Churchill Downs Incorporated (CHDN) Q3 2010 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Churchill Downs Incorporated third quarter results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions) As a reminder, this conference call is being recorded. I would now like to hand the conference over to Ms. Liz Harris, Vice President of Churchill Downs Incorporated and Executive Director of CDI Foundation. Ma'am, you may begin.

A copy of the release announcing the 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 this company may differ materially from what is projected in the 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 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. We appreciate you joining us today. I'll make a few general comments about Q3 and then turn it over to our CFO, Bill Mudd. After that, we will be happy to take your questions. This was an important quarter for us in two ways. First, our results will demonstrate the earnings power of the diversification strategy that we have been pursuing for the last couple of years. And second, there are some important new developments that should increase our potential future growth and financial performance in 2011. Let’s start our review of the quarter by putting it in some historical context. If we look back to Q3 2007, Q3 2008, and Q3 2009, we see net revenues of $104 million, $100 million and $101 million, all in all pretty consistent. This past quarter, net revenues from continuing operations were $136 million, about 35% higher than where we have been the last few years. Looking at EBITDA from continuing operations, we see $10 million in Q3 2007, $11 million in Q3 2008, and $10 million in Q3 2009. Again, pretty consistent. In the just completed quarter, EBITDA from continuing operations was $17 million, up about 75%. We saw the significant increase in both net revenues and EBITDA from continuing operations because growth in our newer online and gaming businesses more than offset declines in our traditional racing operations. This is not a new trend, but the degree of impact at having on our overall results became clearly evident this quarter. Let me turn now to our second point, six recent new developments that should increase our potential future growth and financial performance in 2011. Let’s start with Harlow’s. Financed on September 13th, our intent to acquire Harlow’s Casino Resort & Hotel in Greenville, Mississippi for approximately…

Thank you, Bob. And good morning, everyone. As usual, I will review the information set forth in the tables of the press release. Please note that the discontinued operations section of our financial statements and tables now include the operating results of Churchill Downs Entertainment in addition to Ellis Park and Hollywood Park. As such, the discontinued operations net loss of $4.4 million for the quarter is primarily driven by Churchill Downs Entertainment’s HullabaLOU Music Festival. My further comments will focus on performance from continuing operations for the three months ended September 30th. Let’s begin by reviewing the segment information, which is contained in the schedule titled Supplemental Information by Operating Unit for the three months ended September 30th in the release. For the quarter, we had $135.7 million in net revenues from external customers, an increase of 35% or $34.8 million over the prior year. Racing operations external customer revenues declined $5.9 million or 9% for the period. $4.5 of this decline came from Arlington Park, which raised eight fewer days, a 13% decline versus the same period of 2009. Our Calder facility ran 53 days in the quarter, an increase of one day versus the prior year, and saw a decline of $1.1 million or 5%. We believe export wagering at both race tracks was negatively affected by the Monmouth elite mate, which attracted four fields and commanded a higher share of the export market. Considering the impact of Monmouth Park and the US handle on thoroughbred racing declining 6% in the period according to Equibase, we are rather pleased with these results. Our online business benefited from the first full quarter of Youbet ADW operations, resulting in an external customer revenue growth of $21.4 million. Our TwinSpires ADW business also continued to grow with handle up 12%…

Thanks, Bill. If I could ask our operator Saeed if there are any questions, we’ll be glad to take them now.

Thank you, sir. (Operator instructions) We have a question from Steve Altebrando from Sidoti & Company. Steve Altebrando – Sidoti & Company: Hi, guys.

Good morning.

Good morning, Steve. Steve Altebrando – Sidoti & Company: Did you benefit at all in the quarter from any of the cost savings from Youbet, the $12 million you spoke about?

Bill, do you want to take that one?

Yes, I’d be happy to. Yes, we have, Ryan – or Steve. I’m sorry. I apologize about that. We have year-to-date – I think in the last quarter, I forgot exactly what we’ve reported, but over $12 million of annual synergy savings that we have targeted, we already have $10 million of annual run rate out of the business. So clearly, there is an impact of that in the quarter. Now that being said, part of that cost savings was offset by $1.7 million of cost that we’ve incurred as a result of announcing the 64-employee and retaining these other employees that we want to keep around. Steve Altebrando – Sidoti & Company: Okay. Is that $1.7 million all in the ADW line in terms of breakdown?

Yes, every bit of that is in the ADW line. Steve Altebrando – Sidoti & Company: Okay. And can you just talk about a little bit about the NOLs inherited from the used debt, how that’s going to impact the cash taxes?

