Churchill Downs Inc (CHDN) 2005 Q2 法說會逐字稿

Good day, and welcome to the Churchill Downs Inc. conference call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Mr. Mike Ogburn. Please go ahead, sir.

Good morning, and welcome to this Churchill Downs Inc. conference call to review the Company's earnings results for the second quarter of 2005.

The results were released yesterday afternoon in a press release that has been covered by the financial media. A copy of this release, announcing earnings and any other financial and statistical information about the period to be presented in this conference call, including any information required by Regulation G, is available at the section of the Company's Web site entitled "Investor Relations" located at churchilldownsincorporated.com. Let me also note a release has been issued advising of the accessibility of this conference call on a listen-only basis over the Internet.

As we start, let me express that some statements made in this call will be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Actual performance of the Company may differ materially from that projected in such statements. Investors should refer to statements included in reports filed by the Company with the Securities and Exchange Commission for a discussion of additional information concerning factors that could cause our actual results of operations to differ materially from the forward-looking statements made in this call. The information being provided today is of this date only and Churchill Downs Inc. expressly disclaims any obligation to release publicly any updates or revisions to these forward-looking statements to reflect any changes in expectations.

I'll now turn the call to Tom Meeker, President and Chief Executive Officer.

Good morning and thanks for joining us today. During today's call, as I do routinely, all discuss in general terms the results from the second quarter and Mike Miller, our CFO, will fill you in on the details following my comments. I'll also highlight some of the accomplishments that occurred during the second quarter, and finally, and I think most important, I'll try to provide you a template for what we see us as we're moving forward in terms of growth.

Given the challenges we faced during the second quarter, I was very pleased with the overall performance of the Company. At the revenue line, I was very pleased with the growth in revenues, which were largely attributable to two factors -- one, the Kentucky Operations, which performed extremely well during Derby week and set also sorts of records in attendance and handle. Moreover, putting online the new facilities at Churchill Downs racetrack provided additional revenues in the form of PSL revenue, suite sales. And most important, and I was very encouraged by this, with the addition of all of these suites, we are expected a decline in Marquis Village sales; those did not occur and in fact, we were up in Marquis Village sales.

The other factor was, of course, the Fair Grounds, which came into operations in the fourth quarter of last year and moved over into this year, and that operation continues to operate very effectively, and obviously provided increased revenues during the first six months and marginally in the second quarter.

Likewise, I'm pleased with the EBITDA growth that we experienced from continuing operations. Overall, these increases were dampened by several factors, including a hurricane in Florida, which occasioned the movement of a major event down at the Calder operation. We also had continuing record-breaking rains in Florida for a substantial part of the second quarter while Calder was in operation. We also, as everyone knows and it's been reported widely, throughout the industry, there were a number of breakouts of strangles and herpes -- herpes of the equine type -- which adversely impacted the field sizes at our operations, particularly in Calder. And most important, following the Derby, we had significant declines in our field sizes at Churchill Downs. Those impacts -- the weather, excepting heat, which is now adversely impacting the Kentucky Operation and the Chicago operation, those things seem to have gone away and I would expect as we move forward we will see a more routine kind of environment in terms of the overall racing.

As Michael explained in detail, the bottom-line earnings were adversely impacted year-over-year due to several factors relating to corporate development costs, personnel costs, an anomaly in our tax rate, and depreciation costs. During the quarter, we aggressively moved ahead on various strategic projects, the most important of which obviously is the sale of Hollywood Park, which is underway. We have not closed the transaction. We anticipate closing the transaction in late September; and it's subject to certain conditions of closing, none of which we see -- anticipate any problems with. The sales price is 260 million. That project, that sale, is important obviously for a number of reasons. Obviously, the monetizing of that property provides us significant advantages in terms of our balance sheet. The more important thing that we gain from the sale or the transaction entered into at Hollywood Park is a re-entry right into that market in the event that alternative gaming should pass in some form, be it some agreement with the Native Americans and their gaming operation or some legislative or statutory change that would allow alternative gaming to occur at racetracks in California. In the event that that were to occur, our re-entry right allows us to come back and take control a majority position in that asset for a period of three years. And then subsequent to that for an additional period of time, we have the right to come back into that project in a minority position.

