10Q 2nd Quarter 2005


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
 
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

OR

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Commission file number 0-1469

Churchill Downs Incorporated Logo

(Exact name of registrant as specified in its charter)

Kentucky
61-0156015
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)

700 Central Avenue, Louisville, Kentucky 40208
(Address of principal executive offices) (zip code)

(502) 636-4400
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes X No____

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No____

The number of shares outstanding of registrant's common stock at August 2, 2005 was 12,933,058 shares.

 

Return to Index
 
CHURCHILL DOWNS INCORPORATED
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended June 30, 2005


 
Part I - FINANCIAL INFORMATION
Page
     
Item 1.
Financial Statements
 
     
 
3
     
 
4
     
 
5
     
 
6
     
Item 2.
16
     
Item 3.
34
     
Item 4.
35
     
 
Part II - OTHER INFORMATION
 
     
Item 1.
36
     
Item 2.
36
     
Item 3.
36
     
Item 4.
36
     
Item 5.
37
     
Item 6.
37
     
 
38
     
 
39

2

 
Return to Index
 
PART I.
 
FINANCIAL INFORMATION
 
ITEM 1.
 
FINANCIAL STATEMENTS
 
CHURCHILL DOWNS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands)
 
   
 June 30,
 December 31,
   
   
 2005
 2004
   
ASSETS
         
Current assets:
         
Cash and cash equivalents
 
$14,568
 
$26,487
 
Restricted cash
 
9,107
 
7,267
 
Accounts receivable, net of allowance for doubtful accounts of $881 at June 30, 2005 and
   December 31, 2004
 
35,544
 
41,121
 
      Deferred income taxes    3,618   3,940  
      Other current assets  
6,615
 
3,589
 
       Assets held for sale  
167,380
 
145,034
 
Total current assets
 
236,832
 
227,438
 
Other assets
 
17,678
 
17,105
 
Plant and equipment, net
 
348,604
 
324,738
 
Goodwill
 
53,528
 
53,528
 
Other intangible assets, net
 
18,660
 
19,149
 
Total assets
 
$675,302
 
$641,958
 
LIABILITIES AND SHAREHOLDERS' EQUITY
         
Current liabilities:
         
Accounts payable
 
$37,535
 
$28,872
 
Purses payable
 
17,022
 
8,464
 
Accrued expenses and other liabilities
 
42,064
 
30,985
 
Dividends payable
 
-
 
6,430
 
Income taxes payable
 
4,859
 
96
 
Deferred revenue
 
7,148
 
25,880
 
Liabilities associated with assets held for sale
 
29,888
 
11,852
 
Total current liabilities
 
138,516
 
112,579
 
Long-term debt
 
237,462
 
242,770
 
Other liabilities
 
21,876
 
20,424
 
Deferred revenue
 
18,792
 
19,071
 
Deferred income taxes
 
8,677
 
8,686
 
Total liabilities
 
425,323
 
403,530
 
Commitments and contingencies
         
Shareholders' equity:
         
Preferred stock, no par value; 250 shares authorized; no shares issued
 
-
 
-
 
Common stock, no par value; 50,000 shares authorized; issued 12,930 shares
   June 30, 2005 and 12,904 shares December 31, 2004
 
115,624
 
114,930
 
Retained earnings
 
135,902
 
125,613
 
Unearned compensation
 
(1,762
)
(1,935
)
Accumulated other comprehensive income (loss)
 
215
 
(180
)
Total shareholders’ equity
 
249,979
 
238,428
 
Total liabilities and shareholders’ equity
 
$675,302
 
$641,958
 

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

3

 
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CHURCHILL DOWNS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF NET EARNINGS
AND COMPREHENSIVE EARNINGS
for the three and six months ended June 30, 2005 and 2004
(Unaudited)
(in thousands, except per share data)
 
 
 
Three Months Ended June 30, 
 
Six Months Ended June 30, 
 
   
2005 
 
2004 
 
2005 
 
2004 
 
                   
Net revenues
 
$163,202
 
$140,159
 
$215,019
 
$172,789
 
Operating expenses
 
110,352
 
93,959
 
167,278
 
133,153
 
Gross profit
 
52,850
 
46,200
 
47,741
 
39,636
 
Selling, general and administrative expenses
 
12,461
 
8,298
 
25,382
 
15,858
 
Operating income
 
40,389
 
37,902
 
22,359
 
23,778
 
Other income (expense):
                 
Interest income
 
76
 
75
 
161
 
191
 
Interest expense
 
(390
)
(204
)
(685
)
(385
)
Unrealized gain on derivative instruments
 
204
 
-
 
410
 
-
 
Miscellaneous, net
 
80
 
502
 
617
 
837
 
   
(30
)
373
 
503
 
643
 
Earnings from continuing operations before
  provision for income taxes
 
40,359
 
38,275
 
22,862
 
24,421
 
Provision for income taxes
 
(17,681
)
(15,398
)
(10,042
)
(9,773
)
Net earnings from continuing operations
 
22,678
 
22,877
 
12,820
 
14,648
 
Discontinued operations, net of income taxes:
                 
Earnings (loss) from operations
 
1,508
 
4,819
 
(2,531
)
1,302
 
Net earnings
 
$24,186
 
$27,696
 
$10,289
 
$15,950
 
Other comprehensive (loss) income, net of tax:
                 
Change in fair value of cash flow hedges
 
(674
)
1,320
 
395
 
611
 
Comprehensive income
 
$23,512
 
$29,016
 
$10,684
 
$16,561
 
 
Net earnings (loss) per common share data:
                 
Basic
                 
Net earnings from continuing operations
 
$1.70
 
$1.72
 
$0.96
 
$1.10
 
Discontinued operations:
                 
Earnings (loss) from operations
 
0.11
 
0.36
 
(0.19
)
0.10
 
Net earnings
 
$1.81
 
$2.08
 
$0.77
 
$1.20
 
Diluted
                 
Net earnings from continuing operations
 
$1.69
 
$1.70
 
$0.95
 
$1.09
 
Discontinued operations:
                 
Earnings (loss) from operations
 
0.11
 
0.36
 
(0.19
)
0.09
 
Net earnings
 
$1.80
 
$2.06
 
$0.76
 
$1.18
 
Weighted average shares outstanding:
                 
Basic
 
12,884
 
13,287
 
12,882
 
13,272
 
Diluted
 
13,457
 
13,473
 
13,506
 
13,460
 

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.
 
4

 
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CHURCHILL DOWNS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30,
(Unaudited)
(in thousands)
 
   
2005
 
2004
 
Cash flows from operating activities:
         
Net earnings
 
$10,289
 
$15,950
 
Adjustments to reconcile net earnings to net cash provided by operating activities:
         
Depreciation and amortization
 
13,563
 
10,819
 
Amortization of discount on convertible note payable
 
210
 
-
 
Amortization of restricted stock grant
 
198
 
-
 
Unrealized gain on derivative instruments
 
(410
)
-
 
Loss on asset disposition
 
72
 
-
 
Increase (decrease) in cash resulting from changes in operating assets and liabilities:
         
Restricted cash
 
(17,125
)
(14,478
)
Accounts receivable
 
(14,766
)
(19,863
)
Other current assets
 
(3,482
)
(3,215
)
Accounts payable
 
24,143
 
29,824
 
Purses payable
 
8,558
 
9,448
 
Accrued expenses and other liabilities
 
10,739
 
10,035
 
Income taxes payable
 
4,763
 
7,240
 
Deferred revenue
 
(1,366
)
(7,121
)
Other assets and liabilities
 
1,281
 
2,406
 
Net cash provided by operating activities
 
36,667
 
41,045
 
Cash flows from investing activities:
         
Additions to plant and equipment
 
(32,913
)
(47,828
)
Proceeds on sale of fixed assets
 
2
 
-
 
Net cash used in investing activities
 
(32,911
)
(47,828
)
Cash flows from financing activities:
         
Borrowings on bank line of credit
 
217,423
 
196,295
 
Repayments of bank line of credit
 
(222,942
)
(175,434
)
Repayments of long-term debt
 
-
 
(1,618
)
Change in book overdraft
 
1,285
 
15
 
Payment of dividends
 
(6,430
)
(6,625
)
Common stock issued
 
670
 
1,206
 
Net cash (used in) provided by financing activities
 
(9,994
)
13,839
 
Net (decrease) increase in cash and cash equivalents
 
(6,238
)
7,056
 
Cash and cash equivalents, beginning of period
 
27,712
 
16,440
 
Cash and cash equivalents, end of period
 
21,474
 
23,496
 
Cash and cash equivalents included in assets held for sale
 
(6,906
)
(10,287
)
Cash and cash equivalents in continuing operations
 
$14,568
 
$13,209
 
 
Cash paid during the period for:
         
Interest
 
6,909
 
2,960
 
Income taxes
 
5,511
 
3,009
 
Schedule of non-cash activities:
         
Invoicing for future events
 
1,208
 
362
 
Plant and equipment additions included in accounts payable/accrued expenses
 
4,004
 
5,915
 
Issuance of common stock in connection with restricted stock plan
 
30
 
-
 
 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.
 
5

 
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CHURCHILL DOWNS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
for the three and six months ended June 30, 2005 and 2004 (unaudited)
($ in thousands, except per share data)
 
1.
Basis of Presentation

The accompanying Condensed Consolidated Financial Statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures required by accounting principles generally accepted in the United States of America or those normally made in Churchill Downs Incorporated’s (the "Company") Annual Report on Form 10-K. The year-end Condensed Consolidated Balance Sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. Accordingly, the reader of this Quarterly Report on Form 10-Q should refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 for further information. The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with the Company’s customary accounting practices and have not been audited.

