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, 1998 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.) Penn National Gaming, Inc. 825 Berkshire Blvd., Suite 200 Wyomissing, PA 19610 (Address of principal executive offices) 610-373-2400 (Registrant's telephone number including area code:) Not applicable (Former name, former address, and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ 1
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ____ No ____ (APPLICABLE ONLY TO CORPORATE REGISTRANTS) Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Title Outstanding as of August 12, 1998 Common Stock par value .01 per share 15,155,830 This Report contains forward-looking statements that inherently involve risks and uncertainties. The Company's actual result could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those discussed in this Quarterly Report and those discussed in the Company's Annual Report on Form 10-K. References to "Penn National Gaming" or the "Company" include Penn National Gaming, Inc. and its subsidiaries. 2
Penn National Gaming, Inc. And Subsidiaries INDEX PART I - FINANCIAL INFORMATION Page Item 1 - Financial Statements Consolidated Balance Sheets - June 30, 1998 (unaudited) and December 31, 1997 4-5 Consolidated Statements of Income - Six Months Ended June 30, 1998 and 1997 (unaudited) 6-7 Consolidated Statements of Income - Three Months Ended June 30, 1998 and 1997 (unaudited) 8-9 Consolidated Statement of Shareholders' Equity - Six Months Ended June 30, 1998 (unaudited) 10 Consolidated Statements of Cash Flow - Six Months Ended June 30, 1998 and 1997 (unaudited) 11-12 Notes to Consolidated Financial Statements 13-17 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 18-22 Item 3 - Changes in information about Market Risk 22 PART II - OTHER INFORMATION Item 1 - Legal Proceedings 22 Item 6 - Exhibits and Reports on Form 8-K 23 Signature Page 24 Exhibit Index 25 3
Part I. Financial Information Item 1. Financial Statements PENN NATIONAL GAMING INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) <TABLE> <CAPTION> June 30, December 31, 1998 1997 (Unaudited) ----------- ---------- <S> <C> <C> Assets Current assets Cash and cash equivalents $ 23,492 $ 21,854 Accounts receivable 4,060 2,257 Prepaid expenses and other current assets 2,109 1,441 Deferred income taxes 419 469 Prepaid income taxes 880 3,003 --- ----- Total current assets 30,960 29,024 ------ ------ Property, plant and equipment, at cost Land and improvements 26,249 24,643 Building and improvements 66,845 56,298 Furniture, fixtures and equipment 16,006 13,847 Transportation equipment 479 490 Leasehold improvements 8,451 6,778 Leased equipment under capitalized lease 824 824 Construction in progress 230 11,288 --- ------ 119,084 114,168 Less accumulated depreciation and amortization 13,301 11,007 ------ ------ Net property, plant and equipment 105,783 103,161 ------- ------- Other assets Excess of cost over fair market value of net assets acquired (net of accumulated amortization of $1,695 and $1,389, respectively) 22,749 23,055 Deferred financing costs 2,896 3,014 Miscellaneous 837 624 --- --- Total other assets 26,482 26,693 ------ ------ $163,225 $158,878 ======== ======== </TABLE> See accompanying notes to consolidated financial statement 4
PENN NATIONAL GAMING INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) <TABLE> <CAPTION> June 30, December 31, 1998 1997 (Unaudited) ----------- ------------- <S> <C> <C> Liabilities and shareholders' equity Current liabilities Current maturities of long-term debt and capital lease obligations $ 189 $ 204 Accounts payable 7,093 7,405 Purses due horsemen 1,423 - Uncashed pari-mutuel tickets 950 1,504 Accrued interest 334 326 Accrued expenses 1,848 2,427 Accrued salaries and wages 951 813 Customer deposits 703 470 Taxes, other than income taxes 806 649 --- --- Total current liabilities 14,297 13,798 ------ ------ Long term liabilities Long-term debt and capital lease obligations, net of current maturities 80,113 80,132 Deferred income taxes 11,264 11,092 ------ ------ Total long-term liabilities 91,377 91,224 ------ ------ Commitments and contingencies Shareholders' equity Preferred stock,$.01 par value, authorized 1,000,000 shares; none issued - - Common stock,$.01 par value, authorized 20,000,000 shares; 15,155,830 and 15,152,580 issued and outstanding, respectively 152 152 Additional paid in capital 37,987 37,969 Retained earnings 19,412 15,735 ------ ------ Total shareholders' equity 57,551 53,856 --------- --------- $ 163,225 $ 158,878 ========= ========= </TABLE> See accompanying notes to consolidated financial statements 5
