Churchill Downs Incorporated: Q2 2016 Form 10-Q Summary
Business context and reporting period
Churchill Downs Incorporated operates racing venues, casinos, TwinSpires online wagering, Big Fish Games and other investments. The unaudited report covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. Results are seasonal, with the second quarter benefiting from the Kentucky Derby and Oaks. The company conducted 61 live thoroughbred racing days in Q2 2016 versus 66 in Q2 2015.
Financial performance and key metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenue | $438.5 million | $409.2 million | $726.9 million | $660.1 million |
| Adjusted EBITDA | $162.9 million | $158.9 million | $215.7 million | $208.7 million |
| Operating income | $117.4 million | $105.9 million | $123.7 million | $101.8 million |
| Operating margin | 27% | 26% | 17% | 15% |
| Net income | $69.8 million | $55.1 million | $72.6 million | $53.5 million |
| Diluted EPS | $4.11 | $3.10 | $4.27 | $3.02 |
- Q2 revenue increased $29.3 million, or approximately 7%, while six-month revenue increased $66.8 million, or approximately 10%.
- Q2 Adjusted EBITDA increased $4.0 million, and six-month Adjusted EBITDA increased $7.0 million. Adjusted EBITDA is a non-GAAP measure.
- Q2 net income rose $14.7 million, and six-month net income rose $19.1 million. The six-month income tax provision included a $3.1 million benefit from early adoption of new stock-based compensation accounting guidance.
- Revenue growth was led by Big Fish Games, TwinSpires and the Racing segment. Big Fish Games revenue increased $20.7 million in Q2 and $50.9 million for the six months, primarily from casual and mid-core free-to-play games.
- TwinSpires revenue increased $7.5 million in Q2 and $11.6 million for the six months. Handle increased 16.4% in Q2 and 13.9% for the six months, with active players increasing 26% and 25%, respectively.
- Big Fish Games Adjusted EBITDA declined $7.8 million in Q2 and $12.8 million for the six months. Higher bookings were more than offset by increased user-acquisition, platform and developer costs.
- Cash provided by operating activities was $166.8 million for the six months, compared with $194.2 million in 2015. Free cash flow was $150.5 million versus $177.4 million.
- Capital expenditures were $34.5 million, including $18.2 million of capital project expenditures and $16.3 million of maintenance expenditures. Churchill Downs premium seating and Turf Club projects drove much of the increase in capital project spending.
Balance sheet, debt and liquidity
- At June 30, 2016, cash and cash equivalents were $55.1 million and restricted cash was $31.5 million. Current assets totaled $209.6 million and current liabilities totaled $431.6 million.
- Total debt was $925.7 million, up from $781.8 million at December 31, 2015. Debt consisted primarily of $331.5 million under the Senior Secured Credit Facility and $594.2 million of 5.375% Senior Unsecured Notes due 2021.
- The increase in debt primarily funded the $281.6 million Big Fish Games earnout payment made in March 2016. Remaining Big Fish Games earnout and deferred payment obligations were $66.6 million and $55.6 million at fair value, respectively.
- Senior Secured Credit Facility availability was $344.7 million after $7.2 million of letters of credit. The company was in compliance with its financial covenants: interest coverage of 9.3x versus a minimum of 3.0x, total leverage of 3.0x versus a maximum of 4.5x, and senior secured leverage of 1.2x versus a maximum of 3.5x.
- Total liabilities declined to $1.568 billion from $1.660 billion at year-end, primarily because of the Big Fish Games earnout payment and dividend payment, partially offset by increased borrowings.
- The company paid $19.1 million of dividends and repurchased $17.6 million of common stock during the six months. Approximately $135.0 million remained under the repurchase authorization at June 30, 2016.
Material changes, outlook and unusual items
- Racing benefited from record attendance and higher ticket and media revenue during Kentucky Derby and Oaks week, although the racing calendar included fewer live days.
- Casinos Adjusted EBITDA increased $3.8 million in Q2 and $7.7 million for the six months, supported by MVG and SCH investments, Oxford performance, marketing initiatives and operating efficiencies. Fair Grounds Slots and VSI were affected by the Orleans Parish smoking ban and competitive pressures.
- Big Fish Games bookings increased to $127.9 million in Q2 and $256.1 million for the six months, but profitability was pressured by investments in user acquisition, platform fees and developer fees. Management noted that Big Fish Games revenue is typically lower during summer months.
- Calder exit costs were $1.5 million in Q2 and $1.9 million for the six months, primarily for grandstand demolition. Management expects related property-tax, maintenance, utility, permitting and environmental savings.
- On August 2, 2016, the company agreed to form a 50%-owned joint venture with Saratoga Casino Holdings to acquire Ocean Downs in Maryland, subject to regulatory approvals and other closing conditions. Purchase consideration was not provided in the filing text.
- On July 18, 2016, the IRS notified the company of a potential TwinSpires withholding-tax information filing matter. The potential civil penalty and interest were approximately $1.6 million; no accrual was recorded because payment was not considered probable.
- Management identified risks related to consumer discretionary spending, competition, gaming and wagering regulation, racing licenses and horsemen agreements, online security, mobile-platform relationships, game development, acquisitions, litigation, interest rates and foreign currency.
- A 1-percentage-point increase in LIBOR, assuming constant variable-rate debt, would reduce net income and operating cash flow by approximately $2.2 million.
Important facts for investors to verify
- Whether Big Fish Games can convert bookings and user growth into improved Adjusted EBITDA after elevated user-acquisition and platform spending.
- The timing and amount of remaining Big Fish Games earnout and deferred payment obligations, including the estimated $66.6 million earnout liability payable in 2017–2018.
- Debt reduction plans, interest-rate exposure and compliance with Senior Secured Credit Facility covenants.
- Regulatory developments affecting TwinSpires advance-deposit wagering in Maine, Pennsylvania, Minnesota and Michigan, and any impact on taxes, licenses or market access.
- Completion, regulatory approval, financing and expected returns of the proposed Ocean Downs joint venture acquisition.
- The effect of seasonal racing results, fewer live racing days, casino competition and the Orleans Parish smoking ban on second-half performance.
- The potential resolution and financial impact of the IRS TwinSpires matter and other litigation or regulatory contingencies.