DraftKings Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis should be read in conjunction with our financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q (this “Report”) and the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as filed with the SEC on February 17, 2023 (the "2022 Annual Report"). On May 5, 2022 (the “GNOG Closing Date”), DraftKings Inc. consummated its acquisition of Golden Nugget Online Gaming, Inc. (together with its subsidiaries unless the context requires otherwise, “GNOG”), pursuant to a definitive agreement and plan of merger, dated August 9, 2021 (the “GNOG Merger Agreement”), in an all-stock transaction (the “GNOG Transaction”). DraftKings’ consolidated financial statements exclude GNOG’s operations prior to the GNOG Closing Date, unless indicated otherwise. In connection with the GNOG Transaction, DraftKings Inc. became the going-forward public company and the direct parent company of both DraftKings Holdings Inc. (formerly DraftKings Inc.), a Nevada corporation (“Old DraftKings”), and GNOG, and DraftKings Inc. is the registrant filing this Report as the successor registrant for Old DraftKings. Unless otherwise indicated, the terms “DraftKings,” the “Company,” “we,” “us,” or “our” refer to DraftKings Inc. (or, in respect of periods prior to the GNOG Closing Date, Old DraftKings), together with its consolidated subsidiaries. Cautionary Statement Regarding Forward-Looking Statements This Report contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 that reflect future plans, estimates, beliefs and expected performance. The forward-looking statements depend upon events, risks and uncertainties that may be outside of our control. The words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intends,” “may,” “might,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” “will,” “would” and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking. You are cautioned that our business and operations are subject to a variety of risks and uncertainties, many of which are beyond our control, and, consequently, our actual results may differ materially from those projected. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled “Risk Factors” included elsewhere in this Report. Any statements contained herein that are not statements of historical fact may be forward-looking statements. • factors relating to our business, operations and financial performance, including: • our ability to effectively compete in the global entertainment and gaming industries; • our ability to successfully acquire and integrate new operations; • our ability to obtain and maintain licenses with gaming authorities; • our inability to recognize deferred tax assets and tax loss carryforwards; • market and global conditions and economic factors beyond our control, including the potential adverse effects of the global coronavirus (“COVID-19”) pandemic (or the emergence of additional variants or strains thereof), as well as the potential impact of general economic conditions, including inflation, rising interest rates and instability in the banking system, on our liquidity, operations and personnel; • significant competition and competitive pressures from other companies worldwide in the industries in which we operate; • our ability to raise financing in the future; • our success in retaining or recruiting officers, key employees or directors; and • litigation and the ability to adequately protect our intellectual property rights. These risks and other factors include those set forth under the caption “Risk Factors” in our 2022 Annual Report. Due to the uncertain nature of these factors, management cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. 24 Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any of these statements to reflect events or circumstances occurring after the date of this Report, except as required by applicable law. New factors may emerge, and it is not possible to predict all factors that may affect our business and prospects. Our Business We are a digital sports entertainment and gaming company that provides users with online sports betting (“Sportsbook”), online casino (“iGaming”) and daily fantasy sports (“DFS”) product offerings, as well as DraftKings Marketplace ("Marketplace"), retail sportsbook, media and other consumer product offerings. We are also involved in the design and development of sports betting and casino gaming software for online and retail sportsbooks and iGaming operators. Our mission is to make life more exciting by responsibly creating the world’s favorite real-money games and betting experiences. We accomplish this by creating an environment where our users can find enjoyment and fulfillment through Sportsbook, iGaming and DFS, as well as media and other online consumer product offerings. We are also highly focused on our responsibility as a steward of this new era in real-money gaming. Our ethics guide our decision making, with respect to both the tradition and integrity of sports and our investments in regulatory compliance and consumer protection. We continue to make deliberate and substantial investments in support of our mission and long-term growth. For example, we have invested in our product offerings