During the quarter we expended significant time and effort in obtaining the requisite licenses and permits that allow us to operate slots at the Fair Grounds. That process and the execution risks have been significantly eliminated in that we have been granted a -- excuse me we have -- or will be granted on August the 18th, a conditional use permit. The process is largely complete and they are going through the second reading and the actual vote on August 16th on the ordnance itself, which will allow us to operate 500 machines and up to 700 machines at the Fair Grounds operation in the event the Harrah's operation continues to expand and grow in revenues.

The decision-making process was much longer than we anticipated and much more complicated than we anticipated in respect to obtaining the conditional use permit. But as I said, the road now is clear and we can start construction. We anticipate putting the slot operation online midyear of next year. In the meantime, we are actively redeploying new machines or deploying new machines, VLT's at our various OTB operations. And again, the deployment of those new machines has been slower than expected. The state of Louisiana allows us to put those machines online at a rate of around 28 per week, which is largely significantly less than we anticipated. The performance of the new machines is very good, very positive -- much better than the machines that we bought when we acquired that asset.

During the quarter, we also continued to build out our CRM technology platforms. We have experienced a number of problems of integrating our CRM systems with the various tote platforms that we do business across. And I think that problem highlights the absolute imperative for the industry to improve and continue improving -- or to improve the tote system -- to allow both an open architecture for the customer in terms of customer interface, and on the output side of the tote, allowing us to obtain various data that is important data in terms of overall identifying, valuing our customers and our ability provides us the ability to talk to our customers as we move down the road.

In regards to the tote, we continue to work with other racing companies to restructure and redesign the overall industry tote architecture, we've issued an RFP. We've received significant interest from incumbent providers as well as new providers, and it is anticipated that process will come to closure during the fourth quarter. And following that, we anticipate it will probably take in the order of two years, given the contracts that the various racing companies have with existing providers, two years, to fully deploy a new tote architecture across the industry.

Last month, we also strengthened our management team with the addition of Bill Carstanjen to the team. Bill comes to us from GE. Prior to that, he was with Cravath. And his focus in those two employments were in the area of development and deal making, particularly as it relates to various new projects that GE was involved with in the capital finance area. The importance of adding Bill and his critical skill sets to the overall management team is pretty obvious and I think he will have a significant impact together with the rest of our team members in charting the future growth of the Company.

Let me also now turn our attention to legislative matters. I'll give you kind of an overview of our sense of what's going on in the various jurisdictions in which we do business.

First, let's talk about Florida. Florida continues to be in a state of turmoil brought about by first, the passage of a statewide referendum that called for the state legislative body to implement legislation by July 1st. The statewide referendum also authorized or required a passage of a local referendum in Broward, Miami-Dade counties. As you know, Broward passed the local referendum. Miami-Dade did not. It failed by only 2 percentage points.

The important thing though and the confusion that has been brought about results from the failure of the state legislature to pass implementing legislation as required under the statewide referendum by July 1st. And that has turned the whole process into turmoil. They're in court. Court has opined that absent the failure of the state legislature, passing implementing legislations per the demand of the statewide referendum that the operators are free to engage in slot activity or some form of alternative gaming without the state legislative body getting involved. I don't think that will happen. The sense down there is that there may be a special session as early as the next few months, which will be designed and called for the specific purpose of passing the legislation.

The real question for us remains what is our potential for getting involved through the Calder operation, and I'll turn to gaming in the state of Florida. And I think given the fact that we failed by only 2 percentage points, we continue to believe that we have an excellent opportunity to pass legislation in Miami-Dade, and as a consequence, we continue to focus on that asset and on alternative gaming legislation, trying to get the correct legislation, implementing legislation, passed and we continue to work in terms of developing relationships in the Miami-Dade area with a view towards promoting a local referendum in the early 2007 timeframe.

In terms of Illinois and Indiana, they are sort of the mirror image. There obviously is a keen awareness of the plight of racing in those markets given the competitive forces being brought about by riverboat casinos and freestanding operations in Indiana. However, notwithstanding the fact there is an awareness plight of racing in those jurisdictions, there does not seem to be a clear consensus among all of the political decision makers in those jurisdictions.

