Churchill Downs Incorporated: FY2018 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2018. Churchill Downs operates racing, online wagering, casino gaming and related entertainment businesses through Racing, Online Wagering, Casino, Other Investments and Corporate segments. Big Fish Games was sold on January 9, 2018 and is reported as discontinued operations.
Key 2018 developments included the September opening of Derby City Gaming with 900 historical racing machines, the August consolidation of Ocean Downs, the launch of retail BetAmerica sportsbooks at two Mississippi casinos, and continued expansion into sports betting and iGaming.
Financial performance and liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net revenue | $1,009.0 million | $882.6 million | +14.3% |
| Operating income | $188.8 million | $145.7 million | +$43.1 million |
| Operating margin | 18.7% | 16.5% | +2.2 percentage points |
| Income from continuing operations | $182.6 million | $122.4 million | +$60.2 million |
| Net income | $352.8 million | $140.5 million | +$212.3 million |
| Diluted EPS from continuing operations | $4.39 | $2.55 | +$1.84 |
| Adjusted EBITDA | $328.8 million | $286.2 million | +14.9% |
| Operating cash flow | $197.8 million | $215.1 million | -$17.3 million |
Net income included a $168.3 million after-tax gain from the Big Fish sale. Continuing-operations earnings also benefited from a $42.3 million after-tax gain on the Ocean Downs/Saratoga transaction, the absence of 2017 impairments and debt-extinguishment costs, and a $27.0 million 2018 tax benefit related to the Tax Cuts and Jobs Act.
- Racing revenue was $274.3 million, up $17.0 million, primarily from a strong Kentucky Derby and Oaks week.
- Online Wagering revenue was $290.2 million, up $34.6 million; TwinSpires handle increased 8.3% to approximately $1.4 billion.
- Casino revenue was $411.2 million, up $60.7 million, driven by Ocean Downs consolidation, Oxford’s hotel and expanded gaming floor, and stronger property performance.
- Other Investments revenue was $33.3 million, up $14.1 million, primarily reflecting Derby City Gaming.
- Capital maintenance expenditures were $29.6 million and capital project expenditures were $119.8 million.
At December 31, 2018, cash and cash equivalents were $133.3 million, restricted cash was $40.0 million and total assets were $1.725 billion. Gross debt was $896.0 million, consisting primarily of a $396.0 million Term Loan B and $500.0 million of 4.75% senior notes due 2028; net debt was $880.3 million. The company had $693.1 million of available revolving-credit capacity after letters of credit. It was in compliance with debt covenants, reporting an interest coverage ratio of 8.1x and secured net leverage ratio of 0.7x.
Material changes versus the prior comparable period
- Revenue, operating income and Adjusted EBITDA increased, with growth across all operating segments.
- Operating margin expanded despite higher taxes and purses, content costs, labor, depreciation, marketing and transaction expenses.
- Operating cash flow declined because Big Fish no longer contributed operating cash flow after its sale.
- Cash from investing activities was $824.1 million, including $970.7 million of net Big Fish sale proceeds. Financing cash outflows were $933.3 million, reflecting debt repayments and approximately $547.0 million of share repurchases.
- Total debt declined by $246.0 million, primarily because Big Fish proceeds were used to repay revolver borrowings.
- Shareholders’ equity declined to $473.3 million from $640.3 million, mainly due to $549.5 million of share repurchases and dividends.
- The company adopted ASC 606 and recorded a $29.7 million increase to retained earnings at January 1, 2018; the filing states that the adoption primarily changed revenue and expense classification and contract-liability timing.
Fourth-quarter information
Fourth-quarter 2018 net revenue was $219.0 million, operating income was $12.0 million, income from continuing operations was $7.3 million and net income was $11.4 million, or $0.28 diluted EPS. The comparable fourth quarter of 2017 reported net revenue of $178.9 million, an operating loss of $12.8 million and income from continuing operations of $34.4 million, which included the 2017 tax benefit and was affected by impairment and debt-extinguishment charges.
Outlook, commentary, risks and unusual items
- Management stated that operating cash flow over the next twelve months should be adequate to fund operations and capital expenditures and described the balance sheet as supporting organic growth and strategic acquisitions.
- Presque Isle was acquired on January 11, 2019 for $178.9 million, funded with cash and the credit facility. Lady Luck Nemacolin was expected to close in the first half of 2019, subject to regulatory and other approvals.
- The company expected the Midwest Gaming transactions involving Rivers Casino Des Plaines to close in the first half of 2019, subject to customary conditions and Illinois Gaming Board approval. The planned investment was approximately $407.0 million for an expected ownership increase to approximately 62% after recapitalization.
- BetAmerica launched online sports betting and casino gaming in New Jersey in February 2019. Pennsylvania sports betting and iGaming opportunities remained subject to additional approvals and launch timing.
- Management identified significant exposure to gaming regulation, licensing and taxation, competition, consumer discretionary spending, weather and operational interruptions, cybersecurity, technology failures, labor matters and acquisition integration.
- The Department of Justice Office of Legal Counsel’s revised January 2019 Wire Act opinion could negatively affect interstate online gaming operations.
- Pending or potential contingencies include the Kater and Thimmegowda Big Fish-related class actions, litigation involving Calder, a Louisiana horsemen’s purse class action, challenges involving Kentucky historical racing and the Oak Grove license, and alleged environmental non-compliance at Fair Grounds. The filing does not provide a clear quantified loss range for these matters.
- The company expected capital expenditures to address alleged Clean Water Act/CAFO compliance issues at Fair Grounds.
- A one-percentage-point increase in LIBOR was estimated to reduce annual net income and operating cash flow by approximately $3.1 million, assuming constant variable-rate debt.
Important facts investors should verify
- Separate recurring continuing-operations earnings from the nonrecurring Big Fish sale gain, Ocean Downs transaction gain and tax-related items.
- Post-year-end leverage and liquidity after the Presque Isle acquisition, planned Midwest Gaming investment and other expansion spending.
- Actual performance and profitability of Derby City Gaming, BetAmerica, New Jersey online operations and future Pennsylvania launches.
- Regulatory approvals, timing and economics of Lady Luck Nemacolin and Midwest Gaming.
- Potential financial exposure from litigation, environmental remediation and gaming-license matters.
- Effects of sports betting and iGaming regulation, including the revised Wire Act interpretation and state tax and licensing requirements.
- Impact of the three-for-one stock split, ongoing repurchases and dividend policy on per-share metrics and capital allocation.