Churchill Downs Incorporated
Q4 2019 Earnings Call Transcript

Published: 27 Feb 2020

[Operator:]

Good day, ladies and gentlemen, and welcome to the Churchill Downs Incorporated 2019 Fourth Quarter and Year-End Earnings Conference Call. [Operator Instructions].As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's conference, Mr. Nick Zangari, Vice President, Treasury and Investor Relations.

[Nick Zangari:]

Thank you, Katrina. Good morning, and welcome to our Fourth Quarter and Year-End 2019 Earnings Conference Call. After the company's prepared remarks, we will open the call for your questions. The company's 2019 fourth quarter and year-end business results were released yesterday afternoon. A copy of this release announcing results and other financial and statistical information about the period to be presented in this conference call, including information required by Regulation G, is available at the section of the company's website titled News, located at churchilldownsincorporated.com, as well as in the website's Investors section.Before we get started, I would like to remind you that some of the statements that we make today may include forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC, specifically the most recent report on Form 10-K.Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events.During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and Form 10-K are available on our website at churchilldownsincorporated.com.And now I'll turn the call over to our Chief Executive Officer, Mr. Bill Carstanjen.

[William Carstanjen:]

Thanks, Nick. Good morning, everyone. With me today are several members of our team, including Bill Mudd, our President and Chief Operating Officer; Marcia Dall, our Chief Financial Officer; and Brad Blackwell, our General Counsel. I'll begin with a quick summary of our 2019 accomplishments and how we have positioned our company for significant growth over the next few years. Marcia will then provide a more in-depth review of our financials for the fourth quarter and the total year, and she will also provide an update on our capital plans for 2020. After she has finished, we will be happy to take your questions.In 2019, we demonstrated our ability to acquire strategic assets to grow organically and to effectively manage our capital to drive total shareholder returns that significantly exceeded the S&P 500, the Russell 2000 and the S&P MidCap 400 Index. Our shareholder return also compares very favorably to those of other gaming companies, as well as other entertainment companies whom some investors view as benchmarks for the Kentucky Derby.Our business has delivered $1.3 billion of net revenue and a record $451 million of adjusted EBITDA, up 32% and 37% respectively over prior year. We returned over $115 million to our shareholders through stock buybacks and dividends in 2019 and, on a cumulative basis, have returned over $1 billion to our shareholders over the past 5 years. We did so while aggressively investing to grow our businesses and at the same time, continuing to maintain one of the lowest leverage levels in the gaming industry.2019 and the last several years have been strong, and we are proud of that performance. That is now in the past, though, and all that matters is what we deliver in the future. I can assure you we are extremely focused on continuing to deliver organic growth, smart greenfield opportunities and strategic acquisitions at reasonable multiples, all to grow our adjusted EBITDA, free cash flow and return on investment for our shareholders.Let's begin with the highlights for our Churchill Downs segment. In early May last year, we delivered the 10th consecutive year of record-setting financial performance for Kentucky Derby week, despite very unpleasant rainy weather. Virtually every financial metric we track from wagering to sponsorships to various online metrics and to admissions revenues, just for example, established new all-time highs. Beyond the important financial metrics I was pleased to see, for the first time, the qualifier from the Japanese Road to the Derby, come to the Kentucky Derby and then race so competitively. 2019 was also the first year Japanese betters were allowed to wage around the Kentucky Derby in Japan. We will continue to emphasize for the long term, building the international profile of Kentucky Derby, which we will monetize through admissions, sponsorships and wagering revenues over time. With horse racing in virtually every industrialized nation, we want the Kentucky Derby to continue to grow as a global event.As we look forward to this year's 146th running of the Kentucky Derby on May 2, the team is completing the $11 million renovation of the sixth floor premium seating area next to our most exclusive area, The Mansion. 