Certain prior period financial statement amounts have been reclassified to conform to the current period presentation. In the opinion of management, all adjustments considered necessary for a fair presentation of this information have been made and all such adjustments are of a normal recurring nature.

The Company’s revenues and earnings are significantly influenced by its racing calendar. Therefore, revenues and operating results for any interim quarter are generally not indicative of the revenues and operating results for the year and may not be comparable with results for the corresponding period of the previous year. The Company historically has had very few live racing days during the first quarter, with a majority of its live racing occurring in the second, third and fourth quarters, including the running of the Kentucky Derby and the Kentucky Oaks during the second quarter, the quarter during which the Company typically generates the majority of its annual operating income. As a result of the acquisition of the Fair Grounds Race Course (“Fair Grounds”) during the fourth quarter of 2004, the Company had 63 live racing days during the first quarter of 2005, which compares to 10 live racing days during the first quarter of 2004.

Long-Lived Assets

In the event that facts and circumstances indicate that the carrying amount of tangible or intangible long-lived assets or groups of assets may be impaired, an evaluation of recoverability is performed. If an evaluation were required, the estimated future undiscounted cash flows associated with the assets would be compared to the assets’ carrying amount to determine if an impairment loss should be recorded. In addition, goodwill is otherwise tested for impairment on an annual basis in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets." In assessing whether goodwill is impaired, the fair market value of the related reporting unit is compared to its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair market value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test consists of comparing the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized equal to such excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination is determined. The Company completed the required impairment tests of goodwill and indefinite-lived intangible assets as of March 31, 2005, and no adjustment to the carrying value of goodwill and indefinite-lived intangible assets was required.

Revenue Recognition

The Company’s pari-mutuel revenues include commissions on pari-mutuel wagering at its racetracks and off-track betting facilities (net of state pari-mutuel taxes), plus simulcast host fees from other wagering sites and source market fees generated from contracts with in-home wagering providers. In addition to the commissions and fees earned on pari-mutuel wagering, the Company earns pari-mutuel related streams of revenues from sources that are not related to wagering. These other revenues are primarily derived from statutory racing regulations in some of the states where the facilities are located and can fluctuate materially year-to-year. Non-wagering revenues are primarily generated from admissions, sponsorships, licensing rights and broadcast fees, concessions, video poker, lease income and other sources and are recognized when the related service is performed. Non-wagering revenues also include the Indiana riverboat admissions subsidy, which is recognized ratably over the Company’s fiscal year.

6

 
Return to Index
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)
 
Pari-mutuel revenues are recognized upon occurrence of the live race that is presented for wagering and after that live race is made official by the respective state’s racing regulatory body. Additional non-wagering revenues such as admissions, programs and concession revenues are recognized as delivery of the product or services has occurred.

Greater than 75% of the Company’s annual revenues are generated by pari-mutuel wagering on live and simulcast racing content and in-home wagering. Live racing handle includes wagers made on live races at the Company’s live tracks and also wagers made on imported simulcast signals at the Company’s racetracks during live meets. Import simulcasting handle includes wagers on imported signals at the Company’s racetracks when the respective tracks are not conducting live race meets and at the Company’s off-track betting facilities ("OTB") throughout the year. Export handle includes all wagers made on live racing signals sent to other tracks, OTBs and in-home wagering. In-home wagering, or account wagering, consists of wagers through an advance deposit account.

The Company retains as revenue a pre-determined percentage or commission on the total amount wagered, and the balance is distributed to the winning patrons. The gross percentages retained on live racing and import simulcasting at the Company’s various locations range from approximately 15% to 27%. In general, the fees earned from export simulcasting are contractually determined and average approximately 3.5%. All commissions and fees earned from pari-mutuel wagering are shared with horsemen through payment of purses based on local contracts and statutes and average approximately 50%.

Purse Expense

The Company recognizes purse expense from the statutorily or contractually required percentage of revenue that is required to be paid out in the form of purses to the winning owners of horses in races run at the Company’s racetracks in the period in which wagering occurs. The Company incurs a liability for all unpaid purses to be paid out. The Company may pay out purses in excess of statutorily or contractually required amounts resulting in purse overpayments, which are expensed as incurred. Recoveries of purse overpayments are recognized in the period they are received.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees." Had the compensation cost for the Company’s stock-based compensation plans been determined consistent with Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based Compensation," ("SFAS No. 123") the Company’s net earnings and net earnings per common share for the three and six months ended June 30, 2005 and 2004 would approximate the pro forma amounts presented below:
 
 
 
Three Months Ended June 30, 
 
Six Months Ended June 30, 
 
 
 
2005 
 
2004 
 
2005 
 
2004 
 
Net earnings, as reported
 
$24,186
 
$27,696
 
$10,289
 
$15,950
 
Add: Stock based compensation expense included
    in reported net earnings, net of tax benefit
 
58
 
-
 
115
 
-
 
Deduct: Pro forma stock-based compensation
   expense, net of tax benefit
 
(318
)
(681
)
(635
)
(869
)
Pro forma net earnings
 
$23,926
 
$27,015
 
$9,769
 
$15,081
 
                   
Pro forma net earnings per common share:
                 
Basic
 
$1.79
 
$2.03
 
$0.73
 
$1.14
 
Diluted
 
$1.78
 
$2.01
 
$0.72
 
$1.12
 

The Company anticipates making awards in the future under stock-based compensation plans.
 
7

 
Return to Index
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)

2.
Discontinued Operations

On July 6, 2005, Churchill Downs California Company (“CDCC”), a wholly owned subsidiary of the Company, entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Bay Meadows Land Company, LLC (the “Purchaser”), pursuant to which CDCC will sell, and the Purchaser will acquire, the Hollywood Park Racetrack horse racing facility and the Hollywood Park Casino facility located in Inglewood, California. Pursuant to the Purchase Agreement, the Purchaser will acquire substantially all of the assets of CDCC used in its operation of the Hollywood Park Racetrack which includes land, buildings, improvements and equipment, and the building in which the Hollywood Park Casino is operated and related fixtures (the “Casino Building”) (the acquired assets associated with the Hollywood Park Racetrack and the Casino Building are collectively referred to as the “Assets”).

The Purchaser agreed to pay CDCC $260.0 million cash for the Assets, and in addition, the Purchaser agreed to assume certain liabilities of CDCC relating to the Assets, subject to certain adjustments contained in the Purchase Agreement. Upon execution of the Purchase Agreement, the Purchaser paid into escrow $10.0 million as a deposit to be applied to the purchase price at closing, to occur on September 23, 2005 unless extended pursuant to the Purchase Agreement.

The parties agreed to enter into, at the closing of the transactions contemplated by the Purchase Agreement, a reinvestment agreement among the Purchaser, Stockbridge HP Holdings Company, LLC, a subsidiary of the Purchaser, and Churchill Downs Investment Company, a wholly owned subsidiary of the Company (the “Reinvestment Agreement”). Pursuant to the Reinvestment Agreement, Churchill Downs Investment Company will have the option to reinvest in the Hollywood Park Racetrack business, in the event of certain triggering events which would allow the Hollywood Park Racetrack business to engage in electronic gaming, or other significant gaming and/or subsidies not currently authorized.

The Purchase Agreement provides for a liquidated damages payment to CDCC of $15.0 million related to the Reinvestment Agreement and other consequential damages arising as a result of lost profits if, prior to three years after the date of closing, the Purchaser terminates the Hollywood Park Racetrack business for reasons other than Hollywood Park Racetrack’s allocation of a number of racing dates that is less than the number of racing dates historically allocated to Hollywood Park Racetrack and the Purchaser’s determination that continued operation of the business would be reasonably likely to result in net cash flow (as defined in the Purchase Agreement) of zero dollars or less during the current or any following year.

In addition, the Purchaser agreed to make up to $5.0 million of capital improvements to Hollywood Park Racetrack if the allocation of racing dates to Hollywood Park Racetrack for each of the three years immediately following the closing is not less than the number of racing dates historically allocated to Hollywood Park Racetrack, and if such improvements are not made as required by the Purchase Agreement, the Purchaser is obligated to pay CDCC liquidated damages in the amount of $5.0 million less the amount actually spent on such improvements.

Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), assets to be sold shall be classified as held for sale once all of the following criteria have been met:

§
Management, having the authority to approve the action, commits to a plan to sell the assets.
§
The assets are available for immediate sale in their present condition subject only to terms that are usual and customary for sales of such assets.
§
An active program to locate a buyer and other actions required to complete the plan to sell the assets have been initiated.
§
The sale of the assets is probable and transfer of the assets is expected to qualify for recognition as a completed sale within one year.
§
The assets are being marketed for sale at a price that is reasonable in relation to their current fair market values.
§
Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

8

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)

As of June 30, 2005, all of the above criteria were met and the Assets were reclassified as held for sale. As of July 1, 2005, the Company ceased the recognition of depreciation expense on the long-lived assets included in the assets held for sale. Also, we are required under the existing debt agreements for both the revolving loan facility and the variable rate senior notes to use the proceeds to pay off the debt balances under these facilities.

