Good day, ladies and gentlemen, and welcome to the Churchill Downs Incorporated 2016 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Mr. Mike Anderson, Vice President, Treasury, and Investor Relations.

Great. Thank you, Andrea. Good morning, and welcome to our second quarter 2016 conference call. After the company’s prepared remarks, we will open the call for your questions. The company’s 2016 second quarter business results were released yesterday afternoon. A copy of this release announcing results and other financial and statistical information about the period to be presented in this conference call, including information required by Reg G, is available at this section of the company’s website titled News, located at churchilldownsincorporated.com, as well as in the website’s Investor section. Before we get started, I would like to remind you that some of the statements that we make today may include forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC, specifically the most recent reports on Form 10-Q and Form 10-K. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today’s earnings press release. The press release and Form 10-Q are both available on our website at churchilldownsincorporated.com. And now I would like to turn the call over to our Chief Executive Officer, Mr. Bill Carstanjen. Bill?

Thanks, Mike. Good morning, everyone. With me today are several members of our team, including Bill Mudd, our President and Chief Operating Officer; Marcia Dall, our Chief Financial Officer; and Alan Tse, our General Counsel. I will make a few general comments about the second quarter, and then turn this over to Marcia. After she has finished her comments, Marsha, Bill Mudd and I will be happy to take your questions. The company produced record net revenues, record adjusted EBITDA, and record net income for the quarter. This is, of course, good news. Any day a company can report record numbers is a special day. That said, while Big Fish is up year-over-year in bookings in net revenues, it is down $7.8 million in adjusted EBITDA for the quarter as a result of higher user acquisition spending. We will spend a little extra time talking about Big Fish and the increase in user acquisitions spend in a few minutes. Turning to our business divisions, we had a spectacular Kentucky Derby Week, and that drove the performance of our racing division for the second quarter. We delivered record Kentucky Derby Week adjusted EBITDA up $5.2 million over prior year, and generally were very encouraged by virtually all of the metrics we drive internally to ultimately deliver adjusted EBITDA growth for the Derby. We think we can continue to build on our momentum and are excited about what we can do next year. We otherwise had modest growth in adjusted EBITDA for the rest of the racing division in the second quarter, as our team focused on cost management and operating efficiencies to balance against the modest topline declines we and the entire industry continue to see. I’ve said this before, but I think it always bears repeating. The Kentucky Derby is…

Thanks, Bill. And good morning, everyone. As Bill mentioned in his opening remarks, we delivered a strong performance for the second quarter, with record levels of revenue, adjusted EBITDA, and net income. Free cash flow was down $3.9 million for the quarter. I will go into more detail on the drivers of this decline in a few minutes. We are pleased that we generated a record nearly $70 million of net income, up 27% over the prior year quarter. This resulted in $4.11 of diluted net income per share, which is up 33% compared to the prior year quarter. Our net income was $14.7 million higher for the quarter, primarily as a result of the growth in our operating income; strong growth from our equity investments in Saratoga and Miami Valley Gaming; as well as from a lower effective tax rate for the quarter compared to last year. The second quarter 2015, we had nondeductible acquisition-related charges that resulted in a higher tax rate. Net revenue and adjusted EBITDA were also records for the quarter. Net revenue was $438.5 million, up $29.3 million; and adjusted EBITDA was $162.9 million, up $4 million from the prior year quarter. We enhanced our disclosures for the quarter by adding a high-level walk from net revenue to adjusted EBITDA for each of our segments as an attachment to our press release and to the segment footnote of our 10-Q. We believe this enhanced disclosure will help our investors better understand the key drivers of our operating segment results. Now I will go into more detail for each of our segments. I will begin with our racing segment. Racing revenue increased $2.5 million in the quarter, reflecting a very successful Kentucky Derby and Oaks Week, that was partially offset by a decline in the number…

Thank you, Marcia. Okay, everyone, I think we are ready to take questions.

[Operator Instructions] Our first question comes from the line of Cameron McKnight with Wells Fargo. Your line is open.

Good morning, thanks very much. First question on Big Fish. The tickup in UA spend that we saw last quarter, when do you expect that to start flowing through to revenues? Have you started to see that bear fruit? Or is that something that’s a second half 2016 or early 2017 event?

