Red Rock Resorts, Inc. Q3 FY2020 Earnings Call

Good afternoon and welcome to the Red Rock Resorts Third Quarter 2020 Conference Call. All participants will be in listen-only mode. Please note, this conference is being recorded. I would now like to turn the conference over to Stephen Cootey, Executive Vice President, Chief Financial Officer and Treasurer of Red Rock Resorts. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. Thank you for joining us today on today's Red Rock Resorts third quarter 2020 earnings conference call. Joining me on the call today are Frank and Lorenzo Fertitta, as well as members of our executive management team. I'd like to remind everyone that our call today will include forward-looking statements under the Safe Harbor provision of the United States federal securities laws. Developments and results may differ from those projected. During this call, we will also discuss non-GAAP financial measures. For definitions and complete reconciliation of these figures to GAAP please refer to the financial tables in our earnings press release in form 8-K, which were filed this afternoon prior to the call. Also please note that this call is being recorded. Let's now turn to our third quarter results. On a consolidated basis, we reported net revenue of $353.2 million, down from $465.9 million in the prior third quarter. Adjusted EBITDA of $160.9 million, up 44.8% from $111.1 million in the prior third quarter and our EBITDA margin increased 2,171 basis points to 45.6%. With respect to our Las Vegas operations, we reported net revenues of $320.8 million, down from $440.7 million in the prior quarter. Adjusted EBITDA of $141.7 million, up 38.6% from $102.2 million in the prior third quarter and our EBITDA margin increased 2,997 basis points to 44.2% for the quarter. This also represents our highest third quarter adjusted EBITDA and our highest margins in any quarter in the history of our operations. In order to better understand our third quarter Las Vegas performance, we think it's important to look at our results excluding the impact of our still closed properties, Texas Station, Fiesta Rancho, Fiesta Henderson, and Palms Casino Resort had on the third quarter. When viewing our third quarter Las Vegas performance excluding the still closed properties from each reporting period, we reported net revenue of $316 million, up 0.3% from $314.9 million in the prior third quarter. Adjusted EBITDA of $146.1 million, up 39.7% from $104.6 million in the prior third quarter and our EBITDA margin increased 1,304 basis points to 46.2% for the quarter. Taking a look behind the numbers. The customer trends we saw in June continued throughout the third quarter as we saw strong visitation from a younger demographic, increase spend per visit, more time spent on device plus increased return of our core customer. These positive trends are offset by higher COVID-related costs, costs associated with our closed properties and continued COVID-related restrictions on our business. We expect these cross-currents will continue to exist for a while. While certain of these trends clearly helped drive our record third quarter results, we should note that we are still in the middle of this pandemic and have little visibility regarding the impact this crisis will have on our company and the Las Vegas economy moving forward. On the cost side, the company's performance continues to benefit from the decisive actions that management team took during the closure. Through a combination of streamlining our business, optimizing our marketing initiatives, and renegotiating a number of our vendor and third-party agreements, we now expect annual cost reductions that will be permanently removed from the business to be greater than the $150 million in annual cost reductions we referenced in our prior call. These initiatives have resulted in a leaner, more efficient company, which will enable us to achieve and sustain higher margins and drive more free cash flow to the bottom line going forward. I will now cover a few balance sheet and capital items. The company's cash and cash equivalents at the end of the third quarter were $108.9 million and the total principal amount of debt outstanding at quarter end was $3 billion. In the third quarter, we paid down $285.6 million in debt and since the end of the third quarter, we've paid down an additional $53 million in debt, reducing our debt to below pre-pandemic levels even while carrying our team members throughout the crisis. It should be highlighted that the company was able to generate approximately $124.4 million of free cash flow or $1.06 per share in the quarter and every dollar of that free cash flow went to pay down debt as we continue to focus on deleveraging our balance sheet and increasing our financial flexibility during these uncertain times. Capital spend in the third quarter was $12 million and we anticipate the capital expenditures for the balance of the year to be approximately $9 million, bringing our projected 2020 capital spend to be between $60 million and $65 million. Although we are still in the process of finalizing our 2021 capital budget, we anticipate that it will be between $65 million and $75 million per year. Finally, an update on our two Native American projects. At Graton Casino Resort, we reported management fees for the third quarter of $30.7 million, an increase of 31% from $23.5 million in the third quarter of 2019. Additionally, the tribe has agreed that the management agreements will be extended through February 4, 2021. And we hope to reach an agreement with the tribe on the appropriate additional extension of a term path agreed for 2021 in accordance with the terms of the management agreements. Regarding North Fork, during the quarter, the California Supreme Court finally decided the key issue in the enterprise tribe's case favoring that tribe. The Supreme Court then remanded the North Fork case to the appeals court with a direction to vacate its early decision against the North Fork tribe and reconsider it in light of the enterprise decision. Based on the favorable Supreme Court decision, we have ramped up our development efforts on this project and expect to have a shovel in the ground in the second quarter of 2021. The build is expected to take an additional 15 to 18 months. While we were still working through the planning and budgeting phases of the project, we expect this project to be over 213,000 square feet, including almost 100,000 square feet of casino space initially, including 2,000 class three slots and 40 table games, two standalone restaurant concepts, and a foosball concept. We're excited to begin the development. It is a very attractive project on behalf of the North Fork tribe and will be providing more detail as it becomes available. While Las Vegas is going through some very challenging times, we believe that the very favorable supply-demand dynamic, the stable regulatory environment, and the lowest gaming tax rate in the nation all support a long-term view. A Las Vegas locals market is the most attractive gaming market in the United States. With our best-in-class assets and locations, unparalleled distribution and scale, deep organic development pipeline, and our status as one of the few gaming companies that still owns all of its assets, we remain uniquely positioned to take advantage and thrive in this market. Lastly, we'd like to recognize and extend our thanks to all of our team members for their hard work and to our guests for their support throughout this pandemic. Operator, this concludes our prepared remarks for today, and we are now ready to take questions from participants on the call.

