Churchill Downs Inc (CHDN) 2006 Q3 法說會逐字稿

Good day everyone and welcome to the Churchill Downs Incorporated third quarter earnings conference call. Today's call is being recorded. [OPERATOR INSTRUCTIONS]

At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Communications and Investor Relations, Ms. Julie Koenig. Please go ahead, ma'am.

Thank you and good morning. Welcome to this Churchill Downs conference call to review the Company's results for the third quarter and first nine months of 2006. 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 the section of the Company's website, titled Company News, located at churchilldownsincorporated.com. Let me also note that a news release was issued advising of the accessibility of this conference call on a listen-only basis via phone and 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 are otherwise not statements of historical fact. The actual performance of the Company may differ materially from what is projected in such forward-looking 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 as of this date only, and Churchill Downs Incorporated expressly disclaims any obligation to release publicly any updates or revisions to these forward-looking statements to reflect any changes and expectations.

I will now turn the call over to Bob Evans, President and Chief Executive Officer.

Thanks, Julie. Good morning, everyone. I'd like to welcome you to today's conference call. Thanks for joining us. We're planning an event for investors in the early part of next year at which -- on our strategy for growing the business, and I look forward to meeting many of you in person then. As has been the case in our previous quarterly conference calls, I'll give you some highlights of the quarter and discuss some of our near-term priorities. And then our CFO, Mike Miller, will take you through the specifics of our financial performance. Following that, we'll try to answer any questions you might have.

I joined CDI in mid August. In the last three months I've spent a lot of time getting to know the team, our industry partners and the issues we need to address to promote future growth and profitability. Perhaps the most important thing I can tell you at this point is that I believe there are ways to profitably grow this business. However, we're going to have to think differently about what we do. Let me give you three examples. First, we need to use technology to engage our existing and new customers differently than we have in the past. Think about how you personally today use technology to choose and use the travel, financial services, healthcare, and media and entertainment products and services, to name but a few that you buy. I can guarantee you that the Generation X and Y consumers that hold the most potential to create growth in the racing business use technology in nearly every facet of their daily economic lives. And we need to use technology to introduce our products into the way they live, not require them to modify the way they live in order to enjoy our products.

Second, we need to reinvent the existing products we sell. Every racing day in the United States, there are about 300 horse races presented in the simulcast and internet wagering markets that now account for roughly 90% of all money wagered. During the core afternoon period, there is roughly one race per minute. How can we reinvent the 20 to 30 of those 300 races that occur at Churchill Downs Incorporated tracks so they are the winners in this highly competitive market space? Now you're probably thinking that there's not much new about a horse race, but I'd ask you how cleverly poker, blackjack, and even ballroom dancing have been reinvented in their TV, online and in person forms such that they each now have over 30 million fans.

Third, we need new products. Obviously, alternative gaming, slots, and video poker machines are one such opportunity. But there are others, as well. If you think of us as being in the entertainment industry rather than the horse racing business, then a host of new product ideas begin to emerge. Technology will be increasingly important to all that we do. We have hired a terrific individual to lead our technology initiatives, and we are building a core technology team in Silicon Valley, California. Why Silicon Valley? Because that's where we can build a team of people on the cutting edge of technology innovation, and because we will benefit from the perspective of those outside the traditional racing business. As I said earlier, we will be meeting with you early next year to fill you in on the details of this strategy.

Now, as for our Q3 results, I'm pleased with the revenue growth we enjoyed last quarter, up 4.6% year over year. I'm not pleased with our overall cost structure, and we have already begun working on that. We remain encouraged by the performance of our Louisiana operations. Our simulcast and video poker business continues to outperform pre-hurricane levels and netted $7.6 million of top line growth year over year. We tried something new at Calder Race Course this quarter that produced positive results. From July 31 to August 27, we conducted live racing on only three days a week, Fridays, Saturdays, and Sundays, rather than the traditional five days per week, in an attempt to increase field sizes, handle and purses. We met all three goals during the test period, with average field sizes reaching 9.0 horses. By offering bigger fields, we increased overall wagering on our simulcast signal, both in state and at simulcast outlets around the country during that period. Our August gains helped boost Calder's meet and daily averages for inter-track and interstate wagers. We are pleased with the initial results from this shortened mid-summer schedule, and we are looking at ways to duplicate and hopefully improve upon our 2006 results next year.

Churchill Downs had a truly unique opportunity to host the Rolling Stones in concert in September. We cannot disclose the financial terms per our agreement with the concert promoter, but the event positively impacted our results for the quarter and for the first nine months of the year. And more importantly, it gave us an opportunity to introduce a new kind of customer to Churchill Downs and created yet another historic moment under the twin spires. During the quarter, we reached an agreement to sell Ellis Park to Kentucky businessman Ron Geary, and in doing so, have found a great owner-operator for Ellis, which was no longer a core strategic asset for us. We closed the sale on September 29. Through the agreement, we retained the Ellis signal for our Churchill Downs Simulcast Network.