and technology in order to continuously launch new product innovations; improve marketing, merchandising, and operational efficiency through data science; and deliver a great user experience. We also make significant investments in sales and marketing and incentives to grow and retain our paid user base, including personalized cross-product offers and promotions, and promote brand awareness to attract the “skin-in-the-game” sports fan. Together, these investments have enabled us to create a leading product built on scalable technology, while attracting a user base that has resulted in the rapid growth of our business. Our priorities are to (a) continue to invest in our product offerings, (b) launch our product offerings in new jurisdictions, (c) create replicable and predictable state-level unit economics in sports betting and iGaming and (d) expand our other online consumer product offerings. When we launch our Sportsbook and iGaming product offerings in a new jurisdiction, we invest heavily in user acquisition, retention and cross-selling until the new jurisdiction provides a critical mass of users engaged across our product offerings. Our current technology is highly scalable with relatively minimal incremental spend required to launch our product offerings in new jurisdictions. We will continue to manage our fixed-cost base in conjunction with our market entry plans and focus our variable spend on marketing, user experience and support and regulatory compliance to become the product of choice for users and to maintain favorable relationships with regulators. We also expect to improve our profitability over time as our revenue and gross profit expand as states mature, and our variable marketing expenses and fixed costs stabilize or grow at a slower rate. Our path to profitability is based on the acceleration of positive contribution profit growth driven by increased revenue and gross profit generation from ongoing efficient customer acquisition enabled by the transition from local to regional to national advertising, strong customer retention, improved monetization from increased frequency of customer play and higher hold percentage, as well as scale benefits from investments in our product offerings and technology and general and administrative functions. On a consolidated Adjusted EBITDA basis, we expect to achieve profitability when total contribution profit exceeds the fixed costs of our business, which depends, in part, on the percentage of the U.S. adult population that has access to our product offerings and the other factors summarized in the section entitled “Cautionary Statement Regarding Forward-Looking Statements”. Financial Highlights and Trends The following table sets forth a summary of our financial results for the periods indicated: Three months ended March 31, (amounts in thousands) 2023 2022 Revenue $ 769,652 $ 417,205 Net Loss (397,148) (467,693) Adjusted EBITDA (1) (221,611) (289,509) 25 (1) Adjusted EBITDA is a non-GAAP financial measure. See “Non-GAAP Information” below for additional information about this measure and a reconciliation of this measure to the most directly comparable financial measure calculated in accordance with U.S. GAAP. Revenue increased by $352.4 million in the three months ended March 31, 2023 compared to the three months ended March 31, 2022 primarily due to the strong performance of our Sportsbook and iGaming product offerings as a result of robust customer acquisition and retention, the successful launches of those product offerings in additional jurisdictions and reduced promotional intensity. Key Performance Indicators Monthly Unique Payers (“MUPs”) . We define MUPs as the number of unique paid users per month who had one or more real-money, paid engagements across one or more of our Sportsbook, iGaming, DFS, or Marketplace product offerings via our technology. For reported periods longer than one month, we average the MUPs for the months in the reported period. Although the number of unique paid users includes those users that have participated in a real-money, paid engagement using only promotional incentives (which has not been a material number of users to date), which are fungible with other funds deposited into their wallets on our technology, it does not include users who have made a deposit but have not yet had a real-money, paid engagement. MUPs is a key indicator of the scale of our online gaming user base and awareness of our brand. We believe that year-over-year growth in MUPs is also generally indicative of the long-term revenue growth potential of our online gaming product offerings, although MUPs in individual periods may be less indicative of our longer-term expectations. We expect the number of MUPs to grow as we attract, retain and re-engage users in new and existing jurisdictions and expand our product offerings to appeal to a wider audience. The chart below presents our average MUPs for the three months ended March 31, 2022 and 2023: 26 Average Revenue per MUP (“ARPMUP”). We define and calculate ARPMUP as the average monthly revenue, excluding revenue from gaming software services, for a reporting period, divided by the average number of MUPs for the same period. ARPMUP is a key