PENN Entertainment, Inc. quarterly report, Q2 FY2010

Business context and reporting period

Penn National Gaming, Inc. (now PENN Entertainment, Inc.) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2010. The company operated or held interests in 22 gaming and pari-mutuel facilities across 16 jurisdictions. Unless otherwise stated, figures below are in millions of dollars.

Financial performance and condition

• Revenue and margins: Q2 net revenue rose 3.0%, while operating income fell 32.6%; operating margin was approximately 8.6%, versus 13.2% a year earlier. Six-month revenue was nearly flat, while operating income declined 18.9%.
• Cash flow: Six-month operating cash flow was $223.3, up from $165.3. Investing used $275.2, including $211.0 of property and equipment spending; financing used $263.1. Cash declined $314.9 to $398.2 from year-end 2009.
• Debt and liquidity: Long-term debt, including current maturities, was $2,102.4 at June 30, down from $2,334.8 at year-end. The company reported $398.2 cash and an undrawn $640.6 Tranche B revolving facility. Current assets were $597.5 and current liabilities $311.5. The company said it was in compliance with required financial covenants.
• Other metrics: Total assets were $4,474.5 and shareholders’ equity $1,898.6. Six-month interest expense was $67.2. The effective tax rate was 64.7% for Q2 and 43.1% for the first half.

Material changes versus the prior comparable period

• Q2 gaming revenue increased 3.2%, but performance varied by property. Growth at Empress Casino Hotel, Lawrenceburg, and Penn National Race Course was partly offset by declines at Charles Town and Aurora, among others.
• The Empress comparison benefited from a full quarter of operations in 2010; the property had been closed after a March 2009 fire and reopened with temporary facilities in June 2009. Lawrenceburg also benefited from its new riverboat, opened in June 2009.
• Operating results were weighed down by a $30.5 impairment charge on Columbus land, a $6.6 charge related to ending Aurora’s police-services contract, and higher depreciation and amortization. Q2 impairment losses totaled $30.6 versus $11.7 in 2009.
• Interest expense increased 10.3% in Q2 and 10.0% for the first half, primarily reflecting 2009 subordinated-note issuance and lower capitalized interest, partly offset by lower secured-facility balances and rates.
• Debt repayments and reduced cash balances were significant: the company repaid revolving-loan borrowings using cash on hand. It also repurchased $9.9 of common stock and $11.2 of preferred stock during the first half.

Outlook, commentary, risks, contingencies, and unusual items

• Outlook and projects: No overall earnings or revenue guidance is provided. Management expected an approximately 45% effective tax rate in the second half of 2010. Projects included Perryville, expected to open September 30, 2010 subject to approvals; Ohio casinos planned for 2012; and a Kansas project planned for the first half of 2012. The company estimated its Kansas project contribution at approximately $155 million.
• Capital spending: Expected 2010 capital-project spending was $320.5, excluding licensing fees; $163.1 had been spent by June 30. The company also reported $47.9 of first-half maintenance capital expenditures.
• Post-quarter developments: Beulah Park and the Maryland Jockey Club joint venture transactions closed July 1. On July 16, the company paid Lakes $25 million to terminate its investment/option agreement for the proposed Columbus and Toledo projects. Table games were added at Charles Town and Penn National Race Course in July.
• Contingencies: Disclosed litigation included a Kansas county claim seeking more than $50 million and a real-estate counterclaim seeking $37.5 million; the court granted summary judgment dismissing the latter claim on July 23, 2010. Other matters included an appeal in a securities class action and litigation concerning an Illinois casino tax surcharge. Management said ordinary-course proceedings were not expected to materially harm results, while noting outcomes and insurance coverage cannot be assured.
• Key risks: Management cited weak consumer spending, competition, possible increases in gaming taxes or regulatory restrictions, approvals and construction risks, financing availability, and uncertain returns on development projects. Gaming-license and other regulatory approvals remain important dependencies.
• Unusual items: The $30.5 Columbus land impairment followed voters’ decision on the casino location. A $0.5 loss arose from terminating a revolving-loan tranche. The Empress fire insurance receivable was $13.9 at quarter-end; the company received $20.0 in related insurance proceeds during the first half.

Important facts for investors to verify

• Whether operating trends at weaker properties improved, and how much growth at Empress and Lawrenceburg reflects comparability rather than sustained demand.
• Final costs, funding, regulatory approvals, construction schedules, and expected returns for the Ohio, Kansas, and Perryville developments.
• Cash available after continued capital spending, debt service, share repurchases, and the $25 million Lakes termination payment.
• Progress and recovery amounts on the Empress insurance claim, and any material developments in the disclosed litigation.
• The effect of the preferred stock’s participation and conversion terms on diluted share count and per-share results.