,739

)

Distributions of earnings from unconsolidated affiliates

 

9,000

 

 

Deferred income taxes

 

10,720

 

(14,383

)

Charge for stock-based compensation

 

11,701

 

15,307

 

Impairment losses

 

71,846

 

 

Gain on investment in corporate debt securities

 

(1,325

)

 

(Increase) decrease, net of businesses acquired

 

 

 

 

 

Accounts receivable

 

(188

)

(505

)

Insurance receivable

 

(510

)

1,072

 

Prepaid expenses and other current assets

 

31,614

 

11,316

 

Other assets

 

(23,330

)

(5,191

)

(Decrease) increase, net of businesses acquired

 

 

 

 

 

Accounts payable

 

(3,272

)

(2,647

)

Accrued expenses

 

(30,990

)

(7,026

)

Accrued interest

 

(2,041

)

(646

)

Accrued salaries and wages

 

(15,605

)

(9,895

)

Gaming, pari-mutuel, property and other taxes

 

10,247

 

(4,008

)

Income taxes

 

 

(15,278

)

Other current and noncurrent liabilities

 

3,552

 

4,506

 

Other noncurrent tax liabilities

 

4,084

 

3,336

 

Net cash provided by operating activities

 

291,430

 

230,886

 

Investing activities

 

 

 

 

 

Capital project expenditures, net of reimbursements

 

(70,771

)

(201,948

)

Capital maintenance expenditures

 

(45,846

)

(52,230

)

Proceeds from sale of property and equipment

 

2,818

 

2,803

 

Proceeds from investment in corporate debt securities

 

6,679

 

 

Investment in joint ventures

 

(500

)

(39,600

)

Decrease in cash in escrow

 

26,000

 

15,500

 

Acquisition of gaming licenses, net of acquisition of businesses

 

(52

)

(50,000

)

Net cash used in investing activities

 

(81,672

)

(325,475

)

Financing activities

 

 

 

 

 

Proceeds from exercise of options

 

32,805

 

8,534

 

Repurchase of preferred stock

 

(22,275

)

 

Proceeds from issuance of long-term debt, net of issuance costs

 

20,064

 

151,932

 

Principal payments on long-term debt

 

(275,713

)

(93,305

)

Proceeds from insurance financing

 

15,306

 

 

Payments on insurance financing

 

(11,037

)

(9,364

)

Tax benefit from stock options exercised

 

5,760

 

2,478

 

Net cash (used in) provided by financing activities

 

(235,090

)

60,275

 

Net decrease in cash and cash equivalents

 

(25,332

)

(34,314

)

Cash and cash equivalents at beginning of year

 

260,467

 

238,440

 

Cash and cash equivalents at end of period

 

$

235,135

 

$

204,126

 

 

 

 

 

 

 

Supplemental disclosure

 

 

 

 

 

Interest expense paid, net of amounts capitalized

 

$

52,020

 

$

33,035

 

Income taxes paid

 

$

28,248

 

$

115,054

 

 

See accompanying notes to the condensed consolidated financial statements.

 

8



Table of Contents

 

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 June 30, 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. However, on July 1, 2013, the Company sold its Bullwhackers property located in Colorado and no longer has any operations in the state.

 

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 six months ended June 30, 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 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”) 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 $1.05 billion. The dividend will be paid in a combination of cash and GLPI common stock, with at least 20% being paid in cash and the remainder in GLPI common stock.

 

Upon satisfaction or waiver of conditions to the Spin-Off, Penn will effect the Spin-Off by distributing one share of common stock of GLPI to the holders of Penn common stock and Series C Convertible Preferred Stock (“Series C”) for every share of Penn common stock and every 1/1000th of a share of Series C that they hold at the close of business on the record date for the Spin-Off. See Note 11 for further information on the Series C.  Additionally, certain members of the “Carlino Group,” which consists of Peter M. Carlino and the Carlino Family Trust and the beneficiaries thereof, will receive (i) additional shares of GLPI common stock, in exchange for shares of Penn common stock that they will transfer to Penn immediately prior to the Spin-Off and/or (ii) options to acquire GLPI common stock, in exchange for options to acquire Penn common stock, which options will be issued/tendered following

 

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the Spin-Off. Penn will engage in either or both of these exchanges with the Carlino Group to ensure that they collectively own less than 10%, as required for GLPI to qualify as a REIT, of the outstanding shares of Penn 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 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. In addition, although the Carlino Group has agreed in principle to effect the exchanges mentioned above at a specified valuation, neither the Carlino Group nor the independent directors of Penn, on behalf of Penn, have entered into definitive documentation regarding the exchanges and no assurance can be made that such definitive documentation will be executed and delivered. 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.

 

GLPI has filed a preliminary registration statement on Form S-11 (File No. 333-188608) with the Securities and Exchange Commission for the proposed transaction.  Investors are encouraged to read the registration statement because it contains more complete information about GLPI and its separation from the Company including financial information and disclosures regarding GLPI’s capital structure, senior management and relationship with the Company as well as a detailed description of the conditions that must be satisfied in order to proceed with the proposed transaction, including, without limitation, the continuing validity of the factual representations underlying the private letter ruling, the completion of the financings needed to fund each of the public companies and the successful completion of the gaming and racing regulatory approval process.  Subject to satisfaction of the applicable conditions, the Company is planning to consummate the separation in the fourth quarter of 2013.

 

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 and six months ended June 30, 2013 and 2012 are as follows:

 

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Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Rooms

 

$

8,993

 

$

6,265

 

$

18,312

 

$

12,559

 

Food and beverage

 

31,232

 

27,236

 

63,722

 

54,715

 

Other

 

2,944

 

2,363

 

5,721

 

4,959

 

Total promotional allowances

 

$

43,169

 

$

35,864

 

$

87,755

 

$

72,233

 

 

The estimated cost of providing such complimentary services for the three and six months ended June 30, 2013 and 2012 are as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Rooms

 

$

3,121

 

$

2,307

 

$

6,360

 

$

4,663

 

Food and beverage

 

21,119

 

18,175

 

43,098

 

36,655

 

Other

 

1,383

 

1,429

 

3,027

 

2,951

 

Total cost of complimentary services

 

$

25,623

 

$

21,911

 

$

52,485

 

$

44,269

 

 

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 and six months ended June 30, 2013, these expenses, which are recorded primarily within gaming expense in the condensed consolidated statements of operations, were $267.0 million and $549.0 million, respectively, as compared to $266.6 million and $543.5 million for the three and six months ended June 30, 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 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 June 30, 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.

