Edgar Filing: PENN NATIONAL GAMING INC

penn_Current folio_10Q

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2016

☐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 ☒ No ☐

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 ☒ No ☐

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 ☒		Accelerated filer ☐

Non-accelerated filer ☐		Smaller reporting company ☐
(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 ☐ No ☒

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 October 28, 2016
Common Stock, par value $.01 per share		83,522,580 (includes 175,886 shares of restricted stock)

Table of Contents

Forward-looking Statements

This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the use of forward looking terminology such as “expects,” “believes,” “estimates,” “projects,” “intends,” “plans,” “seeks,” “may,” “will,” “should” or “anticipates” or the negative or other variations of these or similar words, or by discussions of future events, strategies or risks and uncertainties, including future plans, strategies, performance, developments, acquisitions, capital expenditures, and operating results. Actual results may vary materially from expectations. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business, there can be no assurance that actual results will not differ materially from our expectations. Meaningful factors that could cause actual results to differ from expectations include, but are not limited to, risks related to the following: the ability of our operating teams to drive revenue and adjusted EBITDA margins; our ability to obtain timely regulatory approvals required to own, develop and/or operate our facilities, or other delays, approvals or impediments to completing our planned acquisitions or projects, construction factors, including delays, unexpected remediation costs, local opposition, organized labor, and increased cost of labor and materials; the passage of state, federal or local legislation (including referenda) that would expand, restrict, further tax, prevent or negatively impact operations in or adjacent to the jurisdictions in which we do or seek to do business (such as a smoking ban at any of our facilities); the effects of local and national economic, credit, capital market, housing, and energy conditions on the economy in general and on the gaming and lodging industries in particular; the activities of our competitors and the rapid emergence of new competitors (traditional, internet, social, sweepstakes based and video gaming terminals (“VGTs”) in bars, truck stops and other retail establishments); increases in the effective rate of taxation at any of our properties or at the corporate level; our ability to identify attractive acquisition and development opportunities (especially in new business lines) and to agree to terms with, and maintain good relationships with partners/municipalities for such transactions; the costs and risks involved in the pursuit of such opportunities and our ability to complete the acquisition or development of, and achieve the expected returns from, such opportunities; our ability to maintain market share in established markets and ramp up operations at our recently opened facilities; our expectations for the continued availability and cost of capital; the outcome of pending legal proceedings, changes in accounting standards; the impact of weather; with regard to our recently completed restatement, risks relating the remediation of any material weaknesses and the costs to strengthen our internal control structure, potential investigations, litigation or other proceedings by governmental authorities, stockholders or other parties, and the risks related to the impact of the recent restatement of the Company’s financial statements on the Company’s reputation, development projects, joint ventures and other commercial contracts; the ability of the Company to generate sufficient future taxable income to realize its deferred tax assets; with respect to the recently opened Hollywood Casino-Jamul near San Diego, California, particular risks associated with the repayment or subordination of project loans, sovereign immunity, local opposition (including several pending lawsuits), access, regional competition and property performance; with respect to our Plainridge Park Casino in Massachusetts, the ultimate location and timing of the other gaming facilities in the state and region; with respect to our social and other interactive gaming endeavors, including our recent acquisition of Rocket Games, risks related to ultimate profitability, retention of certain key employees cyber-security, data privacy, intellectual property and legal and regulatory challenges; with respect to Prairie State Gaming, risks relating to the closing of a pending acquisition and the integration of all new acquisitions, our ability to successfully compete in the VGT market, our ability to retain existing customers and secure new customers, risks relating to municipal authorization of VGT operations and the implementation and the ultimate success of the products and services being offered; and other factors as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, each as filed with the United States Securities and Exchange Commission. The Company does not intend to update publicly any forward-looking statements except as required by law.

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 — September 30, 2016 and December 31, 2015	4
	Condensed Consolidated Statements of Income —Three and Nine Months Ended September 30, 2016 and 2015	5
	Condensed Consolidated Statements of Comprehensive Income — Three and Nine Months Ended September 30, 2016 and 2015	6
	Condensed Consolidated Statements of Changes in Shareholders’ Deficit — Nine Months Ended September 30, 2016 and 2015	7
	Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2016 and 2015	8
	Notes to the Condensed Consolidated Financial Statements	9

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	46

ITEM 4.	CONTROLS AND PROCEDURES	46

PART II.	OTHER INFORMATION	48

ITEM 1.	LEGAL PROCEEDINGS	48

ITEM 1A.	RISK FACTORS	48

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	48

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	48

ITEM 4.	MINE SAFETY DISCLOSURES	48

ITEM 5.	OTHER INFORMATION	48

ITEM 6.	EXHIBITS	49

SIGNATURES		50

EXHIBIT INDEX		51

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)