It continues quarter-to-quarter. It’s starting to bear fruit now, and it becomes a question of how long we retain the customers that we acquired with that UA spend. So, every time we spend UA, we are picking up new customer cohorts. And depending on game, ranging anywhere from 6 to 18 months is when we sort of harvest the returns from the customers that we acquired.

Got it, thanks. And then on the gaming segment, I mean, you guys have outperformed the regional gaming industry in the second quarter. Can you talk through the revenue environment and what you’re doing on costs?

Yes, I’d be happy to, Cameron. This is Bill Mudd. If you look at each of our casino properties, I think Calder Casino was up 3%, which equated to about $600,000. And Fairground Slots is down about $200,000, which was down about 2%. Everything else was within $100,000 of last year. So I would characterize, from a broad perspective, a very stable environment, and certainly not in the growth stage. But I would say that – again, it comes down to regions. And in Florida, we did a good job of picking up some high-end customers. And in the Oxford market, we had a tough comparison to prior-year, because we had great weather last year. But we continue to see kind of stable middle-tier customers and some strong unrated play from low fuel prices. And then in New Orleans, we were struggling with a little bit of the softness in the oil industry. So, I would say that we view the casinos as stable from a revenue perspective. On a cost perspective, it’s something that we continuously look at, taking ways – finding ways to be more efficient, predominantly through food and beverage, but also through some more marketing programs, and the way that we engage the customer, as well as we have properties that are in close proximity with one another, we look at ways to combine roles to maximize our profitability and efficiency. So, that’s how we think about it.

Great. Thanks. And then one last one, if I may. Just back to Big Fish. I mean, we had a big announcement from Caesar’s yesterday – big valuation, a big multiple in terms of the sale of their social gaming business. Were you guys surprised by that? Or does it just affirm the value that you guys see in Big Fish long-term?

Cameron, it’s Bill Carstanjen. I think just over the course of a career, you see more M&A activity in spaces where there is segment growth. And so, the games – the social games, the mobile games segment in general is an area where, over the last number of years, you’ve seen a lot of market growth. And I think there’s an expectation, as these devices become even more integral to people’s lives, that the market may grow. So I think there is a macro environment there that attracts attention. And then the growth and steadiness of social casino has also been a bright spot for some within the larger market. So I’m not surprised – just commenting on an observer of M&A activity in lots of spaces, including the spaces that we ourselves are in – I’m not surprised that you see optimism and investment in spaces like this. That makes sense, and I think you’ve seen that over a long period of time in different industries. That said, specifically, I can’t compare and contrast the play ticket. That wouldn’t make sense for me to do. So we keep our heads down and try to do better what we do, and certainly pay attention to the market as a whole, and are nothing but encouraged by it. But like I said, we don’t compare ourselves to others. And we keep our heads down and our focus on building our business as sensibly as we can, to create as much value as we can for our investors.

Okay, got it. Thank you very much.

Thank you. Our next question comes from the line of David Katz with Telsey Group. Your line is open.

Hi, good morning.

Good morning, David.

So a couple of details first, if you don’t mind. So, Marcia, in your comments, you talked about a slight decrease in the second-half in UA spend. Is there anything that you can share with us in terms of understanding that the UA spend and revenue generation are not necessarily linear? Is there anything you can share with us about what you can foretell in terms of revenue for the back-half of the year so far?

Yes, David, as you know, we don’t give guidance. We wanted to give investors an understanding of what we anticipate from a UA spend for the second-half of the year. But, as you know, we don’t give revenue guidance or any other guidance.

Are there any new games that are – that you expect to enter the portfolio in the back-half of the year that might drive revenue one way or the other – drive bookings one way or the other?

