Churchill Downs Incorporated — Q3 2019 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2019, compared with the same periods in 2018. Churchill Downs operates racing and historical racing businesses, TwinSpires and other online wagering activities, and casino and gaming properties. The company realigned its reportable segments in the first quarter of 2019 into Churchill Downs, Online Wagering, and Gaming.
Results reflect the January 2019 acquisition of Presque Isle, the March 2019 acquisition and recapitalization of Midwest Gaming, and the March 2019 Lady Luck Nemacolin management and asset transaction. Prior-year results were reclassified to conform to the new segment presentation.
Financial performance and key metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net revenue | $306.3 million | $221.3 million | $1,049.1 million | $790.0 million |
| Operating income | $27.8 million | $20.5 million | $212.2 million | $176.8 million |
| Operating margin | 9% | 9% | 20% | 22% |
| Net income from continuing operations | $15.2 million | $58.0 million | $135.4 million | $175.3 million |
| Net income | $14.8 million | $56.3 million | $133.5 million | $341.4 million |
| Diluted earnings per share | $0.36 | $1.38 | $3.28 | $8.16 |
| Adjusted EBITDA | $88.0 million | $62.1 million | $377.6 million | $285.8 million |
Q3 revenue increased $85.0 million, or approximately 38%, while nine-month revenue increased $259.1 million, or approximately 33%. Adjusted EBITDA increased approximately 42% in the quarter and 32% year to date. The company cautions that Adjusted EBITDA is a non-GAAP measure and may not be comparable with similarly named measures used by other companies.
- Q3 segment revenue: Churchill Downs $31.4 million, Online Wagering $70.2 million, Gaming $178.3 million, and All Other $26.4 million.
- Q3 segment Adjusted EBITDA: Churchill Downs $5.2 million, Online Wagering $15.0 million, and Gaming $71.7 million.
- Online Wagering: Q3 revenue declined $1.7 million, although TwinSpires handle increased 7.9% and active players increased 2.6%. Revenue was affected by exiting certain high-volume, low-margin Velocity customers. Online sports betting and iGaming revenue was negative $0.1 million because New Jersey rebates exceeded gross revenue.
- Gaming: Q3 revenue increased $68.1 million, primarily from Presque Isle, Ocean Downs, and Lady Luck Nemacolin, as well as growth at other properties.
- Cash flow: Nine-month operating cash flow was $260.2 million versus $135.4 million in 2018. Investing cash flow was $(690.6) million, including $410.1 million invested in Midwest Gaming, $172.1 million for Presque Isle, and $91.0 million of capital expenditures. Financing cash flow was $490.9 million.
- Liquidity: September 30 cash and cash equivalents were $189.8 million, with restricted cash of $44.0 million; total cash, cash equivalents, and restricted cash were $233.8 million.
- Debt: Total debt was $1.493 billion, consisting primarily of a $393.0 million Term Loan B, $600.0 million of 2027 Senior Notes, and $500.0 million of 2028 Senior Notes. Net debt after issuance costs and current maturities was $1.470 billion.
- Credit metrics: The company reported an interest coverage ratio of 6.1x versus a minimum requirement above 2.5x, and a secured net leverage ratio of 0.6x versus a maximum requirement below 4.0x. It was in compliance with applicable covenants.
Material changes versus the prior comparable period
- Gaming revenue and Adjusted EBITDA increased substantially because of the Presque Isle acquisition, the Midwest Gaming equity investment, the Ocean Downs transaction, and Lady Luck Nemacolin.
- Derby City Gaming contributed a full quarter of operations in Q3 2019 following its September 2018 opening and drove a significant increase in the Churchill Downs segment.
- Interest expense increased to $18.9 million in Q3 and $52.0 million for the first nine months, compared with $9.9 million and $29.2 million, respectively, due to higher debt balances.
- Net income declined primarily because 2018 included a $168.3 million after-tax gain from the sale of Big Fish Games. Big Fish is presented as a discontinued operation.
- Q3 2019 continuing-operations net income also reflected the absence of the $42.3 million after-tax gain from the 2018 Ocean Downs/Saratoga transaction, a $3.0 million after-tax increase in legal reserves, and non-cash effects from Midwest Gaming interest-rate swaps.
- Shareholders’ equity increased to $550.4 million from $473.3 million at December 31, 2018, despite $68.0 million of share repurchases and $7.7 million of taxes paid related to share-based awards.
Outlook, commentary, risks, contingencies, and unusual items
No formal quantitative revenue, earnings, or Adjusted EBITDA guidance is provided in the filing. Management highlights continued growth in Derby City Gaming and the Gaming segment, TwinSpires customer and handle trends, and potential benefits from expanded Illinois casino, sports betting, iGaming, and advance-deposit-wagering legislation.
- On October 9, 2019, the company completed the $46.0 million Turfway Park acquisition using cash on hand. Management plans a future redevelopment, with total planned development costs of up to $150.0 million including the acquisition price.
- The Board declared an annual cash dividend of $0.581 per share payable January 3, 2020.
- The company recorded a $2.8 million accrual for a proposed Louisiana environmental penalty, subject to final approval.
- Management identifies risks related to discretionary consumer spending, gaming and racing regulation, online wagering legalization and competition, cybersecurity and system failures, weather and catastrophic events, insurance coverage, acquisitions and integration, labor, horse supply, taxation, debt restrictions, and variable interest rates.
- A one-percentage-point increase in the variable rate on the Term Loan B would reduce estimated net income and operating cash flow by approximately $2.8 million, assuming a constant outstanding balance.
- Disclosure controls and procedures were deemed ineffective as of September 30, 2019 because the company failed to timely file an amendment to its March 5, 2019 Form 8-K containing required historical audited and pro forma information for Midwest Gaming. Management stated that the issue did not affect current or historical financial statements and expected to file the amendment within several weeks.
- The filing cover indicates the company had not filed all required reports during the preceding 12 months, consistent with the late Midwest Gaming filing issue.
- Big Fish-related class action litigation remains pending, with proceedings stayed while arbitration issues are considered. The company is indemnifying the buyer under the sale agreement and believes it has meritorious defenses.
Important facts for investors to verify
- Reconcile reported earnings with Adjusted EBITDA and isolate acquisition-related contributions, equity-method income, legal reserves, interest-rate swap effects, and other adjustments.
- Assess leverage, refinancing requirements, variable-rate exposure, debt covenant headroom, and restrictions under the senior note indentures and credit agreement.
- Evaluate the sustainability of Gaming growth after the initial contribution from Presque Isle, Ocean Downs, Lady Luck Nemacolin, and Midwest Gaming.
- Monitor TwinSpires margins, the effect of exiting Velocity customers, and the profitability of online sports betting and iGaming after promotional rebates.
- Verify completion of the required Midwest Gaming Form 8-K amendment and remediation of disclosure controls.
- Review the Turfway Park redevelopment budget, timing, permitting, and expected returns, as well as the company’s ability to fund planned capital spending.
- Consider the impact of seasonality, particularly the concentration of racing revenue around the second quarter and the seasonal nature of Gaming operations.