indicator of our ability to drive usage and monetization of our product offerings. The chart below presents our ARPMUP for the three months ended March 31, 2022 and 2023: The increase in MUPs for the three months ended March 31, 2023, compared to the same period in 2022, primarily reflects strong unique payer retention and acquisition across our Sportsbook and iGaming products as well as the expansion of our Sportsbook and iGaming products into new states, partially offset by a decline in DFS MUPs. ARPMUP increased in the three months ended March 31, 2023, compared to the same period in 2022, primarily due to structural improvement in our Sportsbook hold rates and reduced promotional intensity. Non-GAAP Information This Report includes Adjusted EBITDA, which is a non-GAAP financial measure that we use to supplement our results presented in accordance with U.S. GAAP. We believe Adjusted EBITDA is useful in evaluating our operating performance, similar to measures reported by our publicly-listed U.S. competitors, and regularly used by security analysts, institutional investors and other interested parties in analyzing operating performance and prospects. Adjusted EBITDA is not intended to be a substitute for any U.S. GAAP financial measure. As calculated, it may not be comparable to other similarly titled measures of performance of other companies in other industries or within the same industry. We define and calculate Adjusted EBITDA as net loss before the impact of interest income or expense (net), income tax provision or benefit, and depreciation and amortization, and further adjusted for the following items: stock-based compensation; transaction-related costs; litigation, settlement and related costs; advocacy and other related legal expenses; gain or loss on remeasurement of warrant liabilities; and other non-recurring and non-operating costs or income, as described in the reconciliation below. We include non-GAAP financial measures because they are used by management to evaluate our core operating performance and trends and to make decisions regarding the allocation of capital and new investments. Adjusted EBITDA excludes certain expenses that are required in accordance with U.S. GAAP because they are non-recurring items (for example, in the case of transaction-related costs and advocacy and other related legal expenses), non-cash expenditures (for example, in the case of depreciation and amortization, remeasurement of warrant liabilities and stock-based compensation), or non-operating items which are not related to our underlying business performance (for example, in the case of interest income and expense and litigation, settlement and related costs). 27 Adjusted EBITDA The table below presents our Adjusted EBITDA reconciled to our net loss, which is the most directly comparable financial measure calculated in accordance with U.S. GAAP, for the periods indicated: Three months ended March 31, (amounts in thousands) 2023 2022 Net loss $ (397,148) $ (467,693) Adjusted for: Depreciation and amortization (1) 48,213 32,225 Interest income, net (11,140) (148) Income tax provision 1,368 469 Stock-based compensation (2) 117,400 187,077 Transaction-related costs (3) — 3,774 Litigation, settlement, and related costs (4) 2,563 1,950 Advocacy and other related legal expenses (5) — — Loss (gain) on remeasurement of warrant liabilities 17,035 (12,681) Other non-recurring costs and non-operating (income) costs (6) 98 (34,482) Adjusted EBITDA $ (221,611) $ (289,509) (1) The amounts include the amortization of acquired intangible assets of $29.8 million and $19.2 million for the three months ended March 31, 2023 and 2022, respectively. (2) Reflects stock-based compensation expenses resulting from the issuance of awards under incentive plans. (3) Includes capital markets advisory, consulting, accounting and legal expenses related to evaluation, negotiation and integration costs incurred in connection with pending or completed transactions and offerings, including costs relating to the GNOG Transaction in 2022. (4) Primarily includes external legal costs related to litigation and litigation settlement costs deemed unrelated to our core business operations. (5) Reflects non-recurring and non-ordinary course costs relating to advocacy efforts and other legal expenses in jurisdictions where we do not operate certain product offerings and are actively seeking licensure, or similar approval, for those product offerings. For the three months ended March 31, 2023 and 2022, we did not incur any such costs. This adjustment excludes (i) costs relating to advocacy efforts and other legal expenses in jurisdictions where we do not operate that are incurred in the ordinary course of business and (ii) costs relating to advocacy efforts and other legal expenses incurred in jurisdictions where related legislation has been passed and we currently operate. (6) Primarily includes the change in fair value of certain financial assets, as well as our equity method share of the investee’s losses and other costs relating to non-recurring and non-operating items. Due to the timing of the consummation of the GNOG Transaction, the above periods, to the extent applicable, exclude GNOG’s operations prior to the GNOG Closing Date of May 5, 2022. 