UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Year Ended December 31, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to _________________ Commission File Number 0-1469 CHURCHILL DOWNS INCORPORATED Exact name of registrant as specified in its charter KENTUCKY 61-0156015 State or other jurisdiction of IRS Employer Incorporation or Organization Identification No. 700 CENTRAL AVENUE, LOUISVILLE, KENTUCKY 40208 Address of Principal Executive Offices Zip Code Registrant's Telephone Number, Including Area Code 502-636-4400 Securities registered pursuant to Section 12(b) of the Act: None None Title of Each Class registered Name of Each Exchange on which registered Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE Title of Class 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 and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. (_________) As of March 25, 1999, 7,525,041 shares of the Registrant's Common Stock were outstanding, and the aggregate market value of the shares held by nonaffiliates of the Registrant was $131,000,000. Portions of the Registrant's Proxy Statement for its Annual Meeting of Shareholders to be held on June 17, 1999 are incorporated by reference herein in response to Items 10, 11, 12 and 13 of Part III of Form 10-K. The exhibit index is located on pages 58 to 59. 1
PART I ITEM 1. BUSINESS A. INTRODUCTION Churchill Downs Incorporated (the "Company") is a racing company that primarily conducts pari-mutuel wagering on live Thoroughbred and Standardbred horse racing and simulcast video feeds of races. Additionally, we offer racing services through our other business interests. We own and operate our flagship operation, Churchill Downs racetrack, in Louisville, Kentucky ("Churchill Downs"). Churchill Downs has conducted Thoroughbred racing continuously since 1875, and is internationally known as home of the Kentucky Derby. The Churchill Downs operation also encompasses the Louisville Sports Spectrum, a simulcast- wagering facility. In 1992, we formed Churchill Downs Management Company ("CDMC"), a wholly owned subsidiary that oversees properties we actively manage. CDMC manages Ellis Park Race Course ("Ellis Park"), a Thoroughbred track in Henderson, Kentucky, and the Kentucky Horse Center in Lexington, Kentucky. We acquired ownership of these two facilities in April 1998. Additionally, CDMC manages Hoosier Park in Anderson, Indiana ("Hoosier Park"), of which we are a majority owner. Hoosier Park conducts Thoroughbred, Quarter Horse and Standardbred horse racing. CDMC also manages three Sports Spectrum facilities ("Sports Spectrum") owned by Hoosier Park in Indiana. The Sports Spectrum facilities conduct simulcast wagering on horse racing year-round. We also periodically conduct simulcast wagering at our racetracks. In November 1997, we formed Churchill Downs Investment Company ("CDIC"), a wholly owned subsidiary, to oversee those investments in which we participate as an equity investor and do not actively manage the operations. Among those investments are NASRIN Services, LLC ("NASRIN"), a telecommunications service provider for the pari-mutuel and simulcasting industries, and EquiSource, LLC ("EquiSource"), a procurement business that assists in the group purchasing of supplies and services for the equine industry. We are a minority investor in both NASRIN and EquiSource. In March 1999, CDIC and Autotote Corporation ("Autotote") formed NASRIN, which operates under the NASRIN banner and is managed on a day-to-day basis by Autotote. Autotote owns 70 percent of NASRIN and CDIC owns 30 percent. Currently, neither NASRIN nor Equisource are material investments for us. 2
CDIC also holds our minority investment in Kentucky Downs, LLC ("Kentucky Downs"), a Franklin, Kentucky, racetrack that conducts a limited Thoroughbred race meet as well as year-round simulcasting. Turfway Park - a Florence, Kentucky, racetrack - also holds a minority interest in Kentucky Downs and manages its day-to-day operations. In March 1999, Keeneland Association, Inc. ("Keeneland"), a Lexington, Kentucky, racetrack; Dreamport, Inc., a wholly owned subsidiary of GTECH Corporation; and Dusty Corporation, a wholly owned subsidiary of Harrah's Entertainment, Inc., through a jointly owned company, acquired all of Turfway Park's racetrack-related assets. It is not believed that this transaction will have a material effect on the management of Kentucky Downs. Our investment in Kentucky Downs is not material to the Company's operations at this time. On January 11, 1999, we completed the purchase of a majority ownership interest in Charlson Industries, Inc., a privately held company that provides simulcast graphic software and video services to racetracks and simulcast wagering facilities. Under the purchase agreement, the two parties formed Charlson Broadcast Technologies, LLC ("CBT"). We control a 60% interest in the new venture. The cost of the transaction - including the purchase price, capital commitments and contingent payments - totaled $4.9 million. CBT now owns all the assets formerly owned by Charlson Industries. The new venture is expected to be strategically significant to our development of a comprehensive simulcast product The Company was organized as a Kentucky corporation in 1928. Its principal executive offices are located at Churchill Downs, 700 Central Avenue, Louisville, Kentucky 40208. B. LIVE RACING OPERATIONS We conduct live horse racing at Churchill Downs, Ellis Park and Hoosier Park during each track's respective meets. Live racing produces revenues through pari-mutuel wagering, admissions and seating, concession commissions (primarily the sales of food and beverage items), sponsorship revenues, and license, rights and broadcast fees. The Kentucky Derby and the Kentucky Oaks, both held at Churchill Downs, continue to be our premier racing events. Churchill Downs has also hosted the Breeders' Cup Championship a record four times, in 1988, 1991, 1994 and 1998. The Breeders' Cup races are held annually for the purpose of determining Thoroughbred champions in eight different events. Racetracks across North America compete for the privilege of hosting the Breeders' Cup races each year. Hosting the Breeders' Cup event has a positive impact on marketing, publicity and financial results. 3
Churchill Downs Churchill Downs annually conducts two live Thoroughbred race meets, a Spring Meet (late April through late June) and a Fall Meet (late October through late November). We own the Churchill Downs racetrack site and improvements located at or adjacent to 700 Central Avenue, Louisville, Kentucky (the "Churchill facility"). The Churchill facility consists of approximately 157 acres of land with a one-mile oval dirt track, a seven-eighths (7/8) mile turf track, permanent grandstands and a stabling area. The physical plant includes clubhouse and grandstand seating for approximately 48,500 persons, a general admission area, and food and beverage facilities ranging from fast food to full-service restaurants. The Paddock Pavilion, a state-of-the-art simulcast-wagering facility designed to accommodate 450 patrons, opened in May 1997. The site also has a saddling paddock, infield accommodations for groups and special events, parking areas for the public, and our office facilities. The backside stable area has sprinkled barns sufficient to accommodate approximately 1,400 horses, and other facilities for backstretch personnel. In September 1998, our board of directors approved the construction of a 114-room brick dormitory for backstretch personnel. This $2.4 million project is expected to be completed during the track's 1999 Spring Meet. We have made numerous capital improvements to the Churchill facility during the past 10 years in order to better serve our horsemen and patrons. The dirt and turf tracks provide excellent venues for live Thoroughbred racing. We provide additional stabling facilities and a training track at the Louisville Sports Spectrum, where a portion of the property is used as a Thoroughbred stabling and training annex. We converted a former Standardbred track into a three-quarter (3/4) mile dirt track, which is used for training Thoroughbreds. The existing barns on the property were demolished, and we constructed new sprinkled barns sufficient to accommodate approximately 500 horses, providing a year-round base of operation for many horsemen and enabling us to attract new horsemen who desire to race at Churchill Downs. Our physical plant at the Churchill facility is fully utilized only on those days when live racing is conducted. 4
Ellis Park Race Course Ellis Park conducts Thoroughbred racing from late June or early July through Labor Day. We own the Ellis Park racetrack and improvements located at or adjacent to 3300 U.S. Highway 41 North in Henderson, Kentucky ("Ellis Park facility"). The Ellis Park facility consists of 230 acres of land just north of the Ohio River with a one and one-eighths (1 1/8) mile dirt track, a one-mile turf course, permanent grandstands and a stabling area for 1,290 horses. The physical plant includes clubhouse and grandstand seating for 8,000 people, a general admission area, and food and beverage facilities ranging from fast food to full-service restaurants. The Ellis Park facility also features a saddling paddock, parking areas for the public and office facilities. Hoosier Park Hoosier Park conducts live Standardbred racing (mid-April to late August), live Thoroughbred racing (mid-September to late November) and live Quarter Horse racing (late October). Hoosier Park is located in Anderson, Indiana, about 40 miles northeast of downtown Indianapolis. Hoosier Park leases the land under a long-term lease with the city of Anderson and owns all of the improvements on the site located at 4500 Dan Patch Circle in Anderson, Indiana. The racetrack facility consists of approximately 110 acres of leased land with a seven-eighths (7/8) mile oval dirt track, permanent grandstands, and stabling area. The physical plant includes seating for approximately 2,400 persons, a general admission area, and food and beverage facilities ranging from fast food to a full-service restaurant. The site also has a saddling paddock, parking areas for the public, and office facilities. The stable area has barns sufficient to accommodate 780 horses, and other facilities for backstretch personnel. Hoosier Park is owned by Hoosier Park, L.P. ("HPLP"), an Indiana limited partnership formed in 1994. We currently own a 77% interest in HPLP through Anderson Park, Inc. ("Anderson"), a wholly owned subsidiary of CDMC. The remaining 23% of HPLP is held by unrelated third parties, Pegasus Group, Inc. ("Pegasus"), and Conseco HPLP, LLC ("Conseco"). Conseco and Pegasus are limited partners of HPLP, and Anderson continues to be the sole general partner of HPLP. HPLP has entered into a management agreement with CDMC under which CDMC has operational control of the day-to-day 5
affairs of Hoosier Park and its related simulcast operations. Through CDMC, we have loaned to HPLP $23.2 million, which includes accrued interest, for the development of the racetrack and related simulcast wagering facilities. CDMC is committed to loan an additional $2.6 million to HPLP, but we do not anticipate any additional investment. The loan bears interest of prime plus 2% (9.75% at December 31, 1998). Licensing Kentucky's racetracks, including Churchill Downs and Ellis Park, are subject to the licensing and regulation of the Kentucky Racing Commission ("KRC"), which consists of 11 members appointed by the governor of Kentucky. Licenses to conduct live Thoroughbred race meets and to participate in simulcasting (discussed below) are approved annually by the KRC based upon applications submitted by the racetracks in Kentucky. Although to some extent Churchill Downs and Ellis Park compete with other racetracks in Kentucky for the award of racing dates, the KRC is required by state law to consider and seek to preserve each racetrack's usual and customary live racing dates. Generally, there is no substantial change from year to year in the racing dates awarded to each racetrack. The KRC has awarded Churchill Downs a total of 71 live racing dates in 1999 and Ellis Park a total of 61 days. In Indiana, licenses to conduct live Standardbred and Thoroughbred race meets, including Quarter Horse races, and to participate in simulcasting are approved annually by the Indiana Horse Racing Commission ("IHRC"), which consists of five members appointed by the governor of Indiana. Licenses are approved annually by the IHRC based upon applications submitted by Hoosier Park. Currently, Hoosier Park is the only facility in Indiana licensed to conduct pari- mutuel wagering on live Standardbred, Quarter Horse or Thoroughbred racing and to participate in simulcasting. The IHRC has awarded Hoosier Park a total of 168 live racing dates in 1999. A substantial change in the allocation of live racing days at Churchill Downs, Ellis Park or Hoosier Park could adversely impact our operations and earnings in future years. Service Marks We hold federal service mark registrations on the names "Kentucky Derby," "Churchill Downs," "Churchill Downs Sports Spectrum," "Kentucky Oaks," "Churchill Charlie" and the Twin Spires design in various categories including 6
entertainment business, apparel, paper goods, printed matter and housewares and glass. We license the use of these service marks and derive revenue from such license agreements. C. SIMULCASTING OPERATIONS In the horse racing industry, simulcasting involves sending audio and video signals of live races to off-track facilities, including other racetracks, for the purpose of wagering. We generate a significant portion of our revenues by sending our signals to other facilities and receiving signals from other tracks. These revenues are earned through pari-mutuel wagering on signals that we both send and receive. During 1998, we sold the Churchill Downs, Ellis Park and Hoosier Park signals as separate products. The Kentucky Derby signal was packaged with that of Churchill Downs. Starting in 1999, we intend to also offer all of the signals we own as one product. Ellis Park and Hoosier Park act as year-round simulcast facilities, while Churchill Downs receives signals only during its race meets. The Louisville Sports Spectrum conducts simulcast wagering when Churchill Downs is not operating a live race meet with the exception of Kentucky Derby Day and the immediately following Sunday. The Indiana Sports Spectrums and the Kentucky Off-Track Betting facilities (discussed below) conduct simulcast wagering year-round. Louisville Sports Spectrum We own the real property and improvements known as the Louisville Sports Spectrum, located at 4520 Poplar Level Road in Louisville, Kentucky. Formerly a Standardbred racetrack, this property was acquired by us in 1992 and converted into a simulcast wagering facility and Thoroughbred training annex. The 100,000-square-foot Louisville Sports Spectrum is located on approximately 88 acres of land, about seven miles from Churchill Downs. The Louisville Sports Spectrum provides state-of-the art audio/visual technology, seating for approximately 3,000 persons, parking, offices and related facilities for simulcasting races in Kentucky and throughout the United States. Seven separate areas were created within the structure to accommodate the needs of a variety of patrons, from the seasoned handicapper to the novice player. As mentioned above, the Louisville Sports Spectrum also provides a stabling and training annex for Churchill Downs. 7
