DraftKings Inc. (DKNG) Earnings Call Transcript

All right. So we're going to get started. Robert Fishman. We're very excited to welcome Jason Robins, CEO and Founder of DraftKing. So welcome. Thank you for being here.

Let's kick off actually going back to the fourth quarter, if you want to relive those days.

No, but thank you.

So in your letter to shareholders there, I actually thought you laid out a really interesting...

For the fourth quarter call. All right. That one I do want to go back.

Okay, good. So you laid out your vision of 3 types of growth companies that we're going to see now that the days of free money are essentially behind us. First was the companies that are undercapitalized with need to take drastic actions to survive. Second, companies well capitalized but have difficulty pulling back on spending without hurting their ability to compete, and we're seeing that play out in the media world today. And then third, companies that need to accelerate their path to profitability by strategically cutting back on expenses while still investing behind the long-term competitive advantages. So all that being said, can you just walk us through why you believe DraftKings is that third -- in the third bucket and position to thrive? And really what has changed running this company in this higher rate world that we're all living in today?

Well, first, I'm sure everybody thinks their company is great. So always being aware of my own biases, I really tried to think about that hard. And be objective about it. I think it starts with the people. We have such great talent. One of the things I think we don't talk about a lot but has been a core piece of our success is over the years, we've managed to keep and develop our very best people. I can't think of many really great people that we let go and meaning that we not let go but that we allowed to walk out the door. So if you look at our management team, it's a mix, we have some new people we brought in, our CFO, IR team, all joined in the last 4 years or so. But a lot of the core people, including both of my founders have been around for 8, 10-plus years. And there's a few things that I think come from that. One, they're obviously keeping your best people. That's how you accumulate great talent but there's also a continuity in how we've been able to manage a business. And the core theme of that is really just being very database, very objective about everything. And this comes back to my first job out of college was at Capital One. And the CEO there, I was an intern, he spoke to us and talked about how they created IBS, which I thought was my stomach condition, but call it information-based system, which is just a way of saying like use data to make every single decision and just accumulate data. And so carried over from me everywhere I've gone since, and it's really been foundational to how we built DraftKings. So when it came to, all right, we got to start cutting costs. It wasn't -- and the same way, by the way, we deploy spend too, deploy capital too, is we're extremely databased, extremely objective about it. And so I knew that when I -- because I hadn't really until last year or so, said, hey, this is as important an objective anything else we're doing in the business is defined cost optimization to be very focused on growth and competing. And we do that too now, still very focused on that. This [indiscernible] but I knew as soon as I turn the team on that, that because of the way we had approached everything they were going to be super methodical, and they were going to make sure that we're making good decisions along the way. And the core thing we stressed is this cannot be at the expense of revenue growth. It cannot be the expense of the customer. This has to be smart cost cutting. And I think we've done a great job of that in proving that we're able to both, grow revenue at a rapid clip and reduce cost at the same time, which something I don't think anyone thought we could do. I think everybody thought when we pulled back on a lot of our costs that the revenue growth would suffer, but we've been able to do the opposite. And I really emphasize that point to the team, too, that it's actually not in spite of, it's because of when you get more efficient, when you start focusing on making the most out of every dollar, it actually leads to better decisions and better outcomes. And I think the team has really bought in that the revenue growth and why we're doing so well on the competitive side is actually a big driver of that has been the discipline and the cost focus that we've been able to put forth.

That's great. So maybe just following up, as the market has shifted away from purely growth in TAM story, to focusing on that long term or the even shorter-term path to profitability, I'm wondering how do you balance that, right, in terms of focusing on that long-term growth and given all the upside of what's to come with this specific market and then pulling back to reach profitability faster?