28 Results of Operations Three Months Ended March 31, 2023 Compared to the Three Months Ended March 31, 2022 The following table sets forth a summary of our consolidated results of operations for the interim periods indicated, and the changes between periods: Three months ended March 31, (amounts in thousands, except percentages) 2023 2022 $ Change % Change Revenue $ 769,652 $ 417,205 $ 352,447 84.5 % Cost of revenue 521,740 313,379 (208,361) (66.5) % Sales and marketing 389,133 321,452 (67,681) (21.1) % Product and technology 88,088 81,352 (6,736) (8.3) % General and administrative 160,476 216,606 56,130 25.9 % Loss from operations (389,785) (515,584) 125,799 24.4 % Interest income, net 11,140 148 10,992 7,427.0 % (Loss) gain on remeasurement of warrant liabilities (17,035) 12,681 (29,716) 234.3 % Other income, net 19 37,882 (37,863) 100.0 % Loss before income tax provision and loss from equity method investment (395,661) (464,873) 69,212 14.9 % Income tax provision 1,368 469 (899) 191.7 % Loss from equity method investment 119 2,351 2,232 94.9 % Net loss $ (397,148) $ (467,693) $ 70,545 15.1 % Revenue . Revenue increased $352.4 million, or 84.5%, to $769.7 million in the three months ended March 31, 2023, from $417.2 million in the three months ended March 31, 2022. The increase was primarily attributable to our online gaming revenues, which increased $348.5 million, or 90.1%, to $735.2 million in the three months ended March 31, 2023, from $386.7 million in the three months ended March 31, 2022, primarily due to MUPs increasing by 39.2% and ARPMUP increasing by 35.4%, in each case, as compared to the three months ended March 31, 2022. MUPs and ARPMUP increased primarily due to strong player retention and acquisition across our Sportsbook and iGaming product offerings, as well as the expansion of our Sportsbook and iGaming product offerings into new jurisdictions, structural improvement in our Sportsbook hold rate and reduced promotional intensity. Cost of Revenue . Cost of revenue increased $208.4 million, or 66.5%, to $521.7 million in the three months ended March 31, 2023, from $313.4 million in the three months ended March 31, 2022. Our online gaming product offerings accounted for substantially all of this increase, reflecting growth in revenue from our expanded product and jurisdictional footprint, including the launch of our Sportsbook product offering in Kansas, Maryland, Massachusetts, Ohio and Ontario, Canada and the launch of our iGaming product offering in Ontario, Canada since March 31, 2022. In particular, the cost of revenue increase was primarily attributable to an increase in our variable expenses, such as product taxes and payment processing fees which increased $123.9 million and $22.2 million, respectively. The remaining increase was primarily attributable to an increase in our variable platform costs and revenue share arrangements resulting from additional customer activity. Cost of revenue as a percentage of revenue decreased by 7.3 percentage points to 67.8% in the three months ended March 31, 2023, as compared to 75.1% in the three months ended March 31, 2022, reflecting, in part, structural improvement in our Sportsbook hold rate and reduced promotional intensity, partially offset by a change in revenue mix from our more mature DFS product offering to our Sportsbook and iGaming product offerings, which in general, produce revenue at a higher cost per revenue dollar relative to our more mature DFS product offering. Sales and Marketing. Sales and marketing expense increased $67.7 million, or 21.1%, to $389.1 million in the three months ended March 31, 2023, from $321.5 million in the three months ended March 31, 2022. The increase was primarily attributable to an increase of $42.2 million from activities to acquire and retain players in new jurisdictions that we operate in, such as marketing costs, including advertising and the development of marketing campaigns. Product and Technology. Product and technology expense increased $6.7 million, or 8.3%, to $88.1 million in the three months ended March 31, 2023, from $81.4 million in the three months ended March 31, 2022. The increase primarily reflects additions to our product operations and engineering headcount. 29 General and Administrative. General and administrative expense decreased $56.1 million, or 25.9%, to $160.5 million in the three months ended March 31, 2023, from $216.6 million in the three months ended March 31, 2022. This decrease was primarily driven by a reduction in stock-based compensation expense of $66.3 million, partially offset by an increase in cash-based compensation expense due to an increase in headcount. (Loss) Gain on Remeasurement of Warrant Liabilities. We recorded a loss on remeasurement of warrant liabilities of $17.0 million in the three months ended March 31, 2023, compared to a gain of $12.7 million in the three months ended March 31, 2022 primarily due to changes in the underlying share price of our Class A common stock. Other Income, Net . We had de minimis other income in the three months ended March 31, 2023, as compared to $37.9 million in the three months ended March 31, 2022. This decrease was primarily