Indiana Sports Spectrums Hoosier Park owns and operates three simulcast-wagering facilities in Indiana, which are branded with the Churchill Downs Sports Spectrum name. These simulcast wagering facilities provide a statewide distribution system for Hoosier Park's racing signal and additional simulcast markets for our products. The Sports Spectrum at Merrillville, located about 30 miles southeast of Chicago, consists of approximately 27,300 square feet of space. The Sports Spectrum at Fort Wayne consists of approximately 15,750 square feet of space. Hoosier Park also leases space in the Claypool Courts Building in downtown Indianapolis where it operates the Sports Spectrum at Indianapolis. In October 1998, the IHRC approved the expansion of this facility from approximately 17,500 square feet to 24,800 square feet. This project, completed in February 1999, increased capacity by 180 patrons to 630. Hoosier Park is continuing to evaluate sites for the location of a fourth Sports Spectrum facility. The State of Indiana has enacted legislation that requires a county fiscal body to adopt an ordinance permitting simulcast wagering facilities before such a facility can be located in that county. The county fiscal body may require in the ordinance that the voters of the county must approve the operation of a simulcast-wagering facility in that county. This legislation may affect Hoosier Park's ability to locate its fourth facility in certain counties. Kentucky Off-Track Betting, Inc. In 1992, the Company and three other Kentucky Thoroughbred racetracks formed Kentucky Off-Track Betting, Inc. ("KOTB"), of which we are a 50% shareholder. KOTB's purpose is to own and operate facilities for the simulcasting of races and the acceptance of wagers on such races at locations other than a racetrack. These simulcast wagering facilities may be located no closer than 75 miles from an existing racetrack without the track's consent and in no event closer than 50 miles to an existing track. Each simulcast wagering facility must first be approved by the KRC. Once approved, the simulcast wagering facility may then be established unless the local government where the facility is to be located votes to disapprove its establishment. KOTB currently owns or leases and operates simulcast wagering facilities in Corbin, Maysville, Jamestown, and Pineville, Kentucky. Simulcast wagering facilities developed by KOTB provide additional markets for the intrastate simulcasting of Churchill Downs' and Ellis Park's live races and interstate simulcasting on out-of-state signals. KOTB did not contribute significantly to our operations in 1998 and is not anticipated to have a substantial impact on operations in the future. 8
In-Home Wagering Churchill Downs, in conjunction with ODS Entertainment ("ODS") and InterMedia, continues to operate its in-home interactive television wagering system, the first such system in the country. Testing began in July 1995 and has expanded to approximately 1,250 homes in Jefferson County, Kentucky. In-home patrons can wager on Churchill Downs' live racing, as well as intrastate and interstate race signals. We believe development of such in-home technology can be used as an efficient delivery system that could increase revenues and attract new segments of the market to our racetracks. The second phase of our relationship with ODS will be the launching of the Television Games Network ("TVG"), which is projected to begin in the fourth quarter of 1999. This new network is anticipated to eventually offer 24-hour-a-day programming throughout the United States that will be primarily devoted to developing new fans for racing. Once completed, this would include interactive wagering from home. D. OTHER SOURCES OF REVENUE In addition to revenues from live racing and simulcasting, we generate revenues from additional sources. Riverboat Admissions Tax To compensate for the adverse impact of riverboat competition, the horse industry in Indiana presently receives $0.65 per $3 admission to riverboats in the state. The horse industry is required to allocate 70% of any revenue received from the subsidy directly for purse expenses, breed development and reimbursement of approved marketing costs. The balance, or 30%, is received by Hoosier Park as the only horse racetrack currently operating in Indiana. Kentucky Horse Center We own the real property and improvements known as the Kentucky Horse Center, located at 3380 Paris Pike in Lexington, Kentucky ("KHC"). The KHC is a Thoroughbred training and boarding facility that we acquired with Ellis Park in April 1998. The facility, which sits on 245 acres of land, offers a one-mile dirt track, a five-eighths (5/8) mile training track and stabling for 1,000 horses. Additionally, the KHC has facilities for meetings and larger special events, including a 920-seat auditorium known as the Pavilion. Escorted tours of the KHC's training facilities are offered to the public. KHC's revenues are not material to our operations at this time. 9
E. OTHER FACTORS AFFECTING THE COMPANY'S BUSINESS North American bloodstock sales climbed again in 1998, continuing a trend that began in 1997 when the market rebounded dramatically from its decade long slump. According to The Blood-Horse magazine, expenditures for Thoroughbred weanlings, yearlings, 2 year olds and broodmares totaled $816.9 million in 1998 compared to $693 million in 1997, which was the previous record. Beginning in 1995, the number of Thoroughbred foals born each year had also begun to show an increase. These recent increases in bloodstock prices and number of foals are indicators of a resurgence of the Thoroughbred breeding industry, reversing a trend of declines experienced from 1986 to 1995. These recent increases ultimately resulted in an increase in the number of Thoroughbreds available to run in races, which enables racetracks to increase the number of horses participating in live racing. Churchill Downs, Ellis Park and Hoosier Park were able to effectively compete for horses and experienced a high quality of racing in 1998. Churchill Downs offered record average daily purses that ranked among the highest in the nation. We believe these purses attracted many of the country's top horses and trainers. During Churchill Downs' live race meets, average daily purses reached $436,833. Purse increases at Hoosier Park in 1998 strengthened both its Thoroughbred and Standardbred racing programs and created greater demand from horsemen to race at the Indiana track. Average daily purses of $197,738 resulted in competitive race fields for Hoosier Park's Thoroughbred meet, while average daily purses of $141,535 during its Standardbred meet ranked Hoosier Park behind only The Meadowlands in New Jersey in terms of purse levels. This trend was also evident at Ellis Park, where 1998 average daily purses reached $170,916, compared to $163,546 in 1997. Based on the competitiveness of its racing products in Kentucky and Indiana, we believe we are well positioned to grow our share of the interstate simulcast market. We generally do not directly compete with other racetracks or simulcast facilities for patrons due to geographic separation of such facilities. However, we compete with other sports, entertainment and gaming options, including riverboat casinos and lotteries, for patrons for both live racing and simulcasting (For a further discussion of the Company's competitive environment, see "Management Discussion and Analysis of Financial Condition and Results of Operations"). We have successfully grown our live racing product and positioned ourself to compete by strengthening our flagship operations, increasing our share of the interstate simulcast market, and geographically expanding our racing operations. We also continue to pursue legislation to allow 10
video lottery terminals at our racetrack facilities in Kentucky as a means to attract new patrons and generate additional revenue for purses and capital investment. F. ENVIRONMENTAL MATTERS On January 22, 1992, we acquired certain assets of Louisville Downs, Incorporated for $5,000,000 including the site of the Louisville Sports Spectrum. In conjunction with this purchase, we withheld $1,000,000 from the amount due to the sellers to offset certain costs related to the remediation of environmental contamination associated with underground storage tanks at the site. All of the $1,000,000 hold back had been utilized as of December 31, 1997 and additional costs of remediation have not yet been conclusively determined. The sellers have now received a reimbursement from the State of Kentucky of $995,000 for remediation costs and that amount is now being held in an escrow account to pay further costs of remediation. Approximately $985,000 remains in the account. In addition to the hold back, we have obtained an indemnity to cover the full cost of remediation from the prior owner of the property. In January 1995, Hoosier Park opened the Churchill Downs Sports Spectrum in Merrillville, Indiana. The 27,300 square foot facility is designed exclusively for the simulcast of horse races and the conducting of pari-mutuel wagering. The Merrillville, Indiana, facility is also subject to contamination related to prior business operations adjacent to the property. In conjunction with the purchase, Hoosier Park withheld $50,000 from the amount due to the seller to offset costs related to remediation of the contamination. The contamination on the property is being remediated under the State of Indiana's voluntary remediation program. The State of Indiana approved the remediation plan in May of 1995. The cost of remediation is not expected to exceed $50,000. In addition to the hold back, Hoosier Park has obtained an indemnity to cover the full cost of remediation from the prior owner of the property. It is not anticipated that we will have any material liability as a result of compliance with environmental laws with respect to any of our property. Compliance with environmental laws has not materially affected the ability to develop and operate our properties and we are not otherwise subject to any material compliance costs in connection with federal or state environmental laws. G. EMPLOYEES We employ approximately 500 full-time employees. Due to the seasonal nature of our live racing business, the number of seasonal and part-time persons employed will vary throughout the year, with peak employment occurring Kentucky Derby week when we employ as 11
many as 2,600 persons. During 1998, average employment per pay period was approximately 1,000 individuals. ITEM 2. PROPERTIES Information concerning property owned by the us required by this Item is incorporated by reference to the information contained in Item 1. "Business" of this Report. Upon the closing of our proposed $250 million line of credit, our real and personal property (but not including the property of Hoosier Park, KOTB or Charlson) will be encumbered by liens securing our $250 million credit facility. The shares of stock certain of our subsidiaries will also be pledged to secure this facility. The Kentucky Derby Museum is operated on property adjacent to Churchill Downs. The Museum is owned and operated by the Kentucky Derby Museum Corporation, a tax-exempt organization under Section 501(c)(3) of the Internal Revenue Code of 1986. ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings, other than ordinary routine litigation incidental to our business, to which we are a party or of which any of our property is the subject and no such proceedings are known to be contemplated by governmental authorities. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of our stockholders during the fourth quarter of the fiscal year covered by this Report. 12
PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is traded in the over-the-counter market. As of March 29, 1993, our common stock was listed on the National Association of Securities Dealers, Inc.'s Small Cap Market automated quotation system ("NASDAQ"). As of March 24, 1999, there were approximately 3,100 stockholders of record. The following table sets forth the high and low bid quotations (as reported by NASDAQ) and dividend payment information for our common stock during its last two years: 1998 - By Quarter 1997 - By Quarter ----------------- ----------------- 1st 2nd 3rd 4th 1st 2nd 3rd 4th --- --- --- --- --- --- --- --- High Bid $25.31 $43.25 $41.44 $36.44 $18.50 $19.00 $21.00 $23.38 Low Bid $19.31 $24.00 $27.63 $27.25 $16.00 $16.50 $16.25 $20.75 Dividend per share: Annual $.50 $.25 Special - $.25 Stock quotations and dividend per share amounts reflect retroactive adjustments for the 2- for-1 stock split with a record date of March 30, 1998. Quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily reflect actual transactions. We presently expect that comparable annual cash dividends (adjusted for any stock splits or other similar transactions) will continue to be paid in the future. 13
ITEM 6. CONSOLIDATED SELECTED FINANCIAL DATA <TABLE> <CAPTION> Years ended December 31, 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Operations: <S> <C> <C> <C> <C> <C> Net revenues $147,300,299 $118,907,367 $107,858,818 $92,434,216 $66,419,460 Operating income $17,143,410 $14,405,288 $12,314,897 $10,305,210 $9,861,086 Net earnings $10,518,548 $9,148,560 $8,071,526 $6,203,135 $6,166,353 Basic net earnings per share $1.41 $1.25 $1.08 $.82 $.82 Diluted net earnings per share $1.40 $1.25 $1.08 $.82 $.82 Dividend paid per share Annual $.50 $.25 $.25 $.25 $.25 Special - $.25 $.08 - - Balance Sheet Data At Period End: Total assets $114,650,775 $85,848,808 $80,728,966 $77,486,482 $70,175,840 Working capital (deficiency) $(7,791,319) $(8,032,492) $(10,789,190) $(10,433,929) $(10,131,254) Long-term debt $13,664,839 $2,712,969 $2,952,607 $6,421,176 $8,683,314 Other Data: Stockholders' equity $65,230,988 $53,392,497 $47,780,880 $46,653,157 $42,003,147 Stockholders' equity per share $8.67 $7.30 $6.54 $6.17 $5.55 Additions to racing plant and equipment, exclusive of business acquisitions $3,524,032 $4,568,494 $2,570,795 $8,589,535 $23,310,204 </TABLE> Earnings, dividend and stockholders' equity per share amounts have been retroactively adjusted for the 2-for-1 stock split with a record date of March 30, 1998. 14
