Churchill Downs Incorporated (CHDN) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. And welcome to the Churchill Downs Incorporated Second Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference may be recorded. And now it’s my pleasure to turn the floor over to Courtney Norris, Director of Corporate Communications. Ma’am, the floor is yours.

Good morning and welcome to this Churchill Downs Incorporated conference call to review the company’s results for the second quarter ended June 30, 2012. 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 News located at churchilldownsincorporated.com, as well as in the website's Inventors section. 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 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 performance 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. I will now turn the call over to our Chairman and CEO, Bob Evans.

Thanks, Courtney. Good morning, everyone. Thanks for joining us. With me today are Bill Carstanjen, President and COO; Alan Tse, our General Counsel; and Bill Mudd, our CFO. Usually, Mudd and I both write our comments independently. This time when we exchanged drafts, we realized we both said the same thing. So rather than both of us duplicate that information, Bill's going to take you through the second quarter results then we’ll be back and try to handle whatever questions you might have. Bill?

Thanks, Bob. Good morning, everyone. I'm going to start with a second quarter summary. Overall it was a great quarter with total net revenues up 8% to $271 million, EBITDA was up 12%, $95.3 million and then net income from continuing operations was up 21% to $48.6 million. Diluted earnings per share from continuing operations was $2.77, up 17% versus the second quarter of 2011. Year-to-date cash provided from operating activities is $96.1 million, down from $104.8 million in the prior year. Improvements in operating income were more than offset by $9.3 million for tax refunds received in 2011 and $5.8 million in advance billings for the Breeders' Cup held at our Churchill Downs Racetrack in November of 2011. Year-to-date capital spending is $16.5 million, $10.2 million of which is for maintenance purposes, while $6.3 million was related to new projects. We still expect to spend between $15 million and $20 million on maintenance capital for the year, which does not include capital to renovate Harlow’s. We have already collected insurance proceeds of $15 million which will be spent on the second half for that project. In addition, we also announced $9 million in renovations at Churchill Downs Racetrack to develop a new high-end venue called The Mansion, a new media center and a new gold room for our high-end patrons. We expect to achieve good returns on this investment from incremental ticket revenues, sponsorships and cost deficiencies. Long-term debt for the quarter ended at $63 million, down approximately $65 million from year-end 2011. Our balance sheet remains in great shape with well under 1/2 a turn of leverage at the end of the quarter. So now let’s take a look at our segments. Racing had a strong quarter with net revenues up 8% on annual growth of 7%. Our Churchill Downs property accounted for the majority of improvement. Revenues increased 7% driven by broad based strength in the Kentucky Derby week. Record handle, higher sponsorships, higher ticket pricing and record attendance all contributed to the gain. We also conducted 3 additional live race days versus the second quarter of 2011, primarily due to how the calendar fell year-over-year. Each of our other 3 racing properties recorded year-over-year gains, as well primarily as a result of running additional race days with Arlington up 3%, Calder up 18% and Fair Grounds up 9%. Our Calder facility improvement is driven by additional 11 days of racing. This is the result of starting our meet earlier in April in lieu running in December. And our Fair Grounds game is driven by the Louisiana Derby falling on April 1 this year, coupled with a strong Jazz Fest on the back of perfect weather and an incredible musical lineup. From an EBITDA perspective, racing operations improved $6.6 million year-over-year to $65.4 million for the second quarter. The improvement was primarily driven by an increase in Kentucky Derby week profitability of $5.4 million, but also from an additional 17 days of live racing and from lower labor cost and other ongoing cost reduction efforts. Partly offsetting these improvements is a one-time $2.9 million reduction in operating expense recognized in the prior year related to the tax increment financing agreement with the Commonwealth of Kentucky. Our gaming segment had mixed results in the period. Reported revenues improved 4% to $51.4 million. Calder Casino revenues declined to $2.5 million or 12% on increased regional competitive pressures. To our north, the Native American casino is being very aggressive with merchandise and cash giveaways, while a new competitor has entered the market to our south. We are being very careful reacting to these marketing pressures and allowing customers to try the newest competition. We are keeping a very close eye on the market and we’ll consider adjustments in the third quarter as we fully understand the long-term effects of these actions. Our Louisiana properties posted flat revenues which we believe slightly outperform that market. Harlow’s grew revenues $4.3 million in the quarter as we were closed 25 days of May in the prior year due to the Mississippi River flooding. Gaming EBITDA increased $6.6 million to $19.4 million for the second quarter, $4.6 million of this improvement is driven by insurance recoveries net of losses. We settled our flood insurance claim in the second quarter of 2012 and recorded a $5 million in insurance recoveries net of losses. In the second quarter of 2011, we had insurance recoveries net of losses totaling $0.4 million related to the February 2011 wind storm damage at Harlow’s. Excluding the impact of insurance recoveries, Harlow’s improved EBITDA approximately $3.4 million on 25 additional days of operation, while Calder EBITDA declined approximately $1.1 million on lower revenue from increased competitive pressures. Now, let’s take a look at our Online business. Revenues increased 13% to $52.7 million. Our second quarter Online handle was $251 million, also up 13.4% year-over-year. According to figures published by Equibase.com, handle on U.S. Thoroughbred racing was down 0.2% year-over-year for the second quarter. This means TwinSpires.com handle outpaced the industry by approximately 13.6% for the period. This increase is primarily driven by new players as unique players increased 16% for the period and new account signups increased 23%. Online EBITDA increased $1.2 million or 11% to $12.5 million for the quarter. Improvements driven by handle and revenue were partly offset by a $0.9 million increase and HRTV losses primarily as a result of lower television fees collected from advance deposit wagering companies. We believe this headwind is behind us as the primary driver was content that moved to a competitor and that need is now over. Furthermore, CDI’s annual HRTV funding is capped as part of our joint venture operating agreement. Additionally, we spent $0.4 million to credit the wagering accounts of our customers impacted by incorrect wagering payoffs from a New York Racing Association error, which occurred during 2010 and ‘11. Corporate overhead allocations also increased by $0.2 million on the higher revenue base. Excluding these offsets, our EBITDA growth rate far exceeded our revenue growth rate. Other investments EBITDA was a loss of $0.1 million, down $0.8 million versus the prior year second quarter. Our newly acquired Bluff business is a primary driver, which lost $0.5 million in the quarter and our Lebanon, Ohio joint venture with Delaware North, which lost $0.1 million. Our United Tote business was down $0.2 million year-over-year due to higher bad debt reserves and higher property taxes. Corporate EBITDA was a loss of $2 million versus $1.4 million gain in the second quarter of 2011. $2.7 million of this change is driven by a prior year gain recognition related to the conversion of related party convertible note. In addition, we recognized higher non-cash compensation expenses related to the financial performance of the company. With that, I’ll turn it back over to Bob for some final comments and to take questions. Bob?

