Churchill Downs Incorporated (CHDN) Q2 2010 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to Churchill Downs Incorporated second quarter results conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ms. Liz Harris. Ma'am, you may begin.

Good morning and welcome to this Churchill Downs Incorporated conference call to review the company’s results for the second quarter of 2010. The results were released yesterday afternoon in a news release that has been covered by the financial media. A copy of the release announcing results, as well as 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 Investors 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 otherwise are not statements of historical fact. The actual performance of the company might 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 operation 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 in expectations. Members of our executive team are here and will be available to answer questions after some formal remarks. We will begin now with our President and Chief Executive Officer, Bob Evans. Bob?

Thanks, Liz. Good morning, everyone. Thanks for joining us. I'll make a few general comments about Q2 and then turn it over to our CFO, Bill Mudd, to fill you in on the details. After that, we will be happy to try to answer your questions. Q2 net revenues were up 11% over last year. EBITDA was up $700,000 or 1%. But I had observed that last year included the positive effects of $0.8 million in pari-mutuel tax refunds and a $0.7 million recovery related to the now closed Bay Meadows racetrack in California. And that this year included $4 million in negative effects from deal costs, software asset write-downs, and severance costs, all related to the closing of the Youbet.com deal, which occurred on June 2nd. This was the second highest quarterly EBITDA the company has reported. The highest was $62.9 million in the second quarter of 2006, although that included $10.1 million in hurricane insurance recoveries. Let's take a quick look at each business segment. Racing's second quarter EBITDA was up $0.9 million; Kentucky Oaks and Derby Week was up $3.4 million and established a new EBITDA record for the Week. The rest of our racing operations were down in Q2, consistent with the 6% decline in U.S. thoroughbred racing industry handle and a 5% reduction in the number of CDI race days in Q2 from 118 to 112. Gaming EBITDA was up $1.9 million in the quarter. The Calder Casino obviously increased since it only opened on January 22nd of this year. Our Fair Grounds Slots and video poker businesses were essentially flat. Performance of the Calder Casino continues to improve, both slots and poker were profitable in the quarter on an EBITDA basis, total gross gaming revenue or GGR exceeded $21 million. Since last fall, we…

Thanks, Bob and good morning, everyone. As usual, I will review the information set forth in the tables of the press release. My comments will focus on our performance from continuing operations for the three months ended June 30th. I am going to start with a summary of the second quarter results from the schedule titled Condensed Consolidated Statements of Net Earnings for the three months ended June 30th. For the quarter, we had continuing net revenues from external customers of $200.5 million, which were up 11% or $20.5 million for the period. All business segments experienced revenue growth in the quarter with the exception of Racing operations, which declined 2%. Our second quarter 2010 revenue growth includes Calder Casino revenues of $12.8 million and one month of Youbet.com, ADW, and United Tote operations, which contributed $8.8 million. Unfortunately, operating expenses growth – grew at 17%, outpaced revenue growth in the period. This increase includes the $4.5 million increase in depreciation and amortization, $3.6 million of that is related to the new Calder Casino, while $900,000 is related to the Youbet.com acquisition. We also recognized a $1.3 million asset impairment in our online segment related to the reassessment of the use of certain software in connection with the acquisition. SG&A expenses were up 33% or roughly $4 million. the biggest part of this increase is driven by transaction costs associated with Youbet – the Youbet acquisition of $2.1 million. These transaction costs include expenses for legal support and investment bank consulting NOI. The good news is we do not expect to incur anymore transaction costs related to that deal. The one month of Youbet.com operations added $1.4 million of costs; approximately $400,000 of this related to restructuring after the merger. We do expect to incur more restructuring charges as we…

Thanks, Bill. Saeed [ph] do we have any questions?

(Operator Instructions). First question comes from Ryan Worst from Brean Murray. Ryan Worst – Brean Murray: Hi, good morning, guys.

Hi, Ryan.

Good morning, Ryan. Ryan Worst – Brean Murray: Yes. Just a few questions. One, on that software write-off, was that included in your $4 million of expenses attributable to the Youbet transaction (Multiple Speakers) on top of that?

Yes. Correct. To make that real transparent, $2.1 million of that was the legal fees associated and investment bank fees associated with the transaction. And those costs, because the question will come up, were part of corporate, which largely gets allocated out to the segment. So of that $2.1 million, $1.2 million of that was in racing; $0.3 million of that was in online; $0.2 million of that was in gaming; and $0.4 million of that was in corporate. So that's how the $2.1 million affected the segment. In addition to that, that $1.3 million write-off is in the $4 million and that's completely included in the online segment. And there is $400,000 of restructuring charges that's also included in the online segment. Ryan Worst – Brean Murray: Okay. And Bill, what did you guys have as far as the stock comp in the quarter?

