Business Context and Reporting Period
Churchill Downs Incorporated filed an unaudited Form 10-Q for the three months ended March 31, 2012. The company operates racing, gaming, online wagering and other investment businesses. Results are highly seasonal: the first quarter generally has fewer live racing days, while a substantial portion of racing revenue is generated during the second quarter through the Kentucky Derby and Kentucky Oaks. The company conducted 56 live racing days in the first quarter of 2012 versus 62 in the prior-year quarter.
Key Financial Metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net revenues | $138.2 million | $131.6 million | +5% |
| Operating income (loss) | $3.7 million | $(2.9) million | +$6.6 million |
| Operating margin | 3% | (2)% | Improved |
| Earnings (loss) from continuing operations | $1.4 million | $(3.2) million | +$4.5 million |
| Net earnings (loss) | $1.4 million | $(3.2) million | +$4.5 million |
| Diluted earnings (loss) per share | $0.08 | $(0.19) | +$0.27 |
| EBITDA | $17.3 million | $11.2 million | +55% |
| Cash flow from operations | $55.1 million | $60.5 million | (9)% |
| Free cash flow | $50.2 million | $55.9 million | (10)% |
| Capital expenditures | $9.1 million | $5.5 million | +$3.6 million |
Revenue by segment was $30.2 million for Racing, $59.3 million for Gaming, $44.0 million for Online and $4.6 million for Other. Online revenue increased 20%, while Racing revenue declined 5% and Gaming revenue was essentially unchanged.
At March 31, 2012, cash and cash equivalents were $28.9 million, restricted cash was $41.9 million, total assets were $937.2 million, total liabilities were $344.4 million and shareholders’ equity was $592.8 million. Long-term debt was $107.8 million, down from $127.6 million at December 31, 2011. The company reported $261 million of borrowing capacity under its revolving credit facilities and compliance with debt covenants.
Material Changes Versus the Prior Comparable Period
- Online handle increased 15.2% to $199.8 million, supported by new-customer growth and higher average daily wagering. Online EBITDA increased 38% to $10.4 million.
- Total Racing Operations handle declined 7.3% and racing revenue declined 5%, primarily because of six fewer live racing days. Racing EBITDA nevertheless improved by $1.1 million due to lower utilities and other cost controls.
- Gaming revenue increased marginally. Calder Casino revenue increased 6% on a 7% increase in slot handle, offsetting lower revenue at Harlow’s and modest declines at Fair Grounds Slots.
- Total EBITDA increased $6.2 million, reflecting stronger Gaming and Online results, insurance recoveries and the Calder reimbursement.
- Interest expense declined to $1.2 million from $2.5 million, primarily because of lower average debt balances.
- Operating cash flow declined because Q1 2011 included an $8.5 million federal tax refund. Investing cash use increased because of the Bluff acquisition, the Ohio joint venture investment, additional Kentucky Downs investment and higher capital expenditures.
- The company paid $10.1 million of dividends and repaid $19.8 million of long-term debt during the quarter.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management stated that operating cash flows over the next twelve months are expected to be adequate to fund operations and capital expenditures.
- The company expected approximately $15 million of 2012 capital expenditures for Harlow’s renovations, partially offset by insurance recoveries. Approximately $2.3 million of annual Calder Casino licensing fees were expected in the second quarter.
- Harlow’s continued to operate without permanent dining facilities following 2011 Mississippi River flooding. The company received $5.0 million of insurance proceeds in Q1 and an additional $7.0 million in April 2012; it expected to recognize $5.0 million of net insurance recoveries in Q2.
- Q1 operating expenses benefited from $1.5 million of net insurance recoveries related to Harlow’s wind damage and $0.8 million of reimbursement related to a prior Florida slot-machine referendum. These items are unusual and should be considered when assessing recurring profitability.
- The company acquired Bluff Media for $6.6 million, including estimated contingent consideration of $2.3 million tied to future Internet-poker enabling legislation. It also contributed $4.3 million to the Miami Valley Gaming & Racing joint venture, which is subject to regulatory approvals, legal challenges and other closing conditions.
- Key risks include seasonality, discretionary consumer spending, gaming and racing competition, changes in wagering and gaming laws, licensing, horsemen’s agreements, online security, natural disasters and insurance recoverability, acquisitions and expansion execution, and pending litigation.
- Material legal matters include Hialeah litigation alleging unfair competition with unspecified damages and an Illinois lawsuit involving TwinSpires and Youbet.com in which plaintiffs alleged damages of at least $3.6 million or, alternatively, $0.8 million. Management stated that it did not expect the disclosed proceedings to have a material adverse effect.
- Variable-rate debt creates interest-rate risk: a one-percentage-point increase in LIBOR would reduce annual pretax earnings by approximately $1.1 million, assuming debt balances remain constant.
- The company stated that there were no material changes to previously disclosed risk factors and that disclosure controls were effective as of March 31, 2012.
Important Facts for Investors to Verify
- Separate recurring operating performance from the $1.5 million insurance recovery and $0.8 million Florida reimbursement recognized in Q1, as well as the additional insurance recovery expected in Q2.
- Assess whether Online growth and Gaming performance can offset Racing seasonality, fewer live racing days and pressure at Harlow’s.
- Review the timing, cost and regulatory status of Harlow’s renovations and the Miami Valley Ohio racetrack and VLT project.
- Confirm the company’s available revolver capacity, variable-rate exposure, debt covenant compliance and planned capital spending.
- Monitor the impact of potential Hialeah gaming competition, Illinois and Kentucky wagering legislation, Ohio VLT developments and Internet-gaming regulation.
- Evaluate the status and potential exposure of the Hialeah and TwinSpires-related litigation, for which the filing does not provide a clear expected loss amount.
- Consider the seasonal limitation noted by management: first-quarter results are not necessarily indicative of full-year performance.