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Churchill Downs, Inc. (NASDAQ:CHDN)

Q3 2013 Earnings Conference Call

October 31, 2013 09:00 ET

Executives

Courtney Norris - Director, Corporate Communications

Bob Evans - Chairman and Chief Executive Officer

Bill Mudd - Chief Financial Officer

Bill Carstanjen - President and Chief Operating Officer

Analysts

Cameron McKnight - Wells Fargo

Amit Kappor - Gabelli & Company

Steve Altebrando - Sidoti

Justin Sebastiano - Brean Capital

Operator

Good day, ladies and gentlemen and welcome to the Churchill Downs’ Third Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session with instructions following at that time. (Operator Instructions) As a reminder, this conference is being recorded.

Now, I will turn the conference over to your host, Courtney Norris, Director of Corporate Communications. Please begin.

Courtney Norris - Director, Corporate Communications

Thank you, Tyrone. Good morning and welcome to Churchill Downs Incorporated conference call to review the company’s business results for the third quarter ended September 30, 2013. The company’s third quarter business 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 facts. 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 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 our Chairman and CEO, Mr. Bob Evans.

Bob Evans - Chairman and Chief Executive Officer

Thanks, Courtney. As I was putting together a few comments for today, I realized I was repeating the things that were already in our press release, but rather than I do that to you, I thought we’d just get comments from me, turn this over to Bill Mudd to talk to you through the numbers and then we will come back and answer whatever questions you might have. Bill?

Bill Mudd - Chief Financial Officer

Thanks Bob. Good morning everyone and Happy Halloween. Overall, it was a solid quarter setting new third quarter records for both revenues and adjusted EBITDA. Our third quarter total revenues were up 13% to $185.6 million and adjusted EBITDA was up 31% to $31.8 million.

Net earnings from continuing operations for the quarter, was up 52% to $9.2 million. Year-to-date cash provided from operating activities was $114.4 million, up 12% over the prior year of $102.1 million. Year-to-date capital spending was $29.9 million, $13.8 million of which was for maintenance purposes, while $16.1 million was related to new projects, including the Churchill Downs Mansion and the renovations at Harlow’s, which were completed in the first half of the year. Long-term debt ended the quarter at $325 million, up approximately $115 million from year end 2012. In July, we added approximately $169 million of debt with the closing of the Oxford acquisition. Even with this added debt, our balance sheet remains in great shape.

Now, let’s take a look at the performance of our segments during the third quarter. Our racing operations results were not surprising with revenues down 19%, or $12.2 million resulting in a $3 million decrease in adjusted EBITDA. The revenue decline was driven by a $14 million decline at our Calder property. $9.3 million of this decline was driven by the loss of hosting revenues that Calder has traditionally collected during its live racing meet. As mentioned in the second quarter earnings call, we believe that Florida law requires a racetrack to run no less than three days of live racing per week during consecutive weeks to qualify as a host track to redistribute out of state simulcast signals within Florida and to collect commission revenues on wagers on those tracks. Under this rule Calder is the only thoroughbred track that is qualified to be the host since May. On October 14, the Florida Legislature’s Joint Administrative Procedures Committee which is comprised of five state senators and six state representatives issued a letter to the Division of Pari-Mutuel wagering agreeing with our position that the track must operate no less than three days a week to be considered a host track and citing the relevant Florida statutes.

The division has scheduled a public hearing on November 7 to address this. We will pursue the recovery of the lost hosting revenues since the dispute started on May 7 using all means available to us. In addition, to the lost hosting revenues Calder conducted 17 fewer race days resulting in a revenue decline of $4.4 million. We expect to make up these lost rate space and associated revenues in the first quarter of 2014 when we will raise 39 days. We have not traditionally conducted live racing during the first three months of the year.

We continue to be disappointed we have not reached an agreement with the striding groups Gulfstream Park in South Florida. But the impact of them running on top of our traditional live meet days is now largely behind us and the period from December to April should provide upside as we will conduct live racing and qualify for our share of the hosting revenues.

Churchill Downs racetrack revenues increased $4.1 million on the successful introduction of a new 12 day September homecoming meet. The Kentucky horse racing commission awarded us the September date again in 2014 and we look forward to growing the awareness, attendance and economics of this event. Arlington Park revenues declined 7% year-over-year on a 4% decline in race days due to calendar timing. Overall racing operations adjusted EBITDA declined by $3 million and is due to a $4 million decrease at Calder again approximately $2.7 million of decline is associated with the loss of hosting revenues and approximately $1.3 million is driven by 17 fewer live race days. Arlington Park profitability dropped $1 million on fewer live race days, a negative impact from bad weather and smaller field sizes. Churchill Downs partially offset these headwinds with a $2.3 million improvement generated by its new September live racing meet.

