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Penn National Gaming, Inc.

Q1 2009 Earnings Call

April 23, 2009, 10:00 a.m. ET

Executives

Peter Carlino- Chairman of the Board and CEO

Timothy Wilmott-President and COO

William Clifford-CFO

Steven Snyder- Senior Vice President, Corporate Development

Analysts

Anthony Polatonio- Barclays Capital

David Katz- Oppenheimer

Larry Klatzkin- Jefferies

Dennis Forst- Keybanc

Carlo Santarelli- J.P. Morgan

Lawrence Goldstein- Santa Monica Partners

Larry Haverty- Gameco

Ryan Worst- Brean Murray

Jim Bradshaw- Bares Capital Management

Nicole Teraco- Virgin Capital

Operator

Ladies and gentlemen thank you very much for standing by and welcome to the Penn National Gaming First Quarter Results 2009 Conference Call. During this presentation all participants are in a listen-only mode [Operator Instructions].

As a reminder today’s conference is being recorded on Thursday, April 23rd 2009. It’s now my pleasure to turn the conference over to Joe Jaffoni, Investor Relations; please go ahead sir.

Joe Jaffoni

Thanks Tina and good morning and thanks everyone for joining Penn National Gaming’s 2009 First Quarter Conference Call. We’ll get to management’s presentation and comments momentarily as well as your questions and answers but first I’m going to review the Safe Harbor Disclosure.

In addition…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 in the company’s filings with the Securities and Exchange Commission including the company’s reports on Form 10K and 10Q.

Penn National assumes no obligation to publicly update or revise any forward-looking statements. Today’s call and webcast may also 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 will be found in today’s press release as well as on the company’s web site.

With that, I’d like to turn the call over to Peter Carlino, the company’s Chairman and CEO, Peter.

Presentation

Peter Carlino

Thank you Joe and good morning everyone. I am happy to be here with you this morning to talk about our first quarter results and as usual with me is most of our senior management team so that we can give you as complete a picture as possible.

I think our corporate staff has done a pretty good job, Bill Clifford, in organizing a lot of very complex information in what we think is a fairly effective way. We will rely, as always on your questions to direct us where you’d like us to go. But before I do that let me ask first Tim Wilmott to just give you a very, very brief outline of kind of what the quarter was like and what our performance was like. Under the circumstances I think frankly and given the market not too bad, Tim.

Timothy Wilmott

Thanks Peter. As we look at the first quarter generally January was slightly above our expectations. We had a very robust February, which was by far the best month of the quarter and March was just slightly below expectations. But overall you can see that we produced what I would characterize as very solid results overall for the quarter.

The good news is the first three weeks of April are looking more like January, slightly above our expectations. Again, the message is the world is not ending. People in these regional markets are enjoying casino entertainment. We’re generally seeing trip frequencies and visitation patterns pretty flat year over year across most of our businesses and coupled with the fact that we’ve been able to reduce our operating expenses over the course of the second half of 2008 into 2009 I think resulted in a little better margin performance than what the street expected.

Peter Carlino

Thank you Tim; Bill, I know there’s a couple things I know you want to highlight.

William Clifford

The stuff I really wanted to highlight really relates to the accounting treatment around Joliet with the fire that we had. The accounting principles basically dictate that you can’t recognize…well one, we have insurance and the insurance we fully expect to be reimbursed for all of our construction costs and all of our operating results and lost profit that we will incur as a result of the fire obviously subject to the deductible, a roughly $2.5 million deductible in the property, two days of business interruption and $50,000 on the builder’s risk portion, which is the portion attributable to the construction improvements that were underway.

The piece that I want to clarify or try to help out with here is that recognizing that we were expecting EBITDA results in the second quarter, third and fourth quarter. Unless we can settle the insurance proceeds by the end of the year we will not be allowed by the accounting rules to recognize that EBITDA to our income statement until we actually settle out the claim and have received all the cash.

The impact for that, which we’ve outlined in the guidance but I think may need a little bit of tweaking is the number that’s in there is 14.8, which for the year, which includes the first quarter, which candidly was above our expectations. So if you were to take Joliet’s performance for the second, third and fourth quarter the impact on our guidance is roughly $17 million. With that I’ll turn it back to Peter.

Peter Carlino

Let me make a comment about Joliet. As most of you know, we’re in the process of a significant renovation at that property, which is in part what led or what directly led to this unfortunate fire. As we’ve highlighted in all of our public releases fortunately no one was hurt, which is probably the most significant issue and we expect to be up and operating again pretty quickly. We’ve got a public date out there Tim.

Timothy Wilmott

I think we’re still looking for reopening Joliet just on the casino barge with limited food and beverage offerings the end of the second quarter.

Peter Carlino

The trick to that is, frankly, there’s still a lot of debris out front, which insurance companies are still sifting through. Frankly, until that is out of the way we can’t say with absolute assurance that we’re going to open it so I highlight that point but I think we’re going to get there.

It is also the case that unfortunate though this is it does present us an opportunity to do something newer, different and better and we’ll do our very, very best in the shortest possible time to open Joliet and make it a highly, highly competitive product. Several of us just recently were reviewing architectural sketches and floor plans for a new land side facility as work, by the way, continued the pace on the barge itself right now. It should be very exciting and we’ll make the best of the situation. With that why don’t we turn this open to questions Operator?

Question and Answer Session

Operator

Absolutely sir; ladies and gentlemen, we’ll now proceed to the question and answer session (Operator Instructions). Our first question comes from the line of David Katz from Oppenheimer. Please proceed sir; your line is open.

David Katz- Oppenheimer

Good morning. A couple of issues; I think looking at Missouri and I guess Riverside we’d love some insight as to how to gauge the loss limit and how that plays out. If we look at sort of the first few months we see a little bit of upside revenue wise. There’s incremental tax associated against that. How should we be thinking about that let’s say the next four quarters?

