2006 10-Q 2nd quarter
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, 2006

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



(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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X] 

The number of shares outstanding of registrant's common stock at August 2, 2006 was 13,230,953 shares.
 

 
CHURCHILL DOWNS INCORPORATED
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended June 30, 2006

 
 Page
       
Item 1.
 
 
       
    3 
       
    4
       
   
       
   
6
       
Item 2.
 1
       
Item 3.
 3
       
Item 4.
 3
       
     
       
Item 1.
 3
5
       
Item 1A.
 3
5
     
Item 2.
 3
7
       
Item 3.
 3
       
Item 4.
 3
       
Item 5.
 3
7
       
Item 6.
 3
7
       
 3
8
       
 3
9
 
2


Return to Index
 
PART I.
   
ITEM 1.

CHURCHILL DOWNS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (in thousands)
 
     
June 30, 2006 
   
 December 31, 2005
 
 ASSETS
                 
Current assets:
                 
Cash and cash equivalents
 
$
39,986
   
$
22,488
   
Restricted cash
   
10,682
     
4,946
   
Accounts receivable, net of allowance for doubtful accounts of $503 at June 30, 2006 and $786 at December 31, 2005
   
40,357
     
42,823
   
Deferred income taxes
   
4,054
     
3,949
   
Income taxes receivable
   
-
     
697
   
Other current assets
   
15,574
     
9,085
   
Total current assets
   
110,653
     
83,988
   
Other assets
   
13,690
     
13,020
   
Plant and equipment, net
   
348,740
     
346,530
   
Goodwill
   
53,528
     
53,528
   
Other intangible assets, net
   
17,717
     
18,130
   
Total assets
 
$
544,328
   
$
515,196
   
LIABILITIES AND SHAREHOLDERS' EQUITY
                 
Current liabilities:
                 
Accounts payable
 
$
37,552
   
$
27,957
   
Purses payable
   
27,327
     
14,564
   
Accrued expenses
   
46,256
     
44,003
   
Dividends payable
   
-
     
6,520
   
Income taxes payable
   
9,117
     
-
   
Deferred revenue
   
11,381
     
26,219
   
Total current liabilities
   
131,633
     
119,263
   
Long-term debt
   
22,614
     
33,793
   
Other liabilities
   
23,388
     
21,625
   
Deferred revenue
   
18,443
     
18,614
   
Deferred income taxes
   
5,670
     
5,670
   
Total liabilities
   
201,748
     
198,965
   
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 13,231 shares June 30, 2006 and 13,132 shares December 31, 2005
   
121,499
     
121,270
   
Retained earnings
   
221,081
     
198,001
   
Unearned stock compensation
   
-
     
(3,040
)
 
Total shareholders’ equity
   
342,580
     
316,231
   
Total liabilities and shareholders’ equity
 
$
544,328
   
$
515,196
   

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.
 
3

CHURCHILL DOWNS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF NET EARNINGS
AND COMPREHENSIVE EARNINGS
for the three and six months ended June 30, 2006 and 2005
(Unaudited) (in thousands, except per share data) 
 
   
 Three Months Ended
June 30,
   
   Six Months Ended
June 30,
   
   
 2006
   
 2005
   
 2006
   
 2005
   
Net revenues
 
$
175,025
   
$
163,207
   
$
220,053
   
$
215,089
   
Operating expenses
   
115,937
     
110,599
     
167,808
     
167,752
   
Gross profit
   
59,088
     
52,608
     
52,245
     
47,337
   
Selling, general and administrative expenses
   
11,921
     
12,271
     
23,649
     
25,026
   
Insurance recoveries, net of losses
   
(9,614
)
   
-
     
(10,880
)
   
-
   
Operating income
   
56,781
     
40,337
     
39,476
     
22,311
   
Other income (expense):
                                 
Interest income
   
243
     
76
     
362
     
161
   
Interest expense
   
(579
)
   
(390
 )
 
 
(1,182
)
   
(685
)
 
Unrealized gain on derivative instruments
   
204
     
204
     
408
     
410
   
Miscellaneous, net
   
14
     
132
     
665
     
665
   
     
(118
)
   
22
     
253
     
551
   
Earnings from continuing operations before provision for income taxes
   
56,663
     
40,359
     
39,729
     
22,862
   
Provision for income taxes
   
(23,310
)
   
(17,681
 )
 
 
(16,649
)
   
(10,042
)
 
Net earnings from continuing operations
   
33,353
     
22,678
     
23,080
     
12,820
   
Discontinued operations, net of income taxes:
                                 
Earnings (loss) from operations
   
-
     
1,508
     
-
     
(2,531
)
 
Net earnings
   
33,353
     
24,186
     
23,080
     
10,289
   
Other comprehensive (loss) income, net of income taxes:
                                 
Change in fair value of cash flow hedges
   
-
     
(674
 )
 
 
-
     
395
   
Comprehensive earnings
 
$
33,353
   
$
23,512
   
$
23,080
   
$
10,684
   
Net earnings (loss) per common share data:
                                 
Basic
                                 
Net earnings from continuing operations
 
$
2.46
   
$
1.70
   
$
1.70
   
$
0.96
   
Discontinued operations
   
-
     
0.11
     
-
     
(0.19
)
 
Net earnings
 
$
2.46
   
$
1.81
   
$
1.70
   
$
0.77
   
Diluted
                                 
Net earnings from continuing operations
 
$
2.45
   
$
1.69
   
$
1.69
   
$
0.95
   
Discontinued operations
   
-
     
0.11
     
-
     
(0.19
)
 
Net earnings
 
$
2.45
   
$
1.80
   
$
1.69
   
$
0.76
   
Weighted average shares outstanding:
                                 
Basic
   
13,124
     
12,884
     
13,099
     
12,882
   
Diluted
   
13,623
     
13,457
     
13,624
     
13,506
   

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

CHURCHILL DOWNS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30,
(Unaudited) (in thousands)
     
2006
     
2005
   
Cash flows from operating activities:
                 
Net earnings
 
$
23,080
   
$
10,289
   
Adjustments to reconcile net earnings to net cash provided by operating activities:
                 
Depreciation and amortization
   
10,573
     
13,563
   
Unrealized gain on derivative instruments
   
(408
)
   
(410
)
 
Other
   
880
     
480
   
Increase (decrease) in cash resulting from changes in operating assets and liabilities:
                 
Restricted cash
   
(5,736
)
   
(17,125
)
 
Accounts receivable
   
(10,767
)
   
(14,436
)
 
Other current assets
   
(6,489
)
   
(4,254
)
 
Accounts payable
   
13,756
     
25,883
   
Purses payable
   
12,763
     
6,145
   
Accrued expenses and other liabilities
   
4,556
     
6,090
   
Income taxes payable
   
9,814
     
4,763
   
Deferred revenue
   
(1,776
)
   
3,636
   
Other assets and liabilities
   
1,397
     
2,054
   
Net cash provided by operating activities
   
51,643
     
36,678
   
Cash flows from investing activities:
                 
Additions to plant and equipment
   
(14,180
)
   
(32,913
)
 
Proceeds on sale of fixed assets
   
7
     
2
   
Net cash used in investing activities
   
(14,173
)
   
(32,911
)
 
Cash flows from financing activities:
                 
Borrowings on bank line of credit
   
159,885
     
217,423
   
Repayments of bank line of credit
   
(171,772
)
   
