Churchill Downs Inc (CHDN) 2005 Q4 法說會逐字稿

Good day and welcome to the Churchill Downs fourth quarter and year-end conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Miss Julie [Koenig]. Please go ahead.

Thank you. Good morning and welcome to this Churchill Downs Inc. conference call to review the Company's results for the fourth quarter and full year of 2005. The results were released yesterday afternoon in a news release that has been covered by the financial media. A copy of this release announcing results 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 this section of the Company's website entitled Company News, located at churchilldownsinc.com.

Let me also note a release has been issued advising of the accessibility of this conference call on a listen-only only basis over the Internet. As we begin let me express that some statements made during 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 facts. Actual performance of the Company may differ materially from the projected -- that's 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 will now turn the call to Tom Meeker, President and chief executive officer.

Thanks for joining us this morning for a discussion of our Company's financial performance for the full year 2005 and for the last quarter of 2005. During the course of this morning's conference call I will make a few general comments about the Company's performance over the last year, followed by some comments about where the Company will be focusing its efforts during the coming year. I will then turn the call over to Mike Miller, our Chief Financial Officer, who will give you some more details about last year's performance. And thereafter we will stand ready for any questions you might have.

Despite the natural disasters we faced in 2005 the Company performed exceptionally well. As you know we experienced three significant casualty losses in 2005 brought about by Hurricane Wilma that caused extensive damage to our Calder property. Hurricane Katrina that ravaged the Gulf Coast, flooded New Orleans and inflicted severe damage on our Fair Grounds property and an unexpected but powerful tornado that caused significant damage to our Ellis Park property.

Throughout the third and fourth quarters, our team members devoted countless hours reacting to these events and in short they did an exemplary job, protecting not only our properties but meeting the needs for our team members who were personally affected by these events. And in many cases, our team members were displaced from their homes and moved to other locations.

As previously reported, these casualty losses were insured and with the exception of some deductibles, which Mike will talk about, fully insured and he -- Mike will also give you a status on all of the claims that we're filing.

In 2005, we sold Hollywood Park which resulted in the significant improvement of our balance sheet. While I regret having to leave California Racing, the sale has allowed the Company to concentrate its human and capital resources on areas within the industry that have significantly greater growth potential. The casualty losses and the sale of Hollywood Park did not inhibit our ability to grow our continuing operations; and during 2005, which included our first full year of revenues from our Louisiana operations, revenues grew 13.2% year-over-year; EBITDA grew 16.2% year-over-year; and net earnings grew 31.1% year-over-year.

Mike will give you the underlying details associated with these increases but one of the most important factors was the solid performance of Churchill Downs Racetrack. The facts clearly demonstrate that the $121 million capital investment we made under the Master Plan was well-planned, thoughtfully financed and, most important, well received by our customers. In short, it has and will continue to be a solid investment for the Company.

Our continuing operations also performed well against the backdrop of a challenging year but also for the horse racing industry as a whole. The market was down almost 3.4% in 2005 and there were a number of factors contributing to this decrease. First the year got off to a poor start in California where unprecedented rainfall significantly impacted California racing and the access to that market for our simulcast products. Due to ongoing construction Gulf Stream did not perform as well as in previous years. Churchill Downs Spring Meet was significantly impacted by multiple equine illnesses including strangles and equine herpes that led to repeated quarantines and kept horses from regular training schedules.

Additionally, our hurricane season -- a record hurricane season -- impacted second, third, and fourth quarter results in the important South Florida market. Finally, we had the effect of Hurricane Katrina which negatively impacted the New Orleans market.

In spite of those challenges, Churchill Downs made progress on a number of strategic initiatives in 2005. By the end of the year, we had in place all of the CRM platforms and programs developed by the Company. We are beginning to see positive results from the CRM initiative. Customer satisfaction polls conducted at all of our locations are significantly higher than in previous years. The Twin Spires club membership is up. The total handle run through the Twin Spires club program which is our Affinity program is also significantly higher than in previous years.