Timothy Wilmott

David, what we’ve seen in Riverside with the removal of the $500 loss limit has been mostly visible on table games volumes. We’ve seen about a 25% to 30% increase in table games drop in the first quarter and that’s really driving the revenue growth. We’ve seen some slight growth in slots but it’s been mostly table games. When you net out the revenue growth on top of the 1% increase in tax rate I think our EBITDA margins quarter over quarter were essentially flat. Obviously we had greater EBITDA this year in Riverside than last year but it’s mostly due to table games volume increases.

David Katz- Oppenheimer

So I guess that’s exactly my point is, is there an inflexion point where it becomes a net positive EBITDA for that property?

Timothy Wilmott

Well I think it has been accretive to overall EBITDA. The margins are essentially flat but we’ve seen a revenue growth of almost 8% to 9% in that business for the first quarter so it is accretive to EBITDA based on our first quarter full quarter of operating without the loss limits.

David Katz- Oppenheimer

Tim, are you able to gauge whether or not it’s driving incremental slot play?

Timothy Wilmott

It doesn’t seem to be incremental slot play. It does seem to be slightly better quality slot play because of the limit being removed. But again, by far the greatest and noticeable difference is in the table games.

David Katz- Oppenheimer

Then I just wanted to ask about Illinois. There are obviously a lot of moving parts in that market with the Horseshoe boat that’s open and now the Joliet property going out for a period of time. How should we think about Aurora for the next quarter or so? Are you seeing that you are able to capture any of those customers that were Joliet customers and sort of keep them in the family so to speak?

Timothy Wilmott

We’ve been able, David, to get…with the cooperation of the Illinois Gaming Board we’re able in Aurora to accept Joliet offers that were in the hands of Joliet customers and we’re starting to see some increase in the month of April in Aurora’s business, in part due to Joliet customers that are visiting Aurora.

I would imagine; I don’t know this firsthand but I would imagine obviously Harrah’s Joliet being the big beneficiary of Empress’s closing but we had seen a slight increase in Aurora’s business levels over what we saw in the first quarter due to the movement of customers up there from Joliet.

Peter Carlino

Let me stick my nose in that. I think Tim highlighted that the biggest beneficiary clearly is going to be Harrah’s in the short run but I don’t think that concerns us a great deal, only because our new offering will be new and pretty exciting. I think we will quickly reclaim that business and grab the kind of market share improvement that we are looking for.

Timothy Wilmott

We still, David, before the Joliet fire; we certainly had seen mostly in Aurora the impact of the Hammond offering affecting Aurora, who did get some business from within the Loop in Chicagoland and that’s going to continue to persist as we anniversary that opening come this August of what happened in Hammond.

But generally I thought Aurora’s management of their margins and operating in the first quarter was very solid.

David Katz- Oppenheimer

One last one and then I’ll step aside. With respect to your shopping efforts in Las Vegas whatever insight you can share with us, if it’s more likely, less likely, more attractive, less attractive, any updates on your thinking or approach there I’m sure would be interesting for everyone?

Peter Carlino

I’m going to have to disappoint you, David, by saying that briefly there’s nothing we can say. If anything, that issue has gotten much too much attention, a series a recent articles that link us with potential companies or properties is not helpful to the process and in fact we’ve never publicly said that we want anything more than a single property on the Las Vegas strip if we can find one.

That still remains our interest. Time alone will tell whether we can find the right opportunity at the right price. There’s really nothing else to be said about that. I’m frankly very sorry that all the speculation has been out there. It far over-plays this issue for us right now so we have the interest. Time alone will tell whether we can match it with an opportunity.

David Katz- Oppenheimer

The New York Post is never disappointing and I think you’d be disappointed if I didn’t ask.

William Clifford

I think just as a remark on the Post article; there were quotes and things said that have been pulled all the back to the last year’s Gaming Conference. When you take different quotes and pull them together from different time frames and then lump them together at your will. I’m not quite sure that the Post article is a very good reflection of anything we’ve ever said at any point in time.

Peter Carlino

Exactly. Some of the most interesting quotes were made at a time when none of the stuff that you are all currently thinking about was out there so it’s unfortunate. It’s just a hodgepodge of things pulled together to make a story. We would have preferred not to have seen it that way. Look, common sense says if there’s an opportunity we’re going to follow it but it’s no more exciting than that; enough said.

Operator

Our next question comes from the line of Larry Klatzkin of Jefferies; please go ahead sir, your line is open.

Larry Klatzkin- Jefferies

More on the retirement mode but hi Peter, how are you doing?

Peter Carlino

Hi Larry; the question is how are you doing?

Larry Klatzkin- Jefferies

Living the life of the idle rich. The question I have is one; what’s your hurdle rate? You guys have a nice amount of cash, you’re in a great position; there’s a lot of opportunities out there. What would you look for as your hurdle rate for buying something if something attractive became available?

Peter Carlino

I’m going to let Bill take that but look, the issue is always for us centered around free cash flow. In the end, you can only pay what will generate after all bills are paid free cash to pay down your debts. I’ll let Bill address that and that’s obviously influenced by the cost of money and a whole host of things.

William Clifford

I think and I’ve talked about this numerous times so for those of you that have heard it before bare with me. But, the reality is we’re pretty simplistic about how we do this stuff. We don’t do any kind of really sophisticated stuff that you learn at Wharton Business School. We take a much more simplistic view of the world.

We basically start with EBITDA and we do a qualitative judgment in terms of what we think sustainable EBITDA is. We subtract what we think our interest expense is going to be, what our maintenance Cap ex related to the project is going to be and what our taxes are going to be and there needs to be a residual. Whatever that residual is we then measure that against the total acquisition cost and we’re looking for free cash flow in the 5% range.

So if we were to do a billion-dollar acquisition we would expect to generate an incremental $50 million worth of free cash flow. That process basically…Now, there’s some judgment that comes into play. Obviously to the extent that we find a property that we believe has tremendous upside clearly we would tighten on the current EBITDA basis or even in the first year basis we might tend to move that target down below 5%. If we thought that EBITDA was declining we’d obviously need a target return that’s higher than 5%.

