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Executives

Joseph N. Jaffoni – Investor Relations

Peter M. Carlino – Chairman, Chief Executive Officer

William J. Clifford – Chief Financial Officer

Eric Schippers – Vice President of Public Affairs

Jordan B. Savitch – General Counsel

Timothy J. Wilmott – President, Chief Operating Officer

Steven T. Snyder – Senior Vice President, Corporate Development

Analysts

Lawrence Klatzkin – Jefferies

David Katz – Oppenheimer & Co.

Joseph Greff – J.P. Morgan

Dennis Forst – KeyBanc Capital Markets

Nicole Torraco – Babson Capital

Jacque Cord – Gates Capital Management

Todd Jordan – Research Edge

Jim Bradshaw – Pierce Capital Management

Unidentified Analyst – Morgan Stanley

Larry Havarti – Damco

Neil Portis – Barclays Capital

David Raney – Akar Capital

Penn National Gaming, Inc. (PENN) Q3 2008 Earnings Call October 27, 2008 10:00 AM ET

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Penn National Gaming 2008 third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Joseph Jaffoni, Investor Relations. Please go ahead sir.

Joseph N. Jaffoni

Thank you [Charlene] and good morning everyone and thank you for joining Penn National Gaming’s 2008 third quarter conference call. We’ll get to management’s presentation and comments momentarily, as well as your questions and answers. But first I’ll review the safe harbor disclosure.

In addition to historical facts or statements of current conditions, today’s conference call contains forward-looking statements that involve risks and uncertainties within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements reflect the company’s current expectations and beliefs but are not guarantees of future performance. As such, actual results may vary materially from expectations.

The risks and uncertainties associated with the forward-looking statements are described in today’s news announcement and in the company’s filings with the Securities and Exchange Commission, including the company’s reports on Form 10-K and Form 10-Q. Penn National assumes no obligations to publicly update or revise any forward-looking statements. Today’s call and webcast may include non-GAAP financial measures within the meaning of SEC Regulation G.

When required, a reconciliation of all non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP can be found in today’s press release as well as on the company’s website. With that I’ll turn the call over to Peter Carlino, the company’s Chairman and CEO. Peter.

Peter M. Carlino

Thank you Joe and thanks for satisfying all of our legal requirements on that with that announcement. Welcome everyone to our third quarter conference call. This quarter as you might guess is not exactly the quarter that we had in mind last year, last month, but it is what it is and certainly consistent with what the industry is seeing more broadly.

With me today is pretty much our entire team as always, so that we’re prepared to answer any and all questions that are answerable in this discussion today. Broadly, performance has been changed from I guess terrible to what would the highlight word be? Less than wonderful? And but nonetheless our entire team has been focused of course on margins and adjustments that I think will leave us in good stead going forward.

Lots of things have happened in this last quarter that are summarized. By the way, I think Bill Clifford and his team as always should be I thank them publicly for the terrific way they do in providing the kind of detail that we give to you. We try and we’ve always tried as a public company to be as transparent as possible, to be as predictable as possible although I must say that predictions and estimates are, under these circumstance, pretty much out the window because we scratch our head as you do.

In fact Bill and I and several of us were talking this morning about guidance generally and we’ve decided that your guess is probably as good as ours about where this is all going, as one looks at the economy and the things that affect our business. But look there’s some bright spots. The company is running along very well. And we’ll speak to probably all of the key issues as we go through your questions and answers. So as is consistent with what we’ve done in the past, I’ll say the least and find out what you folks want us to talk about.

So Charlene would you open the floor to questions?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) Your first question comes from Lawrence Klatzkin – Jefferies.

Lawrence Klatzkin – Jefferies

First housekeeping just end of the quarter debt, cash, CapEx, cap wise interest and what CapEx and cap wise interest might be in the fourth quarter?

Peter M. Carlino

Sure. Bill?

William J. Clifford

Sure. Our cash at 9/30 was $125.6 million. We had on our bank debt we had a $1.915 billion outstanding, which broken up by the revolver it’s $54.9 million, A loan was $260 million and then the B loan was $150.5 million. Then we had Cap leases in Pocono Downs payments due, totaling roughly $28.2 million and our two bonds, $250 and $200, brings us to a total debt number of $2 billion 393.8. Capitalized interest in the quarter was $2.4 million and our CapEx for the quarter broken out between projects and maintenance projects was roughly $63.9 million, maintenance CapEx was $12.4 million.

Looking forward into the fourth quarter we think our projects CapEx for the fourth quarter is

$83.1 million, made up of $29 million on maintenance CapEx and $56 million of project CapEx.

Lawrence Klatzkin – Jefferies

Peter as far as getting the rest of the money from Fortress, what exactly has to happen?

Peter M. Carlino

We need an approval Larry in Missouri and that’s scheduled to happen this week. We have no reason to think that it will not. And that should close that issue.

Lawrence Klatzkin – Jefferies

So you could have the money as much as two weeks from now?

Peter M. Carlino

We could have the money as early as Friday.

Lawrence Klatzkin – Jefferies

As far as –

Peter M. Carlino

Next week. I mean the point is I think we’re there.