330 guests will enjoy spectacular upscale and unique experience. If you haven't gotten your tickets yet, you better hurry because we are close to sold out.Our commitment to the safety of our equine athletes remains a top priority across all of our racetracks, and it is especially a focus at Churchill Downs Racetrack. The new quarantine facility and state-of-the-art equine medical center will be completed prior to this year's derby. We have also cofounded an industry integrity initiative among all of the prominent racing organizations in the United States to promote the adoption of best practices to improve equine and jockey safety. Safety and integrity initiatives are important to move the sport forward, and are also just playing good business. We need to meet the ever-evolving expectations of our fans, our regulators and our communities.In addition to our equine and human athletes, we go to great lengths to ensure the safety and security of our guests and team members. We work extremely closely with federal, state and local authorities as well as leading experts to address any relevant health, safety, security and travel concerns that could impact the Derby. This includes the coronavirus. We are doing the same due diligence this year as we prepare for Kentucky Derby 146.As the Derby is still more than 2 months away, we still have a great deal of time to monitor and react. We also will learn from others as they hold their events over the next number of weeks. We will continue to consult with all relevant authorities and will take any and all necessary steps to ensure the safety of all who attend and participate.We have begun the construction of the $300 million hotel and HRM project on the first turn of Churchill Downs Racetrack. We currently have approval for up to 3,000 historical racing machines or HRM units between Churchill Downs Racetrack and Derby City Gaming, of which we currently have approximately 1,000 deployed at Derby City Gaming and expect to deploy approximately 1,000 at Churchill Downs Racetrack.Our immediate objective in getting the site prepared -- utilities ready and pilings installed before the 2020 Derby that will ultimately support the various structures we are building. The second phase of the project will focus on getting the permanent stadium seating installed prior to the 2021 Derby to minimize disruption to our guests. We plan on opening the hotel and HRM facility in the fourth quarter of 2021. The 148 Derby in May 2022 will be the first time our customers will be able to enjoy a once in a lifetime experience at our hotel.As we look forward, we remain committed to investing in the long-term growth of the Kentucky Derby. There are many avenues to grow our signature event over the coming years, from further growth capital projects to pricing segmentation, additional seating capacity, increased wagering, new sponsorships, and media and licensing revenue streams, all while expanding the international interest generated from the European and Japan Roads to the Derby.Our first historical racing machine facility, Derby City Gaming, which is also within the Churchill Downs segment, contributed over $36 million of adjusted EBITDA, and an increase of more than 50% in purses to the horsemen at Churchill Downs Racetrack in its first full year of operations. We just announced that scientific games received approval from the Kentucky Horse Racing Commission with respect to 10 of its most popular titles for deployment in our Derby City Gaming facility and ultimately, for use in our other new HRM facilities. This will enhance our guest experience by providing a greater variety of top gaming titles.We are excited to work with Scientific Games, and we'll continue to add more of their games, along with additional game manufacturers in the future. We've learned a lot from our first full year of operations at Derby City Gaming and we'll use those learnings to improve the performance and experience going forward for each of our HRM facilities.Turning to our online wagering segment. The TwinSpires business performed well in 2019 despite it being quite a challenging year for the horse racing industry. There were several factors that caused the total thoroughbred industry handle to be down 2% in 2019 after 4 consecutive years of growth, including

[Marcia Dall:]