In an otherwise positive quarter, Arlington Park struggled. During the middle part of the Arlington May to September meet, we experienced a high level of injuries to horses racing at Arlington Park. We believe the unusual number of on-track injuries affected trainers' decisions to race their horses at Arlington, which in turn negatively impacted field size. The break downs received a lot of media attention, as well, and we believe the combination of lower field sizes and negative publicity contributed to the significantly lower attendance and wagering for the meet. Now, while no one cause has been determined for the higher number of injuries, experts have ruled out the racing surface itself as a contributing factor. In fact, three separate analyses of the track surface were conducted by outside consulting firms and independent experts, and the studies found no causal factors linking the condition of the track surface to the injuries. We are committed to ensuring the safety of the racing surface on an ongoing basis and for the 2007 meet, which begins next may. And we are looking at a number of initiatives we believe will improve the performance of our Arlington Park next year.

And finally a bit of recent news. As I'm sure most of you know, Churchill Downs hosted the Breeder's Cup World Championships this past weekend, the sixth time Churchill Downs has hosted this prestigious event and the first time since the recent renovation of our facility. I'm happy to report that we set Breeder's Cup records for on-track, off-track and all sources wagering, and we had the third highest attendance in Breeder's Cup history. The five highest Breeder's Cup attendance levels were all achieved here at Churchill Downs. In a couple of weeks we'll be reopening Fair Grounds Race Course on Thanksgiving day, its traditional opening. Our team there has done an unbelievable job of recovering from the extensive damage caused by Hurricane Katrina. To give you a sense about how eager New Orleans is to have racing back, we sold out of reserved seating for our Thanksgiving Day opener within an hour of opening our phone lines to take reservations. And on the day the track reopened for training, November 2, that story made front page news. Once Fair Grounds has reopened, we will switch our focus in Louisiana to creating a slot machine gaming facility, and on determining the best time and way to introduce alternative gaming at the track.

Now, let me turn things over to Mike, who will take you through the numbers, and then we will try to respond to your questions. Mike?

Thanks, Bob, and good morning, everyone. I will briefly go over the financial statements for the quarter and then, as Bob stated, we'll entertain your questions. I plan only to address the quarter's results, but can take any questions you may have about the year-to-date results during the Q&A session.

Let's begin by first reviewing the segment information. As Bob stated, revenues from continuing operations increased approximately 4.6%, thanks to strong performances at Churchill and in Louisiana. At Churchill, we benefited from the Stones concert, as well as an additional week of racing during the quarter that had previously been run at Ellis Park. In 2007, this week we'll return to Ellis, as part of the agreement to sell that unit. The decline in revenues at Arlington were both at the pari-mutuel line as well as in ancillary from admissions, food and beverage, parking, et cetera, which all appear to be related to the quality of our racing product. We are well into our planning cycle for 2007, and will address the operating issues, including field sizes, as well as our overall approach to marketing, with a view to recapturing the patrons and handle loss during its meet.

As Bob stated, I'm also pleased to state the business continues to be brisk in Louisiana, both on the pari-mutuel level, as well as the video poker side. During the quarter we deployed more new video poker machines, consistent with our strategy when we acquired the Fair Grounds. And our complement of machines is now comprised of approximately 75% new technology, compared with an average age of between eight and ten years for the machines which we inherited at the time of acquisition. We are also now determining the best way to get our 700 machine slot operation up and running.

At the EBITDA line, performance for all units except Arlington and Calder closely tracked to revenue trends. At Arlington, the decline in EBITDA exceeded the revenue variance, primarily as a result of purse payments during the quarter exceeding the purses generated from the wagering handle. As we have discussed on previous occasions, these overpayments can be carried forward to future periods and recovered by way of purse reductions. We will be planning our racing program for 2007 to allow us to recover as much of this overpayment as possible, but it may require more than the 2007 racing season to get fully caught up. At Calder we enjoyed a $1.8 million insurance recovery gain, which accounts for their EBITDA increase.

Turning now to the statement of net earnings, the EBITDA from continuing operations generally reconciles to operating income after including the $5.1 million charge for the quarter for depreciation and amortization. Below the operating income level, we actually had a slight increase in interest expense as a result of virtually all of our interest expense in 2005 being allocated to discontinued operations. The turn-around in the miscellaneous category is due to both option income and minority interest income in 2005, both related to our ownership in Hoosier Park. Our affected income tax rate is approximately 5% over the prior year due to a change in the estimate of our reserve for prior year's taxes. Going forward, we would expect our rate to more closely approximate that for the third quarter of 2005. As a reminder, the discontinued operations category includes the impact of both the operating results, as well as the sale of both Hollywood Park in 2005, and Ellis Park in 2005 and 2006. Our overall fully diluted EPS for continuing operations declined from $0.23 to $0.20, due primarily to the poor operating performance at Arlington. It will likely be early in 2007 before we are able to fully address the pertinent issues there, with a view to returning its performance to historic levels.

