Churchill Downs Incorporated — Q2 2015 Form 10-Q Summary
Business context and reporting period
Unaudited results for the three and six months ended June 30, 2015. Churchill Downs operates Big Fish Games, casinos, TwinSpires online wagering, racing operations and other investments. Comparability is substantially affected by the December 2014 acquisition of Big Fish Games, the cessation of Calder pari-mutuel operations in July 2014, and seasonal Kentucky Derby and Kentucky Oaks activity.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net revenue | $409.2 million, up 35% | $660.1 million, up 40% |
| Operating income | $105.9 million, up 12% | $101.8 million, up 6% |
| Operating margin | 26%, versus 31% | 15%, versus 20% |
| Net earnings | $55.0 million, down 4% | $53.5 million, down 6% |
| Diluted EPS | $3.10, versus $3.21 | $3.02, versus $3.17 |
| Adjusted EBITDA | $157.2 million, up 34% | $205.5 million, up 45% |
| Cash flow from operations | Not separately provided for the quarter | $194.2 million, up 63% |
| Free cash flow | Not separately provided for the quarter | $177.4 million, up 66% |
Six-month segment revenue included Big Fish Games of $196.4 million, Casinos of $169.2 million, TwinSpires of $106.1 million and Racing of $179.9 million. Big Fish Games generated $48.3 million of six-month Adjusted EBITDA.
At June 30, 2015, cash and cash equivalents were $59.2 million and restricted cash was $28.7 million. The company reported $373.4 million of available borrowing capacity under its Senior Secured Credit Facility. Debt included $313.7 million outstanding under the variable-rate credit facility and $300.0 million of Senior Unsecured Notes, in addition to Big Fish Games deferred payment and earnout liabilities totaling $423.5 million at fair value. The company was in compliance with its debt covenants; actual interest coverage was 10.7x, total leverage was 2.6x and senior secured leverage was 1.5x.
Material changes versus the prior comparable period
- Big Fish Games, acquired December 16, 2014, added $104.5 million of second-quarter revenue and $196.4 million of six-month revenue; it had no comparable reported revenue in 2014.
- Consolidated operating income increased, but margins declined because of Big Fish Games amortization, research and development costs, acquisition-related charges and other operating expenses.
- Net earnings and diluted EPS declined despite higher operating income because interest expense increased and the effective tax rate rose to 46% from 38%. The higher tax rate reflected non-deductible Big Fish Games acquisition-related items and state and local taxes.
- Big Fish Games acquisition-related fair-value charges were $8.2 million in the quarter and $14.6 million for six months. Big Fish Games deferred-revenue adjustments reduced reported revenue by $8.2 million in the quarter and $21.1 million for six months.
- Racing revenue declined 3% in the quarter and 5% for six months, primarily because Calder no longer conducted pari-mutuel operations and Arlington experienced fewer live racing days and lower subsidies. Churchill Downs racetrack benefited from record Kentucky Derby and Kentucky Oaks week attendance and wagering.
- TwinSpires revenue increased 6% in the quarter and 3% for six months. Handle increased 8.6% and 5.3%, respectively, outperforming the broader pari-mutuel industry.
- Casino revenue increased 2% in the quarter and 1% for six months. Oxford and VSI improved, while Fair Grounds Slots was negatively affected by the Orleans Parish smoking ban effective April 22, 2015.
- Operating cash flow benefited from Big Fish Games bookings and deferred revenue, strong Derby and Oaks results, a $7.5 million MVG dividend and $20.3 million of federal tax refunds. The company used cash to repay debt, resulting in $183.3 million of financing cash outflows.
Guidance, outlook, risks and unusual items
The filing does not provide formal revenue, earnings or EBITDA guidance. Management stated that operating cash flow should be adequate for business operations and capital expenditures over the next twelve months and highlighted $373.4 million of available credit capacity.
- Big Fish Games bookings were $112.7 million in the quarter and $217.5 million for six months. Management cited growth in mobile casino and casual free-to-play games, but noted seasonal weakness typically occurs during summer months.
- Management planned an outdoor smoking patio at Fair Grounds Slots to mitigate the smoking ban's adverse effect.
- On July 28, 2015, the company approved demolition of the Calder grandstand. It expects a roughly $12.4 million impairment charge in the third quarter of 2015 and approximately $3.6 million of demolition costs incurred from the fourth quarter of 2015 through the third quarter of 2016.
- Executive Chairman Robert L. Evans will retire from that role effective September 30, 2015 and remain non-executive chairman. The company expects $1.3 million of third-quarter compensation expense for accelerated restricted-stock vesting and will pay a $0.6 million 2015 bonus.
- Key risks include regulatory and legislative changes affecting Internet gaming, advance deposit wagering and racing; competition in casino and gaming markets; dependence on mobile platforms and third-party game developers; cybersecurity and intellectual-property risks; seasonal racing results; and integration and performance risk related to Big Fish Games.
- A putative Washington class action alleges that Big Fish Casino facilitates unlawful gambling. The case was in an early stage, damages were not specified, and the company could not estimate a potential loss.
- Pending litigation also includes the Louisiana horsemen’s purse dispute and the Kentucky Downs ownership dispute. The company stated that it could not estimate losses beyond amounts accrued and did not expect the matters to have a material adverse effect.
- Interest-rate sensitivity is material: a one-percentage-point increase in LIBOR would reduce annual net earnings and operating cash flow by approximately $1.7 million, assuming constant variable-rate debt.
Most important facts for investors to verify
- Assess underlying Big Fish Games bookings, revenue recognition, deferred revenue and Adjusted EBITDA separately from acquisition accounting effects.
- Verify debt repayment progress, the $423.5 million fair value of Big Fish Games contingent and deferred obligations, and compliance with credit-facility covenants.
- Evaluate whether strong Derby and Oaks performance and TwinSpires handle growth offset structural pressure from Calder’s discontinued racing operations and Arlington’s weaker results.
- Monitor the financial effect of the Fair Grounds smoking ban and the planned Calder grandstand impairment and demolition costs.
- Review the effective tax rate and the extent to which non-deductible acquisition-related charges continue to suppress GAAP earnings.
- Track litigation, gaming legislation, licensing developments and regulatory approvals for the proposed California Internet gaming venture and Saratoga-related investment and management arrangements.