	September 30,		December 31,
	2016		2015
Assets
Current assets
Cash and cash equivalents	$	201,768	$	237,009
Receivables, net of allowance for doubtful accounts of $3,131 and $2,428 at September 30, 2016 and December 31, 2015, respectively		43,209		45,186
Prepaid expenses		59,538		76,784
Other current assets		48,515		13,497
Total current assets		353,030		372,476
Property and equipment, net		2,844,992		2,980,068
Other assets
Investment in and advances to unconsolidated affiliates		158,304		168,149
Goodwill		993,633		911,942
Other intangible assets, net		431,989		391,442
Advances to the Jamul Tribe		360,938		197,722
Other assets		108,793		116,953
Total other assets		2,053,657		1,786,208
Total assets	$	5,251,679	$	5,138,752

Liabilities
Current liabilities
Current portion of financing obligation to GLPI	$	55,256	$	50,548
Current maturities of long-term debt		81,741		92,108
Accounts payable		60,823		72,816
Accrued expenses		94,511		93,666
Accrued interest		8,702		7,091
Accrued salaries and wages		80,697		98,671
Gaming, pari-mutuel, property, and other taxes		62,683		57,486
Insurance financing		675		3,125
Other current liabilities		107,809		82,263
Total current liabilities		552,897		557,774

Long-term liabilities
Long-term financing obligation to GLPI, net of current portion		3,471,453		3,514,080
Long-term debt, net of current maturities and debt issuance costs		1,589,216		1,618,851
Deferred income taxes		120,161		107,921
Noncurrent tax liabilities		28,212		—
Other noncurrent liabilities		43,602		18,169
Total long-term liabilities		5,252,644		5,259,021

Shareholders’ equity (deficit)
Series B Preferred stock ($.01 par value, 1,000,000 shares authorized, 0 shares issued and outstanding at September 30, 2016 and December 31, 2015)		—		—
Series C Preferred stock ($.01 par value, 18,500 shares authorized, 6,931 and 8,624 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively)		—		—
Common stock ($.01 par value, 200,000,000 shares authorized, 85,609,228 and 83,056,668 shares issued, and 83,441,835 and 80,889,275 shares outstanding at September 30, 2016 and December 31, 2015, respectively)		855		830
Treasury stock, at cost (2,167,393 shares held at September 30, 2016 and December 31, 2015)		(28,414)		(28,414)
Additional paid-in capital		1,007,504		988,686
Retained deficit		(1,530,313)		(1,634,591)
Accumulated other comprehensive loss		(3,494)		(4,554)
Total shareholders’ deficit		(553,862)		(678,043)
Total liabilities and shareholders’ deficit	$	5,251,679	$	5,138,752

See accompanying notes to the condensed consolidated financial statements

Table of Contents

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(in thousands, except per share data)

(unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015

Revenues
Gaming	$	654,591	$	651,284	$	1,974,618	$	1,861,539
Food, beverage, hotel and other		147,554		124,721		429,792		350,905
Management service and licensing fees		3,130		2,871		8,567		7,614
Reimbursable management costs		5,965		—		8,820		—
Revenues		811,240		778,876		2,421,797		2,220,058
Less promotional allowances		(45,643)		(39,579)		(130,327)		(115,667)
Net revenues		765,597		739,297		2,291,470		2,104,391

Operating expenses
Gaming		336,669		334,219		1,011,187		942,730
Food, beverage, hotel and other		102,110		89,151		302,062		249,883
General and administrative		114,376		107,614		340,854		342,771
Reimbursable management costs		5,965		—		8,820		—
Depreciation and amortization		67,903		66,141		200,105		191,785
Insurance recoveries		(726)		—		(726)		—
Total operating expenses		626,297		597,125		1,862,302		1,727,169
Income from operations		139,300		142,172		429,168		377,222

Other income (expenses)
Interest expense		(114,349)		(111,406)		(345,548)		(329,550)
Interest income		8,202		3,083		20,039		7,396
Income from unconsolidated affiliates		3,505		3,759		11,662		11,895
Other		404		2,672		(1,978)		4,805
Total other expenses		(102,238)		(101,892)		(315,825)		(305,454)

Income from operations before income taxes		37,062		40,280		113,343		71,768
Income tax (benefit) provision		(9,473)		35,380		9,065		62,016
Net income	$	46,535	$	4,900	$	104,278	$	9,752

Earnings per common share:
Basic earnings per common share	$	0.52	$	0.06	$	1.16	$	0.11
Diluted earnings per common share	$	0.51	$	0.05	$	1.14	$	0.11

See accompanying notes to the condensed consolidated financial statements.