Yes. I think that we start with that notion that this is all for the same reason, which is to build a better business and revenue growth can be not only achieved in spite of, but actually can be helped by figuring out how do you make sure that the entire company is focused on deploying capital and maximizing every dollar we get out of expense, maximizing the productivity of our employees, maximizing the speed and quality of which we can make decisions. A lot of the focus for us, we didn't take cost. We said efficiency. Now cost is obviously part of that, and cost cutting was part of that, but it was all about getting more efficient, getting better. Being able to do the same thing or more, more quickly. How do you deploy product faster with less requirement to use bodies and other sorts of things by automating testing and things like that? How do you -- even down to things like scripts that were being run like, how can you automate, just like little things that all collectively added up. So I think there was a huge benefit there. And we also made very clear -- like we still have capital. Yes, obviously, we know this is important. But this isn't -- and this comes back to the first question you said like, this isn't a situation where the company is in dire straits, and we have -- running out of money. And if we don't start cutting costs that maybe we don't even want to, but we have to, then we're not going to survive. It wasn't that. This is a proactive move to say, how do we position ourselves to be the most healthy, efficient, best run, best-operated company, we possibly can be long term? And what that allowed us to do was to say, " Okay, if there's something you shouldn't cut, don't cut it." Like yes, you may have debates about it, and there might be a case, and we'll get to -- but that's how we get to the right answer. Make smart decisions and make sure that just as much as you're pushing on that, if you see somebody doing -- talking about something we shouldn't cut that's going to damage customer experience in a way that we don't -- something like that, then don't do it. And I think that really framed it well for people where they said, okay, there's a lot of optimization here, a lot of spend that we know just because we haven't focused on it as much that we don't really need. There's a lot of ways we can become more efficient. Again, not because we intentionally put in efficiency in place just because we didn't focus as much on, how do you make decisions faster without sacrificing quality? How do you speed up processes that take 2 weeks and make them take 2 days? Things like that. And so really, the focus was on things that were going to better the long term of the company and should enable revenue growth. And I think when we started looking at that way, we realized it's not a trade-off. There's a lot of things that we -- and there's lots of costs we're not going to touch. But there are things that we know, and we knew intuitively and now we definitively know going in, we're just no-brainer, no regret cuts.

Okay. Great. So we've talked a little bit on the cost side already. But maybe just kind of zooming out, you've been very forthcoming in terms of where you see the TAM going, right, in terms of the top line and the upside opportunities and how quickly this market is growing. I'm curious, as you sit here today, I know you haven't officially updated any longer-term targets. But where do you see upside opportunities on this long-term TAM story?

Well, we are going to talk about it more later this year. So I don't want to steal any thunder from that, but maybe a little bit more high level. I think, one, the U.S. market, it is the leader in virtually any category I can think of on entertainment spend per capita. Most of our early benchmarking was done on other markets. I think that funny enough I got the question like people in the U.K. are rabid betters, like maybe the U.S. will be less like, I don't know, you're not talking to my friends then because they like to bet. And casino spend other forms of spend are very high relative to population in the U.S. So we felt like there was some upside there. I think -- still feel like there's some upside there that the U.S. just on a per capita basis could have deeper penetration, could have larger spend per user, those sorts of metrics. I think also on the share side, we feel like we have some upside. There's been a more rapid consolidation than I was expecting within the market. And we predicted for sports betting 25% to 30% share long term. I think there's potentially some upside there. And then the other thing that I would say is and this is something that time will tell to play out, but right now, we're still operating on a TAM based on certain legalization rates. Sports betting has certainly been faster. I think you could see some upside there. iGaming has been a little slower, but I still continue to believe that there is at least what we feel long term will reach and potentially upside there as well. And so that one could swing either way. But I think depending on how you look at it, I'll talk to some people and like, yes, in this going to be everywhere. And I think the answer is probably yes. It's just a matter of when, not if. So it sort of depends on your timeframe, how you're looking at upside to TAM there.

Okay, cool. So you've also provided long-term guidance on the adjusted EBITDA margin side of over 30%. So as we think about where expenses are today and how you get there, maybe you just want to expand upon what are the biggest opportunities to pulling or normalizing on the expense side or getting the operating leverage there?

