DraftKings Inc. (DKNG) Earnings Call Transcript & Summary

Well, thank you, everyone, for joining us this morning. My name is Bernie McTernan, the Internet analyst here at Needham & Company. My pleasure to introduce Jason Park, CFO of DraftKings. Thank you so much for joining us.

No, thank you for having me. I'm thrilled to be here, and thank you for everything you're doing.

Well, great. I guess maybe to start, even though earnings feels like, it was a month ago. What were some of the key highlights and key takeaways for you?

Yes. So probably 4 things, just excellent revenue growth, acquisition efficiency is better than it's ever been, organization, good balance of revenue growth and cost efficiency and we're on the cusp of profitability on an adjusted EBITDA basis. So just double-clicking into those. Revenue growth is -- like the core drivers underneath our revenue growth are so good, customer retention, monetization, meaning promo intensity coming down, hold percentage coming up. Those things are just working really, really well. Customer acquisition efficiency. We've been talking a lot about when we launch a new state now, we are acquiring so much more of the population in these most recent states, Maryland, Ohio, Massachusetts, then we had certainly relative to the 2018/'19 vintage, but even compared to the states we launched in 2020, 2021. The customer -- we are just acquiring so many more customers, which results in massive sort of per customer efficiencies, which is great to see. And that has profound implications on profitability down the road. Organizationally, I just love the momentum we have internally, on the balance of revenue growth and cost management. I was flying down last night, and I got an e-mail from sort of a mid-level employee saying, "Hey, I found an opportunity." And I'm like, that's -- it wasn't a huge dollar amount, but the indication that everybody in the company is looking for ways to be more efficient in how they're working, or how they're managing a certain vendor relationship and it's just -- it's awesome, and that's a nice internal flywheel that I think will continue to pay dividends. And then, on the cusp of profitability, we said that we'll be approximately breakeven. We're certainly standing behind that in Q2. And then, nearly $150 million of adjusted EBITDA -- positive adjusted EBITDA in Q4, which is great. And then, certainly setting ourselves up for a nice positive adjusted EBITDA year in 2024, regardless of what state legalization scenario unfolds next year. So, I think those are the big highlights.

Those are some good highlights. From one of our key takeaways from the earnings call was just that it seems like you guys are in a sweet spot where LTVs are rising and customer acquisition costs are coming down, which shouldn't normally happen to you guys clearly benefiting from. But maybe just double-clicking on the LTV point, we've done a lot of work on just OSB hold, but if you could just catch us up on how OSB hold has been trending, how you're thinking about it for the rest of the year and some of the drivers.

Yes. So absolutely, I think the LTV to CAC is how we internally run the business, and we think about the right amount of marketing to deploy and LTV, the growth -- simply put as the gross profit generation of each customer we acquire. Hold percentage is a big part of that. There's other factors for sure, customer retention, promo. But, specifically on your question on hold, hold is -- look, it comes down primarily to great product and tech. And hopefully, you guys know that when we acquired SBTech, we vertically integrated, we completed that vertical integration almost 2 years ago now. And that unlocks the ability to increase the amount of markets that we can offer the customer, whether that's Same Game Parlays, a variety of player props and that mix shift of what the customer is engaging on is what's driving a whole percentage of. It's really important for folks to know that our hold percentage is not going up because we're raising prices. Our whole percentage is going up because our customers are buying different products, engaging in different markets than they were before, and that's elevating our overall hold percentage. We were talking this morning about how we prepackage Same Game Parlays, which is a pretty differentiating and it's an ease of use experience for the customer. So, right when you open the DraftKings app, and I encourage you all to do it right now, but DraftKings as the only American sports betting operator, we're pretty in touch with the American sports fans. So, we've got a really fun one, scores and boards for tonight, which is Jayson Tatum, 25 points, 10 rebounds; Jimmy Butler, 25 points, 8 rebounds. That ability, not only to have the product in tech to offer that market but then to also market and merchandising it -- merchandise it right on the home page. And then, customers are saying, "Oh, I want that. I'll put a dollar on that. I'll put $2 on that." And that's what's driving our whole percentage of.