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, 1998 1997 ------------------------------- <S> <C> <C> Revenues Pari-mutuel revenues Live races $ 12,928 $ 11,397 Import simulcasting 34,114 31,338 Export simulcasting 2,828 3,395 Gaming revenue 16,160 - Admissions, programs and other racing revenue 4,427 2,824 Concession revenues 2,956 3,450 ----- ----- Total revenues 73,413 52,404 ------ ------ Operating expenses Purses, stakes, and trophies 13,946 10,318 Direct salaries, payroll taxes and employee benefits 9,263 7,420 Simulcast expenses 6,896 5,881 Pari-mutuel taxes 4,589 4,419 Lottery taxes and administration 6,302 - Other direct meet expenses 11,564 8,499 Off-track wagering concession expenses 3,453 2,640 Other operating expenses 5,021 3,775 Depreciation and amortization 2,841 1,660 ----- ----- Total operating expenses 63,875 44,612 ------ ------ Income from operations 9,538 7,792 ----- ----- Other income (expenses) Interest (expense) (4,243) (1,675) Interest income 451 158 Other 30 (4) -- -- Total other (expenses) (3,762) (1,521) ------ ------ Income before income taxes and extraordinary item 5,776 6,271 Taxes on income 2,099 2,573 ----- ----- </TABLE> See accompanying notes to consolidated financial statements 6
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except share data) (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, 1998 1997 ---------------------------- <S> <C> <C> Income before extraordinary item 3,677 3,698 Extraordinary Item Loss of early extinguishment of debt, net of income taxes of $264 - 383 ---- --- --- Net income $ 3,677 $ 3,315 ======= ======= Per share data Basic Income per share before extraordinary item $0.24 $0.24 Extraordinary item - 0.02 ---- ---- Net income per share $0.24 $0.22 ----- ----- Diluted Income per share before extraordinary item $0.24 $0.24 Extraordinary item - 0.02 ---- ---- Net income per share $0.24 $0.22 ----- ----- Weighted average shares outstanding Basic 15,154 15,126 ------ ------ Diluted 15,558 15,319 ------ ------ </TABLE> See accompanying notes to consolidated financial statements 7
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended June 30, 1998 1997 -------------------------- <S> <C> <C> Revenues Pari-mutuel revenues Live races $ 7,623 $ 7,028 Import simulcasting 17,763 16,541 Export simulcasting 1,502 2,272 Gaming revenue 9,004 - Admissions, programs and other racing revenue 2,472 1,566 Concession revenues 1,694 2,177 ----- ----- Total revenues 40,058 29,584 ------ ------ Operating expenses Purses, stakes, and trophies 7,639 6,116 Direct salaries, payroll taxes and employee benefits 4,904 4,174 Simulcast expenses 3,795 3,045 Pari-mutuel taxes 2,476 2,462 Lottery taxes and administration 3,371 - Other direct meet expenses 6,122 5,121 Off-track wagering concession expenses 1,948 1,674 Other operating expenses 2,625 1,933 Depreciation and amortization 1,422 943 ----- --- Total operating expenses 34,302 25,468 ------ ------ Income from operations 5,756 4,116 ----- ----- Other income (expenses) Interest (expense) (2,134) (775) Interest income 250 72 Other 30 (4) -- -- Total other (expenses) (1,854) (707) ------ ---- Income before income taxes 3,902 3,409 Taxes on income 1,435 1,395 ----- ----- </TABLE> See accompanying notes to consolidated financial statements 8
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended June 30, 1998 1997 -------------------------- <S> <C> <C> Net income $ 2,467 $ 2,014 ======= ======= Per share data Basic net income $0.16 $0.13 ----- ----- Diluted net income $0.16 $0.13 ----- ----- Weighted average shares outstanding Basic 15,156 15,126 ------ ------ Diluted 15,542 15,717 ------ ------ </TABLE> See accompanying notes to consolidated financial statements 9
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Six Months Ended June 30, 1998 (In thousands, except share data) (Unaudited) <TABLE> <CAPTION> Additional Common Stock Paid-In Retained ------------ Shares Amounts Capital Earnings Total ------ ------- ------- -------- ----- <S> <C> <C> <C> <C> <C> Balance, January 1, 1998 15,152,580 $ 152 $ 37,969 $ 15,735 $ 53,856 Issuance of common stock 3,250 - 18 - 18 Net income for the six months ended June 30, 1998 - - - 3,677 3,677 -- -- -- ----- ----- Balance, June 30, 1998 15,155,830 $ 152 $ 37,987 $ 19,412 $ 57,551 ========== ====== ========= ========= ========= </TABLE> See accompanying notes to consolidated financial statements 10