Yes. I think there's a few things I cover. So sort of working down the P&L. One is the promotion rate. So what I think has surprised a lot of people about that is that reductions in promotion rate flow at a very high percentage through to the bottom line because our largest piece of COGS, taxes are typically not -- I mean, sometimes some states give us an allowance for it, but a lot of states do it with promos excluded just on the gross revenue. And then there's other components to the COGS and of course, other parts of the P&L that are really not dependent on the number of motions that we run. So that flows through at a very high level to the bottom line. I think also on the COGS side, as we optimize more and more around things like promotion rate, we're also looking at how do we make sure our payment processing rates are fees that we're paying for data, like all of those things, we get scale and leverage on. Most of our deals have volume thresholds. We went through a whole series, renegotiated a lot of that stuff, and now we have processes in place to continually optimize where we're sending payment processor traffic and things like that, that are really, I think, going to help with our margin rates. And the promotion point, like a lot of that is time. When you do -- when you start a new market, there's a lot of new customer promotions out there. The rate of promotion to new customers as a percentage of gross revenue is far higher than for existing customers. So there's sort of a natural tailwind as the market matures, even beyond the optimization we're doing and that improves the margins of the business long term. And then going more to the fixed cost side of the P&L. We've talked about -- we expect our marketing to be relatively flat year-over-year. I think over the long term, we'll see. But as a percentage of revenue, there might be some upside, meaning it might not have to be as significant as a percentage of revenue as we had previously stated. And then same thing on the fixed cost side, we've really slow growth there. We've said that we're going to grow fixed costs in the single digits. And some of that is incremental R&D type investment, but most of the functions of the business are at scale now. There are some things when we launch new states like customer service reps just with more customers, you need more of that, although we're also over time optimizing there to make sure that we can service with less people per customer and more automation. We've started to use AI and chat box and things. So even that might not be totally -- but I think there are some things, at least in the short term like that, that need to grow a little bit with new customers in new states, but most of our fixed costs are not that way. Most of our fixed costs are things like product and engineering. And that's just a discretionary choice of what we feel like investing. And we do think that those functions are largely at scale and that incremental investment is about new things we need to be doing, not about operating the existing business.

Okay. Great. So talking a little bit more about the top line growth story. We have seen a rapid legalization on the online sports betting, as you've mentioned over the past couple of years. Can you help us think about as that normalizes and obviously, dependence on some big states that's still to come, but how should we think about organic revenue growth over the next couple of years without any change of legalization trends?

We've had really strong organic revenue growth. We talked about in our most recent earnings call. So I've been asked that question a lot and I have to remind people like we're still early days in this market. The oldest state that has had online sports betting, New Jersey launched online sports betting just a little over 4.5 years ago. So we're still super early stage. Many states, including the one we're in now, just completed its first year. So there is still really strong growth in existing states. We talked about on the last earnings call that our 2018, 2019 state vintage, which is our first 2 years. I think New Jersey was the only '18 state, so that's why we grouped it together. But that vintage grew over 80% on a revenue basis year-over-year in Q1. So when you're seeing that kind of growth out of your existing markets, obviously, over time, it will come down, but we expect many years of robust growth even without new state launches. And obviously, new state launches will contribute even further to that. Some of the sources behind that. Obviously, there's organic demand growing, but also, we're taking market share, we're increasing our hold rate. So that's a big one. We're year-over-year. We talked about a 200-and-something basis point increase in hold rate, which means for every dollar bet, we're making 200 basis points more. And obviously, over time, there's some probably ceiling there, but we've seen both, domestically with our chief competitor, FanDuel, and then overseas, that higher hold rates can be managed without jeopardizing demand. And so far, we've seen no decline in demand as we've increased hold rates. So I mean the important thing is we're not increasing it by making the odds any worse for customers. It's just by pushing more parlay in mix and things like that.