In Illinois, for instance, there is a dispute between the governor and the mayor of Chicago as it relates to the placement of new gaming operations in the state and that continues to be -- there is an impasse there and as time goes on, we'll have to eliminate that impasse if there's any potential there. Indiana still remains a potential and I think the next session, we will see some activity, certainly there will be an initiative being pressed by the racing folks in Indiana. Whether or not that will be successful is a matter of some conjecture.

In Kentucky, there's several things happening that provide some degree of optimism without any assurance of passage, but some degree of optimism that certainly did not exist at this time of year in prior years, where we were looking forward to a new legislative session.

An organization called KEEP, which is a grass-roots industry organization, has done a particularly good job in providing grass-roots awareness of the importance of the overall equine industry of the state of Kentucky. We garnered, additionally, wide support from a number of organizations, both in terms of chambers of commerce, educational groups and business groups throughout the state, which shall provide a good bedrock for pursuing alternative gaming legislation in the 2006 timeframe. That is going to be critical and I think our efforts have been elevated significantly as we look forward to the 2006 session.

Let me make a few comments also about the overall state of the racing industry. First there has been much said and written about the problems facing racing. Clearly there are a number of endemic problems, ranging from the short field issue, which I don't think it's just anecdotal. I think there is an endemic problem with short fields occasioned by a myriad of change in dynamics in the industry, but that's something that clearly the industry must address as we move down the road. The offshore competition issue continues to be out there. That's an issue involving an economic model that is not the right model for racing and it needs to be changed. We've spoken about the tote technology. There also exists an issue in terms of uniform medication, as well as general racing rules throughout the industry.

Solution to these problems I believe -- we believe -- will provide not only the industry with new growth potential, but in particular Churchill Downs, given its position in the industry, can expect new growth channels if and when these problems are solved. Now, I said if. I believe that the industry today is making good way in solving many of these problems. Internally, we're working on various issues. Obviously the tote issue, we have taken a lead role in that. Short field issues, we're doing some things there. A good example is what we've done at Ellis Park in terms of changing our racing program down there where we've been able to anecdotally over the first three weeks of that may increase in an environment which is going the other way, increased field sizes down there. So there are fixes to each of these problems and I am very confident that the industry, and with Churchill Downs involved, will find solutions to these problems.

The overall issue of alternative gaming I believe now has become an imperative for the industry. It's become an imperative for several reasons including asset utilization, competitive reasons, and internally, it's an important ingredient to the overall ability of a racetrack or a racing company to promote quality field sizes in terms of their core operations in the area of simulcasting. And as reflected in our decision in California, where we have serious concerns about the long-term health of racing in California given the significant competitive challenges they face with the proliferation of Native American gaming, we are going to continue looking at markets in which we do business. And in those markets where there is not a good potential for alternative gaming legislation being passed, we are going to consider whether or not we should remain in those markets.

New York is another important part of -- clearly, it is an important part of the overall racing fabric of the United States and its importance is just -- from a standpoint of a freestanding operation -- is clearly acknowledged. But it is also important to the overall health of the industry and as such, we are actively involved in looking at what is the right relationship between the state and a potential franchisee in the state of New York. Obviously, given the size of the market, the assets that are in place, namely Saratoga, Aqueduct and Belmont, in the event that a successful bidder does acquire those assets under some new relationship between the state and the franchisee, there is a significant growth opportunity for the successful bidder. I am confident that CDI will become actively involved in the bidding process and we continue to focus our time and effort on looking at finding the right solution for New York.

Now let me talk a little bit about growth. First of all, I'll give you an overlay comment. I think Churchill Downs is well positioned today as it's ever been to execute on various growth opportunities and pursue various growth channels available to it. First, let's look at core operations. We do see some growth, primarily in the non pari-mutuel area, but some growth also in the pari-mutuel area in such operations as Kentucky. Obviously the Kentucky Derby, we've demonstrated that we've been able to grow significantly our non pari-mutuel revenues in the state of Kentucky at the Kentucky operation. And as we move down the road, complemented by commitments and investments we've made in CRM effort, I think Kentucky enjoys a very bright future.

Louisiana, albeit a small operation, has significant growth opportunity in a number of areas. First of all, its overall racing I think has good growth potential. We demonstrated that. Our first race meet under the Churchill Downs banner was very successful. The deployment of new VLT's at the OTB locations and a relook and a redesign of our OTB operations will afford us new growth opportunities down there. And then finally, the addition of -- excuse me 700 slots -- provides an opportunity for increased growth in revenues.