(222,942
)
 
Change in book overdraft
   
(4,161
)
   
1,285
   
Payment of dividends
   
(6,520
)
   
(6,430
)
 
Windfall tax benefit from share-based compensation
   
573
     
-
   
Common stock issued
   
2,023
     
670
   
Net cash used in financing activities
   
(19,972
)
   
(9,994
)
 
Net increase (decrease) in cash and cash equivalents
   
17,498
     
(6,227
)
 
Cash and cash equivalents, beginning of period
   
22,488
     
27,694
   
Cash and cash equivalents, end of period
   
39,986
     
21,467
   
Cash and cash equivalents included in assets held for sale
   
-
     
(11,587
)
 
Cash and cash equivalents in continuing operations
 
$
39,986
   
$
9,880
   
Cash paid during the period for:
                 
Interest
 
$
519
    $
6,909
   
Income taxes
  $
6,019
    $
5,511
   
Schedule of non-cash activities:
                 
Plant and equipment additions included in accounts payable/accrued expenses
   
1,453
     
4,004
   
Issuance of common stock in connection with restricted stock plan
   
216
     
30
   
   
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.
 
5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
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, 2005 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 statement 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.
 
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 was 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 Statement of Financial Accounting Standards ("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, 2006, and no adjustment to the carrying value of goodwill was required.

Revenue Recognition

The Company’s pari-mutuel revenues include commissions on pari-mutuel wagering at its racetracks and off-track betting facilities ("OTBs") (net of state and local 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 directly 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

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 70% 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 patron wagers made on live races at the Company’s racetracks 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 racetracks are not conducting live race meets and at the Company’s OTBs throughout the year. Export handle includes all patron wagers made on live racing signals sent to other tracks, OTBs and in-home wagering. In-home wagering, or advance deposit wagering, consists of patron wagers through a pre-funded account.

The Company retains as revenue a pre-determined percentage or commission on the total amount wagered on live and import simulcasting sources, 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.

Share-Based Compensation

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"), which requires companies to measure compensation costs for all share-based payments (including employee stock options) at fair value for interim or annual periods beginning after June 15, 2005. In April 2005, the U.S. Securities and Exchange Commission issued a rule allowing public companies to delay the adoption of SFAS No. 123(R) to annual periods beginning after June 15, 2005. As a result, the Company adopted SFAS No. 123(R) using the modified-prospective transition method, beginning on January 1, 2006, and therefore began to expense the fair value of all outstanding options related to an employee stock purchase plan over their remaining vesting periods to the extent the options were not fully vested as of the adoption date and will begin to expense the fair value of all options granted subsequent to December 31, 2005 over their requisite service periods. During the three and six months ended June 30, 2006, the Company recorded $34 thousand and $56 thousand, respectively, net of a related income tax benefit of $23 thousand and $40 thousand, respectively, of additional share-based compensation expense as a result of adopting SFAS No. 123(R). Previous periods have not been restated. See Note 5 for further details.
 
7

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

2.
Discontinued Operations

In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the results of operations of Hollywood Park Racetrack sold on September 23, 2005 are reflected in the Condensed Consolidated Statement of Net Earnings as discontinued operations for the three and six months ended June 30, 2005 (in thousands): 
               
 
  Three Months Ended
   
 Six Months Ended 
 
 
 June 30, 2005
   
 June 30, 2005
 
Net revenues
 
$
49,369
   
$
53,804
   
Operating expenses
   
38,553
     
47,016
   
Gross profit
   
10,816
     
6,788
   
Selling, general and administrative expenses
   
2,134
     
3,355
   
Operating income
   
8,682
     
3,433
   
Other income (expense):
                 
Interest income
   
13
     
14
   
Interest expense
   
(3,281
)
   
(5,633
)
 
Miscellaneous, net
   
2
     
2
   
Other income (expense)
   
(3,266
)
   
(5,617
)
 
Income (loss) before provision for income taxes
   
5,416
     
(2,184
)
 
Provision for income taxes
   
(3,908
)
   
(347
)
 
Net earnings (loss)
 
$
1,508
   
$
(2,531
)
 

3.
Natural Disasters

Hurricane Katrina

On August 29, 2005, Hurricane Katrina caused significant damage to the metropolitan New Orleans, Louisiana area. A significant portion of the assets of the Company's Louisiana Operations suffered damages from Hurricane Katrina. The Company carries property and casualty insurance, as well as business interruption insurance. Under existing policies, the Company is required to pay a $500 thousand deductible related to any recoveries for damages. The Company is currently working with its insurance carriers to determine to what extent insurance proceeds may exceed any losses. The Company has not yet determined the ultimate impact that Hurricane Katrina will have on its results of operations. As of June 30, 2006, the Company has received $18.0 million in insurance recoveries.

Hurricane Wilma

On October 24, 2005, Hurricane Wilma caused significant damage to Miami, as well as other parts of South Florida. A significant portion of the assets of Calder Race Course suffered damages from Hurricane Wilma. The Company carries property and casualty insurance as well as business interruption insurance. Under existing policies, the Company is required to pay a deductible equal to 2% of the total insured value on an insurable unit basis related to any recoveries for damages. The Company is currently working with its insurance carriers to determine to what extent insurance proceeds may exceed any losses. As of June 30, 2006, the Company has received $2.0 million in insurance recoveries.

Tornado Damage

On November 6, 2005, a tornado caused significant damage to portions of southwestern Indiana and northwestern Kentucky, including Henderson, Kentucky, the location of Ellis Park Race Course and its on-site simulcast facility. Ellis Park sustained damage to its stable area, as well as several other buildings at the racetrack. The Company carries property and casualty insurance as well as business interruption insurance. Under existing policies, the Company is required to pay a $500 thousand deductible related to any recoveries for damages. The Company does not believe that the tornado damage will have a material, adverse impact on its results of operations. As of June 30, 2006, the Company has received $6.0 million in insurance recoveries.
 
8

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
Financial Information

The casualty losses and related insurance recoveries have been included as components of operating income in the Company’s Condensed Consolidated Statements of Net Earnings. Set forth below is a summary of the impact of the natural disasters on the results of operations of the Company for the three and six months ended June 30, 2006 (in thousands):

 
 
Three Months ended June 30, 2006 
 
 
 
   
Casualty
Losses 
 
 
 
Insurance Recoveries
 
 
 
Insurance Recoveries,
Net of Losses
   
Louisiana Operations
 
$
(5,543
)
 
$
14,830
   
$
9,287
   
Calder Race Course
   
(1,162
)
   
1,813
     
651
   
Ellis Park Race Course
   
(2,678
)
   
2,354
     
(324
)
 
Total
 
$
(9,383
)
 
$
18,997
   
$
9,614
   
       
 
 
Six Months ended June 30, 2006 
 
 
 
   
Casualty
Losses 
 
 
 
Insurance Recoveries
 
 
 
Insurance Recoveries,
Net of Losses
   
Louisiana Operations
 
$
(5,543
)
 
$
15,827
   
$
10,284
   
Calder Race Course
   
(1,162
)
   
1,813
     
651
   
Ellis Park Race Course
   
(3,280
)
   
3,225
     
(55
)
 
Total
 
$
(9,985
)
 
$
20,865
   
$
10,880
   

As of June 30, 2006 and December 31, 2005, approximately $2.3 million and $1.8 million of insurance proceeds were included as a current liability in the Company’s Consolidated Balance Sheets, which represent amounts recovered for costs yet to be incurred.
 
