Churchill Downs Incorporated 2017 Form 10-K Summary
Business context and reporting period
Churchill Downs Incorporated filed its Form 10-K for the fiscal year ended December 31, 2017. The company operates racing, casino gaming, online horse-racing wagering through TwinSpires, and pari-mutuel technology businesses. Continuing operations comprise Racing, Casino, TwinSpires, Other Investments and Corporate. Big Fish Games is presented as discontinued operations after the company agreed to sell it in November 2017; the sale closed on January 9, 2018 for $990.0 million in cash, subject to customary adjustments.
The business is seasonal, with a substantial portion of racing revenue generated during the second quarter around the Kentucky Oaks and Kentucky Derby. The filing also provides unaudited quarterly results; fourth-quarter 2017 operating income was affected by impairment and debt-refinancing charges, while net income benefited from tax reform.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net revenue | $882.6 million | $822.4 million | +7.3% |
| Operating income | $145.7 million | $172.5 million | -$26.8 million |
| Operating margin | 16.5% | 21.0% | -4.5 percentage points |
| Income from continuing operations, net of tax | $122.4 million | $96.7 million | +$25.7 million |
| Net income | $140.5 million | $108.1 million | +30.0% |
| Diluted net income per share | $8.77 | $6.42 | +36.6% |
| Adjusted EBITDA | $366.5 million | $334.5 million | +9.6% |
| Cash flow from operating activities | $218.2 million | $226.8 million | -$8.6 million |
| Capital maintenance expenditures | $33.3 million | $30.9 million | +$2.4 million |
| Capital project expenditures | $83.6 million | $23.8 million | +$59.8 million |
Revenue growth was led by TwinSpires, Casino and Racing. TwinSpires handle increased 16.9% to approximately $1.3 billion, and active players increased 34.8%. Casino revenue increased $17.7 million, while Racing revenue increased $8.5 million, primarily due to a strong Kentucky Derby and Oaks week.
At December 31, 2017, the company reported total assets of $2.36 billion, total liabilities of $1.72 billion and shareholders’ equity of $640.3 million. Cash and cash equivalents were $51.7 million on the balance sheet, while the cash flow statement reported $54.3 million including certain discontinued-operations cash. Total debt was $1.142 billion of principal, or $1.125 billion net of issuance costs and fees.
Material changes versus the prior comparable period
- Operating income declined despite higher revenue because 2016 included a $23.7 million Calder land-sale gain, while 2017 included $21.7 million of non-cash impairment charges and higher operating expenses.
- 2017 operating expense included $13.7 million of impairment for certain TwinSpires i-Gaming assets, $4.7 million related to the Bluff trademark and customer relationships, and $3.3 million related to the Illinois Horseracing Equity Trust.
- Net income benefited from a $57.7 million tax benefit, primarily from remeasurement of deferred tax liabilities under the Tax Cuts and Jobs Act, which reduced the federal corporate tax rate to 21%.
- The company acquired an effective 62.5% equity interest in Ocean Downs in January 2017 and acquired certain BetAmerica assets in April 2017. BetAmerica added $16.1 million of goodwill.
- The company refinanced its debt in December 2017, issuing $500.0 million of 4.75% senior notes due 2028, entering into a $700.0 million revolving facility and a $400.0 million Term Loan B due 2024, and redeeming its $600.0 million of 5.375% senior notes due 2021.
- The refinancing produced a $20.7 million loss on extinguishment of debt, including the call premium and write-off of financing costs.
- Share repurchases totaled $190.9 million in cash-flow reporting, including the June 2017 repurchase of 1.0 million shares from an affiliate of The Duchossois Group for $158.8 million. The company declared a $1.52 per-share dividend for 2017, compared with $1.32 for 2016.
Guidance, outlook, commentary and unusual items
Management stated that operating cash flow over the following twelve months was expected to be adequate to fund operations and capital expenditures. Management described the balance sheet and cash flow profile as supporting organic growth, strategic acquisitions and investment opportunities, but the filing does not provide formal revenue or earnings guidance.
- Churchill Downs expected to complete a $37.0 million project adding more than 1,800 seats through new luxury starting-gate suites and dining tables before the 2018 Kentucky Derby.
- A $32.0 million parking and transportation project at Churchill Downs was scheduled for phased completion in 2018.
- The company announced a $60.0 million Derby City Gaming historical racing machine facility in Louisville, expected to open in the second half of 2018.
- On February 12, 2018, the company completed a $500.0 million modified Dutch auction repurchase of 1,886,792 shares at $265.00 per share.
- On February 28, 2018, the company announced agreements to acquire Presque Isle Downs & Casino and Lady Luck Vicksburg for approximately $229.5 million in cash, subject to closing conditions and gaming and racing licenses.
- After the Big Fish closing, the company used part of the proceeds to repay the $242.0 million revolver balance outstanding at December 31, 2017.
- Key contingencies include an EPA matter involving alleged CAFO non-compliance at Fair Grounds and litigation concerning the allocation of Louisiana video-poker purse supplements to quarter-horse participants. The filing states that the potential loss from ordinary litigation cannot always be estimated and that no material excess exposure was expected based on currently known information.
- Historical racing machine litigation in Kentucky remained pending. A court decision expected in the second or third quarter of 2018 could affect the design, economics and technology of future historical racing machine games.
- Principal risks include extensive gaming and racing regulation, license renewal, increased competition, changes in gaming taxes, consumer discretionary spending, weather and racing interruptions, cyber and system failures, online wagering regulation, debt covenants and variable interest rates. A one-percentage-point increase in LIBOR was estimated to reduce net income and operating cash flow by approximately $6.4 million, assuming constant variable-rate debt.
Most important facts for an investor to verify
- Reconcile continuing-operations performance with total net income, recognizing that Big Fish Games contributed $18.1 million of 2017 income after tax but was sold shortly after year-end.
- Assess normalized profitability excluding the $57.7 million tax benefit, $21.7 million impairment charge, $20.7 million debt-extinguishment loss and the nonrecurring 2016 Calder land-sale gain.
- Verify post-sale debt balances, revolver repayment, interest costs and compliance with the 2017 Credit Agreement’s leverage and interest-coverage covenants.
- Evaluate whether TwinSpires handle and active-player growth can continue after considering content costs, taxes, marketing expense and regulatory changes.
- Review the funding requirements and licensing conditions for the announced Presque Isle Downs and Lady Luck Vicksburg acquisitions and 2018 capital projects.
- Monitor the EPA Fair Grounds matter, Louisiana purse litigation and Kentucky historical racing machine litigation for potential cash costs or operating restrictions.
- Confirm the accounting and cash-flow effects of the Big Fish sale, including working-capital and other closing adjustments not specified in the filing text.