Set forth below is a summary of the results of operations of the assets held for sale for the three and six months ended June 30, 2005 and 2004:
 
 
 Three Months Ended June 30, 
Six Months Ended June 30, 
 
 
2005 
 
2004 
 
2005 
 
2004 
 
                   
Net revenues
 
$49,369
 
$49,476
 
$53,804
 
$54,575
 
Operating expenses
 
38,553
 
37,748
 
47,016
 
46,047
 
Gross profit
 
10,816
 
11,728
 
6,788
 
8,528
 
Selling, general and administrative expenses
 
2,134
 
1,787
 
3,355
 
3,305
 
Operating income
 
8,682
 
9,941
 
3,433
 
5,223
 
Other income (expense):
                 
Interest income
 
13
 
10
 
14
 
10
 
Interest expense
 
(3,281
)
(970
)
(5,633
)
(2,173
)
Miscellaneous, net
 
2
 
2
 
2
 
3
 
   
(3,266
)
(958
)
(5,617
)
(2,160
)
Earnings (loss) before provision for income taxes
 
5,416
 
8,983
 
(2,184
)
3,063
 
Provision for income taxes
 
(3,908
)
(4,164
)
(347
)
(1,761
)
Net earnings (loss)
 
$1,508
 
$4,819
 
$(2,531
)
$1,302
 

Set forth below is a summary of the net assets held for sale as of June 30, 2005 and December 31, 2004:
 
 
 
June30,
2005
 
December 31,
2004 
 
      Current assets          
Cash and cash equivalents
 
$6,906
 
$1,225
 
Restricted cash
 
15,285
 
-
 
Accounts receivable
 
12,367
 
9,402
 
Other current assets
 
957
 
501
 
Plant and equipment, net
 
131,865
 
133,906
 
Assets held for sale
 
167,380
 
145,034
 
Current liabilities:
         
Accounts payable
 
22,030
 
5,265
 
Accrued expenses
 
7,529
 
6,526
 
Deferred revenue
 
329
 
61
 
Liabilities associated with assets held for sale
 
29,888
 
11,852
 
Net assets held for sale
 
$137,492
 
$133,182
 
 
9

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)
 
3.
Convertible Notes Payable

On October 19, 2004, the Company acquired 452,603 shares of its common stock from a shareholder in exchange for a convertible promissory note in the principal amount of $16.7 million, due October 18, 2014. The convertible note was amended and restated on March 7, 2005 (as so amended and restated the "Note") to eliminate the Company’s ability to pay the Note at maturity with shares of its common stock. The Company will pay interest on the principal amount of the Note on an annual basis in an amount equal to what the shareholder would have received as a dividend on the shares that were redeemed. The Note is immediately convertible, at the option of the shareholder, into shares of the Company’s common stock at a conversion price of $36.83. The Note may not be prepaid without the shareholder’s consent. Upon maturity, the Company must pay the principal balance and unpaid accrued interest in cash. Prior to the amendment, the Note was deemed a short forward contract on common stock of the Company that included each of a short call option with a strike price of $36.83, a long put option with an equivalent strike price and a debt obligation consisting of interest amounts equal to the future dividends with respect to the underlying shares and a principal amount equal to the notional amount of $16.7 million. A discount of $4.2 million, representing the difference between the notional amount and the fair market value of $12.5 million of the debt obligation on the date of issuance, was recorded and is being amortized against interest expense over the term of the Note using the effective interest method.

The aforementioned derivative financial instruments were recorded separately and adjusted to fair market value on December 31, 2004 and March 7, 2005 in the Company’s Condensed Consolidated Balance Sheet as follows:

 
December 31, 2004
 
March 7, 2005
 
Change
Long put option
$3,413
 
$3,408
 
$(5)
Short call option
(11,410)
 
(11,233)
 
177
Net derivative financial instrument
$(7,997)
 
$(7,825)
 
$172

Effective on the date of the amendment, the Note was deemed a conventional convertible debt instrument. As such, the Note was adjusted to fair market value on March 7, 2005 against current earnings. The long put option and short call option are included in other assets and other liabilities, respectively, and are both being amortized into earnings on a straight-line basis over the remaining term of the Note. The Company recorded unrealized gains on derivative instruments in the amounts of $204 and $410 during the three and six months ended June 30, 2005, respectively, which includes $204 and $238 of amortization during the three and six months ended June 30, 2005, respectively.

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)
 
4.
Earnings Per Share

The following is a reconciliation of the numerator and denominator of the earnings (loss) per common share computations:
 
   
Three Months Ended June 30, 
 
Six Months Ended June 30, 
 
   
2005
 
2004
 
2005
 
2004
 
Numerator for basic earnings from continuing operations
    per common share:
                 
Net earnings from continuing operations
 
$22,678
 
$22,877
 
$12,820
 
$14,648
 
Net earnings from continuing operations allocated to
   participating securities
 
(770
)
-
 
(435
)
-
 
Numerator for basic earnings from continuing operations
   per common share
 
$21,908
 
$22,877
 
$12,385
 
$14,648
 
                   
Numerator for basic earnings per common share:
                 
Net earnings
 
$24,186
 
$27,696
 
$10,289
 
$15,950
 
Net earnings allocated to participating securities
 
(821
)
-
 
(349
)
-
 
Numerator for basic earnings per common share
 
$23,365
 
$27,696
 
$9,940
 
$15,950
 
                   
Numerator for diluted earnings per common share:
                 
Net earnings from continuing operations
 
$22,678
 
$22,877
 
$12,820
 
$14,648
 
Discontinued operations, net of income taxes
 
1,508
 
4,819
 
(2,531
)
1,302
 
Net earnings
 
$24,186
 
$27,696
 
$10,289
 
$15,950
 
                   
Denominator for earnings per common share:
                 
Basic
 
12,884
 
13,287
 
12,882
 
13,272
 
Plus dilutive effect of stock options
 
120
 
186
 
171
 
188
 
Plus dilutive effect of convertible note
 
453
 
-
 
453
 
-
 
Diluted
 
13,457
 
13,473
 
13,506
 
13,460
 
                   
Earnings (loss) per common share:
                 
Basic
                 
Earnings from continuing operations
 
$1.70
 
$1.72
 
$0.96
 
$1.10
 
Discontinued operations:
                 
Earnings (loss) from operations
 
0.11
 
0.36
 
(0.19
)
0.10
 
Net earnings
 
$1.81
 
$2.08
 
$0.77
 
$1.20
 
                   
Diluted
                 
Earnings from continuing operations
 
$1.69
 
$1.70
 
$0.95
 
$1.09
 
Discontinued operations:
                 
Earnings (loss) from operations
 
0.11
 
0.36
 
(0.19
)
0.09
 
Net earnings
 
$1.80
 
$2.06
 
$0.76
 
$1.18
 
 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)
 
5.
Segment Information

The Company has determined that it currently operates in the following 7 segments: (1) Kentucky Operations, including Churchill Downs racetrack and its off-track betting facility ("OTB") and Ellis Park racetrack and its on-site simulcast facility; (2) Calder Race Course; (3) Arlington Park and its 8 OTBs; (4) Hoosier Park racetrack and its on-site simulcast facility and its 3 OTBs; (5) Louisiana Operations, including Fair Grounds, its 11 OTBs and Video Services, Inc.; (6) Churchill Downs Simulcast Network ("CDSN"), the simulcast product provider of the Company; and (7) other investments, including Churchill Downs Simulcast Productions and the Company’s various equity interests, which are not material. Financial information about the Company’s reported segments in the tables below has been updated to reflect discontinued operations as a result of the Purchase Agreement entered into by CDCC as discussed in Note 2. Eliminations include the elimination of management fees and other intersegment transactions, primarily between CDSN and the racetracks.

The accounting policies of the segments are the same as those described in the "Summary of Significant Accounting Policies" in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. The Company uses revenues and EBITDA (defined as earnings before interest, taxes, depreciation and amortization) as key performance measures of results of operations for purposes of evaluating performance internally. Furthermore, management believes that the use of these measures enables management and investors to evaluate and compare from period to period, the Company’s operating performance in a meaningful and consistent manner. Because the Company uses EBITDA as a key performance measure of financial performance, the Company is required by accounting principles generally accepted in the United States of America to provide the information in this footnote concerning EBITDA. However, these measures should not be considered as an alternative to, or more meaningful than, net earnings (loss) (as determined in accordance with accounting principles generally accepted in the United States of America) as a measure of the Company’s operating results or operating cash flows (as determined in accordance with accounting principles generally accepted in the United States of America) as a measure of the Company’s liquidity.
 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)

The table below presents information about reported segments for the three and six months ended June 30, 2005 and 2004:
 
 
Three Months Ended June 30,
Six Months Ended June 30,
 
2005
 
2004
 
2005
 
2004
Net revenues from external customers:
             
Kentucky Operations
$65,244
 
$57,194
 
$69,621
 
$61,927
Arlington Park
22,472
 
22,610
 
33,917
 
38,665
Calder Race Course
22,812
 
22,170
 
24,430
 
23,685
Hoosier Park
11,527
 
11,193
 
20,438
 
20,603
Louisiana Operations
14,820
 
-
 
31,387
 
-
CDSN
25,523
 
26,132
 
34,289
 
27,011
Total racing operations
162,398
 
139,299
 
214,082
 
171,891
Other investments
206
 
200
 
206
 
238
Corporate
1,019
 
1,024
 
1,152
 
1,024
Net revenues from continuing operations
163,623
 
140,523
 
215,440
 
173,153
Discontinued operations
48,948
 
49,112
 
53,383
 
54,211
 
$212,571
 
$189,635
 
$268,823
 
$227,364
Inter-company net revenues:
             
Kentucky Operations
$14,734
 
$15,257
 
$14,752
 
$15,257
Arlington Park
2,623
 
2,164
 
2,623
 
2,164
Calder Race Course
2,699
 
2,982
 
2,991
 
3,266
Hoosier Park
76
 
43
 
76
 
50
Louisiana Operations
-
 
-
 
6,335
 
-
Total racing operations
20,132
 
20,446
 
26,777
 
20,737
Other investments
680
 
700
 
817
 
845
Corporate
265
 
266
 
525
 
544
Eliminations
(21,498) 
 
(21,776) 
 
