Churchill Downs Incorporated 2016 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2016. Churchill Downs operates through Racing, Casinos, TwinSpires, Big Fish Games, Other Investments and Corporate segments. The company is anchored by the Kentucky Derby, operates approximately 9,030 gaming positions in seven states, runs the TwinSpires online horseracing wagering platform, and owns Big Fish Games.
Results are seasonal, with a substantial portion of racing revenue generated during the second quarter around Kentucky Oaks and Kentucky Derby week. The filing also provides unaudited fourth-quarter 2016 net revenue of $278.3 million and income from operations of $26.8 million.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net revenue | $1,308.6 million | $1,212.3 million | +$96.3 million, or 7.9% |
| Operating income | $194.2 million | $123.6 million | +$70.6 million |
| Operating margin | 14.8% | 10.2% | +4.6 percentage points |
| Net income | $108.1 million | $65.2 million | +$42.9 million, or 65.8% |
| Diluted EPS | $6.42 | $3.71 | +73.0% |
| Adjusted EBITDA | $334.5 million | $302.5 million | +$32.0 million, or 10.6% |
| Operating cash flow | $226.8 million | $264.5 million | -$37.7 million |
| Capital expenditures | $54.7 million | $43.5 million | +$11.2 million |
| Cash and cash equivalents | $48.7 million | $74.5 million | -$25.8 million |
| Total debt | $927.5 million | $788.7 million | +$138.8 million |
| Net debt | $907.5 million | $765.6 million | +$141.9 million |
Revenue growth was led by Big Fish Games, which generated $486.2 million of revenue, up $72.5 million, and TwinSpires, whose revenue increased $20.4 million. Racing revenue increased $3.1 million, while Casinos revenue was essentially flat.
Adjusted EBITDA increased across Racing, Casinos, TwinSpires and Big Fish Games. Segment Adjusted EBITDA was $125.8 million for Casinos, $79.7 million for Racing, $79.1 million for Big Fish Games and $55.2 million for TwinSpires.
Big Fish Games bookings were $486.2 million, up 7.3%. Casual and mid-core free-to-play bookings increased substantially, while social casino and premium bookings declined. TwinSpires.com handle increased 13.7% to $1.1 billion, and active players increased 23.3%.
At year-end, total assets were $2,254.4 million, total liabilities were $1,569.4 million and shareholders’ equity was $685.0 million. The company had $34.3 million of restricted cash and $81.3 million of current Big Fish Games deferred revenue.
Material changes versus the prior comparable period
- Operating income and margin benefited from higher Big Fish Games and TwinSpires performance, a strong Kentucky Derby and Oaks week, lower acquisition expenses, lower Calder exit costs and a $23.7 million gain on the sale of 61 acres of excess Calder land.
- The Calder land sale generated $25.6 million of proceeds. A portion was placed in a qualified intermediary trust for a planned real estate reinvestment.
- Interest expense increased $15.1 million, principally because of higher debt balances and borrowings used to fund the Big Fish Games earnout.
- The company paid $281.6 million of the Big Fish Games earnout in March 2016 and had a remaining earnout liability of $67.9 million at year-end, payable in 2017. A remaining founder deferred payment had a fair value of $27.8 million and was also payable in 2017.
- Operating cash flow declined because 2015 benefited from Big Fish Games deferred revenue changes and other acquisition-related working-capital effects.
- Casino performance was mixed: Oxford and Calder Casino grew, while Riverwalk, Harlow’s and Fair Grounds Slots declined amid market weakness, competition and adverse weather.
- Racing live days declined at Arlington and Fair Grounds, although Churchill Downs revenue and profitability improved with record Kentucky Derby and Oaks week results.
- The company adopted new share-based payment accounting guidance prospectively and recognized a $4.9 million income tax benefit. It also changed corporate expense allocation to an activity-based method and revised its Adjusted EBITDA definition.
Guidance, outlook, risks and unusual items
Management did not provide specific consolidated revenue or earnings guidance in the filing. Management stated that operating cash flow over the next twelve months was expected to be adequate to fund operations and capital expenditures and that the balance sheet supported organic growth, acquisitions and other investments.
Planned or announced investments included a $16.0 million Churchill Downs clubhouse renovation, a $37.0 million project expected to add more than 1,800 seats for the 2018 Kentucky Derby, and a $25.0 million Oxford hotel and gaming-floor expansion expected to open in the second half of 2017.
- Debt increased to $927.5 million, including $327.5 million under the Senior Secured Credit Facility and $600.0 million of 5.375% senior unsecured notes due 2021. The company had $344.7 million of borrowing capacity after letter-of-credit commitments.
- At December 31, 2016, the company reported compliance with its debt covenants: interest coverage of 7.8x versus a minimum of 3.0x, total leverage of 2.8x versus a maximum of 4.5x, and senior secured leverage of 1.1x versus a maximum of 3.5x.
- A one-percentage-point increase in LIBOR was estimated to reduce net income and operating cash flow by approximately $2.1 million, assuming constant variable-rate debt.
- Major risks include extensive gaming and racing regulation, license renewals, potential tax and fee increases, competition from casinos and online wagering, declining or volatile racing participation, weather and catastrophic events, cybersecurity and system failures, dependence on third-party digital platforms, and Big Fish Games content and user-acquisition risk.
- Louisiana temporarily changed sales-tax treatment for racing purchases, which management expected to adversely affect the business. The company also faces proposed or potential gaming expansion in Maine, Florida, New York and Maryland.
- The company is in discussions with the EPA and Department of Justice regarding alleged CAFO non-compliance at Fair Grounds and expects remediation-related capital expenditures.
- Churchill Downs filed a Pennsylvania lawsuit challenging restrictions and licensing fees for advance deposit wagering. A Louisiana horsemen’s purse dispute remained on appeal.
- The filing records a $1.5 million expense for potential penalties related to untimely informational tax returns. A separate potential TwinSpires-related civil penalty of approximately $1.6 million was not accrued because payment was not considered probable.
- No goodwill, indefinite-lived intangible asset or property-and-equipment impairment was recorded in 2016. The company recorded a $9.5 million out-of-period reduction to Big Fish Games goodwill to correct purchase-price-allocation errors, which management determined were not material to prior periods.
- On January 3, 2017, an affiliate acquired Ocean Downs. The company expects to account for its effective 62.5% interest using the equity method.
Most important facts for investors to verify
- Whether Big Fish Games can sustain growth in casual and mid-core free-to-play games while reversing declines in social casino and premium products.
- The timing and cash impact of the remaining $96.2 million of Big Fish Games earnout and deferred founder payments due in 2017.
- Debt repayment capacity and refinancing exposure associated with the approximately $842.5 million of scheduled debt maturities in 2021.
- The sustainability of TwinSpires handle and active-player growth after elevated marketing around major racing events.
- Progress, cost and expected returns from Churchill Downs, Oxford and other capital projects.
- The effect of Louisiana tax changes, gaming expansion proposals and regulatory developments on casino and racing margins.
- Potential liabilities or operating restrictions arising from the Fair Grounds environmental matter, Pennsylvania wagering litigation and Louisiana horsemen’s litigation.
- Big Fish Games revenue-recognition estimates, including the estimated lives of virtual goods and future effects of the new revenue-recognition standard.
- The impact of competition, weather, racing-day allocations and horsemen’s agreements on Racing segment results.