Churchill Downs Incorporated — Q1 2015 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three months ended March 31, 2015, compared with the three months ended March 31, 2014. Churchill Downs operates Big Fish Games, casinos, TwinSpires online wagering, racing operations and other investments. Big Fish Games was acquired on December 16, 2014, so its results were not included in the prior-year period. Results are seasonal, particularly in Racing; the company held 57 live thoroughbred racing days in Q1 2015 versus 97 in Q1 2014.
Key financial metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net revenues | $250.9 million | $167.1 million | +50% |
| Operating income (loss) | $(4.1) million | $1.6 million | $(5.7) million |
| Operating margin | (1.6)% | 0.9% | Down 2.5 points |
| Loss from continuing operations | $(1.6) million | $(0.7) million | $(0.9) million |
| Diluted loss per share | $(0.09) | $(0.04) | $(0.05) |
| Adjusted EBITDA | $48.3 million | $24.5 million | +97% |
| Net cash provided by operating activities | $89.7 million | $51.9 million | +73% |
| Free cash flow | $81.7 million | $45.5 million | +79% |
Segment revenue was $91.9 million from Big Fish Games, $85.4 million from Casinos, $45.3 million from TwinSpires, $24.4 million from Racing and $3.8 million from Other. Big Fish Games generated $104.8 million of bookings and $20.0 million of Adjusted EBITDA.
Cash and cash equivalents were $49.5 million at March 31, 2015, compared with $67.9 million at December 31, 2014. Restricted cash was $20.8 million. Cash declined primarily because of $101.1 million of financing cash outflows, including debt repayments, dividends and payments related to Big Fish Games. The company reported $289.9 million of available borrowing capacity under its Senior Secured Credit Facility.
Total debt and notes payable consisted of $399.8 million outstanding under the Senior Secured Credit Facility, including variable-rate debt, $300.0 million of senior unsecured notes and additional Big Fish Games deferred payment obligations. The company repaid approximately $70.6 million of total debt during the quarter and remained compliant with all debt covenants. Reported covenant ratios were interest coverage of 10.6x, total leverage of 3.2x and senior secured leverage of 2.0x.
Material changes versus the prior comparable period
- Revenue increased $83.8 million, almost entirely because Big Fish Games contributed $91.9 million.
- Operating results worsened despite higher Adjusted EBITDA because of $6.4 million of non-cash Big Fish Games acquisition-related fair-value charges and increased depreciation and amortization.
- Big Fish Games also produced a $12.9 million deferred-revenue reduction under purchase-accounting rules and $10.2 million of research and development expense.
- Casino revenue declined 1%, while Casino Adjusted EBITDA increased 6% to $28.8 million through operating improvements and stronger results at Oxford, MVG and Louisiana properties.
- TwinSpires revenue declined 2%, but handle increased 1.1% and Adjusted EBITDA increased 12% to $11.2 million. Handle growth exceeded the reported 5.2% industry decline.
- Racing revenue declined 20%, primarily because Calder ceased pari-mutuel operations on July 1, 2014. Racing Adjusted EBITDA improved to a loss of $9.2 million from a loss of $10.3 million, partly because of payments under the Calder agreement with The Stronach Group.
- Cash flow from operations benefited from higher deferred revenue, $20.3 million of federal tax refunds and a $3.5 million dividend from Miami Valley Gaming.
- The company sold its remaining HRTV interest in January 2015 for $6.0 million and recognized a $5.8 million gain.
Outlook, risks, contingencies and unusual items
Management stated that operating cash flow over the next 12 months is expected to be adequate to fund operations and capital expenditures. No formal earnings or revenue guidance was provided. Management described the company as being in a strong financial position and reported no current limitation on access to its credit facility.
Key risks include integrating and operating Big Fish Games, dependence on third-party mobile platforms and game developers, online security and intellectual-property risks, competition in gaming and wagering, regulatory and licensing changes, seasonality of racing, interest-rate exposure, litigation and consumer discretionary spending.
- Big Fish Games earnout and deferred founder liabilities increased by $6.4 million to $413.0 million in aggregate fair value, recorded as acquisition-related charges.
- The Big Fish Games acquisition included potential additional contingent consideration of up to $350 million based on performance milestones through December 31, 2015.
- A 1-percentage-point increase in LIBOR would reduce earnings and operating cash flow by approximately $2.2 million, assuming constant variable-rate debt.
- A purported Washington class action filed April 17, 2015 alleges that Big Fish Casino facilitates unlawful gambling. The filing did not specify damages, and the company could not estimate potential exposure.
- Other pending matters include the Louisiana horsemen’s purse dispute, an Illinois tax dispute involving a $2.9 million protest payment, and the Kentucky Downs litigation. Management stated that it did not believe these matters would have a material adverse effect, although possible losses beyond accrued amounts were not estimable.
- New Orleans’ casino smoking ban became effective April 22, 2015, and management expects a negative impact on operations.
- The company expects approximately $0.8 million of 2015 capital expenditures to demolish certain Calder barns and prepare the area for alternative uses.
Important facts for investors to verify
- Whether Big Fish Games bookings, revenue conversion, deferred-revenue accounting adjustments and Adjusted EBITDA meet acquisition expectations.
- The pace of debt repayment and the effect of variable interest rates on cash flow and covenant headroom.
- Whether the company can sustain strong operating cash flow after seasonal Derby-related deferred revenue and tax-refund benefits normalize.
- Racing performance following the loss of Calder pari-mutuel operations and the seasonal concentration of revenue in the second quarter.
- The regulatory and litigation outlook for Big Fish Casino, online wagering and casino operations.
- The potential amount and timing of Big Fish Games earnout and deferred-payment obligations, including the maximum contingent consideration.
- The effect of competitive pressure, smoking restrictions and potential gaming-law changes across Kentucky, Louisiana, Illinois, Florida, Maine, Ohio and New York.