(28,540) 
 
(22,490) 
 
(421) 
 
(364) 
 
(421) 
 
(364) 
Discontinued operations
    421
 
 364
 
421  
 
364
 
$ -
 
$ -
 
$ -
 
$ -
Segment EBITDA and net earnings:
             
Kentucky Operations
$38,177
 
$30,332
 
$31,576
 
$24,156
Arlington Park
2,090
 
2,920
 
439
 
3,324
Calder Race Course
3,018
 
3,354
 
(2,723) 
 
702
Hoosier Park
410
 
493
 
824 
 
1,167
Louisiana Operations
92
 
-
 
1,837 
 
-
CDSN
6,184
 
6,264
 
8,317 
 
6,131
Total racing operations
49,971
 
43,363
 
40,270 
 
35,480
Other investments
372
 
632
 
550 
 
647
Corporate
(3,696) 
 
(1,707) 
 
(7,047)  
 
(3,794) 
Total EBITDA from continuing operations
46,647
 
42,288
 
33,773 
 
32,333 
Eliminations
 
(6) 
 
 
(6)  
Depreciation and amortization
(5,974) 
 
(3,878) 
 
(10,387)  
 
(7,712)  
Interest income (expense), net
(314) 
 
(129) 
 
(524)   
 
(194)  
Provision for income taxes
(17,681) 
 
(15,398) 
 
(10,042)   
 
(9,773)  
Net earnings from continuing operations
22,678
 
22,877
 
12,820  
 
14,648 
Discontinued operations, net of income taxes
1,508
 
4,819
 
(2,531)   
 
1,302 
Net earnings
$24,186
 
$27,696
 
$10,289  
 
$15,950 
 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)

The table below presents total asset information about reported segments:
 
   
June30,
2005
  December 31,
2005
 
Total assets:
         
Kentucky Operations
 
$573,654
 
$572,039
 
Arlington Park
 
85,160
 
83,047
 
Calder Race Course
 
88,467
 
89,393
 
Hoosier Park
 
37,329
 
33,073
 
Louisiana Operations
 
72,967
 
74,971
 
CDSN
 
11,018
 
11,018
 
Other investments
 
129,646
 
114,945
 
Assets held for sale
 
167,380
 
145,034
 
   
1,165,621
 
1,123,520
 
Eliminations
 
(490,319
)
(481,562
)
   
$675,302
 
$641,958
 
           
 
 
Six Months Ended June 30, 
   
2005
 
2004
 
Capital expenditures, net:
         
Kentucky Operations
 
$22,489
 
$40,345
 
Hollywood Park
 
1,135
 
3,133
 
Calder Race Course
 
1,474
 
2,242
 
Arlington Park
 
4,540
 
1,729
 
Hoosier Park
 
124
 
372
 
Louisiana Operations
 
3,045
 
-
 
Other Investments
 
106
 
7
 
   
$32,913
 
$47,828
 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
($ in thousands, except per share data)

6.
Recently Issued Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)") to replace SFAS No. 123, "Accounting for Stock-Based Compensation" and APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123(R) requires, among other things, that all share-based payments to employees, including grants of stock options, be measured based on their grant-date fair market value and recognized as expense in the consolidated financial statements effective for interim or annual periods beginning after December 15, 2005. Unless observable market prices exist, the grant-date fair value is estimated using an appropriate option-pricing model as determined by management. Management must also make certain assumptions about employee exercise habits, forfeiture rates and select an appropriate amortization methodology for recognizing compensation expense. SFAS No. 123(R) permits a modified prospective method of adoption. Under this method, as a result of Staff Accounting Bulletin No. 107, "Share-Based Payment," compensation expense will be recorded in the consolidated financial statements for 1) all awards granted after January 1, 2006 and 2) the future vesting of awards outstanding as of January 1, 2006. Companies may also elect to restate their previously issued consolidated financial statements to provide consistency across all periods presented under a modified retrospective method. We have recently terminated our stock option plans and adopted a restricted stock plan. As a result, no stock options were granted during the six months ended June 30, 2005, and we have no current intentions of granting stock options during the year ended December 31, 2005. Upon adoption of SFAS No. 123(R), we will be required to begin expensing all unvested stock options over their remaining vesting periods. See Note 1 of our Condensed Consolidated Financial Statements for additional details related to pro forma stock-based compensation expense. Management has not yet selected the method of adoption, determined whether the adoption of SFAS No. 123(R) will have a material impact on our consolidated results of operations and earnings per share or determined whether adoption will result in expense amounts materially different from those currently provided under the pro forma disclosures in Note 1.
 
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ITEM 2.

Information set forth in this discussion and analysis contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Private Securities Litigation Reform Act of 1995 (the "Act") provides certain "safe harbor" provisions for forward-looking statements. All forward-looking statements made in this Quarterly Report on Form 10-Q are made pursuant to the Act. The reader is cautioned that such forward-looking statements are based on information available at the time and/or management’s good faith belief with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. Forward-looking statements speak only as of the date the statement was made. We assume no obligation to update forward-looking information to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information. Forward-looking statements are typically identified by the use of terms such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "might," "plan," "predict," "project," "should," "will," and similar words, although some forward-looking statements are expressed differently. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Important factors that could cause actual results to differ materially from expectations include: the effect of global economic conditions; the effect (including possible increases in the cost of doing business) resulting from future war and terrorist activities or political uncertainties; the economic environment; the impact of increasing insurance costs; the impact of interest rate fluctuations; the effect of any change in our accounting policies or practices; the financial performance of our racing operations; the impact of gaming competition (including lotteries and riverboat, cruise ship and land-based casinos) and other sports and entertainment options in those markets in which we operate; the impact of live racing day competition with other Florida, Louisiana and California racetracks within those respective markets; costs associated with our efforts in support of alternative gaming initiatives; costs associated with Customer Relationship Management initiatives; a substantial change in law or regulations affecting pari-mutuel and gaming activities; a substantial change in allocation of live racing days; litigation surrounding the Rosemont, Illinois riverboat casino; changes in Illinois law that impact revenues of racing operations in Illinois; a decrease in riverboat admissions subsidy revenue from our Indiana operations; the impact of an additional Indiana racetrack and its wagering facilities near our operations; our continued ability to effectively compete for the country’s top horses and trainers necessary to field high-quality horse racing; our continued ability to grow our share of the interstate simulcast market; our ability to execute our acquisition strategy and to complete or successfully operate planned expansion projects; our ability to successfully complete any divestiture transaction; our ability to adequately integrate acquired businesses; market reaction to our expansion projects; any business disruption associated with our facility renovations; the loss of our totalisator companies or their inability to provide adequate reliance on their internal control processes through Statement on Auditing Standards No. 70 reports or to keep their technology current; the need for various alternative gaming approvals in Louisiana; our accountability for environmental contamination; the loss of key personnel; and the volatility of our stock price.

You should read this discussion in conjunction with the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q and the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 for further information.

Overview

We conduct pari-mutuel wagering on live Thoroughbred, Quarter Horse and Standardbred horse racing and simulcast signals of races. Additionally, we offer racing services through our other interests, as well as alternative gaming through video poker machines in Louisiana.

We operate Churchill Downs racetrack in Louisville, Kentucky, which has conducted Thoroughbred racing since 1875 and is internationally known as the home of the Kentucky Derby, and Ellis Park Race Course, Inc., a Thoroughbred racing operation in Henderson, Kentucky (collectively referred to as "Kentucky Operations"). We also own and operate Hollywood Park, a Thoroughbred racing operation in Inglewood, California; Arlington Park, a Thoroughbred racing operation in Arlington Heights, Illinois; and Calder Race Course, a Thoroughbred racing operation in Miami Gardens, Florida. During October 2004, we purchased the assets of Fair Grounds Race Course, a Thoroughbred racing operation in New Orleans, Louisiana and the stock of Video Services, Inc. ("VSI"), the owner and operator of more than 700 video poker machines in Louisiana. Additionally, we are the majority owner and operator of Hoosier Park in Anderson, Indiana, which conducts Thoroughbred, Quarter Horse and Standardbred horse racing. We conduct simulcast wagering on horse racing at 23 simulcast wagering facilities in Kentucky, Indiana, Illinois and Louisiana, as well as at our seven racetracks.
 
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The Churchill Downs Simulcast Network ("CDSN") provides the principal oversight of interstate and international simulcast and wagering opportunities, as well as the marketing, sales, operations and data support efforts related to the Company-owned racing content.

Recent Development

On July 6, 2005, Churchill Downs California Company (“CDCC”), a wholly owned subsidiary of the Company, entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Bay Meadows Land Company, LLC (the “Purchaser”), pursuant to which CDCC will sell, and the Purchaser will acquire, the Hollywood Park Racetrack horse racing facility and the Hollywood Park Casino facility located in Inglewood, California. Pursuant to the Purchase Agreement, the Purchaser will acquire substantially all of the assets of CDCC used in its operation of the Hollywood Park Racetrack which includes land, buildings, improvements and equipment, and the building in which the Hollywood Park Casino is operated and related fixtures (the “Casino Building”) (the acquired assets associated with the Hollywood Park Racetrack and the Casino Building are collectively referred to as the “Assets”).

