3. Summary of Significant Accounting Policies

Revenue Recognition and Promotional Allowances

The Company’s revenue from contracts with customers consists of gaming wagers, food and beverage transactions, retail transactions, hotel room sales, racing wagers, management services related to our management of external casino’s, and reimbursable costs associated with our management contracts.

The transaction price for a gaming wagering contract is the difference between gaming wins and losses, not the total amount wagered. The transaction price for food and beverage, hotel and retail contracts is the net amount collected from the customer for such goods and services. Sales tax and other taxes collected on behalf of governmental authorities are accounted for on the net basis and are not included in revenues or expenses. The transaction price for our racing operations, inclusive of live racing events conducted at our racing facilities and our import and export arrangements, is the commission received from the pari-mutuel pool less contractual fees and obligations primarily consisting of purse funding requirements, simulcasting fees, tote fees and certain pari-mutuel taxes that are directly related to the racing operations. The transaction price for our management service contracts is the amount collected for services rendered in accordance with the contractual terms. The transaction price for our reimbursable costs associated with our management contracts is the gross amount of the reimbursable expenditure, which primarily consists of payroll costs, incurred by the Company for the benefit of the managed entity.

Gaming revenue contracts involve two performance obligations for those customers earning points under the Company’s loyalty reward programs and a single performance obligation for customers that do not participate in the programs. The Company applies a practical expedient by accounting for its gaming contracts on a portfolio basis as such wagers have similar characteristics and the Company reasonably expects the effects on the condensed consolidated financial statements of applying the revenue recognition guidance to the portfolio to not differ materially from that which would result if applying the guidance to an individual wagering contract. For purposes of allocating the transaction price in a wagering contract between the wagering performance obligation and the obligation associated with the loyalty points earned, the Company allocates an amount to the loyalty point contract liability based on the stand-alone selling price of the points earned, which is determined by the value of a point that can be redeemed for slot play and complimentaries such as food and beverage at our restaurants, lodging at our hotels and products offered at our retail stores, less estimated breakage. The allocated revenue for gaming wagers is recognized when the wagering occurs as all such wagers settle immediately. The loyalty reward contract liability amount is deferred and recognized as revenue when the customer redeems the loyalty points for slot play and complimentaries and such goods and services are delivered to the customer.

Food and beverage, hotel and retail services have been determined to be separate, standalone performance obligations and the transaction price for such contracts is recorded as revenue as the good or service is transferred to the customer over their stay at the hotel or when the delivery is made for the food and beverage or retail product. Cancellation fees for hotel and meeting space services are recognized upon cancellation by the customer and are included in food, beverage, hotel and other revenue.

Racing revenue contracts, inclusive of the Company’s (i) host racing facilities, (ii) import arrangements that permit the Company to simulcast in live racing events occurring at other racetracks and (iii) export arrangements that permit the Company’s live racing event to be simulcast at other racetracks, provide access to and the processing of wagers into the pari-mutuel pool. The Company has concluded it is not the controlling entity to the arrangement, but rather functions as an agent to the pari-mutuel pool. Commissions earned from the pari-mutuel pool less contractual fees and obligations are recognized on a net basis which is included within food, beverage, hotel and other revenue.

Management services have been determined to be separate, standalone performance obligations and the transaction price for such contracts is recorded as services are performed. The Company records revenues on a monthly basis calculated by applying the contractual rate called for in the contract.

Penn Interactive Ventures generates in-app purchase and advertising revenues from free-to-play social casino games which can be downloaded to mobile phones and tablets from digital storefronts. Players can purchase virtual playing credits within our social casino games which allows for increased playing opportunities and functionality. Penn Interactive Ventures records deferred revenue from the sale of virtual playing credits and recognizes this revenue over the average redemption period of the credits which is approximately three days. Advertising revenues are recognized in the period when the advertising impression, click or install delivery occurs. Penn Interactive Ventures also generates revenue from revenue sharing arrangements with third party content providers whereby revenues are recognized on a net basis since Penn Interactive Ventures is not the controlling entity in the arrangement.

Reimbursable management costs associated with the Company’s management contracts represent amounts received or due pursuant to the Company’s management agreement for the reimbursement of expenses, primarily payroll costs, incurred by the Company on the managed facility’s behalf. The Company is the controlling entity to the arrangement, therefore the reimbursement is recorded on a gross basis with an offsetting amount charged to operating expense.