Arlington remains, long term, a significant value driver for the company. It's a huge facility, number one. Number two, it's one of the best racing facilities in North America. It is located in a large market and as demonstrated by tenants' increases that we've experienced up there, in the long term, Arlington represents, at the core operation level, an opportunity for the Company.

And then finally, without going into all of the details, we have concentrated our efforts and better asset utilization at all of our facilities, particularly at Arlington and at Churchill Downs, where we have seen off-season events occurring more frequently than in the past; better utilization on an ongoing basis of the new facilities that we have here at Churchill Downs; and as time goes on, we see those facilities being a marginal growth driver as we move down the road.

Simulcasting is another growth channel for the Company on several fonts, first, account wagering. We need to solve and rationalize the account wagering platforms in the United States. First and foremost, we believe, and we will continue to pursue, ventures that will lead to a common account wagering or account management system for the industry that is more customer friendly, that allows portability of accounts across various platforms and we believe that there's growth potential just in that exercise. Moreover, I think we need as an industry and Churchill also hand-in-glove with the rest of the industry, need to pursue opening new markets in the United States that will allow for expanded account wagering.

The offshore potential is great. The numbers that have been -- there's much speculation about the numbers that exist offshore in terms of raw handle, but they are significant. And they offshore economic model that exists today is something that if you held everything in check and just jiggered the economic model, would provide growth opportunities for those racing operations that allow for the wagering with -- through offshore entities. And I think that's a potential that we're exploring. And how that's to occur is a matter of some conjecture, but I think that will be (ph). There are point-to-point simulcasting, hard asset to hard asset, is essentially a market share strategy and that's where Churchill Downs has a significant advantage, with its CRM platforms behind it as well as the quality of its product, we believe that we can continue to capture additional market share as we move down the road.

And then finally, international wagering, as we've mentioned before, the international marketplace is a huge target for U.S. racing. And as time goes on, I think U.S. racing through various mechanisms and delivery platforms will be able to enter that market, but I underscore what I've underscored before and that is it is going to be slow in developing. It is a matter of scale. It is a matter of changing various laws and regulations, tax treaties and a myriad of other things. But in the end, the deployment of our signals, U.S. signals, into the international marketplace is an extremely large growth opportunity for all of racing.

Alternative gaming, racino operations, obviously is a growth channel that we have been focused on for several years and will continue to be focused on. We are perfectly positioned in large markets -- Illinois, Florida, Kentucky, and now, even with the sale of Hollywood Park and our re-entry right, we continue to be positioned in the state of California. And over the course -- just one or two of these changes or passage of legislation in this markets will have a significant impact on our Company as well as other companies who do business in those jurisdictions.

We will continue to pursue various acquisitions and joint ventures within the industry and adjacent industries as we move down the road. And the Hollywood Park transaction, obviously, provides us new opportunities in terms of equine (ph) balance sheet to execute on those strategies. And as time goes on, I believe that you will see us involved in new activities with new partners down the road.

Finally, one of the clear advantages our Company has and to some extent is reflected in what we've done with PSL sales, suite sales and various sponsorship arrangements, our brand is a significant value to the overall operations -- to our overall company. And as we move down the road, we will continue to focus on brand extension, both within the industry as well as outside the industry in adjacent businesses. And we see that as a distinguishing characteristic of our company, number one, and again, a significant growth channel as we move down the road.

So I had those general comments have been helpful to you. At this point, we're going to refocus on the activities during the second quarter. In that regard, I'll turn it over the Mike Miller, our CFO.

Thank you, Tom, and good morning, everyone. My comments on our results of operations will be directed primarily to the second quarter of '05 versus '04 and then I have some remarks to make about our balance sheet at June 30 as compared with December 31 of '04. I then intend to provide some color about our ongoing expectations, focusing on business trends, the Fair Grounds operation and the pending sale of Hollywood Park. After that, Tom and I will respond to any questions you may have.

Now as you probably have learned already by looking at the release, our P&L is somewhat hard to follow given the now separation between continuing and discontinued operations. Although I think that's a very fair way to look at our company now. But if my comments are not completely clear to you, please ask me to clarify during the Q&A session.