So, I think that’s pretty much our simplistic way of looking at things and it factors in the cost of capital, factors in what your maintenance costs are going to be and it factors in what you believe your sustainable operating results are going to be.

Larry Klatzkin- Jefferies

That’s a reasonable method to follow; I don’t disagree with it.

Peter Carlino

This is so uncomplicated. I still scratch my head and many of you have heard me say this before. When I first got into the public world and we started talking about these financing’s I began to ask questions like how do we begin to retire debt and some of our trusty banks and lenders said, “You kind of don’t. You just roll it over.”

If you look at a 5% free cash flow after all bills are paid that’s still a 20-year amortization as an old real estate guy…you’ve got to pay down debt so we’re rabidly focused on that. It’s so simple, so axio-magic that I don’t know why anybody even questions it so that’s what it’s all about. How do we build net value for shareholders? That’s our discipline. Our story is no more complicated then that.

Larry Klatzkin- Jefferies

I think that’s a good method. Last question, just a little regulatory look at the threat of Kentucky seems to be going away, how’s Ohio going, possible change in Kansas law and the prospects of a vote in West Virginia?

Peter Carlino

That covers just about everything the company’s working on Larry. We’ll divide that up and sort of spread it around because the situations are different in every state.

West Virginia; let me take that one and then I’ll direct the others elsewhere. It is of course an ongoing huge opportunity for us. The challenge of course is convincing local voters that this is a net plus for the community. There has been a shift in the allocation of potential tax dollars from this in a more favorable way to local schools and the like that may help our ability to sell this to the public at the appropriate time.

We think that this needs to occur in the general election so it won’t happen this spring. It could be run this fall; that decision hasn’t been made yet. We remain intensely engaged with that issue. As you might guess, the state of West Virginia, the state itself, is very, very anxious to have table games comes to Charles Town because we are the largest single facility by far in that state and a huge revenue generator for them and a reliable source of revenue for the state so we’re completely aligned.

The nature of that location and I think many of you know is that we are kind of a…become a bedroom community for Washington DC, parts of Virginia and Maryland. And as more and more folks come in looking to escape the city so to speak these are the people not tied to the community who would just as soon keep all growth out. So we have a very unique situation in our little quadrant of West Virginia that makes it a little bit more challenging.

I have no doubt we’ll get table games at Charles Town; it’s only a matter of when. We’ll keep an eye on the fall and that general election. But until our Government Affairs folks and our entire team conclude that it makes sense to run it we will not so we’ll get there. Steve, do you want to talk about Maryland or Kansas or both?

Steven Snyder

Larry, in response to your other questions; in Maryland, we’ve filed the supplemental application with the Lottery Commission on April 15th. They are really right now sitting back waiting to see what’s going to happen with the zoning issues in Anne Arundel County so the Maryland implementation looks like it’s going to take its time. They are still targeting an Award of Licenses by the fall. We’ll wait and see how that progresses.

In Kansas we’ve filed our zoning and our applications for our site plan in Wyandotte County with the Unified Government. We expect, in fact, the first meeting of the Lottery Facility Review Board in Kansas on the Northeast and South Central zones is this Friday. We’ll get more guidance from that meeting but we do expect that the Kansas awards based on the existing schedule under the statute will come some time also in the fall with final review of background and suitability investigation later on in the calendar year.

You had also asked about Kentucky. I think you know Kentucky is pretty much quiet right now pending a special session and we’ll wait and see what happens with that special session.

You also asked about Ohio. Ohio, the Election Board approved our initiative as a single initiative. If you go to one of the Cleveland Cavaliers playoff games you’ll see our signature gatherers. We are diligently out there collecting signatures with the July 1st target of filing no less than 800,000 signatures in anticipation of the required 412,000 or 420,000 that are required. We continue to work in the state of Ohio to build coalitions both with our local communities that we are proposing these facilities in and with the other business and civic leaders around the state to take this question right to the voters.

That’s kind of the water front. I think I covered all of the states that you had asked about but if I forgot one let me know.

Larry Klatzkin- Jefferies

That’s fine, thank you guys; I appreciate the answers.

Operator

Our next question comes from the line of Felicia Hendrix of Barclays Capital; please go ahead, your line is open.

Anthony Palontonio*-Barclays Capital

Actually, this is Anthony Palontoni on behalf of Felicia. First of all, congratulations guys on the numbers; it was a great quarter. This question is on margins I guess. You brought down cost a lot year over year. Are your competitors actually bringing down marketing costs as well or how is the marketing outlook looking in each of your markets?

Peter Carlino

What we’ve seen out there is for the most part all of our competitors in these regional markets have behaved very rationally in the first quarter. We’re not seeing any markets that are under any heavy promotional spending across our marketplace so that’s been a very positive sign.

I think everyone realizes in these difficult economic times that you’ve got to focus your marketing dollars on your best customers that are your most loyal and there’s not the level of prospecting or stealing of share that we’d typically see in these regional markets going back three or five years ago so that’s behaved very, very well.

Concurrently as I said at the outset, we’ve been able to reduce our expenses almost across the entire enterprise commensurate with business volumes that resulted in these margins that you’re seeing in the first quarter.

Anthony Polatonio- Barclays Capital

The one property that didn’t really increase margins that much was Bangor; what’s going on there and how’s the ramp up going at the new property?

Timothy Wilmott

The issue in Bangor is last year we operated in a very small, temporary facility that had very low overhead expense and we moved into the permanent facility in the third quarter of last year that has much higher overhead with utilities and real estate taxes and so forth. We’ve been able to grow the business about 30% trying to penetrate the Southern Maine markets in the Portland area and Augusta. We still have some work to do there.