9

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

4.
Earnings Per Share

The following is a reconciliation of the numerator and denominator of the earnings (loss) per common share computations (in thousands, except per share data):

 
Three Months Ended
June 30, 
 
Six Months Ended
June 30,
 
     
2006
     
2005
     
2006
     
2005
   
Numerator for basic net earnings from continuing operations per common share:
                                 
Net earnings from continuing operations
 
$
33,353
   
$
22,678
   
$
23,080
   
$
12,820
   
Net earnings from continuing operations allocated to participating securities
   
(1,112
)
   
(770
)
   
(770
)
   
(435
)
 
Numerator for basic net earnings from continuing operations per common share
 
$
32,241
   
$
21,908
   
$
22,310
   
$
12,385
   
                                   
Numerator for basic net earnings per common share:
                                 
Net earnings
 
$
33,353
   
$
24,186
   
$
23,080
   
$
10,289
   
Net earnings allocated to participating securities
   
(1,112
)
   
(821
)
   
(770
)
   
(349
)
 
Numerator for basic net earnings per common share
 
$
32,241
   
$
23,365
   
$
22,310
   
$
9,940
   
                                   
Numerator for diluted net earnings per common share:
                                 
Net earnings from continuing operations
 
$
33,353
   
$
22,678
   
$
23,080
   
$
12,820
   
Discontinued operations, net of income taxes
   
-
     
1,508
     
-
     
(2,531
)
 
Net earnings
 
$
33,353
   
$
24,186
   
$
23,080
   
$
10,289
   
                                   
Denominator for net earnings per common share:
                                 
Basic
   
13,124
     
12,884
     
13,099
     
12,882
   
Plus dilutive effect of stock options
   
46
     
120
     
72
     
171
   
Plus dilutive effect of convertible note
   
453
     
453
     
453
     
453
   
Diluted
   
13,623
     
13,457
     
13,624
     
13,506
   
                                   
Earnings per common share:
                                 
Basic
                                 
Net earnings from continuing operations
 
$
2.46
   
$
1.70
   
$
1.70
   
$
0.96
   
Discontinued operations
   
-
     
0.11
     
-
     
(0.19
)
 
Net earnings
 
$
2.46
   
$
1.81
   
$
1.70
   
$
0.77
   
                                   
Diluted
                                 
Net earnings from continuing operations
 
$
2.45
   
$
1.69
   
$
1.69
   
$
0.95
   
Discontinued operations
   
-
     
0.11
     
-
     
(0.19
)
 
Net earnings
 
$
2.45
   
$
1.80
   
$
1.69
   
$
0.76
   

Options to purchase 37 thousand and 45 thousand shares for the three months ended June 30, 2006 and 2005, respectively, and options to purchase 19 thousand and 28 thousand shares for the six months ended June 30, 2006 and 2005, respectively, were not included in the computation of earnings per common share assuming dilution because the options’ exercise prices were greater than the average market price of the common shares during the respective periods.
 
10

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5.
Share-Based Compensation

At June 30, 2006, the Company has share-based employee compensation plans as described below. The total compensation expense related to these plans, which include a restricted stock plan as well as an employee stock purchase plan, was $200 thousand and $56 thousand, net of an income tax benefit of $140 thousand and $44 thousand, for the three months ended June 30, 2006 and 2005, respectively, and $391 thousand and $111 thousand, net of an income tax benefit of $282 thousand and $87 thousand for the six months ended June 30, 2006 and 2005, respectively. Prior to January 1, 2006, the Company accounted for these plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). Accordingly, the Company generally recognized compensation expense only when it granted options with a discounted exercise price. Any resulting compensation expense was recognized ratably over the associated service period, which was generally the vested term.

Prior to January 1, 2006, the Company provided pro forma disclosure amounts in accordance with SFAS No. 148, "Accounting for Stock-Based Compensation - Transaction and Disclosure," as if the fair value method defined by SFAS No. 123, "Accounting for Stock-Based Compensation" has been applied to its share-based compensation.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R) using the modified prospective transition method and therefore has not restated prior periods' results. Under this transition method, share-based compensation expense for the six months ended June 30, 2006 included compensation expense for all share-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123. Share-based compensation expense for all share-based payment awards granted after January 1, 2006, is based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company recognized these compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of one year for options related to an employee stock purchase plan.

As a result of adopting SFAS No. 123(R), the impact to the Condensed Consolidated Financial Statements for the three months ended June 30, 2006 on earnings from continuing operations before provision for income taxes and net earnings from continuing operations was $57 thousand and $34 thousand lower, respectively, than if the Company had continued to account for share-based compensation under APB No. 25. The impact to the Condensed Consolidated Financial Statements for the six months ended June 30, 2006 on earnings from continuing operations before provision for income taxes and net earnings from continuing operations was $96 thousand and $56 thousand lower, respectively. Such impact relates to the recognition of expense of the fair value of all outstanding options associated with an employee stock purchase plan over their requisite service period. Amounts previously recorded as unearned compensation within shareholders’ equity on the Condensed Consolidated Balance Sheets were reclassified to common stock as of January 1, 2006. In addition, prior to the adoption of SFAS No. 123(R), the Company presented the tax benefit of stock option exercises as operating cash flows. Upon adoption of SFAS No. 123(R), tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options are classified as financing cash flows.
 
11

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company accounted for share-based compensation in accordance with APB No. 25 for the three and six months ended June 30, 2005. Had the compensation cost for the Company’s share-based compensation plans been determined consistent with SFAS No. 123(R), the Company’s net earnings from continuing operations and net earnings from continuing operations per common share for the three and six months ended June 30, 2005 would approximate the pro forma amounts presented below:

(in thousands, except per share data)
 
Three Months Ended
June 30, 2005
   
Six Months
Ended
June 30, 2005
   
Net earnings from continuing operations, as reported
 
$
22,678
   
$
12,820
   
Add: Stock based compensation expense included in reported net earnings from continuing operations
   
56
     
111
   
Deduct: Pro forma stock-based compensation expense, net of tax benefit
   
(313
)
   
(625
)
 
Pro forma net earnings from continuing operations
 
$
22,421
   
$
12,306
   
                   
Net earnings from continuing operations per common share:
                 
As reported
                 
Basic
 
$
1.70
   
$
0.96
   
Diluted
 
$
1.69
   
$
0.95
   
Pro forma
                 
Basic
 
$
1.68
   
$
0.92
   
Diluted
 
$
1.67
   
$
0.91
   
 
Employee Stock Options

The Company sponsors the Churchill Downs Incorporated 2003 Stock Option Plan (the "03 Plan"), the Churchill Downs Incorporated 1997 Stock Option Plan (the "97 Plan"), and the Churchill Downs Incorporated 1993 Stock Option Plan (the "93 Plan"), also collectively referred to as the “Stock Option Plans." These share-based incentive compensation plans are described below.

No stock options are available under the 93 Plan. On March 13, 2003, the Board of Directors suspended the 97 Plan effective upon the shareholders’ approval of the 03 Plan. Awards issued under the 97 Plan prior to its suspension were unaffected by such suspension. On November 13, 2003, the Board of Directors terminated the 03 Plan, effective upon the shareholders' approval of the Churchill Downs Incorporated 2004 Restricted Stock Plan (the "Restricted Stock Plan"). Awards issued under the 03 Plan prior to its termination were unaffected by such termination.