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis includes forecasts of future results of operations which are considered "forward-looking statements" and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our actual results could differ materially from these forecasts, and there can be no assurance that these forecasts of future results will be achieved. Important factors that could cause actual results to differ materially from the presently estimated results include: 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, a substantial change in allocation of live racing days, the impact of competition from alternative gaming (including riverboat and cruise ship casinos and lotteries) and other sports and entertainment options in those markets in which we operate, a decrease in riverboat admissions revenue from our Indiana operations, Year 2000 computer issues and our success in pursuit of our strategic initiatives designed to attract new patrons and generate additional revenues. Overview We conduct pari-mutuel wagering on live Thoroughbred and Standardbred horse racing and simulcast audio and video feeds of races. Additionally, we offer racing services through our other interests. We own and operate Churchill Downs racetrack in Louisville, Kentucky ("Churchill facility"), which has conducted Thoroughbred racing continuously since 1875 and is internationally known as home of the Kentucky Derby. We also own and operate Ellis Park Race Course, a Thoroughbred racetrack, in Henderson, Kentucky ("Ellis Park"), and the Kentucky Horse Center, a Thoroughbred training center, in Lexington, Kentucky. Additionally, we are the majority owner and operator of Hoosier Park in Anderson, Indiana, which conducts Thoroughbred, Quarter Horse and Standardbred horse racing. We conduct simulcast wagering on horse racing at our four simulcast wagering facilities in Louisville, Kentucky, and in Merrillville, Fort Wayne and Indianapolis, Indiana, as well as at our three racetracks. Because of the seasonal nature of our business, revenues and operating results for any interim quarter are not indicative of the revenues and operating results for the year and are not necessarily comparable with results for the corresponding period of the previous year. We normally earn a substantial portion of our net earnings in the second quarter of each year during 15
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS which the Kentucky Derby and the Kentucky Oaks are run. The Kentucky Derby and the Kentucky Oaks are run on the first weekend in May. Our primary sources of income are commissions and fees earned from pari-mutuel wagering on live and simulcast horse races. Other sources of income include admissions and seating, riverboat admission tax subsidy, concession commissions (primarily for the sale of food and beverages), sponsorship revenues, and license, rights and broadcast fees. Churchill Downs and Ellis Park, which we acquired during the second quarter of 1998, as well as Kentucky's other racetracks are subject to the licensing and regulation of the Kentucky Racing Commission ("KRC"). The KRC consists of 11 members appointed by the governor of Kentucky. Licenses to conduct live Thoroughbred race meetings and to participate in simulcasting are approved annually by the KRC based upon applications submitted by the racetracks in Kentucky. Although to some extent Churchill Downs and Ellis Park compete with other racetracks in Kentucky for the awarding of racing dates, the KRC is required by state law to consider and seek to preserve each racetrack's usual and customary live racing dates. Generally, there is no substantial change from year to year in the racing dates awarded to each racetrack. Churchill Downs conducted live racing from April 25 through June 28, 1998, and from November 1 through November 28, 1998, for a total of 71 racing days compared to 77 racing days in 1997. Ellis Park conducted live racing from June 29 through September 7, 1998, for a total of 61 racing days compared to 55 days in 1997, which was prior to our acquisition of Ellis Park . We received approval from the KRC to conduct live racing at Churchill Downs from April 24 through June 27, 1999 ("Spring Meet") and from October 31 through November 27, 1999 ("Fall Meet") for a total of 71 days. Ellis Park has been granted a total of 61 live racing days running from June 28 through September 6, 1999. The total number of days on which Churchill Downs and Ellis Park conduct live racing fluctuates annually according to the calendar year. A substantial change in the allocation of live racing days at Churchill Downs or Ellis Park could adversely impact our operations and earnings in future years. Churchill Downs hosted Breeders' Cup Day on November 7, 1998. Breeders' Cup Day is sponsored by Breeders' Cup Limited, a tax-exempt organization chartered to promote Thoroughbred racing and breeding. The Breeders' Cup Day races are held annually, featuring $13 million in purses, for the purpose of determining Thoroughbred champions in eight different 16
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS events. Racetracks across the United States compete for the privilege of hosting the Breeders' Cup Day races each year, and the 1998 Breeders' Cup was our fourth time hosting this event, the most of any racetrack. Although most of the income earned from this event was allocated to Breeder's Cup Limited, hosting the 1998 event had a positive impact on our 1998 results. In Indiana, licenses to conduct live Standardbred and Thoroughbred race meetings, including Quarter Horse races, and to participate in simulcasting are approved annually by the Indiana Horse Racing Commission ("IHRC"), which consists of five members appointed by the governor of Indiana. Licenses are approved annually by the IHRC based upon applications submitted by Hoosier Park. Currently, Hoosier Park is the only facility in Indiana licensed to conduct live Standardbred, Quarter Horse or Thoroughbred racing and to participate in simulcasting. Quarter Horse races are conducted during some Thoroughbred race days. Hoosier Park conducted live racing from April 17, 1998 through November 28, 1998, for a total of 153 racing days, including 95 days of Standardbred racing and 58 days of Thoroughbred racing (which also includes Quarter Horse races). Hoosier Park received a license to conduct live racing in 1999 for a total of 168 racing days, including 103 days of Standardbred racing and 65 days of Thoroughbred racing. A substantial change in the allocation of live racing days at Hoosier Park could adversely impact our operations and earnings in future years. We employ approximately 500 full-time employees. Due to the seasonal nature of our live racing business, the number of seasonal and part-time persons employed will vary throughout the year, with peak employment occurring Kentucky Derby week when we employ as many as 2,600 persons. Through December 31, 1998, average full-time and seasonal employment per pay period was approximately 1,000 individuals. We generally do not directly compete with other racetracks or simulcast wagering facilities for patrons due to geographic separation of such facilities. However, we compete with other sports, entertainment and gaming options, including riverboat casinos and lotteries, for patrons for both live racing and simulcasting. We attempt to attract patrons by providing the highest quality racing products in attractive entertainment facilities with fairly priced, appealing concession services. Churchill Downs is the premier racetrack in Kentucky for both live racing and simulcasting, based upon total handle and attendance, and Hoosier Park is the only facility in Indiana providing pari-mutuel wagering on live racing. 17
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The development of riverboat gaming facilities began in Indiana pursuant to authorizing legislation passed by the state of Indiana in 1993. Illinois had previously authorized riverboat gaming. There are currently five riverboat casinos operating on the Ohio River along Kentucky's border -- including two in the southeastern Indiana cities of Lawrenceburg and Rising Sun, one in southwestern Indiana in Evansville and one at Metropolis, Illinois. The fifth riverboat casino, licensed to RDI/Caesars World, opened in November 1998 in Harrison County, Indiana, 10 miles from Louisville. Admission and handle figures at the Churchill Downs racetrack during the RDI/Caesars World's opening week in November 1998, were not significantly different from the same period in 1997. However, during December 1998, when the RDI/Caesars riverboat casino and the Louisville Sports Spectrum ("Sports Spectrum") were concurrently open, admission and handle numbers at the Sports Spectrum decreased from those numbers for the same period in 1997. At this time, we cannot determine the extent to which the decrease was due to the new riverboat casino in the Louisville market. Other factors, such as inclement weather, may also have had an impact. The Indiana Gaming Commission voted in September 1998 to grant a license to open a sixth Indiana riverboat along the Ohio River in Switzerland County, about 70 miles from Louisville. The license holder, Hollywood Park-Boomtown, Inc., plans to build a riverboat casino, hotel and resort complex near Vevay, Indiana. Hollywood Park estimates the resort will open as early as the third quarter of 2000. The full impact of riverboat casinos on Kentucky racing cannot be accurately determined until all riverboats are open and the markets are fully matured. Studies project that Churchill Downs could experience a material adverse impact on its wagering and attendance in the Louisville market when the RDI/Caesars World riverboat is open to full capacity and has established itself in the market. These same studies projected similar declines in western and northern Kentucky, but recent experience at Ellis Park and Turfway Park indicates the impact may not be as severe as these studies projected. In addition to those riverboats operating along the Ohio River, five riverboat casinos have opened along the Indiana shore of Lake Michigan near our Sports Spectrum in Merrillville, Indiana. Our pari-mutuel wagering activities at the Merrillville facility have been adversely impacted by the opening of these Lake Michigan riverboats. 18
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Additionally, the Pokagon Band of the Potawatomi Indian Tribe has expressed an interest in establishing land-based casinos in northeastern Indiana and southwestern Michigan although Indiana Governor Frank O'Bannon has publicly expressed his opposition at this time to any further expansion of casino gaming in Indiana. We continue to anticipate that development of any such Indian casino will negatively impact pari-mutuel wagering activities at Hoosier Park's Indiana facilities. However, the extent of the impact is unknown at this time due, in part, to the uncertain geographic distances between Hoosier Park's operations and the potential casino sites. The integration of alternative gaming products at our racetrack facilities is one of our four core business strategies developed to position us to compete in this changing environment. Implementing these strategies, we have successfully grown our live racing product by strengthening our flagship operations, increasing our share of the interstate simulcast market, and geographically expanding our racing operations in Kentucky and into Indiana. Alternative gaming in the form of video lottery terminals and slot machines should enable us to more effectively compete with Indiana riverboat casinos and provide new revenue for purse money and capital investment. We continue to pursue legislation to allow video lottery terminals at our racetrack facilities in Kentucky. Currently, we are working with members of the Kentucky horse industry to establish a consensus for a plan to operate video lottery terminals exclusively at Kentucky's racetracks. The horse industry in Indiana presently receives $.65 per $3 admission to Indiana riverboats to compensate for the effect of riverboat competition. The horse industry is required to allocate 70% of such revenue directly for purse expenses, breed development and reimbursement of approved marketing costs. The balance, or 30%, is received by Hoosier Park as the only horse racetrack currently operating in Indiana. Riverboat admissions revenue from our Indiana operations increased $5.1 million for the year ended December 31, 1998 compared to 1997, as a result of the opening of additional riverboats. The net increase in riverboat admissions revenue, after required purse and marketing expense increases of approximately $3.2 million, is $1.8 million. Legislation which seeks to cap Hoosier Park's share of the $.65 subsidy was introduced in the 1999 session of the Indiana General Assembly. A significant change in Hoosier Park's share of the subsidy would impact funding 19
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for operating expenditures, potentially reducing the number of race dates at Hoosier Park and, in all likelihood, re-emphasize the need for the integration of alternative gaming products at the Hoosier Park racetrack in order for it to effectively compete with riverboat casinos. We have partnered with ODS Technologies L.P. (ODS) in the development and operation of an in-home interactive wagering system in Jefferson County, Kentucky, since 1995. The second phase of our relationship with ODS is the launching of the Television Games Network (TVG), originally projected for the fourth quarter of 1998. In June 1998, an arbitration panel approved United Video Satellite Group, Inc.'s proposal to acquire all of the assets of ODS. United Video, which previously owned approximately 10% of ODS, has bought out the majority partners and assumed control over agreements between ODS and 12 racetracks, including Churchill Downs. At this time, we cannot assess any impact of this development on our in- home wagering operations. RESULTS OF OPERATIONS Wagering information, or handle, and attendance for our three live racing facilities and four separate simulcast wagering facilities during the years ended December 31, 1998 and 1997 are as follows: ($ in thousands, except for number of days) Churchill Downs Hoosier Park Ellis Park* Live Racing 1998 handle $128,250 $16,092 $20,944 1998 no.of days 70 153 61 1997 handle $132,290 $16,937 $17,215 1997 no. of days 77 142 55 Simulcast sending 1998 handle $421,200 $62,720 $116,735 1998 no. of days 70 153 61 1997 handle $424,194 $39,772 $87,799 1997 no. of days 77 142 55 Simulcast receiving 1998 handle $138,443 $133,770 $38,065 1998 no. of days 232 1,219 288 1997 handle $132,431 $130,020 $35,954 1997 no. of days 212 1,215 294 * Handle information for Ellis Park is provided for years ended December 31, 1998 and 1997. However, only revenues generated since its acquisition on April 21, 1998 have been included in the Company's results of operations. 20
