Churchill Downs Incorporated: Q2 2017 Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the three and six months ended June 30, 2017. Churchill Downs operates racing venues, casinos, online wagering through TwinSpires, Big Fish Games, and other investments. Results are seasonal, particularly racing and TwinSpires, with substantial activity concentrated around the Kentucky Derby and Kentucky Oaks.
Financial results and key metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net revenue | $451.9 million | $438.5 million | $731.4 million | $726.9 million |
| Operating income | $129.5 million | $117.4 million | $147.0 million | $123.7 million |
| Operating margin | 29% | 27% | 20% | 17% |
| Net income | $78.3 million | $69.8 million | $85.6 million | $72.6 million |
| Diluted EPS | $4.81 | $4.11 | $5.18 | $4.27 |
| Adjusted EBITDA | $173.0 million | $160.2 million | $230.3 million | $206.9 million |
| Operating cash flow | Not separately provided | Not separately provided | $171.1 million | $166.8 million |
Q2 revenue increased $13.4 million, or approximately 3%, while operating income increased $12.1 million, net income increased $8.5 million, and Adjusted EBITDA increased $12.8 million. Six-month revenue increased $4.5 million, while operating income increased $23.3 million, net income increased $13.0 million, and Adjusted EBITDA increased $23.4 million.
- Racing: Q2 revenue increased $11.0 million to $175.7 million and Adjusted EBITDA increased $7.4 million to $98.7 million, primarily due to strong Kentucky Derby and Oaks performance. Total racing handle increased to $597.3 million from $537.4 million.
- Casinos: Q2 revenue increased $3.9 million to $88.3 million and Adjusted EBITDA increased $4.2 million to $37.5 million, driven by promotional activity, organic growth, and equity investments, including Ocean Downs.
- TwinSpires: Q2 revenue increased $12.1 million to $80.8 million, with active players up 34.0% and handle up 19.6%. Adjusted EBITDA increased $0.5 million to $19.3 million. Six-month handle increased 14.3% and active players increased 33.8%.
- Big Fish Games: Q2 revenue declined $12.6 million to $112.6 million, primarily from casual and mid-core free-to-play and premium games. Adjusted EBITDA nevertheless increased $0.5 million to $18.3 million due mainly to lower user-acquisition spending. Six-month revenue declined $22.7 million, while Adjusted EBITDA increased $11.9 million.
Liquidity, debt, and capital allocation
- Cash and cash equivalents were $41.8 million at June 30, 2017, compared with $48.7 million at December 31, 2016. Restricted cash was $31.6 million.
- Six-month cash flow was $171.1 million from operations, $(97.3) million from investing, and $(81.3) million from financing. Capital expenditures were $64.0 million, including $46.1 million of capital projects and $17.9 million of maintenance expenditures.
- Total debt was $1.077 billion at June 30, 2017, up $149.4 million from year-end. Net debt, net of current maturities, was $1.055 billion versus $907.5 million at December 31, 2016.
- The increase in borrowings primarily funded common-stock repurchases, the Ocean Downs investment, and the BetAmerica acquisition. The company remained in compliance with its credit-facility covenants; total leverage was 3.2x versus a 4.5x limit, and senior secured leverage was 1.5x versus a 3.5x limit.
- Available capacity under the revolving credit facility was $188.2 million after $7.1 million of letter-of-credit commitments.
- The company repurchased 1.077 million shares for $171.7 million under its April 2017 program, including 1.0 million shares purchased from an affiliate of The Duchossois Group for $158.8 million. Approximately $78.3 million of authorization remained at June 30, 2017.
Material changes, outlook, and unusual items
- BetAmerica was acquired on April 24, 2017, and included in TwinSpires. The acquisition was not material to reported results and generated $15.0 million of goodwill and $9.2 million of definite-lived intangible assets.
- Churchill Downs announced an approximately $60.0 million investment to construct an 85,000-square-foot historical racing machine facility in Louisville.
- The company completed the use of a $13.6 million escrow receivable related to the Calder land sale and property purchases.
- Big Fish Games earnout and deferred-payment liabilities had fair values of $33.8 million and $28.1 million, respectively, at June 30, 2017. Payments were expected in 2018 after the earnout deadline was extended from December 15, 2017 to January 3, 2018.
- Management expects to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. The company expects a potentially material effect from recognizing expected breakage revenue on Big Fish Games premium game credits; the impact had not been quantified.
- Management identified seasonality, consumer discretionary spending, gaming and racing regulation, competition, weather, horse availability, technology and cybersecurity risks, platform relationships, intellectual-property risks, and Big Fish Games volatility as important risk factors.
- A one-percentage-point increase in LIBOR, assuming constant variable-rate debt, would reduce net income and operating cash flow by approximately $3.0 million.
Most important facts for investors to verify
- Whether TwinSpires player and handle growth is sustainable after the Kentucky Derby/Oaks season and following the BetAmerica acquisition.
- Whether Big Fish Games can stabilize bookings and revenue while maintaining lower user-acquisition spending.
- The effect of higher leverage, variable interest rates, and scheduled 2021 debt maturities on future liquidity.
- The eventual accounting impact of the 2018 revenue-recognition adoption, particularly Big Fish Games credit breakage and casino loyalty programs.
- Progress, cost, timing, and expected returns from the planned $60.0 million historical racing machine facility and other capital projects.
- Potential effects of gaming legislation, tax changes, regulatory approvals, litigation, weather, competition, cybersecurity incidents, and other contingencies. The filing reports no material changes to previously disclosed legal proceedings or risk factors.