Churchill Downs Incorporated: FY2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. The filing is an annual report; fourth-quarter supplementary results are included. Churchill Downs operates racing, casinos, TwinSpires online wagering, Big Fish Games, and other investments.
Financial performance and liquidity
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Net revenue | $812.9 million | $779.3 million | +4% |
| Operating income | $90.4 million | $90.1 million | Flat |
| Operating margin | 11% | 12% | Down 1 point |
| Earnings from continuing operations | $46.4 million | $55.0 million | -16% |
| Diluted EPS from continuing operations | $2.64 | $3.07 | -14% |
| Adjusted EBITDA | $202.5 million | $176.2 million | +15% |
| Cash flow from operations | $141.6 million | $144.9 million | -2% |
| Free cash flow | $118.9 million | $128.0 million | -7% |
| Total debt | $770.4 million | $369.2 million | +$401.2 million |
Segment revenue: Casinos rose 11% to $329.0 million, TwinSpires rose 3% to $190.3 million, and Big Fish Games contributed $13.9 million after its December 16 acquisition. Racing declined 5% to $261.5 million, while Other Investments declined 21% to $18.3 million.
Cash and liquidity: Cash and cash equivalents were $67.9 million at year-end, with $223.7 million of borrowing capacity under the senior secured credit facility. Working capital was negative $92.3 million. Management stated that expected operating cash flow should adequately fund operations and capital expenditures over the next twelve months.
Debt and covenants: Debt included $258.0 million under the senior secured facility, a $200.0 million term loan, $12.4 million of swing-line borrowings, and $300.0 million of 5.375% senior unsecured notes due 2021. Actual covenant ratios were within limits: interest coverage of 11.7x versus a minimum of 3.0x, total leverage of 3.5x versus a permitted maximum of up to 5.0x, and senior secured leverage of 2.3x versus a maximum of 3.5x.
Material changes versus 2013
- Big Fish Games acquisition: Completed for upfront consideration of approximately $485 million, plus an earnout of up to $350 million. The acquisition added approximately $1.0 billion of assets, including $538.9 million of goodwill, and was funded primarily with new debt.
- Casino growth: Oxford contributed a full year of results and casino revenue increased $31.5 million. Oxford revenue was $76.5 million, while Miami Valley Gaming contributed significantly to equity earnings.
- Racing contraction: Racing handle fell 19% to $1.47 billion and live race days declined to 319 from 374, principally because Churchill Downs ceased pari-mutuel operations at Calder on July 1, 2014.
- TwinSpires: Handle increased 3% to $897.7 million, including 5% organic growth excluding Illinois and Texas effects. Illinois wagering resumed, but Texas wagering remained suspended.
- Calder restructuring: The Stronach Group assumed responsibility for Calder racing operations under an agreement running through December 31, 2020. Churchill Downs retained the Calder Casino. The company recorded $2.3 million of severance costs and $2.4 million of accelerated depreciation.
- Cost and earnings items: Big Fish acquisition-related charges totaled $14.7 million, including transaction expenses, fair-value adjustments, and deferred-revenue reductions. Luckity was closed and generated a $3.2 million impairment charge. The unsuccessful Capital View Casino bid generated $1.0 million of equity losses and a $1.6 million impairment.
- Capital allocation: The company repurchased 691,000 shares for $61.6 million and paid $1.00 per share in dividends, up from $0.87 in 2013.
Fourth-quarter results and unusual items
| Metric | Q4 2014 | Q4 2013 |
|---|---|---|
| Net revenue | $168.3 million | $162.4 million |
| Operating income | $(13.8) million | $(5.6) million |
| Diluted net EPS | $(0.81) | $(0.33) |
Fourth-quarter results reflected Big Fish acquisition and integration costs, Luckity and Capital View impairments, Calder-related costs, higher interest expense, and the seasonal nature of racing operations. Big Fish Games generated $13.9 million of revenue and a $2.9 million pretax loss from acquisition through year-end.
Outlook, risks, and contingencies
- Management did not provide formal revenue or earnings guidance in the filing. It indicated that operating cash flow should fund near-term operations and capital expenditures and that it intended to pursue growth through acquisitions, online wagering, gaming, and mobile games.
- Key risks include high leverage following the Big Fish acquisition, variable-rate debt exposure, covenant compliance, acquisition integration, and the potential $350 million Big Fish earnout.
- Racing and wagering remain exposed to declining industry handle, competition from racinos and online gaming, field-size challenges, weather, horsemen agreements, and changes in racing dates or state subsidies.
- Gaming, ADW, and online operations are subject to extensive licensing, tax, regulatory, responsible-gaming, privacy, cybersecurity, and payment-processing requirements. Legislative changes could materially affect operations.
- The New Orleans smoking ban, effective April 22, 2015, was expected to negatively affect business. The filing also identified possible gaming expansion in Kentucky, Illinois, Florida, Maine, New York, and other states as uncertain but potentially material.
- Pending matters included a Louisiana quarter-horse purse dispute, an Illinois tax apportionment dispute involving a $2.9 million protest payment, and litigation concerning the company’s Kentucky Downs investment. Management stated that it did not expect the disclosed proceedings to have a material adverse effect, but outcomes were uncertain.
- Subsequent to year-end, the company divested its HRTV interest for $6.0 million and recorded a $5.8 million gain in January 2015.
Most important facts for investors to verify
- Whether Big Fish Games achieves projected growth and cash generation and whether the earnout liability, reported at $327.8 million at year-end, ultimately requires substantial cash payment.
- The sustainability of the 2014 Adjusted EBITDA increase after excluding acquisition-related charges, deferred-revenue adjustments, impairments, and other non-GAAP adjustments.
- Debt repayment capacity, variable-rate exposure, refinancing requirements, and compliance with the senior secured facility’s covenants.
- Underlying performance of the legacy casino and racing businesses excluding Oxford, Big Fish Games, and the impact of Calder’s restructuring.
- TwinSpires customer growth and the effect of state taxation and regulatory developments, including the continuing loss of Texas wagering.
- Potential effects of gaming-law changes, licensing renewals, smoking restrictions, horsemen disputes, tax litigation, and other pending contingencies.
- The filing’s exclusion of Big Fish Games from management’s 2014 internal-control assessment because it was acquired late in the year.