Table of Contents

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(in thousands) (unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Net income	$	46,535	$	4,900	$	104,278	$	9,752
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment during the period		(212)		(1,487)		1,060		(2,664)
Other comprehensive (loss) income		(212)		(1,487)		1,060		(2,664)
Comprehensive income	$	46,323	$	3,413	$	105,338	$	7,088

See accompanying notes to the condensed consolidated financial statements.

Table of Contents

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Changes in Shareholders’ Deficit

(in thousands, except share data) (unaudited)


													Accumulated
									Additional		Retained		Other		Total
	Preferred Stock			Common Stock			Treasury		Paid-In		(Deficit)		Comprehensive		Shareholders’
	Shares	Amount		Shares	Amount		Stock		Capital		Earnings		(Loss) Income		Deficit
Balance, December 31, 2014	8,624	$	—	79,161,817	$	813	$	(28,414)	$	956,146	$	(1,635,277)	$	(1,282)	$	(708,014)
Share-based compensation arrangements, net of tax benefits of $10,143	—		—	1,353,264		13		—		24,711		—		—		24,724
Foreign currency translation adjustment	—		—	—		—		—		—		—		(2,664)		(2,664)
Net income	—		—	—		—		—		—		9,752		—		9,752
Balance, September 30, 2015	8,624	$	—	80,515,081	$	826	$	(28,414)	$	980,857	$	(1,625,525)	$	(3,946)	$	(676,202)

Balance, December 31, 2015	8,624	$	—	80,889,275	$	830	$	(28,414)	$	988,686	$	(1,634,591)	$	(4,554)	$	(678,043)
Share-based compensation arrangements, net of tax benefits of $8,510	—		—	859,560		8		—		18,835		—		—		18,843
Foreign currency translation adjustment	—		—	—		—		—		—		—		1,060		1,060
Conversion of preferred stock	(1,693)		—	1,693,000		17		—		(17)		—		—		—
Net income	—		—	—		—		—		—		104,278		—		104,278
Balance, September 30, 2016	6,931	$	—	83,441,835	$	855	$	(28,414)	$	1,007,504	$	(1,530,313)	$	(3,494)	$	(553,862)

See accompanying notes to the condensed consolidated financial statements.

Table of Contents

Penn National Gaming, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands) (unaudited)


Nine Months Ended September 30,	2016		2015

Operating activities
Net income	$	104,278	$	9,752
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		200,105		191,785
Amortization of items charged to interest expense		5,523		4,730
Change in fair values of contingent purchase price		(1,111)		(5,944)
(Gain) loss on sale of property and equipment and assets held for sale		(3,440)		801
Income from unconsolidated affiliates		(11,662)		(11,895)
Distributions from unconsolidated affiliates		21,500		22,050
Deferred income taxes		2,059		50,460
Charge for stock-based compensation		4,554		6,446
Decrease (increase), net of businesses acquired
Accounts receivable		5,305		5,015
Prepaid expenses and other current assets		(4,231)		6,288
Other assets		(1,157)		8,869
(Decrease) increase, net of businesses acquired
Accounts payable		(8,492)		4,763
Accrued expenses		(2,489)		1,248
Accrued interest		1,611		3,680
Accrued salaries and wages		(18,262)		(862)
Gaming, pari-mutuel, property and other taxes		5,499		15,041
Income taxes		22,711		1,666
Other current and noncurrent liabilities		(10,780)		(7,748)
Net cash provided by operating activities		311,521		306,145
Investing activities
Capital project expenditures, net of reimbursements		(14,482)		(125,169)
Capital maintenance expenditures		(51,431)		(41,866)
Advances to the Jamul Tribe		(167,863)		(64,228)
Proceeds from sale of property and equipment and assets held for sale		13,212		389
Investment in joint ventures		—		(2,799)
Acquisition of businesses, gaming and other licenses, net of cash acquired		(56,748)		(450,170)
Net cash used in investing activities		(277,312)		(683,843)
Financing activities
Proceeds from exercise of options		5,654		8,069
Principal payments on financing obligation with GLPI		(37,920)		(35,452)
Proceeds from issuance of long-term debt, net of issuance costs		74,170		517,290
Principal payments on long-term debt		(102,234)		(92,885)
Payments of other long-term obligations		(13,387)		(3,307)
Payments of contingent purchase price		(1,793)		—
Proceeds from insurance financing		9,614		885
Payments on insurance financing		(12,064)		(12,212)
Tax benefit from stock options exercised		8,510		10,126
Net cash (used in) provided by financing activities		(69,450)		392,514
Net (decrease) increase in cash and cash equivalents		(35,241)		14,816
Cash and cash equivalents at beginning of year		237,009		208,673
Cash and cash equivalents at end of period	$	201,768	$	223,489