Promotional Allowances

The retail value of accommodations, food and beverage, and other services furnished to guests for free as an inducement to gamble is included in food, beverage, hotel and other revenue and offset as a deduction to gaming revenue in accordance with the new revenue standard and consists of the following for the period ended March 31, 2018:


Three Months Ended March 31,	2018
	(in thousands)
Lodging	$	9,687
Food and beverage		22,976
Other		976
Total amount recorded in food, beverage, hotel and other revenues and offset to gaming revenues	$	33,639

The estimated cost of providing such complimentary services to guests for free as an inducement to gamble is included in food, beverage, hotel and other expenses and consists of the following for the period ended March 31, 2018:



Three Months Ended March 31,	2018
	(in thousands)
Lodging	$	1,291
Food and beverage		8,619
Other		293
Total cost of complimentary services included in food, beverage, hotel and other expense	$	10,203

Revenue Disaggregation

The Company is a geographically diversified, multi-jurisdictional owner and manager of gaming and racing facilities and video gaming terminal operations. Our operations are focused in regional gaming markets located within the Northeastern, South/Western and Midwestern United States. We also manage casinos for other entities in the United States and Canada. We generate revenues at our owned and operated properties by providing the following types of services: (i) gaming, (ii) food and beverage, (iii) lodging, (iv) racing, (v) reimbursable management costs and, (vi) other. Our revenue disaggregation by type of revenue and geographic location is as follows (in thousands):


Three Months Ended March 31, 2018	Northeast		South/West		Midwest		Other		Total

Gaming	$	355,785	$	97,547	$	201,162	$	-	$	654,494
Food and beverage		19,180		28,279		15,921		263		63,643
Lodging		1,967		23,601		7,953		-		33,521
Racing		5,276		7		-		1,527		6,810
Reimbursable management costs		21,844		6,340		-		-		28,184
Other		10,115		5,522		5,050		8,746		29,433
Total net revenues	$	414,167	$	161,296	$	230,086	$	10,536	$	816,085

Customer-related Liabilities

The Company has two general types of liabilities related to contracts with customers: (i) our loyalty credit obligation and (ii) advance payments on goods and services yet to be provided or for unpaid wagers.

The Company’s loyalty reward programs allow members to utilize their reward membership cards to earn loyalty points that are redeemable for slot play and complimentaries such as food and beverages at our restaurants, lodging at our hotels and products offered at our retail stores across the vast majority of the Company’s casino properties. The Company accounts for the loyalty credit obligation utilizing a deferred revenue model, which defers revenue at the estimated fair value when the loyalty points are earned by our customers. Revenue associated with the loyalty credit obligation is subsequently recognized into revenue when the loyalty points are redeemed. The deferred revenue liability is based on the estimated standalone selling price of the loyalty points earned after factoring in the likelihood of redemption.

The Company’s loyalty credit obligation was $22.4 million at March 31, 2018 compared to $24.7 million upon the adoption of the new revenue standard at January 1, 2018. Our loyalty credit obligations are generally settled within six months of issuance. Changes between the opening and closing balances primarily relate to the timing of the customer’s election to redeem loyalty points for complimentaries and products offered at our food and beverage outlets, hotels and retail stores.

The Company’s advance payments on goods and services yet to be provided or for unpaid wagers primarily consist of the following: (i) deposits on rooms and convention space, (ii) money deposited on behalf of a customer in advance of their property visitation (i.e. front money), (iii) outstanding tickets generated by slot machine play or pari-mutuel wagering, (iv) outstanding chip liabilities, (v) unclaimed jackpots and (vi) gift cards redeemable at our properties.

Advance payments on goods and services are recognized as revenue when the good or service is transferred to the customer. Unpaid wagers primarily relate to the Company’s obligation to settle outstanding slot tickets, pari-mutuel racing tickets and gaming tokens with customers and generally represents obligations stemming from prior wagering events of which revenue was previously recognized.

The Company’s advance payments on goods and services yet to be provided or for unpaid wagers were $21.1 million and $21.2 million at March 31, 2018 and December 31, 2017, respectively, of which $1.2 million and $1.3 million are classified as long-term.

Gaming and Racing Taxes

The Company is subject to gaming and pari-mutuel taxes based on gross gaming revenue and pari-mutuel revenue in the jurisdictions in which it operates. The Company primarily recognizes gaming and pari-mutuel tax expense based on the statutorily required percentage of revenue that is required to be paid to state and local jurisdictions in the states where or in which wagering occurs. In certain states in which the Company operates, gaming taxes are based on graduated rates. The Company records gaming tax expense at the Company’s estimated effective gaming tax rate for the year, considering estimated taxable gaming revenue and the applicable rates. Such estimates are adjusted each interim period. If gaming tax rates change during the year, such changes are applied prospectively in the determination of gaming tax expense in future interim periods. For the three months ended March 31, 2018, these expenses, which are recorded primarily within gaming expense in the condensed consolidated statements of income, were $247.4 million, as compared to $244.4 million for the three months ended March 31, 2017.