We’ve got to get our revenue levels higher. We were unfortunately experiencing a difficult winter in Bangor in the first quarter this year more so than last year so the reasons for the deteriorating margins is because we’re operating in a new larger facility that has to grow this business and enhance the revenue levels higher than we’ve currently experienced and that’s what we are focused on. Continue to create trial where the customers can come from, which is primarily from down South.

Peter Carlino

The truth is, we did open this new product in a recession, which hasn’t helped and Maine in particular has been very, very hard hit. I think if you follow the national press there are harder times in the State of Maine so again, there’s some macro-issues that are impacting that facility.

But I think long-term we’ve got a great piece of urban architecture in downtown Bangor. It’s a terrific facility and I think it will be fine.

Anthony Polatonio- Barclays Capital

I guess more of a topical question on acquisitions and developments; would you be one to take on more debt than you have now in order to pursue all your development opportunities and any acquisition at the same time?

Peter Carlino

The answer is sure but at what rate and at what leverage and the long list of…Obviously the world isn’t what it was and I think we have a very realistic sense of where it is today. For the appropriate property with a strong certainty of the kind of EBITDA that we need sure.

Timothy Wilmott

I think I would add on to the comment Peter just made. I think this is a new era in credit and I foresee this new era lasting for a period certainly in the three to four-year range where companies that have got leverage under four times, which is certainly what we would like to accomplish are going to be rewarded with a lower cost of capital.

Certainly you can see that our bonds are currently trading significantly under pretty much everybody else in the gaming industry and that’s because we’ve got the best leverage. Obviously we’ve also got some cash. But we believe that we will have a competitive advantage to the extent that we can make an acquisition and keep our leverage under four times and it would be our goal to do that.

Now, that doesn’t mean that we won’t make an exception. I think Peter touched on it quite eloquently, which is that if a unique once in a lifetime opportunity avails itself and there’s a clear path to de-leveraging to getting back down below four times in a predictable short period that we would certainly look at going over four times leverage.

But just a run of the mill acquisition development story I don’t think we would expect to take our leverage up over four times. I think we’ll be rewarded with that with a lower cost of capital than the people we will be competing with, which will give us an advantage obviously on purchase price as well as other…Based on our mechanisms and our methodology will give us an advantage to be able to make sure that we’re not losing out on any opportunities that may come down the path.

Operator

Our next question comes from the line of Dennis Forst from Keybanc; please go ahead sir, your line is open.

Dennis Forst- Keybanc

I just had a couple of items for Bill. First of all, capitalized interest in the quarter; was there much of that?

William Clifford

There was roughly $2.9 million.

Dennis Forst- Keybanc

And then Cap ex in the quarter and for the second quarter expectations?

William Clifford

Let me give you the first quarter. We had $63.6 million of total Cap ex. That broke out to roughly $47.6 million in project Cap ex and roughly $16 million of maintenance. In the second quarter we’re looking at $97 million of Cap ex, which would be $71.4 million of projects, roughly $25 million of maintenance Cap ex and obviously that’s made up primarily of Lawrenceburg, which will be in the final stretches of getting completed. For the year we’re looking at total Cap ex of roughly $300 million, which breaks out between project roughly $213 million and roughly $89 million of maintenance Cap ex, although roughly $10 million of it could be characterized as projects.

Dennis Forst- Keybanc

Where does Joliet fall into those numbers?

William Clifford

Joliet; right now we’re still in the process of understanding exactly what our reconstruction costs are and how much we’re going to get reimbursed from the insurance companies. At this point in time we’re basing our estimates and it’s clearly not as a result of any negotiations or feedback or anything else. But it’s our expectation that we’ll spend the $50 million that we had originally projected to spend and that the incremental spend around the pavilion and whatever modifications we may do at the site will be reimbursed from the insurance proceeds.

Dennis Forst- Keybanc

No guesstimate yet of what that incremental spend might have to be?

William Clifford

It’s way too early; there’s two problems. One is we really aren’t anywhere near finished with our estimate on the cost of rebuilding the existing facility as it was, which is the amount that we’re going to be entitled to and we’re not even finished with the conceptual drawings yet of what we intend to build.

So between those two I’ve got two major pieces of information that we just don’t have today. I think clearly I will say this that it’s certainly going to be our goal not to over-spend relative to what the original cost of rebuilding was and that we won’t be spending in excess of the insurance proceeds for that part of the rebuild after factoring in the $50 million.

Peter Carlino

In fact, you can count on that because we’re not starting until we have all of that in hand. We’ve got bid prices. We will execute a plan with bid prices in hand. Then and only then do we commence to do whatever it is we’re going to do. We’re going to be very disciplined about that and cost control is the name of the game for us.

Dennis Forst- Keybanc

Bill, I just wanted to understand your clarification on the Empress impact for the rest of the year. In the guidance you say the impact for $5.7 million of EBITDA, meaning you were expecting $5.7 million and now it’s going to be zero right?

William Clifford

That’s correct.

Dennis Forst- Keybanc

Then the full year once you reopen the boat you will have EBITDA in the third and fourth quarter will you not?

William Clifford

Yes we will. That number that I gave earlier was the difference.

Dennis Forst- Keybanc

The 14.8.

William Clifford

Right because we were originally expecting to be substantially complete with a complete facility I believe in the third quarter of this year and we are now going to be obviously operating out of a temporary facility and we are going to expect that our results will not be as robust as they will be when we have a fully functional facility. Not to mention the construction disruption of customers who will be…obviously as we’re rebuilding the pavilion it’s going to be a big task on our part to be able to figure out a way to get customers on to the casino facility and not have an impact.

Peter Carlino

Let me interject. We had an interesting experience as we were constructing the $50 million in improvements that we had promised that though we were tunneling people through the construction and it was indeed a pretty heavily affected construction site our business was improving. There had been some serious thought, I think, for a while of just kind of leaving it that way because we’re doing so well. Tim, do you want to…?