 

Since the Company reported a net loss for the three months ended June 30, 2013, it was required by ASC 260 to use basic weighted-average common shares outstanding, rather than diluted weighted-average common shares outstanding, when calculating diluted EPS for the three months ended June 30, 2013. In addition, since the Company reported a loss from operations for the three months ended June 30, 2013, the Preferred Stock was not deemed to be a participating security for the three months ended June 30,

 

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2013, pursuant to ASC 260 as the Preferred Stock is not obligated to participate in the losses of the Company. The basic weighted-average common shares outstanding for the three months ended June 30, 2013 were 78,306,436.

 

The following table sets forth the allocation of net income for the three months ended June 30, 2012 and six months ended June 30, 2013 and 2012 under the two-class method:

 

 

 

Three Months
Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

Net income

 

$

66,667

 

$

53,091

 

$

145,286

 

Net income applicable to preferred stock

 

12,914

 

9,983

 

28,183

 

Net income applicable to common stock

 

$

53,753

 

$

43,108

 

$

117,103

 

 

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 June 30, 2012 and six months ended June 30, 2013 and 2012:

 

 

 

Three Months
Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Determination of shares:

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

76,257

 

77,932

 

76,126

 

Assumed conversion of dilutive employee stock-based awards

 

2,453

 

3,058

 

2,325

 

Assumed conversion of restricted stock

 

142

 

92

 

146

 

Assumed conversion of preferred stock

 

27,278

 

22,850

 

27,278

 

Diluted weighted-average common shares outstanding

 

106,130

 

103,932

 

105,875

 

 

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 11 for discussion of the proposed Spin-Off’s potential future impact on the calculation of diluted weighted-average common shares outstanding.

 

Options to purchase 10,638,637 shares were outstanding during the three months ended June 30, 2013, but were not included in the computation of diluted EPS because they are antidilutive since the Company reported a loss from operations for the three months ended June 30, 2013. Options to purchase 99,625 shares were outstanding during the six months ended June 30, 2013, but were not included in the computation of diluted EPS because they were antidilutive. Options to purchase 1,700,528 shares and 3,125,403 shares were outstanding during the three and six months ended June 30, 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:

 

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Three Months
Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2013

 

2012

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

 

 

Calculation of basic EPS:

 

 

 

 

 

 

 

Net income applicable to common stock

 

$

53,753

 

$

43,108

 

$

117,103

 

Weighted-average common shares outstanding

 

76,257

 

77,932

 

76,126

 

Basic EPS

 

$

0.70

 

$

0.55

 

$

1.54

 

 

 

 

 

 

 

 

 

Calculation of diluted EPS:

 

 

 

 

 

 

 

Net income

 

$

66,667

 

$

53,091

 

$

145,286

 

Diluted weighted-average common shares outstanding

 

106,130

 

103,932

 

105,875

 

Diluted EPS

 

$

0.63

 

$

0.51

 

$

1.37

 

 

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 and six months ended June 30, 2013 was $5.4 million and $11.7 million, respectively, as compared to $7.4 million and $15.3 million for the three and six months ended June 30, 2012, respectively.  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 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 six months ended June 30, 2013, however, the Company granted 256,500 shares of restricted stock during this same time period.

 

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 June 30, 2013, there was $27.6 million of total unrecognized compensation cost that will be recognized over the grants remaining weighted average vesting period of 3.08 years. For the three and six months ended June 30, 2013, the Company recognized $2.2 million and $5.0 million of compensation expense associated with these awards, respectively, as compared to $1.3 million and $2.5 million for the three and six months ended June 30, 2012, respectively.

 

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 June 30, 2013, there was $11.2 million of total unrecognized compensation cost that will be recognized over the awards remaining weighted average vesting period of 2.28 years. For the three and six months ended June 30, 2013, the Company recognized $0.9 million and $3.7 million of compensation expense associated with these awards, respectively, as compared to $1.1 million and $2.5 million for the three and six months ended June 30, 2012, respectively.

 

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model at June 30, 2013 and 2012:

 

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2013

 

2012

 

 

 

 

 

 

 

Risk-free interest rate

 

1.08

%

0.84

%

Expected volatility

 

46.27

%

45.78

%

Dividend yield

 

 

 

Weighted-average expected life (years)

 

6.57

 

6.64

 

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 condensed consolidated financial statements.

 

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

 

 

 

Foreign Currency

 

Available for
sale securities

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011

 

$

1,203

 

$

1,115

 

$

2,318

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(167

)

 

(167

)

Unrealized holding gains on corporate debt securities

 

 

85

 

85

 

Ending balance at June 30, 2012

 

$

1,036

 

$

1,200

 

$

2,236

 

 

 

 

 

 

 

 

 

Balance at December 31, 2012

 

$

1,628

 

$

1,394

 

$

3,022

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(999

)

 

(999

)

Unrealized holding losses on corporate debt securities

 

 

(98

)

(98

)

Realized gain on redemption of corporate debt securities

 

 

(1,296

)

(1,296

)

Ending balance at June 30, 2013

 

$

629

 

$

 

$

629

 

 

5.  Property and Equipment

 

Property and equipment, net, consists of the following:

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

 

 

(in thousands)

 

 

 

 

 

 

 

Land and improvements

 

$

438,648

 

$

442,882

 

Building and improvements

 

2,312,637

 

2,283,230

 

Furniture, fixtures, and equipment

 

1,290,690

 

1,240,898

 

Leasehold improvements

 

17,188

 

17,229

 

Construction in progress

 

44,988

 

30,531

 

Total property and equipment

 

4,104,151

 

4,014,770

 

Less accumulated depreciation

 

(1,426,148

)

(1,283,973

)

Property and equipment, net

 

$

2,678,003

 

$

2,730,797

 

 

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Depreciation expense, for property and equipment, totaled $75.5 million and $151.7 million for the three and six months ended June 30, 2013, respectively, as compared to $56.7 million and $109.9 million for the three and six months ended June 30, 2012, respectively.  Interest capitalized in connection with major construction projects was $0.3 million and $0.4 million for the three and six months ended June 30, 2013, respectively, as compared to $3.0 million and $5.9 million for the three and six months ended June 30, 2012, respectively.