I don’t think so. There are new games that will enter the portfolio, but in terms of games where you might see ebb and flow of our UA dollars in any kind of meaningful way, they are largely already out there. As I mentioned in my comments, Jackpot City is a game that’s already been launched worldwide. And hopefully, we see some reasons to invest more dollars in that over the rest of the year. But certainly within the studio, there are some exciting things we are working on, but nothing I expect that will be launched and move the needle in any kind of material way in the second-half. I would say when you think about first-half versus second-half, while our Big Fish division is a large division and a profitable division, in many ways, it’s still very early in its development as a business. You know, we’re not a company that had a large portfolio of games to invest in at any one time. And that has changed over the end of last year and through the first-half of this year. Now we do have a portfolio of games, so we are learning a lot on how these games relate to each other, how we should invest in one versus invest in another, and we’re just drawing a lot of parallels between these games. And it’s sort of sharpening our philosophies on where to invest UA dollars and where not to. So I think if you look at the first-half of our behavior, it’s not – we’re a company that’s maturing in terms of our strategies and processes around how to invest UA dollars when you have a portfolio of opportunities to actually invest those dollars in. So I think we’ll get better at that.

Very helpful. I appreciate it. Now, with respect to the Social Casino business, without going back to the issue of the other deals that have been out there, would it be fair to suggest that one of the takeaways is that they – that there is a high value on branded content within Social Casinos. And is that a potential strategy that you could consider about adding established brands within your Social Casino portfolio, to drive performance and value?

So, let me make sure I answer the question you asked. You are really inquiring about using sort of branded content within the Big Fish brand or another company using branded slots within their Social Casino brand. We, as a strategy, have not focused on doing very much of that, because the owner of the licensed IP is another mouth that you have to feed. So we’re – certainly there are plenty of people that are successful doing that. But we’re just, by nature and background, always thinking about margin and always thinking about the cost and association with the revenue. So our first instinct is always to be a bit careful and considerate in our thinking about whether we want to pay more miles out of our revenue stream. So we always weigh that. We do – we are willing to do some of it. It just hasn’t been our primary strategy for how to grow in the space. But other people are very – you see them out there. Other people have found great success doing that, so I hope there’s more than one way to skin the cat over time. But the way Big Fish built its business and the way we think about it now, it’s not a primary component of our philosophy to try to rely on branded IP.

Understood. And if I can ask one other sort of bigger picture question? Presumably there is a couple of different ways to increase value, one of which is to grow earnings. And the other is to command a higher multiple or a higher valuation. I think your re paths along the first one are clear. How do you think about that second area? Because I think stepping back and looking at the Derby and its inherent value, people are asking about Big Fish and its prospective value out in the market. And clearly, there are people that look at your stock and think, gee – and I would be one of them – you know, gee, I think that they should be able to command a higher multiple. How do you think about strategies around that? And how does that relate to your capital allocation decisions?

Well, I would say that’s – there’s some complexity in that question, and I hope the audience in general followed you, and I’m pretty sure that I did. So I would say the first thing that I think about in the morning when it comes to our company is, how do we increase shareholder value? How do we build wealth? And whether that be in our brick-and-mortar casino space or in the Kentucky Derby or in Big Fish, all those businesses arguably drive different multiples in the markets when they are standalone assets. But my first thought in the morning is not to play games between those, but to figure out ways with our team where we can create shareholder value in those different segments. So – and I think that’s the smart way long-term to think about growing a business and running a company. I do understand and think about sort of the sort of philosophical – and it’s more than philosophical – you know, the reality that multiples can be different across our properties. And when we do buy an asset in one business, it might be changing the blended multiple of all. But I don’t have a great philosophical answer for you on that, other than to commit to our investors that when we do make a strategic move, when we do an M&A transaction, we are always doing so under the expectation that we think we see a way to create shareholder value, even if the multiples at which we are doing it aren’t particularly or entirely clear.

Okay, I appreciate that. And just to be clear about the context of the question, I think it should be – it’s certainly obvious to me – and I’m sure it should be obvious to everyone – that the businesses in and of themselves are being run very, very well. And I didn’t mean to suggest that they are not; because they are.

Well, thanks for saying that, David. And I understood that. I was…

Okay.

Yes, I understood exactly where you’re going with that question. I hope the rest of the audience did. It was a multiples question, and the fact that there might be different multiples attached to our businesses, because our businesses are different from each other. We have some variability in our portfolio of businesses. And I think I got your question right. Tell me if I didn’t.

You did. You did. Thank you very much.

Sure.

Thank you. And our next question comes from the line of Adam Trivison with Gabelli & Company. Your line is now open.

