Penn National Gaming, Inc.
ANNUAL REPORT
Cover photo: Photograph of Thoroughbred
Horse Race at Penn National Race Course.
<PAGE>
[Photo]
The Egyptian Portico at Charles Town Entertainment Complex.
<PAGE>
letter to shareholders 2
1997 financial highlights 4
penn national race course 6
simulcasting 8
off-track wagering 10
charles town races 12
the downs at pocono 14
financial table of contents 15
financial review 16
auditor's report 36
[Photo]
Thoroughbred Racing
PENN NATIONAL GAMING, INC.
While celebrating its twenty-fifth year of operation in 1997, Penn National
Gaming, Inc. enjoyed another year of growth and expansion. As the largest
operator of pari-mutuel wagering locations in Pennsylvania, Penn National
Gaming, Inc. owns and operates Penn National Race Course, one of two
thoroughbred racetracks in Pennsylvania, and Pocono Downs, one of two harness
racing tracks in Pennsylvania, as well as nine off-track wagering facilities.
During 1997, the Company also acquired an 89% interest in Charles Town Races,
which underwent extensive renovations and was reopened as Charles Town
Entertainment Complex, a thoroughbred racing track and video slot machine gaming
center in Charles Town, West Virginia.
Penn National Gaming, Inc. conducts wagering on its own live racing at Penn
National Race Course, Pocono Downs, and Charles Town Races, as well as
thoroughbred and harness racing simulcasts from other racetracks (import
simulcasting). Conversely, the company also exports live races for wagering at
other racetracks and OTWs through the continental United States and the
Caribbean (export simulcasting). Penn National Race Course and Pocono Downs also
conduct wagering on their races and on thoroughbred and harness racing
simulcasts from other racetracks through their telephone account betting
networks (Telebet and Dial-A-Bet, respectively).
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LETTER TO SHAREHOLDERS
In 1997, Penn National Gaming celebrated its 25th year of operation. The year
proved to be a period of significant progress and expansion that yielded a 78%
gain in revenues. Additionally, the Company attracted substantial new equity and
debt capital, which supports Penn National Gaming's present growth initiatives
and provides funds for future expansion. From an operating standpoint, however,
we encountered and overcame difficulties associated with the implementation of
an aggressive growth plan. Penn National's financial performance and
profitability were impacted by various issues and substantial costs and
expenses, including certain non-recurring charges, incurred to support our
growth objectives.
During 1997 we successfully integrated the Pocono Downs race track and off-track
wagering (OTW) operations into Penn National and completed our first full year
of racing at the Pocono facilities. We also commenced development work that led
to the opening of two new OTWs in March 1998. We expanded into West Virginia,
our first jurisdiction outside Pennsylvania, through the January 1997
acquisition of Charles Town Races and commenced a $27 million reconstruction of
the historic Charles Town Races, adding a new video gaming center, simulcast
center, restaurants and other amenities.
By September 1997, we opened the Silver Screen Gaming Center at Charles Town
with 224 video gaming machines. Since opening, we have continued to expand the
machine base, evaluating product offerings from different device manufacturers,
and by the end of April 1998, we expect to have 744 machines in operation. An
additional 55 machines, due in early May, will complete the build-out of our
gaming floor until revenues grow to a level that will support the installation
of up to an additional 201 machines, for which we have already received approval
from the West Virginia Lottery Commission. Since our modest opening last
September, video slot machine wagering at Charles Town has been growing on an
aggregate and per-machine basis as we refine our marketing and operation
approaches. We expect strong operating performance from Charles Town video slot
operations for the full year in 1998.
On the racing side at Charles Town, construction of our new simulcast center
proceeded through the late summer and was completed in March 1998. Live racing
and simulcast business have already been generating "summer levels" of
patronage, supporting our optimism for building a strong racing program at
Charles Town as well.
Total wagering and total revenues for Penn National expanded dramatically
through 1997, with gross wagering growing to $602,836,000 (about 61.6% higher
than that of 1996), however, net income was hampered by the softening of
business at several of our OTW sites due to competition from Philadelphia Park,
Ohio full card simulcasts and Delaware slot machines. In addition to certain
non-recurring charges, the principal factor impacting Penn National's earnings
was interest expense on borrowings related to the Pocono Downs and Charles Town
acquisitions. With the completion of an $80 million bond offering in December
1997, our interest costs have risen, but at the same time, this financing
provides long-term financial stability for the company and sufficient capital to
fund our Pennsylvania off-track facility development efforts, a proposed
Tennessee race track and OTW development, as well as other opportunities that we
are currently evaluating.
Penn National's two new off-track wagering facilities in Hazleton and Carbondale
opened in March 1998. We expect to open sites in Altoona and Stroudsburg later
this year. With eleven off-track sites operating throughout Pennsylvania, we
expect to see growth in both sales and earnings as investment in growth over the
last year and a half begins generating returns. With the revitalized Charles
Town operations and the success of one of several initiatives that Penn National
is currently pursuing in other states, we believe that shareholders can expect
to find a larger, more diversified and more profitable company at this same time
next year. As of this writing, we have been licensed and have received all
necessary approvals in the state of Tennessee to build and operate a harness
race track and OTW facility north of Memphis. Prior to groundbreaking, the sole
remaining issue is for the state legislature to extend the life of the governing
body, the Tennessee Racing Commission, and we expect this to be resolved in the
coming weeks.
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My annual letter would not be complete without addressing the competitive issues
related to proposals to legalize slot machines in Pennsylvania. Slot legislation
was approved by the Pennsylvania Senate in May of 1997, and we believe the bill
had the support of the majority in the House of Representatives. Unfortunately,
Governor Tom Ridge did not support certain portions of the legislation and
indicated that he would veto the bill. Nonetheless, the need to continue to
build the pari-mutuel industry and enhance our competitiveness with the gaming
offerings of surrounding states remains an issue that must be addressed. We
believe that the administration recognizes this and will ultimately support, at
the very least, a referendum presented to the voters of Pennsylvania to
authorize the installation of slot machines at the state's four race tracks.
Timing is always a question, but we would hope to be able to see such a question
put to voters in 1999.
In summary, we have accomplished a great deal over the past year to diversify
the company for continued growth and improving financial performance in the
coming years. Though 1997 proved to be financially challenging, we expect to
return to earnings growth in 1998 as our efforts and investments over the past
year being to deliver returns. We thank you for your continued support and
confidence as demonstrated by your investment in our company and look forward to
reporting to you on our progress.
Sincerely,
/s/ Peter M. Carlino
- --------------------
Peter M. Carlino
Chairman of the Board and Chief Executive Officer
April 20, 1998
[Photo]
Picture of Peter M. Carlino, Chairman and CEO
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1997
SELECTED CONSOLIDATED
FINANCIAL HIGHLIGHTS
In the printed version, a bar graph shows the following for
total wagering (in millions)
1997 $ 316,896
1996 $ 373,012
1995 $ 602,836
In the printed version, a bar graph shows the following for
total revenues (in millions)
1997 $ 57,676
1996 $ 62,834
1995 $ 111,536
In the printed version, a bar graph shows the following for
income from operations (in millions)
1997 $ 8,255
1996 $ 9,460
1995 $ 9,735
year ended december 31, 1995 1996 1997
(in thousands, except per share data)
Other Data
Total Pari-Mutuel Wagering $ 316,896 $ 373,012 $ 602,836
Income Statement Data
Total Revenues $ 57,676 $ 62,834 $ 111,536
Income From Operations 8,255 9,460 9,735
Income before extraordinary item 4,996 5,510 3,769
Net Income 4,996 5,510 2,287
Per Share Data
Basic income per share before
extraordinary item $ .39 $ .41 $ .25
Basic net income per share $ .39 $ .41 $ .15
Diluted income per share before
extraordinary item $ .38 $ .40 $ .24
Diluted net income per share $ .38 $ .40 $ .15
Shares Outstanding
Basic 12,906 13,302 14,925
Diluted 13,017 13,822 15,458
Balance Sheet Data
Cash $ 7,514 $ 5,634 $ 21,854
Working Capital (deficiency) 4,134 (509) 15,226
Total Assets 27,532 96,723 158,878
Total Debt 390 47,517 80,336
Shareholders' Equity 20,802 27,881 53,856
4
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[Photo]
Jockey's numbers hanging on stable wall.
5
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PENN NATIONAL RACE COURSE
[Photo]
Exterior view of Penn National Race Course
Penn National Race Course continues to enjoy a proud heritage in the closed
circles of the racing world. While hosting two major $100,000-added stakes races
in 1997, Penn National racing fans were able to cheer on Joker as he won the
25th running of the Pennsylvania Governor's Cup, and Overcharger as she ran to
victory in Penn National's second annual Distaff. Penn National also proudly
hosted the nationally renowned and largely popular World Series of Handicapping,
which is in its 22nd year.
[Photo]
Picture of jockey's silks
As the only racetrack in the eastern time zone with a slate of year-round
nighttime thoroughbred racing, Penn National has conducted at least 204 days of
live racing each year for the past five years.
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[Photo]
Picture of horse's silks
[Photo]
Picture of jockey's boots
[Photo]
Picture of horse's saddle
7
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[Photo]
Picture of jockey on horse.
Map of U.S. with points indicating export simulcast locations.
8
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SIMULCASTING
The continued growth of its simulcast racing operations, due in part to both the
broadcasting of Penn National and Pocono Downs races and the televising of races
from other tracks, is a large factor in the success of Penn National Gaming,
Inc. in 1997.
Import Simulcasting
Wagering on import simulcasting at all of the Penn National facilities grew
74.8% from $170.8 million in 1996 to $298.5 million in 1997. This substantial
increase can be attributed to the operation of the Lancaster OTW facility for
the full calendar year, the addition of OTW facilities in Williamsport,
Allentown and Erie, and the acquisition of Pocono Downs and Charles Town Races.
As part of its continuing commitment to bringing the very best racing to its
patron, the Company imports simulcast racing from approximately 75 racetracks,
including Belmont Park, Saratoga, Gulfstream Park and Santa Anita.
Export Simulcasting
Export simulcasting also realized spectacular gains in 1997. Penn National Race
Course fills an important void as the only racetrack in the eastern time zone
that runs year-round, night time racing, and exports its races to nearly 98
locations throughout the country.
Export simulcasting grew 56.2%, showing wagering of $176.3 million in 1997
compared to the $112.9 million that was wagered at out-of-state locations in
1996.
[Photo]
Picture of jockeys on horses coming around track at Penn National Race Course.
[Photo]
Picture of jockeys on horses coming around track at Penn National Race Course.
[Photo]
Picture of jockeys on horses coming around track at Penn National Race Course.
[Photo]
Picture of jockeys on horses coming around track at Penn National Race Course.