Gaming revenues improved $30.3 million or 61% driven by the acquisitions of Riverwalk and Oxford Casinos. Excluding these acquisitions our total gaming revenues would have been even with last year. Despite the opening of a new South Florida casino in early July Calder revenues increased 7% for the second consecutive quarter as a result of focused marketing efforts and more importantly the closure of the Florida Internet cafés in early April. Calder’s adjusted EBITDA improved $0.6 million from the increased revenues.

Our Louisiana gaming operations were flat year-over-year as revenues from new off-track betting and video poker facility offset mild softness in our fairground slots business due to a road construction on Gentilly Boulevard. Adjusted EBITDA from these operations dropped to $0.5 million on higher promotional spending during the period. Both of our Mississippi operations experienced revenue declines primarily on the back of continued regional economic weakness and persistently high unemployment. Adding to the pressure is a streak of bad luck as Riverwalk’s hold rate on table games dropped 21% and Harlow’s table hold rate dropped 31% compared to the third quarter of 2012. Harlow’s revenues were also impacted by an ongoing gaming floor redesign, which disrupted midweek operations in August and September. Harlow’s adjusted EBITDA declined $0.8 million on the revenue loss.

We added our newest gaining property with the acquisition of Oxford Casino on July 17, it’s running slightly ahead of our pro forma projections with third quarter revenues up 26% on a comparable basis to the prior year. During 10 weeks of operations post closing Oxford added $5.4 million to our adjusted EBITDA in the quarter.

Our online business performed well posting organic revenue growth of 6.4%. Wagering handle increased by 7.3% driven by 6% increase in unique players and a 7% increase in wagering by existing customers. According to Equibase.com handle on U.S. thoroughbred racing was up 1.3% in the third quarter meaning TwinSpires.com handle outpace the industry growth rate by approximately 6% for the period. We re-launched Luckity.com earlier this month as a real money bingo site with game outcomes dependent on the results of live racing. We believe this is a much improved product and planning to market it in earnest later this quarter. I encourage you to sign up and give it a try.

Online business adjusted EBITDA improved $3.1 million, or 31% in the third quarter, primarily reflecting the increased revenues generated by TwinSpires.com and a $0.6 million reduction in expenditures related to the development of Luckity. Additionally, the prior year included expenses related to announced data security incident and an employee related severance totaling $0.6 million. On September 23, the U.S. District Court of the Western Division of Texas ruled against our suit challenging the constitutionality of Texas law requiring residents to wager in person at a Texas racetrack. As a result of the ruling, we stopped taking wagers from Texas residents from September 25. We have taken $42.2 million of wagers from Texas residents in the first nine months of 2013, which is approximately 6.2% of total TwinSpires.com handle. We believe the law is unconstitutional and filed for an expedited hearing with the U.S. Court of Appeals, which was granted on October 17. We hope to get a ruling allowing us to resume wagering as early as possible next year, but there is no certainty how this will turn out.

Now, I will cover a few of the items below adjusted EBITDA. Illinois Horse Racing Equity Trust Fund proceeds added $4.2 million reflecting the final disbursement related to the tenth Illinois riverboat license. Share-based compensation increased $3 million as a result of the new executive long-term incentive plan that went into effect March 21, 2013. As a reminder, from our second quarter earnings call, the vast majority of these expenses related to the new four-year plan will occur in the first 14 months of the plan. Finally, pre-opening cost associated with our Miami Valley Gaming investment totaled $0.5 million in the quarter. This will increase substantially in the fourth quarter as we enter the final weeks prior to our December 12th opening.

With that, I will turn it over to Bob who will take any questions you may have. Bob?

Bob Evans - Chairman and Chief Executive Officer

Thanks, Bill. Tyrone, do we have any questions?

Question-and-Answer Session

Operator

(Operator Instructions) First question is from Cameron McKnight of Wells Fargo. Your line is open.

Cameron McKnight - Wells Fargo

Good morning. How are you?

Bob Evans

Good morning, Cameron. How are you?

Cameron McKnight - Wells Fargo

Good. Just a quick question on the regional properties, this is the second quarter where we have seen slightly weak results due to a soft macro environment, what’s the ability that you have to manage costs at those properties over, let’s say, the medium term?

Bob Evans

Cameron, this is Bob. Did you say that the gaming properties? We didn’t hear the first part of the question.

Cameron McKnight - Wells Fargo

The regional gaming properties and what’s your ability to manage – what’s your ability to manage costs in a self macro environment.