The Purchaser agreed to pay CDCC $260.0 million cash for the Assets, and in addition the Purchaser agreed to assume and perform certain liabilities of CDCC relating to the Assets, subject to certain adjustments contained in the Purchase Agreement. Upon execution of the Purchase Agreement, the Purchaser paid into escrow $10.0 million as a deposit to be applied to the purchase price at closing, to occur on September 23, 2005 unless extended pursuant to the Purchase Agreement.

The parties agreed to enter into, at the closing of the transactions contemplated by the Purchase Agreement, a reinvestment agreement among the Purchaser, Stockbridge HP Holdings Company, LLC, a subsidiary of the Purchaser, and Churchill Downs Investment Company, a wholly owned subsidiary of the Company (the “Reinvestment Agreement”). Pursuant to the Reinvestment Agreement, Churchill Downs Investment Company will have the option to reinvest in the Hollywood Park Racetrack business, in the event of certain triggering events which would allow the Hollywood Park Racetrack business to engage in electronic gaming, or other significant gaming and/or subsidies not currently authorized.

The Purchase Agreement provides for a liquidated damages payment to CDCC of $15.0 million related to the Reinvestment Agreement and other consequential damages arising as a result of lost profits if, prior to three years after the date of closing, the Purchaser terminates the Hollywood Park Racetrack business for reasons other than Hollywood Park Racetrack’s allocation of a number of racing dates that is less than the number of racing dates historically allocated to Hollywood Park Racetrack and the Purchaser’s determination that continued operation of the business would be reasonably likely to result in net cash flow (as defined in the Purchase Agreement) of zero dollars or less during the current or any following year.

In addition, the Purchaser agreed to make up to $5.0 million of capital improvements to Hollywood Park Racetrack if the allocation of racing dates to Hollywood Park Racetrack for each of the three years immediately following the closing is not less than the number of racing dates historically allocated to Hollywood Park Racetrack, and if such improvements are not made as required by the Purchase Agreement, the Purchaser is obligated to pay CDCC liquidated damages in the amount of $5.0 million less the amount actually spent on such improvements.

Legislative and Regulatory Developments

Federal

On October 11, 2004, the U.S. Congress passed The Foreign Sales Corporation Act (the “Act”). The Act includes a measure that repeals the 30% alien withholding requirements that should allow the U.S. horse racing industry to further export its product to foreign markets. President Bush signed the bill into law on October 22, 2004. The 30% withholding effectively precluded common pooling by foreign countries into U.S. wagering pools. We believe that the elimination of the 30% withholding requirement will help open the $85 billion international market for wagering on horse racing to U.S. tracks. The future impact on our results of operations or financial position at this time is uncertain.
 
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In 2003, the country of Antigua filed a formal complaint against the United States with the World Trade Organization ("WTO"), challenging the United States’ ability to enforce certain Federal gaming laws (Sections 1084, 1952 and 1955 of Title 18 of the United States Code known as the Wire Act, the Travel Act and the Illegal Gambling Business Act, respectively, and collectively the "Acts") against foreign companies that were accepting Internet wagers from United States residents. At issue was whether the United States’ enforcement of the Wire Act, the Travel Act and the Illegal Gambling Business Act against foreign companies violated the General Agreement on Trade in Services ("GATS"). In November of 2004, a WTO panel ruled that the United States, as a signatory of GATS, could not enforce the Acts against foreign companies that were accepting Internet wagers from United States residents. The United States appealed the ruling and, in April of 2005, the WTO's appellate body ruled that the United States had demonstrated that the Wire Act, the Travel Act and the Illegal Gambling Business Act were measures necessary to protect public morals or maintain public order, but that the United States did not enforce the Acts consistently between domestic companies and foreign companies as required by GATS. The WTO’s appellate body specifically referenced the Interstate Horseracing Act, which appeared to authorize domestic companies to accept Internet wagers on horseracing, as being inconsistent with the United States’ stated policy against Internet wagering. In arguments and briefs before the WTO’s appellate body, the United States argued that the Acts, specifically the Wire Act, applies equally to domestic companies and foreign companies and the Interstate Horseracing Act does not create an exception for domestic companies to accept Internet wagering on horseracing. The WTO’s appellate body did not rule on whether an exception was created, but recommended that the WTO’s Dispute Settlement Body request the United States bring measures found to be inconsistent with GATS into conformity with its obligations with GATS. The United States has fifteen months to bring its policies in line with the ruling, assuming it believes any changes are necessary. The effect of this ruling on the ability of domestic companies to accept Internet wagers and other account wagers on horseracing is unclear. The National Thoroughbred Racing Association, on behalf of its members, including Churchill Downs Incorporated, is currently in discussions with the U.S. Trade Representative on various alternatives the United States may choose to take both administratively and legislatively in the wake of the appellate ruling.

Indiana

Indiana HB 1569, which would have authorized slot machines at Indiana’s two pari-mutuel racetracks, was defeated in the Public Policy Committee of the Indiana General Assembly on February 14, 2005.

During April of 2005, Senate Enrolled Act 92 ("SEA 92"), a bill that makes it a Class D Felony for an operator to use the Internet to engage in unlawful gambling in Indiana or with a person located in Indiana, passed both chambers of the Indiana General Assembly and was signed by the Governor. An "operator", as defined by SEA 92, is a person who owns, maintains or operates an Internet site that is used for interactive gambling. Under SEA 92, effective July 1, 2005, an operator is guilty of professional gambling if it uses the Internet to accept, or offer to accept, for profit, money or other property risked in gambling in Indiana or in a transaction directly involving a person located in Indiana. We receive source market fees from various in-home wagering providers for the licensing of our live racing products in the distribution of such products through broadcast mediums such as television or the Internet. In the event these in-home wagering providers are determined to be operators and the activities engaged in by such persons are determined to be unlawful gambling under SEA 92, or such providers decide to cease operations in Indiana due to legal uncertainty as is the case with TVG, one of our major in-home providers in Indiana, the distribution of our products through in-home wagering in Indiana could cease or be seriously curtailed, which could have a material, adverse impact on our results of operations.

Florida

On November 2, 2004, Amendment 4, a slot machine question which sought to allow voters in Miami-Dade and Broward counties to hold local referenda on the issue, passed by a margin of 1.4%. On March 8, 2005, voters in Miami-Dade and Broward counties voted in separate local referenda to decide whether slot machines could be installed at the seven existing pari-mutuel sites in those counties, including Calder. Although the measure passed in Broward County, home of Gulfstream Park, it was unsuccessful in Miami-Dade County, where Calder is located. During the 2005 session of the Florida legislature, which ended in May 2005, the Broward and Miami-Dade pari-mutuel operators tried unsuccessfully to pass enabling legislation authorizing slot machine gaming at Broward pari-mutuel facilities. Amendment 4 mandated that such legislation be passed by the state legislature no later than July 1, 2005. Broward County's four pari-mutuel operators then filed suit in Broward Circuit Court seeking a ruling that slot machine gaming could proceed at their facilities after July 1 without legislative approval. 
 
On June 21, 2005, Broward Circuit Judge Leroy Moe ruled that the Broward pari-mutuel operators have a constitutional right to install slot machines despite the legislature's lack of action, but Judge Moe's ruling was quickly appealed by the State of Florida. Any further action on slot machine gaming in Broward County has been stayed pending the outcome of the State's appeal. We believe that the failure of the referendum to pass in Miami-Dade County was due primarily to Governor Jeb Bush’s active opposition to the measure during the final days of the campaign. We are preparing a strategy to seek passage in Miami-Dade County in 2007 when the issue can again be placed on the ballot. The impact on our results of operations and financial position of the failed referendum in Miami-Dade County is uncertain at this time.
 
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California

In California, Hollywood Park was part of a coalition of racetracks and card clubs supporting Proposal 68 on the November 2004 ballot. The proposal failed to pass by a margin of 16% to 84%. If passed, this initiative would have directed the governor to renegotiate all existing compacts with Native American tribes in California. If the tribes had declined to renegotiate the existing compacts, then five racetracks, including Hollywood Park, and 11 card clubs would have been allowed to operate electronic gaming devices. We continue to work with other members of the California horse industry on a long-term strategy for developing a legislative agenda that addresses the competitive advantages afforded to Native American casinos.

Illinois

In 1999, the State of Illinois enacted legislation that provides for pari-mutuel tax relief and related tax credits for Illinois racetracks, as well as legislation providing for subsidies to Illinois horse racing tracks from revenues generated by the relocation of a license to operate a riverboat casino gaming facility. Arlington Park’s share of subsidies from the relocation of the license under the 1999 legislation would range from $4.6 million to $8.0 million annually, based on publicly available sources. In the event Arlington Park receives such subsidies, additional shares of common stock would be issued to Duchossois Industries, Inc. ("DII"), to a maximum of 1.25 million shares only after the proposed casino opens and subsidies have been distributed for one year, under the merger agreement related to Arlington Park. The additional shares may be issued to DII in the future, subject to the occurrence of certain events as specified in the merger agreement. In January 2001, the Illinois Gaming Board ("IGB") denied a license application of Emerald Casino, Inc. to relocate the license to operate the Rosemont casino. During 2002, Emerald Casino, Inc. filed for bankruptcy and was attempting to sell its license rights subject to the approval of the IGB and the bankruptcy court. In April 2004, the IGB conducted an auction of the license and awarded that license to Isle of Capri Casinos, Inc., which announced plans to locate the license to operate in Rosemont, Illinois. Both the Governor of Illinois and the Attorney General of Illinois have convened investigations of the award by the IGB. The date for final approval by the bankruptcy court of the auction and issuance of the license by the IGB is not known at this time. In April 2005, the IGB, under a new Chairman, announced plans to conduct hearings to investigate the earlier IGB decision to allow Emerald Casino, Inc. to sell its license to Isle of Capri Casinos, Inc. and locate in Rosemont. Emerald Casino, Inc. also recently announced plans to possibly sell its license to Midwest Gaming and Entertainment, LLC, which has proposed a casino in Des Plaines, Illinois.
 