Thanks, Bill. Huey, if there's any questions, we’ll be glad to take them now.

[Operator Instructions] Our first question in the queue is Steve Altebrando with Sidoti & Company.

The flow through in Online, I know is somewhat related to HRTV but it looks like for this -- it was a $1 million swing to the downside year-over-year but only $400,000 for the first 6 months. Could you talk a little bit about how that came about? And then I know this is going back a little bit aways, but if -- how close you are to the cap in terms of your contribution, or the max loss essentially?

Are you talking about the HRTV losses?

Yes.

I'm just trying to catch up with your comment. Our cap is a floating number because of the way that’s kind of on a declining balance basis. It’s a little bit of a complicated scenario. But really, the first -- if you look at the first half of the year, I think our HRTV was – did better than the prior year. Second quarter, we were down. And it’s really a little bit of a calendar swap and some content swaps between the period. So I think the year-over-year adjustments are -- in terms of HRTV are largely behind us at this point.

Okay. And then switching over to Harlow’s, what amenities are remaining to come back online?

Yes.

Bill, you want to take that one?

Sure. This is Bill Carstanjen speaking. We will be opening before the end of the year an entertainment, a multipurpose entertainment venue. There will also be a fitness center, pool, a new buffet and revised steak house and business center. So a series of amenities, all of them are being worked on simultaneously and will all the open for business right about same time.

Okay. So most of what was damaged is not yet back online?

That’s correct. The floor, of course, has been back online and the hotel is. But the other amenities to the property including the food amenities, we’ve really been band-aiding and holding them together while we truly replace them with something that’s not only as good but better than what was there.

Okay. And then switching over to Ohio, seems to be a little bit of a trend the last few years that some operators who have sought to do finance, property-level financing have ultimately elected to essentially finance it by the parent, just given the attractive borrowing cost, particularly you guys have. What do you think the likelihood of that or is that something that’s under consideration for you guys?

Yes. It’s absolutely under consideration, Steve. That decision won’t be made until we get to a point where we're ready to fund it. If the markets are open and we can get a very good rate on project financing, we’ll certainly consider that but we’re keeping enough capacity at the parent level to fund our share if we need to.

Okay. And your revolver, it matures late 2013, is that correct?

Correct.

Okay. Is that something you guys are working on currently to extend?

I would say that we always keep an eye on the debt market, Steve. And we’re, at $63 million of debt at the end of the second quarter and the cash that we generate, I wouldn’t say that’s something that's number one right now.

Okay. And in terms of insurance proceeds, is there anything remaining, any collectibles?

Nothing related to the flood or the wind damage or the tornado. We did have a hailstorm which you’ll see in the 10-Q that affected Churchill Downs Racetrack in the second quarter but I do not expect that to be a material number.

Okay. And then last one and I’ll hop back in the queue. The balance sheet and if you could, I guess, comment a little bit on what you’re seeing on M&A front, it seems like the regional casinos' bid and ask has kind of narrowed lately and if you have any general commentary in terms of, if you prefer, something in interactive space over regional casinos?

Steve, this is Bob. I'd prefer not to comment on that in terms of what our interests are other than to say that our M&A activities are robust. And we’re always on the lookout for a good deal. So beyond that I don’t really want to comment on what specifically we’re looking for.