Timothy Wilmott

The only thing I will also say, Dennis, is when we do open the casino at the end of the second quarter we have accelerated all the work in the VIP areas on the boat and all the casino work so it’s going to be a brand new casino experience. We’re going to have a temporary buffet offering plus a small grill area for food. But the entire casino experience will be brand new and very competitive with the other offerings in Chicagoland.

What we won’t have are all the landside non-gaming amenities yet and that’s what we’re working on as Peter and Bill have said. It’s still in the conceptual stages of how we’re going to rebuild Joliet.

Dennis Forst- Keybanc

So the casino itself will look approximately like you wanted it to look assuming everything went as planned?

Timothy Wilmott

That is correct.

Dennis Forst- Keybanc

I assume, Bill, that along with the lower expectations of EBITDA that there will be some cutback in depreciation too given that the pavilion is not there?

William Clifford

Absolutely. In the second quarter we will recognize no depreciation and then in the third and fourth quarter the only thing that we will be…There will be no depreciation recognized on the pavilion obviously because that’s…

Dennis Forst- Keybanc

Yes, just about. Then lastly, corporate expense was up I think $3 million in the quarter. What did that pertain to?

William Clifford

Roughly two-thirds of that is for lobbying efforts in a variety of locations but primarily Ohio. Also we had some incremental outside services related to work we’re doing on pursuing a variety of opportunities.

Dennis Forst- Keybanc

That’s an evil laugh Peter and thank you very much.

Operator

Our next question comes from the line of Carlo Santarelli from J.P. Morgan. Please go ahead sir; your line is open.

Carlo Santarelli- J.P. Morgan

Just a question; I know you don’t want to talk too much in detail about any potential acquisitions but from your conversations would you say the bid assets for strip assets right now have narrowed or are coming down at least?

Peter Carlino

I’m going to be cute and say no, they haven’t moved an inch but that doesn’t say that something doesn’t happen. That’s the only answer I’m going to give you. My sense is no, that there’s a huge disconnect between perceived value or value that one had in any kind of real estate asset or assets generally and what they’re really worth today.

Of course that, as we try to emphasize, is much constrained by the cost of money. We all know what drove the kind of pricing that we saw before and it is gone. But there are other events putting pressure on these issues that are going to cause some of these things to spring loose.

There are a lot of projects that are partly completed. You know all the stories so that some of these may become available at a reasonable price. There’s very little else that can be said.

Carlo Santarelli- J.P. Morgan

Understood and if you don’t mind I have one follow-up; I was wondering if you guys could discuss a little bit about April trends and possibly how you’re thinking about reaching maybe peak property level margins on flattish revenues going forward? If you guys could comment on that stuff that would be great, thank you.

Timothy Wilmott

I think as I said at the beginning the first three weeks of April have started out and looked very much like January so really just slightly ahead of our expectations, a little bit better than March. We continue to look at opportunities where they are out there to be more efficient in managing our cost structure but I think we’ve got it pretty tightened down.

We always have some opportunities but I think as revenue levels continue to grow hopefully through the course of 2009 as we get into the summer months especially with the third quarter being the strongest quarter we have I think we’re well positioned to handle those business volumes with our current cost structure.

Carlo Santarelli- J.P. Morgan

That’s helpful guys; thank you very much.

Operator

Our next question comes from the line of Larry Haverty from Gameco; please go ahead sir, your line is open.

Larry Haverty- Gameco

Hi Peter, a couple questions; one, the idea that you’d be interested in one facility only on the Las Vegas strip is kind of strange given that the principle players there have very significant frequent flyer programs on their slot play and especially given the lineage of Tim coming from Harrah’s. I’m just curious as to whether you’ve decided that these frequent flyer programs that MGM and Harrah’s have are less of a competitive barrier than perhaps they’ve been telling us? Then I have one follow-up question.

Peter Carlino

I think a couple of us can take a whack at that because it’s actually an interesting question. We are not Harrah’s, we are not MGM, nor do we aspire to be. We don’t want to own Las Vegas. We don’t want to own the Strip. What we want and believe we need to sort of round out our portfolio is a good product, well located that fits the profile of our customer base. So you can quickly conclude that we’re not looking for Asian play. We’re not flying people in from far off places. We’re looking for the kind of product that’s going to serve the kind of folks who frequent our properties and that’s it.

To that end, by the way, we are working very diligently, which Tim could tell you more about in completing our integrated database, which I trust we’ll have complete by the end of 2009 to serve that purpose. We don’t need to have the largest properties. We don’t need to have even necessarily the best property. We need a good property. There are actually quite a few locations that could serve our purpose, some of which might surprise you in their lack of grandeur if you will.

Again, we’re already spending too much time in that area but at least it gives you a sense of our philosophy about how we’ll use this. We’re not trying to make Las Vegas the power base of the company. We want a spot there and no more, Tim.

Timothy Wilmott

But we do, Larry, know already that we have between 3.5 million and 4 million customers that we have relationships with already at our casino properties. As Peter said, we’re consolidating on a common data warehouse platform that will give us certainly an opportunity because we know these customers are already going to Las Vegas. To give them reason to once we do get a property there on the Strip, give them a good reason to stay with us.

That’s where we see some potential upside in moving that business to Las Vegas to benefit down the road an asset that we’ll have there.

Larry Haverty- Gameco

Will you have an integrated card system for your entire set of stores relatively soon?

Peter Carlino

Not an integrated card, Larry, because we don’t have the cross-market visitation that a Harrah’s has. We have some strong crossover regions in Chicagoland and down in Biloxi but it doesn’t warrant the level of investment in IT technology because there isn’t the benefit to be realized.

But with this common platform where the customer warehouse will reside we’ll be able to offer rewards and recognition and marketing interventions to customers to give them reasons to stay with us in Las Vegas that doesn’t warrant a big investment to have a common card that works across all our properties.