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, 1998 1997 -------------------------- <S> <C> <C> Cash flows from operating activities $ 3,677 $ 3,315 Net income Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 2,841 1,660 Extraordinary item, loss on early extinguishment of debt, before tax benefit - 647 Deferred income taxes 222 148 Decrease (increase) in: Accounts receivable (1,803) 1,156 Prepaid expenses and other current assets (668) (2,286) Prepaid income taxes 2,123 1,178 Miscellaneous other assets (213) (503) Increase (decrease) in: Accounts payable (312) 4,480 Purses due horsemen 1,423 458 Uncashed pari-mutuel tickets (554) (587) Accrued expenses (579) (71) Accrued interest 8 (152) Accrued salaries and wages 138 306 Customers deposits 233 261 Taxes other than income taxes 157 (43) --- --- Net cash provided by operating activities 6,693 9,967 ----- ----- Cash flows from investing activities Expenditures for property, plant and equipment (4,932) (15,450) Acquisition of business - (16,000) Increase in prepaid acquisition costs - (176) --- ---- Net cash (used in) investing activities (4,932) (31,626) ------ ------- </TABLE> See accompanying notes to consolidated financial statements 11
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, 1998 1997 -------------------------- <S> <C> <C> Cash flows from financing activities Proceeds from sale of common stock 18 23,082 Tax benefit related to stock options exercised - 573 Proceeds of long-term debt - 16,500 Principal payments on long-term debt and capital lease obligations (34) (19,136) Increase in unamortized finance costs (107) (167) ---- ---- Net cash provided by (used in) financing activities (123) 20,852 ---- ------ Net increase (decrease) in cash and cash equivalents 1,638 (807) Cash and cash equivalents, at beginning of period 21,854 5,634 ------ ----- Cash and cash equivalents, at end of period $ 23,492 $ 4,827 ======== ======= </TABLE> See accompanying notes to consolidated financial statements 12
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Financial Statement Presentation The accompanying consolidated financial statements are unaudited and include the accounts of Penn National Gaming, Inc., (Penn) and its wholly and majority owned subsidiaries, (collectively the "Company"). All significant intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform to current year presentation. In the opinion of management, all adjustments (consisting of normal recurring accruals) have been made which are necessary to present fairly the financial position of the Company as of June 30, 1998 and the results of its operations for the six and three month periods ended June 30, 1998 and 1997. The results of operations experienced for the six month period ended June 30, 1998 are not necessarily indicative of the results to be experienced for the fiscal year ended December 31, 1998. The statements and related notes herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. The accompanying notes should therefore be read in conjunction with the Company's December 31, 1997 annual financial statements. 2. Wagering Information (in thousands) <TABLE> <CAPTION> Three months ended June 30, 1998 -------------------------------- Penn National Pocono Downs Charles Town Total ------------- ------------ ------------ ----- <S> <C> <C> <C> <C> Pari-mutuel wagering in-state company live races $ 21,605 $ 7,410 $ 5,524 $ 34,539 --------- --------- -------- --------- Pari-mutuel wagering on simulcasting: Import simulcasting from other racetracks 44,549 36,253 11,877 92,679 Export simulcasting to out of Pennsylvania wagering facilities 42,964 7,188 - 50,152 ------ ----- --- ------ 87,513 43,441 11,877 142,831 ------ ------ ------ ------- Total pari-mutuel wagering $ 109,118 $ 50,851 $ 17,401 $ 177,370 ========= ========= ======== ========= </TABLE> 13
<TABLE> <CAPTION> Three months ended June 30, 1997 -------------------------------- Penn National Pocono Downs Charles Town Total ------------- ------------ ------------ ----- <S> <C> <C> <C> <C> Pari-mutuel wagering in-state company live races $ 25,084 $ 9,243 $ 4,640 $ 38,967 --------- -------- -------- --------- Pari-mutuel wagering on simulcasting: Import simulcasting from other racetracks 42,603 30,258 6,645 79,506 Export simulcasting to out of Pennsylvania Wagering facilities 38,930 8,827 - 47,757 ------ ----- --- ----- 81,533 39,085 6,645 127,263 ------ ------ ----- ------- Total pari-mutuel wagering $ 106,617 $ 48,328 $ 11,285 $ 166,230 ========= ======== ======== ========= </TABLE> <TABLE> <CAPTION> Six months ended June 30, 1998 ------------------------------ Penn National Pocono Downs Charles Town Total ------------- ------------ ------------ ----- <S> <C> <C> <C> <C> Pari-mutuel wagering in-state company live races $ 41,214 $ 8,323 $ 9,643 $ 59,180 --------- -------- -------- --------- Pari-mutuel wagering on simulcasting: Import simulcasting from other racetracks 87,394 67,318 22,029 176,741 Export simulcasting to out of Pennsylvania Wagering facilities 86,585 7,763 - 94,348 ------ ----- --- ------ 173,979 75,081 22,029 271,089 ------- ------ ------ ------- Total pari-mutuel wagering $ 215,193 $ 83,404 $ 31,672 $ 330,269 ========= ======== ======== ========= </TABLE> <TABLE> <CAPTION> Six months ended June 30, 1997 ------------------------------ Penn National Pocono Downs Charles Town Total ------------- ------------ ------------ ----- <S> <C> <C> <C> <C> Pari-mutuel wagering in-state company live races $ 47,574 $ 9,243 $ 4,640 $ 61,457 ---------- ------------ --------- ---------- Pari-mutuel wagering on simulcasting: Import simulcasting from other racetracks 85,843 59,510 6,645 151,998 Export simulcasting to out of Pennsylvania Wagering facilities 76,361 8,827 - 85,188 ------ ----- --- ------ 162,204 68,337 6,645 237,186 ------- ------ ----- ------- Total pari-mutuel wagering $ 209,778 $ 77,580 $ 11,285 $ 298,643 ---------- ------------ --------- ---------- </TABLE> 3. Commitments At June 30, 1998, the Company was contingently obligated under letters of credit with principal amounts aggregating $2,041,000. The $2,041,000 consists of $1,786,000 for the horsemen's account balances, $100,000 for Pennsylvania pari-mutuel taxes and $155,000 for purses. 14
4. Supplemental Disclosures of Cash Flow Information Cash paid during the six months ended June 30, 1998 and 1997 for interest was $4,230,000 and $2,051,000 respectively. Cash paid during the six months ended June 30, 1998 and 1997 for income taxes was $1,476,000 and $629,000 respectively. 5. Potential Tennessee Development Project In June 1997, the Company acquired twelve one-month options to purchase approximately 100 acres of land in Memphis, Tennessee. Since such time, the Company, through its subsidiary, Tennessee Downs, Inc. ("Tennessee Downs"), has pursued the development of a harness track and simulcast facility on this option site, which is located in the northeastern section of Memphis (The "Tennessee Development Project"). The Company submitted an application to the Tennessee State Racing Commission (the "Tennessee Commission") in October 1997 for an initial license for the development and operation of a harness track and OTW facility at this site. A land use plan for the construction of a 5/8-mile harness track, clubhouse and grandstand area were approved in October 1997 by the Land Use Hearing Board for the City of Memphis and County of Shelby. Tennessee Downs was determined to be financially suitable by the Tennessee Commission and a public comment hearing before the Tennessee Commission was held in November 1997. In December 1997, the Company received the necessary zoning and land development approvals from the Memphis City Council. In April 1998, the Tennessee Commission granted a contingent license to the Company which would expire on the earlier of (i) December 31, 2000 or (ii) the Tennessee Commission's term on June 30, 1998, if such term is not extended by the Tennessee legislature. On May 1, 1998, the Tennessee State Legislature voted against extending the life of the Tennessee Commission, allowing the Tennessee Commission's term to expire on June 30, 1998. The Tennessee Commission held a meeting on May 29, 1998, at which it rejected the Company's request: (i) to grant the Company an unconditional racing license; (ii) for racing days for the periods ending December 31, 2000; and (iii) to operate a temporary simulcast facility. On July 28, 1998, the Company filed for a preliminary injunction and a declaratory ruling on the legal status of racing in Memphis with the Chancery Court in Shelby County. As of August 12, 1998, the Company has invested approximately $500,000 in the Tennessee Development Project. The Company intends to continue its efforts to obtain an unconditional racing license that would expire December 31, 2000. There can be no assurance that the Company's efforts to obtain an unconditional racing license will be successful. 15
6. Subsidiary Guarantors Summarized financial information as of June 30, 1998 and for three and six months ended June 30, 1998 for Penn National Gaming, Inc. ("Parent"), the Subsidiary Guarantors and Subsidiary Nonguarantors is as follows: <TABLE> <CAPTION> June 30, 1998 ------------- Parent Subsidiary Subsidiary Company Guarantors Nonguarantors Eliminations Consolidated ------- ---------- ------------- ------------ ------------ <S> <C> <C> <C> <C> <C> Current assets $ 17,076 $ 8,753 $ 5,598 $ (467) $ 30,960 Net property 416 61,878 43,489 - 105,783 Other assets 102,353 (306,342) 1,463 229,008 26,482 ------- -------- ----- ------- ------ Total 119,845 (235,711) 50,550 228,541 163,225 ------- -------- ------ ------- ------- Current liabilities 85 2,174 3,855 8,183 14,297 Long-term liabilities 80,024 (156,002) 52,037 115,318 91,377 Shareholders' equity 39,736 (81,883) (5,342) 105,040 57,551 ------ -------- ------ ------- ------ Total $ 119,845 $ (235,711) $ 50,550 $ 228,541 $ 163,225 ---------- ----------- ---------- ---------- ---------- </TABLE> <TABLE> <CAPTION> Three months ended June 30, 1998 -------------------------------- <S> <C> <C> <C> <C> <C> Total revenues $ 2,862 $ 22,803 $ 13,697 $ 696 $ 40,058 Total operating expenses 1,097 20,420 12,089 696 34,302 ----- ------ ------ --- ------ Income from operations 1,765 2,383 1,608 - 5,756 Other income (expenses) (1,390) 700 (1,164) - (1,854) ------ --- ------ ------ Income before income taxes 375 3,083 444 - 3,902 Taxes on income 94 1,341 - - 1,435 -- ----- ----- Net income $ 281 $ 1,742 $ 444 $ - $ 2,467 ---------- ----------- ---------- ---------- ----------- </TABLE> <TABLE> <CAPTION> Six months ended June 30, 1998 ------------------------------ <S> <C> <C> <C> <C> <C> Total revenues $ 5,176 $ 42,425 $ 24,667 $ 1,145 $ 73,413 Total operating expenses 1,931 37,996 22,803 1,145 63,875 ----- ------ ------ ----- ------ Income from operations 3,245 4,429 1,864 - 9,538 Other income (expenses) (2,777) 1,345 (2,330) - (3,762) ------ ----- ------ --- ------ Income before income taxes 468 5,774 (466) - 5,776 Taxes on income 26 2,073 - - 2,099 -- ----- --- --- ----- Net income $ 442 $ 3,701 $ (466) $ - $ 3,677 ---------- ----------- ---------- ---------- ---------- </TABLE> Summarized financial information as of June 30, 1997 and for the three and six months ended June 30, 1997, have not been presented. Separate financial statements of the Subsidiary Guarantors and Subsidiary Nonguarantors are not presented because management does not believe such statements are material to investors. 16
7. Year 2000 Compliance The Company is working directly and with its vendors to resolve the potential impact of the year 2000 on the ability of the Company's computerized information systems to accurately process information that may be date- sensitive. Any of the Company's programs that recognize a date using "00" as the year 1900 rather than the year 2000 could result in errors or system failures. The Company utilizes a number of computer programs across its entire operation. The Company has completed its assessment of the areas that must be addressed and currently believes that costs of addressing this issue will not have a material adverse impact on the Company's financial position. However, if the Company and vendors upon which it relies are unable to address any material issue in a timely manner, it would have a material financial impact on the Company. In order to assure that this does not occur, the Company plans to devote such resources as it deems necessary to resolve any significant year 2000 issues in a timely manner. 8. Subsequent Events On July 7, 1998, the Company entered into an agreement with Ladbroke Racing Management - Pennsylvania (Ladbroke) to purchase their Johnstown, Pennsylvania OTW facility. The agreement provides for a purchase price of $1,225,000 for the assignment of the facility lease and the sale of assets and is subject to numerous contingencies, including approval by the Pennsylvania State Racing Commission. Under the terms of the agreements, the Company will sub-lease the facility from Ladbroke and operate the facility from September 1, 1998, the effective date of the agreement, through January 4, 1999, the closing date of the agreement for $12,500 per month, at which time the Company will assume full rights and ownership in the facility. The Johnstown facility will replace the Company's proposed Altoona, Pennsylvania OTW facility upon receipt of regulatory approval. 17
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation Result of Operations Three months ended June 30, 1998 compared to three months ended June 30, 1997 - ----------------------------------------------------------------------------- Total revenue increased by approximately $10.5 million or 35.4% from $29.6 million for the three months ended June 30, 1997 to $40.1 million for the three months ended June 30, 1998. Charles Town Races, which was purchased in January of 1997 and began racing operations on April 30, 1997 and video lottery machines operations on September 10, 1997, accounted for $10.8 million (approximately $1.8 million of pari-mutuel revenues and $9.0 million of gaming revenues) of the increase. Revenues at Penn National Race Course and its OTW facilities decreased by approximately $400,000 due to decreased wagering on Pennsylvania racing. Revenues at Pocono Downs and its OTW facilities increased by approximately $100,000. The net increase was due to a full quarter of operations for the new facilities at Hazleton and Carbondale offset by a decrease in revenue at Allentown due to highway construction, a decrease in revenue at the Wilkes-Barre racetrack due to the opening of the two new OTW facilities and a decrease in revenue at the Erie OTW. Total operating expenses increased by $8.8 million or 34.7% from $25.5 million for the three months ended June 30, 1997 to $34.3 million for the