Supplemental disclosure
Interest expense paid, net of amounts capitalized	$	339,211	$	321,276
Income tax (refunds received)/taxes paid	$	(11,720)	$	879

Non-cash transactions: In January 2015, a repayment obligation for a hotel and event center near Hollywood Casino Lawrenceburg was assumed by a subsidiary of the Company, which was financed through a loan with the City of Lawrenceburg Department of Redevelopment. This non-cash transaction increased property and equipment, net and total debt by $15.3 million. In conjunction with the purchase of Rocket Games on August 1, 2016, the Company increased its acquired assets and other current and noncurrent liabilities by $56.0 million for the fair value of the contingent purchase price consideration at the time of acquisition. The remaining portion of the purchase price was paid in cash.

See accompanying notes to the condensed consolidated financial statements.

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 together with its subsidiaries (collectively, the “Company”) is a diversified, multi-jurisdictional owner and manager of gaming and racing facilities and video gaming terminal operations with a focus on slot machine entertainment. We have also recently expanded into social onling gaming offerings via our Penn Interative Ventures, LLC (“Penn Interactive Ventures”) division and our recent acquisition of Rocket Games, Inc. (“Rocket Games”). As of September 30, 2016, the Company owned, managed, or had ownership interests in twenty-six facilities in the following sixteen jurisdictions: Florida, Illinois, Indiana, Kansas, Maine, Massachusetts, Mississippi, Missouri, Nevada, New Jersey, New Mexico, Ohio, Pennsylvania, Texas, West Virginia and Ontario, Canada.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

The condensed consolidated financial statements include the accounts of Penn and its subsidiaries. Investment in and advances to unconsolidated affiliates, that do not meet the consolidation criteria of the authoritative guidance for voting interest, controlling interest or variable interest entities (“VIE”), are accounted for under the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses for the reporting periods. Actual results could differ from those estimates.

Operating results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. The notes to the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2015 should be read in conjunction with these condensed consolidated financial statements. The December 31, 2015 financial information has been derived from the Company’s audited consolidated financial statements.

2. Summary of Significant Accounting Policies

Revenue Recognition and Promotional Allowances

Gaming revenue consists mainly of slot and video lottery gaming machine revenue as well as to a lesser extent table game and poker revenue. Gaming revenue is the aggregate net difference between gaming wins and losses, with liabilities recognized for funds deposited by customers before gaming play occurs, for "ticket-in, ticket-out" coupons in the customers' possession, and for accruals related to the anticipated payout of progressive jackpots. Progressive slot machines, which contain base jackpots that increase at a progressive rate based on the number of coins played, are charged to revenue as the amount of the jackpots increases. Table game revenue is the aggregate of table drop adjusted for the change in aggregate table chip inventory. Table drop is the total dollar amount of the currency, coins, chips, tokens and outstanding markers (credit instruments) that are removed from the live gaming tables.

Food, beverage, hotel and other revenue, including racing revenue, is recognized as services are performed. Racing revenue includes the Company’s share of pari-mutuel wagering on live races after payment of amounts returned as winning wagers, its share of wagering from import and export simulcasting, and its share of wagering from its off-

Table of Contents

track wagering facilities. Advance deposits on lodging are recorded as accrued liabilities until services are provided to the customer.

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

Revenues include reimbursable costs associated with the Company’s management agreement with the Jamul Indian Village of California (the “Jamul Tribe”), which represent amounts received or due pursuant to the Company’s management agreement for the reimbursement of expenses, primarily payroll costs, incurred on their behalf. The Company recognizes the reimbursable costs associated with this contract as revenue on a gross basis, with an offsetting amount charged to operating expense as it is the primary obligor for these costs.