Larry Haverty- Gameco

Then kind of along similar lines you’ve got a new casino in Pennsylvania and I think if I were you I’d be very happy with what that’s doing and you’ve got a lot of old casinos. I’m kind of fascinated whether you believe some folks in the industry that operators are really restraining from replacing slot machines. Since you’ve got a lot of old stores or old slot machines and then one store with new slot machines whether you could share with us what your experience is on the differential productivity of the old ones and the new ones and how you are looking at replacement demand for slots?

Peter Carlino

Larry, the one thing we haven’t done is cut back any of our maintenance capital towards refreshing our slot floor with new products. Anywhere between one-sixth and one-seventh of the floor gets changed out annually. So even though we do have some facilities that are older in age the slot floor is very competitive with everything else that’s going on in their respective marketplaces.

Even though Penn National is a little over a year old their slot floor doesn’t look much different than what we have for example in Aurora or in Riverside in Kansas City because we make sure that we keep the product fresh and competitive.

Timothy Wilmott

I will also add that a lot of our facilities ironically have been…you had significant Cap ex put into them really aren’t as old as you might necessarily associate them to be. Lawrenceburg is obviously going to be fresh. Charles Town has been ongoing with expansions and new product over the last several years. The Gulf Coast as a benefit of Hurricane Katrina is all brand new construction for all intents and purposes. It’s still the same location, same site.

William Clifford

Riverside is a fresh product.

Timothy Wilmott

Aurora had just before we bought it roughly five years ago; it had a brand casino barge facility added on. Joliet now is going to be a really fresh and new product. Certainly GFR is just a couple of years old.

Generally, I think that’s one of the misconceptions about Penn is that our properties are older. The reality is that we really don’t think for the most part that we have any facilities that are really that old or dated relative to what we would need out of the properties.

Larry Haverty- Gameco

I gather from some of the earlier comments you don’t think that your friends at the banks have gotten more hospitable in the last three months, that there hasn’t been any easing of conditions there in the bank markets that you deal with?

Peter Carlino

I think what we’re starting to see and you can see it in the sub-debt market is there clearly has been an inflow of cash. There’s been a pretty nice run up of late on bonds. The banks on the other hand you’re seeing some amendments get done but we’re not seeing a complete resurgence in the bank lending part.

The numbers we’re hearing are indicating…I get conversations from bankers that tell me that if I was to go out and redo my senior paper I’d pay more than where my sub-debt is currently trading. To me that’s a disconnect that totally hasn’t caught up yet. I have every expectation that in the next several months that that will probably change a bit. But right now I would say that the bond market is actually healthier than the bank market.

Operator

Our next question comes from the line of Nicole Teraco* from Virgin* Capital; please go ahead, your line is open.

Nicole Teraco- Virgin Capital

I’m wondering if you could just help me bridge from your prior EBITDA guidance to your revised guidance for the year? I assume part of that is Joliet and part of that is the better than expected results for this quarter but it seems there’s a little piece missing if you just do that math with those numbers.

Timothy Wilmott

Yes. The math there relates to the…in other words, there’s roughly $17 million from Joliet that’s missing. Obviously the improved results in the first quarter and then there’s $3 million for Pennsylvania regulatory costs.

William Clifford

Unanticipated costs.

Timothy Wilmott

Unanticipated regulatory cost.

Nicole Teraco- Virgin Capital

So your view in terms of the overall environment you could say has not really changed since?

Timothy Wilmott

No. The way we looked at it and our guidance is that we say slightly positive results in January, slightly negative in March and we saw February, which was really outstanding but certainly not in our opinion at this point worthy of assuming that that’s going to carry us on throughout the year.

So what we’ve done is effectively less guidance in alignment with where we were and we’re treating February as an anomaly rather than a sustainable trend. Obviously we’re hoping we’re wrong and if all the sudden we see a lot more February’s then obviously we’ll handily beat the numbers that we’ve got. But we don’t have any data points that give us that confidence that February is going to be recurring, those kinds of results.

Nicole Teraco- Virgin Capital

That $3 million of Pennsylvania regulatory charge; is that a one-time thing or is that something that’s going to be in there…?

William Clifford

We hope it is.

Peter Carlino

Just to comment about that; that’s an assessment, so-called Special Assessment that they would undoubtedly argue the Gaming Board is the result of the delays in opening some of the yet to be opened facilities. In other words, they are not getting the contribution they expected from the full compliment of the Pennsylvania facility.

Now, that having been said, frankly the costs are too darn high period and are spending and squandering too much money and I don’t mind saying that publicly but it is kind of what it is. It’s a one-time charge, something we I guess to the degree we can try to work with them to influence but it’s a supplemental charge.

Nicole Teraco- Virgin Capital

What is outstanding on your revolver right now?

William Clifford

Outstanding on the revolver at the end of the first quarter we had $117 million.

Nicole Teraco- Virgin Capital

I was wondering if you could talk a little bit about your strategic rationale in wanting to acquire or thinking about buying a property on the Strip? I think part of, especially in this environment, part of the perceived value of your company is that you don’t have a property on the Strip and that you’re all local exposure and that you’re not exposed to the really fear declines that Las Vegas has seen and what a lot of people perceive is over capacity there. I was wondering if you could talk about that?

Peter Carlino

Several of us will probably take a whack at that one. Clearly you have to have a view about the future of Las Vegas. Some of us here think that the future of Las Vegas is incredibly bright. It, for a whole lot of reasons, has so much critical mass today. It is without a doubt the greatest entertainment city in the world. Despite the current problems and the over capacity, which by the way, is going to get worse and we’re totally realistic about that, much worse as you look to the future.

We believe that Las Vegas will in time absorb that capacity and return to a very, very robust, very exciting, dramatic place to be and you’ve got a lot of other good things helping you. California is in implosion. I love to say that and more and more people will continue to exit that state as fast as they can get out the door, people and businesses. That’s going to eventually crop up and continue the growth cycle that Las Vegas has long seen.

This is a temporary disruption. It could take several years to unfold and will frankly but our view is it’s a great city. It will be successful. It’s a good time for us to sort of plant our flag there but in a modest way. Remember, I said earlier, we have no ambition to own Las Vegas. We just want our own little corner of the world there and no less and no more.