three months ended June 30, 1998. Charles Town Races accounted for $8.6 million of the increase due primarily to the video lottery operation and the opening of the racing simulcast center. Penn National Race Course and its OTW facilities had a decrease in operating expenses of approximately $600,000 due to the decrease in revenues. Pocono Downs and its OTW facilities had an increase of approximately $100,000 due to a full period of operations at Hazleton and Carbondale offset by decreases at its other facilities. Corporate expenses increased by $158,000 due to the hiring of additional staff for OTW facility management, human resource management and the leasing of additional office space. Depreciation and amortization increased by $479,000 or 50.1% from $943,000 for the three months ended June 30, 1997 to $1,422,000 for the three months ended June 30, 1998. The increase was due primarily to depreciation associated with new facilities for Charles Town Gaming (September 1997), Charles Town Simulcast Facility (January 1998), Hazleton OTW (March 1998) and Carbondale OTW (March 1998). Income from operations increased by approximately $1.6 million or 39.8% from $4.1 million for the three months ended June 30, 1997 to $5.8 million for the three months ended June 30, 1998 due to the factors described above. Other expenses for the three months ended June 30, 1998 consisted of $1.9 million in net interest expense (primarily due to the 10 5/8% Senior Notes issued December 1997) compared to $.7 million in net interest expense for the three months ended June 30, 1997. Income tax expense increased approximately $40,000 or 2.9% from $1,395,000 for the three months ended June 30, 1997 to $1,435,000 for the three months ended June 30, 1998 due to the increase in net income for the period. 18
Net income increased approximately $453,000 or 22.5% from $2.0 million for the three months ended June 30, 1997 to $2.5 million for the three months ended June 30, 1998 due to the factors described above. Six months ended June 30, 1998 compared to six months ended June 30, 1997 - ------------------------------------------------------------------------- Total revenue increased by approximately $21.0 million or 40.1% from $52.4 million for the six months ended June 30, 1997 to $73.4 million for the six months ended June 30, 1998. Charles Town Races, which was purchased in January, 1997 and began racing operations on April 30, 1997 and video lottery machines operations on September 10, 1997, accounted for $21.7 million (approximately $5.5 million of pari-mutuel revenues and $16.2 million of gaming revenues) of the increase. Revenues at Penn National Race Course and its OTW facilities decreased by approximately $1.1 million due to a decrease in revenues at its Chambersburg OTW facility resulting from the opening of the Charles Town Facility, competition in the Reading area from Philadelphia Park facilityand decreased wagering on Pennsylvania racing. Revenue increased at the Williamsport OTW due to a full period of operations in 1998 compared to five months in 1997. Revenues at Pocono Downs and its OTW facilities increased by approximately $300,000. This was due to the opening of new facilities in Hazleton and Carbondale offset by a decrease in revenue at Allentown caused by construction, a decrease in revenue at the Wilkes-Barre racetrack due to an opening of the two new OTW facilities and a decrease in revenue at the Erie OTW facility. Total operating expenses increased by $19.3 million or 43.2% from $44.6 million for the six months ended June 30, 1997 to $63.9 million for the six months ended June 30, 1998. Charles Town Races accounted for $18.7 million of the increase due primarily to the video lottery operation and the opening of the racing simulcast center. Penn National Race Course and its OTW facilities had a decrease in operating expenses of approximately $1.1 million due to the decrease in revenues. Pocono Downs and its OTW facilities had an increase of approximately $200,000 due to three months of operations at Hazleton and Carbondale offset by decreases at its other facilities. Corporate expenses increased by $282,000 due to the hiring of additional office staff for OTW facility management, human resource management and the leasing of additional office space. Depreciation and amortization increased by $1.1 million or 71.1% from $1.7 million for the six months ended June 30, 1997 to $2.8 million for the six months ended June 30, 1998. The increase was due primarily to depreciation associated with new facilities for Charles Town Gaming (September 1997), Charles Town Simulcast Facility (January 1998), Hazleton OTW (March 1998) and Carbondale OTW (March 1998). Income from operations increased by approximately $1.7 million or 22.4% from $7.8 million for the six months ended June 30, 1997 to $9.5 million for the six months ended June 30, 1998 due to the factors described above. Other expenses for the six months ended June 30, 1998 consisted of $3.8 million in net interest expense (primarily due to the 10 5/8% Senior Notes issued December 1997) compared to $1.5 million in net interest expense for the six months ended June 30, 1997. 19