Lawrence Klatzkin – Jefferies

How big lobbying expense fourth quarter? Any kind of magnitude of what we – I mean I’m seeing you spent $28 million on Ohio, but that’s both quarters combined, right?

William J. Clifford

That was through the filing date. You know, the reality is that I don’t think we want to – we’re not going to comment on the exact amount spent. It will be significant and I think people will have to stay tuned in terms of how much we spend and we have an individual here that’s responsible for spending that money and it’s a day-to-day decision in terms of the exact spend.

Peter M. Carlino

We’ve made the judgment, Larry, and to everybody out there that the Ohio issue is important to us and that it was important to get the message out that we needed to sell. Obviously we support slots in Ohio and less than two years ago were part of a referendum effort to get slots in Ohio. This particular bill and this particular effort is particularly egregious because what you’ve got is essentially one individual and a couple of local guys trying to, through the Constitution, to gain a monopoly in the entire state, which is really unprecedented.

Obviously that arrangement is not good for Ohio and it’s not good for us because we have an operation in Toledo and there are others in the state along with us who one day hope that the legislature or by referendum we will get a proper bill balanced across the state, maybe Pennsylvania-like, that really will maximize the opportunity for the state of Ohio. This does quite the opposite. It basically precludes everybody else from participating and should anybody else arrive in the state by referendum or by legislation, their tax rate would go to zero.

So there’s a whole lot of bad things in that bill. We just made the judgment that it’s gotta be killed and we’ll live to play another day. And obviously since this is an ongoing effort, we just are not able to comment beyond that now.

Lawrence Klatzkin – Jefferies

Would you be able to comment, and again I agree with you this shouldn’t pass, but if it does what kind of effect it might have on your Cincinnati property?

Peter M. Carlino

We’re not going to speculate on that. I mean, that’s next quarter’s call. So let’s wait a week and find out what the result is. We’ll talk about it then.

Lawrence Klatzkin – Jefferies

And then Maryland, what are you guys seeing on the vote coming up on that?

Peter M. Carlino

That’s a good question. Why don’t I mean I think why we don’t have Eric comment – Eric Schippers who is our head of government affairs. The question is what do we see in the vote in Maryland? What are the likelihoods of it happening?

Eric Schippers

Yes. I mean the governor has been campaigning pretty heavily for the passage of this in the legislature and most of the money would be tied up in terms of funding important state programs and all that sort of thing. So they’ve made the pro side has made a lot of the argument that if you don’t approve this, that it could result in higher taxes in Maryland and perhaps cut the programs that are so. Looking at the polling that has been released publicly, we think at this there’s a high likelihood that this will pass, certainly given the state of the current economy. But it’s anybody’s guess.

That is at least the folks who are proposing this feel pretty strong about their transit. Let me clarify one thing, too, on Ohio. Peter had mentioned the loophole that would allow the tax rate to go to zero. That would be if a federally recognized tribe would come into Ohio and there are currently 12 Native American tribes that are seeking federal recognition. If a commercial operator were to come in, the tax rate could go down to what the rate is of that other one or 25%. So it’s replete with sweetheart provisions and it’s riddled with loopholes. Suffice to say that the more that Ohioans learn about this the less they like it.

Peter M. Carlino

Yes. There’s a better way. Thanks Eric for making that point. By the way, as you well know, once a commercial or gaming is established in a state it does open the door to Native Americans to come in and of course operate with no taxes, often to the detriment of the commercial facility. And there is as Eric mentioned quite a crowd looking to do that. So this opens that door. We think that’s a very bad thing.

Lawrence Klatzkin – Jefferies

And then the last thing was just the getting table games in West Virginia, what’s the timing and outlook for that?

Peter M. Carlino

Let’s see who we should have answer that question. Eric why don’t you take and help us out?

Eric Schippers

Sure. Well we are authorized to go back before the voters as early as June of 2009. We’re sort of not in a hurry, though, because we want to make sure that the foundation has been laid. I think in terms of our continuing to educate voters there about what table games would mean, not only in terms of additional job creation and economic development, but frankly to maintain competitive advantages with the neighboring states that have approved gaming expansion. So we’re going about telling our story in Charles Town.

We’ll see what happens in Maryland. We’ll see continued expansion in Pennsylvania. And when the time is right, maybe as early as June, maybe later certainly they’ll be driven by the polling, we are intent to take another crack at Charles Town.

Peter M. Carlino

Yes. It’s worth mentioning, Eric, that we just got – which isn’t as easy as it sounds, we just got the support of the HBPA formally, that’s the Horsemen’s Benevolent and Protective Association which represents all of the horsemen at Charles Town who have strongly now supported, which they did not last time. So I think we’re building a very careful groundwork and feel optimistic about the future.

In fact there’s one other issue. Let me say this that it’s now clear to all just how much the absence of table games in, because of the other three facilities in the state, just how much the absence of table games has cost the state of West Virginia and Jefferson County. And I think people are kind of shocked by the performance.

Operator

Your next question comes from David Katz – Oppenheimer & Co.

David Katz – Oppenheimer & Co.