Thanks, Bill, and good morning, everyone. As Bill said, I will provide some details on our fourth quarter and full year 2019 financial results, and we'll then provide an update on our capital management plans and some thoughts regarding our future growth plans.Beginning with our fourth quarter and full year 2019 results. Our fourth quarter net revenue was $281 million, up 28% compared to the prior year quarter, and our total year revenue was $1.3 billion, up 32% compared to 2018. The drivers of the increase in our fourth quarter and total year revenue are relatively consistent. A little over 3/4 of the increase in revenue for both periods was driven by our Gaming segment as a result of the acquisition of Presque Isle, and Lady Luck Nemacolin, and revenue growth from our other gaming properties. As Bill discussed, we also had $5 million of revenue for the year in the Gaming segment from our retail BetAmerica Sportsbooks at our Mississippi properties and Presque Isle.Derby City Gaming, which continued to perform very well in its first full year of operation, contributed a significant portion of the balance of the revenue growth in fourth quarter and the total year. As you know, the fourth quarter is relatively quiet for Churchill Downs Racetrack, with only a 25-day Fall Meet. For the total year, Churchill Downs Racetrack generated strong revenue growth as a result of a strong Derby week in the second quarter.Our fourth quarter revenue for the online wagering segment was relatively flat, as the loss of revenue from a couple of higher volume, low-margin customers in the Velocity group that are reported in the TwinSpires business was offset by an increase in the net revenue from our sports betting and iGaming business, primarily as a result of online wagering in New Jersey.As a reminder, the net revenue from our equity investments, including Rivers Des Plaines and Miami Valley gaming, are not included in our reported net revenue. As you can see in our supplemental disclosures in our press release, our equity investments and gaming properties generated an additional $586 million of total net revenue in 2019, up 59% over the prior year.As we reflect on our 2019 results, we are pleased that in the 2-year period since we completed the sale of Big Fish Games, the team has successfully replaced all of the revenue that was sold with more consistent and sustainable revenue, with higher margins generated by our 3 core segments.Turning to adjusted EBITDA. Our fourth quarter adjusted EBITDA was $74 million, up 72% compared to the prior year quarter, and adjusted EBITDA for the total year was a record $451 million, up 37% over the prior year.Our Gaming segment generated $31 million of adjusted EBITDA growth for the fourth quarter, primarily from the acquisition of Presque Isle and Nemacolin, our equity investment in Rivers Des Plaines as well as growth from all but one of our gaming properties.As you can see from the supplemental information in our press release, our same-store, wholly owned casino margin was 31.2% for the fourth quarter 2019, up 200 basis points compared to the prior year quarter.In our Churchill Downs segment, Derby City Gaming delivered the balance of the growth in the fourth quarter adjusted EBITDA compared to the prior year quarter, and drove a significant portion of the remaining growth and adjusted EBITDA for the total year. The team continues to efficiently provide a unique and entertaining experience for its guests. And they are excited about the opportunity to offer the new units and top titles from Scientific Games beginning in the first quarter of this year.As we expected, Churchill Downs Racetrack had a slight decline in fourth quarter adjusted EBITDA compared to the prior year quarter, due to 2 factors

[William Carstanjen:]

Thanks, Marcia. Okay, everybody, we're ready to take questions. Fire away.

[Operator:]

[Operator Instructions]. For the first question, we have David Katz from Jefferies.

[David Katz:]

I wanted to focus on -- or at least deal with the type of question that we're getting across our coverage around prospective virus impact, and specifically, around the Kentucky Derby. There's been efforts to include our expectation of a Japanese horse involved. Do you have any statistics that you are able to share any qualitative comments you can make around international visitors or attendees at the Derby, whether from Asia or otherwise? Help us sort of deal with that hypothetical matter as we sort of move through this.

[William Carstanjen:]

Sure, David. Let me address that. First, from a broader perspective, the coronavirus itself, we're still more than two months away from our events. So there'll be many, many events, concerts, professional sporting events and all sorts of other events that happen in the country well before we get to our events. So we have a lot of time to monitor and learn and study the best protocols to put in place if it, in fact, becomes relevant for our events. So our team will be very, very focused on that, and pay attention to that, just as we do every year to any other factors that we think potentially could impact us.With respect to the Japanese horse. If a Japanese horse comes to the United States, that's a great thing. We welcome that. That's why we have the Japan Road to the Derby. If the horse doesn't come, another American horse will be eligible under our point system to enter the race. So I don't think that this impacts the field sizes for the Kentucky Derby or the quality of horses that are entered into the Kentucky Derby.With respect to international participation in terms of attendance, I don't know that we have great access to that information in our fingerprints, but it's also not something I'm particularly concerned about. The tickets are -- reserve tickets are largely sold at this time, and there's a healthy secondary market for those tickets as well. So I think it's a fair question to worry about. But from a -- from our calculus and how we think about it, I'm not sure that I see a path where that impacts our attendance in any meaningful way.