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

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 nine months ended September 30, 2016 and 2015 are as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
	(in thousands)
Rooms	$	10,257	$	8,649	$	29,477	$	25,888
Food and beverage		32,977		28,245		94,295		82,896
Other		2,409		2,685		6,555		6,883
Total promotional allowances	$	45,643	$	39,579	$	130,327	$	115,667

The estimated cost of providing such complimentary services for the three and nine months ended September 30, 2016 and 2015 are as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
	(in thousands)
Rooms	$	1,419	$	1,085	$	3,954	$	2,999
Food and beverage		12,488		11,280		36,212		32,761
Other		909		881		2,563		2,605
Total cost of complimentary services	$	14,816	$	13,246	$	42,729	$	38,365

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

Table of Contents

gaming tax expense in future interim periods. Finally, the Company recognizes purse expense based on the statutorily required percentage of revenue that is required to be paid out in the form of purses to the winning owners of horse races run at the Company’s racetracks in the period in which wagering occurs. For the three and nine months ended September 30, 2016, these expenses, which are recorded primarily within gaming expense in the condensed consolidated statements of income, were $257.0 million and $772.9 million, as compared to $259.4 million and $730.9 million for the three and nine months ended September 30, 2015.

Long-term asset related to the Jamul Tribe

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

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

Hollywood Casino Jamul – San Diego is a three-story gaming and entertainment facility of approximately 200,000 square feet featuring 1,731 slot machines, 40 live table games, multiple restaurants, bars and lounges and a partially enclosed parking structure with over 1,800 spaces. In mid-January 2014, the Company commenced construction activities at the site. The facility opened to the public on October 10, 2016. The Company currently provides a portion of the financing to the Jamul Tribe in connection with the project and, following the opening, now manages and provides branding for the casino.

The Company is accounting for the development agreement and related loan commitment letter with the Jamul Tribe as a loan (the “Senior Loans”) with accrued interest in accordance with ASC 310, “Receivables.” The Senior Loans represent initial advances made by the Company to the Jamul Tribe for the development and construction of a gaming facility for the Jamul Tribe on reservation land. As such, the Jamul Tribe owns the casino and its related assets and liabilities. San Diego Gaming Ventures, LLC (“SDGV”), a wholly-owned subsidiary of the Company, is a separate legal entity and, following completion of the project and subsequent commencement of gaming operations on the Property, will be the Penn entity which receives management and licensing fees from the Jamul Tribe. The Company’s Senior Loans with the Jamul Tribe totaled $360.9 million and $197.7 million, which includes accrued interest of $33.2 million, and $13.9 million, at September 30, 2016 and December 31, 2015, respectively. Collectability of the Senior Loans will be derived from the revenues of the casino operations. The Company believes collectability of the Senior Loans is highly certain. However, in the event that projections related to the profitability of the property are inaccurate, the Company may be required to record a reserve related to the collectability of the Senior Loans. Subsequent to September 30, 2016, the Company was repaid a significant amount of the advances to the Jamul Tribe. See Note 12 for further details.

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

Table of Contents

the provisions of the VIE subsections of ASC 810). Based on the status of the Jamul Tribe as a government organization, the Company believes its arrangement with the Jamul Tribe is not within the scope defined by ASC 810.

Earnings Per Share

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

At September 30, 2016 and 2015, the Company had outstanding 6,931 and 8,624, respectively, shares of Series C Convertible Preferred Stock. During the three and nine months ended September 30, 2016, 516 and 1,693 shares, respectively, of Series C Preferred Stock were sold by the holders of these securities, which converted into 516,000 and 1,693,000 shares, respectively, of common stock under previously agreed upon terms. The Company determined that the preferred stock qualified as a participating security as defined in ASC 260 since these securities participate in dividends with the Company’s common stock. In accordance with ASC 260, a company is required to use the two-class method when computing EPS when a company has a security that qualifies as a “participating security.” The two-class method is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is included in the computation of basic EPS using the two-class method. Under the two-class method, basic EPS for the Company’s common stock is computed by dividing net income applicable to common stock by the weighted-average common shares outstanding during the period. Diluted EPS for the Company’s common stock is computed using the more dilutive of the two-class method or the if-converted method.