[Photo]
Picture of jockey on horse
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[Photo]
Patrons at Penn National OTW facility
Map of Pennsylvania with points indicating OTW locations
1
2
3
4
5
6
7
8
9
10
11
12
13
1 penn national otw, chambersburg
2 penn national otw, lancaster
3 penn national otw, reading
4 penn national otw, williamsport
5 penn national otw, york
6 penn national otw, altoona (pending)
7 penn national race course, grantville
8 the downs at carbondale, carbondale
9 the downs at erie, erie
10 the downs at hazleton, hazleton
11 the downs at lehigh valley, allentown
12 the downs at pocono, wilkes-barre
13 the downs at stroudsburg, stroudsburg (pending)
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OFF TRACK WAGERING
[Photo]
Sign at Penn National OTW
[Photo]
Picture of simulcast television
[Photo]
Picture of entrance to a Penn National OTW facility
With the opening of state-of-the-art facilities in Williamsport, Hazleton and
Carbondale, Pennsylvania, the off-track wagering network operated by Penn
National Gaming, Inc., expanded to nine. The above locations joined other
facilities in Allentown, Chambersburg, Erie, Lancaster, Reading and York,
Pennsylvania. Penn National Race Course also serves as a simulcasting hub,
overseeing totals and accounting for Pocono Downs, Charles Town Races and
Colonial Downs.
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[Photo]
Picture of jockeys on horses
CHARLES TOWN RACES
On January 15, 1997, the company acquired Charles Town Races, a thoroughbred
racetrack in Charles Town, West Virginia. The Company has refurbished and
reopened the facility as the Charles Town Entertainment Complex which features
live racing, dining, simulcast wagering, and, effective September 1997, video
slot machines.
In developing the Charles Town Entertainment Complex, the Company preserved the
California mission-style architecture of the original Charles Town Races
facility, while making extensive internal renovations, including a 1930's art
deco, Hollywood theater scene within the Silver Screen Gaming Center. The
Company now has 744 video slot machines in operation.
[Photo]
Photo of patrons at gaming machines at Charles Town Entertainment Complex
[Photo]
Patron at Charles Town Entertainment Complex
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[Photo]
Picture of Select-a-Game, touch-screen video gaming machines
at Charles Town Entertainment Complex
Picture of exterior entrance to Charles Town Races
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[Photo]
Picture of harness horses in paddock before racing at Pocono Downs
THE DOWNS AT POCONO
[Photo]
Picture of patrons watching harness racing at Pocono Downs
[Photo]
Picture of jockey and horse, harness racing
Pocono Downs, located in Wilkes-Barre, is one of two harness racing facilities
in Pennsylvania, and conducted 134 days of live racing during 1997. The
racetrack offers pari-mutuel wagering on both harness and thoroughbred racing,
exports its races to locations throughout the country, and imports both
thoroughbred and harness simulcasts to the racetrack and the OTW facilities.
Along with the acquisition of Pocono Downs, Penn National Gaming, Inc., acquired
OTWs in Allentown and Erie. The off-track wagering facilities in Hazleton and
Carbondale were opened in March 1998.
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[Photo]
Picture of tote board
1997 FINANCIAL REVIEW
selected consolidated financial data 16
management's discussion and analysis 18
consolidated financial statements 22
summary of significant accounting policies 26
acquisitions 28
long-term debt and capital lease obligations 30
customer deposits 31
commitments and contingencies 31
income taxes 33
supplemental disclosures of cash flow
information 34
common stock 34
loss from retirement of debt 36
site development and restructuring charges 36
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SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company for the years
ended December 31, 1993, 1994, 1995, 1996 and 1997, except for Other Data, are
derived from financial statements that have been audited by BDO Seidman, LLP,
independent certified public accountants, adjusted as described in the notes
below. The selected consolidated financial data should be read in conjunction
with the consolidated financial statements of the Company and Notes thereto,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the other financial information included herein.
<TABLE>
<CAPTION>
year ended december 31, 1993(1) 1994 1995 1996 1997(2)
- -------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Income Statement Data
Revenues
Pari-mutuel revenues
Live races $ 29,224 $ 23,428 $ 21,376 $ 18,727 $ 27,653
Import simulcasting 9,162 16,968 27,254 32,992 59,810
Export simulcasting 383 1,187 2,142 3,347 5,279
Gaming machine revenue -- -- -- -- 5,712
Admissions, programs and other racing revenues 2,485 2,563 3,704 4,379 5,678
Concession revenues 1,410 1,885 3,200 3,389 7,404
-------------------------------------------------------------
Total revenues 42,664 46,031 57,676 62,834 111,536
-------------------------------------------------------------
Operating expenses
Purses, stakes and trophies 9,719 10,674 12,091 12,874 22,335
Direct salaries, payroll taxes and employee benefits 6,394 6,707 7,699 8,669 16,200
Simulcast expenses 10,136 8,892 9,084 9,215 12,982
Pari-mutuel taxes 3,568 4,054 4,963 5,356 9,506
Lottery taxes and administration -- -- -- -- 1,874
Other direct meeting expenses 5,817 6,093 7,576 8,536 18,087
OTW concession expenses 767 1,175 2,125 2,349 5,605
Management fees paid to related entity 1,208 345 -- -- --
Other operating expenses 1,959 2,968 5,002 4,942 8,735
Depreciation and amortization 640 699 881 1,433 4,040
Site development and restructuring charges -- -- -- -- 2,437
-------------------------------------------------------------
Total operating expenses 40,208 41,607 49,421 53,374 101,801
-------------------------------------------------------------
Income from operations 2,456 4,424 8,255 9,460 9,735
-------------------------------------------------------------
Other income (expenses)
Interest income (expense), net (962) (340) 198 (156) (3,656)
Other 6 15 10 -- (2)
-------------------------------------------------------------
Total other income (expenses) (956) (325) 208 (156) (3,658)
-------------------------------------------------------------
Income before income taxes and extraordinary item 1,500 4,099 8,463 9,304 6,077
Taxes on income 42 1,381 3,467 3,794 2,308
-------------------------------------------------------------
</TABLE>
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<TABLE>
<CAPTION>
year ended december 31, 1993(1) 1994 1995 1996 1997(2)
- --------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Income before extraordinary item 1,458 2,718 4,996 5,510 3,769
Extraordinary item
Loss on early extinguishment of debt,
net of income taxes of $83 and $1,001, respectively -- 115 -- -- 1,482
-------------------------------------------------------------
Net income $ 1,458 $ 2,603 $ 4,996 $ 5,510 $ 2,287
-------------------------------------------------------------
Per Share Data:
Basic income per share before extraordinary item $.39 $.41 $.25
Basic net income per share $.39 $.41 $.15
Diluted income per share before extraordinary item $.38 $.40 $.24
Diluted net income per share $.38 $.40 $.15
Shares Outstanding:
Basic 12,906 13,302 14,925
Diluted 13,017 13,822 15,458
Supplemental Pro Forma Net Income
Statement Data (4):
Supplemental pro forma net income $ 1,819 $ 2,724
-------------------------------------------------------------
Supplemental pro forma net income per share $ .15 $ .22
-------------------------------------------------------------
Weighted average number of common shares outstanding 12,249(5) 12,663
-------------------------------------------------------------
Operating Data:
Pari-mutuel wagering
Live races $ 138,939 $ 111,248 $ 102,145 $ 89,327 $ 128,090
Import simulcasting 58,252 93,461 142,499 170,814 298,459
Export simulcasting 12,746 40,337 72,252 112,871 176,287
-------------------------------------------------------------
Total pari-mutuel wagering $ 209,937 $ 245,046 $ 316,896 $ 373,012 $ 602,836
-------------------------------------------------------------
Gross profit from wagering(3) $ 15,346 $ 17,936 $ 24,915 $ 27,955 $ 45,589
-------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
as of december 31 1993 1994 1995 1996 1997
- -----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents $ 1,002 $ 5,502 $ 7,514 $ 5,634 $ 21,854
Working capital (deficiency) (4,549) 2,074 4,134 (509) 15,226
Total assets 18,373 21,873 27,532 96,723 158,878
Total debt 10,422 516 390 47,517 80,336
Shareholders' equity 3,418 15,627 20,802 27,881 53,856
</TABLE>
(1) The Consolidated Financial Statements of the Company include entities which,
prior to a recapitalization which occurred in 1994 shortly before the
Company's initial public offering, were affiliated through common ownership
and control.
(2) Reflects the November 27, 1996 acquisition of Pocono Downs and the January
15, 1997 acquisition of a joint venture interest in the Charles Town
Entertainment Complex.
(3) Amounts equal total pari-mutuel revenues, less purses paid to Horsemen,
taxes payable to Pennsylvania and simulcast commissions or host track fees
paid to other racetracks. Figures for the years ended December 31, 1995 and
1996 do not include purses paid at Penn National Speedway.
(4) Supplemental pro forma amounts for the years ended December 31, 1993 and
1994 reflect (i) the elimination of $1,208,000 and $345,000, respectively,
in management fees paid to a related entity, (ii) the inclusion of $320,000
and $133,000, respectively, in executive compensations, (iii) the
elimination of $946,000 and $413,000, respectively, of interest expenses on
Company debt which was repaid with the proceeds of the initial public
offering in 1994, (iv) the elimination of $0 and $198,000, respectively, of
loss on early extinguishment of debt, and (v) a provision for income taxes
of $701,000 and $377,000, respectively, as if the S corporations and
partnerships comprising part of the Company prior to the Reorganization in
1994 had been taxed as C corporations. There were no supplemental pro forma
adjustments for any subsequent periods.
(5) Based on 8,400,000 shares of Common Stock outstanding before the initial
public offering in May 1994, plus 4,500,000 shares sold by the Company in
the initial public offering.
17
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[Photo]
Jockey on horse, training.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company's pari-mutuel revenues have been derived from (i) wagering on the
Company's live races (a) at the Penn National Race Course, (b) at the Company's
OTWs, (c) at other Pennsylvania racetracks and OTWs and (d) through telephone
wagering, as well as wagering at the Company's racetracks on certain stakes
races run at out-of-state racetracks (collectively, referred to in the Company's
financial statements as "pari-mutuel revenues from Penn National races"), (ii)
wagering on full-card import simulcasts at the Company's racetracks and OTWs and
through telephone wagering (collectively, referred to in the Company's financial
statements as "pari-mutuel revenues from import simulcasting") and (iii) fees
from wagering on export simulcasting Company races at out-of-state locations
(referred to in the Company's financial statements as "pari-mutuel revenues from
export simulcasting"). The Company's other revenues have been derived from
admissions, program sales and certain other ancillary activities, food and
beverage sales and concessions and, beginning in September 1997, video gaming
machines ("Gaming Machines").
Over the past several years, attendance at live racing, on an industry-wide
basis, has generally declined. Prior to the inception of OTWs, declining live
racing attendance at a track translated directly into lower purses at that
track. As the size of the purses declined, the quality of live racing at the
track would suffer, leading in turn to further reductions in attendance.
However, the Company believes that increased contributions to the purse pool
from wagers placed at OTWs affiliated with racetracks have significantly offset
the effects of declining live racing attendance on race quality, and thereby
improved the marketability of many tracks' export simulcast products. Indeed,
despite declining live racing attendance, total pari-mutuel wagering on horse
races in the United States has remained relatively constant in recent years.
Moreover, a number of states have recently begun to authorize the installation
of slot machines, video lottery terminals or other gaming machines at live
racing venues such as thoroughbred horse tracks, harness tracks and dog tracks.
The revenue from these gaming opportunities and from the higher volume of wagers
placed at these venues has not only increased total revenues for the tracks at
which they are installed, but has generally further increased purse size and
thereby resulted in higher quality races that can command higher simulcast
revenues.