Moreover, our CRM program was put to the test in responding to an industry problem that surfaced in the first and second quarters of 2005. Namely, the shortage of runners per race at tracks throughout the country. Midyear, we embarked upon Project Breakout, which was targeted at improving our runners per race at various tracks. Based on the data we had available under our CRM program and more importantly the analytical tools resident in the programs and platforms, we were able to significantly improve the number of runners per race at the Churchill Downs fall meet.

Through target efforts to enhance the level of customer service directed at our Kentucky horsemen, including the creation of a Horsemen Services Center, we increased our runners per race average from 9.8 runners per race to 10.2 runners per race year-over-year meet comparison.

In summary, 2005 was a challenging year but despite the challenges the Company continued to grow, strengthened its balance sheet, and continued to move forward on important strategic initiatives. As we look forward I see yet more challenges; but more important I see some exciting opportunities and let me describe where the Company will focus its efforts during the coming year.

First, we have cause for optimism as we look at the business levels across the industry in the first two months. The pari-mutuel market is up almost 2.5% through the end of February year-over-year on strong results from California, Kentucky and improved results from Maryland. Average field sizes have improved, and the impact of the [Mayor] Reproductive Law Syndrome which has contributed to smaller field sizes over last couple of years is diminishing.

Switching from the domestic to the international market, as I've indicated over several years, U.S. racing must concentrate its efforts on international employment as a long-term growth strategy. Towards that end we will continue to pursue initiatives individually and collectively with other industry organizations and companies that are targeted at opening up new markets for U.S. wagering products.

Similarly we will continue our efforts to improve the domestic account wagering operations. Beginning in March of 2007, our exclusive account wagering contracts with TVG will begin to expire. The first contract is with Churchill Downs Racetrack and as we look to the future, several objectives are clear.

First, we must re-examine the business model in this area to ensure that horsemen and tracks obtain a fair share of the revenues associated with this growth channel. Second, we must develop a system that provides the account wagering platform operator with the necessary tools, such as rebating to compete with nonregulated offshore platforms. Third, major racing states such as Florida and Illinois must be encouraged to pass legislation that allow for account wagering, thereby strengthening not only the local industry but the industry at-large.

Finally and most important, we must begin to operate the account wagering systems, or system or systems in a customer-centric manner. Simply put our customers deserve more from the industry and absent that commitment, our customers will seemingly go elsewhere.

Similarly our customers are entitled to a more secure and efficient code system; and during 2005, Churchill Downs together with Magna, Woodbine and other track operators commenced a process that will, in the end, deliver a more secure, customer-friendly and efficient code system for the industry.

I'm pleased to report that progress is being made. With a little luck and continue hard work by all of our partners, I firmly believe that we reengineering process of the [tote] system will accelerate in 2006 and in the near future, the industry will be processing wagers more efficiently with more speed and, most important, across a more secure system.

Just as important, the system will have an open architecture that will allow new and exciting customer interface technologies to be deployed by those account-wagering systems that are operating across the tote system.

During 2006, we will continue to focus on our underperforming assets. We are looking at a number of things, including downsizing facilities consistent with a diminished role of ontrack attendance and handle on overall revenues; developing alternative uses for excess real estate; and, as we have successfully done at Churchill Downs Racetrack, developing a year-round utilization strategy for each of our properties.

Asset utilization is also a focus of our continuing efforts to obtain favorable slot legislation. We will continue these efforts in all jurisdictions in which we do business. This year, we made progress in Kentucky where for the first time we obtained industry consensus on a number of significant issues attending our slot legislation. In Illnois, we saw a subsidy bill barely pass -- barely miss passing, I should say, in the House and we look forward to the veto session later on this year. In Indiana, there was little action taken on the slot initiatives but in place is a strong industry consensus as to where the industry should be going.

Finally in Florida, we were disappointed in the enabling legislation passed by the legislature. But despite the lack of a favorable tax rate, we continue to believe that a business can be built around alternative gaming in Florida. We're actively working to defeat a piece of legislation that would allow for yet another referendum that if passed would prevent voters in Miami-Dade, where our Calder racetrack is located, from making their own decision on whether to allow slots at race tracks.

Finally, we will continue to prepare -- consistent with what I've just said -- prepare for a second countywide vote in the Miami-Dade county location on the issue of slots at race tracks.

