DraftKings Inc. (DKNG) Earnings Call Transcript & Summary

Afternoon. So good afternoon, everyone. Thanks so much for being here. I'm Michael Graham, one of our Internet analysts joined by my colleague, Jason Tilchen. And we're super excited to have DraftKings here. We have Jason Park, CFO. We're very grateful, Jason, that you're here. So thank you.

Thank you for having me. It's nice when these are only a 20 minute walk away from your office.

Yes, Exactly. Exactly. That's why we have the conference in Boston actually. It's for you guys, but -- so you just reported phenomenal numbers in Q2. Your stock has been on a tear for this whole year. Maybe just take a second and share with us what you think are the most important takeaways from Q2 results.

No, thank you, and it's been not only a quarter of hard work, but it's been years of hard work across the entire business and 88% revenue growth, first quarter of positive adjusted EBITDA, really, really proud of that. I think a couple of highlights. We talk a lot about acquisition, retention monetization, and we mean it. Acquisition is working really well, super efficient as one of the few scale national operators, you just get a lot more bang for your marketing buck. Retention, it's so important in this business model, year-over-year retention but season -- sports season to sports season retention in Q1, being able to transition those NFL customers into NBA and then from NBA into MLB in Q2 working really well. There's a lot that goes into that product and CRM. Monetization, when we talk about hold rate and we talked about parlay mix, we're seeing 1,000 basis point improvement year-over-year in the percentage of our handle that's on parlays versus when we were all together a year ago. That's working really well. Promotions, we're just rationalizing. We've always said that as a state matures, you don't need to promote nearly as much to that existing customer, and that is happening. The final thing I'd say is it just fixed cost discipline. We have had 18 or 24 months now of just a lot of internal focus on efficiency, both on the compensation and on the vendor side, and that has resulted in us only growing fixed costs in the single-digit range. And we look forward to even more of that in the back half and in the future.

So clicking into one point that you mentioned was growth in the mature states. A lot of the states that you entered in 2018 to 2021 time frame are clicking along quite nicely and becoming more profitable. But maybe just talk about that kind of magic equation that you're seeing in the future states.

And I mean it is the reason why we've inflected into profitability and why that inflection will continue so rapidly over the coming quarters and years is that of our 21 live states, we're at the point where more and more of them have hit that cash generation phase. It's -- our business model is that we invest into a state for a period of time as we're acquiring. We're investing in marketing, we're investing in promotions. But as you -- coming back to you retain and monetize really well, those states generate really, really healthy cash flow. And so we're at a point now where more of our states are generating positive cash flow and the cumulative contribution profit, gross profit minus marketing across our states will be north of $700 million this year.

And a big part of that is that national advertising. And the underpinning theme there is scale. Every once in a while, something in the marketplace happens and my inbox blows up from investors. And one thing recently was that Penn just announced an agreement with ESPN that has some impact on the competitive landscape, but maybe not a huge impact relative to your scale, but I'd love to just hear your high-level thoughts about that.

Yes. I mean, first off, like I said, we feel like the business is humming. Across acquisition, retention, monetization, we feel really, really confident. From a competitive perspective, we've seen multiple waves of competition since this industry started roughly 5 years ago. So we're used to competition. And again, going across all of our differentiators, product being a huge one. We just feel really confident. And then I think importantly, you can always count on DraftKings to be super analytic and rigorous in our evaluation of any opportunity. And if something looks like it's going to create great shareholder value, we'll pursue it. If not, we won't. Maybe finally, we do have an existing relationship with ESPN and Disney. It's a low-single-digit percentage of our total marketing spend. I think this announcement has no impact on our top line and introduces a little bit of positive flexibility on some of that marketing spend, albeit pretty small percentage of the total.

Speaking of marketing spend and profitability, there was a real big focus on that as the market environment changed over the past few years. When you first introduced your guidance for this year back in November, it was for a loss of about $500 million since reduced that several times to $200 million just last week. Can you just talk about out of the different factors that are driving that, whether it be the hold rate improvements, more efficient user acquisition or just general cost discipline, what's been the biggest factor in creating that upside relative to expenses?