Hi, everyone. Thanks for taking my question. The first on Big Fish. Maybe could you talk about any impact you’ve seen from the release of Pokemon Go, maybe more so in terms of stealing time on device rather than actual dollars? And I guess related to that, you guys have spoken in the past about R&D and virtual reality, and I guess have you guys looked at augmented reality? Or do you have any initiatives that could build out a game in that genre?

So, let me address that – it’s Bill Carstanjen again. I mean, I get excited any time you see a phenomena like Pokemon Go, because it just stands for the proposition that innovation can really drive interest to the space in general, and create new opportunities for all of us, especially those of us that are willing to be fast followers when we are capable of doing it. So, Pokemon Go as a concept is just exciting – seeing 40-year-old man stumble around, tripping over benches in the mall as they try to find the Pokemon creatures – that’s great to see. That’s fun. I would say that we haven’t really seen or noticed any impact on our other games. I think within your question was a question – does Pokemon Go maybe hurt us because time on device – there’s only 24 hours a day and…

Yes.

Pokemon Go driving our customer base to spend their time doing Pokemon Go instead of playing some of our games. It’s a valid theory to consider. We haven’t really seen it. We will have to keep our eye on it. But I don’t – there’s a lot of variables out there at any given time. And I’m not sure that – we’ve talked about that question, and I’m not sure we have anything interesting to report on it. It’s not something that we can directly see. In terms of that technology or similar, that is augmented reality, taking advantage of the massive capability of Google Maps and whatnot. That is an interesting space. Virtual reality, which is distinguishable, that’s another interesting space. Absolutely, we look at both spaces’ opportunity. Virtual reality, we do have some resources internally that are focused on that space. We don’t know how virtual reality or other forms of augmented reality will impact social mobile games. We don’t expect to necessarily be the ones that spot the great innovation that takes those technologies to critical mass on the social mobile space. But we are built and our mindset is to be fast followers, and to find variations of where we see success in the marketplace. So, we keep our eyes on those spaces and invest upfront to try to develop some of the internal capabilities, so that we can respond as those markets – and again, I’m drawing a distinction between augmented reality and virtual reality games – as those markets develop and mature. Right now, they are not developed and mature. It’s more speculative. But Pokemon Go certainly stands for the proposition that there might be good things to come in those spaces for the companies that develop the capabilities to develop in those spaces.

Okay, that’s helpful. And I guess related to the acquisition of Ocean Downs, and I guess the Saratoga relationship more broadly, can you kind of give us a sense of where this all fits into your longer-term strategic plans?

I’ll take that one. I encourage the team jump in if – because some of these questions are fairly broad, and I want to give a thoughtful answer to broader questions. We like the segments we are in. We found ourselves with the opportunity to get into brick-and-mortar gaming originally because we were a race track company that had the right to develop racinos on a couple of our properties. And that’s how we learned the brick-and-mortar casino business. And we sort of – we try to be clear-eyed and dispassionate about how to grow it. We’ve seen a lot of cost-out opportunities; a lot of our team originally comes from General Electric and we’ve learned some basic business skills that have helped us in those travels. And we see efficiency opportunities that have helped us grow, even when same-store sales in the brick-and-mortar casino space tend to be relatively stable. So, the growth possibilities within brick-and-mortar gaming, since same-store sales tend to be relatively flat, really comes from M&A opportunities and from greenfield opportunities. We have a couple in our company with Kentucky and Illinois. And so we dispassionately analyze those. And where we see places where we can create shareholder value, we’re going to do it. And that’s our strategy. That’s our approach and that’s our strategy for that place – for that space. Churchill Downs and particularly the Kentucky Derby, that’s its own thing – as I’d commented in my comments, that that’s its own thing. It’s something that we have been able to consistently grow off of it and expand, and we will keep working to try to do that. But that’s one of those iconic events that really doesn’t fall into a common category that’s easy to analyze. We just have a very experienced team…

Okay, great. Thank you very much.

Thank you. This concludes today’s Q&A session. I would now like to turn the call back over to Bill Carstanjen for any closing remarks.

Okay, thanks very much. We appreciate everybody joining us and participating with us. Again, thank you for your investment in our company. We will try to meet your expectations and keep this thing growing. Thanks very much, everybody. Bye-bye.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.