Yes. As you know, Steve, it will not affect our income tax rate in our reported results, because when we set up purchase account when we bought the business, we created the asset further on the balance sheet. Now there are limitations on how much you can based on what you pay for the company. I don’t have the exact numbers in front of me, but it’s about $2 million per year of cash tax savings that we save by paying less to the federal government. And it will take about ten years to get – it's got $20 million in total at the federal level. Steve Altebrando – Sidoti & Company: Okay. And then in terms of, I guess, United told – it looks like it came in a little higher and even realized a generated EBITDA, but what kind of seasonality is there to that business?

This is Bill Mudd. The seasonality in that business is primarily related to the big event days. So, Triple Crown where we host one of those events and then Kentucky Derby where we have that event. And then this year with Breeders’ Cup obviously being held at United Tote track will be seasonal as well. Steve Altebrando – Sidoti & Company: Okay. And then I guess lastly, what’s the maintenance CapEx these days with the acquisitions you guys have pulled in, excluding what Harlow’s would look like? What’s the typical annual maintenance CapEx?

We would say it’s around $15 million to $20 million. It will be – I think last year’s reported number in maintenance capital, if you look at our presentations on our Investor website, kind of non-big project capital was about $9 million. So last year, I would say, is a low number. $15 million to $20 million is probably right in the sweet spot. Steve Altebrando – Sidoti & Company: Okay. Thanks, guys.

Thank you, Steve.

Thank you. Our next question comes from Ryan Worst from Brean Murray. Ryan Worst – Brean Murray: Good morning, guys.

Good morning, Ryan. Ryan Worst – Brean Murray: You gave the wagering of TwinSpires plus 12% year-over-year. Could you provide that for Youbet, how that did?

Rohit, you want to take that one?

Yes, Bob. Youbet handle in the quarter declined 14.5%. And that’s – that continues a trend that we have seen in the performance of that business since the start of the year. Ryan Worst – Brean Murray: And what’s causing that to be down? Did they lose race tracks or states, or was there a certain competitive event that has caused that?

Yes. There are actually several contributing factors for the decline, and I’ll quickly go over a few of them. First of all, credit card acceptance rates declined sharply, starting in June when the Unlawful Internet Gambling Enforcement Act went into effect June 1st. Secondly, Youbet was unable to offer wagering via interactive voice responses since after June 15th due to a contract dispute. And then another important factor was that the imports of premium racing content in Illinois were cut off between July 12 and September 1 due to an Illinois Racing Board regulation. And that handle after the regulations were changed and the cut-off lifted, but not fully recovered. And then finally, some of the largest Youbet customers have cut back their wagering sharply due to wagering losses and because of the previously mentioned funding issues. Ryan Worst – Brean Murray: Okay. And how come TwinSpires hasn’t been affected and what are you trying to do with the Youbet business to get around the Unlawful Internet Act?

Youbet – TwinSpires actually started preparing for the anticipated implementation of the UIGEA well ahead of time and worked proactively with the credit card companies, MasterCard, Visa, and issuing banks, et cetera. And so TwinSpires was not as dramatically affected by the credit card funding issue. And many of the customers, both at TwinSpires and Youbet, have now started to shift their deposits to other means so that overall we are not affected to any great extent by the credit issues. And also with regards to TwinSpires, we have not seen a sharp decline in Illinois handle because TwinSpires has been less dependent on some large players, which indicates that Youbet stopped wagering during the cut-off of signals in Illinois. Ryan Worst – Brean Murray: Okay. Thanks. And then –

Ryan, the other thing I’d add to it is, we said this in the past about our horse racing track operations is that we stay focused not so much just on handle but on EBITDA. And the conversion of handle to EBITDA varies greatly by the content that’s being wagered on in the location of the better. So I don’t track handle nearly as closely as I check the EBITDA numbers for the business. Just keep that one in mind as you see some of these numbers going forward. Ryan Worst – Brean Murray: Sure. I’m just trying to get a gauge on what you guys think in terms of the growth of that channel of wagering. Last year it grew pretty significantly in a down market. And with TwinSpires being up, Youbet being down, I mean, is that sector continuing to grow and take market share?

Yes. Rohit, we haven’t seen the Q3 Oregon hot numbers, have we?