It's been a mix. I'd say for sure, if we are bridging the roughly $500 million -- negative $500 million back in November to our most recent negative $200 million. So if you bridge that $300 million, I'd probably say about $100 million was cost discipline and just more religion within the company around treating every dollar like it's your own, scrutinizing every vendor, scrutinizing every additional headcount request. That's probably about 1/3 of it. Strong handle, which falls into that retention just our customer activity is off the chart where just the people, Americans love betting on sports and that's probably 1/3 of it. And then monetization, specifically hold rate has been another 1/3 of the improvement.

That's helpful. And we talked earlier about how these mature states are really coming along. In terms of the newer states, you're also seeing really strong user acquisition, really efficient user acquisition in those states compared to some of the launches, 2018, 2019, et cetera. Talk how your launch playbook has evolved over the years and how that's accelerating your time line to profitability in some of these states.

Yes. We're -- it's definitely a combination of just us continuously refining how we launch a new state. Just a reminder, we have this DFS database, which continues to be a real advantage for us and 1 other operator, just how we mine that database in the weeks and months leading up to a new state launching sports betting, we just get better and better, those results continue to be fantastic as the state launches. Just overall media mix and timing prior to launch. We are super data-driven, and we evaluate all of those dials and we refine it. But no question, in addition, just general American awareness of the category and the population rearing to go when their state finally opens, that's helping as well. And as a result, to your point, for every dollar of marketing spend in that first few months or first NFL season, you're just getting super efficient acquisition.

Absolutely. And last week, you guided to basically about $150 million or more -- $150 million to $175 million of EBITDA in Q4, you've talked a lot about next year.

Positive.

Yes, positive. Importantly, and then positive adjusted EBITDA for the full year in 2024. How should we think about margin expansion both next year and then sort of that trajectory going forward?

Yes. So if we start a few years out and come back in, I think this is definitely a 30% EBITDA margin business, 30% plus. In the interim periods, you're going to continue to see this gross margin rate improvement across the business. We posted roughly 600 basis point year-over-year improvement in gross margin rate in both Q1 and Q2 should continue to see nice, healthy gross margin rate improvement for the reasons I just talked about. Promotions come down, hold goes up, that flows through to gross margin really nicely and fixed cost discipline. So the real only variance on a glide path to the 30% is just the timing of new state launches. And as I said, when a new state launches, we'll invest into it. So that sort of creates some bumpiness along the way. But each state will still get to that target contribution profit rate after a few years.

So let's click into the hold rate, which has surely been improving quite a bit. And clearly, that's just like a lot of great profit like flowing through your income statement. One of the key drivers has been Same Game Parlay technology. You've also done a lot on the merchandising front, but just maybe talk a little bit about -- you've got your hold rate up to 10% last quarter. How important has that been? And how much room do you think there is to go there?

Yes. Well, first off, in terms of how important it's been, it's definitely been a real big driver. But in addition to a couple of the other things, it's not as if hold rate is the only reason that we're growing or improving profitability. It's all the things that we talked about. In terms of hold rate, specifically, you're right, we posted a 10% hold rate in Q2. We did comment that some of that was sport outcome and luck. Milwaukee losing in the first round. I could name a couple of others, but there's always some of that. But -- so we said 9% is our structural hold rate in Q2. That's up meaningfully a few hundred basis points versus last year. And underneath of that is really that. It's parlay mix. And so it's what percentage of your total handle is going to those parlays. And then when they're taking a parlay, when they're making -- when you folks are making a parlay bet getting that average leg count up. So it's not just a 2- or 3-leg parlay but a 4- or 5-leg parlay. That is absolutely -- you absolutely need great technology to do that in combination with a little bit of marketing and consumer excitement to get behind those types of wagers. So look, I think we definitely still have room to improve on the parlay mix. There is information out there that shows that we are making rapid, rapid progress, but I don't think we've hit the ceiling yet.

I imagine the parlay better is more of a novice better, more entertainment value. Is that a fair assessment?

No, I don't think it is. I think that what we're seeing in the data is regardless of how active you are or how experienced you are, this is a fun add-on to their -- when they're checking out. Even if you're a big singles better, you're just betting on the outcome of 1 game, $100, they're putting a $5 parlay in. They're like eh, it's a little bit of a lottery ticket sensation. And so it's not really cannibalizing into their original total bet allowance in their head, it's a nice add-on. And regardless of what type of better you are.

