Churchill Downs Incorporated — Q2 2019 Form 10-Q Summary
Business context and reporting period
Churchill Downs Incorporated filed an unaudited Form 10-Q for the three and six months ended June 30, 2019. The company operates racing, online wagering and gaming businesses, including Churchill Downs Racetrack, Derby City Gaming, TwinSpires, BetAmerica and casino properties in eight states. Results are highly seasonal, with the second quarter benefiting from the Kentucky Derby and Oaks.
During the first quarter of 2019, the company realigned its operating segments into Churchill Downs, Online Wagering and Gaming. Prior-period amounts were reclassified for comparability.
Financial performance and key metrics
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Change |
|---|---|---|---|
| Net revenue | $477.4 million | $379.4 million | +$98.0 million |
| Operating income | $156.4 million | $136.6 million | +$19.8 million |
| Operating margin | 33% | 36% | Down 3 points |
| Income from continuing operations | $108.3 million | $103.2 million | +$5.1 million |
| Net income | $107.1 million | $103.1 million | +$4.0 million |
| Diluted earnings per share | $2.63 | $2.52 | +$0.11 |
| Adjusted EBITDA | $215.0 million | $174.5 million | +$40.5 million |
| Metric | Six months ended June 30, 2019 | Six months ended June 30, 2018 | Change |
|---|---|---|---|
| Net revenue | $742.8 million | $568.7 million | +$174.1 million |
| Operating income | $184.4 million | $156.3 million | +$28.1 million |
| Operating margin | 25% | 27% | Down 2 points |
| Income from continuing operations | $120.2 million | $117.3 million | +$2.9 million |
| Net income | $118.7 million | $285.1 million | -$166.4 million |
| Diluted earnings per share | $2.92 | $6.75 | -$3.83 |
| Adjusted EBITDA | $289.6 million | $223.7 million | +$65.9 million |
Second-quarter revenue growth was led by Gaming, which increased to $177.6 million from $108.1 million, and Churchill Downs, which increased to $182.2 million from $154.9 million. Online Wagering revenue increased modestly to $95.6 million from $93.7 million.
- Churchill Downs Adjusted EBITDA increased to $121.9 million from $107.9 million, benefiting from Derby City Gaming and a successful Kentucky Derby and Oaks week.
- Gaming Adjusted EBITDA increased to $76.1 million from $45.7 million, driven primarily by Presque Isle, Midwest Gaming, Ocean Downs and Lady Luck Nemacolin.
- Online Wagering Adjusted EBITDA declined to $22.2 million from $24.4 million due to online sports betting and iGaming build-out costs, the New Jersey launch and higher TwinSpires marketing expense.
- TwinSpires active players increased 18.8% in the second quarter and 17.9% for the six-month period, while net revenue per active player declined 12.7% and 13.3%, respectively.
Cash flow, liquidity and capital structure
| Cash flow or balance-sheet item | June 30, 2019 or six months ended June 30, 2019 |
|---|---|
| Cash flow from operating activities | $214.3 million |
| Cash flow used in investing activities | $653.9 million |
| Cash flow provided by financing activities | $511.8 million |
| Cash and cash equivalents | $202.7 million |
| Cash, cash equivalents and restricted cash | $245.5 million |
| Total debt, before issuance costs | $1.494 billion |
| Total debt, net of current maturities and issuance costs | $1.471 billion |
| Shareholders’ equity | $553.3 million |
Operating cash flow increased $52.0 million from the prior-year period. Investing outflows primarily reflected the $410.1 million Midwest Gaming investment, the $172.1 million Presque Isle acquisition and $58.8 million of capital expenditures. Financing cash inflows primarily reflected the issuance of $600.0 million of 5.50% senior notes due 2027 and net debt borrowings.
At June 30, 2019, the company had a $700.0 million revolving credit facility and a $394.0 million Term Loan B balance. Management reported compliance with applicable debt covenants, including an interest coverage ratio of 7.1x versus a minimum of 2.5x and a secured net leverage ratio of 0.5x versus a maximum of 4.0x. A one-percentage-point increase in variable interest rates was estimated to reduce net income and operating cash flow by approximately $2.9 million.
Material changes versus the prior comparable period
- Presque Isle was acquired in January 2019 for approximately $180.5 million including working capital and purchase-price adjustments; it contributed $67.0 million of revenue through June 30.
- The company acquired approximately 42% of Midwest Gaming in March 2019 for approximately $410.1 million and increased its ownership to 61.3% after a recapitalization. The investment remains accounted for under the equity method because of shared participating rights.
- Ocean Downs was fully consolidated following the 2018 Ocean Downs/Saratoga transaction, while Saratoga revenue was no longer included.
- Debt increased by approximately $598.0 million from December 31, 2018, primarily due to the 2027 Senior Notes. Interest expense increased to $19.4 million in the second quarter from $9.7 million and to $33.1 million for the six-month period from $19.3 million.
- Six-month 2018 net income included a $168.3 million after-tax gain from the sale of Big Fish Games. Big Fish is presented as a discontinued operation; the 2019 six-month comparison therefore understates the underlying improvement in continuing operations.
- The company repurchased approximately 470,024 shares for $43.0 million during the first six months and had approximately $225.0 million of repurchase authorization remaining at June 30, 2019.
Outlook, commentary, risks and unusual items
The filing does not provide quantitative financial guidance. Management stated that Illinois legislation expanding casino gaming and authorizing sports betting, as well as removal of the sunset date for advance-deposit wagering, is expected to have a positive effect on operations. The company also reserved 800 additional gaming positions at Rivers Des Plaines after quarter-end.
Important unusual or non-recurring items include the Midwest Gaming interest-rate-swap fair-value adjustments and recapitalization costs, transaction and pre-opening expenses, increased interest expense from higher debt, and the prior-year Big Fish Games disposal gain. Adjusted EBITDA is non-GAAP and includes equity-investment results while excluding selected charges; it may not be comparable with similarly named measures used by other companies.
- Key operating risks include economic weakness affecting discretionary spending, weather and attendance at live racing events, competition, regulatory changes, online wagering and gaming legalization, cybersecurity and system failures, payment fraud, insurance limitations and labor or horse-supply issues.
- The company is subject to extensive gaming, racing, wagering and licensing regulation, including ongoing uncertainty around historical racing machines and sports betting implementation.
- Material litigation includes the Kater and Thimmegowda class actions related to Big Fish Casino, a Calder injury case scheduled for trial in September 2019, and appeals concerning Kentucky historical racing and racing licenses. Loss exposure for certain matters cannot yet be reasonably estimated.
- Operating lease liabilities totaled $26.5 million at June 30, 2019, and future minimum operating lease payments totaled $30.3 million.
Facts investors should verify
- Whether Gaming growth from Presque Isle, Midwest Gaming and other acquisitions is sustainable after acquisition-related effects and financing costs.
- The pace and profitability of online sports betting and iGaming, particularly as build-out and marketing costs continue.
- Cash generation relative to the company’s approximately $1.494 billion of gross debt, scheduled interest payments and planned capital expenditures.
- The effect of TwinSpires’ increasing active-player base but declining revenue per active player.
- The regulatory and economic impact of Illinois gaming and sports betting legislation and the planned Rivers Des Plaines expansion.
- Potential outcomes and financial exposure from the disclosed litigation and the Kentucky historical-racing appeal.
- Comparability of future earnings with 2018, given the Big Fish Games disposal gain and the company’s segment realignment.