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Comparison of Profit and Loss for Year Ended December 31, 1998 to 1997 Net Revenues Net revenues increased $28.4 million (24%) from $118.9 million in 1997 to $147.3 million in 1998. Churchill Downs revenues increased $3.5 million (5%) due primarily to increases in simulcast revenues and license, rights, broadcast revenues and increased corporate sponsorship of the Kentucky Derby. Hoosier Park revenues increased $6.2 million (15%) primarily due to increased simulcasting revenues and a $5.1 million increase in the riverboat gross admissions subsidy of which a portion was required to be spent on purses and marketing expenses. Ellis Park contributed $17.4 million to 1998 net revenues since its acquisition in the second quarter. Other operations, including the Kentucky Horse Center which was also acquired in the second quarter, comprised the remaining $1.3 million of the increase. Operating Expenses Operating expenses increased $23.7 million (25%) from $95.4 million in 1997 to $119.1 million in 1998. Churchill Downs operating expenses increased $1.9 million (3%) due primarily to increased marketing, simulcast, totalisator and video expenses. Hoosier Park operating expenses increased $5.0 million (14%) due primarily to required increases in purses and marketing expenses of $2.8 million and $0.8 million, respectively, related to the riverboat admissions subsidy. Ellis Park increased 1998 operating expenses by $15.4 million since its acquisition. Other operations, including the Kentucky Horse Center, accounted for the remaining $1.4 million of the increase in operating expenses. Gross Profit Gross profit increased $4.7 million (20%) from $23.5 million in 1997 to $28.2 million in 1998. Churchill Downs and Hoosier Park gross profit increased $1.5 million (9%) and $1.2 million (25%), respectively, for the reasons described above. The Ellis Park acquisition contributed $2.0 million to 1998 gross profit. The slight decrease in the gross profit percentage from 19.7% in 1997 to 19.2% in 1998 was due mainly to a lower gross profit percentage at Ellis Park due to purse increases implemented to improve the quality of racing at the track. 21
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") expenses increased by $2.0 million (22%) from $9.1 million in 1997 to $11.1 million in 1998. SG&A expenses at Churchill Downs increased $1.3 million (19%) due primarily to increased corporate staffing, compensation and business development expenses. Hoosier Park SG&A expenses decreased by $0.2 million (9%) due primarily to declines in professional fees and wages. The acquisition of Ellis Park contributed $0.6 million to the increase in 1998 SG&A expenses. Other operations accounted for the remaining $0.3 million of the increase. SG&A expenses as a percentage of net revenues decreased slightly from 7.6% in 1997 to 7.5% in 1998. Other Income and Expense Interest expense increased $0.6 million from $0.3 million in 1997 to $0.9 million in 1998 as a result of borrowings to finance our second quarter acquisition of Ellis Park and the Kentucky Horse Center. Income Tax Provision Our income tax provision increased by $1.0 million from $5.8 million in 1997 to $6.8 million in 1998 primarily as the result of an increase in pre-tax earnings of $2.3 million. The effective income tax rate increased slightly from 38.9% in 1997 to 39.1% in 1998 due primarily to non-deductible amortization expense related to the acquisition of Ellis Park and the Kentucky Horse Center and increases in other permanent differences, partially offset by the reversal of the valuation allowance on certain state income tax net operatin loss carryforwards. Comparison of Profit and Loss for Year Ended December 31, 1997 to 1996 Revenues Net revenues increased $11.0 million (10%)from $107.9 million in 1996 to $118.9 million in 1997. Churchill Downs revenues increased $2.8 million (4%) due primarily to increases in simulcast revenues that were generated as a result of the new Paddock Pavilion simulcast wagering facility used during live racing. Hoosier Park revenues increased $8.2 million (25%) primarily due to increased simulcasting revenues and a $7.9 million increase in the riverboat 22
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS gross admissions subsidy of which a portion was required to be spent on purses and marketing expenses. Operating Expenses Operating expenses increased $8.5 million (10%) from $86.9 million in 1996 to $95.4 million in 1997. Churchill Downs operating expenses increased $3.2 million (6%) due mainly to increased purses and wages and also increased marketing, simulcast and video expenses. Hoosier Park operating expenses increased $5.3 million (18%) due primarily to increases in purses and marketing expenses of $3.9 million and $1.0 million, respectively, related to the riverboat admissions subsidy. Gross Profit Gross profit increased $2.5 million (12%) from $21.0 million in 1996 to $23.5 million in 1997. Churchill Downs gross profit decreased $0.4 million (2%) and Hoosier Park gross profit increased $2.9 million (86%) for the reasons described above. The gross profit percentage increased slightly from 19.5% in 1996 to 19.7% in 1997. Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") expenses increased by $0.4 million (5%) from $8.7 million in 1996 to $9.1 million in 1997. SG&A expenses at Churchill Downs increased $0.4 million (11%) due primarily to increased corporate staffing, compensation and business development expenses. Hoosier Park SG&A expenses decreased by $0.2 million (8%) while SG&A expenses at other operations were up by $0.2 million. Other Income and Expense Interest income increased $0.2 million from $0.4 million in 1996 to $0.6 million in 1998 as a result of the additional earnings generated by our short-term cash investments (cash equivalents). Miscellaneous income decreased $0.4 million from $0.7 million in 1996 to $0.3 million in 1998 as the result of the gain recognized on Conseco's acquisition of 10% of Hoosier Park in 1996. 23
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Income Tax Provision Our income tax provision increased by $0.9 million from $4.9 million in 1996 to $5.8 million in 1997 primarily as the result of an increase in pre-tax earnings of $1.9 million. The effective income tax rate increased from 38.1% in 1996 to 38.9% in 1997 due primarily to increases in permanent differences. Significant Changes in the Balance Sheet December 31, 1998 to December 31, 1997 The cash and cash equivalent balances at December 31, 1998 of $6.4 million were $2.9 million lower than December 31, 1997, primarily due to aggregate payments on our line of credit which were partially used to fund the Ellis acquisition. Accounts receivable balances grew by $4.9 million in 1998 due to the increase of $1.5 million in the Indiana riverboat admissions receivable, an increase of $1.1 million in receivables relating to advanced billing for the Kentucky Derby, a $1.0 million increase in simulcast and other operating receivables relating to Churchill Downs' Fall race meet and an increase of $0.9 million in the receivable from the Commonwealth of Kentucky relating to purse expense reimbursements. Additionally, Ellis Park and the Kentucky Horse Center accounted for $0.3 million of the overall increase. Intangible assets increased $6.5 million as a result of the acquisition of Ellis Park and the Kentucky Horse Center. Plant and equipment increased $25.0 million during 1998, primarily due to the acquisition of Ellis Park and the Kentucky Horse Center ($22.0 million). Routine capital spending at our operating units made up the remainder of the increase. Accumulated depreciation increased $5.5 million for current year depreciation expense. We borrowed on our bank line of credit during 1998 primarily for the Ellis acquisition during the second quarter. Additional borrowings on the line of credit during the third and fourth quarters were made to fund operating expenses. 24
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Deferred income tax liabilities increased to $6.9 million in 1998, an increase of $4.6 million from 1997 balances, primarily as a result of the acquisition of Ellis Park and the Kentucky Horse Center. Significant Changes in the Balance Sheet December 31, 1997 to December 31, 1996 The cash and cash equivalent balances at December 31, 1997 of $9.3 million were $1.1 million higher than December 31, 1996, based primarily upon our increased earnings. Accounts receivable at December 31, 1997, increased by $2 million due primarily to the increase in the Indiana riverboat admissions tax receivable resulting from the additional Indiana riverboats being open for a longer period of time in 1997 versus 1996. Other assets at December 31, 1997, increased by $2.3 million due primarily to our investment in Kentucky Downs, LLC. The cost of plant and equipment increased by $4.5 million due to the construction of a new on-site simulcast facility at Churchill Downs as well as other routine capital spending. This was offset by approximately $4.2 million in depreciation expense. Income taxes payable decreased by $2.3 million in 1997 due primarily to the timing of estimated tax payments made throughout the year. Liquidity and Capital Resources Working capital as of December 31, 1998, 1997 and 1996 follows: 1998 1997 1996 ---- ---- ---- Deficiency in working capital $(7,791,319) $(8,032,492) $(10,789,190) .71 to 1 .68 to 1 .45 to 1 The working capital deficiency results from the nature and seasonality of our business. Cash flows provided by operations were $10.8, $10.5 and $15.1 million for the years ended December 31, 1998, 1997 and 1996, respectively. The net increase of $.3 million in 1998 resulted from a $1.4 million increase in net earnings and $1.2 million increase in depreciation and amortization coupled with the timing of accounts receivable, accounts payable, income taxes payable and deferred revenue balances. Management believes cash flows from operations and available 25
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS borrowings during 1999 will be sufficient to fund our cash requirements for the year, including capital improvements and any acquisitions. Cash flows used in investing activities were $20.8, $6.9 and $2.6 million for the years ended December 31, 1998, 1997 and 1996, respectively. The $20.8 million in 1998 is primarily comprised of the cash portion of our purchase of Ellis Park and the Kentucky Horse Center during the second quarter of 1998. The $6.9 million in 1997 primarily represents the acquisition of 24% of Kentucky Downs during the third quarter of 1997 and additional capital spending for the construction of a new on-site simulcast facility in Kentucky. Routine capital spending accounted for a portion of the cash used in investing for 1998 and 1997. The capital additions for all locations, including construction of a $2.4 million stable area dormitory at the Churchill Downs facility, are expected to approximate $7.3 million for 1999. Cash flows provided by (used in) financing activities were $7.0, $(2.5) and $(10.2) million for the years ended December 31, 1998, 1997 and 1996, respectively. We borrowed $22 million and repaid $11 million on our line of credit during 1998 primarily to finance the purchase of Ellis Park and the Kentucky Horse Center. Cash dividends of $3.7 million were paid to shareholders in 1998 (declared in 1997) versus $2.4 million paid in 1997 (declared in 1996). We have a $100 million line of credit, of which $89 million was available at December 31, 1998, to meet working capital and other short-term requirements and to provide funding for acquisitions scheduled to close in 1999. We are arranging a new $250 million line of credit which will replace the $100 million line of credit. We anticipate closing on the new line of credit during the second quarter of 1999. Impact of the Year 2000 Issue The "Year 2000 Issue" is the result of computer programs that were written using two digits rather than four to define the applicable year in date-dependent systems. If our computer programs with date-sensitive functions are not Year 2000 compliant, they may be unable to distinguish the year 2000 from the year 1900. This could result in system failure or miscalculations leading to a disruption of business operations. Certain of our mission critical operations are dependent upon computer systems and applications. These systems are either directly owned and controlled by us or are provided under contract by 26