 

6.  Goodwill and Other Intangible Assets

 

A reconciliation of goodwill and accumulated goodwill impairment losses is as follows (in thousands):

 

Balance at December 31, 2012:

 

 

 

Goodwill

 

$

2,214,546

 

Accumulated goodwill impairment losses

 

(833,857

)

Goodwill, net

 

$

1,380,689

 

Goodwill impairment losses

 

(68,727

)

Other

 

(2,549

)

Balance at June 30, 2013:

 

 

 

Goodwill

 

$

2,211,997

 

Accumulated goodwill impairment losses

 

(902,584

)

Goodwill, net

 

$

1,309,413

 

 

The table below presents the gross carrying value, accumulated amortization, and net book value of each major class of other intangible assets at June 30, 2013 and December 31, 2012:

 

 

 

June 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

 

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Net Book
Value

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Net Book
Value

 

Indefinite-life intangible assets

 

$

676,968

 

$

 

$

676,968

 

$

675,901

 

$

 

$

675,901

 

Argosy Casino Sioux City gaming license

 

20,949

 

4,190

 

16,759

 

24,068

 

 

24,068

 

Other intangible assets

 

56,661

 

51,921

 

4,740

 

56,661

 

50,153

 

6,508

 

Total

 

$

754,578

 

$

56,111

 

$

698,467

 

$

756,630

 

$

50,153

 

$

706,477

 

 

As a result of a new gaming license being awarded for the development of a new casino in Sioux City, Iowa to another applicant in April 2013 (see Note 9 for further details), the Company recorded a pre-tax goodwill and other intangible asset impairment charge of $68.7 million ($68.6 million, net of taxes) and $3.1 million ($1.9 million, net of taxes), respectively, for Argosy Casino Sioux City during the three months ended June 30, 2013, as the Company determined that the fair value of its Sioux City reporting unit was less than its carrying amount based on the Company’s analysis of the estimated future expected cash flows the Company anticipates receiving from the operations of the Sioux City facility. Furthermore, the remaining gaming license for Argosy Casino Sioux City of $20.9 million at time of the impairment is now accounted for as a definite lived intangible asset and will be amortized on a straight line basis through June 2014, which is the anticipated opening date of the new facility.

 

The Company’s intangible asset amortization expense was $5.1 million and $6.0 million for the three and six months ended June 30, 2013, respectively, as compared to $40 thousand and $0.2 million for the three and six months ended June 30, 2012, respectively.

 

The following table presents expected intangible asset amortization expense based on existing intangible assets at June 30, 2013 (in thousands):

 

Remainder of 2013

 

$

10,148

 

2014

 

11,332

 

2015

 

19

 

Total

 

$

21,499

 

 

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Table of Contents

 

7.  Investment in Corporate Securities

 

In 2008, the Company made an investment in the corporate debt securities of another gaming company which had a maturity date of November 1, 2012. This investment was accounted for as an available-for-sale investment and was included in other assets within the consolidated balance sheet.  During 2010, the issuer of the security went into default on its obligations as it ceased making interest payments and the security was downgraded by certain rating agencies. As a result, in 2010, the Company wrote down the investment to its fair value, which was based on the transaction prices of the security subsequent to when the issuer defaulted on its obligations. In April 2011, the issuer of the security declared bankruptcy. In the second quarter of 2013, the Company received a distribution of $6.7 million from the finalization of bankruptcy proceedings, which resulted in the recognition of a $1.3 million realized gain included in other income (expenses) within the condensed consolidated statements of operations for the three and six months ended June 30, 2013.

 

8.  Long-term Debt

 

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

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

 

 

(in thousands)

 

 

 

 

 

 

 

Senior secured credit facility

 

$

2,139,300

 

$

2,394,963

 

$325 million 8 ¾% senior subordinated notes due August 2019

 

325,000

 

325,000

 

Other long-term obligations

 

11,217

 

10,000

 

Capital leases

 

2,061

 

2,111

 

 

 

2,477,578

 

2,732,074

 

Less current maturities of long-term debt

 

(82,594

)

(81,497

)

Less discount on senior secured credit facility Term Loan B

 

(1,378

)

(1,504

)

 

 

$

2,393,606

 

$

2,649,073

 

 

The following is a schedule of future minimum repayments of long-term debt as of June 30, 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

 

$

82,594

 

1-3 years

 

192,711

 

3-5 years

 

751,463

 

Over 5 years

 

1,450,810

 

Total minimum payments

 

$

2,477,578

 

 

Senior Secured Credit Facility

 

The Company’s senior secured credit facility had a gross outstanding balance of $2,139.3 million at June 30, 2013, consisting of a $1,015.0 million Term Loan A facility and a $1,124.3 million Term Loan B facility.  No balances were outstanding on the revolving credit facility at June 30, 2013.  Additionally, at June 30, 2013, the Company was contingently obligated under letters of credit issued pursuant to the senior secured credit facility with face amounts aggregating $73.3 million, resulting in $711.7 million of available borrowing capacity as of June 30, 2013 under the revolving credit facility.  The Company made payments of $128.2 million against its Term Loan B facility during 2013.