I have in front of me the purchase agreement with Fortress related to security. And obviously we’ve all been sort of following the state’s approving of it. But the press release refers to other conditions and I’m sure in the depths of this agreement there are other conditions. Are there any that are – that you can or are worth talking about? What other conditions other than that outstanding approval from Missouri?

Peter M. Carlino

It’s either Bill or Jordan. Jordan, why don’t you take that? Jordan Savitch, our General Counsel.

Jordan B. Savitch

No David the biggest hurdle we have to clear is getting the Missouri approval and then after that our expectation is that we deliver the usual closing papers and then effect a closing.

David Katz – Oppenheimer & Co.

And then I’ve noticed you also have in here on another matter some spending plan for Illinois, the Empress Casino and there’s obviously been some discussion, not to get you all cranked up this morning, but about a tenth license in Illinois. Obviously there have been some changes in people’s outlooks for the next 12 to 18 months and you’re still going ahead with that $50 million. Is that a critical spend at this point? How have you thought about that?

Peter M. Carlino

Well, I’m going to let Tim Wilmott handle that question broadly but the $50 million was a requirement frankly that I offered and we as a company offered to the Gaming Commission in exchange for allowing us, as a good faith commitment to the property and allowing us to keep that ownership in the state. So there’s no choice about how to spend it. In fact we’ve come up with a very exciting plan. This is a property that’s been sold several times, neglected horribly, and its performance reflects that.

Obviously we feel very positive about its future, although there are some things – we’re [lobbying] the state against its smoking bans and other things. But why don’t I let Tim kind of describe where we are with that?

Timothy J. Wilmott

Dave we’ve completed the design of the refurbishment of the casino space and the food and beverage areas. In Joliet we’re going to start construction right after the first of the year and the majority of all the work will be completed in the third quarter of 2009, some small remnants will be done in the fourth quarter. But clearly we’re aware of what’s going on in Illinois with the tenth license and frankly quite surprised about some of the values being placed on that tenth license that have been initially big for that.

And certainly we hope the state of Illinois puts that license in a location that best generates the maximum incremental revenues for the state, it doesn’t cannibalize the existing operators in that state. Well let me add that the state has required from our databases of what the zip codes are of our registered customers. Where are people coming from? Which at least highlights to us that they’re mindful of that impact. So we do think the state at least has the goal - the payment itself has the goal of putting a facility into place that will maximize revenues to it but at the same time have the least impact on existing operators.

David Katz – Oppenheimer & Co.

Bill I think you gave us a number for project CapEx. Can you break that down on what you’re spending it on? I think you said $29 maintenance and the rest is project. Where specifically are you going to be spending that?

William J. Clifford

Are you talking about in the fourth quarter?

David Katz – Oppenheimer & Co.

Yes.

William J. Clifford

There’s roughly $11 or $12 million at Penn National related to the expansion as well as the finalizing of the buffet and the new steak house. We’ve got roughly $6 million in Bangor to wrap up construction there. $28.1 million at Lawrenceburg, and then across start we’ve actually got some expenses at Joliet for $1.6 and then the other is Charles Town wrapping up the hotel for

$2 million. We’re going to be doing some modest improvements at Bay St. Louis for $1 million and generally other stuff, small projects at some other facilities.

David Katz – Oppenheimer & Co.

Did you buy back? What have you said about stock repurchase so far in the fourth quarter, or in the third quarter did you sort of give us a final number there?

William J. Clifford

We did. Third quarter we bought a total of 1.149 million shares at an average price of $27.54. Relative to any buyback since then I think we’re going to be – we’re just not going to comment on that process as we move forward, although I think if we do find a price that’s compelling and interesting and we are certainly actively looking at what our best alternatives are for the cash that we’ve got on hand.

Peter M. Carlino

Yes, let me make a comment about that. Obviously we’re pleased to have a fair amount of liquidity right now, but like a kid in a candy store opportunities abound. They really do. So I think I’m going to make this statement publicly to our interested shareholders that Penn will supply or apply the same kind of discipline we always do. I daresay that we meet every day, almost in a formal way, and look at the world around us because it changes daily and try to make a judgment about where do opportunities lie? What’s the next smartest thing we can do? And this is a very careful and thoughtful process.

When required by regulators, either the SEC or by GAAP rules we will make the appropriate disclosure but we don’t see any advantage right now to going beyond that. So I would make the broad comment to shareholders that we believe we’re doing the right things and you’ll just have to wait a little longer to find out what those are.

David Katz – Oppenheimer & Co.

And there’s no comment on share repo in the fourth quarter so far?

Peter M. Carlino

No.

Operator

Your next question comes from Joseph Greff – J.P. Morgan.

Joseph Greff – J.P. Morgan

Can you just give us an update on which markets look more attractive say now versus three months ago, both from the perspective of an operating outlook near term, longer term as well as potential prices or valuation levels to get into certain markets? And then if you can give us an update on Bader Field and maybe how that fits into a development opportunity versus buying and fisting free cash flow? Particularly maybe you can reference some of the things and I guess from the Las Vegas periodicals about buying trophy assets?

And then I have a follow-up question.