Bob Evans

Bill Carstanjen, you want to take that one?

Bill Carstanjen

Sure. We do have some leverage to do that and that’s something that we have taken a very serious look at over the last few weeks as we start our budgeting planning for next year. So with consistent pressures like we are seeing right now, we will be looking hard at the cost structure and also free play comps, combination of those things as well.

Cameron McKnight - Wells Fargo

Great, thanks very much. And then as a follow up, could you outline some just general thoughts on Penn’s conversion into a REIT and operating company and how that impacts the landscape for acquisitions and how you fit in?

Bob Evans

I think I would rather pass on commenting on what other companies are doing. We are certainly aware of what they are doing and have looked into that in detail. I guess in the theory all other things being equal it might increase the value of the existing regional gaming properties, but so far at least I haven’t seen any specific evidence of that in any overwhelming manner. So I prefer not to comment on it and I will sort of agree with your perspective philosophically but I don’t know that I have seen the fact to back it up yet.

Cameron McKnight - Wells Fargo

Great, thanks very much guys.

Bill Mudd

You’re welcome. Thank you.

Operator

Next question is from Amit Kappor of Gabelli & Company. Your line is open.

Amit Kappor - Gabelli & Company

Thanks for taking my question. Can you guys comment on I mean the press release you announced or reiterated the support for the coalition in Kentucky. So can you talk give us more color around that and potentially talk about the goings on in Illinois as well on the gaming legalization front? Thank you.

Bob Evans

Amit I will take, this is Bob I will take the Kentucky and Bill Carstanjen will take Illinois.

Amit Kappor - Gabelli & Company

Thank you.

Bob Evans

So there is a new coalition of business and specifically it has been created in Kentucky called Kentucky Wins, you can go to kentuckywins.com if you want some more information. There is also a Facebook page and that group of leaders is focused on trying to give them expanded gaming bill passed in order to address some, not all but some of the state’s significant budget shortfall problems. And the important thing about that approach is that while the principal goal is to solve the budget shortfall problems of the state we want to do that in the way that it doesn’t negatively impact the racing business. So that’s what Kentucky Wins is, it’s been out active at the local grassroots level trying to build support around this idea of passing an expanding gaming bill in 2014 to adjust the Kentucky budget shortfall, so in short that’s it is. If we have more questions I will try to go deeper. Let me toss it to Bill for a second to cover a little more and then if we haven’t addressed your question fully let me know.

Bill Carstanjen

So this is Bill talking expanded gaming in Illinois has been titled with recent couple of sessions through pension reform. So the governor has made it clear that he wants progress on pension reform in the state before he will address alternative gaming. That’s an environment where prior to the focus on the pension reform legislation was passed twice by the legislature but the governor didn’t sign either of those pieces of legislation. So generally, we like the environment in Illinois and we think the governor has expressed publicly an evolution of his views on expanded gaming. But right now the state I think in most people’s mind is facing a bigger problem and that’s addressing the pension issues. So we are always hopeful and optimistic, but I think in short veto session that’s occurring right now expanded game is not really not the focus.

Amit Kappor - Gabelli & Company

Thank you. Just to follow-up so the Illinois bill that passed the senate is it live now or I guess active now and when is it active through if you guys have that.

Bob Evans

Yes the bill was passed in the spring session is active through the end of this legislative session which I think goes to the end of next year Amit.

Amit Kappor - Gabelli & Company

Thank you.

Bob Evans

So I think this is passed by the senate, it still needs to be taken up in the house.

Amit Kappor - Gabelli & Company

Thank you.

Operator

Our next question is from Steve Altebrando of Sidoti. Your line is open.

Steve Altebrando - Sidoti

Good morning. Couple of questions, can you comment a little bit on the M&A pipeline whether there are deals out there right now to look at?

Bill Mudd

We don’t comment any specifically on any deals but there are always deals out there Steve it’s just a question of whether they are deals that we want to do and at prices we do them at so.

Steve Altebrando - Sidoti

Okay, and then if you could remind me the small expansion in Oxford is that adding gaming machines?

Bill Mudd

Yes, we are adding four table games and 58 machines. It should open before – around mid- December.

Steve Altebrando - Sidoti

Okay, and then the – getting back to the Illinois question that was previously asked. The bill that’s passed right now in the house is that you are saying it’s a life through the end 2014 or is it through this session which I thought ends the first week of 2014.

Bob Evans

But through the session, I might be mistaken that it’s the end of next year. That’s what I thought it was, but it’s been a while since I have looked at it, Steve, but it’s I guess as theoretical as it could be in January. I’ll have to follow up on that one.

