Churchill Downs Incorporated (CHDN) Q4 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Churchill Downs Inc. Fourth Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. Now I’ll turn the conference over to John Asher, Vice President of Communications. Please begin.

Good morning, and welcome to the Churchill Downs Inc. conference call to review the company’s results for the fourth quarter and full year ended December 31, 2011. 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 the website’s Investors 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 by 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 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 in expectations. I’ll now turn our call over to our Chairman and CEO, Bob Evans. Bob?

Thanks, John. I hope when I die and get to heaven and stand in front of St. Peter, you’re there to read the Safe Harbor statement for me. I greatly appreciate that.

I think it’s on my job description.

All right, fair enough. Thanks everyone for joining us this morning. If you’ve read the press release we issued yesterday, you know that our fourth quarter and full year 2011 results are exceptionally strong. Our CFO, Bill Mudd, will take you through the details and then I’ll be back with some comments. After that, we’ll be happy to take your questions. Bill?

Thanks, Bob, and good morning, everyone. As usual, I will review the information set forth in the tables of the press release. Unless otherwise noted, my comments will focus on performance from continuing operations for both the fourth quarter and the full year. Let’s begin by reviewing the segment information which is contained in the schedules titled Supplemental Information by Operating Unit in the release. Total revenues were up 19% for the year and 9% for the quarter when compared with the same period in 2010. For the year, our racing operations revenues declined by 3% or $9.3 million. According to figures published by the Jockey Club, handle and U.S. thoroughbred racing contracted 5.7% during 2011. Our tracks raced 14 fewer days and experienced similar results to the industry with a handle decline of 6%. These losses were partly offset by improvements in our Kentucky Derby Week. For the fourth quarter, racing operations revenues were down 13%. The decline was primarily driven by Calder Racing Operations, which traditionally has live racing in December and decided to shift those live race days to April. Our online business revenues were up 36% for the year and 18% in the fourth quarter. While the total year growth was primarily due to the Youbet acquisition, which closed in June of 2010, the fourth quarter results were the strongest for the year on a comparable basis. According to numbers published by Equibase, the U.S. industry handle was up 1.4% in the fourth quarter while Twin Spires handle was up 15%. We believe the integration distractions are now behind us and Twin Spires’ growth is now outpacing the industry by approximately 10%, which is what we experienced prior to the combination of the 2 businesses. Our gaming business grew revenues 49% year-over-year. The growth in revenues…

Thanks, Bill. I’d like to take a couple of minutes and discuss 2 topics relevant to our shareholders: first, how and why we have transformed the company’s business model; and second, how we intend to invest around this new business model moving forward. To millions of people worldwide, Churchill Downs means the Kentucky Derby, the Kentucky Oaks. Churchill Downs means thoroughbred racing. While that’s what our brands mean, it no longer is our business model, meaning how we will grow and earn an acceptable return on our shareholders’ investment. Our business model has changed dramatically. Just 7 years ago, we owned 7 racetracks: the 4 we currently own plus Hollywood Park, Ellis Park, Hoosier Park. Our business model in the 2000 to 2004 period consisted of conducting on average over 650 days of live racing annually, operating year-round simulcasting, and of course the Kentucky Oaks and Derby. While the returns on invested capital weren’t all that great, at least those businesses operated profitably and they were cash flow positive in the sense of cash flow minus maintenance capital expenditures. In 2005, 2006 and 2007, we sold Hollywood, Ellis and Hoosier. Combined with racing day reductions at our 4 remaining tracks, this year we plan to conduct 384 days of live racing, down about 41% from the 650 days in the early 2000’s. In addition to this significant reduction in supply, the demand for racing measured in terms of U.S. thoroughbred handle has fallen far faster than expected, down 29% from its peak in 2003 according to Equibase. What the changes of the last decade have left us with is an unprofitable business of conducting live racing, excluding the Oaks and Derby, and an unprofitable business of conducting simulcasting when we’re not racing live. More significantly, excluding one-time transactions like last…

[Operator Instructions] We have a question from Steve Altebrando of Sidoti & Company.

There was a meaningful acceleration in the ADW segment, and I know you touched a little bit on the script; but can you talk a little about what factors accounted for this, whether it be share or timing of events, or just overall market growth?

Three things. One is the decline in thoroughbred handle seems to have bottomed out. It’s actually been up a couple of percent over the last 5 months or so, so I think that’s been one significant reason. The second reason is that customers just keep switching channels. More and more people want to bet online rather than bet in bricks-and-mortar outlets. Not a surprise; it’s going on in pretty much every other industry. And then third, it’s hard for us to know this for sure yet, but we think we’re probably gaining share at the expense of the other guys in the advance deposit wagering space. So I’d say those are the 3 primary reasons.