With that in mind, having said all that, I will turn the call over to Mike Miller who will give you all the details associated with our 2005 performance.

Thank you, Tom, and good morning, everyone. I will briefly cover our results for the year as well as comment on our financial position for the into the year. And then as Tom reported, we will respond to any questions you may have.

First, turning to the balance sheet, there are some significant changes when compared to 2004, primarily as a result of the disposition of Hollywood Park last September. Our overall decrease in assets is attributable to the sale, offset by a $22 million increase in plant equipment as well as a $5 million increase in other current assets. The increase in fixed assets is largely a result of the completion of the Master Plan during the second quarter just prior to Derby last year.

Our ongoing capital expenditure program, with the exception of what may happen in New Orleans, would appear to be less than our anticipated depreciation and amortization expense of approximately $22 million. The change in other current assets is the result of an increase in the estimated receivable from our carriers for workers compensation and general liability plans, which also partially explains the increase in the accrued expense category.

The remainder of the $12 million increase in that category is attributable to liabilities recorded at the time of the Hollywood Park sale, representing our best estimate of the future potential cost we may incur, related to our portion of underfunding and certain multiemployer defined benefit plans in California.

With respect to the assets damaged by the hurricanes and the tornado we continued to believe that our insurance coverage will provide adequate protection, and that there will be no significant impairment incurred. We have received advances from our carriers and recovery efforts are well underway in all locations. We and all businesses are, however, paying the price for these disasters.

We recently renewed property and casualty coverages for the Company and, for the year, beginning this very month we will pay an additional $3 million in premiums in our combined deductibles for wind losses at Calder and Fair Grounds will increase by approximately 5 to $6 million. Others in the hospitality and gaming industry on the Gulf Coast are experiencing the same if not worse increases; but we certainly take no comfort in that fact.

At year end, our long-term debt outstanding to banks was only 15 million which reflects the result of applying the approximately $200 million of after-tax proceeds from the Hollywood Park sale to delever. We continue to maintain our $200 million bank revolver with very favorable terms and conditions; and thus our access to capital for growth activities is excellent.

The balance of our long-term debt was created in 2004 in connection with the convertible note issued in conjunction with a stock redemption.

For those of you who have followed us in the past, you know we're not afraid to lever the Company for the right growth opportunities, so long as we can perceive that these investments producing reasonable cash flow which in turn will be used to delever.

In the equity section pleased note the unearned stock compensation resulting or representing, rather, the unamortized proportion of restricted stock grants that were made in 2004 and 2005. Such grants are being amortized expense using the straight line method over the five-year [cliff] vesting period.

Shifting now to the income statement in the segment information, I would like to echo Tom's comments relative to how pleased we are with our accomplishments during 2005 particularly in light of the significant obstacles our employees faced. At Churchill Downs, the team performed beyond expectations as it opened the completely renovated facility for the first time, producing yet another record Oaks and Derby.

The Master Plan with its new venues and amenities outperformed the original estimates developed several years ago when this project was conceived. Likewise at Calder, Ellis Park and Fair Grounds, our employees more than rose to the occasion to overcome the problems created by the disasters. The result of all of these efforts was to produce a 13% increase to revenues for our continuing operations, largely influenced by the first full year inclusion of our Louisiana property.

Arlington Park experienced a decrease in revenues, primarily attributable to a loss of dark day monies resulting from an administrative proceeding with the Illinois Racing Board and is, therefore, not reflective of 2005 operations.

EBITDA growth for continued operations also experienced double-digit growth, in spite of the negative cash flow at Fair Grounds and the reductions at Arlington Park. We do expect a turnaround this year in New Orleans due to a very strong video poker business at our OTBs as well as strong pari-mutuel business. We have fewer OTBs open this time than we did last year but we are currently producing almost twice the EBITDA. Our pari-mutuel business is up 33% year-over-year and video poker revenues are nearly doubled.

We are presently working on a plan to open Fair Grounds for racing once we can establish that a work force will be in place and that a reasonable regional market exists for our product. We expect to make a final decision on this matter prior to April 15th.