The Stock Option Plans provide that the exercise price of any incentive stock option may not be less than the fair market value of the common stock on the date of grant. All outstanding stock options have contractual terms of ten years and generally vest three years from the date of grant.
 
12

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Activity for the Company's Stock Option Plans during the quarters ended March 31, 2006 and June 30, 2006 is presented below (in thousands, except per share data):

   
 Number of
 Shares Under
Option
 
Weighted
Average
Exercise Price
 
Balance, December 31, 2005
 
525
     
$28.30
 
 
Granted
 
-
     
-
 
 
Exercised
 
(59)
     
$19.01
 
 
Cancelled/Forfeited
 
(10)
     
$34.64
 
     
 
         
 
Balance, March 31, 2006
 
456
 
   
$29.37
 
 
Granted
 
-
     
-
 
 
Exercised
 
(36)
     
$24.75
 
 
Cancelled/Forfeited
 
(1)
     
$38.92
 
                 
 
Balance, June 30, 2006
 
419
     
$29.72
 

The following table summarizes information about stock options outstanding and exercisable at June 30, 2006 (in thousands, except per share data):

 
 
 
Shares Under
Option
 
Weighted 
Average
Remaining
Contractual Life
 
 
Weighted Average
Exercise Price
 
 
Aggregate
Intrinsic Value
per Share (1)
 
 
Aggregate Intrinsic
Value (1)
Options outstanding, exercisable and vested at June 30, 2006
 
 
419
 
 
 
4.5
 
 
 
$29.72
 
 
 
$7.73
 
 
 
$3,239

(1) Computed based upon the amount by which the fair market value of the Company’s common stock at June 30, 2006 of $37.45 per share exceeded the weighted average exercise price.

The total intrinsic value of stock options exercised during the three and six months ended June 30, 2006 was $0.5 million and $1.8 million, compared with $29 thousand and $0.4 million for the three and six months ended June 30, 2005, respectively. Cash received from stock option exercises totaled $0.9 million and $2.0 million for the three and six months ended June 30, 2006, respectively, and $46 thousand and $0.7 million for the three and six months ended June 30, 2005, respectively.
 
At December 31, 2005, there were 514 thousand options exercisable with a weighted average exercise price of $28.17.

Restricted Stock Plan

On November 13, 2003, the Board of Directors adopted the Restricted Stock Plan, which was subsequently approved by the shareholders in June of 2004. The Restricted Stock Plan permits the award of common stock to directors and key employees, including officers, of the Company and its subsidiaries who are from time to time responsible for the management, growth and protection of the business of the Company and its subsidiaries. Up to 315 thousand shares of common stock have been reserved and set aside out of the Company's authorized but unissued common stock for issuance under the Restricted Stock Plan. Restricted shares generally vest in full five years from the date of grant or upon retirement at or after age 60. The fair value of restricted shares under the Restricted Stock Plan is determined by the product of the number of shares granted and the grant date market price of the Company’s common stock. For grants made prior to January 1, 2006, the fair value of restricted shares is expensed on a straight-line basis over the requisite service period of five years. For nonvested restricted shares granted prior to January 1, 2006, the unrecognized compensation expense was recognized immediately in current earnings using the nominal vesting approach upon retirement at or after age 60 of a participant.
 
13

Return to Index
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
The Company recorded approximately $283 thousand and $578 thousand of compensation expense, included in net earnings from continuing operations, during the three and six months ended June 30, 2006, respectively, and $100 thousand and $198 thousand of compensation expense, included in net earnings from continuing operations, during the three and six months ended June 30, 2005, respectively. SFAS No. 123(R), as described above, requires the use of the non-substantive vesting period approach for new grants. That is, compensation expense must be recognized immediately for awards granted to retirement eligible employees or over the period from the grant date to the date retirement eligibility is achieved, if that is expected to occur during the nominal vesting period. If the Company had used the non-substantive vesting approach for awards existing prior to January 1, 2006, compensation expense included in net earnings from continuing operations during the three and six months ended June 30, 2006 would have been $206 thousand and $437 thousand, respectively, and $88 and $213 thousand during the three and six months ended June 30, 2005, respectively.

Activity for the Restricted Stock Plan for the quarters ended March 31, 2006 and June 30, 2006 is presented below (in thousands, except per share data):

 
 Number of
Shares
 
 Weighted
 Average Grant 
Date Fair Value
 
Balance, December 31, 2005
 
88
     
$39.47
   
Granted
 
-
     
-
   
Vested
 
-
     
-
   
Cancelled/Forfeited
 
-
     
-
   
                 
Balance, March 31, 2006
 
88
     
$39.47
   
Granted
 
5
     
$43.20
   
Vested
 
-
     
-
   
Cancelled/Forfeited
 
(1
 )
   
$44.02
   
               
Balance, June 30, 2006
 
92
     
$39.61
   

As of June 30, 2006, there was $2.6 million unrecognized share-based compensation expense related to nonvested restricted stock awards that the Company expects to recognize over a weighted average period of 4.0 years.

Employee Stock Purchase Plan

Under the Company's Employee Stock Purchase Plan (the "Employee Stock Purchase Plan"), the Company is authorized to sell, pursuant to short-term stock options, shares of its common stock to its full-time (or part-time for at least 20 hours per week and at least five months per year) employees at a discount from the common stock's fair market value. The Employee Stock Purchase Plan operates on the basis of recurring, consecutive one-year periods. Each period commences on August 1 and ends on the following July 31.

On the first day of each 12-month period, August 1, the Company offers to each eligible employee the opportunity to purchase common stock. Employees who elect to participate for each period have a designated percentage of their compensation withheld (after-tax) and applied to the purchase of shares of common stock on the last day of the period, July 31. The Employee Stock Purchase Plan allows withdrawals, terminations and reductions on the amounts being deducted. The purchase price for the common stock is 85% of the lesser of the fair market value of the common stock on (i) the first day of the period, or (ii) the last day of the period. No employee may purchase common stock under the Employee Stock Purchase Plan valued at more than $25 thousand for each calendar year.

During the 2005 plan year, the Company granted ten thousand shares to eligible employees under the Employee Stock Purchase Plan. The Company’s estimate of options granted in 2005 under the Employee Stock Purchase Plan is based on the number of shares sold to employees under the Employee Stock Purchase Plan for the 2004 plan year, adjusted to reflect the change in the number of employees participating in the Employee Stock Purchase Plan in 2005. During the three and six months ended June 30, 2006, the Company recognized $57 thousand and $96 thousand of compensation expense related to the unvested portion of the grant made during the 2005 plan year.
 
14

Return to Index
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6.
Segment Information

The Company has determined that it currently operates in the following seven segments: (1) Kentucky Operations, including Churchill Downs racetrack, its on-site simulcast facility and racecourse enclosure, and Ellis Park Race Course and its on-site simulcast facility; (2) Calder Race Course; (3) Arlington Park and its eight OTBs; (4) Hoosier Park racetrack and its on-site simulcast facility and its three OTBs; (5) Louisiana Operations, including Fair Grounds, its eleven 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 ("CDSP") and the Company’s various equity interests, which are not material. 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, 2005. 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. EBITDA of the corporate segment for the three and six months ended June 30, 2005 includes approximately $1.3 million of management fees related to Hollywood Park Racetrack, which was sold on September 23, 2005.
 