attributable to a change in the fair value of certain financial assets. Net Loss. Net loss decreased by $70.5 million to $397.1 million in the three months ended March 31, 2023, as compared to a net loss of $467.7 million in the three months ended March 31, 2022, for the reasons discussed above. Liquidity and Capital Resources We had $1.1 billion in cash and cash equivalents as of March 31, 2023 (excluding player cash, which we segregate from our operating cash balances on behalf of our paid users for all jurisdictions and product offerings). We believe our cash on hand is sufficient to meet our current working capital and capital expenditure requirements for a period of at least twelve months. We will continue to evaluate our long-term operating performance and cash needs and believe we are well positioned to continue to fund the operations of our business long-term. Debt. In March 2021, we issued zero-coupon convertible senior notes in an aggregate principal amount of $1,265.0 million (the “Convertible Notes”). The Convertible Notes mature on March 15, 2028, subject to earlier conversion, redemption or repurchase. In connection with the pricing of the Convertible Notes and the exercise of the option to purchase additional Convertible Notes, we entered into privately negotiated capped call transactions (the “Capped Call Transactions”). The Capped Call Transactions are expected generally to reduce potential dilution to DraftKings Inc.’s Class A common stock upon any conversion of the Convertible Notes. The net cost of $124.0 million incurred to enter into the Capped Call Transactions was recorded as a reduction to additional paid-in capital on the Company’s consolidated balance sheet. As of March 31, 2023, the Convertible Notes, net of issuance costs, balance was $1,251.8 million . Leases . We have lease arrangements for certain corporate office facilities, data centers, and motor vehicles. As of March 31, 2023, the Company had lease obli gations of $70.4 million, with $4.0 million payabl e within 12 months. Other Purchase Obligations . We have certain non-cancelable contracts with vendors, licensors and others requiring us to make future cash payments. As of March 31, 2023, these purchase obligations were $1,616.5 million, with $326.8 million payable in the remainder of 2023. Cash Flows The following table summarizes our cash flows for the periods indicated: Three months ended March 31, (amounts in thousands) 2023 2022 Net cash used in operating activities $ (201,492) $ (356,718) Net cash used in investing activities (27,564) (23,065) Net cash used in financing activities (25,166) (12,313) Net decrease in cash and cash equivalents and restricted cash (254,222) (392,096) Cash and cash equivalents and restricted cash at beginning of period 1,778,825 2,629,842 Cash and cash equivalents and restricted cash at end of period $ 1,524,603 $ 2,237,746 Operating Activities . Net cash used in operating activities in the three months ended March 31, 2023 decreased $155.2 million to $201.5 million, compared to $356.7 million in the three months ended March 31, 2022, mainly reflecting an improved net loss, net of non-cash items, of $81.5 million, as well as a cash in-flow from changes in operating assets and liabilities of $13.1 million compared to an outflow of $60.7 million in the three months ended March 31, 2022, primarily due to improved collection of accounts receivable and timing of payments. 30 Investing Activities. Net cash used in investing activities during the three months ended March 31, 2023 increased by $4.5 million to $27.6 million from $23.1 million during the same period in 2022, mainly reflecting an increase in cash paid for internally developed software costs. Financing Activities. Net cash used in financing activities during the three months ended March 31, 2023 increased by $12.9 million to $25.2 million from $12.3 million during the same period in 2022, primarily reflecting purchases of treasury stock related to the satisfaction of withholding taxes due upon the vesting of restricted stock units. Commitments and Contingencies Refer to Note 12 of our unaudited condensed consolidated financial statements included elsewhere in this Report for a summary of our commitments as of March 31, 2023. Critical Accounting Estimates Our financial statements have been prepared in accordance with U.S. GAAP. Our discussion and analysis of the financial condition and results of operations are based on these financial statements. The preparation of these financial statements requires the application of accounting policies in addition to certain estimates and judgments by our management. Our estimates and judgments are based on currently available information, historical results and other assumptions we believe are reasonable. Actual results could differ materially from these estimates. During the three months ended March 31, 2023, there were no changes to the critical accounting estimates discussed in the 2022 Annual Report. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no significant changes in our exposure to market risk during the three months ended March 31, 2023. Refer to Item 7A. Quantitative and Qualitative Disclosures about Market Risk in the 2022 Annual Report.