 

Other Long-Term Obligations

 

In September 2012, the Company received $10 million under a subscription agreement entered into between A3 Gaming Investments, LLC, an investment vehicle owned by the previous owner of the M Resort (“A3 Gaming Investments”), and LV Gaming Ventures, LLC, a wholly-owned subsidiary of the Company and holder of the assets of the M Resort (“LV Gaming Ventures”). The subscription agreement entitles A3 Gaming Investments to invest in a limited liability membership interest in LV Gaming Ventures which matures on October 1, 2016. The investment entitles A3 Gaming Investments to annual payments and a settlement value based on the earnings levels of the M Resort. In accordance with ASC 480, “Distinguishing Liabilities from Equity,” the Company determined that this obligation is a financial instrument and as such should be recorded as a liability within debt. Changes in the

 

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settlement value, if any, will be accreted to interest expense through the maturity date of the instrument. During the six months ended June 30, 2013, the Company recorded $1.2 million in accretion on this instrument.

 

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 June 30, 2013, the Company was in compliance with all required covenants.

 

9.  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 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. The Belle has filed four 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, announcing a process would be instituted to revoke the Belle’s license, and its selection of another gaming operator. 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. Additionally, in June 2013, the Company filed a petition to request the appointment of a third party to receive and hold or distribute the funds to be paid to MRHD (for which oral argument was held in July 2013).

 

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

 

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$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.

 

On June 13, 2013, the Company finalized an agreement to the terms of its previous non-binding memorandum of understanding with the State of Ohio.  The Company has agreed to pay $110 million over a ten year period commencing in July 2013 for certain clarifications from the State of Ohio with respect to various financial matters and limits on competition within the ten year time period.  Additionally, in return for being able to relocate its existing racetracks in Toledo and Grove City to Dayton and Austintown (located in the Mahoning Valley), respectively, the Company agreed to pay the state $7.5 million upon the opening of each facility, as well as eighteen semi-annual installment payments of $4.8 million beginning one year after the opening of each facility.

 

10.  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

 

2,194

 

Additions based on prior year positions

 

1,916

 

Currency translation adjustments

 

(1,459

)

Balance at June 30, 2013

 

$

23,044

 

 

The increase in the Company’s liability for unrecognized tax benefits during the six months ended June 30, 2013 was primarily due to recording additional tax reserves and 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 146.2% and 60.5% for the three and six months ended June 30, 2013, respectively, as compared to 41.0% and 39.1% for the three and six months ended June 30, 2012, respectively, primarily due to the non-deductible portion of the Company’s goodwill impairment charge related to Argosy Casino Sioux City.

 

At June 30, 2013 and December 31, 2012, prepaid expenses within the condensed consolidated balance sheets included prepaid income taxes of $30.0 million and $68.4 million, respectively.

 

11.  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 exchange of shares of the Company’s Preferred Stock for shares of a new class of 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 Preferred Stock 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

 

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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 shares of 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 shares 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 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 Capital 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.

 

12.  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 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 (which was sold on July 1, 2013).

 

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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 June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

258,178

 

$

317,071

 

$

175,897

 

$

10,225

 

$

761,371

 

Income (loss) from operations

 

53,069

 

75,955

 

(47,564

)

(34,579

)

46,881

 

Depreciation and amortization

 

32,573

 

19,292

 

24,655

 

4,095

 

80,615

 

Gain (loss) from unconsolidated affiliates

 

 

 

4,047

 

(226

)

3,821

 

Impairment losses

 

 

 

71,846

 

 

71,846

 

Capital expenditures

 

27,416

 

6,989

 

17,755

 

1,754

 

53,914

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2012

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

217,975

 

348,652

 

137,405

 

8,519

 

712,551

 

Income (loss) from operations

 

47,139

 

76,732

 

37,532

 

(33,388

)

128,015

 

Depreciation and amortization

 

19,645

 

21,784

 

11,212

 

4,150

 

56,791

 

Gain (loss) from unconsolidated affiliates

 

 

 

1,276

 

(222

)

1,054

 

Capital expenditures

 

109,079

 

15,882

 

8,881

 

677

 

134,519

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

545,491

 

634,119

 

360,581

 

19,426

 

1,559,617

 

Income (loss) from operations

 

116,865

 

145,062

 

(10,555

)

(71,176

)

180,196

 

Depreciation and amortization

 

64,830

 

40,125

 

44,543

 

8,188

 

157,686

 

Gain (loss) from unconsolidated affiliates

 

 

 

5,784

 

(242

)

5,542

 

Impairment losses

 

 

 

71,846

 

 

71,846

 

Capital expenditures

 

61,246

 

14,060

 

36,782

 

4,529

 

116,617

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2012

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

423,086

 

719,281

 

287,125

 

19,118

 

1,448,610

 

Income (loss) from operations

 

93,422

 

160,622

 

82,243

 

(65,657

)

270,630

 

Depreciation and amortization

 

37,197

 

44,026

 

22,600

 

6,305

 

110,128

 

Gain (loss) from unconsolidated affiliates

 

 

 

2,954

 

(215

)

2,739

 

Capital expenditures

 

210,959

 

26,541

 

12,813

 

3,865

 

254,178

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance sheet at June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

2,277,845

 

1,169,482

 

1,588,279

 

397,764

 

5,433,370

 

Investment in and advances to unconsolidated affiliates

 

 

86

 

135,298

 

66,163

 

201,547

 

Goodwill and other intangible assets, net

 

1,023,904

 

226,047

 

702,121

 

55,808

 

2,007,880

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

13.  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 was estimated based on a third party broker quote and as such was a Level 2 measurement as defined under ASC 820, “Fair Value Measurements and Disclosures.” The investment in corporate debt securities was measured at fair value on a recurring basis using the market approach. As described in Note 7, a distribution for the redemption of the investment in corporate debt securities was received in the second quarter of 2013.

 

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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. 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.

 

The estimated fair values of the Company’s financial instruments are as follows (in thousands):

 

 

 

June 30, 2013

 

December 31, 2012

 

 

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

235,135

 

$

235,135

 

$

260,467

 

$

260,467

 

Investment in corporate debt securities

 

 

 

6,790

 

6,790

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

 

 

 

 

 

 

 

Senior secured credit facility

 

2,137,922

 

2,140,762

 

2,393,459

 

2,401,225

 

Senior subordinated notes

 

325,000

 

355,875

 

325,000

 

368,875

 

Other long-term obligations

 

11,217

 

11,217

 

10,000

 

10,000

 

 

14.  Insurance Deductibles

 

Hollywood Casino St. Louis Tornado

 

On May 31, 2013, Hollywood Casino St. Louis sustained minor damage as a result of a tornado and was forced to close for approximately fourteen hours.  At the time of the tornado, the Company carried property insurance coverage with a limit of $600 million for both property damage and business interruption applicable to this event. This coverage included a $2.5 million property damage deductible and two days of business interruption deductible for the peril of a tornado.  During the three months ended June 30, 2013, the Company recorded a $2.5 million pre-tax loss for the property damage insurance deductible.