Okay. And then on the poker side and the Bluff Media acquisition, can you kind of give some specifics how that fits into the strategy?

I can, but I’m not going to do it today. Let us put that off for a few months until we’ve developed a few more of our ideas, and I also don’t want to give away anything that might give somebody else a leg up on us. So good question, fair question; just not ready to answer it yet.

Okay, last one and then I’ll pop back in. The balance sheet continues to be, even with the JV, highly overcapitalized versus peers. I guess the question would be why not have a share repurchase authorized, even if there’s not a purpose to be meaningfully buying back stock but at least to be opportunistic?

Hey, Steve, this is Bill. Yes, that’s something that the Board discusses every time we meet. We look at what opportunities we have to spend the cash, whether it be acquisitions, stock buybacks, or even dividends. So good question and one that we certainly discuss every time we meet with the board.

We have a question from Ryan Worst of Brean Murray.

Where does the revenue from the 10th Illinois casino license stand? Will you be collecting that throughout 2012, and how are you going to account for that, if at all?

Hi Ryan, it’s Bill Carstanjen. Those funds have to be allocated by the legislature, so the fact that they’ve been collected or the fact that there’s been previous legislation creating those funds or allocating those funds, they still have to be subsequently allocated by the legislature, and they haven’t been.

Okay, so we’re not going to see them on your income statement until that happens.

Correct.

Okay. And Bob, I just missed it -- what do you guys plan on spending for the refurbishment of Harlow’s?

About $16 million.

$16 million, okay. And when do you expect that to be completed?

This year.

The end of this year.

The end, okay. And then could you guys provide the overall wagering number through Twin Spires in the fourth quarter?

Yes, it’s—let me grab it here. Fourth quarter only, about $192 million.

Our next question is from Anil Gupta of Imperial Capital.

So 2 questions for you -- one is just looking at the online segment this year, you’ve trended kind of in the low to mid-20% range in terms of online margins. On a go-forward basis, is that a pretty reasonable run rate for this business? Are there any additional costs you think you can realize here? And then if we were to move towards an online poker business, do you think we’d probably see it embedded in this segment?

Yes, I would say—let me answer the first one first. I think the margin rates you’re seeing now, as long as we keep the level of volume we have today, it’s very reasonable. It differs by state and by product that you sell, so obviously they can shift around. The other thing I would say is that if volume continues to grow, you should have better margin rates because you have a significant part of that cost structure that is pretty fixed, so your margin rates should expand as your volume grows, assuming you get it in the right locations and on the right product. What was the other question he had?

If we have i-poker, will be on the…

Oh, yes. I-poker, it will definitely be in the online segment, but it will probably be separated from the horseracing component of online.

Okay, thank you. And then as far as the gaming segment is concerned, can you just remind us about any seasonality in this business as we look to 2012?

Yes, the gaming business definitely has seasonality in it. If I remember correctly, it seems like it depends on the location you’re in, but on average about 30% of your total year revenues and earnings happen in the first quarter and then it kind of drops in the second and third, and then back up to kind of an average quarter in the fourth. So there’s definitely seasonality in the gaming business.

We have a follow-up from Steve Altebrando of Sidoti & Company.

Back to the subsidy in Illinois, what is your legal recourse to collecting? I assume these funds are not in escrow; it’s just something that comes out of the general fund. Is that correct?

Yes, that is correct, and there is no really -- my understanding is there is no legal recourse, Steve. It’s a matter of the legislature appropriating those funds, so there’s nothing in the law that says they have to be appropriated. Unlike the original Horse Racing Equity Trust Fund money, that money was automatically appropriated to horseracing interest at the time that it was paid by the riverboats. It was put into escrow only because the court decided that it should go to escrow until the lawsuit was adjudicated. So it’s different on this because it does explicitly have to be appropriated by the legislature.

Okay. And then just lastly, if you can give any background on the decision to JV with Lebanon Downs versus going at it alone. Was it a matter of the return potential or just a matter of 2 parties that were competing for the same property?

Steve, it’s Bill Carstanjen again. The Lebanon transaction really was something that was developed by Delaware North, so they invited us in and they asked to develop the relationship with us.

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

All right, well thanks everybody for joining us today. Hope to see you during Oaks and Derby Week. Until then, if you don’t have anything better to do, you can become part of Derby Nation on Facebook. There’s about 180,000 people out there who are friends and followers of the Kentucky Derby. That’s grown about 15% since the end of last year’s Derby, and we still have the best 2 months ahead of us for attracting new members, so join Derby Nation today and see you at the Oaks and Derby. Thank you.

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