Now, turning attention to the balance sheet, as is often the case, the fluctuations in our working capital accounts are largely a function of the timing of settlements related to our live race meets. In addition, restricted cash increased as a result of the purses being generated in Louisiana, which will be disbursed during the upcoming live meet beginning on Thanksgiving Day. Much of the increase in other current assets is due to significantly higher pre-paid insurance premiums, as a result of March renewal of our property and casualty coverages at a much higher cost. On the insurance front, we have nearly finalized our negotiations with our carriers relative to the property damage portion of our hurricane and tornado losses. We have also submitted our business interruption claim and are looking forward to settling that piece, as well. Hopefully by early 2007. The decrease in dividends payable reflects the payment in January, and the decrease in deferred revenue results from the recognition of derby-related revenues during the second quarter.

At September 30, 2006, there were no outstandings under our $200 million revolver. The balance of our long-term debt represents the convertible note issued in 2004 in connection with a share repurchase and approximately $5 million due to our partner in Hoosier Park, as a result of a participation agreement in Hoosier's debt. Finally, as stated in prior calls, the unearned compensation charge of $3 million has been moved and is now included with common stock, in accordance with the relevant accounting literature. In summary, we enjoyed yet another strong operating quarter and we continue to benefit from the diversification that the Fair Grounds acquisition has afforded. Additionally, our balance sheet provides us with access to affordable capital as we look forward to positioning the Company for growth under Bob's leadership.

That concludes my remarks. I will now turn it back over to the operator for your questions.

[OPERATOR INSTRUCTIONS] We will take the first question from Ryan Worst with Brean Murray.

Thanks. Good morning.

Ryan.

Just a couple of questions. One, Mike, do you have any details on your insurance claims, and what you expect in proceeds and what you have received so far?

I think we stated in the past and I've got Mike Anderson here with me -- as to the total amount that we've received to date, and it's included in the Q. Let's see, I'm looking at it as we speak. Where's the total, Mike? We've recorded actual gains, a total of almost $13 million. And then total proceeds, we received is what, Mike? Do you have that? Is that in there? $18 million? $18 million in New Orleans, $4 million in Florida and $8 million for Ellis Park.

Okay. And what about outstanding claims yet to be recovered?

We're not in a position to disclose that right now. We have submitted our business interruption claim and we're just at the beginnings of the negotiation process on that.

Okay. And then Bob, you spoke a little bit about alternative gaming in New Orleans at the Fair Grounds. When do you think that could be up and running? And kind of wha -- what's the issues there?

Well, the issue is primarily New Orleans and the devastation that's occurred and when will the sufficient population be back to take advantage of, you know, anything we might do. So we're looking at that pretty closely. We're looking at a couple of different alternatives and how we might build out the existing facility, or new facility, to support the slot machines. And we'll probably make a decision on that over the next couple of months. And I would expect, you know, within a year or so after that, maybe less, we'll be in business.

Do you think that there is a market there now that could support some level of slot machines?

Do I think that? Yes. Do I have any data yet that confirms it? No.

Okay. And then what about in Florida? Any thought to when you guys could -- or when you will hold a local vote there for Dade County?

It would be possible to do in 2007, but there's no other local elections scheduled for that time frame, so we're still trying to figure out whether it would make sense to do in '07 or a later year.

There is no note in November in '07?

Not at the moment.

Oh, okay. Okay. And then also regarding technology, it seems like you guys are building an infrastructure. I mean, what are your options there? Are you still looking at, you know, potentially acquiring something? Or is it just going to be that you're going to build up your own account wagering platform?

Well, we're not -- we don't have an acquisition program active where we're out trying to find a particular target to buy. Opportunistically, if we encounter something, we'll consider it. I would like to put off any discussion on what we're going to do specifically in the technology area until shortly after the first of the year. But I can say that we are considering every possible alternative that I've heard mentioned around the Company, plus a few more. So I think we have a pretty aggressive plan. Just for competitive reasons, I don't want to tip off everybody else what we're doing for a while, so give me a couple of months here and then we will be glad to get back with everybody and share our full strategy.

Well, what are you building actually in Silicon Valley? I guess without specifics on the objective, but what about cost-wise, and you know, how big your operation is there?

A small team of six or eight to begin with. And then once we've figured out exactly what we're going to, do that may get larger if we build it ourselves, or outsource it, or acquire something. But we haven't made any of those decisions yet.

Okay. Great. Thank you.

You're welcome.