15

Return to Index
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The table below presents information about reported segments for the three and six months ended June 30, 2006 and 2005 (in thousands):

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
   
   
2006
   
2005
   
2006
   
2005
   
Net revenues from external customers:
                                 
Kentucky Operations
 
$
69,658
   
$
65,976
   
$
73,651
   
$
70,353
   
Arlington Park
   
23,204
     
22,472
     
35,631
     
33,917
   
Calder Race Course
   
23,209
     
22,812
     
25,146
     
24,430
   
Hoosier Park
   
11,086
     
11,527
     
19,339
     
20,438
   
Louisiana Operations
   
18,679
     
14,825
     
33,913
     
31,457
   
CDSN
   
28,904
     
25,523
     
31,468
     
34,289
   
Total racing operations
   
174,740
     
163,135
     
219,148
     
214,884
   
Other investments
   
288
     
206
     
743
     
206
   
Corporate
   
(3
)
   
287
     
162
     
420
   
Net revenues from continuing operations
   
175,025
     
163,628
     
220,053
     
215,510
   
Discontinued operations
   
-
     
48,948
     
-
     
53,383
   
   
$
175,025
   
$
212,576
   
$
220,053
   
$
268,893
   
Intercompany net revenues:
                                 
Kentucky Operations
 
$
17,160
   
$
14,734
   
$
17,160
   
$
14,752
   
Arlington Park
   
3,011
     
2,623
     
3,011
     
2,623
   
Calder Race Course
   
2,776
     
2,699
     
3,031
     
2,991
   
Hoosier Park
   
100
     
76
     
100
     
76
   
Louisiana Operations
   
-
     
-
     
1,407
     
6,335
   
Total racing operations
   
23,047
     
20,132
     
24,709
     
26,777
   
Other investments
   
738
     
680
     
838
     
817
   
Eliminations
   
(23,785
)
   
(21,233
)
   
(25,547
)
   
(28,015
)
 
 
    -      
(421
)
   
-
     
(421
)
 
Discontinued operations
   
-
     
421
     
-
     
421
   
 
 
$
 -    
$
-
   
$
-
   
$
-
   
Segment EBITDA and net earnings:
                                 
Kentucky Operations
 
$
37,732
   
$
36,887
   
$
30,923
   
$
30,251
   
Arlington Park
   
756
     
1,604
     
(1,196
)
   
(47
)
 
Calder Race Course
   
2,856
     
2,534
     
(549
)
   
(3,320
)
 
Hoosier Park
   
147
     
410
     
274
     
824
   
Louisiana Operations
   
14,222
     
772
     
14,361
     
(406
)
 
CDSN
   
7,005
     
6,184
     
7,564
     
8,317
   
Total racing operations
   
62,718
     
48,391
     
51,377
     
35,619
   
Other investments
   
397
     
372
     
996
     
550
   
Corporate
   
(841
)
   
(2,116
)
   
(1,251
)
   
(2,396
)
 
Total
   
62,274
     
46,647
     
51,122
     
33,773
   
Depreciation and amortization
   
(5,275
)
   
(5,974
)
   
(10,573
)
   
(10,387
)
 
Interest income (expense), net
   
(336
)
   
(314
)
   
(820
)
   
(524
)
 
Provision for income taxes
   
(23,310
)
   
(17,681
)
   
(16,649
)
   
(10,042
)
 
Net earnings from continuing operations
   
33,353
     
22,678
     
23,080
     
12,820
   
Discontinued operations, net of income taxes
   
-
     
1,508
     
-
     
(2,531
)
 
Net earnings
 
$
33,353
   
$
24,186
   
$
23,080
   
$
10,289
   
 
16

Return to Index
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The table below presents total asset information about reported segments (in thousands):
 
   
June 30, 2006
 
 December 31,2005
Total assets:
               
Kentucky Operations
 
$
456,837
   
$
440,953
 
Arlington Park
   
88,829
     
84,796
 
Calder Race Course
   
95,197
     
92,552
 
Hoosier Park
   
36,274
     
33,318
 
Louisiana Operations
   
87,834
     
74,157
 
CDSN
   
11,018
     
11,018
 
Other investments
   
154,312
     
143,003
 
     
930,301
     
879,797
 
Eliminations
   
(385,973
)
   
(364,601
)
   
$
544,328
   
$
515,196
 
 
   
Six Months Ended June 30,
 
   
2006
   
2005
 
Capital expenditures, net:
           
Kentucky Operations
 
$
4,814
   
$
22,489
 
Hollywood Park
   
-
     
1,135
 
Calder Race Course
   
5,857
     
1,474
 
Arlington Park
   
1,305
     
4,540
 
Hoosier Park
   
261
     
124
 
Louisiana Operations
   
1,705
     
3,045
 
Other Investments
   
238
     
106
 
   
$
14,180
   
$
32,913
 

 
7.
Recently Issued Accounting Pronouncements

In July of 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement 109” (“FIN 48”). FIN 48 establishes, among other things, that a tax benefit from an uncertain position may only be recognized if it is “more likely than not” that the position is sustainable based on its technical merits. The tax benefit of a qualifying position shall be measured by calculating the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. The assessment of the recognition threshold and the measurement of the associated tax benefit might change as new information becomes available. Unrecognized tax benefits should be recognized in the period that the position reaches the recognition threshold, which might occur prior to absolute finality of the matter. Similarly, recognized tax benefits should be derecognized in the period in which the position falls below the threshold. FIN 48 also requires qualitative and quantitative disclosures, including discussion of reasonably possible changes that might occur in the recognized tax benefits over the next twelve months, a description of open tax years by major jurisdictions and a roll-forward of all unrecognized tax benefits, presented as a reconciliation of the beginning and ending balances of the unrecognized tax benefits on a worldwide aggregated basis. FIN 48 is effective as of the beginning of fiscal years that start after December 15, 2006. The change in net assets that results from the application of FIN 48 shall be recorded as an adjustment to retained earnings. Management has not yet determined the impact that the adoption of FIN 48 will have on the Company’s consolidated financial position, results of operations and earnings per common share.

8.
Subsequent Event
 
On July 15, 2006 the Company entered into a Stock Purchase Agreement with EP Acquisition, LLC (the “Purchaser”) pursuant to which the Company will sell, and the Purchaser will acquire, all issued and outstanding common shares of stock (the “Stock”) of Racing Corporation of America, the parent corporation of Ellis Park Race Course.
 
17

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 

On July 15, 2006, the Company also entered into a Management Agreement with the Purchaser pursuant to which the Purchaser will manage the operations of Ellis Park from July 19, 2006 through the date of the closing. Management has determined that the sale of the Stock will not have a material, adverse impact on the Company’s financial position and results of operations. The closing of the sale of the Stock is anticipated to take place during the third quarter of 2006 and is subject to customary conditions.
 
18

 
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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, Illinois and Louisiana 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; the loss of our totalisator companies or their inability to provide assurance on the reliability of their internal control processes through Statement on Auditing Standards No. 70 audits 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; the impact of natural disasters, including Hurricanes Katrina, Rita and Wilma, on our operations and our ability to adjust the casualty losses through our property and business interruption insurance coverage; any business disruption associated with a natural disaster and/or its aftermath; 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, 2005 for further information, including Part I - Item 1A for a discussion regarding some of the reasons that actual results may be materially different from those we anticipate, as modified by Part II - Item 1A of the Quarterly Report on Form 10-Q .