[Operator Instructions] And our next question in queue comes from Jeffrey Thomison with Hilliard Lyons.

I had some back of the envelope math here, so forgive me if I’m wrong on these numbers. But backing out the insurance recoveries, EBITDA margins may have declined about 50 basis points. Can you just remind us and maybe you already covered this in your comments, but just kind of what was behind that EBITDA margin decline? And then secondly, in terms of the Calder Casino market, a little bit of background if you could as to the timing of the competitive entry, not only of the native American operations but also the new competitive entry, I believe, to the south, I believe you said. And do you think that, that is it for that market or is there still some stuff coming down the pike?

Well, I’ll take the first one. Maybe I’ll let Bill have the second one. On the first one, your EBITDA margins, I think that you’re not -- I'm not sure exactly what your numbers look like, Jeffrey, but remember last year’s $85 million of EBITDA include 2 onetime unusual events, $2.9 million in Tax Increment Financing that we booked as a result of an agreement with the Commonwealth of Kentucky on the TIF agreement related to the master build at Churchill Downs Racetrack back in 2005. And then there was a second one that related to a related party note convertible that was called and converted to shares of Churchill Downs, and that resulted in a $2.7 million EBITDA pick up. So those 2 items obviously added $5.6 million to last year’s number.

You're talking second quarter of last year, right?

Second quarter of last year, correct.

There was also, was there not, a $400,000 insurance gain in last year's second quarter.

Right.

And this year 5.

Right. And I was trying to back both of those out. But I think those other 2 items probably account for that margin change.

Okay. And then on Florida competition, Bill, would you like to take that?

Sure. Why don’t I start and then, Jeffrey, if I don’t capture all of your question we can try again. So in late March, an outfit called Miami Jai-Alai opened up, directly south of us about 16 miles. And Miami is a very complex market with lots of different ethnicities and demographics. So we’ve been learning as they’ve opened up, how they impact our business and we’ve been careful not to overreact because we expected to be some trial and we think we're still in that phase. As thing settle down and we get a true picture of their impact on our customer base, we’ll make adjustments based on what we think makes sense. We’ve also been encountering some very aggressive marketing from the north, with the Seminole, the Hard Rock who've just been very, very aggressive in marketing and have clearly come down, attempting to get some of our core demographic, some of our core customers. So we’ve been caught in the middle of that and certainly we're watching that and talking about it every day. But we want to be careful not to overreact to it because we do try to run the business based on return and margins. And we want to make sure we truly understand the dynamics before we make changes. In terms of additional competition, certainly there is lots of discussion about destination casinos in the market. There's nothing going on strictly right at the moment, legislatively to talk about but that’s something we’ll keep our eye on. And then a facility called Hialeah, potentially will install slots at some point that we’ll have to keep our eye on because they're in the Southern Florida market too. So we’ll be watching what they do and what customers they go after.

That’s a good recap. And just you happen to know how far away the 2 main competitors are from your location exactly?

Sure. Miami Jai-Alai is 16 miles directly south, right off the freeway and then the Seminole facility to the north is right around 9 or 10 miles directly north, also right on the freeway. The facility also sits right off the freeway. So literally we're high enough up to even see the Seminole property from our property at the high end of our floors.

[Operator Instructions] We do have a follow-up question from Steve Altebrando with Sidoti & Company.

You guys didn’t speak much about Luckity.com on the call. I wanted to see if you had any additional color you can add or possibly a timeframe when you’ll be ready to speak more about Luckity?

I think in prior public comments, Bob had identified a late summer timeframe. I think we're still in that timeframe. We haven’t launched it publicly. We'll look to do that in the late summer or early fall. We’ve gotten approval in a couple of jurisdictions where that was required. So we remain essentially on course to get it up and launched this year.

Okay. And then in Illinois obviously, the clock is running on the governor. If it is vetoed, do you suspect there'll be a push to get something, an overwrite in the lame-duck session? And do you guys generally view this is kind of the last shot for Illinois?

So couple questions in there. The first, I think the bill was submitted to the governor around June 29th or so, so we're still in the 60-day window. And we continue to work with the legislative leaders there and the other political leaders there, with respect to the bill that’s been passed by the legislature. To the extent that the bill does get vetoed, I hate to get too far into hypotheticals but certainly there's the fall veto session that will come up. And certainly we're going to pursue all our options in that veto session to work with the legislators and the other political leaders to get this done. Steve, if it doesn’t happen this year, we'll tee it up again next year. We are not going to walk away from the opportunity.

Okay. And then just last question, I know, Bill, you mentioned in your script. But was it -- CapEx, was it $15 million for Harlow’s and $9 million for Churchill Downs?

Correct.

Thank you. Operator Instructions] Okay. With that, that does conclude our time for questions. I’d like to turn the program back over to Mr. Evans for any additional or closing remarks.

Thanks, Huey, for your help. That’s all we’ve got, folks. Thanks for joining us. We'll be back together, not sooner in October. Thank you.

Thank you, presenters. Ladies and gentlemen, this does conclude today’s conference. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.