Churchill Downs Incorporated — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and six months ended June 30, 2011. Churchill Downs operates thoroughbred racing venues, casinos and gaming facilities, online wagering businesses, and pari-mutuel wagering technology services. Results are highly seasonal, with the second quarter typically benefiting from the Kentucky Oaks and Kentucky Derby. The company conducted 105 live racing days in the quarter versus 112 in the prior-year quarter, and 167 days for each six-month period.
Financial performance and liquidity
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net revenues | $249.7 million, up 16% | $381.2 million, up 27% |
| Operating income | $67.5 million, up 40%; 27% margin | $64.6 million; 17% margin |
| Earnings from continuing operations | $40.0 million, up 41% | $36.8 million, up 83% |
| Net earnings | $40.1 million versus $27.6 million | $37.0 million versus $18.9 million |
| Diluted earnings per share | $2.37 versus $1.85 | $2.19 versus $1.31 |
| EBITDA | $85.0 million, up 41% | $96.2 million, up 74% |
| Operating cash flow | Not separately provided | $104.8 million versus $57.9 million |
| Free cash flow | Not separately provided | $95.5 million versus $50.7 million |
- Revenue growth was led by Gaming revenue of $49.5 million for the quarter and $108.5 million year to date, and Online revenue of $46.5 million and $83.3 million, respectively. Racing revenue was substantially stable at $148.2 million for the quarter and declined slightly to $179.8 million year to date.
- Six-month segment EBITDA was $45.8 million for Racing, $30.3 million for Gaming, $18.9 million for Online, and $1.0 million for Other Investments.
- At June 30, 2011, cash and cash equivalents were $31.0 million, restricted cash was $67.4 million, total assets were $998.5 million, and shareholders’ equity was $564.3 million.
- Long-term debt was $185.0 million, down from $265.1 million at December 31, 2010. The related-party convertible note was eliminated through issuance of 452,603 common shares.
- Management reported $183 million of available borrowing capacity under the revolving credit facility, compliance with debt covenants, and no limitations on access to the facility. Variable-rate debt exposure was approximately $185 million; a one-percentage-point increase in LIBOR would reduce annual pretax earnings by approximately $1.9 million.
Material changes versus the prior comparable periods
- Gaming revenue increased 38% in the quarter and 56% year to date, primarily because Harlow’s Casino was acquired in December 2010 and Calder Casino had a full comparable operating period. Harlow’s generated $9.5 million of quarterly revenue and $26.4 million year-to-date despite a 25-day flood-related closure.
- Online revenue increased 56% in the quarter and 73% year to date, largely reflecting the Youbet acquisition and the integration of its platform into TwinSpires.
- Racing Operations revenue increased 1% in the quarter and was essentially flat year to date despite a 5.0% quarterly and 5.4% year-to-date decline in Racing Operations handle. Kentucky Oaks and Derby week produced higher sponsorship, admissions, broadcast-rights and hospitality revenue.
- Total company pari-mutuel handle increased 3% in the quarter and 8% year to date because of the Youbet-related Online business contribution. Combined TwinSpires and Youbet handle nevertheless declined approximately 2.4% quarterly and 5.9% year to date.
- Operating margins improved as revenue growth exceeded expense growth. The prior-year comparison was also affected by the 2010 Youbet software impairment, 2010 Calder Casino preopening costs, and acquisition-related development expenses.
- Operating cash flow rose $46.9 million year to date. Investing cash use fell to $13.9 million from $85.4 million because 2010 included the Youbet acquisition and substantial Calder Casino and Arlington Park expenditures. Financing cash use was $86.7 million, primarily reflecting $80.2 million of net debt repayment and $8.2 million of dividends.
Guidance, outlook, risks and unusual items
- Management stated that operating cash flows over the next 12 months are expected to fund business operations and capital expenditures. No quantitative revenue or earnings guidance was provided.
- Management cited continued weakness in the U.S. economy, declining discretionary spending, and a 7.7% industry decline in U.S. thoroughbred handle for the first six months as ongoing pressures.
- A Kentucky tornado damaged Churchill Downs and caused one cancelled racing day. Mississippi flooding temporarily closed Harlow’s and damaged its entertainment center and dining facilities. Mississippi wind damage also affected Harlow’s. The company expects no material adverse effect and is pursuing insurance recoveries.
- Flood-related accounting included an $8.4 million reduction of property and equipment with a corresponding insurance recovery receivable. A $2.0 million partial insurance settlement was received on July 22, 2011. Wind-related insurance recoveries included $1.0 million received during the second quarter and $0.4 million recorded against business interruption losses.
- A $2.9 million reduction in operating expenses and a $0.6 million reduction in income tax expense resulted from resolution of Kentucky Tax Increment Financing matters. A $2.7 million gain and $1.4 million of interest expense arose from conversion of the related-party convertible note.
- The effective tax rate was 41.1% for the first six months versus 34.7% in the prior year, which benefited from a $1.6 million prior-year tax settlement.
- The company has not recognized up to $15 million of contingent consideration related to the 2007 Hoosier Park sale because collectability was not reasonably assured. A bankruptcy-approved settlement provides for an $8.5 million cash payment, subject to remaining implementation conditions.
- Illinois Horse Racing Equity Trust Fund proceeds of $44.2 million remain restricted in escrow and deferred because of ongoing legal challenges. Approximately $18.6 million is expected to be retained by Arlington Park and $25.6 million allocated to purses.
- Material litigation includes the Hialeah race-course lawsuit, which seeks unspecified damages, and litigation by Illinois racetracks and horsemen alleging Youbet and TwinSpires contract breaches and trade-secret violations. The latter plaintiffs alleged damages of at least $3.6 million or alternatively $0.8 million; a requested preliminary injunction was denied in July 2011.
- Key industry risks include competition from casinos, lotteries and online gaming; changes in wagering and gaming laws; licensing and horsemen-agreement risks; consumer spending weakness; interest-rate exposure; acquisition integration; natural disasters and insurance recoveries; and pending litigation. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether revenue and EBITDA growth remains after fully annualizing the Youbet and Harlow’s acquisitions and excluding favorable one-time items.
- The sustainability of racing profitability despite declining industry and company racing handle.
- The availability and terms of the reported $183 million revolving-credit capacity, variable-rate exposure, and future debt repayment requirements.
- The timing and ultimate collectability of the $8.5 million Hoosier Park settlement and the legal status of the $44.2 million Illinois escrow balance.
- The final insurance recoveries and operational effects associated with the Harlow’s flood and wind damage and the Churchill Downs tornado.
- The potential financial impact of Florida, Illinois, Kentucky, Ohio and federal gaming or wagering legislation.
- The company’s non-GAAP EBITDA and free-cash-flow definitions and their reconciliation to GAAP measures.