Churchill Downs Incorporated — Form 10-Q Summary
Business Context and Reporting Period
This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Churchill Downs operates racing venues, casinos, the TwinSpires online wagering business, Big Fish Games, and other investments. Results are seasonal, with racing and TwinSpires generally strongest during the second quarter around the Kentucky Derby and Kentucky Oaks.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net revenue | $279.5 million | $288.4 million | Down $8.9 million |
| Operating income | $17.5 million | $6.3 million | Up $11.2 million |
| Operating margin | 6% | 2% | Up 4 percentage points |
| Net income | $7.3 million | $2.8 million | Up $4.5 million |
| Diluted EPS | $0.44 | $0.16 | Up $0.28 |
| Adjusted EBITDA | $57.3 million | $46.7 million | Up $10.6 million |
| Operating cash flow | $74.6 million | $66.6 million | Up $8.0 million |
| Capital expenditures | $37.5 million | $16.4 million | Up $21.1 million |
Revenue by segment was Racing $23.9 million, Casinos $87.5 million, TwinSpires $52.0 million, Big Fish Games $112.0 million, and Other Investments $4.1 million. Adjusted EBITDA was $(9.7) million for Racing, $35.3 million for Casinos, $13.2 million for TwinSpires, $20.3 million for Big Fish Games, $0.6 million for Other Investments, and $(2.4) million for Corporate.
Cash and cash equivalents were $54.9 million at March 31, 2017, compared with $48.7 million at December 31, 2016. Restricted cash was $25.0 million. Total debt, including the Senior Secured Credit Facility and Senior Unsecured Notes, was $973.8 million before current maturities and certain issuance-cost adjustments; net debt was $953.0 million. Available capacity under the Senior Secured Credit Facility was $294.8 million after $7.1 million of letters of credit.
Material Changes Versus the Prior Comparable Period
- Revenue declined 3.1%, primarily because Big Fish Games revenue fell $10.1 million and Racing revenue fell $2.4 million.
- Big Fish Games Adjusted EBITDA increased $11.4 million despite lower revenue, primarily because user-acquisition spending declined $18.3 million.
- TwinSpires revenue increased $2.4 million, supported by a 19.7% increase in active players and 6.8% handle growth.
- Casino revenue increased $1.0 million, driven primarily by Oxford, Calder, and Harlow’s, partly offset by Riverwalk.
- Racing performance was affected by a contagious equine disease outbreak at Fair Grounds, limited field sizes, related remediation costs, and the shift of the Louisiana Derby from March 2016 to April 2017.
- Total operating expense declined $20.1 million, led by an $18.7 million reduction in marketing and advertising expense and a $2.5 million reduction in acquisition expense.
- Interest expense increased $1.2 million because of higher debt balances, while the income tax provision increased $8.3 million. The prior-year period included a $3.1 million tax benefit from excess deductions related to restricted stock vesting.
- The Company acquired its interest in Ocean Downs through a joint venture in January 2017, investing $24.0 million and reporting an effective 62.5% interest through its ownership structure.
Cash Flow, Debt, Liquidity, and Unusual Items
- Operating cash flow was $74.6 million. Investing cash outflows were $51.4 million, including $37.5 million of capital expenditures and the $24.0 million Ocean Downs investment, partly offset by a $10.1 million escrow recovery.
- Financing cash outflows were $17.0 million, including $31.7 million paid toward the Big Fish Games earnout, $21.8 million of dividends, and $8.6 million of share repurchases. The Company also had $46.4 million of net borrowings on its bank line of credit.
- The remaining Big Fish Games earnout liability was $33.7 million and the deferred payment liability was $28.0 million at March 31, 2017. The Company expected both obligations to be paid in 2018; the earnout payment originally due December 15, 2017 was extended to January 3, 2018.
- The Company was in compliance with its credit-facility covenants. Reported ratios were 7.6 to 1 interest coverage, 3.0 to 1 total leverage, and 1.2 to 1 senior secured leverage, versus maximum or minimum requirements of 3.0 to 1, 4.5 to 1, and 3.5 to 1, respectively.
- A one-percentage-point increase in LIBOR would reduce estimated net income and operating cash flow by approximately $2.3 million, assuming variable-rate debt balances remain constant.
- On April 25, 2017, the Board authorized a new $250.0 million share-repurchase program, replacing the prior program. The new authorization includes the prior program’s remaining $114.6 million and is not incremental to it.
Guidance, Outlook, Management Commentary, and Risks
The filing does not provide explicit numerical revenue, earnings, or cash-flow guidance. Management emphasized that quarterly results are not necessarily indicative of full-year performance because of seasonality, particularly the concentration of racing and wagering activity around the Kentucky Derby and Kentucky Oaks.
Management identified potential positive effects from proposed or enacted gaming legislation in Maryland, including possible gaming-tax reductions and lower racing-related capital-spending thresholds. The filing stated that the effect of pending Florida legislation concerning the Seminole Compact, casino expansion, and potential decoupling could not yet be determined.
Key risks include consumer discretionary spending, gaming and racing regulation, competition, weather and racing disruptions, horse availability, technology and system failures, cybersecurity and privacy issues, mobile-platform relationships, Big Fish Games product acceptance, intellectual-property claims, labor issues, acquisition integration, debt restrictions, interest-rate exposure, and litigation. The Company stated that there were no material changes to previously disclosed legal proceedings or risk factors.
Goodwill and indefinite-lived intangible asset testing identified no impairment as of March 31, 2017. The Company changed its annual impairment-testing date from March 31 to April 1. Pending accounting standards, including revenue recognition, leases, credit losses, and restricted-cash presentation, may materially affect future financial statement presentation or reported amounts; the filing states that impacts remain under evaluation.
Facts Investors Should Verify
- Whether Big Fish Games bookings and revenue stabilize after the Q1 decline, and whether reduced user-acquisition spending is sustainable.
- Whether TwinSpires’ active-player and handle growth continues through the Derby-related second quarter.
- The financial and operating impact of Ocean Downs and other unconsolidated investments.
- The timing and funding of the approximately $62 million of Big Fish Games earnout and deferred-payment obligations expected in 2018.
- Debt reduction plans, covenant headroom, variable-rate exposure, and the effect of the $250.0 million repurchase authorization on liquidity.
- The outcome and effective dates of Florida and Maryland gaming legislation.
- The effect of the contagious equine disease disruption and Louisiana Derby timing on full-year Racing results.
- Future accounting impacts from the pending revenue-recognition and lease standards.