In comparing our quarterly results from year-to-year, there are a few key components which account for most of the difference -- general business conditions, interest expense, depreciation and tax rates. I will speak to each of these as they are not necessarily apparent from examining the face of the statements. And also please note now that all of the operating results of Hollywood Park, including that portion of our CDSN operation related to the Hollywood Park signal, net of taxes, are included in one line on the face of the statement labeled as discontinued operations. And we'll be reporting in this fashion from this point forward.

First, our revenues from continuing operations increased by slightly more than $23 million year-over-year, primarily resulting from the addition of the Fair Grounds as well as the impact of the total rollout of the master plan at Churchill and significant increases in wagering for Oaks and Derby. I am pleased to say now that the master plan has been completed; it's going to be coming in on budget with respect to the $121 million of capital, and I'm also pleased to say that the EBITDA -- the incremental EBITDA that we expected years ago when we started this project, we will meet or exceed in all categories of the master plan.

Our overall racing calendar produced five more days in '05, but the mix was not favorable because we lost four thoroughbred days at Churchill, which were replaced by nine Standardbred days at Hoosier and the thoroughbred stable was more profitable than the Standardbred stable.

Our EBITDA operating margins for the second quarter of '05 from continuing operations decreased approximately 1.5 percentage points to 28.6% for the quarter due to the addition of nearly $15 million of revenue at the Fair Grounds, which produced very little EBITDA for the quarter. And I'll speak more about the Fair Grounds just a bit t later.

The primary difference between EBITDA and operating income is depreciation. Our depreciation expense is approximately 2.1 million higher in '05 primarily as a result of the now complete master plan project as well as the addition of the Fair Grounds assets. Our run rate for depreciation for the balance of the year should approximate what you see for the second quarter.

For the six months and to a lesser degree in the second quarter, there is a fairly significant increase in the SG&A line, which is due to several factors -- the referendum costs in Florida, which were approximately $3.1 million, the first-time inclusion of the Fair Grounds this year, and the development costs in California as well as higher corporate expenses related to increased personnel costs, compliance with Sarbanes-Oxley, and our CRM initiative. These increases were partially offset by $1 million spent in lobbying in 2004 for the California ballot initiative, which obviously did not repeat itself in 2005.

Below the operating income line, if you have reviewed our operating expenses in the past, you will notice the apparent significant decrease in interest expense. For both '05 and '04 as required by GAAP, we have recorded as part of the discontinued operations line approximately 3.3 million and $970,000, respectively, of interest expense included in discontinued operations. The GAAP rationale for this treatment is that the way our current debt agreements are configured, any proceeds from a sale of asset of this magnitude must be applied to outstanding debt balances. Obviously, if we decide to redeploy this capital in a manner other than reducing debt, it will require an amendment of our debt agreements.

The increase in the overall interest expense from 907,000 to 3.3 million is directly related to our outstanding debt balances, which again are tied to the Fair Grounds acquisition in '04 and the continued buildout of that property as well as the master plan.

Finally, in explaining fluctuations between the two years, there are two other items to be discussed. First, included in the earnings from discontinued operations is a charge of 919,000, representing costs incurred in connection with the sale of Hollywood Park. Second, there is a considerable fluctuation in the effective tax rates from year-to-year of almost a full 6 percentage points between '04 and '05, which is a second-quarter and a first-half anomaly resulting from a significant amount of nondeductible legislative costs incurred year-to-date 2005 compared to last year. The full 47.2% rate is not apparent from the face of the statements as taxes are netted against operations in the discontinued line. So the taxes are really manifested in two places now on the P&L.

For the full year, we expect our tax rate to be approximately 40%, so we do have an anomaly again for not only the quarter, but for the first half. All of this resulted in EPS of continuing operations of $1.69 compared to $1.70 for 2004, which we think is reflective of our current business trends.

That's really it for the P&L. A lot of moving parts with results that indicate a slight softness in business trends, but better than the industry as a whole. The impact of our investment activity is manifested in the increased interest, depreciation, and the anomaly of the income tax rate account for approximately $0.38 of earnings when comparing the quarters year-to-year at the net earnings line.

My final comment relates to the disparity that exists when you compare earnings from '04 to '05 at the two levels. A $0.01 drop at the continuing operations line versus a $0.26 decline for net income. This difference really representative a validation of the strategic decision we made to sell Hollywood Park and underscores the impact that this redeployment of capital may have.