No, that's great. And you touched on retention as well. I remember when we first initiated on you guys seemingly forever ago, but it was that you guys will never be able to retain the customers that you have, their empty calorie revenue, but I remember that first Analyst Marketing Day or the Analyst Day that you guys did, where retention was over 100%. It was almost like you like almost -- it was virtually like here the room gas, like, "Oh my gosh, I can't believe it's that high." But what's driving that retention in your view? Is it product? Like what else is going into that?

Yes. So if we talk about retention, right, because there's customer retention, then there's revenue retention. If we just -- well, you know what, I can talk about it altogether. But fundamentally, it comes down to great product. It is an inherently sticky product. So people who are engaging in this enjoy it. It's a very high ROI source of entertainment in their entertainment budget. And then it's everything, ease of use of the app, great customer experience, they've got a question. We're very responsive. We invest into our customer experience and customer support functionality. It's all -- it's a conglomeration of all those factors that's keeping our players around. And then, on the gross revenue retention is that as players stay, their engagement level goes up over time as well. And that's because they -- a variety of factors. Their income is going up over time. So their percentage of their entire entertainment budget is going up. They are engaging in more sports throughout a calendar year. So maybe they were -- they entered and they were really only an NFL better, but now they're excited about transitioning from that Super Bowl and NFL playoff period directly into NBA, March Madness. So all of those factors are resulting in great retention.

Right. And then, so the other side of that LTV to CAC equation focusing on CAC, seems like customer acquisition costs are falling in the industry, maybe competition. But, can you just talk about how much it cost to acquire a customer maybe at the peak a year, 1.5 years ago over the competitive landscape and then what it might cost now?

Yes. we disclosed in our call about 2.5 weeks ago that our Q1 customer acquisition costs were down close to 30% year-over-year. And I think, what underneath that is a few things. So number one, as a scale operator and there's only really 2, maybe 3 truly national scale operators, we can shift from relatively expensive local marketing to relatively cheap and very efficient national marketing. So that's a big driver of our acquisition efficiency. I think, another factor is we're just getting better and better at our state launch playbook. So every time we launch a new state, we are turning dials on the medium [ miss ], the timing, the role of team deals in a state. And so, I think we are just constantly learning and optimizing how we launch a state. And I think externally, there's just American consumers are just more and more aware of this product category. So, when you live in a state that finally launches online sports betting, they're rearing to go. They've got friends, family members who have been doing it in their state, and they finally get -- their state finally legalizes and they're jumping in, which helps.

Right, right. No, that's great. One thing that we look for across our coverage list is the network effect, what is the flywheel effect. I know you guys recently lost some social features at the betting groups. But, do you think it's possible to get a network effect in sports betting where the scale kind of gets more scale? And is that a focus for you guys? And if so, how can you drive it?

Yes. I mean I think network effect in terms of liquidity, not so much, definitely in the daily fantasy product. Liquidity is a huge -- it becomes a differentiator. If you're playing daily fantasy and you're entering a $10 line up, you'd rather have a chance to win $1 million than a chance to win $10,000. So for sure, on the daily fantasy side. On the sports betting side, you mentioned it, I think, our social product is sneaky powerful. I'm hearing more and more our consumer research is indicating that our players are engaging in this functionality. It's a product where people like to brag, and they like to -- maybe they made 3 bets and one of them hit, but they'll brag about the one that hit. And the social functionality and their building groups of their high school friends and their college friends and the ability to immediately see, when one of your friends places a bet. And then, very easily tail that bet or fade that bet. We're seeing..

[indiscernible] betting with my friends.

We have -- yes, we're seeing good pickup on that. So I think that's a type of network effect.