How do you think about longer term the right level for the hold rate relative to like customer experience and engagement?

Yes. Well, I'd say a few things. So first off, when we look at empirically the handle, so how much people are wagering relative to how much the house is holding, we are seeing no downtick in handle because the house is holding higher because we're still in that 6% to 9% range over the last year. So that's great news. So that supports the add-on comment that this is an add-on. The other thing -- a few other things I'd say is it's very player specific. So this is where one of the many areas that we're deploying -- deploying AI and ML today that it's looking at player-specific win rates and promotional reinvestment and it's rightsizing those types of investments on a very, very specific level.

So one of the things that we like about the outlook for you guys is that you're sort of purpose-built with like a super strong foundation with your tech stack, all in-house. So that's enabled you to bring this parlay technology to market and rapidly gain share in that area. Can you share anything with us about like as we get it ready for football season like -- do you have any tricks up your sleeve or any products? Or what do you...

We are super excited. We're jacked about the product enhancements that are coming from for NFL and college football, my product team has sworn me not to unveil all of the enhancements that are coming. But I think what's important is that we do a great job of listening to our customers. And we have a very rigorous ongoing product road map process where a list of enhancements that we can make are generated. We do our best to quantify the EBITDA potential net of R&D resources to build and deploy those things, and we just knock them down. So I think it is important to know that it's just as much about hundreds of little improvements to how things show up in your app, the speed of a micro bet, the speed of the consumer's ability to get money on and off the site, the ability for a parlay better to see how each leg of their parlay is performing, right? These are all they're not blockbuster grand reveal enhancements, but there are hundreds and thousands of just ongoing improvements to the customer experience.

Absolutely. I just want to switch gears a second and talk about legalization. Kentucky, you said to launch at the end of next month. We've got North Carolina, maybe early next year. That will bring us over to 50% of the U.S. population with access to regulated online sports betting. But seemingly, the only questions we get are about California, Texas and Georgia, I'm sure it's the same thing for you guys. So -- what are some of the key issues that need to be resolved before we see those 3 very populous states join the fray here?

I think -- I'm not sure that there's any real issues per se. It's just there's time that has to happen. Texas feels really good. Georgia feels really good. California, it's hard to believe that California won't have it at some point in time. Texas is interestingly, to my point about time, they only convene every other year. So we got awfully close in the 2023 congressional season. They'll reconvene in 2025. Intelligence looks like that, that's pretty good. Georgia feels fairly optimistic. They've made good runs at it for the last 2 or 3 years, and they'll run at it again with our support of the pros to their state of launching mobile sports betting. So broadly optimistic about all of them, timing, hard to predict.

Absolutely. And we just had Ohio recently raise a tax rate 10% to 20%, just 6 months after launching OSB in that state. We've seen a number of other states introduce or pass legislation around advertising restrictions. What are some of the key regulatory issues that the management team is most focused on? And if there's anything that keeps you up at night?

Well, I'm not -- I don't think anything really keeps me up at night on regulatory. Regulatory is a big word. I mean the first thing that comes to mind is responsible gaming. We invest so much. Nobody cares more about responsible gaming than DraftKings. It is so paramount to the health of the overall industry, technology investments, reporting visibility into everything in our product and our consumers on responsible gaming is so important to us. Tax rates, not too concerned there. Ohio was a well-telegraphed change that goes back to even before that they even legalized that, that was coming. The data will show that there is an optimal tax rate for a state to appropriately pool the sports betting that's occurring already from illegal markets onto regulated markets and I think state regulators across the nation understand the balance there. So not too worried on that front. I think those are the big things.

All right. And then obviously, on the legalization front, the last missing piece in most states is online casino. It's been much slower progress there. There's some optimism, maybe Maryland, New York, some of the Midwest states could potentially legalize next year. What do you think are the biggest misconceptions that are preventing some states from legalizing? And is there a sort of a catalyst or a spark that you see sort of opening the floodgates for iGaming?

Yes. Again, similar to sports betting, I don't think there's any particular issue. Again, it's more of time and if you go back to 2019, when we are meeting with potential shareholders we always said that iGaming or iCasino would be a 2- to 3-year follower after online sports betting gets legalized, and we're approaching that time frame now. The states you mentioned are the right ones, Maryland, New York, the Midwest corridor, meaning Illinois, Iowa, Ohio, Indiana, all feel pretty high potential, New Hampshire just a few minutes away. So it definitely feels like there's momentum and it's feels like the natural evolution that they enjoy the tax revenues from online sports betting, and they're going to want the tax revenues from iGaming.