[David Katz:]

Perfect. And just similarly around the Kentucky Derby and the exciting hotel and HRM facilities you're going to build, can we just recheck the prospect of any construction that will be going on over the next couple of years that could either, visually or literally, have any effect on that all-important event? How should we be comfortable with that?

[William Carstanjen:]

Well, in the section where we're building the hotel and HRM facility, traditionally, there are temporary seats that are constructed in that area. Our team has carefully staged the construction to ensure that those seats are all there for this Derby. There will be some infrastructure that gets relocated, that services those seats, but those seats will be where they normally are for this year's Derby. And there's a plan in place to make sure those seats aren't lost for next year's Derby as well.So you raised a good point and one that Bill Mudd and Kevin Flanery and the team are very focused on, to make sure that our guests are not displaced and that there's a plan to maintain their experience as best we can, and certainly maintain the ability to provide those seats to people.

[David Katz:]

Got it. And one last one, if I may. With respect to Illinois, and to your comment in the bill of a -- I believe, it's an October deadline for new casino licenses to be announced or issued. A twofold relevance for you. One, some other license becoming active through a temporary facility, and Waukegan, obviously, which we're highly interested in. Is there any information we can garner about whether that October time line is -- how long we're going to have to wait? And/or do you think there's any probability that it could be sooner than that?

[William Carstanjen:]

Well, there's certainly a probability that it could be sooner than that. But there also isn't any hard information available that we can share with you to give you any guidance on that. Certainly, I think everybody involved, whether it be us through bidding for the Waukegan license or any of the other potential license holders that are -- who are bidding for the other licenses, we all hope and think it's a legitimate possibility that the Gaming Commission moves faster than the October 29 deadline. I'm sure they would like to. I'm sure that, that would be their expectation or hope as well. But we don't have any information at all that we can share with you on what their time frame will be. So we'll keep monitoring that. And if we do get information that we could share publicly, we would. But I think we're all just going to have to be patient. That's not within our control. But certainly, everybody, including the state who is eagerly awaiting that -- those revenues, everybody had an interest in that process moving as fast as it responsibly can.

[Operator:]

For the next question, we have Joe Stauff from Susquehanna.

[Joseph Stauff:]

Bill, you touched on sort of a satellite facility and offering that you could do during Turfway construction. I was wondering

[William Carstanjen:]

Thanks, and I appreciate that because sometimes it's hard to remember all the parts of the multipart question. So I'll let...

[Joseph Stauff:]

That probably helps me more than you.

[William Carstanjen:]

So first, the relative size of the property, it's going to depend. We can't disclose a number yet because it will depend on pending down the most attractive real estate option. And then secondly, getting the Racing Commission's approval. I think, I wouldn't want to risk prejudicing the process with the Racing Commission in any way, so I think those are still discussions that we need to have privately with them, in conjunction with identifying the right facility. But it certainly will not be of the size of what we're doing at Turfway Park. It will be a much more modest offering than that. But I think a really good thing for the state and a good thing for our company, depending on where we can find a location to put it.The facility, as we envision, would offer both HRMs and a full suite of simulcast products that are available. So it would be both a place to wager on the horses. So our fans at Turfway Park have a place to go during this extensive reconstruction process of the Turfway Park site, but would also offer a modest but healthy number of HRM opportunities for players so that we can build the purse account and generate returns for the state and our own company.