Yes. No, that's great. And then also just lastly, on customer acquisition, just the competitive environment, trending off the lows, but fanatics is supposed to be launching sometime soon. They just made an acquisition. How do you anticipate the competitive landscape, looking at your crystal ball could look for this upcoming NFL season?

Yes. I mean, look, I think it's -- it feels like to me that the table is pretty set with the 2 -- the top 2 operators at sort of 70% to 75% of the market. And frankly, that's faster consolidation than I would have thought 3 or 4 years ago. And I think, it's no coincidence that those top 2 players are vertically integrated. They're in the most states. Therefore, they can deploy national marketing. They've got the daily fantasy database, which provides a real cross-sell competitive advantage. So I think, we're always ready for new competition, and we're keeping our eyes on even the small long-tail operators who are single-digit market share operators. We're always looking to see what they might be doing differently or innovating. But right now, it feels like a very healthy industry structure.

Got it. Any specific thoughts on fanatics acquiring points bet?

I saw the same news that all of you did. It feels like, there's I don't know any more than you do. I do know that Michael Rubin is an awesome guy and Matt King. We have a ton of respect for Matt and Michael. So I look forward to seeing what they do.

Understood. Maybe -- so one thing when we think about this LTV to CAC equation, kind of the 2 metrics that you guys talked to, where it's 2 to 3 gross profit paybacks. But then, also within that, contribution margin because you mentioned Massachusetts, Ohio, you're acquiring a lot more customers than you did kind of that curve of contribution margin is deeper in the beginning and then, the trajectory is steeper on the way out. How should we think about those 2 equations with each other?

Yes. This is -- this gets pretty complicated. But to put it simply, I think the best way to think about this is, internally, we talk about customer cohorts in state vintages. So from a customer cohort perspective, we have said repeatedly that we are willing to invest in acquiring a customer, such that they're as long as their gross profit on a 2- to 3-year basis pays back on what we spent to acquire them. We are on a customer cohort basis for sure, seeing faster than 2- to 3-year gross profit payback periods. That's on a customer cohort basis. Now on a state vintage basis, what's interesting, and this brings back -- comes back to the comment on -- that I made about the profound implications of faster ramp of a state. And simply put, if we used to think that we'd launch a state, we'd acquire 2% of the population in the first year, 2% in the population in the second year, 2% of the population in the third year. But all of a sudden, you're acquiring 6% in the first year, and those customer cohorts within that first year are now paying back faster, then you end up with this dynamic where the state turns cash flow positive much faster.

Right. On that point, do you think just the opportunity is now bigger? Like so if, New Jersey went 2% per year, do you think Massachusetts going to start at a higher level and then still add and it's just a bigger TAM now than it was? Or it's really just getting to that end point, a little bit quicker?

We don't know. We don't know yet. I would say that we're operating like the TAM that we used to think was there, is probably still the TAM. And it's just an acceleration of the acquisition. But, we'll obviously look at the data and if we think that the ceiling is actually higher, the TAM is actually bigger within a state, then we'll react accordingly.

Right. Okay. I guess, we'll probably hear about that more in 4Q at the Investor Day.

Yes.

Maybe on that and kudos for the team to point together those state vintages because back to back quarters, that's really what's telling the story, where handles growing, but revenue is growing a lot faster than that, in gross margins coming up and all that while sales and marketing is coming down. But, any other insights you can provide just in terms of the power of giving you the confidence that this model is working?