I also want to call your attention to the new presentation of our segment data, particularly the allocation of corporate expenses which in turn mirrors the way in which operations are managed. We are allocating 80% of such expenses incurred by corporate departments to the operating units, based on their live pari-mutuel revenues or in the case of Louisiana, pari-mutuel revenues as well as video poker revenues.

This decision has been brought about by our focus on centralizing certain administrative functions to enhance overall operating efficiencies. We will continue to challenge this method from time to time to ensure this most clearly reflects our operations.

For 2005, $11.8 million of expenses were allocated to the operating units. I would refer you to the 2004 amounts prior to restatement to better understand the impact of this change.

On the face of the income statement the pre-tax line for continuing operations is flat from year to year. As is usually the case, there are several moving parts to this equation but I would want to point out some of the more significant components.

In 2004, we had $10.5 million of unusual charges resulting from an impairment loss, as well as a non-cash loss from the issuance of a derivative instrument. In 2005, our depreciation and amortization expense increased by $5.7 million, primarily as a result of the completed Master Plan. We also incurred 2.2 million in charges to reflect the new contract changes for the CEO as well as absorbing a $3 million EBITDA loss in New Orleans and approximately $1 million in severance-related costs related to staffing realignment.

I could ramble on with more items but I don't want to sound apologetic. We're very very pleased with our results and are excited about the prospects for the future and our current financial position. That having been said, we will always closely examine non- or underperforming assets and will continue to scrub our cost structure for expense reduction opportunities.

One final word related to EPS. What would appear to be a significant increase in EPS from $0.74 to $0.98 also requires some explanation. We experienced an anomaly with our effective tax rate in 2004 due to the nondeductibility of the derivative loss of a significant portion in the impairment loss and legislative expenses. We began a return to normalcy in 2005 with respect to our effective tax rate and expect this trend to continue for 2006.

Now I will turn the call back to the operator and we will address whatever questions you may have.

(OPERATOR INSTRUCTIONS) Tim Rice with Rice Volker.

My question relates to the Fair Grounds operation. You mentioned you'd make a decision by April 15th which I guess is the day you need to make a decision for the Commission as far as your racing days. If you were to opt not to run the meet what would the impact be on your OTB operations? Would you have to -- would you still be allowed to run those?

The OTB operations are dependent upon the underlying license you have for the live meet. And last year, we obtained a waiver of that requirement by displacing up to Shreveport and we have had a number of discussions with the Commission. We are both vectored towards the same target and that is ensuring that we do the right thing for racing in Louisiana. I don't think our OTB operations are in jeopardy at this point, even if we had to return to Shreveport to run the Fair Grounds meet.

Our objective though as we've stated to the Commission is to, as quickly as possible, return to New Orleans given the fact that there are a number of -- or notwithstanding the fact there are a number of contingencies including such things as market and employment base that we need down there to operate in that location.

Basic things such as water, electricity we still -- I'm not sure we are hoping to have electricity on. In fact it may be on by now. But there are a number of factors that we have to sort our way through to ensure that when we do reopen that we can run the best possible meet.

Great. I certainly hope that's sooner rather than later.

So do we. We are very encouraged by the level of business at the OTBs. As Mike indicated, we are down to about seven OTBs I believe it is right now and they are performing far in excess of what they were performing prior to the hurricane.

There's a lot of people hungry for live racing down there.

Right.

The other question was relating to Calder. What -- can you talk a little bit about your progress in restoring that property in the wake of its hurricane damage?

It's fully restored with exception of a couple of barns that we still have to reroof; and we are hopefully going to have the new tote board and actually a much improved tote board installed down there. Andy, when is that going to be (MULTIPLE SPEAKERS)

Shortly after the meet begins.

Tim, the damage there was largely in the barn area particularly roofs in the barn area. There wasn't a tremendous amount of damage on the front side other than the loss of the tote board. We started repairing those barns, probably a day or two after the storm. And it's just about completed. And we lost very little business. We had other accommodations for horsemen, for barn areas. But just about have it back to where it needs to be.

Thanks very much.

Ryan Worst with Brean Murray.

