Business Context and Reporting Period
Churchill Downs Incorporated filed an unaudited Form 10-Q for the three months ended March 31, 2016. The company operates racing, casinos, online wagering through TwinSpires, Big Fish Games, and other investments. Results are seasonal, with racing and TwinSpires generally benefiting from the Kentucky Derby and Oaks in the second quarter.
The company conducted 54 live thoroughbred racing days in the first quarter of 2016, compared with 57 in the prior-year quarter. The filing also reflects the January 1, 2016 reclassification of I-Gaming and Bluff Media operations into TwinSpires and changes to the definition of Adjusted EBITDA.
Financial Highlights
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net revenue | $288.4 million | $250.9 million | +$37.5 million |
| Adjusted EBITDA | $52.8 million | $49.8 million | +$3.0 million |
| Operating income (loss) | $6.3 million | $(4.1) million | +$10.4 million |
| Operating margin | 2% | (2)% | Improved |
| Net income (loss) | $2.8 million | $(1.6) million | +$4.4 million |
| Diluted EPS | $0.16 | $(0.09) | Improved |
| Operating cash flow | $66.6 million | $89.7 million | $(23.1) million |
| Free cash flow | $58.7 million | $81.7 million | $(23.0) million |
Revenue growth was led by Big Fish Games, which increased revenue by $30.2 million to $122.1 million, primarily from casual and mid-core free-to-play games. TwinSpires revenue increased $4.1 million, supported by a 10.6% increase in handle. Racing revenue increased $2.6 million, while casino revenue increased $0.5 million.
Adjusted EBITDA improved in Casinos by $3.9 million, TwinSpires by $2.0 million, and Racing and Other Investments by a combined $2.2 million. Big Fish Games Adjusted EBITDA declined $5.0 million because of higher user-acquisition spending and the absence of certain prior-year business-combination accounting benefits.
Liquidity, Cash Flow, Debt, and Balance Sheet
- Cash and cash equivalents were $51.1 million at March 31, 2016, compared with $74.5 million at December 31, 2015. Restricted cash was $23.2 million.
- Total debt was $987.2 million, up $205.4 million from year-end 2015, primarily because borrowings funded the Big Fish Games earnout payment.
- Debt consisted principally of $393.3 million under the Senior Secured Credit Facility and $593.9 million carrying value of 5.375% Senior Unsecured Notes due 2021.
- The company had $284.7 million of borrowing capacity under the Senior Secured Credit Facility and remained compliant with its debt covenants. Reported ratios were 10.3x interest coverage, 3.2x total leverage, and 1.4x senior secured leverage.
- Financing activities used $75.1 million, including a $261.9 million Big Fish Games earnout payment, partially offset by $205.1 million of bank-line borrowings net of repayments.
- Capital expenditures were $16.4 million, including $8.5 million of capital-project spending and $7.9 million of maintenance capital expenditures.
The February 2016 credit agreement amendment extended the Senior Secured Credit Facility and Term Loan maturities to February 2021. A one-percentage-point increase in LIBOR would reduce net income and operating cash flow by an estimated $1.5 million, assuming constant debt balances.
Material Changes Versus the Prior Comparable Period
- Revenue increased 15.0%, but operating expenses increased $27.1 million, including $14.0 million of additional marketing and advertising expense and $12.8 million of higher platform and development fees, primarily at Big Fish Games.
- Big Fish Games bookings increased to $128.2 million from $104.8 million. Casual and mid-core free-to-play revenue increased $28.9 million, while social casino and premium revenue declined.
- TwinSpires total handle increased to $236.7 million from $214.1 million; its commission rate declined to 19.0% from 19.3%.
- Casino performance benefited from Oxford Casino growth, Saratoga management-fee and equity income, and Miami Valley Gaming. Fair Grounds Slots remained pressured by the Orleans Parish smoking ban and regional competition.
- Operating results benefited from lower acquisition-related charges, which declined to $2.7 million from $6.4 million, but included $0.4 million of Calder demolition and exit costs.
- Net income benefited from a $3.1 million income-tax benefit resulting from early adoption of ASU 2016-09 on employee share-based payments. The company also recorded a $5.8 million gain on the sale of its HRTV investment in the prior-year quarter that did not recur.
Outlook, Commentary, Risks, and Unusual Items
The filing does not provide formal financial guidance. Management expects seasonal strength in racing and TwinSpires during the second quarter around the Kentucky Derby and Oaks, but cautions that quarterly results are not necessarily indicative of full-year performance.
- Big Fish Games faces risks from user-acquisition costs, mobile-platform relationships, game-content availability, programming defects, security breaches, and changing consumer usage of smartphones and tablets.
- Racing, casino, and wagering results depend on consumer discretionary spending, competition, racing days, horsemen agreements, gaming licenses, and changes in federal or state law.
- Pennsylvania legislation changed advance-deposit-wagering taxes and licensing requirements and could materially adversely affect TwinSpires; the company was evaluating alternatives.
- Illinois legislation concerning advance-deposit wagering was under consideration and, if not enacted, could materially affect the business. Other proposed gaming changes in Florida, Maine, Kentucky, New York, and California had uncertain effects.
- The company is exposed to variable-rate debt, general economic conditions, foreign currency movements, litigation, regulatory changes, natural disasters, and intellectual-property claims.
- On April 18, 2016, the Illinois Thoroughbred Horsemen’s Association sued Arlington and others regarding horsemen-group authority and related racing rights. The court denied requests for a temporary restraining order and preliminary injunction on April 20, 2016.
- Big Fish Games achieved its earnout milestones; the company paid $281.6 million in March 2016 and reported $66.1 million of remaining earnout liability, expected to be paid in 2017.
- Annual impairment testing identified no required adjustment to goodwill or indefinite-lived intangible assets.
Investor Verification Checklist
- Verify the sustainability of Big Fish Games bookings growth and whether increased user-acquisition spending converts into durable revenue and EBITDA.
- Monitor total leverage, interest expense, covenant headroom, and the company’s ability to fund remaining Big Fish Games earnout and deferred-payment obligations.
- Assess the impact of seasonal Kentucky Derby and Oaks results on second-quarter racing, TwinSpires, and deferred revenue.
- Track Fair Grounds Slots performance, the Orleans Parish smoking-ban effects, and competitive conditions across casino markets.
- Review developments in Pennsylvania and Illinois advance-deposit-wagering regulation and the Arlington horsemen litigation.
- Separate GAAP earnings from Adjusted EBITDA and free cash flow, particularly the effects of deferred revenue, acquisition-related charges, stock compensation, and tax benefits.