Stock comp in the quarter – let me see here, I got it. Just give me a quick second to work for. $700,000. Ryan Worst – Brean Murray: Okay. And then also, Bill, could you just upon what CapEx was in the quarter and what you expect for the year? And then also, how the acquisition of United Tote impacts your CapEx projections going forward? So how much will you be spending on United Tote annually?

Yes, that's a great question. Year-to-date, we spent about $52 million in capital. And I think through the first quarter, we spent about $89 million. So what is that – about $33 million; $24 million of that was related to the Arlington land purchase which really occurred last year, so excluding that, about $9 million. And of that $9 million, it looks like about $4 million of that was related to the Calder slot facility. Ryan Worst – Brean Murray: Okay, great.

With regard to the United Tote capital spend, we are actually in the middle of going through and reviewing our – how we are going to run that business. Clearly it's been capital star for a few years. But the return on capital in that business is very low as it stands today. So being very selective about how we go about doing that. And right now, we are probably not quite as prepared as I would like to be to answer that question, Ryan. Ryan Worst – Brean Murray: Okay. But there is other options in terms of financing those deals, like providing vendor financing, I guess (Multiple Speakers)?

Yes, I mean – largely, the capital in that business and this is why I am hesitant to talk to that is, as you know, there is two ways you can do that. One, we can provide the capital and build for the capital and build a capital charge; or we can have the customers buy that capital. So I am not exactly sure how that business model works within United Tote for all the different customers. We are going through all the customers now, understanding where the capital is deployed and then how we are going to do that going forward for our business. Ryan Worst – Brean Murray: Okay. And then also, on the divestiture of the JV with Magna Entertainment, Horse Racing TV, when did that occur? Did that impact the second quarter or what was the loss for that last year?

Well, first of all, we are still 50-50 partners in HRTV, we have not exited that joint venture. The only joint venture that was – actually was TrackNet Media in the second quarter. And TrackNet Media really consisted, there wasn't any assets, there was a small lease that actually we were going to pick up because we can use the space. Other than that it was employee-related expenses and those costs were taken in the second quarter. And that – when I say employee-related expenses, it was restructuring because some of those employees were terminated as part of dissolving that joint venture. Ryan Worst – Brean Murray: So where were those restructuring included on the income statement?

Well, it's not a very material number first of all. It's actually very small, it was only three or four people. Ryan Worst – Brean Murray: Okay, that's fine. And then the funds that you guys are supposed to get back from Illinois Horse Racing Fund, is that still in escrow and when would you expect to receive that and how much?

Yes. Well, first of all, it is still in escrow. And when we expect to receive is a good question. Kind of like getting slots in Illinois. If you can handicap – I would love to hear it. So the bottom line is, as you know, it went through the U.S. Supreme Court. They refused to hear it. The Illinois Supreme Court, prior for it going to U.S. Supreme Court, had ruled in our favor. It went back to the state courts and there were other lawsuits filed by the casinos of Illinois. And basically it's in the judge's hand. So we are kind of waiting for that decision. When that happens – and if there is another angle that they take to delay us being able to take those funds, who knows, but what's out there today is we got about $36.5 million sitting on the balance sheet, it's all sitting in that deferred Illinois revenue subsidy on the liability line. The asset line is sitting in restricted cash. So that's where the two offsets are. And if you look at what portion of that CDI is about $15.5 million of CDI is about $21 million would go to purses in Illinois. Ryan Worst – Brean Murray: Okay. Thanks. And then maybe Bob, you could kind of talk about the trends that you are seeing in the concert business? Obviously, it sounds like there was a big falloff in ticket sales this year. And doesn't that make you more hesitant to enter that business, given that the trends seem to be declining? And if there is specific measures on how you could reduce that loss over the near term, that would be – also be helpful.