Thank you. Today's first question comes from Joe Greff with JP Morgan. Please go ahead.

Good afternoon, everyone. I believe we are all trying to understand how sustainable these significant expense reductions and margin gains are. Could you elaborate, Steve and Frank, on your thoughts regarding their sustainability? What can we expect as revenues start to recover? I suspect you might agree that 44.2% margins in the Las Vegas locals market may not be sustainable. How do you view sustainability from a percentage standpoint? Additionally, could you discuss your thoughts on reopening some of the foreclosed properties in the locals market? What factors are you considering when evaluating the reopening? That's all from me, thank you.

All right, Joe I'll start and then Frank and Lorenzo will probably jump in. But I can tell you we're gaining confidence each month that we continue to operate a higher margin we have historically seen for the foreseeable future. Throughout the quarter, we've been very disciplined, keeping our labor and marketing expenses in check. We understand this is really the new normal in this uncertain demand environment. As you also know, the majority of our mix right now is probably from gaming, which is high-margin business, which helps us sustain those margins. Though, that said, we are looking forward to the return of some of the business that we've lost due to COVID, such as hotel and catering, and some of our red revenues, which are also high margin.

I think we believe that there's been a permanent shift in the cost structure. During the shutdown, it gave us the ability to question everything we were doing and to be very cautious reopening. I don't think we see buffets coming back anytime in the near future. We really looked at delayering marketing costs and being more efficient on the marketing side, much more focused on direct relationship marketing more than mass-market promotions and things of that nature. So I think we believe that there's a permanent reduction in the cost of operating a business.

I think your second question was about reopening the properties. We still don't have a clear timeline. We're taking the necessary time to understand the impact this pandemic may have on our company and the Las Vegas economy.

But we have good distribution throughout the market right now. We're seeing good crossover play from the properties that are closed and the facilities that we currently have open.

Maybe just a follow-up to that, Frank, if this revenue and expense environment sustains itself for the next six months, is that an environment in which you would then consider reopening or you would just continue maintaining the status quo in terms of the number of properties?

We're going to continue to reevaluate, but we really liked what we saw this last quarter, I can tell you that. Lorenzo, do you have anything to add?