The amount of revenue to the Company from a wager depends upon where the race is
run and where the wagering takes place. Pari-mutuel revenues from Company races
and import simulcasting of out-of-state races have consisted of the total amount
wagered, less the amount paid as winning wagers. Pari-mutuel revenues from
wagering at the Company's racetracks or the Company's OTWs on import
simulcasting from other Pennsylvania racetracks have consisted of the total
amount wagered, less the amounts paid as winning wagers, amounts payable to the
host racetrack and pari-mutuel taxes to Pennsylvania. Pari-mutuel revenues from
export simulcasting have consisted of amounts payable to the Company by the
out-of-state racetracks with respect to wagering on live races at the Company's
racetracks. Operating expenses have included purses payable to the Thoroughbred
Horsemen, commissions to other racetracks with respect to wagering at their
facilities on races at the Company's racetracks, pari-mutuel taxes on races at
the Company's racetracks and export simulcasting and other direct and indirect
operating expenses.
The Pennsylvania Race Horse Industry Reform Act ("The Pennsylvania Racing Act")
specifies the maximum percentages of each dollar wagered on horse races in
Pennsylvania which may be retained by the Company (prior to required payments to
the Thoroughbred Horsemen and applicable taxing authorities). The percentages
vary, based on the type of wager; the average percentage has approximated 20%.
The balance of each dollar wagered must be paid out to the public as winning
wagers. With the exception of revenues derived from wagers at the Company's
racetracks or the Company's OTWs, the Company's revenues on each race are
determined pursuant to such maximum percentage and agreements with the other
racetracks and OTWs at which wagering is taking place. Amounts payable to the
Thoroughbred Horsemen are determined under agreements with the Thoroughbred
Horsemen and vary depending upon where the wagering is conducted and the
racetrack at which such races take place. The Thoroughbred Horsemen receive
their share of such wagering as race purses. The Company retains a higher
percentage of wagers made at its own facilities than of wagers made at other
locations.
On November 27, 1996, the Company acquired Pocono Downs for an aggregate
purchase price of $48.2 million plus approximately $730,000 in
acquisition-related fees and expenses. Pocono Downs conducts harness racing and
pari-mutuel wagering at its track outside Wilkes-Barre, Pennsylvania, export
simulcasting of Pocono Downs races to locations throughout the United States,
pari-mutuel wagering at Pocono Downs and at OTWs in Allentown and Erie,
Pennsylvania on Pocono Downs races and on import simulcast races from other
racetracks and telephone account
18
<PAGE>
wagering on live and import simulcast races. The Company applied and was
approved by the Pennsylvania State Harness Racing Commission for a new racing
license and 1998 harness racing dates at Pocono Downs. This approval entitles
the Company to reduce, for a period of four years, its pari-mutuel tax by
one-half percent with respect to wagering at Pocono Downs and the Company's OTWs
in Allentown, Carbondale, Erie, Hazleton and Stroudsburg, Pennsylvania.
Prior to the acquisition of Pocono Downs, the Company operated four OTWs, one
each in Chambersburg, Lancaster, Reading and York, Pennsylvania. The Company
added the OTWs in Allentown and Erie, Pennsylvania in November 1996 through the
acquisition of Pocono Downs and added two OTWs through the opening of the
Williamsport OTW in February 1997 and the Hazleton OTW in March, 1998. The
Company opened on March 31, 1998, an OTW in Carbondale, Pennsylvania. Subject to
the receipt of all regulatory approvals, the Company anticipates opening
additional OTWs in Stroudsburg and Altoona, Pennsylvania, at which time the
Company would operate 11 of the 23 OTWs, authorized under Pennsylvania law.
On January 15, 1997, the Company acquired for a net purchase price of
approximately $18.2 million (including acquisition costs) a controlling joint
venture interest in Charles Town Races. After substantially completing a major
renovation and refurbishment of the property, the Company reopened Charles Town
Races as the Charles Town Entertainment Complex which features Gaming Machines,
live racing, simulcast wagering and dining. The Company currently owns an 89%
joint venture interest in the Charles Town Joint Venture. Racing operations
reopened at the Charles Town Entertainment Complex in April 1997. Gaming Machine
operations commenced with a soft opening on September 10, 1997, followed by the
Company's grand opening on October 17, 1997. The Company operated an average of
approximately 300 Gaming Machines in September 1997, and increased the number of
Gaming Machines in operation to 550 as of October 31, 1997. The Company has
installed and is operating, as of March 1998, 609 Gaming Machines at the Charles
Town Entertainment Complex, and anticipates that the Company will install 135
additional Gaming Machines by April 1998. The Company ultimately intends to
operate at the Charles Town Entertainment Complex 1,000 Gaming Machines, the
maximum number it is currently permitted to operate by law if demand warrants.
RESULTS OF OPERATIONS
The following table sets forth certain data from the Consolidated Statements of
Income of the Company as a percentage of total revenues:
year ended december 31 1995 1996 1997
- -------------------------------------------------------------
Revenues
Pari-mutuel revenues
Live races 37.1% 29.8% 24.8%
Import simulcasting 47.3 52.5 53.6
Export simulcasting 3.7 5.3 4.7
Gaming Machine revenues -- -- 5.1
Admissions, programs and
other racing revenues 6.4 7.0 5.1
Concession revenues 5.5 5.4 6.7
-----------------------
Total revenues 100.0 100.0 100.0
Operating expenses
Purses, stakes and trophies 21.0 20.5 20.0
Direct salaries, payroll taxes
and employee benefits 13.3 13.8 14.5
Simulcast expenses 15.8 14.7 11.7
Pari-mutuel taxes 8.6 8.5 8.5
Lottery taxes and administration -- -- 1.7
Other direct meeting expenses 13.1 13.6 16.2
OTW concession expenses 3.7 3.7 5.0
Other operating expenses 8.7 7.9 7.8
Depreciation and amortization 1.5 2.3 3.6
Site development and
restructuring charges -- -- 2.2
-----------------------
Total operating expenses 85.7 84.9 91.3
-----------------------
Income from operations 14.3 15.1 8.7
Total other income (expenses) 0.4 (0.2) (3.3)
-----------------------
Income before income taxes
and extraordinary item 14.7 14.9 5.4
-----------------------
Net income 8.7% 8.8% 2.1%
-----------------------
[Photo]
Tack
19
<PAGE>
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total revenue increased by approximately $48.7 million, or 77.5%, from $62.8
million in 1996 to $111.5 million in 1997. Pocono Downs, which was acquired in
the fourth quarter of 1996 accounted for $30.8 million of the increase. Charles
Town Races, which was purchased in January 1997, accounted for $16.5 million of
the increase. The Company renovated and refurbished the Charles Town
Entertainment Complex following its acquisition and commenced racing operations
on April 30, 1997 and Gaming Machine operations, with a soft opening, on
September 10, 1997. The remaining revenue increase of $1.4 million was primarily
due to an increase of approximately $6.2 million associated with the opening of
the Penn National OTW facility in Williamsport in February 1997, and a full year
of operations at the Lancaster OTW facility. This increase was offset by a
decrease in revenues of approximately $4.2 million at the Company's OTW
facilities in Reading and York. Management believes that the decrease in
revenues at these facilities was primarily due to the opening of a competitor's
OTW facility and the opening of the Company's Lancaster OTW facility in July
1996. The Company also had a decrease in revenues of $.6 million due to the
closing of Penn National Speedway at the end of the 1996 season.
Total operating expenses increased by approximately $48.4 million, or 90.7%,
from $53.4 million in 1996 to $101.8 million in 1997. Pocono Downs and Charles
Town Races, which the Company did not operate in the corresponding prior period,
accounted for $25.5 million and $17.5 million of this increase, respectively.
Operating expenses also increased by $5.4 million primarily due to an increase
of $4.4 million associated with the opening of the Company's new OTW facility in
Williamsport in February 1997, and a full year of operations at the Lancaster
OTW facility. This increase was offset by a decrease in operating expenses of
approximately $1.9 million at the Penn National Race Course facility and at the
Company's OTW facilities in Reading and York associated with lower revenues at
those facilities. The increase in corporate expenses of $1.4 million was due to
increased personnel, office space and other administrative expense necessary to
support the expansion of the Company. The Company also incurred site development
and restructuring charges in the amount of $2.4 million. The site development
charges ($1.7 million) consist of $800,000 related to the Charles Town Races
facility and $935,000 related to the abandonment of certain proposed operating
sites during 1997. The restructuring charges primarily consist of $350,000 in
severance termination benefits and other charges at the Charles Town Races
facility, $300,000 for the restructuring of the Erie, Pennsylvania off-track
wagering facility and $52,000 of property and equipment written-off in
connection with the discontinuation of Penn National Speedway, Inc. operations
during 1997. The Company also had a decrease in expenses of $.9 million due to
the closing of Penn National Speedway at the end of the 1996 season.
Income from operations increased by approximately $265,000, or 2.9%, from $9.5
million in 1996 to $9.7 million in 1997 due to the factors described above. The
Company had other expenses of approximately $3.7 million in 1997 compared to
$156,000 in 1996, primarily as a result of increased interest expense. The
increase in interest expense is due to the Company's incurring bank debt for the
purchase of Pocono Downs and Charles Town Races, and for the renovations to the
Charles Town Facility and issuing $80.0 million of 10.625% Senior Notes on
December 12, 1997 to repay existing bank debt.
The extraordinary item consisted of a loss on the early extinquishment of debt
in the amount of $1,482,000, net of income taxes. The loss consists primarily of
write-offs of deferred finance costs associated with the retired bank notes and
legal and bank fees relating to the early extinquishment of the debt.
Net income decreased by approximately $3.2 million or 58.5%, from $5.5 million
in 1996 to $2.3 million in 1997 based on the factors described above. Income
taxes decreased by $1.5 million from $3.8 million in 1996 to $2.3 million in
1997 as a result of the decrease in income for the year.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total revenues increased by approximately $5.2 million, or 8.9%, from $57.7
million in 1995 to $62.8 million in 1996. The increase was attributable to an
increase in import and export simulcasting revenues, offset in part by a
decrease in pari-mutuel revenues on live races at the Penn National Race Course.
The increases in pari-mutuel revenues from import simulcasting, admissions,
programs and other racing revenues and concession revenue were due primarily to
operating the York OTW facility for twelve months in 1996 compared to nine
months in 1995, the opening of the Lancaster OTW facility in July 1996, and the
additional revenue from the acquisition of Pocono Downs since November 28, 1996.
The increase in export simulcasting revenue of $1.2 million or 56.3% from $2.1
million to $3.3 million resulted from the marketing of the Penn National Race
Course races to additional out-of-state locations. The decrease in pari-mutuel
revenues on the Penn National Race Course races was due to increased import
simulcasting revenue from wagering on other racetracks at Company facilities and
inclement winter weather conditions throughout the state of Pennsylvania during
the first quarter of 1996. For the year, the Penn National Race Course was
scheduled to run 217 live race days but canceled eleven in the first quarter of
1996 due to weather. In 1995, the Penn National Race Course ran 204 live race
days and had six cancellations.
Total operating expenses increased by approximately $4.0 million, or 8.0%, from
$49.4 million in 1995 to $53.4 million in 1996. The increase in operating
expenses resulted from a full year of operations for the York OTW compared to
nine months in 1995, six months of operating expenses for the new Lancaster OTW,
one month of operating expenses at Pocono Downs and the expansion of the
corporate staff and office facility at Wyomissing in June of 1995.
20
<PAGE>
Income from operations increased by approximately $1.2 million, or 14.6%, from
$8.3 million in 1995 to $9.5 million in 1996 due to the factors described above.