Peter M. Carlino

Well you’ve got, as I hear it, three separate questions. Why don’t we, because there are some geographic differences around the company, the country in performance, why don’t I ask Tim to answer that question?

Timothy J. Wilmott

Generally, Joe, with what we’re seeing across our businesses I would say that the southern properties and specifically those attached to in and around the oil industry tend to be a little bit stronger right now than other operations in the Midwest or the East. But still from a consumer standpoint there’s no strength there. September was probably the worst month I’ve ever seen in my 20 plus years in the industry. October’s been a bit better but still not good, more like July and August. So really as we look at the regional markets out there it’s all tied to consumers and we’re not seeing any signs of strength at this point.

Now related to Atlantic City, then I’ll turn it back over to Peter, you know we just got the RSQ. We think Atlantic City is going to be a very long term opportunity. It’s going to take five, seven, eight years before anything would materialize there. We’re looking at the RSQ very closely and trying to understand what the city and state of New Jersey is asking for. At this point we haven’t made any determination on how our next steps are going to be for an Atlantic City opportunity.

Peter M. Carlino

Yes I mean it’s fair to say that right now Atlantic City is significantly challenged, and that’s not going to change any time soon. Bader presents a unique opportunity but I think Tim answered it pretty well. It’s going to take some time for this whole process to unfold. And again we’ll approach it cautiously and carefully and going to sort this out. So it’ll be a little bit before you hear much from us on that subject.

I guess there was sort of a quick question about Nevada and Las Vegas in particular. I guess hidden among your requests. You know, we continue to poke around that market. Obviously it’s doing a whole lot less well than even we would have envisioned for all the reasons that you know. Again that falls into the category of things changing daily. We’re very anxious to see what happens with earnings ourselves there, when all the releases start to roll in. We don’t expect they’re going to be wonderful. And again we remain focused on just trying to cherry pick the right opportunity if it appears.

So we’re under no desperation to do that. As they say we’re going to just take a deep breath every morning, kind of survey the world around us and decide what’s the next smart thing to do is. That’s the best answer I can give you for Las Vegas. Kind of who knows? But believe me we’re very in tune to it.

Joseph Greff – J.P. Morgan

And Tim you sort of partially answered my next question here. On October 2 you talked about seeing facility revenue being down north of 21% and you said October was a bit better. I know October’s not done yet but maybe you can help us understand October trends and then Bill maybe you can sort of talk about what you’re incorporating or what your thought process is for the balance of this quarter? Not to go crazy on a month-to-month guidance basis but just how you’re thinking about trends in general.

Timothy J. Wilmott

Well generous be moved put in the press release last time was about the 20% was excluding Penn National and Bangor and basically trying to give people an understanding of the flavor of what was happening with our business in the month of September across all of the other properties including the ones we had major capital put into. As far as what we’ve done for the guidance, what we’ve done is taken a look at October trends and basically extrapolate that out through the quarter.

So what we’re assuming is what we’re seeing in October is what we’re going to see for the rest of the quarter, you know adjusted for seasonality and properties that are, obviously there’s some judgment in there as well, relative to what we see in terms of properties ramping up. And what we think we’re going to be doing internally in terms of improving operations and various other steps that we’ve taken to hopefully optimize results in some very tough times.

Yes, go ahead.

Peter M. Carlino

You know, Joe, the things remain the same as we’ve seen in the first three quarters the smoking impact in Illinois continues. Thank God we’re going to anniversary that at the end of this year. The impact of the casinos at Lawrenceburg continues. And the general malaise over the economy in almost every other market continues. So we’re seeing just more of the same of what we saw in the second quarter and in July and August.

Joseph Greff – J.P. Morgan

And Bill where do you see CapEx for next year? Can you just look at the statement that you have in the press release in terms of what you have left remaining to be expended? Unless your comments on the 4Q is a good level to use for project CapEx for ’09?

William J. Clifford

Yes, I mean I think maintenance CapEx will probably be around $80 million for the year, somewhere between $75 and $80. We haven’t finalized those numbers at this point. On the project CapEx the only things that we’ve really got on the drawing boards today are the Hotel [Zia] as well as Joliet and so I would expect – and then finishing up the Lawrenceburg project, so based on the numbers in the press release we should still get there.

Operator

Your next question comes from Dennis Forst – KeyBanc Capital Markets.

Dennis Forst – KeyBanc Capital Markets

I’ve wanted to get a clarification on the debt number. Bill I think you started off by saying debt was $1.91 billion, but that’s probably the bank debt?

William J. Clifford

That’s the bank debt.

Dennis Forst – KeyBanc Capital Markets

Plus another $450 for the bonds?

William J. Clifford

Plus another $450 for the bonds plus another $28 in capital leases and in obligations to some Mohicans relative to the Pocono’s sale.

Dennis Forst – KeyBanc Capital Markets

So somewhere around $2.4 is the total. And I think it said in the press release the $775 will go immediately to reduce the is it the revolver? Or some of the term loans?

William J. Clifford

William J. Clifford

Revolver.

Dennis Forst – KeyBanc Capital Markets

How big is the revolver right now?

William J. Clifford

The revolver at 9/30 was $54.9.