Yes, if you examine the consolidated gaming revenues, they have increased compared to last year when we operated 10 properties. Generating that gaming revenue through six facilities instead of 10 allows for a more favorable flow through, which naturally enhances margins and profitability. We are pleased with the performance we observed in the third quarter, and we will keep reassessing our situation as we move forward.

Thank you.

The next question today comes from Carlo Santarelli with Deutsche Bank. Please go ahead.

Hey, guys, thank you for taking my question. Steve, you had mentioned the supply and demand dynamic. I'm not sure if this is exactly what you were referring to but do you guys have any sense of what kind of gaming supply in the locals market looks like on a year-over-year basis kind of be in the 3Q or what that looked like in terms of units online, units offline, properties open, properties closed from your peers, and maybe some of the other kind of outside of the core casino slot machines, things like that? What that looks like year-over-year.

The market has clearly contracted. I can provide you with specific details later in a private discussion. You heard on yesterday's call that one of our primary competitors also had several properties closed, indicating that the local market has diminished.

But when we're talking about demand, you have growing populations, and you have tax refugees moving from neighboring states into Las Vegas, home sales are unbelievably strong, there's very little supply of homes in the market with high demand. As population continues to grow, we control literally almost all of the supply where you could even build a new locals casino so it's a very interesting dynamic to have the limits on supply with growing demand at the same time.

Yes, for sure. Thank you for that. If I could just ask one follow-up. If you guys think about just in the opened assets, I'm not talking about the portfolio that's offline but if you think about the opened assets, and the revenue by vertical, i.e. if you're thinking about the casino footprints relative to the restaurants relative to the hotels, etcetera. With the changes that you've made from a cost structure perspective, what do you think the headroom is kind of relative to 2019 same-store revenue? Are you able to get 90%, 95% of revenue with your buffets closed, and maybe more limited F&B offering and some of the other amenities closed? If everything else kind of escalated back to 100% of what it was in 2019, albeit the gaming floor hotel, stuff like that?

Yes, I think we can. We're close to almost 80% right now. The way this all stands and we're still dealing with capacity constraints on the restaurants, and also wanted to think about some of the more profitable lines of business that have been really restrained relative to COVID. When you think about hotel, catering, theaters, those represent a significant portion of our revenue, but also would be a significant portion of our profit, almost to the extent of about $12 million. When you think of all the, let's call it the lines of business that have been restricted due to COVID.

Understood. Thanks, Steve. Thanks, everyone.

The next question today comes from Steven Wieczynski with Stifel. Please go ahead.

Hey, guys, good afternoon. Not sure of your comment on this or not, but can you talk about maybe what you saw through or what you've seen so far through October and has that been kind of similar trends to what you saw throughout the third quarter?

Steve, this is going to be a tough one to answer because, as you recall, we did get some guidance on July but it was really very specific kind of situation and time where we only had 26 operating days throughout the court to comment on so I think going back to our current policy and not talk about operating performance in the current quarter.

Okay. Understood. The second question, I think the casino revenue side makes sense in terms of why that was so strong but I think what was somewhat surprising to us was actually the hotel side of things. Obviously with a significant lower room count than where you were a year ago, but is there any way to help us think about, maybe who's using those rooms at this point, and how much are those being used not on a promotional basis versus kind of a cash rate?

It's very little calm and so what you have seen is kind of that natural transition of we've lost a lot of group nights and so group nights are down significantly in the third quarter but what they've been really replaced by has been a lot of transients and FIT business, which has been very great for the business. So it's really the drive. One of the things, this is a business that's really relying on airlift. It's not relying on conventions or meeting and so we're really relying on local drive-in traffic, which has been.

While we're missing profit from hotel and catering, we're primarily a gaming company. A significant portion of our revenues and profits, around 70% to 80%, comes from slots and table games. We anticipate the return of hotel and catering operations, which are also profitable for us, but our results indicate that we can still generate revenue even in the current environment.

Okay, great. Thanks, guys. Appreciate it.

The next question today comes from Shaun Kelley with Bank of America. Please go ahead.