We will now move to a question from Tim Rice with Rice Voelker.

Good morning. I'm a little confused with your hesitancy with the Fair Grounds slot facility ,given the fact that the Harrah's Land-Based Casino here continues to report record win at their operation. And if you see sufficient demand to operate a race meet, I'm just confused as to why you wouldn't think that that would justify accelerating the slot facility?

Well, Tim, you know, I answered the question earlier, do I think there is demand, yes, I do. Do I have any confirming data at this point? No, I don't. And there's still a question as to the -- sort of the construction process. Do we do a stand-alone facility, do we use the existing facility in some capacity? So we've got some architects working on that. And as I said, we'll make a decision here in a very short period of time.

But you don't think that Harrah's Casino, having record handle ten minutes away is confirming data?

I told you, I think there is demand. I also said I don't have any confirming data. And even if I did, we still have some architectural and construction questions that we have to resolve.

Okay.

I have this interest of being in the slot business in New Orleans ASAP.

Okay. And one other quick question. What is your view about converting the surface at Churchill to poly track?

Well, with the Breeder's Cup here last weekend, I've probably been asked this question somewhere in the neighborhood of 10,000 times at this point, and I could give you a 20-minute answer. I will give you a one-minute answer, which is, all of the initial evidence suggests it's a very positive thing to do. But my father, who worked for Monsanto Chemical, was involved with astro turf was introduced in 1965. And here we are 41 years later still debating whether natural grass or artificial turf is best for baseball, football, et cetera. So while I think that's the direction the industry is going to go, and I think you will probably see us do it at at least one track to sort of get our feet wet, I don't think the final jury has returned on just what the right answer is here. And you know, my guess is, 40 years from now, we'll still be debating this issue within the horse racing business. But all of the early evidence at Turfway, Keeneland, Woodbine, is very positive and I think you will see us and the rest of the industry move in that direction in an orderly manner.

Great. Thanks very much.

You're welcome.

We will now move to our next question, and that will come from [Jenn Gonsey] with Gabelli and Company.

Hi. Just a few more quick questions on the Fair Grounds. I was just wondering, you were talking about possibly doing it. Do you have any idea of, you know, what sort of margins or tax rates would be for the machines, once you got them?

Well, the tax rates are -- they're statutory. And I don't have them from the tip of my finger here what they are, but that's something that could be readily determined. Margins is not something that we're ready to talk about at this juncture.

Okay. And just for clarification, how many video poker machines does you have now and how many do you see yourself having in the long term?

The video poker machines, it's approximately 700 today. We will continually explore the possibility of, you know, expanding that, but right now, that's about the complement. That's down from what we acquired at the time of acquisition, because we have a couple of OTB's that were destroyed in the hurricane, which still haven't returned to service yet.

And how many more machines would be when those return?

Well, we're still trying to make a determination if and where they will return, so not ready to give you a number there on that one.

Okay. Thanks.

Moving now to a question from [Steve Altonbrando] from Sidoti and Company.

Thank you. With the sale of Ellis, should we consider the depreciation in the quarter as a run rate going forward?

Let's see if I can answer that. Yes, I think that's a fair statement. Given our level of CapEx spend and the fact that Ellis is included in discontinued, I think that should closely approximate the run rate, yes.

Can you give us any specifics in terms of how you're going to try to turn Arlington around, whether it be on the cost side, or plans to drive revenue?

No, we're early in that process, and that's going to be unfolding over the next weeks and short months, if you would, so we can be ready for the May opening, but no specifics at this time.

Okay. Were there any one-time expenses in Louisiana in the quarter? I'm still a little bit confused. It looks like sequentially, video poker revenue was roughly the same, yet margin was down pretty significantly. I realize that pari-mutuel wagering was down, but that is typically a lower margin business.

We are learning about the market in Louisiana and it goes -- both pari-mutuel and poker go through highs and lows very predictably down there. In the summer months, the revenues slow down for both pari-mutuel and poker. And also, in the previous quarter, in the second quarter, we enjoyed the Jazz Fest, which is a very high margin product that maybe skewed the results for the second quarter. I was trying to look at the third quarter.

Okay, thanks. Can you just remind me quickly is it the buildout period for the slots probably will be roughly a year after you decide?

Well, it depends on how we ultimately choose to do it. Whether it's a stand-alone or whether we retrofit interior space, or et cetera. So I don't have a specific buildout period yet.

Okay. Thank you very much.

[OPERATOR INSTRUCTIONS] [inaudible] there is no further questions, I'll turn the call back over to you for closing remarks.

Listen, everybody, thanks for joining us today. As I said, we're going to host an event in the early part of next year for investors, and I look forward to meeting as many of you as possible in person then. Thanks very much.

That does conclude your conference for today. We do thank you for your participation. Everyone have a wonderful day.