The Company had other operating expenses of $156,000 in 1996 compared to other
operating income of $208,000 in 1995, primarily as a result of increased
interest expense. The increase in interest expense is due to the Company
incurring bank debt of $47 million on November 27, 1996 for the purchase of
Pocono Downs.
Net income increased $514,000 or 10.3%, from $5.0 million in 1995 to $5.5
million in 1996 reflecting the factors described above. Income tax expense
increased from $3.5 million to $3.8 million due to the increase in income for
the year.
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 year ended December 31, 1997
($10.7 million) consisted of net income and non-cash expenses ($6.3 million),
the extraordinary loss relating to early extinquishment of debt ($2.5 million),
the repayment of the Charles Town Entertainment Complex receivable in January
1997 ($1.3 million) and other changes in certain assets and liabilities ($.6
million).
Cash flows used in investing activities for the year ended December 31, 1997
($47.6 million) consisted of the acquisition of the Charles Town Races ($18.2
million), construction in progress and renovation and refurbishment of the
Charles Town Races ($25.5 million), and $3.9 million in capital expenditures,
including approximately $700,000 for the completion of the Williamsport OTW
facility.
Net cash flows from financing activities totaled approximately $53.2 million
for the year ended December 31, 1997. Cash flows consisted principally of $23.1
million in proceeds from an equity offering in February 1997, $16.5 million in
proceeds from long-term debt used as payment for the acquisition of Charles Town
Races on January 15, 1997, $31.0 million in additional proceeds from long-term
debt used for renovations at the Charles Town Entertainment Complex and capital
improvements at other locations, and $80 million from the issuance on December
12, 1997, of 10.625% Senior Notes due 2004. The Company used the proceeds from
the equity offering to repay $19.0 million of its bank debt (including
borrowings from the acquisition of the Charles Town Races facility), with the
remaining amount used for the refurbishment of the Charles Town Entertainment
Complex. The Company used $59.0 million of the proceeds from the issuance of the
Senior Notes to repay the balance of its bank debt on December 12, 1997. The
Company also incurred $3.0 million of financing costs associated with the sale
of the Senior Notes.
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, which expenses
may not be reimbursed by the four municipalities which are parties to an
existing settlement agreement. The Company is unable to estimate the amount, if
any, that it may be required to expend.
During 1998 the Company anticipates capital expenditures of approximately $7.2
million to complete construction of four additional OTW facilities. 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 $1.4 million on the refurbishment of the Charles Town
Entertainment Complex (excluding the cost of Gaming Machines). If approval of
the Tennessee license is received, the Company anticipates expending $9.0
million to complete the first phase of the project.
The Company entered into a 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. The Company
would not have been in compliance with certain convents had the bank group not
granted waivers of certain technical defaults regarding minimum consolidated net
worth, consolidated cash interest ratio and minimum leverage ratio. 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 is secured by the assets of the Company and
certain of its subsidiaries and guaranteed by all subsidiaries, except the
Charles Town Joint Venture.
The net proceeds of the 1997 equity offering, together with cash generated from
operations, borrowings under the 10.625% Senior Notes and the revolving credit
facility, were sufficient to repay amounts outstanding under the Credit
Facility. The Company currently estimates that such proceeds will also 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, in addition to that available from the foregoing
sources. The Company may, from time to time, seek additional funding through
public or private financing, including equity financing. There can be no
assurance that adequate funding will be available as needed or, if available, on
terms acceptable to the Company.
21
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
december 31, 1996 1997
- -------------------------------------------------------------------
(in thousands, except share data)
Assets
Current assets
Cash and cash equivalents $ 5,634 $ 21,854
Accounts receivable 4,293 2,257
Prepaid expenses and
other current assets 1,552 1,441
Deferred income taxes 90 469
Prepaid income taxes -- 3,003
-------------------
Total current assets 11,569 29,024
-------------------
Property, plant and equipment, at cost
Land and improvements 15,728 24,643
Building and improvements 30,484 56,298
Furniture, fixtures and equipment 8,937 13,847
Transportation equipment 366 490
Leasehold improvements 6,680 6,778
Leased equipment under
capitalized lease 1,626 824
Construction in progress 2,926 11,288
-------------------
66,747 114,168
Less accumulated depreciation
and amortization 8,029 11,007
-------------------
Net property, plant and equipment 58,718 103,161
-------------------
Other assets
Excess of cost over fair market
value of net assets acquired
(net of accumulated amortization
of $811 and $1,389, respectively) 21,885 23,055
Prepaid acquisition costs 1,764 --
Deferred financing costs 2,416 3,014
Miscellaneous 371 624
-------------------
Total other assets 26,436 26,693
-------------------
$ 96,723 $158,878
-------------------
See accompanying summary of significant accounting policies and notes to
consolidated financial statements.
december 31, 1996 1997
- --------------------------------------------------------------------
(in thousands, except share data)
Liabilities and Shareholders' Equity
Current liabilities
Current maturities of long-term
debt and capital lease obligations $ 1,563 $ 204
Accounts payable 5,066 7,405
Purses due horsemen 1,421 --
Uncashed pari-mutuel tickets 1,336 1,504
Accrued expenses 1,373 2,753
Accrued salaries and wages 507 813
Customer deposits 420 470
Taxes, other than income taxes 392 649
------------------
Total current liabilities 12,078 13,798
------------------
Long-term liabilities
Long-term debt and capital lease
obligations, net of current
maturities 45,954 80,132
Deferred income taxes 10,810 11,092
------------------
Total long-term liabilities 56,764 91,224
------------------
Commitments and contingencies
Shareholders' equity
Preferred stock, $.01 par value,
authorized 1,000,000 shares;
issued none -- --
Common stock, $.01 par value,
authorized 20,000,000 shares;
issued and outstanding 13,355,290
and 15,152,580, respectively 134 152
Additional paid-in capital 14,299 37,969
Retained earnings 13,448 15,735
------------------
Total shareholders' equity 27,881 53,856
------------------
$ 96,723 $158,878
------------------
22
<PAGE>
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
year ended december 31, 1995 1996 1997
- -------------------------------------------------------------------------
(in thousands, except share data)
Revenues
Pari-mutuel revenues
Live races $ 21,376 $ 18,727 $ 27,653
Import simulcasting 27,254 32,992 59,810
Export simulcasting 2,142 3,347 5,279
Gaming revenue -- -- 5,712
Admissions, programs and
other racing revenues 3,704 4,379 5,678
Concession revenues 3,200 3,389 7,404
-----------------------------------
Total revenues 57,676 62,834 111,536
-----------------------------------
Operating expenses
Purses, stakes and trophies 12,091 12,874 22,335
Direct salaries, payroll taxes
and employee benefits 7,699 8,669 16,200
Simulcast expenses 9,084 9,215 12,982
Pari-mutuel taxes 4,963 5,356 9,506
Lottery taxes and administration -- -- 1,874
Other direct meeting expenses 7,576 8,536 18,087
Off-track wagering
concessions expenses 2,125 2,349 5,605
Other operating expenses 5,002 4,942 8,735
Depreciation and amortization 881 1,433 4,040
Site development and
restructuring charges -- -- 2,437
-----------------------------------
Total operating expenses 49,421 53,374 101,801
-----------------------------------
Income from operations 8,255 9,460 9,735
-----------------------------------
Other income (expenses)
Interest (expense) (71) (506) (4,591)
Interest income 269 350 935
Other 10 -- (2)
-----------------------------------
Total other income (expenses) 208 (156) (3,658)
-----------------------------------
See accompanying summary of significant accounting policies and notes to
consolidated financial statements.
year ended december 31, 1995 1996 1997
- ----------------------------------------------------------------
(in thousands, except share data)
Income before income taxes and
extraordinary item $ 8,463 $ 9,304 $ 6,077
Taxes on income 3,467 3,794 2,308
---------------------------
Income before extraordinary item 4,996 5,510 3,769
Extraordinary item
Loss on early extinguishment
of debt, net of income taxes
of $1,001 -- -- 1,482
---------------------------
Net income $ 4,996 $ 5,510 $ 2,287
---------------------------
Per share data
Basic
Income per share before
extraordinary item $ .39 $ .41 $ .25
Extraordinary item -- -- .10
---------------------------
Net income per share .39 .41 .15
---------------------------
Diluted
Income per share before
extraordinary item $ .38 $ .40 $ .24
Extraordinary item -- -- .09
---------------------------
Net income per share .38 .40 .15
---------------------------
Shares outstanding
Basic 12,906 13,302 14,925
Diluted 13,017 13,822 15,458
[Photo]
Horse on exercise walker at sunrise
23
<PAGE>
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
additional
common stock paid in retained
shares amount capital earnings total
- ----------------------------------------------------------------------------------------------------------------
(in thousands, except share data)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 12,900,000 $ 43 $ 12,642 $ 2,942 $ 15,627
Issuance of common stock 45,000 - 179 - 179
Net income for the year - - - 4,996 4,996
--------------------------------------------------------------
Balance, December 31, 1995 12,945,000 43 12,821 7,938 20,802
Issuance of common stock 410,290 4 1,565 - 1,569
Stock splits - 87 (87) - -
Net income for the year - - - 5,510 5,510
--------------------------------------------------------------
Balance, December 31, 1996 13,355,290 134 14,299 13,448 27,881
Issuance of common stock 1,725,000 17 22,914 - 22,931
Exercise of stock options and warrants 72,290 1 154 - 155
Tax benefit related to stock options exercised - - 602 - 602
Net income for the year - - - 2,287 2,287
--------------------------------------------------------------
Balance, December 31, 1997 15,152,580 $ 152 $ 37,969 $ 15,735 $ 53,856
--------------------------------------------------------------
</TABLE>
See accompanying summary of significant accounting policies and notes to
consolidated financial statements.
[Photo]
Inside the stables
[Photo]
Patron at Charles Town Entertainment Complex
24
<PAGE>
[Photo]
Jockey on a horse, training.
PENN NATIONAL GAMING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
year ended december 31, 1995 1996 1997
- ------------------------------------------------------------------------------------------------------------
(in thousands, except share data)
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 4,996 $ 5,510 $ 2,287
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization 881 1,433 4,040
Extraordinary loss relating to early extinguishment of debt,
before income tax benefit - - 2,483
Deferred income taxes (benefit) 20 228 (97)
Decrease (increase) in
Accounts receivable (362) (1,870) 2,036
Prepaid expenses and other current assets (158) 871 111
Prepaid income taxes - - (3,003)
Miscellaneous other assets 5 (255) (258)
Increase (decrease) in
Accounts payable (15) 1,288 2,339
Purses due horsemen 297 (248) (1,421)
Uncashed pari-mutuel tickets 184 632 168
Accrued expenses (504) 827 1,380
Accrued salaries and wages 128 265 306
Customer deposits 16 105 50
Taxes other than income taxes 239 146 257
Income taxes 190 (985) -
--------------------------------------
Net cash provided by operating activities 5,917 7,947 10,678
--------------------------------------
Cash flows from investing activities
Expenditures for property, plant and equipment (3,958) (6,995) (29,196)
Acquisition of business, net of cash acquired - (47,320) (18,248)
(Increase) in prepaid acquisition costs - (1,514) (176)
--------------------------------------
Net cash (used in) investing activities (3,958) (55,829) (47,620)
--------------------------------------
Cash flows from financing activities
Proceeds from sale of common stock $ 179 $ 1,569 $ 23,086
Tax benefit related to stock options exercised - - 602
Proceeds from long-term debt - 47,000 111,167
Principal payments on long-term debt and capital lease obligations (126) (123) (78,348)
Increase in unamortized financing cost - (2,444) (3,345)
--------------------------------------
Net cash provided by financing activities 53 46,002 53,162
--------------------------------------
Net increase (decrease) in cash and cash equivalents 2,012 (1,880) 16,220
Cash and cash equivalents, beginning of period 5,502 7,514 5,634
--------------------------------------
Cash and cash equivalents, end of period $ 7,514 $ 5,634 $ 21,854
--------------------------------------
</TABLE>
See accompanying summary of significant accounting policies and notes to
consolidated financial statements.