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS third party technology service providers. To address the Year 2000 issue, we have categorized the Year 2000 Issue into four principal areas. A) Systems Owned By the Company The first area is related to systems that are owned by us. These systems include application software and dedicated hardware that administrate our core operations. In addition, there are numerous applications that provide administrative support and management reporting functions. Some of these applications have been developed internally and others have been purchased. To address Year 2000 compliance across this broad category of systems, we have broken each system down into its most elemental pieces in order to study the hardware including any embedded chip technology/firmware, the operating systems and finally, the applications themselves. Hardware including any embedded chip technology/firmware that was not Year 2000 compliant has been identified and replaced as part of the routine turnover of technology capital. Hardware remaining to be replaced is scheduled for upgrading during the first half of 1999. By June 1999, all hardware and embedded chip technology/firmware owned by the Company is expected to be Year 2000 compliant. All operating systems supporting specific applications have been checked by advancing the dates to determine if operating system-level functionality is impacted by the date change. As new operating system upgrades are made available and installed, periodic testing will continue to assure operating system-level functionality is maintained. In addition, we have contacted the developers of the operating systems we use and have received assurances as to their compatibility with the Year 2000 transition. Application software compliance with the Year 2000 has been certified through a combination of technical consultation with the software developers and testing. Applications developed with internal resources have been written with the Year 2000 compliance in mind using development tools that are Year 2000 compliant. We have received assurances from third parties on Year 2000 compliance for financial reporting, payroll, operations control and reporting and internal communications applications. We require Year 2000 compliance on any software upgrades. 27
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Based on the schedule outlined above, we expect to be Year 2000 compliant with our owned systems prior to the year 2000. The system will be tested by advancing dates to include a majority of the Year 2000 critical dates by the fourth quarter of 1999. However, even though our planned modifications to internally owned hardware and software should adequately address Year 2000 issues, there can be no assurance that unforeseen difficulties will not arise. B) Technology Services Provided to the Company Under Contract By Third Parties The second area is services provided to us by third parties. Many of these services are mission critical and could materially impact us should the systems upon which the services are dependent be unable to function. The totalisator services provided by United Tote are the most critical to our operations. Totalisator services include the calculation of amounts wagered and owed to winning ticket holders. United Tote developed a plan to bring all systems provided to us into Year 2000 compliance during 1998. United Tote and the Company initiated this plan during the second quarter of 1998 by undertaking a comprehensive system hardware and software upgrade that is Year 2000 compliant. The systems were successfully installed in three phases with the last phase having been completed in October 1998. All on-track, intertrack wagering and hub operations are Year 2000 compliant. We will continue to work closely with United Tote to assure that future releases and upgrades are Year 2000 compliant by including this provision as a condition of contracting for future services. The video services provided by an outside vendor are also important to our operations. Video services include the capture, production and distribution of the television signal for distribution to customers located on our premises and to customers located at remote outlets throughout the nation. We are working closely with the vendor to ensure the software applications that provide the graphical enhancements and other distinguishing features to the televised signal for Churchill Downs and Hoosier Park are Year 2000 compliant. The existing software for the graphical enhancements to the television signal is not Year 2000 compliant. We have contacted the developer of the software package directly and have received assurances that an upgrade to the software will be Year 2000 compliant. We purchased certain data and statistical information from Equibase for resale to the public. This information is an essential element of our product and is included in printed material made 28
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS available to our customers to assist in their wagering decisions. Equibase has implemented a Year 2000 remediation plan, which is expected to be completed by the second quarter of 1999. A variety of other smaller and less critical technology service providers are involved with the Company's product. We have received assurance letters from a majority of these suppliers and will continue to work to receive assurances from those remaining. Because of the nature of our business and its dependence upon key technology services provided by third parties, we require that all new software and technology services are Year 2000 compliant. This requirement extends to include patches, upgrades and fixes to existing technology services. In the event that any of our third party service providers do not successfully and timely achieve Year 2000 compliance, and we are unable to replace them with alternate service providers, it could result in a delay in providing our core live racing and simulcasting products to our customers and have a material adverse effect on our business, financial condition and results of operations. C) Industry-wide Issues Because a significant portion of our revenues are derived from customers at other racing organizations that are confronted with the same technological issues, including totalisator, video and statistical information services, we have been actively participating in an industry-wide assessment and remedial efforts to address the Year 2000 issue. D) Feedback Control Systems A variety of the newer control and regulating systems are date sensitive. Environmental control systems, elevator/escalator systems, fire control and security systems utilize date-sensitive software/embedded chip technology for correct operation. We have systems that perform each of these functions, and are identifying if any of these systems employ technology that may not be Year 2000 compliant. We will work closely with these manufacturers to develop a remedial plan to assure year 2000 compliance if problems are identified. 29
CHURCHILL DOWNS INCORPORATED ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS To date, we have incurred less than $25,000 in costs to remediate Year 2000 compliance issues. Our management believes that any future costs to remediate Year 2000 compliance issues will not be material to our financial position or results of operations. We are currently evaluating our most reasonably likely worst-case Year 2000 scenario and are also developing contingency plans to be implemented as part of our efforts to identify and correct Year 2000 issues affecting our owned systems as well as issues involving third party service providers. We intend to complete both its evaluation of a worst-case Year 2000 scenario and contingency planning by June 30, 1999. Subsequent Events On January 13, 1999, we acquired a 60% interest in Charlson Broadcast Technologies, LLC, ("CBT") for the purchase price of $5.4 million. CBT provides simulcast graphic software video services to racetracks and simulcast wagering facilities throughout the United States. The purchase agreement includes provisions for an additional contingent purchase price to be paid by us to the former owners of the 60% interest based upon the achievement of certin operating targets. On January 21, 1999, we entered into an agreement to acquire all of the outstanding shares of Calder Race Course, Inc., and Tropical Park, Inc. ("Calder"), from KE Acquisition Corp., a private holding company. Terms of the agreement include a purchase price of $86 million subject to certain adjustments. Closing of the acquisition is expected in early April 1999. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our major market risk exposure is primarily due to possible fluctuations in interest rates as they relate to its variable rate debt. We do not enter into derivative financial investments for trading or speculation purposes. As a result, we believe that our market risk exposure is not material to our financial position, liquidity or results of operations. 30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors Churchill Downs Incorporated In our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a) (1), present fairly, in all material respects, the consolidated financial position of Churchill Downs Incorporated and its subsidiaries as of December 31, 1998, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the consolidated financial statement schedule listed in the index appearing under Item 14 (a) (2), presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/PricewaterhouseCoopers PricewaterhouseCoopers LLP Louisville, Kentucky February 24, 1999 31
CHURCHILL DOWNS INCORPORATED CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> December 31, ASSETS 1998 1997 1996 ---- ---- ---- <S> <C> <C> <C> Current assets: Cash and cash equivalents $ 6,379,686 $ 9,280,233 $ 8,209,414 Accounts receivable 11,968,114 7,086,889 5,218,236 Other current assets 1,049,084 540,489 679,221 ------------ ------------ ----------- Total current assets 19,396,884 16,907,611 14,106,871 Other assets 3,796,292 3,884,080 1,574,714 Plant and equipment, net 83,088,204 63,162,767 62,882,189 Intangible assets, net 8,369,395 1,894,350 2,165,192 ------------ ------------ ----------- $114,650,775 $85,848,808 $80,728,966 ============ ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 6,530,502 $ 5,732,783 $5,403,000 Accrued expenses 8,098,228 7,937,575 8,021,487 Dividends payable 3,762,521 3,658,468 2,375,271 Income taxes payable 257,588 186,642 2,510,508 Deferred revenue 8,412,552 7,344,830 6,511,902 Long-term debt, current portion 126,812 79,805 73,893 ------------ ------------ ----------- Total current liabilities 27,188,203 24,940,103 24,896,061 Long-term debt, due after one year 13,538,027 2,633,164 2,878,714 Outstanding mutuel tickets (payable after one year) 806,573 1,625,846 2,031,500 Deferred compensation 949,187 880,098 825,211 Deferred income taxes 6,937,797 2,377,100 2,316,600 Stockholders' equity: Preferred stock, no par value; authorized, 250,000 shares; issued, none - - - Common stock, no par value; authorized, 20,000,000 shares, issued 7,525,041 , shares 1998, 7,316,934 shares, 1997 and 7,308,524 shares, 1996 8,926,975 3,614,567 3,493,042 Retained earnings 56,598,957 49,842,930 44,352,838 Deferred compensation costs (229,944) - - Note receivable for common stock (65,000) (65,000) (65,000) ------------ ------------ ----------- 65,230,988 53,392,497 47,780,880 ------------ ------------ ----------- $114,650,775 $85,848,808 $80,728,966 ============ ============ =========== </TABLE> The accompanying notes are an integral part of the consolidated financial statements. 32
CHURCHILL DOWNS INCORPORATED CONSOLIDATED STATEMENTS OF EARNINGS <TABLE> <CAPTION> Years ended December 31, 1998 1997 1996 <S> <C> <C> <C> Net revenues $147,300,299 $118,907,367 $107,858,818 ------------- ------------ ------------ Operating expenses: Purses 50,192,973 39,718,374 34,439,143 Other direct expenses 68,895,654 55,705,722 52,438,836 ------------- ------------ ------------ 119,088,627 95,424,096 86,877,979 ------------- ------------ ------------ Gross profit 28,211,672 23,483,271 20,980,839 Selling, general and administrative 11,068,262 9,077,983 8,665,942 ------------- ------------ ------------ Operating income 17,143,410 14,405,288 12,314,897 ------------- ------------ ------------ Other income (expense): Interest income 679,782 575,084 390,669 Interest expense (896,067) (332,117) (337,438) Miscellaneous income 342,423 325,087 673,398 ------------- ------------ ------------ 126,138 568,054 726,629 ------------- ------------ ------------ Earnings before provision for income 17,269,548 14,973,342 13,041,526 taxes Provision for income taxes 6,751,000 5,824,782 4,970,000 ------------- ----------- ------------ Net earnings $10,518,548 $9,148,560 $8,071,526 ============= ============ ============ Earnings per common share data: Basic $1.41 $1.25 $1.08 Diluted $1.40 $1.25 $1.08 Weighted average shares outstanding: Basic 7,460,058 7,312,052 7,445,542 Diluted 7,539,482 7,320,670 7,447,706 </TABLE> The accompanying notes are an integral part of the consolidated financial statements. 33
CHURCHILL DOWNS INCORPORATED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY <TABLE> <CAPTION> Years Ended December 31, 1998, 1997 and 1996 Note Deferred Common Stock Retained Receivable Compensation Shares Amount Earnings Common Stock Costs Total <S> <C> <C> <C> <C> <C> <C> Balances December 31, 1995 7,569,206 $3,504,388 $43,486,460 $ (65,000) $(272,691) $46,653,157 Net earnings 8,071,526 8,071,526 Deferred compensation amortization 272,691 272,691 Issuance of common stock at $14.45 per share 7,818 112,970 112,970 Repurchase of common stock (268,500) (124,316) (4,829,877) (4,954,193) Cash dividends, $.33 per share (2,375,271) (2,375,271) --------- ---------- ----------- --------- --------- ----------- Balances December 31, 1996 7,308,524 3,493,042 44,352,838 (65,000) - 47,780,880 Net earnings 9,148,560 9,148,560 Issuance of common stock at $14.45 per share 8,410 121,525 121,525 Cash dividends, $.50 per share (3,658,468) (3,658,468) --------- ---------- ----------- --------- --------- ----------- Balances December 31, 1997 7,316,934 3,614,567 49,842,930 (65,000) - 53,392,497 Net earnings 10,518,548 10,518,548 Deferred compensation 344,046 (344,046) - Deferred compensation amortization 114,102 114,102 Issuance of common stock at $24.25 per share in conjunction with RCA acquisition 200,000 4,850,000 4,850,000 Issuance of common stock at $14.60 per share 8,107 118,362 118,362 Cash dividends, $.50 per share (3,762,521) (3,762,521) --------- ---------- ----------- --------- --------- ----------- Balances December 31, 1998 7,525,041 $8,926,975 $56,598,957 $ (65,000) $(229,944) $65,230,988 ========= ========== =========== ========== ========== =========== </TABLE> The accompanying notes are an integral part of the consolidated financial statements. 34