Turning now to the balance sheet, there are a couple of things to highlight. The increase in total assets of 33.3 million is comprised of 23.9 million in new increases to plant and equipment and assets held for sale of 22.4 million, partially offset by decreases in cash and cash equivalents of 11.9 million. The assets held for sale increased primarily due to an increase of cash, which is a function of the timing of Hollywood's live race meet.

Total current liabilities increased by 25.9 million due to the timing of the settlement in the various payables and accrued expenses, offset partially by the first-quarter payment of dividends and the recognition of deferred revenues related to Churchill Downs during the second quarter. Additionally, the liabilities held for sale increased also as a result of the timing of Hollywood's live race meet, which generates additional payables and accrued expenses.

Let me now turn my attention to a look ahead for the balance of the year. We talked about softness in the pari-mutuel business, which we believe to be primarily due to a decrease in field sizes for all the reasons that Tom spoke of, which results in a less than desirable wagering product. So we will continue to fight that reality for the balance of the year. That having been said, we have continued to fare slightly better than the overall industry and our current business trends would indicate that after giving effect to the departure of Hollywood Park at the end of the third quarter and the Hollywood Park signal from CDSN, our operating units should perform at or near 2004 levels for the balance of the year.

For the Fair Grounds, we have previously communicated that we expected to produce a pretax profit in 2005 in spite of the historic losses incurred there in the recent years. At this time, we now expect to incur a small pretax loss as we have been unable to introduce the new video poker machines or VLT's at the pace that we had formally hoped. We are very pleased with the performance of the machines that have been deployed, producing a significantly higher net win than the old machines. And along with the slots anticipated in the latter half of 2006, anticipate solid gains in both cash flow and pretax earnings from this unit next year.

The investment in people and systems in our corporate unit are now virtually complete and we are prepared to maximize the profitability of our operating units and fully exploit our development opportunities. As mentioned in the release, it is too early to state what the financial impact of the Hollywood Park transaction will be. But as of now, it appears at worst we would be able to substantially pay down our existing debt, which would have the impact of avoided interest expense in the future. We are exploring all avenues to determine the optimum use of this capital and should be able to provide more definitive information in the upcoming months.

As we have done in the past and will continue to do, I won't update you on our capital spending. We stated at the last call that we expect the year to be in the range of 49 to $55 million and I'm just affirming that we still expect to end up in that range. And the only thing that might change that would be the rate of spend in Louisiana as we now plan to build out that operation.

That concludes my remarks and I'll now turn it over to the operator for your questions.

(OPERATOR INSTRUCTIONS). Tim Rice, Rice Volger (ph).

Tom, I've got two questions. The first one relates to the upcoming approval of interstate account wagering in Nevada. Could you comment on the potential impact of that and whether there's any chance of negotiating more favorable terms with those Nevada sports books?

I wish I could tell you something positive. Over the course of the years, Nevada -- all of these non racetrack operators have been very reticent about changing the economic model. Nevada has been the strongest because they have a joint purchasing arrangement down there where everything goes through a centralized group. I wouldn't expect too much of an improvement out of that, quite honestly.

Okay.

To be very candid.

Okay. The second question relates to Calder. I notice -- it may sound like a little bit of a reach -- but given the value of the property, is there any possibility that you would consider the sale of the real estate there and consider possibly (technical difficulty) Calder a Gulfstream operation?

We're looking at Florida from a number of angles. The primary focus right now and the prism that we're looking through is the alternative gaming play. I think given the fact that we lost by such a narrow margin there, we continue to believe that Calder represents a significant asset. Huizinga is looking to develop properties there, right next door at Pro Player. And that could -- and with all of the access it has to the interstate, Florida Turnpike, etc., it is a significant opportunity. And I think before we would consider anything else, we would have to be assured that our potential for executing on our alternative gaming strategy was not real.

What we're doing down there -- it's kind of a -- with all of the turmoil going on down there and with the events going on and Tallahassee, or potentially with respect to the enabling legislation, notwithstanding the fact that we lost the election, it does afford us an opportunity to really kind of fully evaluate that asset. We think a lot of the execution risk will be eliminated at or around the time of 2007 in that we'll know the tax rate, we'll know what the rules are, and we'll be able to, in a much better way, make a determination of whether or not we'll actively pursue and to what level we'll pursue in terms of dollars, the referendum in Miami-Dade.