We haven’t seen the Q3 numbers. However, Bob, in the first half of the year, Oregon licensed ADWs as a group grew handle 9% over the prior period. Ryan Worst – Brean Murray: Okay. That’s all –

(inaudible) That’s not a perfect number, but it’s probably the best number that’s out there on how much total ADW wagering is growing. Ryan Worst – Brean Murray: That’s good to hear. And then, Bob, could you talk about Calder? After the tax relief there, it kind of would have expected margins to be a little bit better on the wagering on the slot side. So could you talk about maybe the promotional environment or something that might have put your margins in the third quarter compared to where they could be? And then if you could touch upon leverage? It looks like – pro forma at the Harlow’s, you’ll still be levered as a company less than two times. Could you talk about where you feel comfortable and how aggressive you will continue to be on the acquisition front?

All right. Let me take the second question first and then after that I’ll toss it back to Bill Carstanjen to talk about Calder and the issues that you ask about there. We don’t wake up every day with a particular leverage target in mind. I think we will always be conservatively managed with respect to the use of debt in anything that we do. So I guess I would argue for a lower rather than a higher leverage number. We’re very aware of what other people in the gaming space have done and currently live with in terms of their leverage situation. So in terms of just managing the balance sheet, I think we’ll continue to be pretty conservative. However, we’ve got some capacity. As I mentioned, we have increased the maximum amount available to us under our credit facility by $100 million to $375 million. And our business development group has and will continue to look for opportunities to put some of that cash to work. So we are interested in other investments and acquisitions, but I think we’ll manage our balance sheet pretty conservatively as we go through time. Bill, have you got anything you can add on Calder?

Sure. I’ll start with the seasonality that you see in the Miami market. This is the toughest time of the year in that market for everybody, and we think it is for us. We think that we’ve seen some seasonality ourselves, and we’ll know that for sure after we have a full year plus of operations. But Ryan’s point was a really good one on margins. That’s how we plan on running the business, with not only firm focus on GGR but just on the margins. So as we right-size our promotions and adjust based on what others are doing in the market, we are learning a lot. And I think we’ll keep tweaking what we do based on the fact that it’s become clear in that market that there is a portion of the customer base that will go in between the different facilities. There is a portion that seems pretty loyal based on probably locations and there is a portion that seems to be willing to travel. So we’re figuring that out as we build our database and we track the activities of the people that come through our database. And we’re getting smarter every month, and I think that will become evident as we move through this quarter.

Yes. This is Bill Mudd, Ryan. One thing I would say is, if you go out and look at – if you pull the data from the Florida Department of Pari-Mutuel Wagering and you look at our other local pari-mutuel gaming operators and what their game revenues do on quarter-to-quarter, if you go back and you look at 2008 second quarter and you compare third quarter of ’08 to second quarter of ’08, the operators declined anywhere from 10% to 19%. 10% on the low end, 19% on the high end, and the average about 15%, going from second quarter to third quarter. And then if you look at 2009 and you compare third quarter of ’09 to second quarter of ’09, you will they declined anywhere from 8% to 12%, and 10% on average. So the last two years, they declined anywhere from 10% to 15%, which show that the seasonal decline from the second to the third quarter were down about 10 points, so roughly in line with what the other operators experienced in that same period. So that’s why we’re not too concerned about the decline in the third quarter. I think it will prove to be a seasonal effect. Fourth quarter should be up anywhere from – depending on how you look at it, on the high end 16%, anywhere to somewhere in the 2% to 3% range based on historical – competitors’ historicals. And then the first quarter obviously is a much bigger quarter. So what you get in the first quarter with the heaviest quarter, it will be different in the third quarter. Ryan Worst – Brean Murray: Okay, great. Thanks very much, guys.

Thank you.

Saeed, anyone else?

I’m showing no one else in queue at this time, sir.

All right. Well, thanks very much. Let me just – before we turn off here, in closing that a lot of buzz around Churchill Downs this week. We’re excited about to be hosting the 27th Breeders' Cup World Championships tomorrow and on Saturday. We’ll be doing that for a record seventh time. This year’s Championships has one of the greatest storylines we’ve seen in racing in a long time with the undefeated mare Zenyatta seeking to end her carrier with a perfect 20-0 record. But to do that, she’s got to beat the boys in Saturday’s Breeders’ Cup Classic, which will be run, for the first time, under the lights at Churchill Downs. The Zenyatta story has sort of captured Americans’ attention. She has been on 60 Minutes in the last week. She has been in Sports Illustrated. She even made Oprah’s Power List of 20 most influential females of 2010. And we are optimistic here that Zenyatta, that story plus the Churchill Downs location will lead to strong results for the Breeders’ Cup this week and for us in terms of attendance in wagering and in terms of the economic impact that this event has on Louisville and Central Kentucky. So we are looking forward to the next several days at Churchill Downs. Thanks to all of you that joined us on the call. Have a happy holiday. We will talk to you all next year. Thank you.

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