25
<PAGE>
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Penn National
Gaming, Inc. and its subsidiaries (collectively the "Company"). All significant
intercompany accounts and transactions have been eliminated in consolidation.
Certain prior years' amounts have been reclassified to conform to the 1997
presentation.
DESCRIPTION OF BUSINESS
The Company, which began operations in 1972, provides pari-mutuel wagering
opportunities on both live and simulcast thoroughbred and harness horse races at
two racetracks and seven off-track wagering facilities ("OTWs") located in
Pennsylvania and pari-mutuel wagering opportunities and video gaming machines at
Charles Town Races, the Company's Charles Town, West Virginia thoroughbred race
track. Prior to the consummation of the acquisitions of Pocono Downs and Charles
Town Races (see Note 2), the Company owned and operated Penn National Race
Course located near Harrisburg, Pennsylvania ("Penn National Race Course"), and
operated four OTWs, one each in Chambersburg, Lancaster, Reading and York,
Pennsylvania. On November 27, 1996, the Company consummated the acquisition of
Pocono Downs (the "Pocono Downs Acquisition") and as a result acquired Pocono
Downs Racetrack, located outside Wilkes-Barre, Pennsylvania ("Pocono Downs"),
and OTWs in Allentown and Erie, Pennsylvania. In February 1997, the Company
opened its seventh OTW in Williamsport, Pennsylvania.
On January 15, 1997, a joint venture, in which the Company holds an 89%
interest, acquired substantially all of the assets relating to Charles Town
Races, a thoroughbred racing facility in Jefferson County, West Virginia (the
"Charles Town Acquisition"). The Company refurbished and reopened the Charles
Town facility as an entertainment complex featuring live racing, dining,
simulcast wagering and, effective September 1997, Gaming Machines.
At each of its three racetracks, the Company conducts pari-mutuel wagering on
thoroughbred and harness races from the Company's racetracks and simulcasts from
other racetracks. The Company also simulcasts its Penn National Race Course and
Pocono Downs races for wagering at other racetracks and OTWs, including all
Pennsylvania racetracks and OTWs and locations outside Pennsylvania. Wagering on
Penn National Race Course and Pocono Downs races and races simulcast from other
racetracks also occurs through the Company's Pennsylvania racetracks' telephone
account betting network.
GLOSSARY OF TERMINOLOGY
The following is a listing of terminology used throughout the financial
statements:
the company's racetracks - Penn National Race Course near
Harrisburg, Pennsylvania, Pocono Downs near Wilkes-Barre,
Pennsylvania and Charles Town Races in Charles Town,
West Virginia.
gaming machines - Video lottery terminal gaming machines.
otw - Off-track wagering location.
pari-mutuel wagering - All wagering at the Company's racetracks, at
the Company's OTWs and all wagering on the Company's races
at other racetracks and OTWs.
telebet - Telephone account wagering.
totalisator services - Computer services provided to the Company by various
totalisator companies for processing pari-mutuel betting odds and wagering
proceeds.
pari-mutuel revenues:
live races - The Company's share of pari-mutuel wagering on live races within
Pennsylvania and West Virginia and certain stakes races from racetracks
outside of Pennsylvania and West Virginia after payment of the amount
returned as winning wagers.
import simulcasting - The Company's share of wagering at the Company's
racetracks, at the Company's OTWs and by Telebet on full cards of races
simulcast from other racetracks.
export simulcating - The Company's share of wagering at out-of-state locations
on live races.
A summary of pari-mutuel wagering for the periods indicated is as follows:
December 31, 1995 1996 1997
- --------------------------------------------------------------
Pari-mutuel wagering on the
Company's live races $ 102,145 $ 89,327 $ 128,090
Pari-mutuel wagering on
simulcasting
Import simulcasting from
other racetracks 142,499 170,814 298,459
Export simulcasting to
out of Pennsylvania
wagering facilities 72,252 112,871 176,287
-------------------------------
Total pari-mutuel wagering $ 316,896 $ 373,012 $ 602,836
-------------------------------
RACING MEET
The Penn National Race Course racing seasons for the years ended December 31,
1995, 1996 and 1997 totaled 204, 206 and 212 live race days, respectively. For
the year ended December 31, 1997, the Pocono Downs and Charles Town Races racing
seasons totaled 134 and 159 live race days, respectively.
DEPRECIATION AND AMORTIZATION
Depreciation of property, plant and equipment and amortization of leasehold
improvements are computed by the straight-line method at rates adequate to
allocate the cost of applicable assets over their estimated useful lives.
Depreciation and amortization for the years ended December 31, 1995, 1996 and
1997 amounted to $814,000, $1,301,000 and $3,193,000, respectively.
26
<PAGE>
The excess of cost over fair value of net assets acquired is being amortized on
the straight-line method over a forty-year period. Amortization expense for
1995, 1996 and 1997 amounted to $67,000, $98,000 and $578,000, respectively. The
Company evaluates the recoverability of the goodwill quarterly, or more
frequently whenever events and circumstances warrant revised estimates and
considers whether the goodwill should be completely or partially written off or
the amortization period accelerated.
Deferred financing costs are charged to operations over the life of the
underlying indebtedness. Amortization of deferred financing costs for 1995, 1996
and 1997 amounted to $-0-, $34,000 and $269,000, respectively.
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 121 ("SFAS 121") "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" during the year ended
December 31, 1995. SFAS 121 establishes accounting standards for the impairment
of long-lived assets, certain identifiable intangibles and goodwill related to
those assets to be held and used and for long-lived assets and certain
identifiable intangibles to be disposed of. The Company reviews the carrying
values of its long-lived and identifiable intangible assets for possible
impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable based on undiscounted
estimated future operating cash flows. As of December 31, 1997, the Company has
determined that no impairment has occurred.
INCOME TAXES
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 requires
a company to recognize deferred tax liabilities and assets for the expected
future tax consequences of events that have been recognized in a company's
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the difference between the financial
statement carrying amounts and tax bases of assets and liabilities using enacted
tax rates in effect in the years in which the differences are expected to
reverse.
CASH AND CASH EQUIVALENTS
The Company considers all cash balances and highly liquid investments with
original maturities of three months or less to be cash equivalents.
NET INCOME PER COMMON SHARE
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128 ("SFAS 128") "Earnings Per Share" in 1997. SFAS 128 provides
for the calculation of "basic" and "diluted" net income per share. Basic net
income per share includes no dilution and is calculated by dividing net income
by the weighted average number of common shares outstanding for the period.
Dilutive net income per share reflects the potential dilution of securities that
could share in the net income of the Company which consist of stock options and
warrants (using the treasury stock method). deferred financing costs
DEFERRED FINANCING COSTS
Deferred financing costs, which are incurred by the Company in connection with
debt, are charged to operations over the life of the underlying indebtedness
using the interest method adjusted to give effect to any early repayments.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to credit risk
consist of cash equivalents and accounts receivable.
The Company's policy is to limit the amount of credit exposure to any one
financial institution and place investments with financial institutions
evaluated as being creditworthy, or in short-term (less than seven days) money
market and tax free bond funds which are exposed to minimal interest rate and
credit risk. At December 31, 1997, the Company had bank deposits which exceeded
federally insured limits by approximately $960,000 and money market and tax free
bond funds of approximately $18,939,000. Concentration of credit risk, with
respect to accounts receivable, is limited due to the Company's credit
evaluation process. The Company does not require collateral from its customers.
The Company's receivables consist principally of amounts due from other
racetracks and OTWs. Historically, the Company has not incurred any significant
credit related losses.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions are used to estimate the fair value of
each class of financial instruments for which it is practical to estimate.
Cash and Cash Equivalents: The carrying amount approximates the fair value due
to the short maturity of the cash equivalents.
Long-Term Debt and Capital Lease Obligations: The fair value of the Company's
long-term debt and capital lease obligations is estimated based on the quoted
market prices for the same or similar issues or on the current rates offered to
the Company for debt of the same remaining maturities. The carrying amount
approximates fair value since the Company's interest rates approximate current
interest rates.
PREPAID ACQUISITION COSTS
Prepaid acquisition costs, which were incurred by the Company substantially in
connection with the Charles Town Acquisition (see Note 2), are included in the
purchase price of the Charles Town Acquisition and allocated to the appropriate
assets.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles 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 at the reporting period. Actual
results could differ from those estimates.
27
<PAGE>
ACQUISITIONS
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 129, "Disclosure of Information
about Capital Structure" ("SFAS 129"), effective for periods ending after
December 15, 1997, establishes standards for disclosing information about an
entity's capital structure. SFAS 129 requires disclosure of the pertinent rights
and privileges of various securities outstanding (stock, options, warrants,
preferred stock, debt and participation rights) including dividend and
liquidation preferences, participant rights, call prices and dates, conversion
or exercise prices and redemption requirements. Adoption of SFAS 129 will have
no effect on the Company because it currently discloses the information
specified.
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"), establishes standards for reporting and display of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other disclosures, SFAS
130 requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements.
Statement of Financial Accounting Standards No. 131, "Disclosure about Segments
of a Business Enterprise" ("SFAS 131"), establishes standards for the way that
public enterprises report information about operating segments in annual
financial statements and requires reporting of selected information about
operating segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS 131 defines operating segments as
components of an enterprise about which separate financial information is
available and that is evaluated regularly by the chief operating decision maker
in deciding how to allocate resources and in assessing performance.
Statement of Financial Accounting Standards No.132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits" ("SFAS 132"), revises
employers' disclosures about pension and other postretirement benefit plans. It
does not change the measurement or recognition of those plans. It standardizes
the disclosure requirements for pensions and other postretirement benefits to
the extent practicable, requires additional information on changes in the
benefit obligations and fair values of plan assets that will facilitate
financial analysis and eliminates certain existing disclosure requirements.
SFAS 130, SFAS 131 and SFAS 132 are effective for financial statements for
periods beginning after December 15, 1997 and require comparative information
for earlier years to be restated. Due to the recent issuance of these standards,
management has been unable to fully evaluate the impact, if any, they may have
on future financial statement disclosures.
POCONO DOWNS ACQUISITION
On November 27, 1996, the Company purchased all of the capital stock of The
Plains Company and the limited partnership interests in The Plains Company's
affiliated entities (together, "Pocono Downs") for an aggregate purchase price
of $48.2 million plus acquisition-related fees and expenses of $730,000. Pocono
Downs conducts live harness racing at the harness racetrack located outside
Wilkes-Barre, Pennsylvania, export simulcasting of Pocono Downs races to
locations throughout the United States, pari-mutuel wagering at Pocono Downs and
at OTWs in Allentown and Erie, Pennsylvania on Pocono Downs races and on import
simulcast races from other racetracks, and telephone account wagering on live
and import simulcast races.