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.
 
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We operate the Churchill Downs racetrack, its on-site simulcast facility and training facility 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 Arlington Park, a Thoroughbred racing operation in Arlington Heights, Illinois and its eight off-track betting facilities ("OTBs"); Calder Race Course, a Thoroughbred racing operation in Miami Gardens, Florida; and Fair Grounds Race Course (“Fair Grounds”), a Thoroughbred racing operation in New Orleans, Louisiana, its eleven OTBs and Video Services, Inc. ("VSI") (collectively referred to as "Louisiana Operations"). Additionally, we are the majority owner and operator of Hoosier Park in Anderson, Indiana, which conducts Thoroughbred, Quarter Horse and Standardbred horse racing, its on-site simulcast facility and its three OTBs.

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 Developments

Racing World

On April 3, 2006, we entered into a definitive agreement (the “Agreement”) with Magna Entertainment Corporation (“MEC”) and Racing UK to form a subscription television channel that will broadcast races from our racetracks, racetracks of MEC, as well as other North American and international racetracks, into the United Kingdom and Ireland. As part of the Agreement, the Company, MEC and Racing UK became owners of Racing World Limited. Under the terms of the Agreement, we anticipate making a total investment in this venture of 375 thousand British pounds.

Insurance Recoveries, Net of Losses

As of June 30, 2006, we have received $18.0 million, $2.0 million and $6.0 million in insurance recoveries related to damages suffered from natural disasters by our Louisiana Operations, Calder Race Course and Ellis Park, respectively. We recorded $10.9 million of insurance recoveries, net of losses in our Condensed Consolidated Statements of Net Earnings for the six months ended June 30, 2006. Please refer to Note 3 to our Condensed Consolidated Financial Statements for further details regarding the natural disasters and related casualty losses and insurance recoveries.

Sale of Ellis Park Race Course

On July 15, 2006 we entered into a Stock Purchase Agreement with EP Acquisition, LLC (the “Purchaser”) pursuant to which we will sell, and the Purchaser will acquire, all issued and outstanding common shares of stock (“the Stock”) of Racing Corporation of America, the parent corporation of Ellis Park Race Course.

On July 15, 2006, we also entered into a Management Agreement with the Purchaser pursuant to which the Purchaser will manage the operations of Ellis Park from July 19, 2006 through the date of the closing. Management has determined that the sale of the Stock will not have a material, adverse impact on our financial position and results of operations. The closing of the sale of the Stock is anticipated to take place during the third quarter of 2006 and is subject to customary closing conditions.

Employment Agreement - Robert L. Evans

On July 18, 2006, we entered into an employment agreement (“the Employment Agreement”) with Robert L. Evans, who will replace Thomas H. Meeker as President and Chief Executive Officer of the Company, and serve as a member of the Board of Directors of the Company (the “Board”), effective August 14, 2006. The Employment Agreement was approved by the Board.

The Employment Agreement has an initial term of employment for three years, with automatic one-year extensions (unless either party provides a written notice not to extend the term of employment at least 90 days prior to the then-current expiration date). The Employment Agreement provides for earlier termination under certain circumstances.
 
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The Employment Agreement provides for an annual base salary of $450,000, with reviews for potential increase at the discretion of the Board. Mr. Evans will be first eligible to participate in the annual performance bonus plan for the performance period commencing January 1, 2007, with his initial target bonus opportunity for such period to be 75% of his base salary.

The Employment Agreement further provides that Mr. Evans will receive the following equity-based awards: (i) 65,000 restricted stock units representing shares of the Company’s common stock, vesting quarterly over five years, with Mr. Evans entitled to receive the shares underlying the units (along with a cash payment equal to accumulated dividend equivalents beginning with the lapse of forfeiture, plus interest at a 3% annual rate) six months after termination of employment; (ii) 90,000 restricted shares of the Company’s common stock, with vesting contingent upon the Company’s common stock reaching certain closing prices on Nasdaq for twenty consecutive trading days; (iii) 65,000 restricted shares of the Company’s common stock, vesting quarterly over five years, and contingent upon the Company’s common stock reaching a certain closing price on Nasdaq for ten consecutive trading days; and (iv) a stock option, vesting quarterly over three years, to purchase an aggregate of 130,000 shares of the Company’s common stock, with an exercise price equal to the fair market value of a share of the Company’s common stock on the date of the grant.

Florida Court Ruling

On August 8, 2006, the District Court of Appeals, First District, State of Florida rendered a decision in the case of Floridians Against Expanded Gambling (“FAEG”), et. al versus Floridians for a Level Playing Field, et. al. FAEG challenged the process by which signatures were collected in order to place a constitutional amendment allowing Miami-Dade and Broward County voters to approve slot machines in pari-mutuel facilities on the ballot in 2004. The District Court of Appeals reversed a decision of the Florida trial court, which granted summary judgment and dismissed the challenge, and remanded the case back to the trial court for an evidentiary hearing to determine whether sufficient signatures were collected in the petition process. As the decision was filed August 8, 2006, we are still in the process of reviewing with counsel its impact on the potential for slots at Calder Race Course and options relative to the pending litigation.

Legislative and Regulatory Developments 

Federal

WTO

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 Acts 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 Acts 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 (“IHA”), 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 IHA 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 for domestic U.S. companies was created under the IHA, but recommended that the WTO's Dispute Settlement Body request the United States to bring measures found to be inconsistent with GATS into conformity with its obligations under GATS. The United States was given until April 3, 2006 to bring its policies in line with the ruling, assuming it believed any changes were necessary. On April 10, 2006, the United States delegation to the WTO submitted a brief report to the Chairman of the Dispute Settlement Body (“U.S. Report”) stating that no changes are necessary to bring U.S. policies in line with the ruling. In support of its position, the United States delegation informed the Dispute Settlement Body that on April 5, 2006, the United States Department of Justice confirmed the United States Government position regarding remote wagering on horseracing in testimony before a subcommittee of the United States House of Representatives. According to the U.S. Report, in that testimony, the Department of Justice stated its view that regardless of the IHA, existing criminal statutes prohibit the interstate transmission of bets or wagers, including wagers on horseracing, and informed the subcommittee that it is currently undertaking a civil investigation relating to a potential violation of law regarding this activity. Antigua has not indicated what actions, if any, it will take in response to the U.S. Report and the United States' position relative to interstate wagering on horseracing. The effect of the WTO ruling on the ability of domestic companies to accept Internet wagers and other account wagers on horseracing remains unclear.
 
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Federal Legislation

The U.S. House of Representatives is considering the Internet Gambling Prohibition and Enforcement Act (“HR 4411”) that combines bills offered by Representative Bob Goodlatte (R-VA) and Representative Jim Leach (R-IA), which would criminalize gaming over the Internet by amending the Wire Act to specifically cover Internet activities. HR 4411 contains a “rule of construction” and a “Sense of Congress” which explicitly state that the provisions of HR411 are not intended to criminalize any activity that is currently permitted by the IHA. HR 4411 has been approved by the House of Representatives and will be considered by the United States Senate during the last half of 2006. HR 4411 states it does not change the existing relationship between the IHA and the Wire Act.

Indiana

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. Some of these in-home wagering providers accept pari-mutuel wagers from Indiana residents. TVG, one of our major in-home providers in Indiana, has ceased operations in Indiana due to legal uncertainty created by SEA 92.