Thank you very much. Mike, you guys really didn't mention too much about the fourth quarter specifically. And it looks like costs increased quite a bit during the quarter. Could you shed some light if there is any kind of one-time in nature costs associated with cleanups and the cost to get things back up and running at the facilities impacted by the natural disasters? And then I have a couple of other follow-up questions.

Most of those cleanup costs we believe are covered by insurance, Ryan. So that shouldn't be the reason for any increase. We did have a couple of unusual items that -- we had a $2.2 million adjustment for the [CERF] for the CEO related against some contract changes. We had about $1 million incurred for severance-related costs in that quarter as well. So those are some big drivers of cost for the quarter.

Mike where would those items show up on the EBITDA breakout between facilities?

Well, there would be some in corporate and some spread to the facilities, to the operating units as I talked about with our approach now spreading corporate cost to the units. They would be spread, really, throughout all of them, Ryan, including corporate.

So there is approximately I guess 3.2 million in one-time (indiscernible) costs associated with what you mentioned?

That's what comes to mind. There are probably some others but they weren't (MULTIPLE SPEAKERS)

And then the $3 million loss in New Orleans at the Fair Grounds? Was that a function of just lower business volumes? It sounds like business volumes have done pretty well. Or is that kind of -- what's the reason behind such a significant loss there?

You need a little bit of history there. As you recall when we bought that property in October of 2004, it had been losing a significant amount of money. So we ran the first live meet there beginning November of 2004 and ran a very successful live meet. But by the same token we had not even anticipated turning that operation fully around in 2005.

So the amount of loss for the year, $3 million, was not unanticipated but it was exacerbated by, obviously, the storm. We are very encouraged by the OTB operations but that having been said from August 28th, the day of the storm until sometime in October, we had no business there. And then the OTBs got back up and running the latter part of October.

But that was scaled, it was slow. They didn't all just come back online.

Yes we opened them as we were able, and we still don't have all of them reopened. With respect to the live meet, our arrangement with Louisiana Downs, the lease if you would as such, was that we would keep the export pari-mutuel revenues. But just about the balance of anything related to the live meets and (technical difficulties) benefited Louisiana Downs. So actually I am very pleased the loss didn't exceed that.

Tom, could you talk about where you are in the process of the RP? I thought that a decision was going to be made in the near future. Is that still the case? Or has that been pushed out a little bit? And then if you could touch upon this announcement yesterday by Magna Entertainment to export North American Racing Singles to the UK through [Lab Roakes]. Are you guys participating in that? And then if you could maybe be a little more specific on the options available to you as far as pursuing your objectives for account wagering?

Let me go back. What was the first one? The first one -- the tote. The tote or our RFP process is fully engaged. There's some discussions going on right now and I would, among the participants in the RFP process as well as the number of tote providers. I would think that within the coming month, we should have some clarity that we can deliver to the market on what is going to happen on that front. I continue to say, not only from the standpoint of a more efficient system but the transactional part of our business needs to be fixed and I'm not suggesting there's any gross lack of integrity in the system.

But as you well know we are not processing bets as quickly as we should. We have odds that are coming up a minute to two minutes past the running of the race. So it's a strategic imperative from that standpoint. But more important it's also a strategic imperatives that we develop a transactional platform that has an open architecture on the front end, so that we can start hooking on these new technologies as they come available, be they TDAs, self-serve machines. You name it.

And I think that process and the architecture that was described in the RFP will be something a little nearer the benefit of the entire industry.

The second question relates to Magna. Yes.

Their agreement with Lab Roakes.

Yes, I'm not -- I can't comment on the Lab Roakes thing, but we have been under the guise of Racing World, been working with Magna for the last several months. And we are encouraged by what we see as an opportunity in moving into the UK and Ireland under the guise of Racing World. That's about all I can say about that.

Finally the account wagering strategy for the Company. As you know, we made the decision in fact ODS -- which was the precursor of the TBG platform -- that came out of our Company. We, together with the ODS folks, developed the original platform and ultimately it was bought by TBG or Genstar. And we were one of the original signatories of the Founders Agreement which committed us for a term of years to use TBG as our exclusive distributor and production and account-wagering operator. And those contracts while they go over a period of about 13 months -- the first of which comes up in March of '07.

