Business Context and Reporting Period
Churchill Downs Incorporated filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2014. The company operates racing, casino gaming, online wagering and related businesses. Results are seasonal, with the second quarter typically benefiting from the Kentucky Derby and Kentucky Oaks. The company conducted 65 live thoroughbred racing days in the third quarter, compared with 104 in the prior-year quarter, primarily because Calder ceased pari-mutuel operations on July 1, 2014.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Change | Nine Months Ended September 30 | Change |
|---|---|---|---|---|
| Net revenue | $173.7 million | Down 6% | $644.6 million | Up 4% |
| Operating income | $8.4 million | Down 18% | $104.1 million | Up 9% |
| Operating margin | 4.8% | Down from 5.5% | 16% | Up from 15% |
| Earnings from continuing operations | $3.5 million | Down 62% | $60.2 million | Down 1% |
| Diluted EPS from continuing operations | $0.20 | Down from $0.51 | $3.40 | Comparable with $3.39 |
| Adjusted EBITDA | $32.2 million | Up 1% | $173.2 million | Up 10% |
Gaming revenue increased 2% in the quarter and 14% year to date, supported by the Oxford Casino acquisition and the opening of Miami Valley Gaming. Racing revenue declined 19% in the quarter and 2% year to date. Online revenue declined 5% in the quarter but increased 4% year to date. Gaming Adjusted EBITDA rose 22% in the quarter and 27% year to date, while Online Business Adjusted EBITDA declined 15% and 9%, respectively.
Net cash provided by operating activities was $114.2 million for the nine months, essentially unchanged from $114.4 million in the prior-year period. Free cash flow was $96.1 million, down 4% from $100.6 million. Capital expenditures were $48.9 million, up 64%, including $30.7 million of capital project expenditures. Investing cash outflows were $59.4 million, compared with $220.9 million in 2013, which included the Oxford acquisition.
At September 30, 2014, cash and cash equivalents were $42.0 million and restricted cash was $27.1 million. Total assets were $1.33 billion, total liabilities were $617.3 million and shareholders' equity was $715.0 million. Long-term debt was $383.4 million. The company reported $410.6 million of available borrowing capacity under its Senior Secured Credit Facility and was in compliance with all debt covenants. The facility had $83.4 million outstanding and a 1% increase in LIBOR would reduce annualized earnings and operating cash flow by approximately $0.5 million, assuming constant borrowings.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue fell $11.8 million, primarily because Calder racing revenue declined $8.2 million after pari-mutuel operations ceased, while Online revenue declined because Texas wagering was no longer accepted.
- Nine-month revenue increased $27.7 million, primarily from Oxford, which contributed $58.8 million of revenue during the period, compared with $17.7 million in the comparable 2013 period.
- Quarterly earnings were pressured by $2.3 million of Calder severance and benefit costs, $1.3 million of accelerated Calder depreciation, higher interest expense, and the absence of $4.2 million of prior-year HRE Trust Fund proceeds.
- Interest expense increased to $15.1 million year to date from $4.1 million, primarily because of the $300 million Senior Unsecured Notes issued in December 2013.
- The company repurchased 691,000 shares for $61.6 million during the nine months and paid $15.2 million of dividends. Approximately $38.4 million remained available under the repurchase authorization.
- Online Business handle increased 3.3% year to date, but Texas handle declined $42.2 million following the cessation of Texas wagering. Illinois handle increased $30.2 million after wagering resumed.
Outlook, Commentary, Risks and Unusual Items
- Management stated that operating cash flow over the next twelve months is expected to be adequate to fund operations and capital expenditures.
- The company expected to fund approximately $9.5 million of additional contributions to its Ohio and New York joint ventures during the fourth quarter of 2014, including approximately $8.5 million for Miami Valley Gaming and approximately $1.0 million for the Capital View Casino project.
- The company entered into a July 2014 arrangement under which The Stronach Group operates Calder racing facilities through 2020, while Churchill Downs retains the Calder Casino. The arrangement reduced non-stakes purse supplements from 12% to 10% of slot revenue and resulted in the termination of 214 Calder employees.
- In October 2014, the company agreed to acquire a 25% interest in Saratoga Casino Holdings and entered into a five-year management agreement, subject to regulatory approvals and licensing requirements.
- The company decided to cease Luckity operations and expected to record an approximately $3.2 million impairment charge in the fourth quarter of 2014.
- Pending matters include Louisiana horsemen’s purse litigation, the Illinois Department of Revenue tax dispute involving a $2.9 million protest payment, and Kentucky Downs litigation. The company stated that it did not expect these matters to have a material adverse effect, but the filing does not provide a clear potential loss range.
- The Fifth Circuit affirmed the ruling upholding Texas restrictions on online wagering; the company was evaluating its remaining legal options.
- Key business risks include regulatory and licensing changes, gaming and racing competition, consumer discretionary spending, interest-rate exposure, litigation, online security breaches, horsemen’s agreements, and the ability to execute acquisitions and expansion projects.
- The filing states that disclosure controls and procedures were effective as of September 30, 2014, with no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether Calder’s lease arrangement and casino operations offset the loss of pari-mutuel revenue and whether additional Calder depreciation or restructuring costs occur.
- The sustainability of Oxford and Miami Valley Gaming contributions, including their operating performance and required capital funding.
- The effect of higher debt service and variable-rate exposure on cash flow and covenant compliance.
- The financial impact of the Luckity shutdown, the Saratoga Casino Holdings transaction, and the proposed Capital View Casino project.
- The outcome and potential financial exposure of the Louisiana, Illinois and Kentucky Downs legal proceedings and the $1.9 million Pennsylvania ADW tax refund claim.
- Whether Online Business growth can offset the loss of Texas wagering and increased state taxation.