But again, the prism we are looking through right now says that we have to stay in place, continue -- and it's a terrific operation. It has been and it will continue to be in terms of a pure racing operation. It operates well. It's probably one of our more efficient operations down there, so in the short term, we're going to continue to focus on racing and again, keep our eye on alternative gaming.

Thanks very much.

Ryan Worst, C.L. King.

Just a couple of questions. Could you go over what we lobbying expense was in the second quarter versus last year?

Well, for the first half, I think maybe is a better way to look at the lobbying expense, Ryan, because the vote, as you will recall in Florida was in March. And it was about 3.1 million in Florida and last year, it was about a million in California. So that's kind of the (multiple speakers) --

(multiple speakers) the delta --

Yes, a $2.1 million increase. There was not any significant expense really in the second quarter of this year. Now we've got our ongoing efforts which repeat pretty much the same from year to year. But in terms of a onetime element, most of that was in the first quarter.

Okay. I just wanted to make sure of that. I thought I heard that wrong. Tom, in the press release you stated that business levels for the balance of the year should be similar to the second half of last year. Are you talking revenue side? Because again, last year, you obviously spent a lot of money on the legislative issues in Florida in the second half. So are you talking about operating profit wise or revenue wise?

Ryan, this is Mike; let me respond to that. When we say that they are going to be approximately the same -- I guess it wasn't obvious, but it was intended to be obvious, that that's excluding onetime type items. We're talking about general business conditions and general operating results primarily to EBITDA line, is where that's referenced.

So excluding those costs in Florida?

Of course. Now, should there be some opportunity, which we don't see today, as we've said before, we will continue to see that if there is a legislative opportunity and spend.

But something could happen in New York that would require us to elevate some spends.

But based on what we see today -- I'm just talking about general business operations -- and nothing to do with development opportunities or legislative spends.

Understood. Did you have any racing days at the Fair Grounds in the second quarter?

No, they ended their meet in March.

Okay. And then could you just go over -- I kind of missed what you said about all of the things that cost you about $0.38 relative to last year.

Well, it's the increase in interest. We had about a $2.3 million increase in interest expense. We had a rounded $2.1 million increase in depreciation and then we had that anomaly with respect to the effective tax rates.

Okay. And could you also go over again how that interest rate shows up on the income statement?

The interest rate? The interest expense?

Interest expense. I'm sorry.

It's buried in the discontinued operations line for both years.

We've got like to like.

Yes, it's comparable. In discontinued operations, let me get back to my notes here.

So it's a benefit to this year's operations at Hollywood Park?

No, it's not a benefit. The interest expense that we actually incurred on our outstanding debts is now reflected as part of discontinued operations. We had -- and I'm searching here for my notes -- was it 3.3?

Yes.

3.3 million of interest this year and about 970,000 last year of real interest expense. It's just a question of where it's now reflected on the face of the statements. And so you don't see it and that's why I wanted to point it out. We have incurred and will continue to incur interest expense at least through the closing of the Hollywood Park sale. And then it just depends upon how we deploy that capital as to what our interest expense beyond that would be.

So your interest expense above the discontinued operations line kind of assumes that you use the proceeds to pay down debt?

Yes, that's an assumption that GAAP forces upon you; and it's based upon -- they look at your debt agreements to see how those proceeds must be used. So barring a change in those agreements, which indeed we would do if we decide to redeploy that capital in other directions, it would pay down debt and that's why it's reflected in discontinued operations.

Okay. And then Tom, just one last question. It's well-publicized recently that a competitor of yours, Magna, is looking for strategic partners to develop some of their gaming operations. Churchill Downs with its healthy balance sheet, seems to me it would be a logical choice as you guys could work somehow to keep the proceeds of that untapped gaming potential within the industry. Has there been any thought to pursuing that on Churchill Downs behalf?

I'll answer yes, but beyond that, I can't make any comment.

Okay. Thank you.

At this time, there are no more questions in queue. (OPERATOR INSTRUCTIONS). At this time you have one last question in queue. Ryan Worst, C.L. King.