The Pocono Downs Acquisition was accounted for using the purchase method of
accounting. Accordingly, a portion of the purchase price was allocated to the
net assets acquired based on their estimated fair values. In accordance with
SFAS 109, the Company recorded an additional increase to goodwill of
approximately $9.7 million and a corresponding increase to a deferred tax
liability, representing the difference between the financial and tax bases of
certain assets acquired.
The results of operations of Pocono Downs have been included in the Company's
consolidated financial statements since the effective date of the acquisition.
The balance of the purchase price was recorded at cost over net assets acquired
as goodwill, approximately $10.4 million, and is being amortized over forty
years on a straight-line basis. The Company used its Credit Facility (see Note
3) and cash of Pocono Downs to fund the acquisition.
In addition, pursuant to the terms of the purchase agreement, the Company will
be required to pay the sellers of Pocono Downs an additional $10 million if,
within five years after the consummation of the Pocono Downs Acquisition,
Pennsylvania authorizes any additional form of gaming in which the Company may
participate. The $10 million payment would be payable in annual installments of
$2 million for five years, beginning on the date that the Company first offers
such additional form of gaming.
CHARLES TOWN ACQUISITION
On February 26, 1996, the Company entered into a joint venture agreement (the
"Charles Town Joint Venture") with Bryant Development Company and its affiliates
("Bryant"), the holder of an option to purchase substantially all of the assets
of Charles Town Racing Limited Partnership and Charles Town Races, Inc.
(together, "Charles Town") relating to the Charles Town Race Track and
Shenandoah Downs (together, the "Charles Town Entertainment Complex") in
Jefferson County, West Virginia. In connection with the Charles Town Joint
Venture agreement, Bryant assigned the option to the Charles Town Joint Venture.
In November 1996, the Charles Town Joint Venture and Charles Town
28
<PAGE>
[Photo]
Picture "Game King" video gaming machine.
entered into an amended and restated option agreement. On November 5, 1996,
Jefferson County, West Virginia approved a referendum permitting installation of
gaming machines at the Charles Town Entertainment Complex. On January 15, 1997,
the Charles Town Joint Venture acquired substantially all of the assets of
Charles Town for approximately $16.0 million plus acquisition-related fees and
expenses of approximately $2.2 million.
Pursuant to the original operating agreement governing the Charles Town Joint
Venture, the Company held an 80% ownership interest in the Charles Town Joint
Venture and was obligated to contribute 80% of the purchase price of the Charles
Town Acquisition and 80% of the cost of refurbishing and Charles Town
Entertainment Complex. In consideration of the fact that the Company contributed
100% of the purchase price of the Charles Town Acquisition and 100% of the cost
of refurbishing the Charles Town Entertainment Complex, the Company amended its
operating agreement with Bryant to, among other things, increase the Company's
ownership interest in the Charles Town Joint Venture to 89% and decrease
Bryant's interest to 11%. In addition, the amendment provided that the entire
amount the Company has contributed to the Charles Town Joint Venture for the
acquisition and refurbishment of the Charles Town Entertainment Complex would be
treated, as between the parties, as a loan to the Charles Town Joint Venture
from the Company. Accordingly, prior to the distribution of any profits pursuant
to the Charles Town Joint Venture, the Company must be repaid in full all such
contributions or loans, plus accrued interest, which as of December 31, 1997,
amounted to $45.9 million.
Bryant had acquired its option from Showboat Operating Company ("Showboat").
Showboat has retained an option (the "Showboat Option") to operate any casino at
the Charles Town Entertainment Complex in return for a management fee (to be
negotiated at the time, based on rates payable for similar properties) and a
right of first refusal to purchase or lease the site of any casino at the
Charles Town Entertainment Complex proposed to be leased or sold and to purchase
any interest proposed to be sold in any such casino on the same terms offered by
a third party or otherwise negotiated with the Charles Town Joint Venture. The
rights retained by Showboat under the Showboat Option extend for a period of
five years from November 6, 1996, the date that the Charles Town Joint Venture
exercised its option to purchase the Charles Town Races, and expires thereafter
unless legislation to permit casino gaming at the Charles Town Entertainment
Complex has been adopted prior to the end of the five-year period. If such
legislation has been adopted prior to such time, then the rights of Showboat
continue for a reasonable time (not less than 24 months) to permit completion of
negotiations.
While the express terms of the Showboat Option do not specify which activities
at the Charles Town Entertainment Complex would constitute operation of a
casino, Showboat has agreed that the installation and operation of gaming
devices linked to the lottery (like the Gaming Machines the Company has
installed and will continue to install) at the Charles Town Entertainment
Complex's racetrack would not trigger Showboat's right to exercise the Showboat
Option. The Company would be required to pay a management fee to Showboat for
the operation of the casino.
The Charles Town Joint Venture refurbished and reopened the Charles Town
Entertainment Complex as an entertainment complex that features live racing,
dining, simulcast wagering and, effective September 1997, the operation of
gaming machines. The cost of the refurbishment was approximately $27.0 million
inclusive of $614,000 of capitalized interest and exclusive of the costs of
leasing gaming machines through December 31, 1997. Construction in progress at
December 31, 1997 primarily consists of approximately $9.5 million related to
the Charles Town Entertainment Complex refurbishments. The estimated cost to
complete these refurbishments as of December 31, 1997 is approximately $475,000.
Effective June 4, 1996, the Charles Town Joint Venture entered into a Loan and
Security Agreement with Charles Town. The Loan and Security Agreement provided
for a working capital line of credit in the amount of $1,250,000 and a requisite
reduction of the purchase price under the option, by $1.60 for each dollar
borrowed under that line. Upon consummation of the Charles Town Acquisition,
Charles Town Races, Inc. repaid the loan. The parties agreed that $936,000 of
the amount borrowed was eligible for the $1.60 purchase price reduction and are
negotiating the applicability of the purchase price reduction to the remaining
$219,000 that was borrowed.
The Charles Town Acquisition was accounted for using the purchase method of
accounting. Accordingly, a portion of the purchase price was allocated to the
net assets acquired based on their estimated fair values. The balance of the
purchase price was recorded as cost over net assets acquired as goodwill,
approximately $1.7 million, and is being amortized over forty years on a
straight-line basis. The Company used its credit facility (see Note 3) and cash
from operations to fund the acquisition.
The 1997 results of operations of Charles Town have been included in the
Company's consolidated financial statements since January 15, 1997, the
effective date of the acquisition. The 1997 results of Charles Town closely
represent a full year of operations and the 1996 results of Charles Town are
immaterial to the financial statements taken as a whole, therefore, no pro forma
financial information is presented.
[Photo]
Picture of Select-A-Game video gaming machine.
29
<PAGE>
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
<TABLE>
<CAPTION>
Long-term debt and capital lease obligations are as follows:
december 31, 1996 1997
- --------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Long-term debt
Senior Notes - $80 million face amount, due December 15, 2004 with interest
payable at 10.625% per annum to noteholders semi-annually on June 15 and
December 15, commencing June 15, 1998. The notes are unsecured and are
unconditionally guaranteed by certain subsidiaries of the Company $ -- $80,000
Term loans payable to a bank group in quarterly installments (see additional
information below under Credit Facilities). These term loans were paid in
December 1997 from the proceeds of the Debt Offering 47,000 --
Other notes payable 380 279
Capital lease obligations 137 57
-----------------
47,517 80,336
Less current maturities 1,563 204
-----------------
$45,954 $80,132
-----------------
</TABLE>
CREDIT FACILITIES
At December 31, 1996 and 1997, the Company was contingently obligated under
letters of credit with face amounts aggregating $1,436,000 and $1,634,000,
respectively. These amounts consisted of $1,336,000 and $1,534,000,
respectively, relating to the horsemens' account balances and $100,000 for
Pennsylvania pari-mutuel taxes in each period.
In November 1996, the Company entered into an agreement with a bank group which
provides an aggregate of $75 million of credit facilities, which included a $5
million revolving credit facility ("1996 Credit Facility"). Simultaneously with
the closing of the 1996 Credit Facility, the Company repaid amounts outstanding
under its old credit facility and replaced it. The 1996 Credit Facility
consisted of two term loan facilities of $47 million and $23 million (together,
the "Term Loans") which were used for the Pocono Downs and Charles Town
acquisitions, respectively, and which were used for a portion of the cost of
refurbishment of the Charles Town Entertainment Complex, and a revolving credit
facility of $5 million (together, the "Loans"). The Term Loans were repaid in
December 1997 with the proceeds of the Company's debt offering. See "Debt
Offering" hereinafter. At such time, the 1996 Credit Facility was amended and
restated to provide for a $12 million revolving credit facility, including a $3
million sublimit for standby letters of credit, which matures in December 2002.
The revolving credit facility is secured by substantially all of the assets of
the Company. The revolving credit facility provides for certain covenants,
including those of a financial nature. The Company would not have been in
compliance with certain covenants had the bank group not granted waiver of
certain technical defaults regarding minimum consolidated net worth,
consolidated cash interest coverage ratio and minimum leverage ratio. However,
at December 31, 1997, the Company had not drawn any portion of the revolving
credit facility (although a $1.6 million letter of credit was issued against
such revolving credit facility) and had adequate capital resources even without
consideration of its revolving credit facility.
At the Company's option, the revolving facility may bear interest at the highest
of: (1) 1/2 of 1% in excess of the federal reserve reported certificate of
deposit rate, (2) the rate that the bank group announces from time to time as
its prime lending rate and (3) 1/2 of 1% in excess of the federal funds rate
plus an applicable margin of up to 2% or the revolving facility may also bear
interest at a rate tied to a eurodollar rate plus an applicable margin of up to
3%.
Mandatory repayments of the revolving facility are required in an amount equal
to a percentage of the net cash proceeds from any issuance or incurrence of
equity or funded debt by the Company, that percentage to be dependent upon the
then outstanding balance of the revolving facility and the Company's leverage
ratio; however, the existing credit facility, as amended, permitted the Company
to retain up to the first $19 million of proceeds from an offering of the
Company's equity securities. Mandatory repayments of varying percentages are
also required in the event of either asset sales in excess of stipulated amounts
or defined excess cash flow.
DEBT OFFERING
On December 12, 1997, the Company and certain of its subsidiaries (as
guarantors) entered into a purchase agreement for the sale and issuance of
$80,000,000 aggregate principal amount of its 10.625% Senior Notes due 2004 (the
"Offering"). The net proceeds of the Offering were used for repayment of
existing indebtedness, for capital expenditures and for general corporate
purposes. Interest on the notes will accrue from their date of original issuance
(the "Issue Date") and will be payable semi-annually, commencing in 1998. The
notes will be redeemable, in whole or in part, at the option of the Company in
2001 or thereafter at the redemption prices set forth in the Offering, plus
accrued and unpaid interest to the date of redemption.