Hi, good afternoon, everyone. Just two questions. First got to stick with the P&L. Steve, we look at the casino operating expenses. They were down 35% year-over-year, but obviously revenues are flat for the whole company. It's pretty astounding. Could you just give us any more color on specifically, maybe what's going on at the casino floor? Is that purely labor? Is there anything else that you're able to do? Obviously, the closed properties are going to factor in here but it just seems pretty stunning to get that much operating leverage on the casino line item specifically.

We basically went back to the basics of the fact that we have the best locations and the best properties, and went back to focusing on just direct the relationships with the customer, and really focused on delayering and being more efficient in our promotions and marketing. Steve.

I agree with that. Shaun, you touched on the other pieces, right. We've become much more efficient on the labor floor and we've been able to funnel quite a bit across overplay from what was 10 large properties into six.

We have become more efficient from a labor and a scheduling standpoint but at the same time, we're also bearing the cost of additional operating expenses and labor, due to the safety precautions related to COVID. So every entrance we have somebody taking temperatures and obviously a significantly higher crew of people going through the casino constantly cleaning as well. While we're able to be more efficient on the labor side, we're doing that, at the same time, while bearing a higher expense due to COVID. We're obviously hoping that doesn't last forever.

Our gaming revenues have increased slightly, but we are operating with four fewer facilities, which brings associated expenses. In Nevada, we experience the most operating leverage, as more of every gaming dollar contributes directly to EBITDA, given the state's tax rate.

Thank you for the information. My follow-up question is about the free cash flow conversion, which was quite high this quarter. How should we view the ratio of EBITDA to cash flow going forward? Specifically, Steve, you mentioned the CapEx plan, which doesn't seem to differ much. Can we expect to see similar ratios in the future? Is there anything we should be aware of regarding this?

Yes, you're talking about a 78%. I think ratio is what you're referring to. So when you think about our cash flow, from a tax perspective we're not going to be a taxpayer in 2020, most likely not be a taxpayer from 2021. Working capital should be almost a zero to positive-sum game as we're still receiving some benefit from the CARES Act in terms of cash. As we mentioned, CapEx about $65 million to $75 million. So Lorenzo and Frank, we have no deferred capital maintenance. Now I think we're reaping the reward of that program we've done in the past and so we'd be very disciplined about the capital focus. Then a cash interest expense as we're starting to pay down debt should be a net 110 to 120 range in terms of millions. So you can kind of figure that in but we should have a very high free cash flow to EBITDA yield.

Thank you, all.

Our next question today comes from Barry Jonas with Truist Securities.

Hi, guys. For starters, where are you guys on potential land sales? I think some land arena was probably for sale at one point. What's the latest there in overall?

Barry, this is Rod Atamian. We're gradually making good progress on those sales. You mentioned the Reno property in particular, we have an 88-acre piece up there at the Mount Rose property that's been on the market. Again, we're making progress there. We'll notify you when we actually close on land sales. These things are contended to have some long and titling periods at times and we want to make sure that we're sure they're closing before we make any announcements. So with respect to the Convention Center site, specifically in Reno, we are still evaluating that for future development but overall, very positive and constructive on the unsolicited interest we're getting across our portfolio for access property.

Got it. Great. Then, Steve in your comments, you talked about maybe a second grade and extension, just curious if you can give them more color. I think stuff like that is usually less common in terms of longer-term extension so is the intent something more short-term to get through COVID or are you hoping to do something really more long-term?

Well, I'm going to turn that over to my esteemed colleague, Jeff Welch?

Hi, we're not expecting a kind of bull on re-up of the management agreement, not even remotely. All we are talking about is a provision in the management agreements, there are gaming and non-gaming management agreements at Graton. That basically say that the term of the management agreement will be extended by a period equal to a period that starts on the date of the original closure and it ends when substantially all the amenities are turned back on. At Graton, we do not believe substantially all of the amenities have been turned back on yet so an extension much longer than the three months that the tribe has already agreed to, we believe is warranted.

Great, and then just last one for me. You guys have always thought of as a leader in gaming for technology. Curious to get your views on cashless gaming.