I want to follow up on the parlay. So can you talk about how DraftKings is using parlays to increase that user engagement? And how is it driving the higher handle and hold? And then maybe if you want to throw out, how much share of your total handle is coming from parlays or where you see that going?

So parlays have been, I think, a great example, and there's others that we're looking at on the product side, but obviously, the focal point externally has been on parlays for good reason. It's a great example of a win-win for the customer in the business. Customers love it. It creates a value proposition for them where they can win multiples on their money. They can make a small investment and potentially have a big pay day. And that provides a lot of enjoyment. We saw this back to the days of daily fantasy sports where we still do now when we're running our contest, for example, every NFL week, we have $1 million top price, usually $3 million to $5 million total prize pool contest, like $20 to enter. We have another one that's $3 to enter. You can win $100,000 and usually $1 million-plus price pool. And then we have other games where you play against one person. And we always took a higher percentage of the pot in the big -- the sort of like win multiples on my money type games. And what we saw was despite that being a higher-margin product, that was the most popular product. And more and more traffic kept going in, more when people kept doing it. And the reason why it was that core value prop of I want to be able to -- today, it could be the day that I put in $20, which from some people [indiscernible] VR games there, too, but for a lot of people, that's not a big investment. That could end up with $1 million in my account at the end of today. And so you're not thinking about what percentage am I paying, you're thinking about that. And I think parlays function the same way. We have people that will make [ 8, 9 ] leg parlay bets with 10,000 to 1 payouts and put $5 on it. So they're not thinking about like, hey, on average, is my $5 turning into $450 or $4, they're thinking about, wow, that $5 could turn into $50,000 or something like that. And I think that is both, a win for the customer because it's giving them more enjoyment, more of a value prop that they're seeking and for the company. And economically, it's not worse for the customers. It's basically like they're making multiple bets at once. So it sounds like we're making the odds worse or anything like that. Same odds they could get if they bet one thing, one and then roll their money back into the second thing, literally, the same odds. It's just allowing it to happen at the same time, which gives them both, the opportunity for a big payday and gives us a higher margin.

How much, just a quick follow-up, the social media play into that? Like is that something an opportunity for you guys to lean even more heavily into?

For sure. I mean we've, in the last couple of years, invested in our own social features. We've also integrated more with social platforms. The more that this becomes mainstream, the more this will matter, but it's always been a social thing. I think maybe 5, 10 years ago, it was a little more taboo, people didn't talk about it. Now everybody talks it. It's a social activity. When you're betting, you're telling your friends about it, usually more when you win than lose but sometimes upfront. And people like to share those things. Sometimes a friend will take the other side of it. But that all stimulates action. It gets -- I mean I can think of a million times, right, a friend who told me, hey, I like this bet, and I'm like, I going to check it out. Or told me I'm betting this, so like I didn't remember that was on. But yes, now I remember, I'm going to do it. So you get those anecdotal examples with just very real data and real-world evidence, and it's pretty clear to me that there's something there. So we continue to invest in both, our own social features on our platform as well as deepening our integrations with the social media platforms out there.

So another product that is clearly of interest to you and the broader betting space is the opportunity for live in-game betting in the U.S. specifically. So just curious, how is DraftKings positioned today? And how are you going to essentially be leading the charge on this? From what we've seen around the world, it's a big opportunity here.

Yes. We -- I think we actually are differentiated more in-game betting maybe than any other part of our betting suite. So we're the only company that offers a full suite of micro bets across all the major sports. Micro bets being like what's the next pitch going to be in baseball or who's going to score the next basket in NBA. The other thing I would say is we -- now there's a few others that have it, but we were the first to launch live same game parlay for NBA. Same thing, I believe, for baseball as well as college sports. And then the other thing is there is a recent study that showed that we had by far the best uptime in the industry for live markets which is a very important component of one, obviously, people can't bet if it's not live up, but also very frustrating experience for the customer when you try to make a live bet and the thing keeps spinning. And then it says, sorry, you didn't get it in time, you're like, wait a minute, you just spun for 20 seconds, did I not get it in on time or do you not process it on time? So we're trying to -- I mean obviously, there's some level you have to risk manage too. You can't just leave everything open. But we very early when we were migrating onto our own proprietary in-house technology set a core piece. So we have like 4 pillars, and one of them was live market uptime. And so that's been something we're really focused on. And I think we're -- according to independent study, I saw recently best in the industry on that front.