The following table sets forth the allocation of net income for the three and nine months ended September 30, 2016 and 2015 under the two-class method:


	Three Months Ended September 30,		Three Months Ended September 30,		Nine Months Ended September 30,		Nine Months Ended September 30,
	2016		2015		2016		2015
	(in thousands)				(in thousands)

Net income	$	46,535	$	4,900	$	104,278	$	9,752
Net income applicable to preferred stock		3,658		476		9,268		951
Net income applicable to common stock	$	42,877	$	4,424	$	95,010	$	8,801

Table of Contents

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 and nine months ended September 30, 2016 and 2015:


	Three Months Ended September 30,	Three Months Ended September 30,	Nine Months Ended September 30,	Nine Months Ended September 30,
	2016	2015	2016	2015
	(in thousands)		(in thousands)
Determination of shares:
Weighted-average common shares outstanding	83,065	80,243	81,917	79,803
Assumed conversion of dilutive employee stock-based awards	1,233	2,355	1,381	2,307
Assumed conversion of restricted stock	38	58	41	60
Diluted weighted-average common shares outstanding before participating security	84,336	82,656	83,339	82,170
Assumed conversion of preferred stock	7,086	8,624	7,991	8,624
Diluted weighted-average common shares outstanding	91,422	91,280	91,330	90,794

Options to purchase 2,990,243 shares and 1,621,219 shares were outstanding during the nine months ended September 30, 2016 and 2015, 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 for the three and nine months ended September 30, 2016 and 2015 (in thousands, except per share data):


	Three Months Ended September 30,		Three Months Ended September 30,		Nine Months Ended September 30,		Nine Months Ended September 30,
	2016		2015		2016		2015
Calculation of basic EPS:
Net income applicable to common stock	$	42,877	$	4,424	$	95,010	$	8,801
Weighted-average common shares outstanding		83,065		80,243		81,917		79,803
Basic EPS	$	0.52	$	0.06	$	1.16	$	0.11

Calculation of diluted EPS using two-class method:
Net income applicable to common stock	$	42,877	$	4,424	$	95,010	$	8,801
Diluted weighted-average common shares outstanding before participating security		84,336		82,656		83,339		82,170
Diluted EPS	$	0.51	$	0.05	$	1.14	$	0.11

Stock-Based Compensation

The Company accounts for stock compensation under ASC 718, “Compensation-Stock Compensation,” which requires the Company to expense the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. This expense is recognized ratably over the requisite service period following the date of grant.

Table of Contents

The fair value for stock options was estimated at the date of grant using the Black-Scholes option-pricing model, which requires management to make certain assumptions. The risk-free interest rate was based on the U.S. Treasury spot rate with a term equal to the expected life assumed at the date of grant. Expected volatility was estimated based on the historical volatility of the Company’s stock price over a period of 5.40 years, in order to match the expected life of the options at the grant date. Historically, at the grant date, there has been no expected dividend yield assumption since the Company has not paid any cash dividends on its common stock since its initial public offering in May 1994 and since the Company intends to retain all of its earnings to finance the development of its business for the foreseeable future. The weighted-average expected life was based on the contractual term of the stock option and expected employee exercise dates, which was based on the historical and expected exercise behavior of the Company’s employees. The Company granted 1,573,651 stock options during the nine months ended September 30, 2016.

Stock-based compensation expense for the three and nine months ended September 30, 2016 was $1.5 million and $4.6 million, as compared to $2.0 million and $6.4 million for the three and nine months ended September 30, 2015, and is included within the condensed consolidated statements of income under general and administrative expense.

The Company’s cash-settled phantom stock unit awards (“PSUs”), which vest over a period of three to four years, entitle employees and directors to receive cash based on the fair value of the Company’s common stock on the vesting date. The PSUs are accounted for as liability awards and are re-measured at fair value each reporting period until they become vested with compensation expense being recognized over the requisite service period in accordance with ASC 718-30, “Compensation—Stock Compensation, Awards Classified as Liabilities.” The Company had a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its PSUs of $2.9 million and $7.8 million at September 30, 2016 and December 31, 2015, respectively. For PSUs held by Penn employees, there was $8.8 million of total unrecognized compensation cost at September 30, 2016 that will be recognized over the grants remaining weighted average vesting period of 1.45 years. For the three and nine months ended September 30, 2016, the Company recognized $2.1 million and $5.7 million of compensation expense associated with these awards, as compared to $1.9 million and $11.4 million for the three and nine months ended September 30, 2015. The changes are primarily due to volatility in stock price year-over-year for both Penn and Gaming and Leisure Properties, Inc., (“GLPI”) awards held by Penn employees. Amounts paid by the Company for the three and nine months ended September 30, 2016 on these cash-settled awards totaled $5.4 million and $9.9 million, as compared to $7.6 million and $12.9 million for the three and nine months ended September 30, 2015.