 

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

 

Our Operations

 

We are a leading, diversified, multi-jurisdictional owner and manager of gaming and pari-mutuel properties. As of June 30, 2013, we 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. However, on July 1, 2013, we sold our Bullwhackers property located in Colorado and no longer have any operations in the state.

 

We have made significant acquisitions in the past and expect to continue to pursue additional acquisition and development opportunities in the future. In 1997, we began our transition from a pari-mutuel company to a diversified gaming company with the acquisition of the Charles Town property and the introduction of video lottery terminals in West Virginia. Since 1997, we have continued to expand our gaming operations through strategic acquisitions (including the acquisitions of Hollywood Casino Bay St. Louis and Boomtown Biloxi, CRC Holdings, Inc., Hollywood Casino Corporation, Argosy Gaming Company, Zia Park Casino, Sanford-Orlando Kennel Club and M Resorts), greenfield projects (such as Hollywood Casino at Penn National Race Course, Hollywood Casino Bangor and Hollywood Casino Perryville), and property expansions (such as Hollywood Casino at Charles Town Races and Hollywood Casino Lawrenceburg). Most recently, we, along with our joint venture partner, opened Hollywood Casino at Kansas Speedway on February 3, 2012 and in Ohio, we opened our Hollywood Casino Toledo facility on May 29, 2012 and our Hollywood Casino Columbus facility on October 8, 2012. Finally, on November 2, 2012, we acquired Harrah’s St. Louis facility, which we are in the process of renovating and rebranding to Hollywood Casino St. Louis.

 

The vast majority of our revenue is gaming revenue, derived primarily from gaming on slot machines and to a lesser extent, table games, which are highly dependent upon the volume and spending levels of customers at our properties. Other revenues are derived from our management service fee from Casino Rama, our hotel, dining, retail, admissions, program sales, concessions and certain other ancillary activities, and our racing operations. Our racing revenue includes our share of pari-mutuel wagering on live races after payment of amounts returned as winning wagers, our share of wagering from import and export simulcasting, and our share of wagering from our off-track wagering facilities.

 

Key performance indicators related to gaming revenue are slot handle and table game drop (volume indicators) and “win” or “hold” percentage. Our typical property slot hold percentage is in the range of 6% to 10% of slot handle, and our typical table game win percentage is in the range of 12% to 25% of table game drop.

 

Slot handle is the gross amount wagered for the period cited.  The win or hold percentage is the net amount of gaming wins and losses, with liabilities recognized for accruals related to the anticipated payout of progressive jackpots.  Our slot hold percentages have consistently been in the 6% to 10% range over the past several years.  Given the stability in our slot hold percentages, we have not experienced significant impacts to earnings from changes in these percentages.

 

For table games, customers usually purchase cash chips at the gaming tables.  The cash and markers (extensions of credit granted to certain credit worthy customers) are deposited in the gaming table’s drop box.  Table game win is the amount of drop that is retained and recorded as casino gaming revenue, with liabilities recognized for funds deposited by customers before gaming play occurs and for unredeemed gaming chips.  As we are focused on regional gaming markets, our table win percentages are fairly stable as the majority of these markets do not regularly experience high-end play which can lead to volatility in win percentages.  Therefore, changes in table game win percentages do not typically have a material impact to our earnings.

 

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

 

We continue to expand our gaming operations through the implementation and execution of a disciplined capital expenditure program at our existing properties, the pursuit of strategic acquisitions and the development of new gaming properties, particularly in attractive regional markets. Current capital projects are ongoing at several of our properties. Additional information regarding our capital projects is discussed in detail in the section entitled “Liquidity and Capital Resources—Capital Expenditures” below.

 

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

 

On November 15, 2012, we announced that we intend to pursue a plan to separate the majority of our operating assets and real property assets into two publicly traded companies, including an operating entity, PNG, and, through a tax-free Spin-Off of our real estate assets to holders of our common and preferred stock, a newly formed publicly traded REIT, GLPI, subject to required gaming regulatory body approvals and other contingencies noted below. 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 renewal options, which are at PNG’s option). 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.

 

Based on the Company’s current real estate portfolio, GLPI is expected to initially own the real estate for 17 casino facilities. Through its rent structure, which is partially based on the performance of the facilities, GLPI would expect to grow organically by participating in PNG’s growing revenue base. In addition, GLPI would focus on expanding its gaming and leisure sector real estate portfolio through acquisitions, and thereby diversify its asset base and tenant base over time. GLPI will also own and operate Hollywood Casino Perryville and Hollywood Casino Baton Rouge through its taxable REIT subsidiary.

 

After the proposed Spin-Off of GLPI shares to the Company’s shareholders, GLPI will declare a dividend to its shareholders to distribute any accumulated earnings and profits attributable to any pre-REIT years to comply with certain REIT qualification requirements. We currently estimate that, if GLPI were to elect REIT status as of January 1, 2014, the aggregate amount of the taxable dividend would be approximately $1.05 billion. The dividend will be paid in a combination of cash and GLPI common stock, with at least 20% being paid in cash and the remainder in GLPI common stock. In addition, going forward, the Company expects that GLPI will distribute at least 90% of its annual taxable income as dividends.

 

Prior to the Spin-Off, the Company anticipates refinancing its existing debt obligations and PNG and GLPI are expected to enter into new credit facilities.

 

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 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 Company expects to receive opinions from outside counsel regarding certain aspects of the transaction that are not covered by the private letter ruling.