Pursuant to the Illinois Horse Racing Act, Arlington Park (and all other Illinois racetracks) is permitted to receive a payment commonly known as purse recapture. Generally, in any year that wagering on Illinois horse races at Arlington Park is less than 75% of wagering both in Illinois and at Arlington Park on Illinois horse races in 1994, Arlington Park is permitted to receive 2% of the difference in wagering in the subsequent year. The payment is funded from the Arlington Park purse account. Under the Illinois Horse Racing Act, the Arlington Park purse account is to be repaid via an appropriation by the Illinois General Assembly from the Illinois General Revenue Fund. However, this appropriation has not been made since 2001. Subsequently, Illinois horsemen unsuccessfully petitioned the Illinois Racing Board ("IRB") to prevent Illinois racetracks from receiving this payment in any year that the Illinois General Assembly did not appropriate the repayment to the racetrack’s purse accounts from the General Revenue Fund. Further, the Illinois horsemen filed lawsuits seeking, among other things, to block payment to Illinois racetracks, as well as to recover the 2002 and 2003 amounts already paid to the Illinois racetracks. These lawsuits filed by the Illinois horsemen challenging the 2002 and 2003 reimbursements have been resolved in favor of Arlington Park and the other Illinois racetracks. Several bills were filed in the 2003, 2004 and 2005 sessions of the Illinois legislature that, in part, would eliminate the statutory right of Arlington Park and the other Illinois racetracks to continue to receive this payment. None of these bills passed. As the legal right still exists, Arlington Park has elected to continue to receive the recapture payment from the purse account. If Arlington Park loses the statutory right to receive this payment, there would be a material adverse impact on Arlington Park’s results of operations.
 
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During January and February when there is no live racing in Illinois, the IRB designates a Thoroughbred racetrack as the host track in Illinois. The IRB appointed Arlington Park as the host track in Illinois during January 2005, which resulted in pari-mutuel revenues comparable to the same period in 2004. The IRB did not appoint Arlington Park as the host track in Illinois for February 2005, which resulted in a decrease of $1.8 million in pre-tax earnings for the month of February in 2005 compared to the same period in 2004. Arlington Park’s future designation as the host track is subject to the annual appointment by the IRB.

In 2005, gaming expansion legislation, which included authorization for electronic gaming devices at racetracks, passed a House Committee, but was not called for a vote on the House Floor before the deadline of April 15. Additionally House Bill 1917 was introduced to increase the limit on riverboat casino gaming positions from 1,200 to 3,000 and require riverboats to deposit 3% of adjusted gross revenues into the Horse Racing Equity Fund. This would take the place of the State subsidy to racing from the relocation of the tenth riverboat casino, authorized in 1999 but never funded due to the failure to relocate that license. House Bill 1917 also was not acted upon prior to the legislature's adjournment.

Kentucky

The Kentucky horse industry continues to seek legislation to allow alternative forms of gaming at the State’s eight existing racetracks. Alternative forms of gaming would enable our Kentucky racetracks to better compete with neighboring gaming venues by providing substantial new revenues for purses and capital improvements. Several alternative gaming bills were introduced in the 2005 session of the Kentucky General Assembly. The 2005 session concluded with no action having been taken with respect to such bills.

Louisiana

In 2003, the Louisiana Legislature passed a bill authorizing the operation of slot machines at Fair Grounds subject to amendment of Louisiana’s contract with Harrah’s Casino in New Orleans (which prohibited other land-based gaming in Orleans Parish), subject to Orleans Parish voter approval, and subject to the owner and operator of the track securing the necessary gaming licenses from the Louisiana Gaming Control Board. In addition, video poker operations must be discontinued at the main racetrack location when slot machines become operational.

In October 2003, Orleans Parish voters approved a referendum authorizing slot machine gaming at Fair Grounds conditioned upon the adoption of certain zoning and permitting requirements. In 2003, the Louisiana Legislature passed an act that limited the number of slot machines that may be operated at Fair Grounds to 400 slot machines through June 30, 2005 and 500 slot machines thereafter. However, the act provides that if gross gaming revenues at Harrah’s Casino in New Orleans exceed $350.0 million for any previous 12-month period, up to 700 slot machines may be operated at Fair Grounds.

After approval of the amendment to Louisiana’s contract with Harrah’s Casino by the Louisiana Gaming Control Board in December 2004 and by the Joint Legislative Committee on the Budget in January 2005, on February 2, 2005, Harrah’s Casino and the State of Louisiana executed an amendment to their contract providing for slot machines at Fair Grounds.

Churchill Downs Louisiana Horseracing Company, LLC has initiated a process to obtain the necessary gaming licenses to own and operate slot machines at Fair Grounds and to seek the necessary local zoning change and permits. In April 2005, the Louisiana Gaming Control Board found that Fair Grounds passed suitability requirements to maintain a license to conduct slots gaming at the racetrack. In early May 2005, the Gaming Control Board found that Fair Grounds passed suitability requirements to maintain a license to conduct video poker operations at its off-track betting locations. Failure to obtain the necessary gaming licenses to own and operate slot machines at Fair Grounds, as well as local zoning change and permits, could have a material adverse impact on our results of operations.
 
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On June 16, 2005, the New Orleans City Council approved hours of operation for slot machines at Fair Grounds as part of its conditional use permit. There are additional provisos that have not yet been approved relating to other conditional use activities, which we and the New Orleans City Council are currently negotiating.

In April 2005, the New Orleans City Council instructed the city attorney to file a declaratory judgment action to determine if installation of slots at Fair Grounds would violate the City Charter. The Louisiana Attorney General has expressed an opinion that the addition of slots at the racetrack would not violate the City Charter. As of the date of filing of this Quarterly Report on Form 10-Q, the City Council has not filed this declaratory judgment.

In June 2005, a resident living near Fair Grounds filed a lawsuit alleging, among other claims, that slot machines at the racetrack would be a violation of the City Charter, which limits New Orleans to one land-based casino. Based upon an opinion from the Louisiana Attorney General and other legal advice, we do not believe slot machines at Fair Grounds are a violation of the City Charter.

The City of New Orleans is challenging the live pari-mutuel tax calculation used by Fair Grounds Corporation, the seller of Fair Grounds to Churchill Downs Louisiana Horseracing Company, LLC. The City’s interpretation is different from the interpretation and methods used by all of the racetracks in Louisiana. If the City of New Orleans were to prevail in its interpretation of the tax calculation, Fair Grounds could be assessed for an underpayment of taxes from the date of our ownership of the track. As of June 30, 2005, there has not been an assessment of such taxes. We currently anticipate that the amount of additional taxes that would be due by applying the City’s interpretation of the tax calculation would not be material to our consolidated results of operations.

While there were a number of bills filed during the recently completed legislative session that could have affected our video poker operations, none of the bills was enacted into law.

Critical Accounting Policies

Our Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States. Accordingly, we are required to make estimates, judgments and assumptions that we believe are reasonable based on historical experience, contract terms, observance of known trends in the Company and the industry as a whole, and information available from other outside sources. Our estimates affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those initial estimates. In general, however, our estimates have historically approximated actual results.

Our most significant estimates relate to the valuation of plant and equipment, receivables, goodwill and other intangible assets, which may be significantly affected by changes in the regulatory environment in which we operate, and to the aggregate costs for self-insured liability and workers' compensation claims. Additionally, estimates are used for determining income tax liabilities and the valuation of interest rate risk derivative contracts (interest rate swaps).

We evaluate our goodwill, intangible and other long-lived assets in accordance with the application of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Intangible Assets" ("SFAS No. 142") and SFAS No. 144, "Accounting for the impairment or disposal of Long-Lived Assets." For goodwill and intangible assets, we review the carrying values at least annually during the first quarter of each year or whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. We assign estimated useful lives to our intangible assets based on the period of time the asset is expected to contribute directly or indirectly to future cash flows. We consider certain factors when assigning useful lives such as legal, regulatory, competition and other economic factors. Intangible assets with finite lives are amortized using the straight-line method.
 
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While we believe that our estimates of future revenues and cash flows are reasonable, different assumptions could materially affect our assessment of useful lives and fair market values. Changes in assumptions may cause modifications to our estimates for amortization or impairment, thereby impacting our results of operations. If the estimated lives of our intangible assets were to decrease based on the factors mentioned above, amortization expense could increase significantly.

Our business can be impacted positively and negatively by legislative and regulatory changes and by alternative gaming competition. A significant negative impact from these activities could result in a significant impairment of our plant and equipment and/or our goodwill and intangible assets in accordance with generally accepted accounting principles.

We also use estimates and judgments for financial reporting to determine our current tax liability, as well as those taxes deferred until future periods. Net deferred and accrued income taxes represent significant assets and liabilities of the Company. In accordance with the liability method of accounting for income taxes as specified in SFAS 109, "Accounting for Income Taxes," we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns.

Adjustments to deferred taxes are determined based upon changes in differences between the book basis and tax basis of our assets and liabilities, measured by future tax rates we estimate will be applicable when these differences are expected to reverse. Changes in current tax laws, enacted tax rates or the estimated level of taxable income or non-deductible expenses could change the valuation of deferred tax assets and liabilities and affect the overall effective tax rate and tax provision.