[Joseph Stauff:]

I see. Two more questions, please. So I just wanted to clarify, say, on the license issuance process in Illinois. Is it fair to assume that the compete -- a different site, Rockford. I believe there's one bidder, and that bidder had applied earlier, I guess, versus your joint bid in Waukegan. Is it fair to assume that -- assuming October 29 is the last date that Illinois would decide with respect to that application or that license much earlier? Or is it -- is the timing also -- whatever you can share with us. I know it's always difficult to try to handicap regulators. But I was just wondering on the timing of that piece?

[William Carstanjen:]

Well, not every license in the state that is being offered has multiple bidders. So there are situations where there's just a single bidder, and there are other circumstances in the states where bidders have said that they would do a temporary, and that's part of their approach to winning new license.With respect to the timing on when the racing -- or when the Illinois Gaming Board is going to make a decision, I just can't responsibly speculate on that, other than I can identify that they have motives, just like we all do to move as quickly as they responsibly can. The governor has talked about the importance of this revenue to the state, et cetera. So I think everybody would like to move as expeditiously as possible. And I'm sure that, that includes the Illinois Gaming Board, that they would like to move as expeditiously as they can through this process. But I'm just not the person that can be in a position to comment on whether they'll be finished and win in advance of the October deadline.Joe, I know that's not a very satisfying answer. [Indiscernible] a territory where we don't control bets. And I just want to be respectful of the people that do. But I can tell you, I can't comment on their motivations and their incentives. Everybody wants this to move as quickly as possible in Illinois. But I don't want to be dismissive of their significant workload and their efforts. We'll just have to wait until they're ready.

[Joseph Stauff:]

Okay. And just two clarifying questions. So one, when you exited Saratoga, I believe, in August of '18, correct me if I'm wrong, but you guys retain the access to potential online sports skin when New York gets there. Is that accurate?

[William Carstanjen:]

Yes.

[Joseph Stauff:]

And can you tell me when, in the online segment currently, the impact from your Velocity business within the online segment, when we, at least in 2020, would anniversary the impact, I guess, from lower activity, specific in the Velocity business?

[William Carstanjen:]

Let me just make sure we understand that question. Would you [indiscernible]. I just want to make sure I understand that.

[Joseph Stauff:]

Yes, yes, yes, sure. Let me resay that. All I'm saying is, in the context of the online business, Velocity has contracted in 2019. And what I was just trying to figure out is, okay, when we kind of lap 1 year out, sort of the year-over-year impact of that first real hit in the Velocity business that occurred in 2019. Hopefully, that's clear.

[William Carstanjen:]

I think it's clear. Well, let me start, and then I'm sitting here next to my colleague, Bill Mudd. This is a case where Bill, if you think I didn't quite capture, you jump in. I think Velocity saw some contraction last year, and there is a point at which we lap it. But I have to say that I think that trend, in general, in Velocity is not something we expect to continue. So I don't feel Velocity will be a meaningful negative impact. It may even be a positive impact for this coming year. So I think there are actually multiple factors there. But I would suggest that the trends from last year are not something you should focus on seeing continue.

[William Mudd:]

Yes, I would agree with that. In the left that I think you're talking about probably was kind of middle of the second quarter type of impact, if that's the case.

[Joseph Stauff:]

That's right.

[William Mudd:]

But to Bill's point, these are all very binomial and can move very quickly. So I view it more as an upside than any kind of material risk for this year.

[Joseph Stauff:]

I see, I see. So you would expect that business to effectively kind of reflate, not decline further or flatten out?

[William Mudd:]

That's the way I feel about it, yes.

[Operator:]

For the last question, we have Mr. Dan Politzer from JPMorgan.

[Daniel Politzer:]

The first one I want to hit on is sports betting, and I guess, your overarching strategy there. How are you thinking about this business with respect to maybe adding a media partner, just given what's been going on in the space lately? And how do you think about your strategy for size versus profitability, especially as it relates to online versus retail? I know there's a lot in there, but just happy to get some color.