William Clifford

I would add on to that that it’s also our view quite candidly that once we get through the expansion of properties that are trying to get finished right now and obviously some are progressing more smoothly than others. But once those projects get done we don’t really see a whole lot more construction and added capacity coming into the town for quite an extended period of time.

While the town is absorbing the additional capacity and returning to more robust levels that that will create an opportunity for us to participate in that upswing that we think will happen in Las Vegas over the next five years.

Obviously the one caveat is that we are not going to stretch too far to get something in Las Vegas. It’s not a mission critical statement. It’s a goal and we’re never going to deviate from our overall philosophy of growing free cash flow in our pursuit to get to Las Vegas. We believe it is the mechanism that will enhance that.

The one thing you can’t fix is over paying for an asset and so that’s part of our discipline here. We’ll look at it and take a view and we’re doing a lot of analysis on Las Vegas understanding the history of it, understanding revenues per occupied room, where they trended in 2003 really through 2008, where do we think those revenues are going to go in the future.

We are going to hopefully take an educated view as to what we think the average revenue per room in Las Vegas is going to be for the next five years and reasonable margins around that and base our acquisition price on what we think the town is going to do. Then more specifically whichever property we should be so fortunate as to be able to negotiate for.

Peter Carlino

Bill, I think you did a terrific job. Then if I have to say so it’s not mission critical and that’s a good way to explain it. I emphasize again if you look at the new capacity that is just ahead of us that things are going to get much worse before they get better. That’s my view. Do the math on average room rates and look at the new capacity. Tim, do you want to add to that?

Timothy Wilmott

I couldn’t say it better than you guys did. I think 2009, 2010 and 2011 are going to be tough years but there’s no other place in the world like Las Vegas. It’s a long-term vision that we think Las Vegas is going to be a very viable market for us five, seven, ten years down the road. That’s why we have an interest in it and being there and being part of that growth story.

Nicole Teraco- Virgin Capital

Thanks; I appreciate your thoughts on that.

Operator

Our next question comes from the line of Ryan Worst of Brean Murray; please go ahead sir, your line is open.

Ryan Worst- Brean Murray

In terms of the acquisition priority, Peter, obviously you’ve thoroughly covered Las Vegas but are there any other markets that you are still interested in?

Peter Carlino

Any of the big markets. The view today is that if there’s gaming happening Penn has to be there to the best degree that we possibly can. That’s why you see us in all the new venues and why our Government Affairs folks are in such places as Massachusetts and Texas and Kentucky and you name it. There’s not a place that we’re not at least looking around to make sure that we are competitive in there if it’s going to open up.

There are some markets we’ve been fiddling around and have in the past; Detroit. Specific spots are really not important. I think you can conclude that if there’s an opportunity Penn’s there somewhere. We may not actually get to the goal line because we choose not to but if it’s out there in the US we’re there. I can promise you that.

Ryan Worst- Brean Murray

Bill, in terms of Lawrenceburg you guys mentioned that there’s going to be some preopening and construction disruption; any kind of idea of how much that would cost and I guess most of those costs would be incurred in the second quarter?

William Clifford

That’s right. We try and stay away from specific guidance. I’m not sure if Tim wants to talk about the amount. The preopening is going to be fairly minimal. I think the biggest part of the destruction is actually the actual transfer of operations from the existing boat to the new boat and that’s really where we see the bulk of it.

Peter Carlino

There’s going to be a time, Ryan, some time in late June where we’re going to have to shut the casino down and move product over to the new casino vessel but we’re on schedule with everything. We expect to open this in the beginning of the third quarter and we’re going to be on budget and I think we’re going to have a category killer product in Lawrenceburg.

We’re going to be re-branding Lawrenceburg to a Hollywood and it’s going to create a whole new experience for t customers there. I think the level of disruption at the end of the second quarter will be minimized and it won’t be that material.

Ryan Worst- Brean Murray

Tim, what do you think about the impact of the racinos; is that waning a little bit or are you still seeing a significant impact in terms of your customer base?

Timothy Wilmott

We certainly did see the impact when Indiana Live opened up their $200 million expansion in the mid part of March. That certainly affected business there. We have not seen any waning of business away from the racinos. If you look at their March results I think they were the best on a combined basis than they have been since they opened the middle part of last year. We’ve lost about 60% of our business from the Indianapolis market into Lawrenceburg.

Certainly the capital that just went into play there has created a whole new level of energy and excitement at Indiana Live so we’re still having that play out and affecting our business a bit in Lawrenceburg.

Ryan Worst- Brean Murray

On the corporate expense side do you expect that number to kind of stay elevated over the next few quarters?

William Clifford

I think the biggest number we’ve got to worry about is obviously what we might be doing in Ohio. If we get into a full-blow campaign those expenses could certainly continue and maybe ramp up slightly. But other than that I don’t see our corporate expenses deviating much.

Operator

Our next question comes from Lawrence Goldstein of Santa Monica Partners; please go ahead sir, your line is open.

Lawrence Goldstein- Santa Monica Partners

Peter, we’ve been shareholders from the day of the public offering courtesy of Tony Pollock convincing us and we’ve been happy ones. It seems to me that listening to conference over the years and so on that really nothing has changed. There are just more zeros, more development, more acquisition, more spread, more states and always EBITDA.

There was one thing that was different and I would appreciate a comment on it and that was the sale of the company that obviously didn’t go through. The thinking had to clearly change at that point, at the point of the decision to sell the company.

Your colleague just mentioned a moment ago that when you think long-term you’re thinking about where you want to be I think you said seven to ten years, seven or eight years out, which is just great. My question is having gone through that experience what might shareholders look forward to as the end game; a succession to you when your day to retire comes or are we going to be part of something else?

