Churchill Downs Incorporated: Q1 2018 Form 10-Q Summary
Business Context and Reporting Period
Churchill Downs Incorporated operates racing, online wagering, casino gaming and related investments. This unaudited report covers the three months ended March 31, 2018, compared with the prior-year quarter. Results are seasonally affected by the racing calendar, with substantially higher racing activity generally occurring in the second quarter around the Kentucky Derby and Kentucky Oaks.
On January 9, 2018, the company completed the $990.0 million sale of Big Fish Games. Big Fish is presented as a discontinued operation for all periods, and the continuing-operations discussion primarily reflects Racing, TwinSpires, Casino, Other Investments and Corporate.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenue | $189.3 million | $167.5 million | +$21.8 million |
| Operating income | $19.7 million | $8.5 million | +$11.2 million |
| Operating margin | 10% | 5% | +5 percentage points |
| Net income | $182.0 million | $7.3 million | +$174.7 million |
| Diluted EPS | $12.55 | $0.44 | +$12.11 |
| Adjusted EBITDA | $49.2 million | $36.3 million | +$12.9 million |
| Operating cash flow | $55.9 million | $65.3 million | -$9.4 million |
Adjusted EBITDA margin was approximately 26.0% in Q1 2018, compared with approximately 21.7% in Q1 2017. Net income included $167.9 million of after-tax income from discontinued operations, principally the $168.3 million after-tax gain on the Big Fish sale; therefore, reported EPS and net margin are not representative of continuing operations.
- Revenue by segment: Racing $23.7 million, TwinSpires $63.2 million, Casino $98.1 million and Other Investments $4.3 million.
- TwinSpires: Handle increased 20.2% to $304.1 million; revenue increased $11.2 million and adjusted EBITDA increased $3.3 million to $16.5 million.
- Casino: Revenue increased $10.6 million and adjusted EBITDA increased $9.0 million to $44.3 million, driven primarily by marketing and promotional activities.
- Racing: Total handle increased to $209.8 million from $203.7 million, while segment revenue was broadly flat and adjusted EBITDA improved modestly to a loss of $9.4 million.
- Cash and liquidity: Cash and cash equivalents were $202.7 million at March 31, 2018, and cash, cash equivalents and restricted cash totaled $234.2 million.
- Debt: Total debt was $899.0 million before issuance costs, down from $1,142.0 million at December 31, 2017. Net debt after issuance costs was $882.6 million. Debt consisted principally of a $399.0 million Term Loan B due 2024 and $500.0 million of 4.75% Senior Notes due 2028.
- Debt compliance: The company reported a 5.7-to-1.0 interest coverage ratio versus a minimum of 2.5-to-1.0 and a 1.0-to-1.0 secured net leverage ratio versus a maximum of 4.0-to-1.0.
- Capital expenditures: Capital expenditures totaled $34.0 million, including $7.5 million of maintenance expenditures and $26.5 million of capital project expenditures.
Material Changes Versus the Prior Comparable Period
- Continuing-operations revenue increased 13.0%, led by TwinSpires and Casino.
- Operating income more than doubled, while operating expenses increased $10.6 million. Content expense increased $6.2 million, taxes and purses increased $3.8 million, and transaction expense increased $1.4 million due to planned acquisitions.
- Interest expense declined $2.2 million to $9.6 million, primarily reflecting lower borrowings after repayment of the prior revolving credit facility.
- Operating cash flow declined despite higher earnings, primarily due to timing of deferred revenue payments related to the Kentucky Derby and Oaks events.
- Investing cash flow was $936.7 million, primarily reflecting $970.7 million of net cash proceeds from the Big Fish sale.
- Financing cash flow was negative $843.8 million, including $514.4 million of share repurchases, $343.9 million of bank-line repayments, $23.7 million of dividends and payments related to Big Fish earnout and deferred obligations.
- The company completed a $500.0 million modified Dutch auction tender offer, repurchasing 1,886,792 shares at $265 per share. Total Q1 share repurchases were $514.4 million.
- The company adopted ASC 606, Revenue from Contracts with Customers, using the modified retrospective method. The filing states that the adoption did not materially affect Q1 2018 net income or cash flows, but it changed certain balance-sheet classifications and increased opening retained earnings by $29.1 million.
Guidance, Outlook, Commentary, Risks and Unusual Items
The filing does not provide quantitative earnings or revenue guidance. Management expects seasonality to result in higher racing revenue and operating results during the second quarter. The company also announced agreements to acquire substantially all assets related to Presque Isle Downs & Casino and Lady Luck Casino Vicksburg for approximately $229.5 million in cash. Closing was subject to customary conditions and gaming and racing-license approvals.
- Management attributed TwinSpires growth to handle growth that exceeded the broader U.S. thoroughbred industry and attributed Casino growth to marketing and promotional initiatives.
- As of March 31, 2018, the Racing segment had $218.4 million of remaining performance obligations, with $52.4 million expected to be recognized in 2018.
- A one-percentage-point increase in LIBOR, assuming constant variable-rate debt, would reduce net income and operating cash flow by approximately $7.6 million.
- The company faces regulatory and legislative risks across racing, casino and advance-deposit wagering activities, as well as competition, consumer discretionary-spending volatility, weather, technology and cybersecurity risks, labor issues, and risks associated with acquisitions and expansion projects.
- The Ninth Circuit reversed and remanded the dismissal of the Kater class-action litigation related to Big Fish Casino. Churchill Downs agreed to indemnify the purchaser for specified losses and expenses related to the litigation and stated that it believes it has meritorious defenses.
- Ordinary-course litigation continues. The company stated that any potential excess exposure over recorded reserves is not expected to be material, although certain proceedings cannot yet be reasonably estimated.
- The company adopted new accounting standards concerning revenue, restricted cash, cash-flow classifications, tax effects in accumulated other comprehensive income and stock-compensation modifications; management reported no material impact on current-period results from most of these adoptions.
Important Facts for Investors to Verify
- Separate continuing-operations performance from the $167.9 million of after-tax discontinued-operation income and the $168.3 million after-tax Big Fish sale gain.
- Assess whether TwinSpires handle growth and Casino promotional gains are sustainable after the unusually strong Q1 comparisons.
- Review leverage, variable-rate exposure and compliance with the credit agreement, particularly following the share repurchase and proposed acquisitions.
- Confirm the timing, funding and regulatory approvals for the Presque Isle and Lady Luck Vicksburg acquisitions.
- Monitor the Kater litigation, indemnification obligations and any related financial exposure.
- Consider racing seasonality and the timing of Kentucky Derby and Oaks-related deferred revenue when evaluating quarterly cash flow.
- Review the effects of ASC 606 on deferred revenue, contract liabilities and segment revenue comparability.