[William Carstanjen:]

Sure. So with respect to partners, media partners or others, first, we did want vendor relationships as we entered this business that allowed us to enter the business as much in a variable-cost model as we could. Because just having started businesses as we have within Churchill, we know that they can be lumpy at first, and it's hard to predict exactly how they'll grow and win. So you want a variable cost structure as much as you can at first to make sure that your costs aren't outsized compared to your revenues. So feel very comfortable with our vendor relationship and -- relationships and what we've decided to outsource versus to do internal. And I think that's been a component of how we've approached the business.With respect to true partnerships with media companies or otherwise, I think with any partnership you have to look at what they bring to the table and how much it would cost you to get it from a vendor or from -- or develop it yourself. So I think we'll look at all those -- yes, we've looked at media deals. I think we'll continue to look at media deals and other types of deals. But it's really a question of analyzing clearly with the data you have, whether it's worth the cost of the partnership and worth sharing the upside. Generally, as we've approached this business, much like when we entered TwinSpires all those years ago, we want to be careful about giving away the upside, and we want to make sure that we keep as much of the upside as we responsibly can. And if we do give up upside, like if we have to enter a particular jurisdiction because we don't, ourselves, have any way to get access to the jurisdiction, we want to make sure we have a very good theory on quantifying that upside that we're giving up. So we've been cautious, maybe more cautious than others. And maybe appropriately or inappropriately so, but we tend to be very, very careful on sharing upside for the long-term when it's not easy to completely quantify.Your second question, with respect to size versus probability, there's probably a number of places to go with that. And so let me just start, and then you can follow-up if I didn't go in the direction you were anticipating.Really, really like the retail sports betting, as Marcia was alluding to and I tried to allude to as well, since the cost of acquisition of the customer base within the casino is nominal compared to the cost of reaching potential customers in the online space, the margins are very good. So we like that, and we'll do as much of that as we can. In the online space, so far, what we've seen, it can be expensive to acquire customers in the online space. It's just an expensive digital world. We want to make sure our product is mature and performs as required, so it doesn't disappoint the customers. And we want to make sure we develop data on the value of customers so that we can compare it carefully to the cost of those customers. So there are different theories to approach this business, and we respect everybody that's made their choices on this. But from our company's perspective, we are very data driven, we are a very data-driven group. So we tend to be incremental. We tend to be careful. We tend to test and retest, and that can come at the expense of speed. But over the long term, we think we'll have this data to make good decisions. So we're going to plug along at a pace that makes sense for us and try to get better every quarter. And indeed, within every quarter, every week, every month, we'll try to get better and smarter about how we make decisions and spend our capital.

[Daniel Politzer:]

That's helpful. I appreciate that detail. If I could squeeze in one more. Just pivoting to Rivers. And how are you think about the remaining 39% ownership there? And have you given thoughts to consolidating it? Or what are the puts and takes to that kind of relationship? And how do you see it evolving over time?

[William Carstanjen:]

The majority of the interest in Rivers that Churchill doesn't own really is owned by Neil Bluhm and his family and other -- some other key executives within his organization, and they're tremendous partners, and bring tremendous value to our company and there is no interest or plan to seek consolidation of that. The plan is to continue to work with partners that bring tremendous value and improve our company and improve our efforts together in that jurisdiction. So just harkening back a few minutes ago to the discussion about media partners in our online business and how we want to be careful and thoughtful about that, well, Illinois is an example where we have a tremendous partner that makes our company better and that we learn from and that we're pursuing other opportunities with, like Waukegan. So I wouldn't expect any change in that anytime in the near term.

[Operator:]

I am showing no further questions at this time. I would now like to turn the conference back to Mr. Bill Carstanjen.

[William Carstanjen:]

Thank you, everyone. I really appreciate your time. I appreciate your interest in our company, we all do. We appreciate your good questions and your confidence in us and your investments in us. So we're going to keep doing what we do, and we'll talk to you at a very short period of time, less than two months or about two months from now, we'll talk to you again and report further. So thanks, everybody.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.