PENN National Gaming, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The filing is under Penn National Gaming, Inc., the company’s name at the time; the request identifies the company as PENN Entertainment, Inc.
Business context
The company operated or held interests in 28 gaming, racing, and video gaming terminal businesses across 16 jurisdictions. Its regional casino operations are reported in Northeast, South/West, and Midwest segments, with corporate and interactive operations in “Other.”
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net revenues | $826.9 million | $796.5 million | $1,643.0 million | $1,572.7 million |
| Income from operations | $181.8 million | $135.0 million | $353.9 million | $275.3 million |
| Net income | $54.0 million | $17.1 million | $99.4 million | $22.2 million |
| Diluted EPS | $0.57 | $0.18 | $1.05 | $0.24 |
| Adjusted EBITDA | $247.1 million | $227.4 million | $489.7 million | $454.8 million |
| Adjusted EBITDA after GLPI Master Lease payments | $131.2 million | $113.4 million | $257.9 million | $228.4 million |
Reported operating margin was approximately 22.0% in Q2 2018 versus 16.9% in Q2 2017; reported net margin was approximately 6.5% versus 2.1%. These comparisons require caution because the company adopted ASC 606 in 2018 and did not restate prior periods.
- Gaming revenue declined 2.3% in Q2 and 1.7% in the first half. Food, beverage, hotel and other revenue declined 12.1% and 11.8%, respectively. Management attributed substantial portions of these movements to ASC 606 presentation changes.
- Reported net revenue increased 3.8% in Q2 and 4.5% in the first half. ASC 606 changed the treatment of promotional allowances, loyalty points, racing revenue, and reimbursable Casino Rama costs; it increased reported net revenue by $11.8 million in Q2 and $26.2 million in the first half relative to the prior accounting treatment.
- Operating income and adjusted EBITDA improved year over year. Management cited margin-improvement initiatives, lower depreciation and amortization, stronger results in several regional properties, and contributions from the 2017 Tunica acquisitions.
- Net income included a $17.0 million recovery related to the sale of the Jamul Indian Village Development Corporation (JIVDC) loan and related commitments. The recovery is unusual and materially aided the comparison with 2017.
Cash flow, liquidity and obligations
- First-half operating cash flow was $207.1 million, compared with $213.9 million in 2017. Investing cash outflow was $79.1 million, compared with $166.2 million; financing cash outflow was $205.8 million, compared with $52.8 million.
- Cash and cash equivalents were $200.2 million at June 30, 2018, down from $278.0 million at year-end 2017. Current assets were $308.5 million and current liabilities $489.3 million.
- Long-term debt, including current maturities, totaled approximately $1.08 billion on the balance sheet. Separately, the GLPI Master Lease financing obligation was approximately $3.51 billion, including current and long-term portions. The company paid $231.8 million under the Master Lease in the first half.
- The senior secured facility had $590.0 million outstanding; no revolver borrowings were outstanding. After letters of credit, available revolving capacity was $678.0 million. The company reported compliance with required financial covenants.
- First-half capital expenditures were $33.0 million, excluding gaming-license fees. The company reported expected 2018 maintenance capital expenditures of $103.6 million and project capital expenditures of $2.1 million; future development spending for its new Pennsylvania licenses was not yet determined.
Material developments, outlook and risks
- ASC 606 adoption reduced opening retained earnings by $9.7 million. Management said it did not expect a material continuing impact on net income. The accounting change materially affects revenue line-item comparability.
- The company sold its JIVDC loan and related commitments in May 2018 for $15.2 million, recognized a $17.0 million recovery, and ended its management relationship with the property. Casino Rama’s management contract ended July 18, 2018.
- Penn expected its approximately $2.8 billion Pinnacle acquisition to close early in Q4 2018, subject to remaining approvals and other conditions. The plan included divestitures and a GLPI sale-leaseback; the company had financing commitments and expected acquisition-related leverage to rise. A separate approximately $115 million Margaritaville operations acquisition was expected to close late in Q4 2018, subject to conditions.
- Following the Supreme Court decision overturning the federal sports-betting ban, the company anticipated beginning sports wagering in Q3 2018 in Mississippi, West Virginia, and potentially Pennsylvania. Success depends on legislation, regulation, partners, competition, and returns on investment.
- Management believed cash from operations, cash on hand, and available credit would meet foreseeable needs, but cautioned that cash generation, projected earnings, and future borrowing availability are not assured. Acquisitions or expansions could require additional financing.
- Key operating risks include competition and new gaming supply, state and local gaming-tax or regulatory changes, economic and consumer-spending conditions, project approvals and construction costs, integration and financing risks for pending deals, and the ability to grow interactive gaming and sports betting. Rocket Speed had declining adjusted EBITDA; management found no goodwill impairment at June 30 but warned future shortfalls could require a write-off.
- The company reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter. No new material legal proceedings were reported.
Important facts for investors to verify
- How much of reported revenue and margin growth reflects underlying operations versus ASC 606 presentation changes and the one-time JIVDC recovery.
- Final approvals, closing timing, financing terms, divestiture proceeds, lease changes, and integration costs for the Pinnacle and Margaritaville transactions.
- The company’s post-transaction leverage, lease obligations, covenant headroom, and capacity to reduce debt while funding capital needs.
- Actual construction scope, timing, and investment requirements for the York and Berks/Lancaster County Pennsylvania casino licenses.
- Whether sports betting and interactive gaming achieve regulatory approval, customer uptake, and returns sufficient to justify investment.