 

The completion of the proposed transaction is contingent on receipt of regulatory approvals, which the Company anticipates could occur in the second half of 2013, the receipt of final approval by the Company’s Board of Directors, the receipt of legal and accounting opinions, 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.

 

GLPI has filed a preliminary registration statement on Form S-11 (File No. 333-188608) with the Securities and Exchange Commission for the proposed transaction.  Investors are encouraged to read the registration statement because it contains more complete information about GLPI and its separation from the Company including financial information and disclosures regarding GLPI’s capital structure, senior management and relationship with the Company as well as a detailed description of the conditions that must be satisfied in order to proceed with the proposed transaction, including, without limitation, the continuing validity of the factual representations underlying the private letter ruling, the completion of the financings needed to fund each of the public companies and the successful completion of the gaming and racing regulatory approval process.  Subject to satisfaction of the applicable conditions, the Company is planning to consummate the separation in the fourth quarter of 2013.

 

Segment Information

 

We have aggregated our properties into three reportable segments: (i) Midwest, (ii) East/West, and (iii) Southern Plains, which is consistent with how our Chief Operating Decision Maker reviews and assesses our 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 our Casino Rama management service contract and the Mahoning Valley and Dayton Raceway projects in Ohio which we anticipate completing in 2014.

 

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

 

The Other category consists of our standalone racing operations, namely Beulah Park, Raceway Park, Rosecroft Raceway, Sanford-Orlando Kennel Club, and our joint venture interests in Sam Houston Race Park, Valley Race Park and Freehold Raceway. If we are successful in obtaining gaming operations at these locations, they would be assigned to one of our regional executives and reported in their respective reportable segment. The Other category also includes our corporate overhead operations which does not meet the definition of an operating segment under Accounting Standards Codification 280, “Segment Reporting,” and our Bullwhackers property (which was sold on July 1, 2013).

 

Executive Summary

 

Economic conditions and the expansion of newly constructed gaming facilities continue to impact the overall domestic gaming industry as well as our operating results. We believe that current economic conditions, including, but not limited to, high unemployment levels, low levels of consumer confidence, and higher taxes, have resulted in reduced levels of discretionary consumer spending compared to historical levels. Additionally, the expansion of newly constructed gaming facilities has increased competition in many of our regional markets.

 

We believe our strengths include our relatively low leverage ratios compared to the regional casino companies that we directly compete against and the ability of our operations to generate positive cash flow. These two factors have allowed us to develop what we believe to be attractive future growth opportunities. We have also made investments in joint ventures that we believe may allow us to capitalize on additional gaming opportunities in certain states if legislation or referenda are passed that permit and/or expand gaming in these jurisdictions and we are selected as a licensee.

 

Financial Highlights:

 

We reported net revenues and income from operations of $761.4 million and $46.9 million, respectively, for the three months ended June 30, 2013 compared to $712.6 million and $128.0 million, respectively, for the corresponding period in the prior year and net revenues and income from operations of $1,559.6 million and $180.2 million, respectively, for the six months ended June 30, 2013 compared to $1,448.6 million and $270.6 million, respectively, for the corresponding period in the prior year. The major factors affecting our results for the three and six months ended June 30, 2013, as compared to the three and six months ended June 30, 2012, were:

 

·                  A pre-tax goodwill and other intangible asset impairment charge of $71.8 million for Argosy Casino Sioux City in our Southern Plains segment during the three and six months ended June 30, 2013.

 

·                  The partial opening of a casino complex at the Arundel Mills mall in Maryland in June 2012 and its second phase opening in mid-September 2012, which negatively impacted Hollywood Casino at Charles Town Races and Hollywood Casino Perryville.

 

·                  The opening of Hollywood Casino Toledo on May 29, 2012, which generated $51.1 million and $102.2 million of net revenues for the three and six months ended June 30, 2013, respectively, as compared to $25.3 million for the corresponding periods in the prior year.

 

·                  The opening of Hollywood Casino Columbus on October 8, 2012, which generated $55.3 million and $118.9 million of net revenues for the three and six months ended June 30, 2013, respectively.

 

·                  New competition in our Midwest segment for Hollywood Casino Lawrenceburg, namely the March 4, 2013 opening of a casino in Cincinnati, Ohio, the opening on June 1, 2012 of a new racino in Columbus, Ohio, as well as our Columbus casino.

 

·                  The acquisition of Harrah’s St. Louis facility, now known as Hollywood Casino St. Louis, on November 2, 2012, which contributed $54.1 million and $111.9 million of net revenues for the three and six months ended June 30, 2013, respectively.

 

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·                  The opening of a new riverboat casino and hotel in Baton Rouge, Louisiana on September 1, 2012, which negatively impacted Hollywood Casino Baton Rouge in our Southern Plains segment.

 

·                  The February 3, 2012 opening of our joint venture, Hollywood Casino at Kansas Speedway, which negatively impacted the results at our Argosy Riverside property in our Southern Plains segment.

 

·                  A pre-tax insurance loss of $2.5 million at Hollywood Casino St. Louis during the three and six months ended June 30, 2013, as compared to a pre-tax insurance gain of $3.4 million and $7.2 million at Hollywood Casino Tunica during the three and six months ended June 30, 2012, respectively.

 

·                  Net income decreased by $78.8 million and $92.2 million for the three and six months ended June 30, 2013, respectively, as compared to the three and six months ended June 30, 2012, primarily due to the variances explained above, as well as increased interest expense offset by decreased income taxes.