The notes are general unsecured senior obligations of the Company and rank
equally in right of payment to any existing and future unsubordinated
indebtedness of the Company and senior in right of payment with all existing and
future subordinated indebtedness of the Company. The notes are unconditionally
guaranteed (the "Guarantees") on a senior basis by certain of the Company's
existing subsidiaries (the "Subsidiary Guarantors"). The Guarantees are general
unsecured obligations of the
30
<PAGE>
Subsidiary Guarantors and rank equally in right of payment to any unsubordinated
indebtedness of the Subsidiary Guarantors and rank senior in right of payment to
all other subordinated obligations of the Subsidiary Guarantors. The notes are
effectively subordinated in right of payment to all secured indebtedness of the
Company, including indebtedness incurred under the amended $12 million revolving
credit facility.
The following is a schedule of future minimum lease payments under capitalized
leases and repayments of long-term debt as of December 31, 1997:
term loans
and
capitalized notes
december 31, leases payable total
- ---------------------------------------------------------------
(in thousands)
1998 $ 51 $ 157 $ 208
1999 10 32 42
2000 - 35 35
2001 - 38 38
2002 - 17 17
Thereafter - 80,000 80,000
--------------------------
Total minimum payments 61 80,279 80,340
Less interest discount amount 4 - 4
--------------------------
Total present value of net
minimum lease payments
and total notes payable 57 80,279 80,336
Current maturities 47 157 204
--------------------------
Total noncurrent maturities $ 10 $ 80,122 $ 80,132
--------------------------
On February 18, 1997, the Company completed a secondary public offering of
1,725,000 shares of common stock and used $19 million of the $23 million
proceeds therefrom to reduce the then outstanding Term Loan amounts (see Note
8).
CUSTOMER DEPOSITS
Customer deposits represent amounts held by the Company for telephone wagering.
COMMITMENTS AND
CONTINGENCIES
In November 1997, the Company signed a new Totalisator services and equipment
agreement for all of its subsidiaries. The agreement is for five years, expiring
on March 31, 2003. The new agreement provides for annual payments based on a
specified percentage of the total amount wagered at the Company's facilities
with a minimum annual payment of $1,475,000.
The Company is also liable under numerous operating leases for automobiles,
other equipment and buildings, which expire through 2004. Total rental expense
under these agreements were $672,000, $1,001,000 and $807,000 for the years
ended December 31, 1995, 1996 and 1997, respectively.
The future lease commitments relating to noncancelable operating leases as of
December 31, 1997 are as follows:
(In thousands)
- ------------------------------------------------------
1998 $ 1,035
1999 1,084
2000 1,099
2001 1,067
2002 1,070
Thereafter 1,696
- -----------------------------------------------------
$ 7,051
- -----------------------------------------------------
On April 12, 1994, the Company entered into employment agreements with its
Chairman and Chief Financial Officer at annual base salaries of $225,000 and
$95,000, respectively. The agreements became effective June 1, 1994 and, as
amended, terminate on June 30, 1999. Each agreement prohibits the employee from
competing with the Company during its term and for one year thereafter, and
requires a death benefit payment by the Company equal to 50% of the employee's
annual salary in effect at the time of death.
In August 1994, the Company signed a consulting agreement with its former
Chairman expiring in August 1999 at an annual payment of $125,000.
On June 1, 1995, the Company entered into an employment agreement with its
President and Chief Operating Officer at an annual base salary of $210,000. The
agreement terminates on June 12, 1998. The agreement prohibits the employee from
competing with the Company during its term and for two years thereafter, and
requires a death benefit payment by the Company equal to 50% of the employee's
annual salary in effect at the time of his death.
[Photo]
Horse looking out over his stall door.
31
<PAGE>
[Photo]
Jockey leading horse.
Under an agreement between the Company and its former president, the former
president received options to purchase 150,000 shares of common stock at the
fair value as of the date of grant of $3.33 per share expiring May 31, 2000.
The Company has two profit sharing plans under the provisions of Section 401(k)
of the Internal Revenue Code; The Penn National Gaming, Inc. Profit Sharing Plan
(the "Penn National 401(k) Plan") and the Pocono Downs Inc. Profit Sharing Plan
(the "Pocono Downs 401(k) Plan") cover all eligible employees who are not
members of a bargaining unit. Both Plans enable employees choosing to
participate to defer a portion of their salary in a retirement fund to be
administered by the Company. The Company's contributions to the Penn National
401(k) Plan are set at 50% of employees' elective salary deferrals which may be
made up to a maximum of 6% of employee compensation. The Company has no
obligation to contribute to the Pocono Downs 401(k) Plan. However, for the years
ended December 31, 1995, 1996 and 1997 the Company has made discretionary
contributions to the Pocono Downs 401(k) Plan based upon a percentage of the
employee elective deferrals which may be made up to a maximum of 15% of employee
compensation. The Company made contributions to these plans of approximately
$70,000, $89,000 and $145,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
Charles Town has a defined contribution plan covering substantially all of its
employees. Charles Town makes monthly contributions equal to the amount accrued
for retirement expense, which is calculated as .25% of the daily mutual handle
and .5% of the net video lottery revenues. Total contributions for the year
ended December 31, 1997 was $114,000.
In June 1997, the Charles Town Joint Venture, which is operated as PNGI Charles
Town Gaming, LLC, an 89% subsidiary of the Company entered into an agreement
(the "GTECH Agreement") with GTECH relating to the lease, installation and
service of a video lottery system ("VLS") at the Charles Town Entertainment
Complex. The GTECH Agreement provides that GTECH will be the exclusive provider
of VLS and related services, including video lottery terminals and slot
machines, if any, at the Charles Town Entertainment Complex; provided, however,
the Charles Town Joint Venture has retained management control over the VLS. The
GTECH Agreement has a term of five years from the first date on which 400 Gaming
Machines are installed, operational and generating net win (total of all cash
inserted into, or game credits played on, a video lottery terminal minus the
total value of all prizes paid). Pursuant to the GTECH Agreement, the Charles
Town Joint Venture has agreed to pay GTECH a fee which can range between 4% and
10% of Gaming Machine gross revenue. The Company generally is obligated to pay a
lower percentage of Gaming Machine gross revenue to GTECH at higher levels of
average win per day per machine and a higher percentage of Gaming Machine gross
revenue at lower levels of average win per day per machine; provided, however,
the Charles Town Joint Venture is obligated to pay GTECH the greater of the
percentage fee described above or a minimum annual fee of $4.3 million if more
than 800 Gaming Machines are in operation at the Charles Town Entertainment
Complex. The payments pursuant to the GTECH Agreement include the cost of the
rental of the Gaming Machines, the rental of the software (which is not a
component of the VLS, as defined), technical assistance and programming
services, maintenance and marketing services. At the end of the term of the
GTECH Agreement, the Charles Town Joint Venture will purchase the VLS from GTECH
for a cash purchase price equal to the net unamortized residual value of the
VLS. In the event GTECH terminates the agreement because of the Charles Town
Joint Venture's material misrepresentation and/or breach of the GTECH Agreement,
the Charles Town Joint Venture must purchase the VLS from GTECH at a price equal
to the net unamortized residual value of the VLS at that time and pay an
additional one-time fee as follows: for such termination in the first year of
the term, $8.5 million, for such termination in the second year of the term,
$6.6 million; for such termination in the third year of the term, $5.0 million;
for such termination in the fourth year of the term, $3.7 million; and for such
termination in the fifth year of the term, $2.5 million. Pursuant to the GTECH
Agreement, the Charles Town Joint Venture must maintain tangible net worth equal
to at least 105% of the amounts payable as additional fees in the event of a
termination as set forth in the preceding sentence.
On March 26, 1997, the Company entered into an agreement to purchase property
for its Carbondale, Pennsylvania OTW facility. The agreement provides for a
purchase price of $200,000 and is subject to numerous contingencies, including
approval by the Pennsylvania State Harness Racing Commission (the "Harness
Racing Commission"). On June 5, 1997, the Company's application was approved by
the Harness Racing Commission. In October 1997, the Company entered into a
construction contract regarding the Carbondale OTW facility. Commitments under
this contract at December 31, 1997 were approximately $1.2 million. The Company
expects to have the facility constructed and operational in the first quarter of
1998.
On June 20, 1997, the Company acquired options to purchase approximately 100
acres of land in Memphis, Tennessee for an aggregate purchase price of $2.7
million. The Company paid $11,000 to acquire the options and has the right to
extend the options from month to month until June 20, 1998 upon the payment of
$11,000 per month. The Company has filed an application to the Tennessee State
Racing Commission for the proposed development of a harness racetrack and
off-track wagering facility at the site on October 9, 1997. The Company
anticipates to hear the results of the Commission's review of the application
during the second quarter of 1998.
On July 9, 1997, the Company entered into a lease agreement for its Hazleton,
Pennsylvania OTW facility. The initial term of the lease is for ten years with
two additional five-year renewal options available. This lease provides for
minimum annual lease payments of $98,400 in years one through five and
32
<PAGE>
$108,240 in years six through ten. The agreement is subject to numerous
contingencies, including approval by the Harness Racing Commission. On September
26, 1997, the Company's application was approved by the Harness Racing
Commission. In November 1997, the Company entered into a construction contract
regarding the Hazleton OTW facility. Commitments under this contract at December
31, 1997 were approximately $1.2 million. The Company expects to have the
facility constructed and operational in the first quarter of 1998.
On September 9, 1997, the Company entered into a lease agreement for its
Stroudsburg, Pennsylvania OTW facility. The initial term of the lease is for ten
years with two additional five-year renewal options available. This lease
provides for minimum annual lease payments of $101,640 during its initial term.
The table above does not reflect this lease commitment. The agreement is subject
to numerous contingencies, including approval by the Harness Racing Commission.
On November 6, 1997, the Company's application was approved by the Harness
Racing Commission. The Company is awaiting land development plan approvals and
has no definitive date of opening at this time.
On September 26, 1997, the Company entered into a lease agreement for its
proposed Altoona, Pennsylvania OTW facility. The initial term of the lease is
for ten years with two additional five-year renewal options available. This
lease provides for minimum annual lease payments of $92,400 during its initial
term. The table presented above does not reflect this lease commitment. The
agreement is subjected to numerous contingencies, including approval by the
Pennsylvania State Horse Racing Commission. On January 15, 1998, the Company's
application was approved by the Pennsylvania State Horse Racing Commission. The
Company expects to have the facility renovated and operational in the third
quarter of 1998.
The Company is subject to possible liabilities arising from environmental
conditions at the landfill adjacent to Pocono Downs racetrack. Specifically, the
Company may incur expenses in connection with the landfill in the future, which
expenses may not be reimbursed by the four municipalities which are parties to
an existing settlement agreement. The Company is unable to estimate the amount,
if any, that it may be required to expend. income taxes
INCOME TAXES
The provision for income taxes
charged to operations was
as follows:
year ended december 31, 1995 1996 1997
- --------------------------------------------------------------
Current tax expense
Federal $ 2,605 $ 2,686 $ 2,006
State 842 880 399
-----------------------------
Total current 3,447 3,566 2,405
-----------------------------
Deferred tax expense (benefit)
Federal 15 178 (56)
State 5 50 (41)
-----------------------------
Total deferred 20 228 (97)
-----------------------------
Total provision $ 3,467 $ 3,794 $ 2,308
-----------------------------
Deferred tax assets and
liabilities are comprised of the
following:
december 31, 1996 1997
- --------------------------------------------------------------
Deferred tax assets
Reserve for debit balances of
horsemens' accounts, bad
debts restructuring charges
and litigation $ 90 $ 469
-----------------------------
Deferred tax liabilities
Property, plant and equipment $ 10,810 $ 11,092
-----------------------------
The following is a reconciliation
of the statutory federal income
tax rate to the actual effective
income tax rate for the
following periods:
year ended december 31, 1995 1996 1997
- -----------------------------------------------------------------
Percent of pretax income
Federal tax rate 34.0% 34.0% 34.0%
Increase in taxes resulting from
state and local income taxes,
net of federal tax benefit 6.7 6.6 3.9
Permanent difference relating to
amortization of goodwill .3 .2 .9
Other miscellaneous items - - (.8)
--------------------------
41.0% 40.8% 38.0%
--------------------------
33
<PAGE>
SUPPLEMENTAL DISCLOSURES
OF CASH FLOW INFORMATION
Cash paid during the year for interest was $71,000, $506,000 and $4,346,000 in
1995, 1996 and 1997, respectively.
