Business context and reporting period
PENN Entertainment, Inc., then named Penn National Gaming, Inc., filed this Form 10-K for the fiscal year ended December 31, 2016. The company operated or held interests in 27 gaming, racing, and video gaming terminal facilities across 17 jurisdictions. Its principal business was regional casino and slot-machine gaming; the filing also covers acquisitions, social gaming, and management contracts. Figures below are in U.S. dollars.
Financial performance and liquidity
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net revenue | $3,034.4 million | $2,838.4 million | +6.9% |
| Income from operations | $543.0 million | $467.8 million | +16.1% |
| Net income | $109.3 million | $0.7 million | Improved |
| Diluted EPS | $1.19 | $0.01 | Improved |
| Adjusted EBITDA | $843.8 million | $796.3 million | +6.0% |
| Operating cash flow | $404.8 million | $399.0 million | +1.5% |
| Capital expenditures | $97.2 million | $199.2 million | Lower |
| Cash and cash equivalents at year-end | $229.5 million | $237.0 million | Lower |
Operating margin was approximately 17.9%, compared with 16.5% in 2015; net margin was approximately 3.6%, compared with approximately 0.02%. These percentages are calculated from reported figures. Adjusted EBITDA is a non-GAAP measure and excludes payments under the GLPI Master Lease, among other items; it is not a substitute for cash flow or GAAP earnings.
Gaming revenue increased 4.4% to $2,606.3 million; food, beverage, hotel, and other revenue rose 18.5% to $575.4 million. The Northeast segment reported $1,568.5 million of revenue and $489.1 million of adjusted EBITDA; South/West reported $546.6 million and $128.6 million; Midwest reported $877.6 million and $287.3 million. “Other,” including corporate costs, reported a $61.1 million adjusted EBITDA loss.
For the fourth quarter of 2016, net revenue was $742.9 million, operating income was $113.8 million, and net income was $5.0 million. The comparable 2015 quarter reported revenue of $734.0 million, operating income of $90.6 million, and a net loss of $9.1 million.
At year-end, reported debt was $1,415.5 million and the GLPI financing obligation was $3,514.1 million. The latter arose from the Master Lease, which is accounted for as a financing obligation. The company made $442.3 million of Master Lease payments in 2016; the obligation carries a 35-year assumed term and a 9.7% inception discount rate. The filing reported $419.1 million of available revolving-credit capacity and compliance with required financial covenants at December 31, 2016.
Material changes versus the prior comparable period
- Revenue growth reflected a full year of operations at Plainridge Park Casino, Tropicana Las Vegas, and Prairie State Gaming, plus Rocket Speed revenue after its August 2016 acquisition. The filing identifies these businesses as significant contributors; reported growth is not solely organic.
- Operating income rose despite higher gaming, food and hotel, and depreciation expenses. There were no impairment losses in 2016, compared with $40.0 million in 2015. 2015 also included favorable property-tax settlements, including $17.4 million cited in the operating expense discussion.
- Net income increased substantially from near break-even, but interest expense remained high at $459.2 million, up 3.6%. Interest income rose to $24.2 million, principally reflecting interest accrued on Jamul Tribe loans.
- Operating cash flow increased modestly. Investing cash use fell to $79.3 million from $781.0 million, mainly reflecting Jamul refinancing proceeds and lower acquisition spending. Financing activities used $333.0 million, versus $410.4 million provided in 2015, as debt repayments increased.
- Cash decreased by $7.5 million during 2016. Shareholders’ equity remained in deficit, at negative $543.3 million, though less negative than in 2015.
Outlook, commentary, risks, and unusual items
Management said cash from operations, cash on hand, and available credit were expected to cover anticipated lease obligations, debt service, capital spending, and working capital for the foreseeable future, while cautioning that cash generation, projections, and future borrowing availability were not assured. No quantified 2017 earnings or revenue guidance is provided. Planned 2017 project capital spending was approximately $36.7 million, primarily for Tropicana Las Vegas improvements and Hollywood Casino St. Louis hotel renovations.
- Competitive and market exposure: Management described regional gaming trends as softening midway through 2016, particularly among unrated players. New and expanding casinos, VGTs, online gaming, and other entertainment alternatives could pressure revenue. Charles Town generated approximately 13% of 2016 net revenue and faced increased Maryland competition, including MGM National Harbor, which opened in December 2016.
- Jamul credit and operating risk: The company’s Jamul loan had a $98.0 million unpaid principal balance and a $92.1 million carrying value at year-end. Management concluded the loan was impaired but recorded no reserve because estimated discounted cash flows exceeded carrying value. It expected the Tribe could breach debt-to-earnings covenants by June 2017 absent a waiver; the company also expected most or all of its Term C loan to become subordinated if leverage conditions were not met and expected no management fees in 2017. Fee and loan recovery depend substantially on casino cash flows.
- Lease and leverage burden: The GLPI Master Lease covers 18 facilities, is triple-net, and cannot generally be terminated without GLPI’s consent. The filing states that lease payments consume more than half of operating cash flow and may constrain debt service, investment, and flexibility.
- Restatement and controls: The company restated certain prior-period financial statements in the first quarter of 2016, including corrections involving complex lease accounting. Management and the auditor reported effective internal control over financial reporting at year-end 2016 after remediation of prior material weaknesses. Controls at Rocket Speed, Slot Kings, and Bell Gaming were excluded from the assessment.
- Financing after year-end: In January 2017, the company refinanced its credit facilities and issued $400 million of 5.625% senior notes due 2027. It reported $25.2 million of refinancing and debt-extinguishment charges, including a call premium, to be recognized in first-quarter 2017. The revised revolving facility was $700 million. In February 2017, the board authorized a $100 million share-repurchase program over two years; no shares were repurchased in fourth-quarter 2016.
- Other items: A $3.1 million Tropicana bankruptcy-related dispute was settled and paid in 2016. The company maintained a full valuation allowance on net deferred tax assets. Gaming operations are subject to extensive licensing and tax regulation, labor agreements, weather and cyber risks, and potential litigation. Management said ordinary-course legal proceedings were not expected to materially affect results, but outcomes remain uncertain.
Most important facts for investors to verify
- Whether 2016 revenue and EBITDA growth is sustainable after separating acquired-business contributions from comparable-property performance, and assessing the impact of new regional competition.
- The Jamul casino’s operating trajectory, covenant status, loan subordination, and prospects for collecting principal, interest, and management fees.
- Total fixed cash commitments: debt service, GLPI financing payments, Ohio obligations, and maintenance and expansion capital needs; adjusted EBITDA excludes Master Lease payments.
- Effects of the January 2017 refinancing on borrowing costs, maturities, available liquidity, and covenant headroom, including the reported $25.2 million charge.
- Progress in sustaining effective financial controls following the restatement, and integration of the three acquisitions excluded from the year-end controls assessment.