Dennis Forst – KeyBanc Capital Markets

So you can only pay down $55 million. That leaves over $700 million. Where does that go? Because we have negative care down, it will stay in cash?

William J. Clifford

That will stay in cash or we’ll invest it or we’ll use it for stock buyback.

Dennis Forst – KeyBanc Capital Markets

And then on the Fortress or on the payment of the $775, only Missouri is left outstanding. What day does Missouri meet to discuss that?

Peter M. Carlino

Wednesday.

Dennis Forst – KeyBanc Capital Markets

So we might hear something Wednesday about that?

Peter M. Carlino

It’s fair to say you probably will.

Dennis Forst – KeyBanc Capital Markets

Lastly on promotional allowances, promotional allowances were actually a couple million dollars higher sequentially than the first or second quarter, yet revenues have been about the same, actually gaining revenues were down in the third quarter from the first or second. Is there any particular markets that are more promotional? Or is it just necessary in general to spend more money promotionally in this environment?

William J. Clifford

Dennis, the only market that really represents a material change in the third quarter is the start up of our facility in Bangor, but that’s not a big, large operation. So I would say the rest of it is generally just across the board. In certain markets like Charles Town where we’re trying to market more aggressively, stimulate the demand to the better quality customers, that would probably be another property that is showing an increase in promotional allowances that would be above what you’ve traditionally seen in the past as Penn P&L.

Dennis Forst – KeyBanc Capital Markets

But is it fair for us to think that most companies are being pretty conservative about spending in this environment, given that a lot of customers are not going to come out no matter how attractive you make it?

Peter M. Carlino

I think that’s a very fair comment, especially at the low end of the database in the unrated segments. You’re really seeing the retail consumer, the customer spending less than $100 per visit at our casinos, being the most impacted by this economy.

Dennis Forst – KeyBanc Capital Markets

You can go for table games in West Virginia next year, but what would be the timing of that? When would there be an election?

Peter M. Carlino

I think Eric answered that question before pretty thoroughly, but why don’t you take another stab at that Eric?

Eric Schippers

Sure. We could go before the county commissioners in Jefferson County and ask to be placed on a special ballot as early as June of 2009. We are looking at the polling, and of course we’ll continue to look at the research. We are telling our story. We are making our case to the people of Jefferson County. We want to get this right. We want to win and we want to do it, not based on an arbitrary timeline but based on when we think we have the best chance of winning.

Dennis Forst – KeyBanc Capital Markets

Would that not be in the more general election? Are there any elections in West Virginia that you could piggyback on and not have to pay for a special ballot?

Eric Schippers

You know, we can’t really speculate on when the time is going to be right because there’s a lot of dynamics that could change. Obviously you look at Maryland and what may happen there. You look at Pennsylvania with the downtown Philadelphia casinos, when will they be online is unclear. A lot of different dynamics. What the economy will be like then. So we’re just going to continue to keep our finger on the pulse there.

As I said we’re spending a lot of time and energy there now, talking about the good things we’ve done in the community, talking about what the impact of table games would mean for that community. How it would transform Charles Town into a true entertainment destination. Certainly with the new hotel that’s opened there we could fit perfectly. But again we want to choose a time that’s going to give us the best likelihood of success and that’s going to be driven starting in June 2009 by the polling.

Dennis Forst – KeyBanc Capital Markets

And then what, Peter, when do you think gaming would actually start in Maryland should it get passed next week?

Peter M. Carlino

Boy, maybe Steven Snyder has a point of view. That’s utterly unknowable. It could be as we found in Pennsylvania years, but Steve do you want to have fun with that?

Steven T. Snyder

Yes I think that years is probably the right kind of timeframe to be looking at because you’ve got to remember the Maryland statute requires local zoning approval, so there are a number of features in the Maryland statute that are going to require some pretty heavy lifting between

November 4 of this year and the opening of the facility. So I would be mildly surprised to see anything come on line much before late 2010 or into 2011.

Dennis Forst – KeyBanc Capital Markets

Well that sounds reasonable. Could be 2012 or later.

Steven T. Snyder

Yes. Absolutely correct.

Peter M. Carlino

Pennsylvania is a good model, I mean, and this was a perfect bill but it’s turned out to be more problematic for many operators than any of us would have guessed.

Operator

Your next question comes from Nicole Torraco – Babson Capital.

Nicole Torraco – Babson Capital

What is your minimum cash balance?

William J. Clifford

The minimum cash balance in terms of what we need for operations?

Nicole Torraco – Babson Capital

Yes.

William J. Clifford

We’re operating pretty close to that. We made some adjustments earlier in the year and really did a very thorough job of analyzing the minimum cash needs, and I would say $125 is a pretty good -

Nicole Torraco – Babson Capital

So about $125?

William J. Clifford

Yes. Maybe there’s another $5 but that’s a good broader –

Nicole Torraco – Babson Capital

And you guys have talked a little bit about using the additional liquidity to maybe repurchase stock. Any thoughts on re-looking at your bonds which are trading at a discount right now?