All right. Well, the trend has been up on music concerts, live music concerts and festivals over the last decade. Just the current year is turning out to be a tough year for everybody. The headlines on the music industry publications are things like cruel summer. So, the trend has been up for a long period of time, just a tough year. We will think a little bit more about what that means. But we will go back and sort of rework our thinking around this entire event, similar to what we did with night racing. We learned a lot. The number one goal in getting through this year was to do something memorable so that we would establish the brand. I think we ended up selling tickets in 47 states. We wanted to get outside of just the Louisville and Kentucky area and bring people in from across the country. We were successful in doing that. We had no idea how many same day or walk-up column what you want to say else, we would have. Based upon what other events had their experience, there was a significant number there that we thought was reasonable to expect. I think we just got slammed by the heat, the walk-up or same day business was just nonexistent or virtually nonexistent. So we basically built a show that was bigger than the number of people that showed up. We can make some adjustments to that next year. We found out what types of acts work better than other types of acts. So we learned a lot, but we ramp this thing and if – if we can't figure out a way to make this a significant EBITDA contributor, well, we are – I don't know if you can hear it on the phone, we got a heck of a thunderstorm going on here. If we can't figure out a way to make it a significant EBITDA contributor over time, we will stop doing it, just the way we stopped some of the things that we have initiated. And the ones that work, we keep investing and trying to grow. Ryan Worst – Brean Murray: Okay, that sounds reasonable. And then could you just touch upon the incremental savings for Youbet, where you achieved that or where you think you will achieve that? And then maybe if you have a chance to talk about revenue synergies there, is that a potential in – over the next year or so?

Well, let me give you a couple of high-level thoughts and then Bill can give you the details on where the cost synergies are being realized at least at a macro level. What we focused on – we have owned the business for two months. So what we focused on is getting to the cost synergies that we thought were there and we are running significantly ahead of our plan. Therefore we have changed our target from $10 million to $12 million on an annualized ongoing basis. So that's good. The piece that we are still sorting out is exactly how we are going to combine the two businesses in terms of how they go to market and I thought it was best to wait until after we concluded the acquisition and get the input of the Youbet people rather than try to do this just on our own. So that work is underway right now. We will figure that out over the next couple of months and then put it in place following that. So I don't really have an answer on the go-to-market side, but maybe Bill can give you a few more details on the cost synergy side.

Yes. Obviously, a lot of the cost, as we had described, when we purchased the company is employee related. So there has been several employee terminations as part – as soon as we closed on the transaction. On top of that, a whole lot of the public company expenses have been reduced. So whether it's director's fees or insurance cost or – a whole list of different things. On top of that, we have done a nice job of integrating the financial aspects of that business. So a lot of that has moved to Louisville. So a whole lot of employee type of costs, some costs associated with offices and the like. But in terms of your question on revenue, there is possibly some revenue type of costs, but it's probably going to be more related to the Tote business. So, obviously, a number of our platforms today are not on United Tote and that's something we will consider going forward. Not necessarily revenue for you guys, but I guess, more of a synergy between the two businesses. Ryan Worst – Brean Murray: Yes. How about on the marketing side, the synergies that could be possible there? I mean, I guess you are still marketing and promoting two different brands at this point. Is that eventually going to be one brand or at least do you foresee the marketing at least being combined under – maybe two banners, but half the advertising?

Ryan, we just – we haven’t made a final decision on that. I think it could still go either way. We might continue two brands; I kind of doubt it, but we might. More likely we will end up with one brand. Which one it is, can't actually tell you at this point. We are doing some research on that. I think the most important thing is from a customer experience, whatever it's called – it could be called Bob.com, I don't care. But whatever it's called, I don't want to change the customers' experience, how they log on, enter their passwords, PINs, deposit money, decide what to bet on, place their bets, find out the results, watch the video – I don't want to change that experience. So that – it's not so important what the brand is necessarily, it's what the customers' actual use model is. And we are just defining that step by step so we don't overlook anything and leave something out that some group of customers want. So it's just going to take it a couple more months to finalize that and we said we would do that within that first six months. So I think we will run ahead of that schedule. But I just can't tell you definitively right now. Ryan Worst – Brean Murray: Okay. Thanks a lot. Good quarter, guys. And thanks for taking on my questions. Just one more question and that will be it. Just – it seems like this business is just going to throw off a tremendous amount of cash flow over the next year and now that you have all the Youbet acquisition behind, you have buildout of Calder. I mean, what are your plans for that cash flow? Is there any plans to institute a share repurchase program?

It's not something we would comment on in this forum. So if we get to those decisions, we will make those announcements at that time. But we have noticed the same trend about the future. Ryan Worst – Brean Murray: Okay, thanks.

Thank you.

Thank you. (Operator Instructions). Our next question comes from Steve Altebrando from Sidoti & Company. Steve Altebrando – Sidoti & Company: Hi guys. How are you?

Good morning, Steve.

Hi, Steve. Steve Altebrando – Sidoti & Company: For the music festival, is there a number attendance wise – a breakeven number?