CHURCHILL DOWNS INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> Years Ended December 31, 1998 1997 1996 <S> <C> <C> <C> Cash flows from operating activities: Net earnings $10,518,548 $9,148,560 $8,071,526 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 5,743,932 4,558,761 4,814,114 Deferred income taxes (121,000) 352,100 (461,000) Deferred compensation 183,191 54,887 226,690 Increase (decrease) in cash resulting from changes in operating assets and liabilities: Accounts receivable (2,972,985) (2,053,211) (2,943,932) Other current assets (292,994) (152,868) 232,699 Accounts payable (1,245,550) 329,783 (1,114,508) Accrued expenses (579,904) (83,912) 4,710,605 Income taxes payable (refundable) 70,946 (2,323,866) 1,461,000 Deferred revenue 757,889 1,017,486 237,958 Other assets and liabilities (1,245,808) (377,523) (109,037) ------------ ----------- ----------- Net cash provided by operating activities 10,816,265 10,470,197 15,126,115 ------------ ----------- ----------- Cash flows from investing activities: Acquisition of business, net of cash acquired of $517,151 (17,232,849) - - Additions to plant and equipment, net (3,524,032) (4,568,494) (2,570,795) Purchase of minority-owned investment - (2,337,500) - ----------- ----------- ----------- Net cash used in investing activities (20,756,881) (6,905,994) (2,570,795) ----------- ----------- ----------- Cash flows from financing activities: Decrease in long-term debt, net (140,164) (239,638) (3,468,569) Borrowings on bank line of credit 22,000,000 Repayments of bank line of credit (11,000,000) Dividends paid (3,658,468) (2,375,271) (1,892,302) Common stock issued 118,362 121,525 112,970 Common stock repurchased - - (4,954,193) Loan origination costs (279,661) - - ----------- ----------- ----------- Net cash provided by (used in) financing activities 7,040,069 (2,493,384) (10,202,094) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents (2,900,547) 1,070,819 2,353,226 Cash and cash equivalents, beginning of period 9,280,233 8,209,414 5,856,188 ----------- ----------- ----------- Cash and cash equivalents, end of period $6,379,686 $9,280,233 $8,209,414 =========== =========== =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 497,307 $151,397 $277,149 Income taxes $ 7,129,540 $7,914,974 $3,970,000 Schedule of Non-cash Activities: Issuance of common stock related to the acquisition of RCA $ 4,850,000 - - Invoicing for future Kentucky Derby and Oaks $ 677,733 $ 402,328 $ 586,886 Plant & equipment additions included in accounts payable $95,055 - - Compensation expense $ 344,406 - - </TABLE> The accompanying notes are an integral part of the consolidated financial statements. 35
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation and Summary of Significant Accounting Policies: Basis of Presentation: Churchill Downs Incorporated (the "Company") conducts Spring, Summer and Fall live race meetings for Thoroughbred horses and participates in intrastate and interstate simulcast wagering at its racetracks in Kentucky. In Indiana, the Company, through its subsidiary, Hoosier Park L.P. (Hoosier Park), conducts live Thoroughbred, Quarter Horse and Standardbred horse races and participates in interstate simulcast wagering. Both its Kentucky and Indiana operations are subject to regulation by the racing commissions of the respective states. The accompanying consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, Ellis Park Race Course (Ellis Park), Churchill Downs Management Company (CDMC), Churchill Downs Investment Company (CDIC), the Kentucky Horse Center and Anderson Park Inc. (Anderson) and its majority-owned subsidiary, Hoosier Park. All significant intercompany balances and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. A Summary of Significant Accounting Policies Follows: Cash Equivalents: The Company considers investments with original maturities of three months or less to be cash equivalents. The Company has, from time to time, cash in the bank in excess of federally insured limits. Plant and Equipment: Plant and equipment are recorded at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets. 36
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. Basis of Presentation and Summary of Significant Accounting Policies: (cont'd) Intangible Assets: Amortization of the cost of acquisition in excess of fair value of assets acquired and the Indiana racing license is provided over 40 years using the straight-line method. Organizational costs were amortized using the straight-line method over 24 months to 60 months. Loan origination costs on the Company's line of credit are being amortized under the effective interest method over 36 months, the term of the loan. 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 would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the assets would be compared to the assets' carrying amount to determine if a write-down to market value or discounted cash flow value is required. Deferred Revenue: Deferred revenue includes primarily advance sales related to the Kentucky Derby and Oaks races in Kentucky. Stock-Based Compensation: The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees". In accordance with Statement of Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-based Compensation" proforma disclosure of net earnings and earnings per share are presented in Note 10 as if SFAS No. 123 had been applied. Reclassification: Certain financial statement amounts have been reclassified in the prior years to conform to current year presentation. 37
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Acquisitions: On April 21, 1998, the Company acquired from TVI Corp., ("TVI") all of the outstanding stock of Racing Corporation of America ("RCA") for a purchase price of $22.6 million, including transaction costs. RCA owns and operates Ellis Park Race Course in Henderson, Kentucky, and the Kentucky Horse Center, a training facility located in Lexington, Kentucky. The purchase price was paid as 200,000 shares of the Company's common stock valued at $4.9 million with the remainder paid in cash. The purchase price was allocated to the acquired assets and liabilities based on their fair values on the acquisition date with the excess of $6.4 being amortized over 40 years. The acquisition was accounted for by the Company under the purchase method of accounting and, accordingly, the results of operations of RCA subsequent to April 20, 1998, are included in the Company's consolidated results of operations. Pursuant to the terms of the purchase agreement between the Company and TVI, if alternative gaming (whether full casino, slot machine or video lottery) is legalized in the Commonwealth of Kentucky by December 31, 2015, TVI will receive royalty payments equal to 50% of annual earnings before interest and taxes of the gaming operations at Ellis Park Race Course and at the Kentucky Horse Center. Should gaming be legalized before December 31, 2006, such royalties will be payable for ten years from the date that such gaming becomes fully operational. The royalty period will be reduced by one year for each year from 2006 through 2015 in which gaming is legalized. Following are the unaudited pro forma results of operations as if the April 21, 1998 transaction had occurred on January 1, 1997 (in thousands, except per share and share amounts): 1998 1997 ---- ---- Net revenues $149,272 $137,316 Net earnings $9,404 $8,845 Earnings per common share: Basic $1.25 $1.18 Diluted $1.24 $1.18 Weighted average shares outstanding: Basic 7,520,332 7,512,052 Diluted 7,599,756 7,520,670 38
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Acquisitions: (cont'd) This unaudited proforma financial information is not necessarily indicative of the operating results that would have occurred had the transaction been consummated as of January 1, 1997, nor is it necessarily indicative of future operating results. In July 1997, the Company purchased a 24% interest in the Kentucky Downs racecourse in Franklin, Kentucky. The Company's investment of $2.2 million is accounted for under the equity method of accounting. 3. Plant and Equipment: Plant and equipment is comprised of the following: 1998 1997 1996 ---- ---- ---- Land $7,631,657 $5,999,036 $5,879,994 Grandstands and buildings 73,376,961 57,579,747 56,154,054 Equipment 4,979,383 3,416,306 2,936,129 Furniture and fixtures 5,341,119 4,327,797 3,603,276 Tracks and other improvements 37,997,696 33,118,100 31,377,753 Construction in process 249,438 113,210 74,206 ------------ ------------ ------------- 129,576,254 104,554,196 100,025,412 Accumulated depreciation (46,488,050) (41,391,429) (37,143,223) ------------ ------------ ------------- $83,088,204 $63,162,767 $62,882,189 ============ ============ ============= Depreciation expense was $5,490,450, $4,287,916, and $4,038,135 for the years ended December 31, 1998, 1997 and 1996. 4. Intangibles assets: The Company's intangible assets are comprised of the following: <TABLE> 1998 1997 1996 ---- ---- ---- <S> <C> <C> <C> Cost of acquisition in excess of fair value of net assets acquired $6,448,867 - - Indiana racing license 2,085,428 $2,085,428 $2,085,428 Loan origination costs 279,661 - - Organizational and preopening costs - - 932,738 ----------- ----------- ----------- 8,813,956 2,085,428 3,018,166 Accumulated amortization (444,561) (191,078) (852,974) ----------- ----------- ----------- $8,369,395 $1,894,350 $2,165,192 =========== =========== =========== </TABLE> 39
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. Intangibles assets: (cont'd) Amortization expense was $253,482, $270,845 and $775,979 for the years ended December 31, 1998, 1997 and 1996. 5. Income Taxes: Components of the provision for income taxes are as follows: 1998 1997 1996 ---- ---- ---- Currently payable: Federal $6,110,000 $4,616,800 $4,538,000 State & local 762,000 856,100 893,000 ----------- ----------- ------------ 6,872,000 5,472,900 5,431,000 ----------- ----------- ------------ Deferred: Federal 45,500 308,100 (382,000) State & local 6,500 44,000 (79,000) ----------- ----------- ------------ 52,000 352,100 (461,000) ----------- ----------- ------------ Reversal of valuation allowance (173,000) - - ----------- ----------- ------------ $6,751,000 $5,825,000 $4,970,000 =========== =========== ============ The Company's income tax expense is different from the amount computed by applying the statutory federal income tax rate to income before taxes as follows: 1998 1997 1996 ---- ---- ---- Federal statutory tax on earnings before income tax $5,942,000 $5,141,000 $4,464,000 State income taxes, net of federal income tax benefit 747,000 612,000 537,000 Permanent differences and other 235,000 72,000 (31,000) Reversal of valuation allowance (173,000) - - ----------- ------------ ----------- $6,751,000 $5,825,000 $4,970,000 =========== ============ =========== At December 31, 1998, the Company has net operating loss carryforwards of approximately $3,885,000 for Indiana state income tax purposes expiring from 2009 through 2011 and approximately $8,786,000 for Kentucky state income tax purposes expiring from 2002 through 2011. Management has determined that its ability to realize future benefits of the state net operating loss carryforwards meets the "more likely than not" criteria of SFAS No. 109, "Accounting for Income Taxes"; therefore, no valuation allowance has been recorded at December 31, 1998. 40
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. Income Taxes: (cont'd) Components of the Company's deferred tax assets and liabilities are as follows: <TABLE> <CAPTION> 1998 1997 1996 ---- ---- ---- <S> <C> <C> <C> Deferred tax liabilities: Property & equipment in excess of tax basis $7,804,600 $2,415,000 $2,284,000 Racing license in excess of tax basis 650,000 636,000 657,000 ----------- ----------- ----------- Deferred tax liabilities 8,454,600 3,051,000 2,941,000 ----------- ----------- ----------- Deferred tax assets: Supplemental benefit plan 315,400 295,000 273,000 State net operating loss carryforwards 856,700 173,000 176,000 Allowance for uncollectible receivables 87,100 71,000 66,000 Other assets 191,300 250,000 136,000 Other accruals 246,100 128,400 511,500 ----------- ----------- ----------- Deferred tax assets 1,696,600 917,400 1,162,500 ----------- ----------- ----------- Valuation allowance for state net operating loss carryforwards - 173,000 176,000 ----------- ----------- ----------- Net deferred tax liability $6,758,000 $2,306,600 $1,954,500 =========== =========== =========== Income taxes are classified in the balance sheet as follows: Net non-current deferred tax liability $6,937,800 $2,377,100 $2,316,600 Net current deferred tax asset (179,800) (70,500) (362,100) ----------- ------------ ----------- $6,758,000 $2,306,600 $1,954,500 =========== ============ =========== </TABLE> 41
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. Stockholders' Equity: On March 19, 1998, the Company's Board of Directors authorized a 2-for-1 stock split of its common stock effective March 30, 1998. All share and per share amounts in the accompanying consolidated financial statements have been restated to give effect to the stock split. Additionally, the Company's Board of Directors approved a stockholder "Rights Plan" (the "Plan") on March 19, 1998, which grants each stockholder the right to purchase a fraction of a share of Series 1998 Preferred Stock at the rate of one right for each share of the Company's common stock. The rights will become exercisable 10 business days (or such later date as determined by the Board of Directors) after any person or group acquires, obtains a right to acquire or announces a tender offer for 15% or more of the Company's outstanding common stock. The rights would allow the holder to purchase preferred stock of the Company at a 50% discount. The Plan is intended to protect stockholders from takeover tactics that may be used by an acquirer that the Board believes are not in the best interests of the shareholders. The Plan expires on March 19, 2008. 7. Employee Benefit Plans: The Company has a profit-sharing plan that covers all full-time employees with one year or more of service. The Company will match contributions made by the employee up to 2% of the employee's annual compensation and contribute a discretionary amount determined annually by the Board of Directors. The Company's contribution to the plan for the years ended December 31, 1998, 1997 and 1996 was $806,000, $535,000, and $402,000 respectively. The Company is a member of a noncontributory defined benefit multi-employer retirement plan for all members of the Pari-mutuel Clerk's Union of Kentucky. Contributions are made in accordance with negotiated labor contracts. Retirement plan expense for the year ended December 31, 1998, 1997 and 1996 was $258,000, $205,000, and $183,000, respectively. The Company's policy is to fund this expense as accrued. The estimated present value of future payments under a supplemental benefit plan is charged to expense over the period of active employment of the employees covered under the plan. Supplemental benefit plan expense for the years ended December 31, 1998, 1997 and 1996 was $55,200, $51,000, and $51,000 respectively. 42
