Churchill Downs Incorporated — Q2 2014 Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and six months ended June 30, 2014. Churchill Downs operates racing, gaming, online wagering and other investments. Results are seasonal, with a substantial portion of racing revenue generated during the second quarter by the Kentucky Oaks and Kentucky Derby. The financial statements are unaudited.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net revenues | $303.7 million, up 7% | $471.0 million, up 9% |
| Operating income | $94.2 million, up 15% | $95.7 million, up 12% |
| Operating margin | 31.0%, versus 29.0% | 20.3%, versus 19.7% approximately |
| Earnings from continuing operations | $57.3 million, up 14% | $56.6 million, up 10% |
| Diluted earnings per share | $3.21, versus $2.81 | $3.17, versus $2.87 |
| Adjusted EBITDA | $116.5 million, up 12% | $141.0 million, up 13% |
- Second-quarter revenue growth was driven primarily by the Oxford Casino acquisition, stronger Kentucky Oaks and Derby results, and online handle growth. Six-month revenue included $36.9 million from Oxford.
- Gaming revenue increased 23% in the second quarter and 21% for the six-month period, although Mississippi and Louisiana properties declined. Oxford contributed $19.4 million of second-quarter revenue and $36.9 million for six months.
- Online revenue increased 9% in the quarter and 8% year to date. Online handle increased 4.7% and 6.5%, respectively; excluding Illinois and Texas effects, handle increased 5.5% and 6.9%.
- Racing revenue increased 1% in the quarter and 3% year to date. Racing Operations Adjusted EBITDA increased 11% in the quarter and 14% for six months.
- Consolidated pari-mutuel handle declined 17% in the quarter and 10% year to date, primarily due to Calder weakness and field-size challenges at Churchill Downs and Arlington.
- Net cash provided by operating activities was $119.1 million, up from $100.3 million. Free cash flow, as defined by the company, was $106.7 million, up from $91.1 million.
- Capital expenditures were $38.5 million, including $27.9 million in Racing Operations. Investing cash outflows were $47.2 million.
- Cash and cash equivalents were $46.7 million at June 30, 2014, compared with $44.7 million at December 31, 2013. Restricted cash was $35.7 million.
- Long-term debt was $368.8 million, excluding current maturities. The company had $68.8 million outstanding under its variable-rate Senior Secured Credit Facility and reported $425.2 million of available borrowing capacity.
- The company was in compliance with debt covenants: interest coverage was 14.8x versus a minimum of 3.0x; total leverage was 1.9x versus a maximum of 5.0x; and senior secured leverage was 0.4x versus a maximum of 3.5x.
Material changes versus the prior comparable period
- The July 2013 Oxford Casino acquisition materially increased Gaming revenue and Adjusted EBITDA but also increased gaming taxes, operating expenses, depreciation and amortization.
- Interest expense increased substantially following the December 2013 issuance of $300 million of 5.375% Senior Unsecured Notes due 2021. Six-month interest expense increased to $9.9 million from $2.7 million.
- Equity income from Miami Valley Gaming increased as the facility moved beyond its pre-opening period; the company recognized $4.8 million of equity earnings for six months versus a $0.8 million loss in the prior year.
- The company repurchased 691,000 shares for $61.6 million in a privately negotiated transaction and paid $15.2 million of dividends. Approximately $38.4 million remained available under the repurchase authorization.
- Other Investments Adjusted EBITDA declined to a $2.0 million loss for six months, primarily due to lower United Tote activity and Internet gaming development costs.
Guidance, outlook, commentary and risks
- Management stated that operating cash flow over the following twelve months was expected to be adequate to fund operations and capital expenditures. No formal revenue or earnings guidance was provided.
- On July 1, 2014, The Stronach Group agreed to operate Calder’s live racing and certain racing and training facilities through December 31, 2020, at its own expense. Churchill Downs will continue to operate Calder Casino.
- The Calder arrangement reduced the casino’s overnight purse supplement rate from 12% to 10% of slot revenue. Churchill Downs expected approximately $2.0 million of severance and related benefit costs in the third quarter after notifying 214 Calder employees of termination.
- The company filed a bid for a proposed New York destination resort casino with Saratoga Harness Racing. The project is estimated at approximately $330 million, including a $50 million license fee; the company expected to fund its share through the credit facility and anticipated a $2.6 million contribution in the third quarter. Award of the license was uncertain.
- Key risks include regulatory and legislative changes affecting gaming and online wagering, competition among racetracks and casinos, racing-day and horse-supply availability, economic weakness in regional markets, interest-rate exposure, litigation, licensing requirements, cybersecurity, acquisitions and the volatility of discretionary consumer spending.
- Pending matters include challenges to Pennsylvania ADW taxation, a Louisiana horsemen’s purse class action, an Illinois tax dispute involving a $2.9 million protest payment, the Kentucky Downs ownership dispute and an appeal concerning Texas online wagering restrictions. Management stated it did not expect these matters to have a material adverse effect, but possible losses beyond accrued amounts were not clearly estimable.
- A one-percentage-point increase in LIBOR, assuming constant variable-rate debt, would reduce net earnings and operating cash flow by approximately $0.4 million.
Important facts for investors to verify
- Separate Oxford acquisition benefits from underlying organic growth and assess whether regional gaming declines persist.
- Review the financial and operating impact of the Calder racing lease, casino-only operations, employee terminations and expected severance costs.
- Monitor the effect of the $300 million Senior Unsecured Notes and variable-rate debt on interest expense, leverage and liquidity.
- Evaluate the sustainability of Kentucky Oaks and Derby-related revenue and margin gains given the company’s significant seasonality.
- Track regulatory outcomes affecting Pennsylvania ADW taxes, Texas wagering, Kentucky historical racing, online gaming and the proposed New York casino.
- Reconcile Adjusted EBITDA and free cash flow to GAAP measures because both are non-GAAP metrics and may not be comparable with other companies.