Well, we thought we had one. I don't know. I don't want to throw a number out there about the future yet, because I don't know exactly what show we are going to produce in 2011; whether it's two days, three days, four days; whether it's in July or some other month; how many bands; how many headliners. So until we have sorted that all out based upon what we learned, I don't have a new breakeven attendance number. And even if I did, it's a function of the ticket pricing as well. So it's not just how many people pay, it's what they are willing to pay. Steve Altebrando – Sidoti & Company: Okay. Looking at Calder a bit, it looks like according to the state data, you guys have been pretty promotional. Is there a plan to pull back on that? And also, if you could refresh me, is there – are you taxed on promotional on free play?

Let me – first of all, I don't – I'm not sure. Are you looking at the database at the state level? Steve Altebrando – Sidoti & Company: Yes.

So you got to remember what's included in the Florida Department of Pari-Mutuel numbers as they report. There is only certain items that you do not pay taxes on and that is things like $25 to sign up, to get a new player card so that you can track the player and advertise directly to them. So those type of expenses are tax – you don't pay taxes on those, which is nice. But that's the part that you are seeing in the Department of Pari-Mutuel Wagering website. We tend to be – because we are new and we are still signing up a lot of new players, we are probably showing a bigger number there. The numbers that you don't see in there is whenever they give away things at the gaming facilities. Those are not tax deductible and they show up in the expense line, they don't show up in the revenue line. So we may not be actually promoting as much – so for example a new car, a new motorcycle-type of events. Those don't show up in the numbers you are seeing. They show up in the cost line. So – in fact, we may not be promoting as much as our competition, because they are maybe doing more of those type of things. SO I'm just saying, be careful about how you review that information. So yes, I would say that we are probably a little bit heavier, because we are opening up, we are building our database, new people sign up, where they get free play that is tax deductible, obviously we want to use that lever as long as we can.

Steve, this is Bob. The only other thing I would add to this is that this is another business that's new and we are learning. So our assumption was because we have focused very much on being a local casino, serving the local Floridians as opposed to chasing the tourists that come in and out of the state during the year, but we thought we would be less seasonal in our business performance than the other casinos have been. So far that looks like it's the case. We haven’t gotten all the way through the summer obviously yet. So we are still trying to figure out what the right mix of marketing is relative to the market we are trying to serve. And it's just a learning experience. So my guess is when we tee this up for 2011, we will have a much crisper view on just when to spend the marketing dollars and how best to spend them. So far this year, it's somewhat been an experiment because we don't – it's our first time through a 12-month calendar year. Steve Altebrando – Sidoti & Company: Right. Okay. Just to be clear, I mean, the line I'm referring to is there is a promotional credits dollar value line, which I'm assuming is free play.

You are right. It's in qualified free play, there is only certain things that you can free play on that is non-taxable. And then there is a bunch of stuff that if you want to do to give free play away, that doesn't fall in that criteria. It is taxable and you won't see it in that line item. It would be in the marketing expense line item. Steve Altebrando – Sidoti & Company: Okay. But for that – because the promotional credits are running about $900,000 a month, I guess, the question is, are you paying a 50% tax on that?

I agree. I'm just – to be clear though – I guess I don't really understand your question, but there are certain things that are tax deductible that show up in our line item and obviously we want to take advantage of the things you don't get taxed on, free play that does not get taxed on while you can. Steve Altebrando – Sidoti & Company: Okay.

And anything that is taxable, you wouldn't see it in that line is my point, which is obviously much more expensive, because it's hundred-cent dollars instead of fifty-cent dollars. Steve Altebrando – Sidoti & Company: Right. Okay. And then other – I mean, you touched on it a little bit on the script, but is there room for a lot of, I guess, efficiencies to come out of the property, it's still relatively new but is there material room to grow margins there excluding the tax rate?

No, I don't – I wouldn't put that in a bucket of things that are – I think we have opportunities obviously, do better job marketing to know our promotional expenses, to your point, probably will come down after our database peaks out things of that nature. But in terms of operational efficiencies, I think we started out pretty well. Now, that doesn't mean that we are not trying to improve it, but I wouldn't make them that major statement. Steve Altebrando – Sidoti & Company: Okay. All right. Thanks guys.

You are welcome. Saeed, anything else?

I'm showing no further questions at this time, sir.

Okay. Well, thanks, everyone for joining us. The thunderstorm here just stopped, so I guess that's a good omen. I'll talk to you all next quarter. Thanks again.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect and have wonderful day.