Long-term asset related to the Jamul Indian Village

The unpaid principal balance of the loan to the Jamul Indian Village Development Corporation (“JIVDC”) at March 31, 2018 and December 31, 2017 was $98.5 million and $98.3 million, respectively. The net carrying value of the loan to the JIVDC totaled $20.6 million and $20.9 million at March 31, 2018 and December 31, 2017, respectively. The Company’s remaining exposure at March 31, 2018 was $27.6 million inclusive of future unfunded commitments on the loan.

Earnings Per Share

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

The following table reconciles the weighted-average common shares outstanding used in the calculation of basic EPS to the weighted-average common shares outstanding used in the calculation of diluted EPS for the three months ended March 31, 2018 and 2017:


	Three Months Ended March 31,	Three Months Ended March 31,
	2018	2017
	(in thousands)
Determination of shares:
Weighted-average common shares outstanding	91,191	90,751
Assumed conversion of dilutive employee stock-based awards	3,260	1,105
Assumed conversion of restricted stock	199	61
Diluted weighted-average common shares outstanding	94,650	91,917

Options to purchase 646,307 and 4,545,585 shares were outstanding during the three months ended March 31, 2018 and 2017, respectively, but were not included in the computation of diluted EPS because they were antidilutive.

The following table presents the calculation of basic and diluted EPS for the Company’s common stock for the three months ended March 31, 2018 and 2017 (in thousands, except per share data):


	Three Months Ended March 31,		Three Months Ended March 31,
	2018		2017
Calculation of basic EPS:
Net income applicable to common stock	$	45,437	$	5,104
Weighted-average common shares outstanding		91,191		90,751
Basic EPS	$	0.50	$	0.06

Calculation of diluted EPS using two-class method:
Net income applicable to common stock	$	45,437	$	5,104
Diluted weighted-average common shares outstanding		94,650		91,917
Diluted EPS	$	0.48	$	0.06

Stock-Based Compensation

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

The fair value for stock options is estimated at the date of grant using the Black-Scholes option-pricing model, which requires management to make certain assumptions. The risk-free interest rate was based on the U.S. Treasury spot rate with a term equal to the expected life assumed at the date of grant. Expected volatility was estimated based on the historical volatility of the Company’s stock price over a period of 5.30 years, in order to match the expected life of the options at the grant date. Historically, at the grant date, there has been no expected dividend yield assumption since the Company has not paid any cash dividends on its common stock since its initial public offering in May 1994 and since the Company intends to retain all of its earnings to finance the development of its business for the foreseeable future. The weighted-average expected life was based on the contractual term of the stock option and expected employee exercise dates, which was based on the historical and expected exercise behavior of the Company’s employees. The Company granted 661,175 and 1,446,353 stock options during the three months ended March 31, 2018 and 2017, respectively.

Stock-based compensation expense for the three months ended March 31, 2018 was $2.9 million as compared to $2.2 million for the three months ended March 31, 2017, and is included within the condensed consolidated statements of income under general and administrative expense.

The Company’s cash-settled phantom stock unit awards (“PSUs”), which vest over a period of four years, entitle employees and directors to receive cash based on the fair value of the Company’s common stock on the vesting date. The PSUs are accounted for as liability awards and are re-measured at fair value each reporting period until they become vested with compensation expense being recognized over the requisite service period in accordance with ASC 718-30, “Compensation—Stock Compensation, Awards Classified as Liabilities.” The Company had a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its PSUs of $0.8 million and $4.8 million at March 31, 2018 and December 31, 2017, respectively, primarily due to payouts on the awards. For PSUs held by Penn employees, there was $5.9 million of total unrecognized compensation cost at March 31, 2018 that will be recognized over the grants remaining weighted average vesting period of 2.63 years. For the three months ended March 31, 2018, the Company recognized $0.1 million of compensation expense associated with these awards, as compared to $4.3 million for the three months ended March 31, 2017. The changes are primarily due to the final vesting of the Company’s Transition Award Program on July 23, 2017 as well as changes in Penn’s stock prices at March 31 compared to December 31 in both years. Amounts paid by the Company for the three months ended March 31, 2018 on these cash-settled awards totaled $4.1 million as compared to $3.5 million for the three months ended March 31, 2017.

For the Company’s cash-settled stock appreciation rights (“SARs”), the fair value of the SARs is calculated during each reporting period and estimated using the Black-Scholes option pricing model based on the various inputs discussed below. The Company’s SARs, which vest over a period of four years, are accounted for as liability awards since they will be settled in cash. The Company had a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its SARs of $16.8 million and $24.0 million at March 31, 2018 and December 31, 2017, respectively. For SARs held by Penn employees, there was $12.9 million of total unrecognized compensation cost at March 31, 2018 that will be recognized over the awards remaining weighted average vesting period of 2.55 years. For the three months ended March 31, 2018, the Company recognized a benefit to compensation expense of $4.0 million associated with these awards, as compared to compensation expense of $4.0 million for the three months ended March 31, 2017. The changes are primarily due to changes in Penn’s stock prices at March 31 compared to December 31 in both years. Amounts paid by the Company for the three months ended March 31, 2018 on these cash-settled awards totaled $3.0 million as compared to $1.1 million for the three months ended March 31, 2017.