William J. Clifford

Well we certainly look at that. That’s part of what we want to discuss with our senior credit folks in terms of whether that’s an option. As it stands right now we’ve got some limitations in terms of what we can do with that.

Nicole Torraco – Babson Capital

What are those limits?

William J. Clifford

Well the limitations are that there’s some prohibitions against paying back sub-debt before senior debt.

Operator

Your next question comes from [Jacque Cord] – Gates Capital Management.

Jacque Cord – Gates Capital Management

Just a follow up on that, with respect to the statement that’s in the press release maybe you can elaborate, doesn’t the formation of the unrestricted subsidiary eliminate or reduce some of these provisions? Or how should we read into that?

William J. Clifford

Well it does but I think the reality is it’s our intent to have a cordial and a reasonable discussion with our senior credit facility member. And as we’re not – we’d like to do something that works for both sides. Clearly there’s an option here from the company’s perspective that we can put it there and have ultimate flexibility, but the reality is the company would like if it’s possible to come to some sort of cordial understanding in terms of how we might be able to make these proceeds work for the best interests of both parties.

In other words, rather than putting it completely into a subsidiary where there’s no collateral for the senior, what we’d like to do is talk about how we might roll that back in but do that in a way that allows the company to pursue the goals it wants to pursue which are not all currently contemplated within the senior debt facility.

Peter M. Carlino

Bill, I must say that is a great answer. Thank you. Look, that says it very, very well.

Operator

Your next question comes from Todd Jordan – Research Edge.

Todd Jordan – Research Edge

On your [beck] team that you’re subsidiary that you’re setting up, I’m assuming that your goal with the subsidiary will be to invest in a company that you have targeted for a potential acquisition. This isn’t really an investment vehicle. Is that correct?

William J. Clifford

Yes. And I’ll let you know the reality is that even though you might make an investment, you can’t have certainty that you’ll have success with that potential acquisition. Others might be making investments in entities that are not particularly excited about selling themselves. So the reality is that that result may or may not end up in an actual acquisition.

Peter M. Carlino

Let me restate what I had said before. There are many, many opportunities now on every side of the equity debt spectrum, starting with us moving right down the line. And the challenge for us as a company of course is to look at the countless choices and make the smartest choice. And that’s the process that we’re engaged in right now. So you’ve going to have to stay tuned, but you’ve got the spirit with which we approach the use of this cash.

Operator

Your next question comes from [Jim Bradshaw – Pierce Capital Management].

Jim Bradshaw – Pierce Capital Management

Thanks. Actually you guys have just recently answered mine. Thank you.

Peter M. Carlino

Okay.

Operator

Your next question comes from [Unidentified Analyst] – Morgan Stanley.

Unidentified Analyst – Morgan Stanley

With the subsidiary that you’ll be potentially buying debt instruments through, will we see mark to market in terms of where the debt is trading, potentially adding to earnings volatility?

William J. Clifford

No. Well actually what happens is the mark to market runs through the OCI, through equity assuming that the stated goal would be buying instruments with the goal of acquiring the company. To the extent that we have a change in that philosophy then we’d have to, when we’d actually sell them we would obviously have to recognize a gain or loss at that point.

Unidentified Analyst – Morgan Stanley

I guess similar to one of your competitors buying stock in another competitor and they marked it down once they decided they weren’t buying the company? Is that the right way to think about it?

William J. Clifford

Exactly. Same concept.

Operator

Your next question comes from [Larry Havarti – Damco].

Larry Havarti – Damco

Is anyone else that you can see getting as enlightened as the authorities in Atlantic City, the depravity from the smoking bans may be worth more than saving the health of the voters?

Peter M. Carlino

You know sadly I must say and I think Tim said it publicly “you got a lot of bad press” that maybe the world is headed to smoking bans almost everywhere. Let’s face it. Smoking bans are not good for our business. I mean, that’s been well established. Illinois has had the view “oh don’t worry, we’ll spring back” but the reality is it will come back somewhat but it’s a permanent loss of business. This simply time and play. So it’s no good news. It’s just not good news.

Gamers tend to be disproportionately smokers. That’s the reality. So with the public health issues are what they are, I think that pressure will continue. I personally would like to see and would have liked to see people focus on air quality rather than smoking ban. This is a personal view. But look this is a social crusade. Legislatures and others are trying to get people to stop smoking. That’s really what this is about. If it was a health issue they’d simply regulate air quality. But that’s not what this is. This is a crusade and I think it ought to be a universal crusade.

And unfortunately it can hurt us in the areas where you’ve got Native American facilities or others who are not forced to play by any rules. So I think this is a trend that will slowly continue. Pennsylvania had a fairly enlightened point of view about it, and that is providing a measured look at what is the effect of smoking bans and considering that maybe there’s places where you can smoke and maybe places where you don’t smoke. Hopefully that kind of concept will remain and maybe others will consider it as well.

But outright smoking bans as Atlantic City has just demonstrated really a bad idea. It’s bad for business. And there’s no way getting around it. Is that helpful?

Larry Havarti – Damco

Yes. The second thing is as you survey the investment opportunities in the industry, where do shall we say semi-completed projects where there is a financial stress of one kind or another look on your spectrum of appetizing opportunities? Or are they off the board?

