Churchill Downs Incorporated 2018 Q3 Form 10-Q Summary
Business context and reporting period
Churchill Downs Incorporated filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. The company operates racing venues, TwinSpires online wagering, casinos, and other investments. Big Fish Games was sold on January 9, 2018 and is presented as discontinued operations. Ocean Downs became wholly owned and was consolidated on August 31, 2018. Derby City Gaming opened in Louisville in September 2018.
Financial results and key metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net revenue | $221.3 million | $196.9 million | $790.0 million | $703.7 million |
| Operating income | $20.5 million | $27.0 million | $176.8 million | $158.4 million |
| Operating margin | 9% | 14% | 22% | 23% |
| Net income | $56.3 million | $16.7 million | $341.4 million | $102.3 million |
| Diluted EPS | $4.12 | $1.08 | $24.50 | $6.32 |
| Adjusted EBITDA | $62.1 million | $58.1 million | $285.8 million | $248.4 million |
| Operating cash flow | Not separately provided | Not separately provided | $135.4 million | $167.2 million |
Q3 revenue increased 12.4%, while nine-month revenue increased 12.3%. Q3 operating income declined despite higher revenue because of transaction expenses, Arlington weather impacts, higher salaries and benefits, Churchill Downs maintenance costs, and Derby City Gaming pre-opening expenses. Nine-month operating income increased 11.6%.
Net income benefited substantially from unusual items: the nine-month results included a $168.3 million after-tax gain on the Big Fish sale and a $42.3 million after-tax gain on the Ocean Downs/Saratoga transaction. Q3 included the Ocean Downs/Saratoga gain but no Big Fish sale gain. Adjusted EBITDA, which excludes selected items and is non-GAAP, increased 6.9% in Q3 and 15.1% for the nine months.
Segment performance
- Racing: Revenue increased $17.6 million, or 7.2%, for the nine months, led by a successful Kentucky Derby and Oaks week. Q3 revenue declined $0.9 million and adjusted EBITDA declined $2.9 million, primarily due to Arlington weather and higher Churchill Downs maintenance costs.
- TwinSpires: Revenue increased $30.6 million, or 15.4%, for the nine months, supported by 10.4% handle growth. Q3 handle increased 1.0%, and adjusted EBITDA rose $0.5 million.
- Casino: Revenue increased $38.0 million, or 14.4%, for the nine months, and adjusted EBITDA increased $21.6 million. Drivers included promotional activity, Oxford’s hotel and expanded gaming floor, Calder improvements, and Ocean Downs consolidation.
- Other Investments: Revenue increased $2.1 million for the nine months, primarily due to Derby City Gaming. Q3 included $2.6 million of pre-opening expense.
Cash flow, debt and liquidity
- Cash, cash equivalents and restricted cash totaled $170.1 million at September 30, 2018, including $131.3 million of unrestricted cash and $38.8 million of restricted cash, compared with $85.5 million at December 31, 2017.
- Operating cash flow was $135.4 million for the nine months, down from $167.2 million, primarily because of timing and reductions in deferred revenue related to Kentucky Derby and Oaks payments.
- Investing activities provided $848.9 million, principally from $970.7 million of Big Fish sale proceeds. Capital expenditures totaled $125.5 million, including $105.6 million of capital project expenditures.
- Financing activities used $899.1 million, including $514.7 million of share repurchases, $374.7 million of long-term debt repayments, $54.7 million of Ocean Downs debt repayment, and $23.5 million of dividends.
- Total debt principal was $897.0 million at September 30, 2018, consisting of $397.0 million under the Term Loan B and $500.0 million of 4.75% senior notes due 2028. Debt principal declined $245.0 million from year-end 2017, and the revolving credit facility had no outstanding balance.
- The company reported compliance with its debt covenants. The interest coverage ratio was 7.0x versus a minimum of 2.5x, and the secured net leverage ratio was 0.7x versus a maximum of 4.0x.
Material changes, outlook and unusual items
- The Big Fish transaction generated $970.7 million of cash proceeds and a $219.5 million pretax gain, or $168.3 million after tax. Big Fish results are excluded from continuing operations.
- The Ocean Downs/Saratoga transaction resulted in full ownership of Ocean Downs, elimination of the company’s Saratoga equity interests, and a $54.9 million pretax gain. The transaction also provided potential 15-year exclusive rights to operate online sports betting and iGaming for certain New York and Colorado interests, subject to legalization and royalties.
- The company launched BetAmerica Sportsbook at two Mississippi properties and continued preparations for sports betting and iGaming in additional jurisdictions. Management stated that expanded legalization could benefit the business, but outcomes remain subject to regulation, competition and market adoption.
- Presque Isle Downs and Lady Luck Nemacolin transactions were expected to close in the first quarter of 2019, subject to Pennsylvania regulatory approvals and other conditions. The Lady Luck Vicksburg transaction was terminated, resulting in a $5.0 million termination fee included in transaction expense.
- Subsequent to quarter-end, the board approved a $1.63 per-share annual dividend, a three-for-one stock split, and a new common stock repurchase program of up to $300.0 million.
- The company announced an agreement to acquire at least 50.1% of Midwest Gaming, parent of Rivers Casino Des Plaines, for cash consideration of at least $326.0 million and potentially up to $500.0 million. The transaction was expected to close in the first half of 2019, subject to regulatory and antitrust approvals, and would involve approximately $300.0 million of new Midwest Gaming credit facilities.
- Management identified risks involving discretionary consumer spending, gaming and racing regulation, sports betting and iGaming legalization, competition, weather, labor and horse supply, technology and cybersecurity, payment processing, acquisitions, debt covenants, litigation and potential operating disruptions.
- Material legal matters include the remanded Kater litigation related to Big Fish Games, the Louisiana horsemen’s purse class action, a Calder personal injury case scheduled for trial in February 2019, and potential appeals concerning Kentucky historical racing machines. The company stated that it has meritorious defenses; loss amounts were not clearly quantified in the filing.
Investor verification items
- Separate recurring earnings from the $168.3 million after-tax Big Fish gain and $42.3 million after-tax Ocean Downs/Saratoga gain.
- Assess whether Casino and TwinSpires revenue and adjusted EBITDA growth continues after promotional activity, Ocean Downs consolidation and ASC 606 classification changes.
- Monitor operating cash flow relative to capital expenditures, the planned Midwest Gaming acquisition, and additional sports betting and iGaming investment.
- Review the effect of the $500.0 million share repurchase, subsequent $300.0 million authorization, dividend, and stock split on share count and capital allocation.
- Verify closing dates, financing terms and regulatory approvals for Presque Isle, Lady Luck Nemacolin and Midwest Gaming.
- Evaluate unresolved litigation, regulatory proceedings and the potential financial exposure from matters for which the filing does not provide a clear loss estimate.