Cash paid during the year for income taxes was $2,839,000, $2,490,000 and
$3,649,000 in 1995, 1996 and 1997, respectively.
Noncash investing and financing activities were as follows:
During 1996, the Company purchased Pocono Downs for an aggregate purchase price
of $47,320,000, net of cash acquired. In conjunction with the acquisition,
liabilities were assumed as follows:
Fair value of assets acquired $ 53,150,000
Cash paid for the capital stock and the limited
partnership interests 47,320,000
------------
Liabilities assumed $ 5,830,000
------------
During 1996, the Company issued a $250,000 long-term note payable for the
incurrence of prepaid Charles Town Acquisition costs.
COMMON STOCK
On February 18, 1997, the Company completed a secondary public offering of
1,725,000 shares of its common stock. The net proceeds of $23 million were used
to reduce $19 million of the Term Loan amounts outstanding under the Existing
Credit Facility with the balance of the proceeds used to finance a portion of
the cost of the refurbishment of the Charles Town Entertainment Complex (see
Note 2 for Acquisitions).
In April 1994, the Company's Board of Directors and Shareholders adopted and
approved the Stock Option Plan ("Plan"). On April 30, 1997, the shareholders and
the Board of Directors approved an increase in the number of authorized shares
underlying stock options to be granted from 1,290,000 to 2,000,000 shares.
Therefore, the Plan permits the grant of options to purchase up to 2,000,000
shares of Common Stock, subject to antidilution adjustments, at a price per
share no less than 100% of the fair market value of the Common Stock on the date
an option is granted with respect to incentive stock options only. The price
would be no less than 110% of fair market value in the case of an incentive
stock option granted to any individual who owns more than 10% of the total
combined voting power of all classes of outstanding stock. The Plan provides for
the granting of both incentive stock options intended to qualify under Section
422 of the Internal Revenue Code of 1986, and nonqualified stock options which
do not so qualify. Unless the Plan is terminated earlier by the Board of
Directors, the Plan will terminate in April 2004.
Stock options that expire between May 26, 2001 and October 23, 2006 have been
granted to officers and directors to purchase Common Stock at prices ranging
from $3.33 to $17.63 per share.
All options and warrants were granted at market prices at date of grant. The
following table contains information on stock options issued under the Plan for
the three year period ended December 31, 1997:
exercise
option price range average
shares per share price
- -----------------------------------------------------------------
Outstanding at
January 1, 1995 465,000 $ 3.33 $ 3.33
Granted 345,000 3.33 5.51
--------- to 5.58
Outstanding at
December 31, 1995 810,000 3.33 3.82
to 5.58
Granted 280,000 5.63 12.99
to 17.63
Exercised (110,250) 3.33 3.33
---------
Outstanding at
December 31, 1996 979,750 3.33 9.10
to 17.63
Granted 100,000 11.50 15.59
to 16.63
Exercised (39,250) 3.33 4.01
--------- to 5.63
Outstanding at
December 31, 1997 1,040,500 3.33 7.31
--------- to 17.63
In addition, 300,000 common stock options were issued outside the Plan on
October 23, 1996. These options were issued at $17.63 per share and are
exercisable through October 23, 2006.
[Photo]
Jockey atop horse.
34
<PAGE>
Exercisable at year-end:
exercise weighted
option price range average
shares per share price
- -----------------------------------------------------------------
1995 270,000 $3.33 $ 3.33
to $5.58
1996 337,250 3.33 3.71
to 17.63
1997 653,833 3.33 7.08
to 17.63
Options available for
future grant: 1994 Plan
----------------------------------
1997 805,000
----------------------------------
The following table summarizes
information about stock
options outstanding at
December 31, 1997:
ranges total
$3.33 $5.58 $3.33
range of exercise prices to $5.50 to $17.63 to $17.63
- -----------------------------------------------------------------
Outstanding options:
Number outstanding at
December 31, 1997 641,000 694,500 1,335,500
Weighted average remaining
contractual life (years) 5.82 7.36 6.62
Weighted average exercise
price $ 3.84 $ 14.97 $ 9.63
Exercisable options
Number outstanding at
December 31, 1997 471,000 182,833 653,833
Weighted average
exercise price $ 3.79 $ 15.56 $ 7.08
Warrants outstanding have been granted to the underwriters of the Company's
initial public offering and to certain officers and directors to purchase Common
Stock at prices ranging from $3.33 to $4.00 per share which expire on June 2,
1999 and May 31, 2000.
During 1995, the Company canceled 150,000 warrants which were granted to a
former officer of the Company at a price of $3.33 per share and were to expire
on May 31, 2000. The 150,000 canceled warrants were replaced with 150,000 shares
of common stock purchase options at an exercise price of $3.33 per share. A
summary of the warrant transactions follows: exercise price weighted warrant
range average shares per share price
exercise weighted
option price range average
shares per share price
- -----------------------------------------------------------------
Warrants outstanding at
January 1, 1995 690,000 $3.33 $ 3.85
to $4.00
Warrants canceled (150,000) 3.33 3.33
Warrants exercised (45,000) 4.00 4.00
---------
Warrants outstanding at
December 31, 1995 495,000 4.00 4.00
Warrants exercised (300,000) 4.00 4.00
---------
Warrants outstanding at
December 31, 1996 195,000 4.00 4.00
Warrants exercised (46,000) 4.00 4.00
---------
Warrants outstanding at
December 31, 1997 149,000 4.00 4.00
During 1995, the FASB adopted Statement of Financial Accounting Standards No.
123 ("SFAS 123"), "Accounting for Stock-Based Compensation", which has
recognition provisions that establish a fair value based method of accounting
for stock-based employee compensation plans and established fair value as the
measurement basis for transactions in which an entity acquires goods or services
from nonemployees in exchange for equity instruments. SFAS 123 also has certain
disclosure provisions. Adoption of the recognition provisions of SFAS 123 with
regard to these transactions with nonemployees was required for all such
transactions entered into after December 15, 1994, and the Company adopted these
provisions as required. The recognition provision with regard to the fair value
based method of accounting for stock-based employee compensation plans is
optional. Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employers" ("APB 25") uses what is referred to as an intrinsic value
based method of accounting. The Company has decided to continue to apply APB 25
for its stock-based employee compensation arrangements. Accordingly, no
compensation cost has been recognized. Had compensation cost for the Company's
employee stock option plan been determined based on the fair value at the grant
date for awards under the plan consistent with the method of SFAS 123, the
Company's net income and net income per share would have been reduced to the pro
forma amounts indicated below:
35
<PAGE>
year ended december 31, 1995 1996 1997
- --------------------------------------------------------------
Net income
As reported $ 4,996,000 $ 5,510,000 $ 2,287,000
Pro forma 4,984,000 5,344,000 1,660,000
Basic net income
per share
As reported $ .39 $ .41 $.15
Pro forma .39 .40 .11
Diluted net income
per share
As reported $ .38 $ .40 $ .15
Pro forma .38 .39 .11
The fair value of each option and warrant grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 1995, 1996 and 1997: dividend
yield of 0%; expected volatility of 20%; risk-free interest rate of 6%; and
expected lives of 5 years. The effects of applying SFAS 123 in this pro forma
disclosure are not indicative of future amounts. SFAS 123 does not apply to
awards prior to 1995 and additional awards in future years are anticipated.
LOSS FROM RETIREMENT OF DEBT
In 1997, the Company recorded an extraordinary loss of $1,482,000 after taxes
for the early retirement of debt. The extraordinary loss consists primarily of
write-offs of deferred finance costs associated with the retired notes and legal
and bank fees relating to the early extinguishment of the debt.
SITE DEVELOPMENT
AND RESTRUCTURING CHARGES
During 1997, the Company incurred site development ($1,735,000) and
restructuring ($702,000) charges of $2,437,000. The site development charges
consist of $800,000 related to the Charles Town Races facility and $935,000
related to the abandonment of certain proposed operating sites during 1997. The
restructuring charges primarily consist of $350,000 in severance termination
benefits and other charges at the Charles Town Races facility; $300,000 for the
restructuring of the Erie, Pennsylvania off-track wagering facility and $52,000
of property and equipment written-off in connection with the discontinuation of
Penn National Speedway, Inc. operations during 1997. These charges, net of
income taxes, decreased the 1997 net income and diluted net income per share by
$1,462,000 and $0.09 per share, respectively.
REPORT OF INDEPENDENT
CERTIFIED PUBLIC
ACCOUNTANTS
PENN NATIONAL GAMING, INC.
AND SUBSIDIARIES
WYOMISSING, PENNSYLVANIA
We have audited the accompanying consolidated balance sheets of Penn National
Gaming, Inc. and Subsidiaries as of December 31, 1996 and 1997, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Penn National
Gaming, Inc. and Subsidiaries at December 31, 1996 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ BDO Seidman, LLP
- --------------------
BDO Seidman, LLP
March 2, 1998
Philadelphia, Pennsylvania
36
<PAGE>
[Photo]
Horse's bridle hanging over stable door.
Officers and Directors
Peter M. Carlino
Chairman of the Board and Chief Executive Officer
William J. Bork
President, Chief Operating Officer and Director
Robert S. Ippolito
Chief Financial Officer, Secretary and Treasurer
Philip T. O'Hara, Jr.
Executive Vice President of Pari-Mutuel Operations
Joseph A. Lashinger, Jr. Esq.
Vice President
Robert Abraham
Vice President/Controller
Harold Cramer, Esq.
Director, Counsel to
Mesirov Gelman Jaffe Cramer & Jamieson, LLP
David A. Handler
Director, Senior Vice President of Corporate Finance,
Jefferies & Company, Inc.
Robert P. Levy
Director, Chairman of the Board, Atlantic City
Racing Association
John M. Jacquemin
Director, President, Mooring Financial Corporation
Corporate Offices
Wyomissing Professional Center
825 Berkshire Blvd., Suite 200
Wyomissing, Pennsylvania 19610
610-373-2400
Independent Certified
Public Accountants
BDO Seidman, LLP
1601 Market Street
Philadelphia, Pennsylvania 19103
Legal Counsel
Mesirov Gelman Jaffe Cramer & Jamieson, LLP
1735 Market Street
Philadelphia, Pennsylvania 19103
Transfer Agent and Registrar
Continental Stock Transfer & Trust Company
2 Broadway
New York, New York 10004
Form 10-K
The annual report to the Securities and Exchange Commission may be obtained free
of charge upon written request to the company at its corporate offices.
Market Information
The Common Stock of the Company is listed on the Nasdaq National Market under
the symbol PENN.
<PAGE>
Jockey on horse, training.
[Logo]