Peter M. Carlino

You know, there’s nothing that we don’t look at. Let’s set it at a medium. I’m not sure this is the most charming view. But I often think of ourselves – this was at an investor conference, I often think of ourselves as much as you can picture this sort of as a wolf surveys its territory. And that’s always been the case. Picture a great plain and kind of a low rise of a hill and kind of the wolf sitting there kind of staring out at the horizon, looking for one of two things. Either weakness someplace that he can go and pounce on or on the other hand looking defensively at his territory.

And we I think bring that kind of passion and enthusiasm and rigor to the process. So picture us now sort of surveying the territory, looking for what’s out there. And again there’s lots of choices. And by the way, I think as this whole thing evolves with patience, and patience is going to be the key word, there’s going to be some things that spring loose that we wouldn’t have dreamed of a year ago. So that we want to make sure that we’ve got some dry firepower and again, patience is one word I think I should introduce, it should sort of drive what we’re doing here.

And so it shall be. So that’s all I can really say about it. But we look at the whole world. We look at everything around us. We consider every possibility. And that’s as it always has been.

Operator

Your next question comes from [Neil Portis] – Barclays Capital.

Neil Portis – Barclays Capital

There were a number of property level management changes in the quarter. Have those been completed or are there more to come?

Peter M. Carlino

Tim should answer that.

Timothy J. Wilmott

Yes I have reorganized the operating side of the business, Neil, to be a bit more efficient and provide a little bit more oversight to our businesses and essentially the deck’s been cleared and I think we’re well positioned, well organized now to grow this business moving forward.

Peter M. Carlino

That’s a good answer. I like that.

Operator

Your next question comes from [David Raney – Akar Capital].

David Raney – Akar Capital

Peter, maybe just a few more comments about the process in Pennsylvania about potentially re-allocating floor space between smoking and nonsmoking and how long a timeframe the evaluation process goes on? And then the second would be, any comments about margins at Bangor or Harrisburg versus expectations?

Peter M. Carlino

All right, let me split those of course and let Eric Schippers or Jordan Savitch answer the question in Pennsylvania.

Eric Schippers

You’ve talked to the property probably more recently than I have on how they’ve allocated their floor.

Jordan B. Savitch

I think in terms of smoking, this is – I’ll speak to it from the political standpoint and then Tim can speak to it as to how it’s been put in practice at the property. What the folks in Pennsylvania have understood is that there is a severe impact from smoking bans as Peter has talked about before and in fact, this was an issue that was not easy to pass through the legislature. It came down to a conference committee.

And in the interest of sort of splitting the baby, they decided that we’ll start with allowing a smaller percentage of your floor that can be smoking and then go back after 90 days, I believe it is, and look at the impact. And look at the machine performance from the smoking section and the nonsmoking section and allow the operator to come back to the gaming board and petition to increase the size of the smoking section. And again that’s with the understanding that there is going to be an economic impact. So we want to take it on a case by case basis.

Timothy J. Wilmott

The only thing I’ll add to it, Eric, is that David the 25% allocation, we have not found in the operation to be detrimental to the customer experience up to this point. That said, I think we have early indication that there will be clear evidence that the productivity of the slot machines in the smoking area have outperformed the would be performance of the machines in the nonsmoking area. So that’s the early trend and if that continues, then we do have the flexibility to increase up to 50% of the allocation for smoking for our products at Penn National.

So that’s at least the early read of what we’re seeing since we’ve gotten the 25% rule. Regarding the margins in the businesses in Bangor and Penn National, Bangor we’ve had the facility open for three months. We’ve grown revenues almost 50% year-over-year in the quarter. As you can imagine, with a larger operation and a higher cost structure we still have further growth to be achieved. We’re spending to try to create awareness in our key feeder markets there. It’s clearly not going to have the margins that we operated in in the temporary facility up in Maine.

But we have seen very encouraging signs of doubling the database and reaching into these petered markets for the long term growth of this operation. But I don’t think you’ll ever see the margins that you saw in that temporary facility that we had where we were operating on a very limited basis.

At Penn National we have EBITDA margins that are approaching 20% and we expect that to continue to grow as we again grow the business and penetrate into the petered markets in central Pennsylvania. We recently within the last couple weeks opened a much needed buffet in the business, doing very well initially with our cover counts there and it’s still said the steakhouse is under construction, will open up before the end of this year which will complete the opening of this new facility outside of Harrisburg.

And margins have improved over the course of the time and they’ll continue to improve as we get into 2009.

Peter M. Carlino

Peter M. Carlino

Yes, let me make a comment about Penn National because I think for many of our shareholders it is the showcase for what we do well as a company. I’ve said many times that we’re not in the business of building monuments to ourselves or anybody else. We’re about shareholder value and maintaining to the best of our ability as close to the highest return on capital in the industry as we can make it. And I would actually suggest that any of you who can get out to Harrisburg and see Penn National, you’re looking at probably one of the best capital spends in the gaming business.

