Churchill Downs, Incorporated

Good day, ladies and gentlemen, and welcome to the Churchill Downs, Incorporated, 2018 Fourth Quarter and Year-End Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Nick Sangieri, Vice President, Treasury, Risk Management, and Investor Relations.

Thank you, Tiffany. Good morning and welcome to our fourth quarter and year-end 2018 earnings conference call. After the company's prepared remarks, we will open the call for your questions. The company's 2018 fourth quarter and year-end business results were released yesterday afternoon. A copy of this release announcing results and other financial and statistical information about the period to be presented in this conference call, including information required by Regulation G is available at the section of the company's website titled News, located at churchildownsincorporated.com, as well as in the website's investor section. Before we get started, I would like to remind you that some of the statements that we make today may include forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC, specifically the most recent report on Form 10-K. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update these assumptions as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and form 10K are available on our website at ChurchillDownsIncorporated.com. One additional note, in the fourth quarter of 2018, we changed our Twin Spires segment name to Online Wagering as we continue to expand our online sports betting and iGaming platforms. And now I'll turn the call over to our Chief Executive Officer, Mr. Bill Carstanjen. Thanks, Nick.

Good morning, everyone. With me today are several members of our team, including Bill Mudd, our President and Chief Operating Officer, Marcia Dall, our Chief Financial Officer, and Brad Blackwell, our General Counsel. I will walk you through our key 2018 performance highlights and how we have positioned our company for growth in each of our core business segments. Marcia will then provide additional details on our fourth quarter and full year earnings. After she is finished, we will be happy to take your questions. In 2018, we executed on the sale of a non-strategic asset and demonstrated our ability to grow organically on multiple fronts, acquire strategic assets, and effectively manage our capital to drive total shareholder return that exceeded the S&P 500, the Russell 2000, and virtually all of our gaming peers. We also returned over $555 million to our shareholders while maintaining one of the lowest leverage levels in the gaming industry. Here are a few of the 2018 highlights. In early January last year, we completed the sale of Big Fish. In late February, we announced the signing of an agreement to acquire Presque Isle Downs and Casino in Pennsylvania, an excellent brick and mortar casino which will also provide access to sports and online wagering across the entire Pennsylvania market. In early May, we had a record-setting Kentucky Derby Day and Kentucky Derby Week with respect to all of our significant financial metrics. In August, we opened our retail BetAmerica Sportsbook at our two Mississippi properties, leveraging the expertise of our Twin Spires team and using, we believe, best-in-class technology from our technology partner, SB Tech, to produce our custom-designed kiosks. At the end of August, we traded our 25% interest in Saratoga, New York, and Colorado for the remaining interest in Ocean Downs so that we now own 100% of Ocean Downs, while retaining the rights to online sports betting and iGaming if made available to the Saratoga, New York and Colorado properties. In September, we opened Derby City Gaming, our 900-unit historical racing machine facility in Louisville, the performance of which has meaningfully exceeded our expectations. In November, the Kentucky Horse Racing Commission issued us a license to construct a $150 million facility in Oak Grove, that will include, among other things, a harness racetrack and up to a 1,500 unit historical racing machine facility. And in October, we signed an agreement to acquire at least 50.1% of Midwest Gaming, which owns River Casino Des Plaines in the Chicago region of Illinois. As a result of elections made by certain minority shareholders, we will actually acquire close to 62%. While pursuing these initiatives, we stayed focused on the performance of our core businesses Delivering over $1 billion of net revenue and $329 million of adjusted EBITDA, up 14% and 15% respectively over prior year. As we begin 2019, we are pursuing the following strategic paths to grow our company. First, we remain committed to investing in the Kentucky Derby to grow this iconic piece of American culture and enable it to remain a healthy and lucrative financial asset. Second, we are pursuing greenfield opportunities with respect to historical racing machine facilities and believe we can achieve healthy returns for our shareholders from these investments. At the same time, we continue to be disciplined strategic buyers of existing casinos that meet our investment criteria. And third, we are pursuing the expansion of our BetAmerica Sportsbook and iGaming platform. This effort will be led by our Twin Spires team. As states open up their markets, we will further invest in our team and our online footprint. New Jersey and Pennsylvania are the two states we are most excited about currently, but we hope that over time these are simply two of many states where we have opportunities to expand. Now I will make a few comments on our growth plans for each of our operating segments. Starting with the racing segment, the Kentucky Derby is the big driver of our growth. As I mentioned, we set records last year for virtually all of our significant financial benchmarks despite suffering the wettest Kentucky Derby in history. Beyond the metrics, our mission is to improve everything we do surrounding the Kentucky Derby. We have consistently invested to deliver a world-class experience for our customers. Our strategy for the long-term growth of the Derby is to invest in projects that help more of our guests feel a strong connection to the event and to experience as a participant, not just as a spectator, the unique magic that is the Kentucky Derby. For this year's Kentucky Derby, we will unveil our $5 million rooftop lounge