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. Slot machine gaming was approved by the Florida legislature during a special session of the Florida legislature on December 9, 2005. Slot operations are expected to commence in a staggered manner at Broward's four pari-mutuel wagering facilities from September of 2006 through 2008. We believe that the failure of the local referendum to pass in Miami-Dade County was due primarily to Governor 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 when the issue can again be placed on the ballot. The earliest that it can be placed on the ballot is March 8, 2007, but it may be 2008 before the issue is actually placed on the ballot. We are currently determining the most advantageous date for placing the issue on the ballot. The impact on our results of operations and financial position of the failed referendum in Miami-Dade County and the operation of slot machines at pari-mutuel wagering facilities in Broward County is uncertain at this time.

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.
 
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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. Since the statute remains in effect, Arlington Park continues 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.

Under previously enacted legislation, the Illinois Horse Racing Equity fund was scheduled to receive a portion (up to 15% of adjusted gross receipts) of wagering tax from the tenth riverboat casino license issued. The grant of the tenth riverboat license is currently the subject of numerous legal challenges and, as such, is currently not an operational riverboat license. The funds were scheduled to be utilized for purses and track discretionary spending. Because the tenth license has never been operational, the Illinois Horse Racing Equity fund has never had any funds to distribute.

In the Spring of 2006 session of the Illinois General Assembly, legislation was passed to create and fund the Horse Racing Equity Trust fund. The Horse Racing Equity Trust fund is to be funded from revenues of Illinois riverboat casinos that meet a certain threshold. Sixty percent of the funds are to be used for horsemen’s purses (57% for thoroughbred meets and 43% for standardbred meets). The remaining 40% is to be distributed to racetracks (30.4% of that total for Arlington Park) and is to be used for improving, maintaining, marketing and operating Arlington Park and may be used for backstretch services and capital improvements. The legislation expires two years after its immediate effective date. The governor of Illinois signed the legislation on May 26, 2006 as Public Act 94-0805.

In an effort to prevent implementation of Public Act 94-0805, the four Illinois riverboat casinos that meet the threshold to contribute to the fund filed a complaint on May 30, 2006 in the Circuit Court of Will County, Illinois. The complaint was filed against the State Treasurer and the IRB to enjoin the imposition and collection of the 3% “surcharge” from the casinos, which was to be deposited in the Horse Racing Equity Trust fund. The riverboats have been paying the monies into a special escrow account and have demanded that the monies not be distributed. A temporary restraining order was granted to prevent distribution of these monies. The complaint alleges that Public Act 94-0805 is unconstitutional. The Illinois Attorney General will represent Illinois on this matter. As of the date of the filing of this Quarterly Report on Form 10-Q, management does not know the impact that the ultimate outcome of this matter will have on our consolidated financial position and results of operations.

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 designated Arlington Park as host track in Illinois during January of 2006 for 29 days, which is the same as January of 2005. In addition, Arlington Park was designated as host track for eight days during February of 2006, which resulted in an increase of $0.5 million in pre-tax earnings for the month of February of 2006 compared to the same period of 2005. Arlington Park's future designation as the host track is subject to the annual designation by the IRB. A change in the number of days that Arlington Park is designated "host track" could have a material, adverse impact on our results of operations.

Kentucky

The Kentucky horse industry continues to seek legal authority to offer alternative forms of gaming at Kentucky'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 filed in the 2006 session of the Kentucky General Assembly, including two bills filed in the House and two in the Senate. The Kentucky Equine Education Project ("KEEP"), an alliance of the Commonwealth's equine industry leaders, including our Company, supported legislation that called for a statewide voter referendum in the Fall of 2006 to amend the State constitution to allow Kentucky's eight racetracks to offer full casino gaming. The Commonwealth's share of the new revenue would have been earmarked for education, healthcare, local development and environmental concerns benefiting the entire Commonwealth under the KEEP plan. For several reasons, including active and public opposition by the Senate President and the governor publicly questioning the economics of alternative gaming, no alternative gaming legislation was passed. KEEP has vowed to continue the fight for full casino gaming at racetracks in 2007, and we plan to participate actively in that effort. 
 
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Kentucky statutes provide for the payment of supplemental purses by Kentucky racetracks for designated races won by Kentucky-bred horses. A portion of the excise tax collected on live, inter-track and simulcast wagering is available to reimburse each Kentucky racetrack for monies paid out as supplemental purses. The payment of the monies is administered through the Kentucky Thoroughbred Development Fund (the “KTDF”). Ellis Park is currently seeking reimbursement for $775,380 from the KTDF for monies paid out as supplemental purses in 2005. The Kentucky Horse Racing Authority has requested the Kentucky State Auditor to audit the KTDF to determine amounts owed to Ellis Park as well as other racetracks. The timing and outcome of the audit are unknown at this time.

Louisiana

We have received statutory, regulatory and other authorizations to operate slot machines at Fair Grounds. Failure to maintain the necessary gaming licenses to own and operate slot machines at Fair Grounds could have a material, adverse impact on our results of operations. Under the Louisiana statute, Fair Grounds was permitted to operate 500 slot machines. As a result of Hurricane Katrina, the agreement between Harrah's Casino in New Orleans and the State of Louisiana has been amended to eliminate the $350.0 million gaming revenue threshold before Fair Grounds may operate 700 slot machines. Conforming legislation was passed in the 2006 session of the Louisiana legislature. Due to Hurricane Katrina, we are currently evaluating the feasibility of beginning construction of a new slot facility.

Churchill Downs Louisiana Horseracing Company, LLC has completed the process to seek the necessary local zoning change and permits. On August 18, 2005, the New Orleans City Council passed ordinances approving hours of operation for slot machines at Fair Grounds as part of its conditional use permit. The ordinances also established additional provisos negotiated by Churchill Downs Louisiana Horseracing Company, LLC and the New Orleans City Council relating to other conditional use activities.

In April 2005, the New Orleans City Council instructed the city attorney to file a declaratory judgment action to determine if installation of slot machines 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. In June of 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 the installation of slot machines at Fair Grounds violates the City Charter.

Critical Accounting Policies

Our Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America. 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 our 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 retentions under our liability and workers' compensation policies. Additionally, estimates are used for determining income tax liabilities and the valuation of interest rate risk derivative contracts (interest rate swaps) and other derivative instruments.

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" 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
 
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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.

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.

In connection with losses incurred from natural disasters, insurance proceeds are collected on existing business interruption and property and casualty insurance policies. When losses are sustained in one period and the amounts to be recovered are collected in a subsequent period, management uses estimates and judgment to determine the amounts that are probable of recovery under such policies as specified in Financial Accounting Standards Board Interpretation No. 30, "Accounting for Involuntary Conversion of Nonmonetary Assets to Monetary Assets."

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 annually 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.

In the past, we have utilized 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 was 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 were 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, 2006 business insurance renewals included substantially the same coverages and retentions as previous years. However, our property retentions in Florida and Louisiana increased significantly for wind damage. 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.
 
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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 of our annual operating income.

Our pari-mutuel revenues include commissions on pari-mutuel wagering at our racetracks and off-track betting facilities (net of state and local 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 directly 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 70% of our annual revenues are generated by pari-mutuel wagering on live and simulcast racing content and in-home wagering. Live racing handle includes patron 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 advance deposit wagering, consists of patron wagers through a pre-funded account.