Income tax expense decreased approximately $474,000 or 18.4% from $2,573,000 for the six months ended June 30, 1997 to $2,099,000 for the six months ended June 30, 1998 due to the decrease in income for the period. The extraordinary item in 1997 consisted of a loss on the early extinquishment of debt in the amount of $383,000 net of income taxes. The Company used approximately $19 million of the $23 million in proceeds from the February 1997 equity offering to reduce long-term debt, resulting in a write- off of $647,000 for fees associated with the early extinquishment of debt. Net income increased approximately $362,000 or 10.9% from $3.3 million for the six months ended June 30, 1997 to $3.7 million for the six months ended June 30, 1998 due to the factors described above. Liquidity and Capital Resources - ------------------------------- Historically, the Company's primary sources of liquidity and capital resources have been cash flow from operations, borrowings from banks and proceeds from issuance of equity securities. Net cash provided from operating activities for the six months ended June 30, 1998 ($6.7 million) consisted of net income and non-cash expenses ($6.7 million), an increase in purses due horsemen ($1.4 million), income taxes payable ($2.1 million), a decrease in accounts receivable ($1.8 million) and a decrease in other changes in working capital ($1.7 million). Cash flows used in investing activities ($4.9 million) consisted of renovation and refurbishment of the Charles Town facility and race track surface ($1.1 million) and $3.8 million in capital expenditures, including approximately $3.2 million for the completion of the Hazleton and Carbondale OTW facilities. Cash flows from financing activities ($123,000) consisted principally of additional financing fees associated with the sale of Senior Notes in December 1997. The Company is subject to possible liabilities arising from the environmental condition at the landfill adjacent to Pocono Downs. Specifically, the Company may incur expenses in connection with the landfill in the future. Such expenses may not be reimbursed by the four municipalities that are parties to the settlement agreement. The Company is unable to estimate the amount, if any, that it may be required to expend. During the balance of 1998, the Company anticipates capital expenditures of approximately $3.5 million to purchase the Johnstown OTW facility and the construction of one additional OTW facility. For the existing racetracks and OTW facilities at Penn National Race Course and Pocono Downs, the Company plans to spend an additional $500,000 and $350,000, respectively, on building improvements and equipment. The Company anticipates expending approximately $.5 million on the refurbishment of the Charles Town Entertainment Complex (excluding the cost of Gaming Machines). If approval of the Tennessee license beyond June 30, 1998 is ultimately received, the Company anticipates expending $9.0 million to complete the first phase of the project. 20
The Company entered into a credit facility in December 1997 (the "Credit Facility") with Bankers Trust Company, as agent. The Credit Facility provides for, subject to certain terms and conditions, a $12.0 million revolving credit facility and has a five-year term from its closing. The Credit Facility, under certain circumstances, requires the Company to make mandatory prepayments and commitment reductions and to comply with certain covenants, including financial ratios and maintenance tests. In addition, the Company may make optional prepayments and commitment reductions pursuant to the terms of the Credit Facility. Borrowings under the Credit Facility will accrue interest, at the option of the Company, at either a base rate plus an applicable margin of up to 2.0% or a eurodollar rate plus an applicable margin of up to 3.0%. The Credit Facility contains certain covenants that, among other things, restrict the ability of the Company and its subsidiaries to dispose of assets, incur additional indebtedness, incur guarantee obligations, repay indebtedness or amend debt instruments, pay dividends, create liens on assets, make investments, make acquisitions, engage in mergers or consolidations, make capital expenditures, or engage in certain transactions with subsidiaries and affiliates and otherwise restrict corporate activities. The Credit