Yes. Well, I feel like this has been the single most misunderstood part of the DraftKing's business model. This -- the -- how the order cohorts and therefore, older state vintages behave over time. And that's why we provided those additional disclosures about the 2018, 2019 vintage and the 2020 and 2021 vintage states because what's happening is pretty much what we had thought was going to happen all along, which is that you acquire a bunch of customers in the first or second year, you retain them pretty well, you're reducing your promotional intensity into those customers because you're investing into that customer in the first year. But you're bringing them off of that promotional intensity in the second and third year. In conjunction, the hold rate is going up. So, what -- the byproduct of all of this is that your GAAP net revenue is screaming coming into that second or third year of a state really importantly, and you published a note on this, the gross margin flow-through of better -- of lower promo and higher hold is very high. It flows through, depending on which one and that 60% to 80% range. And therefore, that's why the gross margin rate improved so dramatically, too, as the state enters the second, third, fourth year of operation. And then finally, I think this -- again, people didn't understand this is that the absolute marketing dollars you're deploying into a state in its fourth, fifth, sixth year is coming down because, again, we operate on an LTV to CAC basis. So as the state matures, you're hitting the ceiling of -- you're done acquiring in that state. You're obviously not going to continue to deploy marketing because there's not many customers left to acquire. So absolute marketing dollars are coming down, too. All of those factors are resulting in the very nice cash flow generation coming off of the older vintage states.

One of the most common questions I get from investors on that slide is how is handle still growing 25% in those older state vintages? Like it's just -- at some point, you would have thought New Jersey would look more like a GDP plus, but still 25% growth is enormous. So what -- is it mix shift? Or what's driving the handle growth in those older states?

Well, it's -- you're retaining players really well. And then, the activity on a per player basis is increasing, which is -- goes back to my comments earlier around they're engaging in different bet types. They're trying out new sports, that NASCAR better is now betting on the PGA, which, for example, or the NFL better is now transitioning into the -- to the NBA. And right now, we're seeing NBA and March Madness players transition into MLB. So all of those factors are resulting in handle growth.

Right. Okay. And then, just going back to the 2D 3-year payback, so you're spending below that. But how do you know you're not under-investing in customer acquisition right now? Like what gives you the confidence that you're spending the right amount?

I think we -- it's a great question. We are looking at that constantly. And I think it depends on which time period you're in, in the state. I think, we feel great about what -- how we deployed marketing dollars even though the acquisition costs were so low. Like could we have spent a little bit more probably. But there's also a natural limit of the inventory in a market in the first 2 or 3 months of a launch as well. So right now, I think theoretically, you could argue that maybe we could be investing a little bit more, but we feel really good about the levels where we are.

Do you think if -- and I know it's a tough question to ask, but if we were 2 years ago, would -- like would that spending have been different? Like, going back to that original point where kind of the company philosophy has changed towards now, embracing profitable growth more? Would you have been leaning into sales and marketing more 2 years ago?

I don't think so. I don't think we would have done anything differently 2 years ago.

Okay. Fair enough. And then maybe just lastly on new state launches, is there any way for us to think about just how much of a drag that is on EBITDA right now, and maybe how much it was last year? And as we think about the launch calendar seems a bit light over the next 18 months, what that means?

Yes. I mean, I think one could take some of the disclosures we've taken, we provided on like Arizona, for instance, and what percentage of the population we acquire in the first 3 months, 6 months, a year of a state launch, you can apply a pretty efficient CAC number to each -- to that population, the number of players we require. And that will get you a rough size of how much we invest into a state open to in the first year.

Okay. Maybe just shifting over to tech and product development. What's been most impactful over the past year for you guys?

Good question. I mean, the power of our increasing hold rate cannot be underestimated. And then, underneath of that, Same Game Parlays have been huge. Same Game Parlays player embedded within that player props, just again, coming back to the thematic of giving customers markets that they want to bet on. And again, all of that was predicated on us being vertically integrated on the sports bet engines side.

Right. Okay. And then, the next 6 to 12 months, what's on the road map? What should we expect this NFL season that we didn't have last year?

There's more. I think we've got more in-housing to do both on the OSB and iGaming side. We want to broaden the offering. And, to the extent that there are parts of the markets that we are still renting, whether that be on the sports betting or the iGaming side, we'll constantly look at the sort of the build-by-rent analysis, and bring some of that in-house too.

And in that equation, is it that the products are getting cheaper to do yourself? Or is that you guys are growing so then all of a sudden, that equation to buy is now more efficient? Like, how do you guys think about that?