Steve Altebrando - Sidoti

Okay. Okay, thank you.

Operator

(Operator Instructions) Next question is from Justin Sebastiano of Brean Capital. Your lien is open.

Justin Sebastiano - Brean Capital

Thanks. Good morning guys. You mentioned low table hold at Harlow’s and Riverwalk as part of the reason for the weakness there, can you maybe quantify what you think the impact of that low table hold was on the EBITDA both properties?

Bill Mudd

Yes, give me one second it will take me a minute.

Justin Sebastiano - Brean Capital

Sure. I guess in the meantime, Mississippi seemed to be more impacted by the soft macro environment, do you guys agree with that compared to your other regional properties and just what we have heard from your peers so far?

Bob Evans

Yes, it is definitely more impacted than others, much higher unemployment. I think the higher payroll taxes had a disproportionate impact on discretionary income in that region.

Justin Sebastiano - Brean Capital

Okay. While you are digging for that and just overall promotional environment across all of your properties, the casinos, I mean, how is that – does anyone market more or less rational than some others?

Bill Mudd

I think that ebbs and flows. I think I don’t if I can answer that quantitatively across all the markets off the top of my head, but I would tell you that for us, Mississippi right now is an area, where we are looking closely at that in terms of what the competitors are doing or what we are doing as we see sort of a consistent decline in the environment.

Justin Sebastiano - Brean Capital

And that’s more to just manage it and be more targeted to sort of try to may be get rid of the unprofitable comps and just kind of try to drive EBITDA there or is it more if we are not quite there yet, where it’s gotten irrational, but it might go towards that?

Bill Mudd

Yes. When you see shifts in your environment, you have to look at all your segments to see generally if the way you are approaching the customers that within those segments still makes sense. So I don’t think you ever adopted or at least in our company, we haven’t adopted a philosophy that we stick to all the time, no matter what as we see changes in the macro environment. And in our macro environment, we revisit all of our assumptions on comps and free play and reinvestment. And we are doing that pretty significantly right now in Mississippi.

Justin Sebastiano - Brean Capital

Okay. And….

Bob Evans

So...

Justin Sebastiano - Brean Capital

Go ahead, I am sorry.

Bill Mudd

At Harlow’s, the effect on EBITDA was around 300,000 and at Riverwalk is around 200,000.

Justin Sebastiano - Brean Capital

Okay. And then forgive me I missed the very beginning when you guys are talking about the Florida host, what’s the public hearing date?

Bob Evans

November 7.

Justin Sebastiano - Brean Capital

Okay. And you expect to make up what you lost this quarter on the race, the 39 race days you are going to have in Q1, is that what you guy said?

Bill Mudd

Now, I said there are two pieces to it. One is the post revenues, which is about $9.3 million of revenues in the current period and $2.7 million of our share of that after taxes and purses, so that piece hopefully will get resolved in November 7 hearing. I don’t know how that will turn out, but that’s the intent. We did race 17 fewer days in the third quarter. We raced fewer days. We raced fewer days in second quarter as well. We are going to make up those by racing 39 days in the first quarter of next year. So there are two independent things and the timing of which, the only thing I can tell you is we will race 39 days in the first quarter.

Justin Sebastiano - Brean Capital

Okay.

Bill Mudd

We haven’t actually raced any.

Justin Sebastiano - Brean Capital

I am sorry, what was the revenue impact then for those loss racing days?

Bill Mudd

I think, we will see here, was it 4.3? That was 14 in total accounting. 9.3 was on host revenues and 4.4 is related to pure race days.

Justin Sebastiano - Brean Capital

Got it. Okay, thank you for that. And then just lastly as far Steve mentioned the M&A pipeline, I won’t try to pin you down for specifics, but have you just in 30,000 foot view, have you seen multiples increase from the sellers? Have they asked for higher multiples over the past 12 months since Penn has done this re-conversion and as they have gotten closer and now basically converted to the REIT? Have you seen those multiples expand for what sellers are expecting?

Bill Mudd

As Bob said, we haven’t seen it yet. We disclosed in Oxford at a 7.5 multiple is what we thought ends up being a little bit less than that. So beyond that, I can’t really comment.

Justin Sebastiano - Brean Capital

Okay, thanks guys.

Bob Evans

Tyrone, any other questions?

Operator

Thank you. There are no further questions at this time sir.

Bob Evans - Chairman and Chief Executive Officer

Okay. Well, unless anybody has got anything else, I think we are finished. Thanks for joining us today. Have a Happy Halloween season. We will talk to you after the first of the year. Bye-bye.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your program. You may now disconnect. Have a wonderful day.

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