and entertainment area on top of the starting gate suites. There are many avenues to grow our signature event over the coming years, from additional pricing segmentation, additional seating capacity for portions of the roughly 110,000 guests who come to the Derby and do not have a seat, additional sponsorships, and leveraging the interest generated from the European and Japan roads to the Derby. With respect to racing at Churchill Downs Racetrack, we are excited about the increase to the purse money account for 2019 generated by the historical racing machines at Derby City Gaming. Just as an example, we are increasing the prize money for the Kentucky Derby from $2 million to $3 million, and on a smaller scale, increasing the purses meaningfully for every category of races we run. We believe increased purse money will help us attract more and better quality horses to Churchill Downs, Ultimately, this will increase the amount wagered on our races, which is good for horse ownership and other industry participants, as well as for the Commonwealth of Kentucky. Turning to our Twin Spires business in our online wagering segment, adjusted EBITDA was up 6.1% for the quarter and 13% for the year. However, our Twin Spires handle was up 8.3% in 2018 and up only 1.2% in the fourth quarter. Clearly, we've experienced a decline in the handle growth rate over the second half of 2018. At the same time, total active players were up 19% in 2018 and up 13% in the fourth quarter. We continue to reach new customers and to engage or re-engage with existing ones with our marketing programs consistent with prior periods. We had two conflicting trends, particularly in the fourth quarter, modest handle growth and yet strong double-digit growth in total active players. Our revenue per customer dropped by 12% in the fourth quarter, and although we had strong growth in total active players, our overall handle growth was very modest. We still achieve solid adjusted EBITDA results because we pay close attention and respond quickly to our data. Our business processes and focus on margins keep us very disciplined. We believe there are two drivers of our trend towards declining revenue per customer. First, we are seeing increased competition for higher volume customers who receive rebates. As you know, rebates cut into our margins and high-level rebating has always been a slippery slope that can become an unwise, pervasive business practice. In the face of this increasing challenge, we revisited our business model with respect to player rebates and incentives. We concluded that we are best served by letting certain customer cohorts leave as margins become too thin. Our objective is always to grow our business profitably over the long term, and we will not sacrifice a sustainable business model in the face of shorter-term competitive pressures. Second, as our customer base is growing, we expect the average handle per user to decline. Although we want to mitigate the rate of decline as best we can by retaining the more experienced, higher wagering customers who we can profitably retain. As new customers come into our platform in large numbers, as they did in 2018, these players are on average much less experienced and wager considerably less. They do tend to be higher margin for us, however, because they do not require significant rebates. The macro environment for horse racing is stable, and our team believes there's still organic growth to harvest in the ADW space. We have the unique opportunity every year to market extensively during the Kentucky Derby and Triple Crown season to attract new players to our Twin Spires platform. This is still a very good business, and we remain very optimistic about its long-term growth potential despite the recent competitive pressures. Turning to our casino segment. In 2018, we experienced relatively stable operating environments across all of our casino markets, and we grew revenue and adjusted EBITDA at each of our existing properties. 2019 so far has seen a continuation of these trends. However, we may see some increased competitive pressures in certain markets over the balance of the year. I'm excited about the future for the casino segment because we have a nice pipeline of growth beyond the continued performance of our existing properties. As you know, we issued a press release in the fourth quarter announcing our agreement to acquire at least 50.1% of Midwest Gaming, which owns the River Casino Des Plaines in Illinois. Based on our purchase of all of the ownership interests held by the Clairvest Group and the ownership interests tendered by certain minority shareholders with tag-along rights, we estimate that we will own approximately 62% of Midwest Gaming after the subsequent recapitalization. We expect to pay approximately $407 million in cash. The most significant remaining closing condition for this transaction is the regulatory approval of the Illinois Gaming Board. We are on the agenda for the March 1st meeting, that's tomorrow, but there is no guarantee that we will receive approval on that date. We would intend to close the transaction including the recapitalization of the entity within one to two weeks after we receive the Illinois Gaming Board approval. We regard Rivers as an important strategic acquisition for the following reasons. It gives us an investment in a premier gaming property in a highly desirable location in the Chicagoland market with future upside if gaming expansion is passed. We also believe it provides significant upside if Illinois ultimately grants sports betting and iGaming rights to brick and mortar casino license holders. And it is in a casino gaming market we have always valued as we work with the Illinois legislature to determine the future of our Arlington Park racetrack. In the past, we have not aggressively pursued regional casino acquisitions when multiples are comparatively high compared to prior periods. However, this asset is one of the few we especially value for the reasons I just noted and because Neil Bloom and his organization, with their deep understanding of the Illinois environment, will be our partner. We also consider our acquisition of Presque Isle Downs and Casino in Erie, Pennsylvania to be an important strategic move We closed on this acquisition on January 11th of this year. Presque