CHDN

Churchill Downs Inc. 10-Q Summary (Period Ended September 30, 2005)

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for Churchill Downs Inc. for the period ended September 30, 2005. The Company operates pari-mutuel wagering on live and simulcast horse racing and offers alternative gaming (video poker) in Louisiana. The reporting period is significantly impacted by the sale of its Hollywood Park assets and the operational disruptions caused by Hurricane Katrina in Louisiana.

Key Financial Metrics

Material Changes vs. Prior Period

• Discontinued Operations: The Company sold the assets of Hollywood Park on September 23, 2005, recognizing a net gain of $69.9 million. This transaction drove the majority of the reported net earnings for the quarter and year-to-date.
• Debt Reduction: Proceeds from the Hollywood Park sale were used to pay off approximately $229.0 million in long-term debt (revolving loan facility and Senior Notes). Long-term debt on the balance sheet dropped from $242.8 million (Dec 31, 2004) to $18.1 million (Sep 30, 2005).
• Revenue Growth: Net revenues from continuing operations increased 9% for the quarter and 19% for the nine months compared to the prior year, primarily due to the acquisition of Louisiana Operations (Fair Grounds) in late 2004.
• Impairment Reversal: The prior year period (2004) included $6.2 million in asset and intangible impairment losses at Ellis Park, which were not present in the 2005 period, improving year-over-year comparability for continuing operations.

Outlook, Risks, and Contingencies

• Natural Disasters:
  • Hurricane Katrina: Caused significant damage to Louisiana Operations. The Company received $4.0 million in insurance proceeds (classified as restricted cash) and recorded a $1.4 million reduction in SG&A expenses. The ultimate impact on operations remains under evaluation.
  • Hurricane Wilma: Damaged Calder Race Course in Florida (October 2005). Operations resumed partially by late October and fully by November 3, 2005. Insurance claims are pending.
  • Tornado: Damaged Ellis Park in Kentucky (November 2005). Reopening date was undetermined at the time of filing.
• Regulatory Risks:
  • Internet Wagering: A WTO ruling regarding U.S. enforcement of gaming laws against foreign internet operators creates uncertainty for in-home wagering revenue streams.
  • Slot Machines: Legislative efforts to authorize slot machines in Florida (Miami-Dade) and Kentucky are ongoing but face legal and political hurdles.
• Internal Controls: Management identified a material weakness in internal controls regarding a third-party service organization that processes pari-mutuel wagering. Management could not obtain evidence of the effectiveness of controls at this service provider.

Investor Verification Checklist

• Continuing Operations Profitability: Verify the sustainability of earnings excluding the one-time $69.9 million gain from the Hollywood Park sale. Continuing operations net earnings were $3.8 million for the quarter.
• Insurance Recoveries: Monitor the status of insurance claims related to Hurricanes Katrina and Wilma and the tornado damage at Ellis Park to assess potential future cash inflows or write-offs.
• Internal Control Remediation: Review subsequent filings for updates on the material weakness regarding the third-party wagering service provider and the steps taken to remediate it.
• Regulatory Approvals: Track legislative progress on slot machine authorization in Florida and Kentucky, as these are critical to future revenue growth strategies.
• Debt Covenants: Confirm compliance with the new Amended and Restated Credit Agreement entered into on September 23, 2005, which includes leverage and interest coverage ratios.