 

Segment Developments:

 

The following are recent developments that have had or will have an impact on us by segment:

 

Midwest

 

·                  In March 2012, we announced that we had entered into a non-binding memorandum of understanding (“MOU”) with the State of Ohio that establishes a framework for relocating our existing racetracks in Toledo and Grove City to Dayton and Austintown (located in the Mahoning Valley), respectively, where we intend to develop new integrated racing and gaming facilities, budgeted at approximately $254 million and $261 million, inclusive of $50 million in license fees and $75 million in relocation fees, respectively. Pursuant to this arrangement, the Ohio Lottery Commission would retain 33.5% of video lottery terminal revenues (exclusive of the horsemen’s share). In addition, the MOU restricts any other gaming facility from being located within 50 miles of our Columbus and Toledo casinos, as well as our relocated racetracks, with certain exceptions. In mid-June 2013, the definitive agreement between the Company and the State of Ohio was signed.  In June 2012, we announced that we had filed applications with the Ohio Lottery Commission for Video Lottery Sales Agent Licenses for our Ohio racetracks, and with the Ohio State Racing Commission for permission to relocate the racetracks. The new Austintown facility, which will be a thoroughbred track and feature up to 1,000 video lottery terminals, will be located on 184 acres in Austintown’s Centrepointe Business Park near the intersection of Interstate 80 and Ohio Route 46. The Dayton facility, which will be a standardbred track and feature up to 1,500 video lottery terminals, will be located on 125 acres on the site of an abandoned Delphi Automotive plant near Wagner Ford and Needmore roads in North Dayton. On May 1, 2013, the Company received approval from the Ohio Racing Commission for our relocation plans for each new racetrack and video lottery terminal facility and expects both to open in the second half of 2014. The opening of our Dayton facility may have an adverse impact on our Hollywood Casino Columbus facility.

 

·                  On October 21, 2011, the Ohio Roundtable filed a complaint in the Court of Common Pleas in Franklin County, Ohio against a number of defendants, including the Governor, the Ohio Lottery Commission and the Ohio Casino Control Commission. The complaint alleges a variety of substantive and procedural defects relative to the approval and implementation of video lottery terminals as well as several counts dealing with the taxation of standalone casinos. We, along with the other two casinos in Ohio, filed motions for judgment on the pleadings. In May 2012, the complaint was dismissed; however, the plaintiffs filed an appeal and oral arguments were held on January 17, 2013.  In March 2013, the Ohio appeals court upheld the ruling. The decision of the appeals court was appealed to the Ohio Supreme Court by the plaintiffs on April 30, 2013 and the Ohio Supreme Court has elected to accept the appeal.

 

·                  On March 4, 2013, a new casino in Cincinnati, Ohio opened, which has had and will continue to have a negative impact on Hollywood Casino Lawrenceburg’s financial results. In addition, on June 1, 2012, a new racino at Scioto Downs in Columbus, Ohio opened and has also negatively impacted Hollywood Casino Lawrenceburg and competes in the same market as Hollywood Casino Columbus. Additionally, new racinos in Ohio are planned at Lebanon Raceway and River Downs, both of which are anticipated to be completed in early 2014. We anticipate the opening of these new racinos will have a further adverse impact on Hollywood Casino Lawrenceburg and we anticipate that the Lebanon Raceway facility will have a negative impact on Hollywood Casino Columbus.

 

East/West

 

·                  In our East/West segment, Hollywood Casino at Charles Town Races and Hollywood Casino Perryville faced increased competition and their results have been negatively impacted by the opening of a casino complex, Maryland Live!, at the Arundel Mills mall in Anne Arundel, Maryland. The casino opened on June 6, 2012 with approximately 3,200 slot machines and

 

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significantly increased its slot machine offerings by mid-September 2012 to approximately 4,750 slot machines. In addition, the Anne Arundel facility opened table games on April 11, 2013 which has negatively impacted Hollywood Casino at Charles Town Races.  Additionally, in late August 2013, Maryland Live! plans to open a 52 table poker room, which we anticipate will further negatively impact our Hollywood Casino at Charles Town Races facility.

 

·                  In November 2012, voters approved legislation authorizing a sixth casino in Prince George’s County and the ability to add table games to Maryland’s five existing and planned casinos. On March 5, 2013, table games were opened at Hollywood Casino Perryville. The new law also changes the tax rate casino operators pay the state, varying from casino to casino, allows all casinos in Maryland to be open 24 hours per day for the entire year, and permits casinos to directly purchase slot machines in exchange for gaming tax reductions. For our Hollywood Casino Perryville facility, the tax rate would decrease upon the opening of the Prince George casino from 67 percent to 61 percent with an option for an additional 5 percent reduction if an independent commission agrees. In May 2013, three different bidders, including the Company, submitted proposals for a Prince George casino. Our proposal includes a $700 million casino resort, which would be constructed at our Rosecroft Raceway facility, with 3,000 video lottery terminals, 100 table games and 40 poker tables, as well as a hotel, variety of food and beverage options, an entertainment and multi-purpose event center, a new grandstand facility, and structured and surface parking. Though we are participating in the bidding process, we believe another operator could be selected, and as a result our financial results would be adversely impacted as it would create additional competition for Hollywood Casino at Charles Town Races and Hollywood Casino Perryville.

 

·                  On April 5, 2013, we announced that we and the Jamul Indian Village (“the Tribe”) have entered into definitive agreements to jointly develop a Hollywood-branded casino and resort on the Tribe’s trust land in San Diego County, California. The proposed facility is located approximately 20 miles east of downtown San Diego. The proposed $360 million development will include a three-story gaming and entertainment facility of approximately 200,000 square feet featuring at least 1,700 slot machines, 50 live table games including poker, multiple restaurants, bars and lounges and a partially enclosed parking structure with over 1,900 spaces.  It is anticipated that construction could commence late this year with an expected construction period of approximately 24 months.  We may, under certain circumstances, provide backstop financing to the Tribe in connection with the project and, upon opening, we will manage the casino and resort.

 

Southern Plains

 

·                  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, and its QSO, 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 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. We 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 casino opens to the public, but not beyond. We are currently reviewing all of our options and will maintain an open dialogue with members of the IRGC, Sioux City officials, and our employees regarding the IRGC’s decision. The Belle has filed four 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, announcing a process would be instituted to revoke the Belle’s license, and its selection of another gaming operator. 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. Additionally, in June 2013, the Company filed a petition to request the appointment of a third party to receive and hold or distribute the funds to be paid to MRHD (for which oral argument was held in July 2013).

 

·                  A new riverboat casino and hotel in Baton Rouge, Louisiana opened on September 1, 2012. The opening of this riverboat casino has and will continue to have an adverse effect on the financial results of Hollywood Casino Baton Rouge. In addition, a casino in Biloxi opened in late May 2012, which has and will continue to have an adverse effect on the financial results of our Boomtown Biloxi property.