Great. You touched on iGaming legalization earlier in terms of potential upside or maybe that it's even gone a little bit slower. I'm curious if you can share a little bit more about the economics where you are live in iGaming and OSB. How different of a economic profile are those states versus the others?

Well, the TAM is just bigger. It's a simple way to put it. And the answer, why is, one, you're monetizing your current customer base by selling -- cross-selling them to a second product. And then also, there's a new base of customers that just aren't into sports betting and maybe are more into slots or whatever else that you can access. So bigger TAM means more opportunity to acquire a larger customer base and to monetize that customer base greater. And those 2 things go hand in hand because, of course, with the greater monetization of the customer base, you can get the same or better paybacks at a higher CAC. So that also allows you to expand your addressable market and to grab share more. So I think that's definitely the simplest way of putting it. The other thing, I think, is if you look at it, from a unit economic standpoint, because so much of the iGaming revenue for us comes from cross-sell, and we don't have to reacquire that customer. It also significantly increases the LTV to CAC ratio. And we do have higher CAC thresholds in states that have casino, but still if you look at the LTV to CAC, it's orders -- it multiple times higher in casino states. So those are the big differences, I think.

So maybe if you want to just expand upon that in terms of the new state launches just launched in your hometown and Ohio, my hometown. So I'm just wondering if you compare those new launches towards how those compare versus some of the launches over the past couple of years? And how quickly things are changing on that front?

Well, both Ohio and Massachusetts and Maryland, which we launched in December as well, really, I think, were emblematic of a continuing trend that we've seen that every time we launch a new state, I think, isn't going to get more extreme and just seems to get more extreme with every subsequent state launch, which is the speed with which these new states are ramping up. And the nice consequence of that is the path to profitability is much faster in these states. So to put in perspective, Ohio, which we launched Jan 1, in the first 2 months, and I included February, which is a short month, we had 6% of the Ohio population -- adult population that we had acquired compare that to New Jersey, where it took us years to get to half of that. And I think that those are 2 points of time first date, one of the more recent states. But if you look at like Arizona, a couple of -- Kansas, that trend has been continuing. And each time we see it, we say, wow, like is this the new normal? And then we're like even more next time. So I don't know where that ends, but we've certainly seen that. I think some of the reasons behind it. One is just overall awareness familiarity with the market. But I do think the biggest driver of it is national advertising. By the time we launched Ohio and Massachusetts, we had people that have been seeing ads for the entire NFL season, part of the NBA season, those people in New Jersey or in other early states weren't, because we were doing all local advertising. So you might go to New Jersey, and it would seem like it's like the Super Bowl, everything is going on is sports betting. But then you go a couple of states over and nothing. And now it's -- I think we're creating more national awareness, more pent-up demand. So these new state launches seem to be ramping up faster.

Awesome. Maybe if we can talk about the tech [ side ], right? I mean, something that you've talked a lot about over the years. What areas on your platform do you think has the most room to still improve? You've clearly spent a lot of time focusing on this and getting it to the place where it is today. Where do we go from here?

From like tech side or more like the consumer side or the product side?

On the behind the scenes side.