In terms of where we might be going I can't really speak specifically. But we are looking at a myriad of opportunities that are available to us. The objectives that I set forth in the opening comments are the objectives that will guide our decision-making processes. We determine how best to develop not only for our Company but for the industry at-large. A coherent, customer-friendly account wagering platform.

My questions, which I've asked our folks as well as the industry at-large, my questions really center on the customer. Why does a customer have to have three, four, five accounts? Why can't the customer choose what he sees and where he wants to bet? Why do we provide barriers to our customers in terms of wagering on events that they want or races that they want to wager on? So those are going to be baseline criteria that we will use in making a decision not only for our Company but, hopefully, a decision in order to benefit the larger industry.

(OPERATOR INSTRUCTIONS) Jen Gandy with Cavelli and Company.

I was just wondering if you could possibly break out your revenues and EBITDA for the Video Poker operations?

No. We've chosen to not do that at this point in time. So no, we will not do that as we speak.

Okay and just any -- regarding the gaming legislation in Florida I was wondering when do you anticipate if there is going to be a vote in Miami-Dade County, when do you anticipate that happening?

We would hope in 2007 or early 2008. It depends upon various issues down there attending elections.

Would that be in later 2007?

Say again.

Would that be in later of 2007?

Yes. Probably the latter part of 2007. Early part of 2008.

What about Kentucky? Do you have any clarity on that?

Nothing other than what has been reported widely across the press. There is a bill that may or may not get out of Committee today that would allow for a statewide referendum on the issues of slots at race tracks. And I think as we move down the road next couple of weeks we will have much more clarity on that. I think the important thing in Kentucky is the fact that we have for the first time been able to achieve a consensus among all of the constituents involved in racing be they horsemen, jockeys, track operators, racing commission, a myriad of folks that have a vested interest in this industry. And there is a concerted effort that has been achieved, or a consensus I should say, and that is very encouraging.

And any plans for a share buyback or anything like that?

Not at this time. No.

If there were, I don't think we would announce it here.

Ryan Worst. Brean Murray.

Mike could you just go over again what you said about the increase in insurance cost? I didn't quite catch all the numbers.

The year begins March 1, our insurance here does. Our renewals other than for property were generally flat or slightly down. Slightly down will be as a result of no longer having Hollywood in our family but our premiums for property coverage will increase, beginning in March on about a $3 million run rate annually. And in addition, our retentions or our deductibles, if you would, for wind damage at Calder and Fair Grounds increased dramatically, somewhere in the nature of probably 5 to $6 million more exposure for the Company, as a result of not only the losses that we sustained but that these carriers sustained in general in the Gulf region.

Could you just touch upon Arlington Park? If you look at the EBITDA breakout it looks like you lost almost $2 million more than last year in the fourth quarter. And I was wondering what drove that decline?

The dark time money would have been in the fourth quarter.

Right it's just the EBITDA in the fourth quarter went from a loss of 2.7 million last year to 4.5 million this year.

There was some soft business in the fourth quarter. We also had some expenses in the fourth quarter, related to severance cost and insurance cost. And actually there's probably a list of about 10 things not any one of which is significant. But they all added up.

Thanks.

There are no further questions at this time.

Again thank you for joining us this morning. I will tell you parenthetically last year in the fourth quarter I looked forward to this column and I somewhat dreaded it in light of all of the casualties that we were suffering. And with the events that culminated at Ellis Park, it was a fairly bleak time within the Company.

I am pleased, though, to be with you this morning and I am more pleased with the fact that I was able to report that the Company, despite all of these challenges that we faced in 2005, performed exceptionally well by any measurement. I'm even more pleased by what I was discussing with you this morning in terms of the opportunities that are available to the industry not only for our Company but in terms of transforming the industry and getting it on a growth path that is significant -- that will be significant for all of us.

So as we move forward, I look forward to the next call that we will have to discuss these things and at that time be able to report hopefully on equally exciting news and good performance. So thanks again for joining us this morning.

Once again, that does conclude today's conference call. We appreciate your participation and you may now disconnect.