Churchill Downs Incorporated — Q3 2017 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods. Churchill Downs operates racing, casinos, TwinSpires online wagering, Big Fish Games, and other investments. Results are seasonal, particularly for racing, TwinSpires, and Big Fish Games.
Financial results and key metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net revenue | $314.8 million | $303.4 million | $1,046.2 million | $1,030.3 million |
| Operating income | $33.0 million | $26.8 million | $180.0 million | $150.5 million |
| Operating margin | 10% | 9% | 17% | 15% |
| Net income | $16.7 million | $8.7 million | $102.3 million | $81.3 million |
| Diluted EPS | $1.08 | $0.52 | $6.32 | $4.79 |
| Adjusted EBITDA | $76.0 million | $71.1 million | $306.3 million | $278.0 million |
- Q3 revenue increased $11.4 million, or approximately 4%, while operating income rose $6.2 million and net income rose $8.0 million.
- Nine-month revenue increased $15.9 million, or approximately 2%; operating income increased $29.5 million and net income increased $21.0 million.
- Q3 revenue by segment was Racing $38.8 million, Casinos $87.5 million, TwinSpires $65.9 million, Big Fish Games $117.9 million, and Other Investments $4.7 million.
- Nine-month revenue growth was led by TwinSpires, up $25.3 million, Casinos, up $9.4 million, Racing, up $7.2 million, and Other Investments, up $1.1 million. Big Fish Games declined $27.1 million.
- Q3 Adjusted EBITDA increased $4.9 million. Casinos increased $9.1 million and TwinSpires increased $4.1 million, partly offset by a $10.2 million decline at Big Fish Games.
- Nine-month Adjusted EBITDA increased $28.3 million, led by Casinos up $14.3 million, Racing up $6.4 million, TwinSpires up $5.7 million, and Big Fish Games up $1.7 million.
- TwinSpires Q3 active players increased 23.9% and handle increased 20.6%; nine-month active players increased 34.5% and handle increased 16.4%.
- Big Fish Games Q3 bookings increased to $123.9 million from $118.5 million, but reported revenue declined because casual and mid-core free-to-play and premium revenue decreased. Nine-month bookings declined to $346.8 million from $374.6 million.
Cash flow, liquidity, debt, and capital allocation
- Nine-month operating cash flow was $164.2 million, down from $189.0 million, primarily due to timing of deferred revenue, lower Big Fish Games bookings, and higher prepaid developer fees.
- Cash used in investing activities was $124.6 million versus $46.2 million, including $89.1 million of capital expenditures, a $24.0 million Ocean Downs investment, and the $23.1 million BetAmerica acquisition.
- Cash used in financing activities was $31.7 million versus $160.0 million. The company repurchased $181.1 million of common stock and paid $21.8 million of dividends.
- Cash and cash equivalents were $57.8 million at September 30, 2017, with restricted cash of $37.3 million. The Senior Secured Credit Facility had $132.7 million of available capacity after $7.1 million of letters of credit.
- Total reported debt was $1,128.9 million, including $528.9 million under the Senior Secured Credit Facility and $600.0 million of 5.375% Senior Unsecured Notes, all principally maturing in 2021. Net debt, net of current maturities, was reported at $1,106.3 million.
- The company was in compliance with debt covenants: interest coverage was 7.5x versus a greater-than-3.0x requirement, total leverage was 3.3x versus a less-than-4.5x limit, and senior secured leverage was 1.6x versus a less-than-3.5x limit.
- On April 25, 2017, the company authorized a $250.0 million share repurchase program. Through September 30, it had repurchased 1.077 million shares under that program for $171.7 million, with approximately $78.3 million remaining.
Material changes, outlook, and unusual items
- The BetAmerica asset acquisition closed April 24, 2017, with $16.1 million of goodwill and $8.1 million of definite-lived intangible assets recognized; management stated the acquisition was not material to results.
- The company acquired an effective 62.5% interest in Ocean Downs through its equity-method investment structure and recorded a $24.0 million initial equity investment.
- Maryland legislation provided an effective 10% gaming tax reduction for qualifying Ocean Downs VLT revenue beginning August 1, 2017. Pennsylvania legislation expanded online gaming and reduced ADW license fees; management expected a positive impact.
- Management announced plans to invest approximately $60.0 million in a historical racing machine facility in Louisville and proposed two additional racing facilities in Kentucky with Keeneland.
- The Oxford hotel was expected to open in mid-November 2017. No consolidated earnings or revenue guidance was provided in the filing.
- The company expects to pay approximately $34.2 million of Big Fish Games earnout obligations and $28.3 million of deferred founder payments in 2018. Contractual obligations totaled $1.513 billion, including debt principal, interest, deferred payments, earnout liabilities, and operating leases.
- The company expects to adopt the new revenue recognition standard on January 1, 2018, using the modified retrospective method. Management expects the treatment of Big Fish Games premium-game credit breakage to have a material impact on the consolidated financial statements; the effect had not been quantified.
- Other notable items included lower Calder exit costs, reduced acquisition expense, higher stock-based compensation, unfavorable foreign exchange expense at Big Fish Games, and a 2017 equine disease outbreak that reduced Fair Grounds revenue and Adjusted EBITDA.
- The Board declared a $1.52 per share annual cash dividend on October 24, 2017, payable January 5, 2018.
Risks and contingencies
- Key risks include consumer discretionary spending, gaming and racing regulation, taxation, competition, seasonality, weather, labor and horse-supply issues, technology and cybersecurity failures, intellectual property claims, platform dependence at Big Fish Games, and acquisition integration.
- The company has variable-rate debt exposure; a one-percentage-point increase in LIBOR was estimated to reduce net income and operating cash flow by $3.3 million, assuming constant debt balances.
- Pending matters include a Louisiana horsemen’s purse litigation matter, a Kentucky historical racing machine proceeding with a January 2018 trial date, and ordinary-course litigation. Management stated that any potential excess litigation exposure was not expected to be material, although a substantial judgment or settlement could adversely affect results.
- Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether TwinSpires player and handle growth continues and offsets higher content, tax, and processing costs.
- Whether Big Fish Games can stabilize casual and premium products while controlling user acquisition spending and foreign exchange volatility.
- The effect of higher leverage, variable interest rates, 2021 maturities, and remaining share repurchase commitments on liquidity.
- The quantified balance-sheet and revenue effects of adopting the new revenue recognition standard in 2018.
- Progress, cost, and returns from the Louisville and proposed Kentucky historical racing facilities, the Oxford hotel opening, and Ocean Downs.
- Outcomes of the Kentucky historical racing litigation and Louisiana purse litigation, as well as the related regulatory and legislative developments.