So sticking with iGaming, you have a stated goal of being the #1 market share player in that market. What have you learned so far? Maybe give us an update on how you approach that player relative to a sports betting player? And how do you kind of cross market to them? Like what are your learnings so far? What do you...

Well, there's so much, I think First and foremost, there is absolutely a sports betting first iGaming player and a casino-first iGaming player. So that sports betting-first player who enjoys a few hands of Blackjack during a TV time out versus perhaps a more slot machine heavy, doesn't really care about sports demographic is absolutely validated in underlying our thesis of the acquisition of the Golden Nugget brand, which helps us attack the second segment, which is working. Cross-sell. So once you get a sports better acquired and cross-selling them into iGaming, that's working beautifully well, roughly 50% of our sports betters, if they're in a state with iGaming, we are able to cross-sell them into a little bit of blackjack or a little bit of roulette or craps or whatever they enjoy. I think we're probably best in industry on that. I think in terms of differentiation on the iGaming, like from a product perspective, I think we're quite distanced from the competition. You've heard us talk about building in-house games for years and that could be something as simple as a DraftKings-built Blackjack game, which is great for my gross margin rate because I don't have to pay a third party to rent the Blackjack game. But you've also heard us talk about building completely proprietary games like Rocket. I was on the phone with a large fund this morning, and he said, this Rocket game is unbelievable. It's so fun. And that's a game that we built completely in-house. So that is not only a great gross margin rate driver, but it's a complete differentiator from the consumer experience. Also on the differentiation side, we are really proud of what we've done with jackpots. I think the nature of the iGaming, that second segment is that they may be a little bit more superstitious, Mondays I play on this app and Wednesdays I play on that app, but the jackpot technology, where that really helps consolidate their share of wallet into 1 or 2 apps, and I think that, that's -- yes, I probably shouldn't talk about that too much. But -- it's been a nice -- it was the right thinking, and we've been in market for that in multiple states and it's really good.

Let me slip in one more before Jason. Just on the -- back on the OSB side on the product front, and you just talk about live betting for a moment. Live betting is so much more popular in Europe than in the U.S. So maybe just talk about like how that's progressing and how important that is?

I think in the short term, we'll continue to do what we're doing. So we've already got a great suite of live betting. I think that's a big part of why our Q2 was good as well, where our MLB, we were very pleasantly surprised with Major League Baseball and pitch-by-pitch, is something that our customers were asking for, and we gave it to them and that was live, that's live. When you benchmark the U.S. consumer's live betting versus some other markets around the world, it's clear that we still have some room to go. And I think that will be a combination of building the products and consumers looking for new and innovative things that they can wager on. So we look to lead the way there, too.

Speaking of innovative ways to engage, sport writers talk a lot about player tracking and investments that they're making on the data collection side to enable sort of new player props. Where do you see the opportunity around in certain sports or just in terms of going beyond the typical traditional statistics and going into some more advanced analytics.

I think it's one of the most exciting things about this industry that there are so many things that people can wager on in sports and we're still -- we're right here in 2023, talking about the migration from single bets, money lines, over unders into parlays, into 4-leg parlays, into live betting, there's a runway of innovation that's going to come that is enabled by data collection, but also only limited by the creativity and interest of sports fans on things that they can and want to wager on.

Absolutely. And we're running low on time, but maybe sort of just to wrap things up, what are some of the most important factors that you think could swing your second half results to the upside as we look towards Q3, Q4?

I mean we provided revenue and EBITDA guidance last Friday. We obviously feel really great about that. Big swings, continued overperformance and retention I don't think you embed this, but sport outcomes always play a role, and you sort of as sophisticated investors can see through that on any given quarter. And then outside of that, just we are continuously looking for more efficiencies on the corporate cost side. And to the extent we find a whole bunch of I don't even want to say nickels and dimes, like pennies because we've found all the dollars and quarters at this point, but we are continuing to drag the rate and look for more.

All right. I think we're going to leave it there. That was great. Thanks so much, Jason.

Happy to.