I think through this crisis is one thing is said is to give the customers what they want and cashless is definitely something they want. So you can anticipate that we are working heavily to produce a cashless solution and a one wallet solution for the casino. We expect to introduce that next year.

Great, thanks so much, and congratulations.

The next question today comes from Jared Shojaian with Wolfe Research, please go ahead.

Hi, good afternoon, everyone. Thanks for taking my question. Can you just tell us if you've seen any impact on demand or revenues since the capacity limit was raised from 50 people to 250 people? Because I could see an argument for being positive, obviously, but even negative, frankly, if it opens up other leisure alternatives, has that been meaningful in any way over the last few weeks?

It's really just happened recently. I think we do think it certainly is a positive for us moving forward, particularly in the social catering side. There's been a lot of delayed weddings, small things of that nature, which we typically cater to, especially here, obviously, in the local regional market. Once again, it's been fairly recent, since that's gone in place, but we would expect that to be a net positive force moving forward and in 2021.

Okay, thank you. Then I guess along the same line of thinking there, can you just give us some insight into the talks you've been having with governmental officials, or maybe what you've been hearing just concerning the risk that capacity limitations get tightened again, or even worse risk of another shutdown?

I think the latest that we have heard, I think the governor came out yesterday and in fact talked about in early 2021, potentially moving to 50% capacity for meetings and convention and groups and things of that nature. So we took that as a positive sign looking forward into 2021. Other than that, we haven't heard anything relative to any restrictions, or anything like that.

Okay, thank you very much.

Just to add to the flip side of that, Jared, as we mentioned, we've paid down pretty much the entire revolvers. We have about over a billion dollars liquidity. As mentioned in our previous calls even with carrying all of our employees, our burn rate was a little bit south of $50 million. If we went to something more draconian, our burn rates went south of $30 million, which gives us almost three years of run rate.

Thank you. Our next question today comes from Chad Beynon with Macquarie. Please go ahead.

Hi, good afternoon. Thanks for taking my question. Given your free cash flow generation, and really just the recovery that we're talking about here, how are you guys thinking about returning to paying a dividend? Can you just remind us on the restrictions from a covenant standpoint?

Yes, certainly. The board reviews the allocation of capital, especially dividends, on a quarterly basis. Currently, there isn't a set timeline, but our major shareholders are in agreement with the rest. Regarding the covenants, there are significant opportunities to reinstate the dividend due to specific allowances related to it.

Okay, great. Thanks. Then regarding your older aged customer cohort, did you see any recovery in that segment as we kind of moved through the quarter or is that older age customer still not really participating at the properties at this point?

It's Lorenzo, we did start to see the older age customer start to come back to the properties particularly kind of around Labor Day and after Labor Day. We really started to see more of a pickup so the answer's yes.

Thank you, guys. Nice quarter.

Our next question comes from Steven Grambling with Goldman Sachs. Please go ahead.

Hey, thanks. Perhaps the flip side of Chad's question on the older customer, I think one of the concerns out there is that if other forms of entertainment come back, the new younger customers are going to get a look elsewhere and that marketing may have to come back. Can you expand on how that customer profile is changing and how they may be engaging with your marketing similar or different to what has historically been the core rated player?

Sure, we have seen a younger demographic for sure.

We have been doing a good job on getting them to sign up for the loyalty program so that we can have relationship marketing with them going forward.

I think if you look at the amenity packages that we have, particularly at Red Rock and Green Valley and the food and beverage offered there already kind of cater to that younger crowd, whether it be Blue Ribbon, sushi, and Red Rock, Hearthstone, new Italian restaurant that we have there, T-bones and then a number of restaurant that click hospitality has put in place for us in Green Valley Ranch. So we do feel like that relative to the locals market that we have the best amenities really to attract that upper and younger, kind of working mobile demographics.

Would you generally say that the way that they're engaging from a play standpoint follows a similar path to that older demographic when they first come in? This is one quick follow up.

That's a tough one to answer. I can't tell you that segment of the market is one of our fastest-growing segments of all the segments in our database.

Got it. That's it for me. Thanks so much.

Ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to the management team for any final remarks.

Well, thank everybody for joining us, and we look forward to talking to you in about 90 days.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.