Behind the scenes side. Well, that's a great -- I don't think I've ever been asked that question, but it's a great question. So one, I think for us, cost, a lot of our cost comes from the people and the products that we create. And there are costs we never talk about, but they really are material as you grow, things like our Amazon web service costs, our GeoComply costs, just things that are technology related. A big part of our cost focus over the last year has been to look at how we can get more efficient in the way that our products operate from a technology perspective. How do we get the same customer, the same experience, but have less pings to GeoComply or less bandwidth required from Amazon Web Services. And that efficiency is a big area that I think we don't talk about a lot, but a big focus of our team. And as we scale, it gets more and more so because that all, of course, is its COGS, it's related to scale. So that's a big one. I think that some of the other things I would note are the big enabler for a lot of the consumer-facing feature is a little bit of a cheap because it's going to get to a consumer-facing feature, but the back-end stuff is what enables it, are the data warehouses and the models that we're able to build. So sure, everybody has game outcome that's easy. But to be able to have a data set that includes all bets that could have been made against how many points a fourth off the bench player from the NBA was going to get in a regular season game and then to be able to build models and test models in a quick fashion on that is really a huge part of what we're investing in on the back end. And that just enables more rapid deployment of consumer features because you can offer more bet types if you have more robust models. It enables better uptime because you're more confident in your numbers, enables larger limits because you're more confident it's the same thing, you can take bigger bets. It also enables us to hold more, hold higher rate. So a lot of good stuff comes from that, and that's been a big investment or as we call it, sports data warehouse has been a big initiative for us over the last year or so.

Awesome. Maybe the follow-up would be the Golden Nugget integration. And maybe if you just want to talk about what improvements you expect to happen once that kind of comes all together.

So there's a few things I'd point to. I'll start with the cost side. Golden Nugget like most in the industry, they don't use a lot of their own in-house. They don't use any of their in-house technology or they haven't historically. Before we acquired them, they were on third-party software for virtually everything. So migrating a lot of that onto our platform, migrating a lot of the games onto our in-house games, those sorts of things are going to yield significant cost savings. And again, it's another one that scales with the business because most of those deals, if not all of them, have some revenue share component to it. That's just how the industry is built. So being able to say, okay, instead of paying x percent for every single platform paying, we're basically paying nothing, just the cost of the engineering to keep it up, which over time, becomes de minimis as a percentage of revenue. Really big deals. Same thing on the content. DraftKings has a ton of in-house games we developed. We were able to push players to them because a lot of times they're better and other times, if it's something like Blackjack, where it's basically the same game, no reason to use a third party. Those things, I think, also are going to drive better at unit economics. And then moving on to the revenue side. We've looked at this across the board, because it's easy to compare side-by-side in a lot of these things. So we know, for example, how well does the Golden Nugget platform convert a new customer relative to DraftKings. We know for a Golden Nugget customer who's trying to deposit, what percentage of those deposits get through successfully and what's the average deposit amount that we can accept versus a DraftKings customer. So on and so forth. Same thing when it comes to monetization on the product. We know when we acquire a player versus when Golden Nugget acquired a player onto the online casino product. What is that players frequency, what is that players spend per day, those sorts of things. And there's a lot, not just sort of technology product, CRM, other things that go behind that, but it's all linked because right now, before we migrate, everything is sort of on that legacy system for Golden Nugget, including CRM and all that stuff, because it was easier to operate it all that way versus trying to transition and then transition again to a new platform once we did it. So you're going to see, I think, as we -- it will be state by state, so it won't be all at once. As we migrate just the step function up on a lot of those top line drivers and top line metrics. I really think it would just be as simple as just plugging in a better engine as well as the cost savings. The cost savings, some of them will take a little time, because there's contracts that have to roll off. So I don't want people to think the day that we migrate, all of a sudden, those costs go away. There are some legacy contracts. But again, that will be the gift that keeps on giving as time goes on, because it's just every time one of those contracts expire, it's just margin straight to our bottom line.

Awesome. You alluded to this in some of your opening comments, but I'm wondering how would you characterize the changes we've seen in competitive pressures today? Clearly, a lot has happened over the past year? And then maybe how much time do you actually spend focusing on what your competitors are even doing?