We retain as revenue a predetermined percentage or commission on the total amount wagered on live and import simulcasting sources, 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 periods indicated, certain operating data:
 
 (In thousands, except per share data and live race days)  
 Three Months Ended June 30,
   
 Change
   
 2006
   
 2005
   
 Amount
   
  %
                         
Total pari-mutuel handle
 
$
1,269,571
   
$
1,182,752
   
$
86,819
   
7
%
Number of live race days
   
192
     
187
     
5
   
3
%
                               
Net pari-mutuel revenues
 
$
105,307
   
$
100,295
   
$
5,012
   
5
%
Other operating revenues
   
69,718
     
62,912
     
6,806
   
11
%
Total net revenues
 
$
175,025
   
$
163,207
   
$
11,818
   
7
%
                               
Gross profit
 
$
59,088
   
$
52,608
   
$
6,480
   
12
%
Gross margin percentage
   
34
%
   
32
%
             
                               
Operating income
 
$
56,781
   
$
40,337
   
$
16,444
   
41
%
Net earnings from continuing operations
 
$
33,353
   
$
22,678
   
$
10,675
   
47
%
                               
Diluted net earnings from continuing operations per common share
 
$
2.45
   
$
1.69
               

Three Months Ended June 30, 2006 Compared to the Three Months Ended June 30, 2005

Our total net revenues increased $11.8 million primarily due to increased revenues during the week of the Kentucky Derby, which resulted in higher revenues in our Kentucky Operations and CDSN segments. Net revenues from the Louisiana Operations also increased significantly primarily as a result of increased wagering at our video poker operations as well as an increase in import simulcasting pari-mutuel revenues. Net revenues from Arlington Park increased primarily as a result of five more live racing days during the three months ended June 30, 2006 compared to the same period of 2005. 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 net earnings from continuing operations per common share included:

 
·
During the three months ended June 30, 2006, we recorded insurance recoveries, net of losses of $9.6 million related to damages sustained from natural disasters that occurred during 2005 by the Louisiana Operations, Calder Race Course and Ellis Park.
 
·
Our effective tax rate decreased from 44% to 41% resulting primarily from the non-deductibility of legislative initiative costs recognized during 2005.
 
27

Consolidated Expenses

The following table is a summary of our consolidated expenses: 
 
 (In thousands)
 
Three Months Ended June 30,
   
Change
 
 
 2006
 
 
2005
   
 $
 
 %
 
                       
Purse expenses
 
$
48,830
   
$
45,216
   
$
3,614
   
8
%
Depreciation/amortization
   
5,275
     
5,974
     
(699
)
 
(12
)%
Other operating expenses
   
61,832
     
59,409
     
2,423
   
4
%
SG&A expenses
   
11,921
     
12,271
     
(350
)
 
(3
)%
Insurance recoveries, net of losses
   
(9,614
)
   
-
     
(9,614
)
 
(100
)%
Total expenses from continuing operations
 
$
118,244
   
$
122,870
   
$
(4,626
)
 
(4
)%
                               
Percent of revenue
   
68
%
   
75
%
             

Three Months Ended June 30, 2006 Compared to the Three Months Ended June 30, 2005

Total expenses decreased 4% during the three months ended June 30, 2006, primarily as a result of insurance recoveries, net of losses of $9.6 million related to damages sustained from natural disasters that occurred during 2005 by the Louisiana Operations, Calder Race Course and Ellis Park. Purse expenses from the Kentucky Operations increased $1.7 million primarily due to a successful Kentucky Derby week. Purse expenses from the Louisiana Operations increased $1.2 million primarily due to higher revenues from our video poker operations and import simulcasting pari-mutuel operations. Other operating expenses from the Kentucky Operations and CDSN increased primarily as a result of increased expenses related to the Kentucky Derby, including those associated with fulfilling the sponsorships related to the Kentucky Derby. 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: 
 
 (In thousands)  
 Three Months Ended June 30,
 
      Change
 
 
 
 
2006
 
 
 
2005 
 
 
 
$
   
% 
 
                               
Interest income
 
$
243
   
$
76
   
$
167
   
220
%
Interest expense
   
(579
)
   
(390
)
   
(189
)
 
(48
)%
Unrealized gain on derivative instruments
   
204
     
204
     
-
   
-
 
Miscellaneous, net
   
14
     
132
     
(118
)
 
(89
)%
Other income (expense)
 
$
(118
)
 
$
22
   
$
(140
)
 
(636
)%
                               
Provision for income taxes
 
$
(23,310
)
 
$
(17,681
)
 
$
(5,629
)
 
(32
)%
                               
Effective tax rate
   
41
%
   
44
%
             
 
Three Months Ended June 30, 2006 Compared to the Three Months Ended June 30, 2005

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

 
·
Our effective tax rate decreased from 44% to 41% resulting primarily from the non-deductibility of legislative initiative costs recognized during 2005.
 
28


Return to Index
 
Net Revenues By Segment

The following table presents net revenues, including intercompany revenues, by our reported segments:
 
 (In thousands)  
 Three Months Ended June 30,
   
         Change
 
 
 
 2006
 
 
 2005
 
 
 $
 
 %
 
                       
Kentucky Operations
 
$
86,818
   
$
80,710
   
$
6,108
   
8
%
Arlington Park
   
26,215
     
25,095
     
1,120
   
4
%
Calder Race Course
   
25,985
     
25,511
     
474
   
2
%
Hoosier Park
   
11,186
     
11,603
     
(417
)
 
(4
)%
Louisiana Operations
   
18,679
     
14,825
     
3,854
   
26
%
CDSN
   
28,904
     
25,523
     
3,381
   
13
%
Total Racing Operations
   
197,787
     
183,267
     
14,520
   
8
%
Other Investments
   
1,026
     
886
     
140
   
16
%
Corporate
   
(3
)
   
287
     
(290
)
 
(101
)%
Eliminations
   
(23,785
)
   
(21,233
)
   
(2,552
)
 
(12
)%
Net revenues from continuing operations
 
$
175,025
   
$
163,207
   
$
11,818
   
7
%

Three Months Ended June 30, 2006 Compared to the Three Months Ended June 30, 2005

Significant items affecting comparability of our revenues by segment include:

 
·
Net revenues from the Kentucky Operations and CDSN increased primarily as a result of a successful Kentucky Derby week, including continued benefits realized from the newly renovated Churchill Downs racetrack facility as well as higher non-wagering revenues associated with the Kentucky Derby.
 
·
Net revenues from the Louisiana Operations also increased significantly primarily as a result of increased wagering at our video poker operations as well as an increase in import simulasting pari-mutuel revenues. Since the reopening of our OTBs in Louisiana after Hurricane Katrina, we experienced a significant rise in business levels that we believe is attributable to the limited entertainment options available in the Gulf Coast region.
 
·
Net revenues from Arlington Park increased primarily as a result of five more live racing days during the three months ended June 30, 2006 compared to the same period of 2005. The live racing meet of Arlington Park began on the weekend of the Kentucky Derby during 2006.

Expenses by Segment

The following table presents total expenses, including intercompany expenses, by our reported segments: 
 
 (In thousands)
 
  Three Months Ended June 30,
     
       Change
 
 
 
 
2006
 
 
 
2005
 
 
 
$
    %  
                               
Kentucky Operations
 
$
51,863
   
$
47,013
   
$
4,850
   
10
%
Arlington Park
   
26,166
     
24,395