Peter Carlino

Wow, that’s like hearing true confession or something; that’s an interesting question, probably the one thing I was really not prepared to answer but let’s take a whack at it. There’s no mystery.

I don’t think any of us here are looking at an end. We view ourselves, frankly, as at the beginning.

The sale process is just one of those unfortunate things. I think we had the right idea at the right time. The goal here is always to maximize shareholder value. I know we say it every piece of literature we put out but it is a religion here. We are not confused as management of this company what our goal is. It’s the game if you will; it’s the game we play. It is to build a bigger, better, smarter company but never at the expense of…remember, it’s about building shareholder value.

Now, I’ve been very correct in trying to measure value of course looking at our stock price day to day. If you look at the history of that over time you can get whiplash looking at the up and down and up and down and frankly it’s not an issue that I spend any time thinking about; not at all.

People wander into my office and say, “Do you see what our stock did today?” I say, “No, I haven’t any idea nor frankly do I care” because markets are ephemeral. We get calls. It was a surprise in our first years as a public company when people would call. I can understand when the price was down and God, what’s going on? They would call just as frequently as the price went up; why’s it up? Of course then I started giving smartass answers like there’s more buyers than sellers, who knows?

Our view is simple. If you put up the numbers day in day out year in year out the market figures it out. I am interested in the trend line, not in the data point day to day. So that if you look at Penn over a long period of years and thank God we’ve been able to build this business and build earnings and do all those things that would justify the kind of performance that we’ve had that has been very good and thank God we’ve been able to do that.

We got to a point where I judged that there was a terrific opportunity. We weren’t out to sell this company. It was not a goal; had never crossed my mind. But, again, my responsibility is to shareholders, to my family who I represent and whose shares frankly I vote and to whom I’m responsible and to every other shareholder in this company.

So that if the price is at a level where you say to yourself, “My gosh, that’s awfully appealing; I think we’ll take it” of course we would do that and we did it in a nanosecond. It was the right idea at the right time. I like where tax rates were. I had a view that capital gains taxes weren’t going to stay where they were and my worst fears have been more than realized.

So we made the right choice. We maybe did six months too late in kind of getting there because of the unique nature of this business. The long time, the long regulatory process of approval and we just didn’t quite make it to the goal. There’s nothing we could have done different or better. It’s incredibly sad say I as a shareholder to all of you who have been with us but that game’s over.

We exited with a fair settlement and we’re trying to do the very best we can do. Again, I can’t worry when the stock hits silly numbers. What we do is take a view here; we’re back in a new game again. We’re an ever stronger company than we ever were before and now we’re off to the new horizon with the same goals in mind.

Where that path will lead, will we be a public company, independent 100 years from now I kind of hope so, a hundred years from now long after I’m gone. But the course will take what it will take.

You’re asking philosophy really and I’m telling you that we’re just back to a new base and happily better than most.

William Clifford

That’s right and I would add on to that when we were back in that period we were in competitive bid situations looking to buy assets in companies and organizations and finding ourselves at roughly 70% of the winning bid. We came to the recognition that we really weren’t going to be able to buy anything given where the markets were and where the appetite was.

Further, when you compounded that and I’m not going to say I could take credit for predicting the demise of the credit market but I knew it wasn’t going to get any better than when people were able to borrow money at nine times what others [inaudible] plus 200 or 250. It wasn’t going to get any better than that. That’s really what caused multiples to go where they were at the time or at least that’s my view that that’s what caused multiples to go at the time because very cheap capital at high leverage rates allowed you to pay very, very incredibly high prices for companies and still generate a positive return for the equity.

So a combination of those events led us to the conclusion that the valuations that we could get for the company were stuff that we probably wouldn’t see…it was irresponsible not to take advantage of that era and that time. Obviously as Peter just indicated we were about six months late but at least for having gone through the effort and charged ahead we certainly came out better for having tried than had we not done anything at all. That’s obviously in the form of the settlement that we got after the deal didn’t happen.

Peter Carlino

Other than lamenting what might have been; I think all of us do a little bit of that, everybody in the corporate staff as well but that’s yesterday’s news. We’re well onto now doing what we must do to start that climb to growth again.

We have a view that over the next few years if things go our way and we run this company responsibly that we have every opportunity to get back to the same kind of number even inflation adjusted and cost of carry adjusted to get shareholders back to where we’d like them to be so that’s our view.

Lawrence Goldstein- Santa Monica Partners

It sounds like in summary of that long-winded and I appreciate response if somebody’s willing to pay more than it’s worth you’ll have to pay attention to that and just as you indicated you may bid 70% of what transaction took place. When you can buy something below what it’s worth you’ll buy and in between you’re going to keep your nose to the grindstone, stick to the last.

By the way, I wasn’t saying too bad you didn’t sell. I was saying what should we look forward to in the future, being independent or not? I am frankly very delighted that you didn’t sell because I don’t see any reason why if you stick to your last you won’t grow bigger faster.

Peter Carlino

We appreciate that point of view and that’s certainly our attitude here. Besides, it is what it is and we’re off to the next segment so…

Operator

Our next question is from the line of Jim Bradshaw from Bares Capital Management; go ahead sir, your line is open.

Jim Bradshaw- Bares Capital Management

Most of my questions have been answered. I was just wondering if you purchased any corporate bonds this quarter?

William Clifford

No. We didn’t have any activity around corporate bonds or stock buyback in the first quarter.

Peter Carlino

Operator, I think we’re going to give this just a few more minutes and then we’re going to have to call it so let’s take one or maybe two more questions.

Operator

Gentlemen, I will send the conference back to you for concluding remarks.

Peter Carlino

Maybe I scared everybody away. As always, we thank you for joining us today. I hope we’ve given you a flavor of what’s going on here at Penn and we look forward to seeing you again next quarter; thanks very much.

Operator

Thank you. Ladies and gentlemen, that does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect. Thank you once again; have a great day.

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Source: Penn National Gaming, Inc. Q1 2009 Earnings Call Transcript
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