We utilize interest rate swap contracts to hedge exposure to interest rate fluctuations on our variable rate debt and have designated these swaps as cash flow hedges of anticipated interest payments. Our interest rate swap contracts match the critical terms of the underlying debt, thus qualifying for hedge accounting. Such critical terms include notional amounts, benchmark interest rate basis, interest reset dates and payment dates. The fair market value of the swaps is recorded on the balance sheet as an asset or liability with the offset recorded in accumulated other comprehensive income net of income taxes. Any changes in the fair market value of the swaps are adjusted to the asset or liability account and recorded net of the income taxes in other comprehensive income.

We maintain an allowance for doubtful accounts receivable that have been deemed to have a high risk of collectibility. We analyze historical collection trends and customer creditworthiness when evaluating the adequacy of our allowance for doubtful accounts receivable. Any changes in our assumptions or estimates could impact our bad debt expense and results of operations.

For our business insurance renewals over the past several years, we have assumed more risk than in prior years, primarily through higher retentions and higher maximum losses for stop-loss insurance for certain coverages. Our March 1, 2005 business insurance renewals included substantially the same coverages and retentions as previous years. We estimate insurance liabilities for workers' compensation and general liability losses based on our historical loss experience, certain actuarial assumptions of loss development factors and current industry trends. Any changes in our assumptions, actuarial assumptions or loss experience could impact the total insurance cost and overall results of operations. Our ability to obtain insurance coverage at acceptable costs in future years under terms and conditions comparable to the current year is uncertain.

Consolidated Net Revenues

Our net revenues and earnings are significantly influenced by our racing calendar. Therefore, revenues and operating results for any interim quarter are not generally indicative of the revenues and operating results for the year, and may not be comparable with results for the corresponding period of the previous year. We historically have very few live racing days during the first quarter of each year, with a majority of our live racing occurring in the second, third and fourth quarters, including the running of the Kentucky Derby and Kentucky Oaks in the second quarter, the quarter during which we typically generate the majority or our annual operating income. As a result of the acquisition of Fair Grounds during the fourth quarter of 2004, the Company had 63 live racing days during the first quarter of 2005, which compares to 10 live racing days during the first quarter of 2004.
 
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Our pari-mutuel revenues include commissions on pari-mutuel wagering at our racetracks and off-track betting facilities (net of state pari-mutuel taxes), plus simulcast host fees from other wagering sites and source market fees generated from contracts with our in-home wagering providers. In addition to the commissions earned on pari-mutuel wagering, we earn pari-mutuel related streams of revenues from sources that are not related to wagering. These other revenues are primarily derived from statutory racing regulations in some of the states where our facilities are located and can fluctuate materially year-to-year. Non-wagering revenues are primarily generated from admissions, sponsorships, licensing rights and broadcast fees, Indiana riverboat admissions subsidy, concessions, video poker, lease income and other sources.

Pari-mutuel revenues are recognized upon occurrence of the live race that is presented for wagering and after that live race is made official by the respective states’ racing regulatory body. Additional non-wagering revenues such as admissions, programs and concession revenues are recognized as delivery of the product or services has occurred.

Greater than 75% of our annual revenues are generated by pari-mutuel wagering on live and simulcast racing content and in-home wagering. Live racing handle includes wagers made on live races at our live tracks and also wagers made on imported simulcast signals at our racetracks during our live meets. Import simulcasting handle includes wagers on imported signals at our racetracks when the respective tracks are not conducting live race meets and at our OTBs throughout the year. Export handle includes all wagers made on our live racing signals sent to other tracks, OTBs and in-home wagering. In-home wagering, or account wagering, consists of wagers through an advance deposit account.

We retain as revenue a predetermined percentage or commission on the total amount wagered, and the balance is distributed to the winning patrons. The gross percentages retained on live racing and import simulcasting at our various locations range from approximately 15% to 27%. In general, the fees earned from export simulcasting are contractually determined and average approximately 3.5%. All commissions and fees earned from pari-mutuel wagering are shared with horsemen through payment of purses based on local contracts and statutes and average approximately 50%.
 
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Results Of Continuing Operations

The following table sets forth, for the three months ended June 30, 2005 and 2004, certain operating data:
 
   
Three Months Ended June 30,   
 
Change   
 
 (In thousands, except per share data and live race days)  
2005
 
2004 
 
$ 
 
% 
 
                   
Total pari-mutuel handle
 
$1,182,752
 
$1,175,577
 
$7,175
 
1
%
Number of live race days
 
187
 
182
 
5
 
3
%
                   
Net pari-mutuel revenues
 
$100,294
 
$92,728
 
$7,566
 
8
%
Riverboat subsidy
 
2,700
 
2,708
 
(8
)
-
 
Other operating revenues
 
60,208
 
44,723
 
15,485
 
35
%
Total net revenues
 
$163,202
 
$140,159
 
$23,043
 
16
%
                   
Gross profit
 
$52,850
 
$46,200
 
$6,650
 
14
%
Gross margin percentage
 
32
%
33
%
       
                   
Operating income
 
$40,389
 
$37,902
 
$2,487
 
7
%
Net earnings from continuing operations
 
$22,678
 
$22,877
 
$(199
)
(1
)%
                   
Diluted earnings from continuing operations per share
 
$1.69
 
$1.70
         

Our total net revenues increased $23.0 million primarily as a result of our acquisition of Fair Grounds and VSI (the “Louisiana Operations). We acquired Fair Grounds and VSI in October 2004. Net revenues from Kentucky Operations also increased significantly as we realized benefits from the opening of the newly renovated Churchill Downs racetrack facility, including increased attendance during the week of the Kentucky Derby. Further discussion of net revenue variances by our reported segments is detailed below.

Significant items affecting comparability of operating income, net earnings from continuing operations and diluted earnings from continuing operations per share included:   
 
§      
Corporate expenses increased $2.2 million during the three months ended June 30, 2005 primarily as a result of increased costs associated with our initiative to attract and retain appropriate personnel to achieve our business objectives and increased costs associated with the Customer Relationship Management ("CRM") initiative.
§      
Our effective tax rate rose from 40% to 44% resulting primarily from the non-deductibility of legislative initiative costs.

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Consolidated Expenses

The following table is a summary of our consolidated expenses for the three months ended June 30, 2005 and 2004:
 
   
Three Months Ended June 30, 
Change 
 
(In thousands)
 
2005
2004
$
 %
 
             
Purse expenses
 
$41,729
 
$37,881
 
$3,848
 
10
%
Riverboat purse expenses
 
1,336
 
1,344
 
(8
)
(1
)%
        Depreciation/amortization
 
5,974
 
3,878
 
2,096
 
54
%
Other operating expenses
 
61,313
 
50,856
 
10,457
 
21
%
        SG&A expenses
 
12,461
 
8,298
 
4,163
 
50
%
Total
 
$122,813
 
$102,257
 
$20,556
 
20
%
                   
        Percent of revenue
 
75
%
73
%
       

Total expenses increased 20% during the three months ended June 30, 2005 primarily as a result of increased expenses of $16.1 million related to the acquisition of the Louisiana Operations. Corporate SG&A expenses also increased by $2.2 million as more fully described below in the discussion of expense variances by segment. Depreciation expense from Kentucky Operations increased $1.2 million as a result of additional depreciation expense related to the newly renovated Churchill Downs racetrack facility that was completed during the three months ended June 30, 2005. Further discussion of expense variances by our reported segments is detailed below.

Other Income (Expense) and Provision for Income Taxes

The following table is a summary of our other income (expense) and the provision for income taxes for the three months ended June 30, 2005 and 2004:
 
   
Three Months Ended June 30, 
 
Change 
 
   (In thousands)  
2005 
 
2004 
 
$ 
 
% 
 
                   
Interest income
 
$76
 
$75
 
$1
 
1
%
Interest expense
 
(390
)
(204
)
(186
)
(91
)%
Unrealized gain on derivative instruments
 
204
 
-
 
204
 
100
%
Miscellaneous, net
 
80
 
502
 
(422
)
(84
)%
Other income (expense)
 
$(30
)
$373
 
$(403
)
(108
)%
                   
Provision for income taxes
 
$(17,681
)
$(15,398
)
$(2,283
)
(15
)%
                   
Effective tax rate
 
44
%
40
%
       

Significant items affecting the comparability of other income and expense and the provision for income taxes include:

§     
During the three months ended June 30, 2004, we recognized $0.3 million of miscellaneous income related to consideration for the extension of an option to purchase an interest in Hoosier Park.
§     
We recognized an unrealized gain on derivative instruments of $0.2 million related to changes in the fair market value of embedded derivatives within a convertible promissory note issued during the fourth quarter of 2004.
§     
Our year-to-date effective tax rate increased from 40% to 44% resulting from the non-deductibility of the legislative initiative costs.
 
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Net Revenues By Segment

The following table presents net revenues, including intercompany revenues, by our reported segments for the three months ended June 30, 2005 and 2004:
 
 
 
Three Months Ended June 30, 
 
Change 
 
    (In thousands)
 
2005
 
2004
 
$
 
%
 
                   
Kentucky Operations
 
$79,978
 
$72,451
 
$7,527
 
10
%
Arlington Park
 
25,095
 
24,774
 
321
 
1
%
Calder Race Course
 
25,511
 
25,152
 
359
 
1
%
Hoosier Park
 
11,603
 
11,236
 
367
 
3
%
Louisiana Operations
 
14,820
 
-
 
14,820
 
100
%
CDSN
 
25,523
 
26,132
 
(609
)
(2
)%
Total Racing Operations
 
182,530
 
159,745
 
22,785
 
14
%
Other Investments
 
886
 
900
 
(14
)
(2
)%
Corporate
 
1,284
 
1,290
 
(6
)
-
 
Eliminations
 
(21,498
)
(21,776
)
278
 
1
%
Net revenues from continuing operations
 
$163,202
 
$140,159
 
$23,043
 
16
%

Significant items affecting comparability of our revenues by segment include:

§      
Net revenues from Kentucky Operations increased as we realized benefits from the opening of the newly renovated Churchill Downs racetrack facility, including increased attendance during the week of the Kentucky Derby.
§      
During the fourth quarter of 2004, we completed our acquisition of the Louisiana Operations which contributed $14.8 million to the overall increase in revenues.
 