Just one more follow-up. You talked about kind of the redesign of the tote system. Are you hoping or is the goal there more revenue enhancement or cost savings or both?

No, there are a number -- I think depending upon how much volume you put across it, it could result in some marginal declines in cost, but I think that's a foolish way of looking at the tote. It's a revenue enhancement. For instance, right now as you see with respect to our CRM -- the integration of our CRM technologies with the tote system, where you're trying to capture data about what and how people bet and that sort of thing, it's a very difficult job for us, and we have to develop interfaces and all of this, that, and the other thing. We need an architecture that is customer friendly on the customer interface side so we can plug in virtually any type of customer interface from a PDA to a freestanding self-serve machine to an attended machine to IBR (ph); all of those technologies are sitting out there and we constantly find ourselves in a position of having to develop intermediate technologies to allow us to hook up to the tote. So there is a revenue enhancement component to this thing as we are able to deploy on the front end new technologies, and on the back end, take out valuable information about our customers.

But the override is this whole question of integrity and as we saw what occurred in Chicago at the Breeders' Cup several years ago and with the late odds changes that we continue to experience across the industry, we have to concentrate on the customer and make sure that the customer firmly believes, as indeed is the case, but firmly believes in his or her mind that the system is secure. And today, we don't have that firm belief in the minds of our customers. And so it's a number of things. There are some cost savings potentially, but I think to go with that view and that view alone is foolhardy. There is a revenue potential, but the most important thing is the customer-centric focus for tote.

Okay. Is it fair to say that maybe the allocation of the cost will switch around from less on the back end and more in the customer interface direction?

I'm not sure I understand your question.

Maybe the outcome of this will be spending less on the kind of common back end of the tote and more on --

No, no. Let me just give you a primer. If you look at it with three different functions lined across the top, the customer interface, that is the machine, the technology that interfaces with the customer, then you have a communication link, which is part of RFP, and then you have the transactional part of the tote, which is the second box.

The black box is the one that we are working on and focused on. If you had the black box with an open architecture so that the providers -- content providers, tracks, whoever, can hook up to the tote through an open architecture, you need that, and it doesn't -- we don't have that today.

The third box is the output side and that's the output of data, be it graphic presentation data, real-time betting data, tick -- just like the market ticker tape -- real-time data spitting out the back end of the tote. Which would allow us to do a number of things -- one, improve the odds presentation for the customer real-time. Number two, provide us an opportunity to capture the data with respect to various transactions that would become proprietary in terms of our CRM program. And using that data to parse the value of the customer to identify the customers' preferences and design and develop products that are targeted to that customer. So there are three different components.

The relationship between the tote provider and the track would be primarily on the transactional part -- the middle piece. And then we could go out and for instance today, if you are a United Tote subscriber, you have to have United Tot front ends. All the customer interfaces are United Tote. As contrasted to a casino operation that has a centralized computer system and on the front end, they may have 10 different manufacturers of machines on their floor at any one time. So the customer interface side would be available to us under the new format, would be available to the individual tracks to develop their technologies with other vendors, et cetera.

And then on the back end side with the output, individual tracks or organizations could then use the output side of the tote, the transactional part, to interface with their CRM technologies on a proprietary level to allow them to value, identify, and develop products and services unique to a particular customer.

Ryan, this is Mike. I think it's fair to say that the RFP and the very robust structure that we are demanding now for this new architecture could very well result in higher fees from a tote Company in order to produce the results that Tom talked about. Because it's a very different machine that exists today, and there's going to have to be capital deployed on their part. So although we don't have any numbers, and I think there could be a general expectation that what we pay for that service could actually increase in the future.

At this time, there are no questions in queue. You may continue with your presentation or closing comments.

This is Tom again. As we identified to you, we are very encouraged about what we see going on in the industry. And in terms of our operations, we continue to practice very strong discipline in terms of managing our core operation. I think to a large degree, the execution risk that we face in various growth channels is mitigated by our disciplined approach to managing not only our operations, but our development activities, and finally, our balance sheet. The company is positioned for growth. There are a number of opportunities out there that allow us -- and complemented by our disciplined approach to things, we think we can surmount any of the execution risks that are available. Again, thank you for joining us this morning. We look forward to talking to in the near future and certainly by the end of next quarter.