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. Long-Term Debt: On September 15, 1998, the Company obtained a $100 million line of credit, which expires in September 2001, through a syndicate of banks headed by its principal lender. The new credit facility replaces a $50 million line of credit obtained during the second quarter of 1998. The interest rate on borrowings is based upon LIBOR plus 50 to 112.5 additional basis points which is determined by certain Company financial ratios. There was $11.0 million outstanding on the line of credit at December 31, 1998, and no borrowings outstanding at December 31, 1997 and 1996 under previous lines of credit. Provisions contained in the line of credit agreement require the Company to maintain specified levels of net worth, a specific ratio of consolidated funded debt to consolidated earnings before interest, taxes, depreciation and amortization and a specific ratio of consolidated earnings before interest and taxes to the sum of consolidated interest expense and consolidated dividends. The Company also has two non-interest bearing notes payable in the aggregate face amount of $900,000 relating to the purchase of an intrastate wagering license from the former owners of the Louisville Sports Spectrum property. Interest has been imputed at 8%. The balance of these notes net of unamortized discount was $196,000, $276,000, and $350,000 at December 31, 1998, 1997 and 1996, respectively. The notes require aggregate annual payments of $110,000. On May 31, 1996, the Company entered into a Partnership Interest Purchase Agreement with Conseco, L.L.C. ("Conseco") for the sale of 10% of the Company's partnership interest in Hoosier Park to Conseco. The transaction also included assumption by Conseco of a loan to the Company of approximately $2,600,000, of which the balance is $2,395,092 at December 31, 1998. The loan requires interest of prime plus 2% (9.75% at December 31, 1998) payable monthly with principal due November 2004. The note is collateralized by 10% of the assets of Hoosier Park. Conseco had an option to purchase an additional 47% interest in Hoosier Park which expired unexercised on December 31, 1998. Future aggregate maturities of long-term debt are as follows: 1999- $ 127,000 2000- 126,000 2001- 11,008,000 2002- 9,000 2003- - Thereafter - 2,395,000 ----------- $13,665,000 =========== 43
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. Operating Leases: The Company has a long-term operating lease for the land in Anderson, Indiana on which its Hoosier Park facility is located, as well as operating leases for the Indianapolis off-track betting facility and certain totalisator and audio/visual and other equipment and services. The Anderson lease expires in 2003, with an option to extend the lease for three additional ten year terms. The Indianapolis lease expires in 2009, with an option to extend the lease for two additional five year terms. The leases include provisions for minimum lease payments as well as contingent lease payments based on handle or revenues. Total rent expense for all operating leases was $4,022,000, $3,803,000 and $3,465,000 for the years ended December 31, 1998, 1997 and 1996. Future minimum operating lease payments are as follows: Minimum Lease Payment ------- 1999 $ 725,604 2000 704,625 2001 556,214 2002 462,045 2003 372,840 Thereafter 1,694,301 ---------- $4,515,629 ========== 10. Stock-Based Compensation Plans: The Company sponsors both the "Churchill Downs Incorporated 1997 Stock Option Plan" (the "97 Plan") and the "Churchill Downs Incorporated 1993 Stock Option Plan" (the "93 Plan"), stock-based incentive compensation plans, which are described below. The Company applies APB Opinion 25 and related interpretations in accounting for both the plans. However, pro forma disclosures as if the Company adopted the cost recognition provisions of SFAS 123 are presented below. The Company is authorized to issue up to 300,000 shares and 400,000 shares of common stock (as adjusted for the stock split) under the 97 Plan and 93 Plan, respectively, pursuant to "Awards" granted in the form of incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended) and non-qualified stock options. Awards may be granted to selected employees of the Company or any subsidiary. 44
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. Stock-Based Compensation Plans: (cont'd) Employee Stock Options: Both the 97 Plan and the 93 Plan 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. The exercise price of any nonqualified stock option is not so limited by the plans. The Company granted stock options in 1998, 1997 and 1996. The stock options granted in those years have contractual terms of 10 years and varying vesting dates, ranging from one to three years following the date of grant. In accordance with APB 25, the Company has not recognized any compensation cost for these stock options. A summary of the status of the Company's stock options as of December 31, 1998, 1997 and 1996 and the changes during the year ended on those dates is presented below: <TABLE> <CAPTION> 1998 1997 1996 ----------------------- ----------------------- ----------------------- # of Shares Weighted # of Shares Weighted # of Shares Weighted Underlying Average Underlying Average Underlying Average Options Exercise Options Exercise Options Exercise Prices Prices Prices <S> <C> <C> <C> <C> <C> <C> Outstanding at beginning of the year 426,532 $19.45 337,000 $19.08 248,000 $22.34 Granted 51,766 $32.50 89,532 $20.83 274,400 $18.97 Exercised - - - - - - Canceled - - - - 185,400 $23.27 Forfeited - - - - - - Expired - - - - - - Outstanding at end of year 478,298 $20.86 426,532 $19.45 337,000 $19.08 Exercisable at end of year 248,000 $21.02 207,400 $19.67 - - Weighted-average fair value per share of options granted during the year $10.42 $6.34 $5.55 </TABLE> The fair value of each stock option granted is estimated on the date of grant using the Black- Scholes option-pricing model with the following weighted-average assumptions for grants in 1998, 1997 and 1996, respectively: dividend yields ranging from 1.20% to 1.54%; risk- free interest rates are different for each grant and range from 5.75% to 6.63%; and the expected lives of options are different for each grant and range from approximately 5.83 to 6.5 years,and expected volatility rates of 24.86%, 19.38% and 18.75% for years ending December 31, 1998, 1997 and 1996. 45
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. Stock-Based Compensation Plans: (cont'd) The following table summarizes information about stock options outstanding at December 31, 1998: <TABLE> <CAPTION> Options Outstanding Options Exercisable ------------------------------------- ------------------- Number Weighted Average Weighted Number Weighted Range of Outstanding Remaining Average Exercisable Average Exercise Prices at 12/31/98 Contributing Life Exercise Price at 12/31/98 Exercise Price - --------------- ----------- ----------------- -------------- ----------- -------------- <S> <C> <C> <C> <C> <C> $15.75 to $19.25 315,900 6.05 $18.72 211,000 $20.89 $21.25 to $32.50 162,398 8.20 $25.02 37,000 $21.71 ------- ------- TOTAL 478,298 6.77 $20.86 248,000 $21.02 ======= ======= </TABLE> 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 next 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 elect to participate for each period to 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 $25,000 for each calendar year. Under the Employee Stock Purchase Plan, the Company sold 8,107 shares of common stock to 102 employees pursuant to options granted on August 1, 1997, and exercised on July 31, 1998. Because the plan year overlaps the Company's fiscal year, the number of shares to be sold pursuant to options granted on August 1, 1998, can only be estimated because the 1998 plan year is not yet complete. The Company's estimate of options granted in 1998 under the Plan is based on the number of shares sold to employees under the Plan for the 1997 plan year, adjusted to reflect the change in the number of employees participating in the Plan in 1998. 46
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. Stock-Based Compensation Plans: (cont'd) A summary of the status of the Company's stock options under the Employee Stock Purchase Plan as of December 31, 1998, 1997 and 1996 and the changes during the year ended on those dates is presented below: <TABLE> <CAPTION> 1998 1997 1996 ---------------------- ---------------------- ---------------------- # of Shares Weighted # of Shares Weighted # of Shares Weighted Underlying Average Underlying Average Underlying Average Options Exercise Options Exercise Options Exercise Prices Prices Prices <S> <C> <C> <C> <C> <C> <C> Outstanding at beginning of the year 8,030 $14.60 8,000 $14.45 7,818 $14.45 Adjustment to prior year estimated grants 77 $14.60 410 $14.45 - - Granted 5,238 $31.45 8,030 $18.94 8,000 $17.22 Exercised 8,107 $14.60 8,410 $14.95 7,818 $14.45 Forfeited - - - - - - Expired - - - - - - Outstanding at end of year 5,238 $31.45 8,030 $18.94 8,000 $17.22 Exercisable at end of year - - - - - - Weighted-average Fair value per share of options granted during the year $12.16 $5.36 $5.35 </TABLE> 47
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. Stock-Based Compensation Plans: (cont'd) Had the compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS 123, the Company's net earnings and earnings per common share for 1998, 1997 and 1996 would approximate the pro forma amounts presented below: 1998 1997 1996 ----------- ----------- ---------- Net earnings: As reported $10,518,548 $9,148,560 $8,071,526 Pro-forma $10,086,914 $8,605,000 7,530,000 Earnings per common share: As reported Basic $1.41 $1.25 $1.08 Diluted $1.40 $1.25 $1.08 Pro-forma Basic $1.35 $1.18 $1.01 Diluted $1.34 $1.18 $1.01 The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. The Company anticipates making awards in the future under its stock-based compensation plans. 11. Fair Values of Financial Instruments: Financial Accounting Standards Board ("FASB") Statement No. 107, "Disclosure about Fair Value of Financial Instruments," is a part of a continuing process by the FASB to improve information on financial instruments. The following methods and assumptions were used by the Company in estimating its fair value disclosures for such financial instruments as defined by the Statement: Cash and Cash Equivalents - The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value. Long-Term Debt - The carrying amounts of the Company's borrowings under its line of credit agreements and other long-term debt approximates fair value, based upon current interest rates. 48
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. Contingencies: On January 22, 1992, the Company acquired certain assets of Louisville Downs, Incorporated for $5,000,000 including the site of the Louisville Sports Spectrum. In conjunction with this purchase, the Company withheld $1,000,000 from the amount due to the sellers to offset certain costs related to the remediation of environmental contamination associated with underground storage tanks at the site. All of the $1,000,000 hold back had been utilized as of December 31, 1998 and additional costs of remediation have not yet been conclusively determined. The sellers have now received a reimbursement from the State of Kentucky of $995,000 for remediation costs and that amount is now being held in an escrow account to pay further costs of remediation. Approximately $985,000 remains in the account. In addition to the hold back, the Company has obtained an indemnity to cover the full cost of remediation from the prior owner of the property. It is not anticipated that the Company will have any liability as a result of compliance with environmental laws with respect to any of the Company's property. Except as discussed herein, compliance with environmental laws has not affected the ability to develop and operate the Company's properties and the Company is not otherwise subject to any material compliance costs in connection with federal or state environmental laws. 13. Earnings Per Common Share Computations: The following is a reconciliation of the numerator and denominator of the earnings per common share computations: <TABLE> <CAPTION> 1998 1997 1996 ---- ---- ---- <S> <C> <C> <C> Net earnings (numerator) amounts used for basic and diluted per share computations: $10,518,548 $9,148,560 $8,071,526 =========== ========== ========== Weighted average shares (denominator) of common stock outstanding per share computations: Basic 7,460,058 7,312,052 7,445,542 Plus dilutive effect of stock options 79,424 8,618 2,164 ----------- ---------- ---------- Diluted 7,539,482 7,320,670 7,447,706 =========== ========== ========== Earnings per common share: Basic $1.41 $1.25 $1.08 Diluted $1.40 $1.25 $1.08 </TABLE> Options to purchase 51,766, 9,800 and 135,250 shares for the years ended December 31, 1998, 1997 and 1996, 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. 49
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. Segment Information In 1998 the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company has determined that it currently operates in the following four segments: (1) Churchill Downs racetrack and the Louisville Sports Spectrum simulcast facility, (2) Ellis Park racetrack and its on-site simulcast facility, (3) Hoosier Park racetrack and its on-site simulcast facility and the other three Indiana simulcast facilities and (4) Other operations. Most of the Company's revenues are generated from commissions on pari-mutuel wagering at the Company's racetracks and simulcast wagering facilities, as well as simulcast fees, admissions and concessions revenue and other sources. Other operations includes the Kentucky Horse Center and the Company's investments in various other business enterprises. The Company's equity in the net income of equity method investees is not significant. Eliminations include the elimination of management fees and other intersegment transactions. The accounting policies of the segments are the same as those described in the "Summary of Significant Accounting Policies." The Company evaluates the performance of its segments and allocates resources to them based on earnings before interest, taxes, depreciation and amortization ("EBITDA") and operating income. 50