Expenses by Segment

The following table presents total expenses, including intercompany expenses, by our reported segments for the three months ended June 30, 2005 and 2004:
 
   
 Three Months Ended June 30,
 Change
 
    (In thousands)  
 2005 
 2004
 $
 
 %
 
               
Kentucky Operations
 
$45,113
 
$44,217
 
$896
   
2
%
Arlington Park
 
24,365
 
22,930
 
1,435
   
6
%
Calder Race Course
 
23,696
 
23,102
 
594
   
3
%
Hoosier Park
 
11,525
 
11,104
 
421
   
4
%
Louisiana Operations
 
16,069
 
-
 
16,069
   
100
%
CDSN
 
19,340
 
19,867
 
(527
)
 
(3
)%
Total Racing Operations
 
$140,108
 
$121,220
 
$18,888
   
16
%
Other Investments
 
784
 
786
 
(2
)
 
-
 
Corporate
 
5,184
 
3,004
 
2,180
   
73
%
Eliminations
 
(23,263
)
(22,753
)
(510
)
 
(2
)%
Total
 
$122,813
 
$102,257
 
$20,556
   
20
%

Significant items affecting comparability of our expenses by segment include:
 
     §
Depreciation expense from Kentucky Operations increased $1.2 million as a result of additional depreciation expense related to the newly renovated Churchill Downs racetrack facility that was completed during the three months ended June 30, 2005.
§
During the fourth quarter of 2004, we completed our acquisition of the Louisiana Operations, which contributed $16.1 million to the overall increase in expenses.
§
Corporate expenses increased during the three months ended June 30, 2005 compared to the three months ended June 30, 2004 primarily as a result of increased costs associated with our initiative to attract and retain appropriate personnel to achieve our business objectives and increased costs associated with the CRM initiative.
 
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Discontinued Operations

The following table presents earnings from discontinued operations for the three months ended June 30, 2005 and 2004:
 
   
Three Months Ended June 30, 
 
Change 
 
   (In thousands)
 
2005
 
2004
 
$
 
%
 
                   
Net revenues
 
$49,369
 
$49,476
 
$(107
)
-
 
Operating expenses
 
38,553
 
37,748
 
805
 
2
%
Gross profit
 
10,816
 
11,728
 
(912
)
(8
)%
Selling, general and administrative expenses
 
2,134
 
1,787
 
347
 
19
%
Operating income
 
8,682
 
9,941
 
(1,259
)
(13
)%
Other income (expense):
                 
Interest income
 
13
 
10
 
3
 
30
%
Interest expense
 
(3,281
)
(970
)
(2,311
)
(238
)%
Miscellaneous, net
 
2
 
2
 
-
 
-
 
   
(3,266
)
(958
)
(2,308
)
(241
)%
                   
Earnings before provision for income taxes
 
5,416
 
8,983
 
(3,567
)
40
%
Provision for income taxes
 
(3,908
)
(4,164
)
256
 
6
%
Net earnings
 
$1,508
 
$4,819
 
$(3,311
)
(69
)%

Significant items affecting comparability of earnings from discontinued operations include:

§
SG&A expenses increased during the three months ended June 30, 2005 as we recognized higher development expenses in the current year related to the sale of the assets of Hollywood Park. During the three months ended June 30, 2004, we incurred development expenses related to the California alternative gaming initiative.
§
Pursuant to the sale of the assets of Hollywood Park, we are required, under the existing debt agreements for the revolving loan facility and the variable rate senior notes, to use the proceeds to pay off the debt balances under these facilities unless amendments are made to the facilities that provide otherwise. As such, all interest expense related to these facilities has been allocated to discontinued operations for the three months ended June 30, 2005 and 2004. Interest expense increased as a result of additional borrowings for the acquisition of the Louisiana Operations as well as a higher interest rate environment.
 
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Results Of Continuing Operations

The following table sets forth, for the six months ended June 30, 2005 and 2004, certain operating data:
 
   
 Six Months Ended June 30,
 Change
 
   ( In thousands, except per share data and live race days)  
2005
 
2004
 
$ 
 
 
%
 
                     
Total pari-mutuel handle
 
$1,676,639
 
$1,400,894
 
$275,745
   
20
%
Number of live race days
 
250
 
192
 
58
   
30
%
                     
Net pari-mutuel revenues
 
$139,983
 
$118,544
 
$21,439
   
18
%
Riverboat subsidy
 
5,519
 
5,535
 
(16
)
 
-
 
Other operating revenues
 
69,517
 
48,710
 
20,807
   
43
%
Total net revenues
 
$215,019
 
$172,789
 
$42,230
   
24
%
                     
Gross profit
 
$47,741
 
$39,636
 
$8,105
   
20
%
Gross margin percentage
 
22
%
23
%
         
                     
Operating income
 
$22,359
 
$23,778
 
$(1,419
)
 
(6
)%
Net earnings from continuing operations
 
$12,820
 
$14,648
 
$(1,828
)
 
(12
)%
                     
Diluted earnings from continuing operations per share
 
$0.95
 
$1.09
           

Our total net revenues increased $42.2 million primarily as a result of our acquisition of the Louisiana Operations. We acquired the Louisiana Operations in October 2004. Net revenues from Kentucky Operations also increased significantly as we realized benefits from the opening of the newly renovated Churchill Downs racetrack facility, including increased attendance during the week of the Kentucky Derby. The increased revenues from the Louisiana Operations were partially offset by reduced revenues at Arlington Park as a result of fewer days that Arlington Park was appointed host track in Illinois during the six months ended June 30, 2005 compared to the same period in 2004. Further discussion of net revenue variances by our reported segments is detailed below.

Significant items affecting comparability of operating income, net earnings from continuing operations and diluted earnings from continuing operations per share included:
 
§      
We incurred $3.0 million of expenses related to alternative gaming initiatives in Florida during the six months ended June 30, 2005.
§      
Corporate expenses increased $3.8 million during the six months ended June 30, 2005 primarily as a result of increased costs associated with our initiative to attract and retain appropriate personnel to achieve our business objectives, increased professional fees related to obtaining compliance with the Sarbanes-Oxley Act of 2002 and increased costs associated with the CRM initiative.
§      
Our year-to-date effective tax rate rose from 40% to 44% resulting primarily from the non-deductibility of legislative initiative costs.
 
28

 
Return to Index

Consolidated Expenses

The following table is a summary of our consolidated expenses for the six months ended June 30, 2005 and 2004:
 
   
 Six Months Ended June 30,
 Change
 
    (In thousands)  
 2005
 2004
 $
 %
 
             
Purse expenses
 
$57,444
 
$47,244
 
$10,200
 
22
%
Riverboat purse expenses
 
2,731
 
2,747
 
(16
)
(1
)%
Depreciation/amortization
 
10,387
 
7,712
 
2,675
 
35
%
Other operating expenses
 
96,716
 
75,450
 
21,266
 
28
%
SG&A expenses
 
25,382
 
15,858
 
9,524
 
60
%
Total
 
$192,660
 
$149,011
 
$43,649
 
29
%
                   
Percent of revenue
 
90
%
86
%
       

Total expenses increased 29% during the six months ended June 30, 2005 primarily as a result of increased expenses of $38.0 million related to the impact of the acquisition of the Louisiana Operations. We also incurred $3.0 million of additional expenses related to legislative costs for alternative gaming (included in SG&A expenses) as mentioned above. Corporate SG&A expenses also increased by $3.8 million as more fully described below in the discussion of expense variances by segment. Depreciation expense from Kentucky Operations increased $1.2 million as a result of the additional depreciation expense related to the newly renovated Churchill Downs racetrack facility that was completed during the six months ended June 30, 2005. Lower purse expense of $2.2 million at Arlington Park, primarily as a result of fewer days that Arlington Park was appointed the host track in Illinois during the six months ended June 30, 2005 compared to the same period of 2004, partially offset these increases. Further discussion of expense variances by our reported segments is detailed below.

Other Income (Expense) and the Provision for Income Taxes

The following table is a summary of our other income (expense) and the provision for income taxes for the six months ended June 30, 2005 and 2004:
 
 
 
 Six Months Ended June 30,
 Change 
 
   (In thousands)
 
2005 
 
2004 
 
 
% 
 
                   
Interest income
 
$161
 
$191
 
$(30
)
(16
)%
Interest expense
 
(685
)
(385
)
(300
)
(78
)%
Unrealized gain on derivative instruments
 
410
 
-
 
401
 
100
%
Miscellaneous, net
 
617
 
837
 
(220
)
(26
)%
Other income (expense)
 
$503
 
$643
 
$(140
)
(22
)%
                   
Provision for income taxes
 
$(10,042
)
$(9,773
)
$(269
)
(3
)%
                   
Effective tax rate
 
44
%
40
%
       

Significant items affecting the comparability of other income and expense and the provision for income taxes include:

  §       
We recognized an unrealized gain on derivative instruments of $0.4 million