Churchill Downs Incorporated — Q1 2014 Form 10-Q Summary
Business context and reporting period
Churchill Downs Incorporated operates racing, casino gaming, online wagering and related businesses. This unaudited quarterly report covers the three months ended March 31, 2014, compared with the three months ended March 31, 2013. Results are seasonal: racing revenue is concentrated in the second quarter around the Kentucky Derby and Kentucky Oaks, while gaming revenue historically benefits from first-quarter seasonality.
The Company conducted 92 live thoroughbred racing days in the quarter versus 56 in the prior-year period, primarily because Calder conducted 39 winter racing days versus none in the prior year. Oxford Casino, acquired in July 2013, contributed $17.5 million of revenue and $2.5 million of pretax earnings in the quarter.
Financial performance and key metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net revenue | $167.3 million | $147.9 million | +13% |
| Operating income | $1.6 million | $3.0 million | -$1.5 million |
| Operating margin | 0.9% | 2.1% | Down 1.2 points |
| Income from continuing operations | $(0.7) million | $1.1 million | Decline of $1.8 million |
| Net income | $(0.7) million | $1.1 million | Decline of $1.8 million |
| Diluted earnings per share | $(0.04) | $0.06 | Declined |
| Adjusted EBITDA | $24.5 million | $21.1 million | +16% |
| Cash flow from operations | $51.9 million | $46.7 million | +11% |
| Free cash flow | $45.5 million | $43.0 million | +6% |
| Capital expenditures | $20.2 million | $13.7 million | +47% |
Revenue growth was led by Gaming, which increased 20% to $86.6 million, including Oxford. Racing revenue increased 10% to $30.6 million, and Online revenue increased 7% to $46.1 million. Other revenue declined 19% to $4.1 million.
Adjusted EBITDA increased to $24.5 million. Gaming Adjusted EBITDA rose 24% to $27.3 million, while Racing Operations improved 9% but remained negative at $(10.3) million. Online Business Adjusted EBITDA declined 12% to $10.0 million, and Other Investments declined to $(1.4) million.
Operating performance was pressured by higher share-based compensation, increased gaming and pari-mutuel taxes, Internet gaming development costs, and higher costs associated with Calder’s additional racing meet. Interest expense increased to $5.0 million from $1.5 million, primarily because of the $300 million Senior Unsecured Notes issued in December 2013.
Cash, debt and liquidity
- Cash and cash equivalents were $47.2 million at March 31, 2014, compared with $44.7 million at December 31, 2013.
- Total debt was approximately $365.8 million, consisting primarily of borrowings under the Senior Secured Credit Facility and the $300 million of 5.375% Senior Unsecured Notes due December 15, 2021.
- The Senior Secured Credit Facility had $65.7 million outstanding and $428.3 million of borrowing capacity available at quarter-end; it matures May 17, 2018.
- The Company was in compliance with all debt covenants. Actual interest coverage was 19.7x versus a minimum of 3.0x; total leverage was 1.9x versus a maximum of 4.5x; and senior secured leverage was 0.4x versus a maximum of 3.5x.
- Cash used in investing activities was $27.9 million, including $20.2 million of capital expenditures and $6.5 million contributed to Miami Valley Gaming.
- Cash used in financing activities was $21.6 million, including $15.2 million of dividends and $7.4 million of share repurchases, primarily shares withheld for employee tax obligations.
Material changes versus the prior comparable period
- Oxford Casino added $17.5 million of revenue and $4.2 million of Adjusted EBITDA.
- Miami Valley Gaming generated $32.8 million of net revenue and $4.1 million of net income; Churchill Downs recognized $2.0 million of equity earnings and contributed $6.5 million during the quarter.
- Online wagering handle increased 8.8% to $211.8 million. Illinois wagering resumed and increased by $14.6 million, while Texas wagering was eliminated following the suspension of Texas accounts in September 2013.
- Total Racing Operations handle increased 15%, primarily from Calder’s additional live racing days.
- Mississippi and Louisiana gaming properties experienced revenue declines due to regional economic weakness, poor weather and lower attendance.
- Share-based compensation expense increased to $5.2 million from $3.4 million. Unrecognized compensation expense under the long-term incentive plan was $6.8 million at March 31, 2014.
- Deferred revenue increased $21.6 million to $87.4 million, primarily from advance billings for the 2014 Kentucky Derby and Kentucky Oaks.
- The Company received an additional $0.4 million of insurance recovery related to the 2012 Kentucky hailstorm; the claim has been finalized and no further recoveries are expected.
Outlook, risks, contingencies 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 filing provides no formal revenue or earnings guidance.
- Key risks include seasonality, competition among racing and gaming facilities, changes in gaming and wagering laws, licensing requirements, consumer discretionary spending, interest rates, insurance costs, regulatory changes and litigation.
- Florida racing-host regulations remain unresolved and may affect Calder’s long-term racing and simulcast economics.
- The Company is awaiting a Fifth Circuit ruling on its challenge to Texas restrictions on online pari-mutuel wagering. TwinSpires continues not to accept wagers from Texas residents.
- A Louisiana class action alleges that certain video poker-derived purse supplements should have been allocated to quarter-horse participants. The plaintiffs seek future payments and damages; the filing does not provide a clear potential loss amount.
- The Illinois Department of Revenue dispute involves a $2.9 million protest payment related to the calculation of the Company’s Illinois sales factor. The matter remains pending.
- The Kentucky Downs dispute concerning the Company’s put right remained in discovery with no trial date set.
- New Kentucky legislation enacted after quarter-end imposes a 1.5% tax on historical racing handle and a 0.5% tax on Kentucky resident ADW wagers beginning August 1, 2014. Management stated the ADW tax is not expected to have a material negative impact, while the impact of the historical racing tax remains unclear.
- The Company completed its annual goodwill and indefinite-lived intangible asset impairment testing with no impairment recorded.
- Proposed federal and state gaming legislation, including possible restrictions on Internet gaming and potential gaming expansion in Kentucky, Illinois, Florida, Maine and Louisiana, could materially affect the business, although outcomes were uncertain at filing.
Investor verification checklist
- Verify the sustainability of revenue and Adjusted EBITDA growth after the Oxford acquisition and the initial ramp-up of Miami Valley Gaming.
- Assess whether higher interest expense, share-based compensation and regulatory taxes continue to suppress GAAP earnings despite positive operating cash flow.
- Review debt maturity, interest-rate exposure and covenant headroom; a 1-percentage-point increase in LIBOR was estimated to reduce annual earnings and operating cash flow by approximately $0.4 million.
- Monitor Calder’s racing-host status and the effects of overlapping Florida race dates.
- Track the Texas online wagering appeal, Louisiana purse litigation, Illinois tax dispute and Kentucky Downs litigation.
- Evaluate capital spending and ongoing contributions to Miami Valley Gaming relative to free cash flow and future operating needs.
- Consider the significant seasonality of racing results and avoid annualizing first-quarter earnings or margins.