For the Company’s stock appreciation rights (“SARs”), the fair value of the SARs is calculated during each reporting period and estimated using the Black-Scholes option pricing model based on the various inputs discussed below. The Company’s SARs, which vest over a period of four years, are accounted for as liability awards since they will be settled in cash. The Company had a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its SARs of $7.1 million and $8.0 million at September 30, 2016 and December 31, 2015, respectively. For SARs held by Penn employees, there was $4.3 million of total unrecognized compensation cost at September 30, 2016 that will be recognized over the awards remaining weighted average vesting period of 2.72 years. For the three and nine months ended September 30, 2016, the Company recognized compensation expense of $0.4 million and $1.8 million associated with these awards, as compared to a credit of $3.0 million and compensation expense of $4.1 million for the three and nine months ended September 30, 2015. The changes are primarily due to volatility in stock price year-over-year for both Penn and GLPI awards held by Penn employees. Amounts paid by the Company for the three and nine months ended September 30, 2016 on these cash-settled awards totaled $1.0 million and $2.5 million, as compared to $0.3 million and $2.6 million for the three and nine months ended September 30, 2015.

Table of Contents

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model for stock option awards granted during the nine months ended September 30, 2016 and 2015, respectively:


	2016		2015

Risk-free interest rate	1.20	%	1.53	%
Expected volatility	31.23	%	36.84	%
Dividend yield	—		—
Weighted-average expected life (years)	5.40		5.45

Segment Information

The Company’s Chief Executive Officer and President, who is the Company’s Chief Operating Decision Maker (“CODM”), as that term is defined in ASC 280, “Segment Reporting” (“ASC 280”), measures and assesses the Company’s business performance based on regional operations of various properties grouped together based primarily on their geographic locations. During the second quarter of 2016, the Company changed its three reportable segments from East/Midwest, West and Southern Plains to Northeast, South/West, and Midwest in connection with the addition of a new regional vice president and a realignment of responsibilities within our segments. This realignment changed the manner in which information is provided to the CODM and therefore how performance is assessed and resources are allocated to the business.

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

The South/West reportable segment consists of the following properties: Zia Park Casino, Hollywood Casino Tunica, Hollywood Casino Gulf Coast, Boomtown Biloxi, M Resort, and Tropicana Las Vegas, which was acquired on August 25, 2015, as well as the Hollywood Casino Jamul-San Diego project with the Jamul Tribe, which opened on October 10, 2016.

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

The Other category consists of the Company’s standalone racing operations, namely Rosecroft Raceway, which was sold on July 31, 2016, 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. Additionally, Penn Interactive Ventures, the Company’s wholly-owned subsidiary which represents its social online gaming initiatives, including the recently acquired Rocket Games, would meet the definition of an operating segment under ASC 280, but is quantatively not significant to the Company’s operations as it represents 0.5% of net revenues and 0.4% of income from operations for the nine months ended September 30, 2016.

In addition to GAAP financial measures, management uses adjusted EBITDA as an important measure of the operating performance of its segments, including the evaluation of operating personnel and believes it is especially relevant in evaluating large, long lived casino projects because it provides a perspective on the current effects of operating decisions separated from the substantial non-operational depreciation charges and financing costs of such projects. The Company defines adjusted EBITDA as earnings before interest, taxes, stock compensation, debt

Table of Contents

extinguishment charges, impairment charges, insurance recoveries and deductible charges, depreciation and amortization, changes in the estimated fair value of contingent purchase price, gain or loss on disposal of assets, and other income or expenses. Adjusted EBITDA is also inclusive of income or loss from unconsolidated affiliates, with the Company’s share of non-operating items (such as depreciation and amortization) added back for its joint venture in Kansas Entertainment. Adjusted EBITDA excludes payments associated with our Master Lease agreement with GLPI as the transaction is accounted for as a financing obligation. Adjusted EBITDA should not be construed as an alternative to operating income, as an indicator of the Company’s operating performance, as an alternative to cash flows from operating activities, as a measure of liquidity, or as any other measure of performance determined in accordance with GAAP. The Company has significant uses of cash flows, including capital expenditures, interest payments, taxes and debt principal repayments, which are not reflected in adjusted EBITDA.

See Note 8 for further information with respect to the Company’s segments.

Other Comprehensive Income

The Company accounts for comprehensive income in accordance with ASC 220, “Comprehensive Income,” which establishes standards for the reporting and presentation of comprehensive income in the consolidated financial statements. The Company presents comprehensive income in two separate but consecutive statements. For the three and nine months ended September 30, 2016 and 2015, the only component of accumulated other comprehensive income was foreign currency translation adjustments.