 

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Other

 

·                  On July 1, 2013, we sold our Bullwhackers property. The Bullwhackers casino, which is located in Black Hawk, Colorado, included 10,425 square feet of gaming space with approximately 280 slot machines. The property also included a gas station/convenience store located approximately 7 miles east of the Bullwhackers casino on Highway 119.

 

Critical Accounting Estimates

 

We make certain judgments and use certain estimates and assumptions when applying accounting principles in the preparation of our consolidated financial statements. The nature of the estimates and assumptions are material due to the levels of subjectivity and judgment necessary to account for highly uncertain factors or the susceptibility of such factors to change. We have identified the accounting for long-lived assets, goodwill and other intangible assets, income taxes and litigation, claims and assessments as critical accounting estimates, as they are the most important to our financial statement presentation and require difficult, subjective and complex judgments.

 

We believe the current assumptions and other considerations used to estimate amounts reflected in our consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in our consolidated financial statements, the resulting changes could have a material adverse effect on our consolidated results of operations and, in certain situations, could have a material adverse effect on our consolidated financial condition.

 

For further information on our critical accounting estimates, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the notes to our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. There has been no material change to these estimates for the six months ended June 30, 2013.

 

Results of Operations

 

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

 

·                  The fact that most of our properties operate in mature competitive markets. As a result, we expect a majority of our future growth to come from prudent acquisitions of gaming properties (such as our recent acquisition of Harrah’s St. Louis gaming and lodging facility from Caesars Entertainment which closed on November 2, 2012), jurisdictional expansions (such as the February 2012 opening of a casino through a joint venture in Kansas, the May 2012 opening of Hollywood Casino Toledo, the October 2012 opening of Hollywood Casino Columbus, and the opening of video lottery terminal facilities at two racetracks in Ohio which are expected to commence operations in 2014), expansions of gaming in existing jurisdictions (such as the introduction of table games in July 2010 at Hollywood Casino at Charles Town Races and Hollywood Casino at Penn National Race Course, Hollywood Casino Bangor in March 2012, and more recently at Hollywood Casino Perryville in March 2013) and expansions/improvements of existing properties.

 

·                  The fact that a number of states (such as Massachusetts) are currently considering or implementing legislation to legalize or expand gaming. Such legislation presents both potential opportunities to establish new properties (for example, in Kansas where we opened a casino through a joint venture in February 2012, in Ohio where we opened a casino in Toledo in May 2012 and in Columbus in October 2012, and in Maryland where we opened Hollywood Casino Perryville on September 27, 2010) and increased competitive threats to business at our existing properties (such as the introduction/expansion of commercial casinos in Kansas, Maryland, Ohio, and potentially Kentucky, a new riverboat casino and hotel in Baton Rouge, Louisiana which opened on September 1, 2012, a new casino in Biloxi, Mississippi which opened in late May 2012, a new casino that opened in Oxford, Maine on June 5, 2012, and the introduction of tavern licenses in several states).

 

·                  The actions of government bodies can affect our operations in a variety of ways. For instance, the continued pressure on governments to balance their budgets could intensify the efforts of state and local governments to raise revenues through increases in gaming taxes and/or property taxes, or via an expansion of gaming. In addition, government bodies may restrict, prevent or negatively impact operations in the jurisdictions in which we do business (such as the implementation of smoking bans).

 

·                  The continued demand for, and our emphasis on, slot wagering entertainment at our properties.

 

·                  The successful execution of the development and construction activities currently underway at a number of our facilities, as well as the risks associated with the costs, regulatory approval and the timing of these activities.

 

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·                  The risks related to economic conditions and the effect of such conditions on consumer spending for leisure and gaming activities, which may negatively impact our operating results and our ability to continue to access financing at favorable terms.

 

The consolidated results of operations for the three and six months ended June 30, 2013 and 2012 are summarized below:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Revenues:

 

 

 

 

 

 

 

 

 

Gaming

 

$

679,829

 

$

634,846

 

$

1,397,754

 

$

1,290,923

 

Food, beverage and other

 

121,044

 

109,955

 

242,904

 

222,863

 

Management service fee

 

3,667

 

3,614

 

6,714

 

7,057

 

Revenues

 

804,540

 

748,415

 

1,647,372

 

1,520,843

 

Less promotional allowances

 

(43,169

)

(35,864

)

(87,755

)

(72,233

)

Net revenues

 

761,371

 

712,551

 

1,559,617

 

1,448,610

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Gaming

 

341,889

 

330,875

 

703,907

 

671,044

 

Food, beverage and other

 

88,910

 

84,985

 

179,175

 

172,789

 

General and administrative

 

128,730

 

115,251

 

264,307

 

231,248

 

Depreciation and amortization

 

80,615

 

56,791

 

157,686

 

110,128

 

Impairment losses

 

71,846

 

 

71,846

 

 

Insurance deductible charges, net of recoveries

 

2,500

 

(3,366

)

2,500

 

(7,229

)

Total operating expenses

 

714,490

 

584,536

 

1,379,421

 

1,177,980

 

Income from operations

 

$

46,881

 

$

128,015

 

$

180,196

 

$

270,630

 

 

Certain information regarding our results of operations by segment for the three and six months ended June 30, 2013 and 2012 is summarized below:

 

 

 

Net Revenues

 

Income (loss) from Operations

 

Three Months Ended June 30,

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Midwest

 

$

258,178

 

$

217,975

 

$

53,069

 

$

47,139

 

East/West

 

317,071

 

348,652

 

75,955

 

76,732

 

Southern Plains

 

175,897

 

137,405

 

(47,564

)

37,532

 

Other

 

10,225

 

8,519

 

(34,579

)

(33,388

)

Total

 

$

761,371

 

$

712,551

 

$

46,881

 

$

128,015

 

 

 

 

Net Revenues

 

Income (loss) from Operations

 

Six Months Ended June 30,

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Midwest

 

$

545,491

 

$