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. Segment Information: (cont'd) The table below presents information about reported segments for the years ending December 31, 1998, 1997 and 1996: Segment Information (in thousands) <TABLE> <CAPTION> Churchill Hoosier Ellis Park Other Elimina- Downs Park Operations tions Total <S> <C> <C> <C> <C> <C> <C> Net revenues: 1998 $80,925 $47,744 $17,386 $2,497 $(1,252) $147,300 1997 77,404 41,503 - 1,299 (1,299) 118,907 1996 74,540 33,319 - 1,334 (1,334) 107,859 EBITDA: 1998 $14,417 $5,599 $2,305 $909 - $23,230 1997 14,205 4,282 - 802 - 19,289 1996 15,390 1,565 - 847 - 17,802 Operating income: 1998 $10,700 $4,499 $1,422 $522 - $17,143 1997 10,557 3,088 - 760 - 14,405 1996 11,482 6 - 827 - 12,315 Total assets: 1998 $89,427 $31,732 $23,038 $71,109 $(100,655) $114,651 1997 72,490 29,689 - 31,180 (47,510) 85,849 1996 71,047 28,626 - 26,062 (45,006) 80,729 </TABLE> Following is a reconciliation of total EBITDA to income before provision for income taxes: (in thousands) 1998 1997 1996 ---- ---- ---- Total EBITDA $23,230 $19,289 $17,802 Depreciation and amortization (5,744) (4,559) (4,814) Interest income (expense) (216) 243 53 -------- -------- -------- Earnings before provision for income taxes $17,270 $14,973 $13,041 ======== ======== ========= 51
CHURCHILL DOWNS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 15. Subsequent Events: On January 13, 1999, the Company acquired a 60% interest in Charlson Broadcast Technologies, LLC ("CBT") for a purchase price of $5.4 million. CBT provides simulcast graphic software video services to racetracks and simulcast wagering facilities throughout the United States. The purchase agreement includes provisions for an additional contingent purchase price to be paid by the Company to the former owners of the 60% interest based upon the achievement of certain operating targets. On January 21, 1999, the Company entered into an agreement to acquire all of the outstanding shares of Calder Race Course, Inc., and Tropical Park, Inc. ("Calder"), from KE Acquisition Corp., a private holding company. Terms of the agreement include a purchase price of $86 million subject to certain adjustments. Closing of the acquisition is expected in early April 1999. 52
<TABLE> <CAPTION> Supplementary Financial Information(Unaudited) Common Stock Information Per Share of Common Stock ----------------------------------------------------- Operating Net Basic Diluted Net Income Earnings Earnings Earnings Market Price Revenues (Loss) (Loss) (Loss) (Loss) Dividends High Low -------- ---------- ----------- -------- -------- --------- ------ ----- <S> <C> <C> <C> <C> <C> <C> <C> <C> 1998 $147,300,299 $17,143,410 $10,518,548 $1.41 $1.40 Fourth Quarter 31,241,540 (1,290,562) (779,990) (.10) (.10) $0.50 $36.44 $27.25 Third Quarter 33,299,256 (1,016,288) (654,915) (.09) (.09) 41.44 27.63 Second Quarter 67,374,352 22,219,991 13,522,484 1.81 1.79 43.25 24.00 First Quarter 15,385,151 (2,769,731) (1,569,031) (.21) (.21) 25.31 19.31 - ----------------------------------------------------------------------------------------------------------------------- 1997 $118,907,367 $14,405,288 $9,148,560 $1.25 $1.25 Fourth Quarter 28,021,261 (269,688) 30,749 0.00 0.00 $0.50 $23.38 $20.75 Third Quarter 16,827,607 (3,005,270) (1,819,209) (0.25) ( 0.25) 21.00 16.25 Second Quarter 60,779,635 20,815,669 12,785,706 1.75 1.75 19.00 16.50 First Quarter 13,278,864 (3,135,423) (1,848,686) (0.25) (0.25) 18.50 16.00 - ----------------------------------------------------------------------------------------------------------------------- 1996 $107,858,818 $12,314,897 $ 8,071,526 $1.08 $1.08 Fourth Quarter 26,369,324 (1,092,044) (171,138) (0.02) (0.02) $0.33 $18.25 $17.00 Third Quarter 15,200,752 (2,782,430) (1,580,988) (0.21) (0.21) 18.75 17.00 Second Quarter 54,939,249 19,637,584 11,896,865 1.59 1.59 22.00 18.00 First Quarter 11,349,493 (3,448,213) (2,073,213) (0.27) (0.27) 20.00 16.00 - ----------------------------------------------------------------------------------------------------------------------- </TABLE> The Company's Common Stock is traded in the over-the-counter market. As of March 29, 1993, the Company's Common Stock was listed on the National Association of Securities Dealers, Inc.'s SmallCap Market under the symbol CHDN. As of March 24, 1999, there were approximately 3,100 stockholders of record. Earnings (loss) per share and other per share amounts have been retroactively adjusted for the 2-for-1 stock split with a record date of March 30, 1998. Quarterly earnings (loss) per share figures may not equal total earnings (loss) per share for the year due in part to the fluctuation of the market price of the stock. The above table sets forth the high and low bid quotations (as reported by NASDAQ) and dividend payment information for the Company's Common Stock during its last three years. Quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily reflect actual transactions. 53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required herein is incorporated by reference from sections of the Company's Proxy Statement titled "Section 16(a) Beneficial Ownership Reporting Compliance," "Election of Directors," and "Executive Officers of the Company," which Proxy Statement will be filed with the Securities and Exchange Commission pursuant to instruction G(3) of the General Instructions to Form 10-K. ITEM 11. EXECUTIVE COMPENSATION. The information required herein is incorporated by reference from sections of the Company's Proxy Statement titled "Election of Directors - Compensation and Committees of the Board of Directors," "Compensation Committee Report on Executive Compensation," "Compensation Committee Interlocks and Insider Participation," "Performance Graph," and "Executive Compensation," which Proxy Statement will be filed with the Securities and Exchange Commission pursuant to instruction G(3) of the General Instructions to Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required herein is incorporated by reference from the sections of the Company's Proxy Statement titled "Common Stock Owned by Certain Persons," "Election of Directors" and "Executive Officers of the Company," which Proxy Statement will be filed with the Securities and Exchange Commission pursuant to instruction G(3) of the General Instructions to Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required herein is incorporated by reference from the section of the Company's Proxy Statement titled "Certain Relationships and Related Transactions," which Proxy Statement will be filed with the Securities and Exchange Commission pursuant to instruction G(3) of the General Instructions to Form 10-K. 54
PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K Pages (a)(1) Consolidated Financial Statements The following financial statements of Churchill Downs Incorporated for the years ended December 31, 1998, 1997 and 1996 are included in Part II, Item 8: Report of Independent Accountants 31 Consolidated Balance Sheets 32 Consolidated Statements of Earnings 33 Consolidated Statements of Stockholders' Equity 34 Consolidated Statements of Cash Flows 35 Notes to Consolidated Financial Statements 36-52 (2) Schedule VIII - Valuation and Qualifying Accounts 57 All other schedules are omitted because they are not applicable, not significant or not required, or because the required information is included in the financial statement notes thereto. (3) For the list of required exhibits, see exhibit index. (b) Reports on Form 8-K: (1) Report on Form 8-K - Description of Capital Stock, Item 5 Other Events, was filed on December 14, 1998 (2) Report on Form 8-K/ A-2, filing of accountant's consent, Item 7 Financial Statements and Exhibits, ws filed on December 21, 1998. (c) Exhibits See exhibit index. (d) All financial statements and schedules except those items listed under items 14(a)(l) and (2) above are omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto. 55
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHURCHILL DOWNS INCORPORATED /s/Thomas H. Meeker --------------------- Thomas H. Meeker President and Chief Executive Officer March 16, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. <TABLE> <S> <C> <C> /s/Thomas H. Meeker /s/Robert L. Decker /s/Vicki. L. Baumgardner - --------------------------------- ----------------------------- -------------------------------- Thomas H. Meeker, President and Robert L. Decker, Executive Vicki L. Baumgardner, Vice Chief Executive Officer Vice President and Chief President, Finance and Treasurer March 16, 1999 Officer March 16, 1999 (Director and Principal Executive March 16, 1999 (Principal Accounting Officer) Officer) (Principal Financial Officer) /s/Daniel P. Harrington /s/Frank B. Hower, Jr. - --------------------------------- ----------------------------- -------------------------------- Daniel P. Harrington Frank B. Hower, Jr. Arthur B. Modell March 16, 1999 March 16, 1999 March 16, 1999 (Director) (Director) (Director) /s/William S. Farish /s/G. Watts Humphrey, Jr. /s/Carl F. Pollard - --------------------------------- ----------------------------- -------------------------------- William S. Farish G. Watts Humphrey, Jr. Carl F. Pollard March 16, 1999 March 16, 1999 March 16, 1999 (Director) (Director) (Director) /s/J. David Grissom /s/W. Bruce Lunsford /s/Dennis D. Swanson - --------------------------------- ----------------------------- -------------------------------- J. David Grissom W. Bruce Lunsford Dennis D. Swanson March 16, 1999 March 16, 1999 March 16, 1999 (Director) (Director) (Director) /s/Charles W. Bidwill, Jr. /s/Seth W. Hancock /s/Darrell R. Wells - --------------------------------- ----------------------------- -------------------------------- Charles W. Bidwill, Jr. Seth W. Hancock Darrell R. Wells March 16, 1999 March 16, 1999 March 16, 1999 (Director) (Director) (Director) </TABLE> 56
CHURCHILL DOWNS INCORPORATED SCHEDULE VIII. - VALUATION AND QUALIFYING ACCOUNTS <TABLE> <CAPTION> Balance, Accounts Balance, Beginning obtained in Charged to End Description of Period Acquisition Expenses Deductions of Period Year ended December 31, 1998: <S> <C> <C> <C> <C> <C> Allowance for doubtful account and notes receivable $176,000 $98,000 $1,000 $(56,000) $219,000 Valuation allowance for deferred tax asset 173,000 - (173,000) - - -------- -------- ---------- ---------- --------- $349,000 $98,000 $(172,000) (56,000) $219,000 ======== ======== ========== ========== ========= Year ended December 31, 1997: Allowance for doubtful account and notes receivable $165,000 - $61,000 $(50,000) $176,000 Valuation allowance for deferred tax asset 176,000 - - (3,000) 173,000 -------- -------- -------- ---------- -------- $341,000 - $61,000 $(53,000) $349,000 ======== ======== ======== ========== ======== Year ended December 31, 1996: Allowance for doubtful account and notes receivable $135,000 - $30,000 - $165,000 Valuation allowance for deferred tax asset 104,000 - 72,000 - 176,000 -------- -------- -------- ---------- -------- $239,000 - $102,000 - $341,000 ======== ======== ======== ========== ======== </TABLE> 57
<TABLE> <CAPTION> EXHIBIT INDEX Numbers Description By Reference To <S> <C> (2) (a) Stock Purchase Agreement dated as Exhibit 2.1 to Current Report on Form of March 28, 1998 between Churchill 8-K dated April 21, 1998 Downs Incorporated and TVI Corp. (b) Agreement and Plan of Merger dated Exhibit 2.2 to Current Report on Form as of April 17, 1998 by and among 8-K dated April 21, 1998 TVI Corp., Racing Corporation of America, Churchill Downs Incorporated and RCA Acquisition Company (3) (a) Amended and Restated Articles of Report on Form 10-Q for the fiscal Churchill Downs Incorporatiod quarter ended June 30, 1998 (b) Restated Bylaws as amended Report on Form 10-Q for the fiscal quarter ended June 30, 1998 (4) Rights Agreement dated as of Exhibit 4.1 to Current Report on Form March 19, 1998 between Churchill 8-K dated March 19, 1998 Downs, Inc. and Bank of Louisville (10)(a) Churchill Downs Incorporated Amended Pages 61 to 71, Report on Form 10-K and Supplemental Benefit Plan dated the year ended December 31, 1998 December 1, 1998* (b) Employment Agreement dated as of Exhibit 19(a) to Report on Form 10-Q October 1, 1984, with for fiscal quarter ended 4 Thomas H. Meeker, President * October 31, 198 (c) Churchill Downs Incorporated for Exhibit 10 (c) to Report on Form 10-K Incentive Compensation Plan (1997)* for the year ended December 31, 1996 (d) Churchill Downs Incorporated Exhibit 10(h) to Report on Form 10-K for 1993 Stock Option Plan * for the eleven months ended December 31, 1993 (e) Stock Purchase Agreement naming Exhibit 10(i) to Current Report on Dominick Marotta, Frank Marotta, Form 8-K filed with the Securities Louis E. Carlo and Edward F. and Exchange Commission on Draugelis February 10, 1994 (f) Amendment of Employment Agreement Report on Form 10-K for the fiscal with Thomas H. Meeker, President, year ended January 31, 1986; Report dated October 1, 1984 * on Form 10-K for the fiscal year ended January 31, 1987; 1988, 1990, 1991, 1992 and 1993 (g) Amendment No. 1 to Churchill Downs Exhibit 10 (g) to Report on Form 10-K Incorporated 1993 Stock Option Plan* for the year ended December 31, 1994 58
(h) $100 Million Revolving Facility Report on Form 10-Q for the fiscal Credit Agreement between Churchill quarter ended September 30, 1998 Downs Incorporated, Churchill Downs Management Company, Churchill Downs Investmwnt Company, Racing Coporation of America, Ellis Park Race Course, Inc., the banks party thereto and PNC Bank, National Association, as Agent, dated as of September 15, 1998 (i) Amended and Restated Lease Exhibit 10 (l) to Report on Form 10-K Agreement dated January 31, 1996 for the year ended December 31, 1995 (j) Partnership Interest Purchase Exhibit 10(k) to Report on Form 10-K Agreement dated December 20, 1995 for the year ended December 31, 1995 among Anderson Park, Inc., Conseco HPLP, LLC, Pegasus Group, Inc. and Hoosier Park, L.P. (k) Employment Agreement between Exhibit 10 (l) to Report on Form 10-Q Churchill Downs Incorporated and for the fiscal quarter ended Robert L. Decker * March 31, 1997 (l) Amendment No. 2 to Churchill Downs Report on Form 10-K for the year Incorporated 1993 Stock Option Plan* ended December 31, 1997 (m) Churchill Downs Incorporated Report on Form 10-K for the year 1997 Stock Option Plan* ended December 31, 1997 (n) Churchill Downs Incorporated Amended Pages 72 to 88, Report on Form 10-K for and Restated Deferred Compensation the year ended December 31, 1998 Plan for Employees and Directors* (21) Subsidiaries of the registrant Report on Form 10-K for the year ended December 31, 1994 59
(23) Consent of PricewaterhouseCoopers, LLP Page 89, Report on Form 10-K for the Independent Accountants year ended December 31, 1998 (27) Financial Data Schedule for the Page 90, Report on Form 10-K for year ended December 31, 1998 the year ended December 31, 1998 *Management contract or compensatory plan or arrangement. </TABLE> 60