Table of Contents

3. New Accounting Pronouncements

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The amendments are intended to address diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide guidance on the following specific cash flow issues: (a) debt prepayment or debt extinguishment costs; (b) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (c) contingent consideration payments made after a business combination; (d) proceeds from the settlement of insurance claims; (e) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (f) distributions received from equity method investees; (g) beneficial interest in securitization transactions; and (h) separately identifiable cash flows and application of the predominance principle. For public companies, the amendments are effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The company is currently assessing the impact that the adoption of these amendments will have on its consolidated statement of cash flows and related disclosures.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which impacts virtually all aspects of an entity’s revenue recognition. The core principle of Topic 606 is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In July 2015, the FASB deferred the effective date of the standard by one year which results in the new standard being effective for the Company at the beginning of its first quarter of fiscal year 2018. In addition, during March, April and May 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing and ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, respectively, which clarified the guidance on certain items such as reporting revenue as a principal versus agent, identifying performance obligations, accounting for intellectual property licenses, assessing collectability and presentation of sales taxes. Management has not yet completed its assessment of the impact of the new standard on the Company’s consolidated financial statements. Although the Company is currently assessing the impact that the adoption of the new standard will have on its consolidated financial statements and related disclosures, we do believe it will result in changes to our accounting for loyalty points that are earned by our customers. The Company’s Marquee Rewards program allows customers, who are members and utilize their rewards membership card to earn promotional points that are redeemable for slot play and complimentaries. The accumulated points can be redeemed for food and beverages at our restaurants, and products offered at our retail stores across the vast majority of Penn’s casino properties. The estimated liability for unredeemed points is currently accrued based on expected redemption rates and the estimated costs of the services or merchandise to be provided. Under the new standard, we will need to defer the full retail value of the complimentaries until the future revenue transaction occurs. Although the exact amount of the increase to our point liabilities has not yet been determined, we do not anticipate it will have a significant impact on our earnings.

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

Table of Contents

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which will require, among other items, lessees to recognize a right-of-use asset and a lease liability for most leases. Extensive quantitative and qualitative disclosures, including significant judgments made by management, will be required to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing contracts. The accounting applied by a lessor is largely unchanged from that applied under the current standard. The standard must be adopted using a modified retrospective transition approach and provides for certain practical expedients. The ASU is effective for public entities for fiscal years beginning after December 15, 2018, with early adoption permitted. Management has not yet completed its assessment of the impact of the new standard on the Company’s consolidated financial statements. However, the Company has numerous operating leases which, under the new standard, will need to be reported as an asset and a liability on its balance sheet. The precise amount of this asset and liability will be determined based on the leases that exist at the Company on the date of adoption.

In February 2015, the FASB issued ASU 2015-02 with new consolidation guidance which modifies the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The main provisions of the new guidance include modifying the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, the evaluation of fees paid to a decision maker or a service provider as a variable interest, and the effect of fee arrangements and related parties on the primary beneficiary determination, as well as provides a scope exception for certain investment funds. The new guidance is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the new guidance using a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. A reporting entity also may apply the new guidance retrospectively. The Company adopted this guidance in the first quarter of 2016 and it had no impact to the Company’s financial statements.

4. Acquisitions

On August 1, 2016, the Company acquired 100% of the outstanding equity securities of social casino game developer, Rocket Games, for initial cash consideration of $59.1 million subject to customary working capital adjustments. The Stock Purchase Agreement includes contingent consideration payments over the next two years that will be based on a multiple of 6.25 times Rocket Games’ then-trailing twelve months of earnings before interest, taxes, depreciation and amortization, subject to a cap of $110 million. Up to $10 million of the contingent consideration is accounted for as compensation as it is tied to continued employment over a two year period. The acquisition was funded by Penn with cash on hand and revolving commitments under the Company’s senior secured credit facility. The preliminary fair value of the contingent purchase price was estimated to be $56.0 million at the acquisition date based on an income approach by applying an option pricing method to the Company’s internal earning projections using a Monte Carlo simulation. The preliminary purchase price allocation resulted in goodwill of $81.7 million, other intangible assets of $43.4 million, current assets of $7.7 million, other assets of $0.3 million, current contingent consideration liabilities of $28.2 million, other current liabilities of $5.9 million, non-current contingent consideration liabilities of $27.8 million and deferred tax liabilities of $12.1 million. Contingent consideration, goodwill, other intangible assts and the related deferred tax liabilities are provisional amounts as of September 30, 2016. This acquisition complements Penn’s interactive gaming strategy through its wholly-owned subsidiary Penn Interactive Ventures which is included in the Other category.

Table of Contents

5. Property and Equipment

Property and equipment, net, consists of the following:


		September 30,			December 31,