That is to say, dollar for dollar we’ve managed to produce just an incredible amount of excitement in for the lowest possible cost, and that’s always our game and I think it’s a pretty good commercial for what we do as a company and who we are as a business. I’d encourage you to go take a look at it. It’s a pretty cool place. And I think done for a very, very modest price.

Operator

We have a follow-up question from Joseph Greff – J.P. Morgan.

Joseph Gregg – J.P. Morgan

Bill with respect to the fourth quarter guidance, the share count, is that a weighted average assuming the dilution from the preferred hits November 1?

William J. Clifford

It is and it also assumes there’s no share buyback – well, it doesn’t include any share backs that might happen in the fourth quarter.

Operator

There is a follow-up question from Dennis Forst – KeyBanc Capital Markets.

Dennis Forst – KeyBanc Capital Markets

I wanted to get a clarification on corporate overhead for the quarter just completed. It was

$27.3 million for the quarter? Right, Bill?

William J. Clifford

Yes.

Dennis Forst – KeyBanc Capital Markets

That includes the lobbying cost and the severance package?

William J. Clifford

It does and it also – yes.

Dennis Forst – KeyBanc Capital Markets

So in the fourth quarter we’ll include lobbying charges, too.

William J. Clifford

Fourth quarter we’ll also have lobbying charges. That’s right.

Dennis Forst – KeyBanc Capital Markets

So next year, assuming normal year of operations, the number I’m thinking is somewhere in the $60 million range? Maybe even less than that? It was $55 million last year.

William J. Clifford

Yes. You can definitely be comfortable that fourth quarter overhead will decline next year.

By a lot. By a lot. I think the number somewhere in that $55 or $60 million range is probably right.

Dennis Forst – KeyBanc Capital Markets

There’s not much lobbying in next year unless you do something in Charles Town.

William J. Clifford

That’s right. Well, the problem with lobbying is it’s somewhat of an unpredictable industry in that stuff pops up that, quite candidly, you have to react to. But in terms of what we can see today what’s going to happen next year I think the only thing you would say that’s happening there is table games in West Virginia.

Dennis Forst – KeyBanc Capital Markets

And when will the Q be filed?

William J. Clifford

One day before the due date which I think is November – the first week of November.

Operator

There is a follow up question from David Katz – Oppenheimer & Co.

David Katz – Oppenheimer & Co.

If I could just go back to the maintenance CapEx for a minute, if I look at it sort of how you’ve been running in the past and I think I just want to make sure I heard you right, you did say

$29 for the fourth quarter which is quite a bit higher than what you’ve been running. And then the third quarter’s a bit lower. What’s going on there, if anything?

William J. Clifford

Well there’s some timing issues relative to when the properties started spending the money. At some level I think this maintenance CapEx might be a little high. But when we surveyed our properties relative to the original maintenance CapEx budget, nobody was indicating they had any excess monies available and they were going to try to get it all spent in the fourth quarter. The more likely realistic scenario is that some of this money will spill over in the first quarter next year.

Peter M. Carlino

You know there’s a gaming show coming up and trying to see what the manufacturers new products may be out there to the properties, just holding on to make sure that they have enough powder if they see something they really like to be able to get that ready to be on the floor for the early part of 2009.

William J. Clifford

Part of that is historically we’ve had properties that have wanted to borrow from the following year’s budget to buy slot machines and we’ve tended to discourage that practice in terms of if you want to buy something in the fourth quarter, don’t spend all your money in the first and second quarter.

David Katz – Oppenheimer & Co.

So if we want to think about a run rate for next year on an annualized basis, something in the low $20’s is probably a reasonable number?

William J. Clifford

Well I think maintenance CapEx next year should be between $75 and $80.

David Katz – Oppenheimer & Co.

With respect to Lawrenceburg, just looking at the updated press release, you’re talking about capacity for a pretty big slot floor there. Are there any aspects of that project, including sort of slot capacity that you could consider altering or changing depending on what the outcome in Ohio is or any other sort of global factors?

Peter M. Carlino

I’ll put Tim into that.

Timothy J. Wilmott

There sure is and obviously we’re watching what’s going to go on in Ohio, we’re watching what’s going on with the impact of the racinos around Indianapolis. And we’re looking at potential if these impacts are there to look at our counts for gaming product, and we have a possibility to not put as much product on the floor if that option is available to us, we’ll certainly look at it. But those decisions don’t have to be put into stone until sometime in the late first quarter of next year because it’s only going to take us about three months or so to finalize the layout and get the product on the floor.

Peter M. Carlino

But we should say to be fair, Tim, that the bulk of the capital spend is going to continue regardless. And I will again add this commercial that, now having seen what the final product’s going to look at, it’s going to be very exciting, very, very compelling in that market.

Timothy J. Wilmott

And the only thing I’m referring to is the gaming product on the floor. Everything else as Peter said is committed and will open up in July of ’09.

Operator

As there are no more questions at this time, I’ll turn the call back over to you.

Peter M. Carlino

Very good. We thank you all for tuning in this morning and let’s hope that the market improves next quarter and beyond. Thanks very much.

Operator

Ladies and gentlemen that does include the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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Source: Penn National Gaming, Inc. Q3 2008 Earnings Call Transcript
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