Facility is secured by the assets of the Company and certain of its subsidiaries and guaranteed by all subsidiaries, except the Charles Town Joint Venture. In addition, the Credit Facility requires the Company to comply with certain financial ratios and maintenance tests. As of December 31, 1997, the Company would not have been in compliance with certain covenants under the Credit Facility had the bank group not granted a waiver, through March 30, 1998, of certain defaults regarding minimum consolidated net worth, consolidated cash interest coverage ratio and minimum leverage ratio. At the end of the first quarter, the Company was in technical default of certain required ratios, which defaults were waived and ratios were adjusted. On June 30, 1998, the Company was in compliance with all applicable ratios. As of August 11, 1998, the Company had not drawn any portion of the Credit Facility (although a $2.0 million letter of credit was issued against such Credit Facility) and had adequate capital resources even without consideration of the Credit Facility. A portion of the net proceeds of the offering of the 10 5/8% Senior Notes was used to repay amounts outstanding immediately prior to the offering under a pre-existing credit facility. The Company currently estimates that excess proceeds from the offering, cash generated from operations and available borrowings under the Credit Facility will be sufficient to finance its current operations, planned capital expenditure requirements and the costs associated with the Tennessee development project. There can be no assurance, however, that the Company will not be required to seek additional capital through public or private financing, including equity financing, in addition to that available from the foregoing sources. There can be no assurance that adequate funding will be available as needed or, if available, on terms acceptable to the Company. 21
Item 3. Changes in Information About Market Risk All of the Company's debt obligations at June 30, 1998, were fixed rate obligations and Management, therefore, does not believe that the Company has any material market risk from its debt obligations. Part II. Other Information Item 1. Legal Proceedings In December 1997, Amtote International, Inc. ("Amtote"), filed an action against the Company and the Charles Town Joint Venture in the United States District Court for the Northern District of West Virginia. In its complaint, Amtote (i) states that the Company and the Charles Town Joint Venture allegedly breached certain contracts with Amtote and its affiliates when it entered into a wagering services contract with a third party (the "Third Party Wagering Services Contract"), and not with Amtote, effective January 1, 1998, (ii) sought preliminary and injunctive relief through a temporary restraining order seeking to prevent the Charles Town Joint Venture from (a) entering into a wagering services contract with a party other than Amtote and (b) having a third party provide such wagering services, (iii) seeks declaratory relief that certain contracts allegedly bind the Charles Town Joint Venture to retain Amtote for wagering services through September 2004 and (iv) seeks unspecified compensatory damages, legal fees and costs associated with the action and other legal and equitable relief as the Court deems just and appropriate. On December 24, 1997, a temporary restraining order was issued, which prescribes performance under the Third Party Wagering Contract. On January 14, 1998, a hearing was held to rule on whether a preliminary injunction should be issued or whether the temporary restraining order should be lifted. On February 20, 1998, the temporary restraining order was lifted by the court and the Company terminated Amtote Agreement and proceeded under the Third Party Wagering Services Contract. Amtote is contuning its litigation against the Company for monetary damages. The Company believes that this action, and any resolution thereof, will not have any material adverse impact upon its financial condition, results, or the operations of either the Charles Town Joint Venture or the Company. 22
Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.77 Purchase Agreement dated July 7, 1998, between Ladbroke Racing Management and Mountainview Thoroughbred Racing Association. (b) Reports on Form 8-K None 23
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Penn National Gaming, Inc. August 14, 1998 By: /s/ Robert S. Ippolito - --------------- -------------------------- Date Robert S. Ippolito, Chief Financial Officer, Secretary/Treasurer 24
EXHIBIT INDEX Exhibit Nos. Description of Exhibits Page No. Purchase Agreement dated July 7, 1998, between Ladbroke Racing Management and Mountainview Thoroughbred Racing Association. 26-39