Isle has limited competition geographically and is a nicely constructed property. We will begin construction of a new retail BetAmerica sportsbook in the casino and plan to open it in the second quarter. Presque has already been approved for an interactive gaming certificate as well as a sports betting certificate to offer online sports betting, both of which are subject to conditions such as testing, and an ultimate go live date that has not yet been set by the gaming control board. We believe Presque Isle has potential for a very nice upside. And last, in our other investments operating segment, we opened Derby City Gaming in Louisville in mid-September. The results have been extremely encouraging. We will be adding another 100 machines to Derby City Gaming early in the second quarter based on the significant growth we have seen in the last four months. We have approval for up to 2,000 machines under the Churchill Downs racing license, and we will continue to evaluate adding more machines as warranted by the facility's performance. As I mentioned earlier, we were awarded a racing license for our proposed Oak Grove, Kentucky historical racing machine facility. We expect to conduct 12 harness racing days in October 2019 and plan to open the historical racing facility during the first half of 2020. We're excited about the opportunity to build this facility about an hour north of Nashville, Tennessee, which was ranked by Forbes as the seventh fastest growing city in America in 2018. Our acquisitions in the casino space and our pursuit of historical racing facilities reflect our long-held strategy of pursuing both acquisitions and greenfield investments in gaming properties we believe will offer stable, predictable cash flows in diverse markets. We like states that we believe may ultimately grant access to sports and online casino gaming to their brick-and-mortar casino license holders as well. We have a deeply experienced online team, and an important objective for this team is to lead us beyond horse racing into sports betting and online casino wagering. Our team has started to do this with our efforts in Mississippi, New Jersey, and soon Pennsylvania. In Mississippi, where we have our Harlow's and Riverwalk Vicksburg casinos, Wagering on sports is now permitted in the brick and mortar locations, but not outside of the confines of the casino. We launched a sports book at each property in late August. Given wagering is limited solely to the physical location, we view Mississippi as an excellent opportunity to test our technology and build our team's expertise before the stakes are raised in more economically significant markets. The 2018 numbers have been released by the State of Mississippi and we've been very pleased so far with our performance in our local markets in Greenville and Vicksburg. Our BetAmerica sportsbooks were profitable in the fourth quarter of 2018 and are included in our casino segment results. We believe they are also driving traffic to other gaming products on the floor. In all jurisdictions, BetAmerica will be our brand for both brick and mortar sportsbooks and online sports betting and casino wagering. In New Jersey, we've entered into what is known as a skin agreement with the Golden Nugget Atlantic City Casino to gain access to the New Jersey online market. We do not have a casino in New Jersey to enter the market directly, but have an arrangement with Golden Nugget which allows us full management and control of our own site. Earlier this month we launched our BetAmerica platform. We've been surprised how well we have started in New Jersey because we have not yet marketed in any material way. We are still awaiting approval from Apple to put our iOS app in the Apple Store. Thus, our product is largely available only on desktop right now. We are also completing the implementation of our full list of payment and game vendors, which we think will give us an extremely competitive, compelling product. Given we have outsourced technology, which we believe is best in class, while already building a team with significant online capabilities, the cost for entry into new markets is relatively modest for us. and we've been thoughtful in our approach to working with vendors and market access partners to preserve as much upside for ourselves as practicable. We expect to spend a modest amount on sports betting and iGaming marketing in 2019 in New Jersey and Pennsylvania of which the timing and amounts will depend on a number of factors including final regulatory approvals, sports seasonality and return on our ad spend. A few final thoughts. Over the past five years, we have delivered a total shareholder return of 183% and have returned over $1 billion to our shareholders through share repurchases and dividends while growing our operations significantly. We have accomplished this while remaining very modestly levered at 2.3 times as of year end. We have significant flexibility because of our strong operating performance and low leverage. This gives us the ability to invest in our existing businesses as well as new greenfield opportunities to drive organic growth and to also pursue strategic opportunities that we believe will create long-term shareholder value while maintaining capacity for dividend growth and opportunistic share repurchases. We've done this for a while and plan to continue to be thoughtful stewards of our shareholder capital and assets. I'm excited about 2019 and beyond. I want to acknowledge Mr. Richard Duchossois, one of our longtime stalwart directors who is retiring and will not be standing for reelection at our next annual shareholder meeting in April. Mr. D., as I call him, has been a source of inspiration and a true mentor for me personally and for so many of us in the company. I am so grateful for his significant contributions to the company and for his friendship. On behalf of the company, we thank him for his exemplary service and note that he will be greatly missed. Our next call is scheduled for the week before the Kentucky Derby. Our team has a lot to do before then, but everything is in good shape as of right now, 65 days out. Now I'd like to turn the call over to Marcia to provide some additional details on the fourth quarter. After that, we will answer any questions that you have. Thank you. Marcia?