In addition to the variances in cash-settled awards explained above, accrued salaries and wages decreased during the three months ended March 31, 2018 due to the payment of 2017 bonuses, which was $6.6 million higher compared to the prior year.

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model for stock option awards granted during the March 31, 2018 and 2017, respectively:


Three months ended March 31,	2018		2017
Risk-free interest rate	2.26	%	1.97	%
Expected volatility	30.80	%	30.67	%
Dividend yield	—		—
Weighted-average expected life (years)	5.30		5.30

Segment Information

The Company’s Chief Executive Officer, who is the Company’s Chief Operating Decision Maker (“CODM”), as that term is defined in ASC 280 “Segment Reporting”, measures and assesses the Company’s business performance based on regional operations of various properties grouped together based primarily on their geographic locations.

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

The South/West reportable segment consists of the following properties: Zia Park Casino, Hollywood Casino Tunica, Hollywood Casino Gulf Coast, Boomtown Biloxi, M Resort, Tropicana Las Vegas, 1st Jackpot and Resorts which were acquired on May 1, 2017, as well as our management contract with Hollywood Casino Jamul-San Diego. In late February 2018, the Company and the Jamul Tribe mutually agreed that Penn would no longer manage the facility or provide branding and development services on May 28, 2018. The Company will provide a transition that it anticipates will last through approximately late May.

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

The Other category consists of the Company’s standalone racing operations, namely Sanford-Orlando Kennel Club, the Company’s joint venture interests in Sam Houston Race Park, Valley Race Park, and Freehold Raceway. If the Company is successful in obtaining gaming operations at these locations, they would be assigned to one of the Company’s regional executives and reported in their respective reportable segment. The Other category also includes the Company’s corporate overhead operations, which does not meet the definition of an operating segment under ASC 280. Additionally, the Other category includes Penn Interactive Ventures, the Company’s wholly-owned subsidiary that represents its social online gaming initiatives, including Rocket Speed. Penn Interactive Ventures meets the definition of an operating segment under ASC 280, but is quantitatively not significant to the Company’s operations as it represents less than 2% of net revenues and income from operations for the three months ended March 31, 2018, and its total assets represent less than 2% of the Company’s total assets at March 31, 2018.

Management uses adjusted EBITDA as an important measure of the operating performance of its segments, including the evaluation of operating personnel and believes it is especially relevant in evaluation large, long-lived casino projects because it provides a perspective on the current effects of operating decisions separated from the substantial non-operational depreciation charges and financing costs of such projects. The Company defines adjusted EBITDA as earnings before interest, taxes, stock compensation, debt extinguishment and financing charges, impairment charges, insurance recoveries and deductible charges, depreciation and amortization, changes in the estimated fair value of our contingent purchase price obligations, gain or loss on disposal of assets, the difference between budget and actual expense for cash-settled stock-based awards, preopening and significant transaction costs and other income or expenses. Adjusted EBITDA is also inclusive of income or loss from unconsolidated affiliates, with our share of non-operating items (such as depreciation and amortization) added back for our joint venture in Kansas Entertainment. Adjusted EBITDA excludes payments associated with our Master Lease agreement with GLPI as the transaction was accounted for as a financing obligation.

In the first quarter of 2018, we changed the definition of adjusted EBITDA to exclude preopening costs, significant transaction costs and the variance between our budgeted and actual costs incurred on cash-settled stock based awards which are required to be marked to market each reporting period. We determined to exclude preopening costs and significant transaction costs to more closely align the Company’s calculation of adjusted EBITDA with our competitors. Preopening costs and significant transaction costs are also excluded from adjusted EBITDA for bonus calculation purposes. We have excluded the favorable or unfavorable difference between the budgeted expense and actual expense for our cash-settled stock-based awards as it is non-operational in nature. Additionally, this variance is excluded from adjusted EBITDA for bonus calculation purposes. In connection with the change to the definition of adjusted EBITDA, we reclassified our prior period results to conform to the current period presentation.

Adjusted EBITDA should not be construed as an alternative to operating income, as an indicator of the Company’s operating performance, as an alternative to cash flows from operating activities, as a measure of liquidity, or as any other measure of performance determined in accordance with GAAP. The Company has significant uses of cash flows, including capital expenditures, interest payments, taxes and debt principal repayments, which are not reflected in adjusted EBITDA.

See Note 7: “Segment Information” for further information with respect to the Company’s segments.