Churchill Downs Incorporated — Q3 2015 Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended September 30, 2015. The financial statements are unaudited. The company operates Big Fish Games, casinos, TwinSpires online wagering, racing properties and other investments. Results are seasonal, particularly in racing and Big Fish Games.
Financial performance
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net revenue | $279.8 million | $173.5 million | $939.9 million | $644.1 million |
| Operating income | $9.5 million | $8.4 million | $111.2 million | $104.1 million |
| Operating margin | 3% | 5% | 12% | 16% |
| Net earnings | $4.2 million | $3.5 million | $57.7 million | $60.2 million |
| Diluted EPS | $0.24 | $0.20 | $3.26 | $3.40 |
| Adjusted EBITDA | $70.6 million | $32.5 million | $276.1 million | $174.0 million |
Revenue increased 61% in the quarter and 46% year to date, primarily because Big Fish Games was acquired on December 16, 2014 and had no comparable 2014 consolidated revenue. Operating income increased despite higher amortization, acquisition-related charges and Calder exit costs. Net earnings declined 4% year to date because the effective tax rate increased to 44% from 37%, while Q3 net earnings increased 19%.
Segment trends
- Big Fish Games: Contributed $103.5 million of Q3 revenue, $300.0 million for nine months, and Adjusted EBITDA of $33.3 million and $81.6 million, respectively. Q3 bookings were $114.4 million; year-to-date bookings were $332.0 million. Management cited continued strength in Gummy Drop!, Big Fish Casino and the Dungeon Boss launch.
- Casinos: Revenue increased 1% in Q3 and 1% year to date. Oxford, Calder Casino and VSI improved, while Fair Grounds Slots was adversely affected by the New Orleans smoking ban and Mississippi properties experienced competitive pressure.
- TwinSpires: Revenue increased 9% in Q3 and 5% year to date. Handle rose 9.4% in Q3 and 6.6% year to date, outperforming industry handle growth. Unique players increased 23% in Q3.
- Racing: Revenue decreased 5% in Q3 and 5% year to date. Arlington was pressured by fewer race days, smaller fields, lower purses and weather; Calder pari-mutuel operations ceased in July 2014. These effects were partly offset by a strong Kentucky Oaks and Kentucky Derby week.
Cash flow, liquidity and capital structure
| Metric | 9M 2015 | 9M 2014 |
|---|---|---|
| Cash flow from operations | $223.2 million | $114.2 million |
| Cash used in investing | $28.4 million | $59.8 million |
| Cash used in financing | $210.4 million | $57.1 million |
| Free cash flow | $200.6 million | $96.1 million |
| Cash and cash equivalents at period end | $51.1 million | $42.0 million |
Cash from operations benefited from Big Fish Games, strong Derby and Oaks performance, TwinSpires growth, tax refunds and higher deferred revenue. Capital expenditures were $30.8 million, including $22.6 million of maintenance expenditures. Total debt was $587.1 million at September 30, 2015, down from $770.4 million at December 31, 2014. Debt included $287.1 million under the Senior Secured Credit Facility and $300.0 million of 5.375% senior unsecured notes due 2021. Available borrowing capacity was $397.5 million. The company reported compliance with all debt covenants, including interest coverage of 11.0x, total leverage of 2.3x and senior secured leverage of 1.3x.
Material changes and unusual items
- Big Fish Games generated $49.4 million of reported year-to-date related charges, comprising $17.4 million of non-cash fair-value adjustments to earnout and deferred founder liabilities and $32.0 million of deferred-revenue adjustments.
- Calder exit costs were $13.5 million year to date, including a $12.7 million non-cash impairment charge and $0.8 million of demolition costs. Additional demolition costs of approximately $3.6 million were expected from Q4 2015 through Q3 2016.
- Big Fish Games revenue recognition was adversely affected by a $5.0 million Q3 revenue reduction related to purchase timing, partly offset by a $1.8 million reduction in operating expenses. The filing states that the effect on Q3 operating income was unfavorable by $3.2 million.
- The company recorded a $5.8 million gain from the January 2015 sale of its HRTV investment and received $6.0 million of proceeds.
- Share-based compensation was $10.6 million year to date. The company recognized $1.3 million of Q3 expense for accelerated vesting related to the Executive Chairman’s retirement.
- On October 2, 2015, the company acquired a 25% interest in Saratoga Casino Holdings for approximately $24.8 million. A further payment of approximately $6.4 million was expected subject to regulatory approval and adjustments.
Outlook, risks and contingencies
Management stated that operating cash flow over the following twelve months was expected to fund operations and capital expenditures. No formal revenue or earnings guidance was provided. Key risks include seasonality, competition in casinos and racing, dependence on racing and gaming licenses, regulatory changes affecting online gaming and advance deposit wagering, cybersecurity and third-party mobile-platform relationships affecting Big Fish Games, integration and performance risks from the acquisition, interest-rate exposure and litigation.
A 1-percentage-point increase in LIBOR was estimated to reduce net earnings and operating cash flow by approximately $1.6 million, assuming constant variable-rate debt. Pending matters included a Big Fish Casino class action in Washington, a Louisiana horsemen’s purse dispute and Kentucky Downs litigation. Management stated that it did not believe the ultimate outcomes would have a material adverse effect, although possible loss amounts were not clearly estimated in the filing.
On October 26, 2015, the board declared a $1.15-per-share annual dividend payable January 6, 2016 and authorized repurchases of up to $150 million, including remaining amounts under the prior authorization.
Investor verification items
- Reconcile Big Fish Games bookings, deferred revenue, revenue recognition and the effect of acquisition accounting on reported margins.
- Assess the sustainability of the $200.6 million year-to-date free cash flow and the extent to which it benefited from tax refunds and working-capital changes.
- Verify debt repayment plans, variable-rate exposure, covenant headroom and the maturity or refinancing risk of the credit facilities.
- Monitor additional Calder demolition costs and expected operating efficiencies.
- Evaluate the impact of the New Orleans smoking ban, racing-day reductions, Arlington performance and competitive casino conditions.
- Track the Big Fish Casino litigation, Louisiana horsemen’s dispute, Kentucky Downs proceedings and pending gaming legislation.
- Review the Saratoga investment, required regulatory approvals and the planned hotel expansion.