Red Rock Resorts, Inc. (RRR) Q3 2019 Earnings Report, Transcript and Summary

Good day and welcome to the Red Rock Resorts Third Quarter 2019 Earnings Conference Call. [Operator Instructions] And please note, this event is being recorded. I would now like to turn the conference over to Mr. Stephen Cootey, Executive Vice President, Chief Financial Officer and Treasurer. Please go ahead.

Thank you, Operator. Good afternoon, everyone, and welcome to Red Rock Resorts third-quarter 2019 earnings conference call. Joining me on the call today from Red Rock Resorts are Frank Fertitta, Chairman and Chief Executive Officer; Rich Haskins, President; Bob Finch, Executive Vice President and Chief Operating Officer; and Robert Tamian, Executive Vice President, Strategy and Development. On the call today, we'll include forward-looking statements under the safe harbor provisions of the United States Federal Securities Laws. Developments and results may differ from those projected. The risks and uncertainties related to these statements are detailed in our filings with the SEC. During this call, we will also discuss non-GAAP financial measures. For definitions and a complete reconciliation of these figures to GAAP, please refer to the financial tables in our earnings press release and Form 8-K, which were filed this afternoon prior to the call. Also, please note that this call is being recorded. Let's turn now to our third-quarter results. On a consolidated basis, net revenues increased 13%, $465.9 million, adjusted EBITDA decreased 1.8% to $111.1 million and margins decreased 262 basis points to 23.8% for the quarter. With respect to our Las Vegas operations, net revenues for the quarter increased 13.1% to $440.7 million, adjusted EBITDA decreased 0.8% to $97.2 million and margins decreased 309 basis points to 22%. In order to better understand the financial performance of both our core business and the Palms, we think it's important to look at the third-quarter results from both of those perspectives. When viewing our third quarter Las Vegas performance, excluding the Palms, results continue to be solid and demonstrate the ongoing strength of our core business. Measured on that basis, net revenues increased 3.6%, adjusted EBITDA increased 6% and margins increased 67 basis points to 29.6% for the quarter. In addition, flow-through for our Las Vegas properties ex Palms was just under our historical 50% to 70% range. The same-store measured results represent our highest third-quarter net revenue since 2007, our highest third-quarter adjusted EBITDA since 2008 and our highest - our second highest third-quarter margin since 2008. Turning now to the Palms third-quarter performance. Net revenue for the quarter was $79.5 million while adjusted EBITDA for the quarter was negative $9.8 million. In short, while the property is experiencing exceptional top line growth across both gaming and non-gaming segments with gaming revenues up nearly 30% for the quarter, the expense side of the business has been challenging to date due in large part to the entertainment and fixed-cost structures associated with the KAOS dayclub/nightclub. Therefore, we have decided to close the club effective immediately and reassess the use of those venues going forward. In the interim, we intend to use the venues for private meeting space and special events in addition to everyday resort full operations. When viewing the Palm's third-quarter performance, excluding the nightclub and dayclub and adjusted for normalized hold, net revenue was $60.9 million and adjusted EBITDA was $3.7 million in the third quarter, respectively. In connection with that decision to reassess the use of the dayclub/nightclub venues, we've taken a onetime charge of $28.2 million in the third quarter related to the termination of certain artist performance agreements and employment agreements, and we anticipate taking similar onetime charges over the next couple of quarters in the range of $16 million to $22 million. Let's take - let's look now at some of the key economic indicators in Las Vegas. As we begin the fourth quarter, the future outlook remains very bright for the city and surrounding area as it continues to be one of the fastest-growing economies in the United States. Population is at an all-time high and rising as Las Vegas remains the second fastest-growing MSA in the nation. Employment also remains at record levels, growing at two times the national average, and we now have seen 100 consecutive months of broad-based employment growth. Average wages, as measured by weekly earnings per employee continue to rise with Las Vegas reporting an increase of 2.3% for the trailing 12 months ended September 2019, and we have now experienced 71 consecutive months of wage growth. Moreover, total earnings, which takes into account both employment and wages, increased 5% over the same period. In addition, unemployment was down 50 basis points year over year to 4%, approximately 1,000 basis points off the peak. Housing also remained solid as median home - median sale prices were up 4.7% in September. Finally, there's over $20 billion in new capital investment projects planned in Las Vegas, $13 billion of which have already broken ground led by the new Raiders' stadium, Project NEON, the Convention Center expansion and multiple strip developments, all of which will further expand the local economy. These robust economic factors are also fueling what is a very strong and resilient Las Vegas locals gaming market. Not only was the locals market the fastest-growing regional gaming market in the United States on a same-store sales basis in both 2017 and 2018, it remains the fastest-growing market on a trailing 12-month basis. Notably, during those same time periods, our locals gaming revenues, excluding the Palms and Palace Station, have outpaced the growth rate of the remainder of the market. These positive economic trends, along with a very favorable supply demand dynamic, stable regulatory environment and the lowest-gaming tax rate in the nation, only serve to support our view that the Las Vegas locals market is the most attractive gaming market in the United States. And with our best-in-class assets and locations, unparalleled distribution and scale and deep organic development pipeline, we remain uniquely positioned to take advantage of this extremely vibrant market. Moving on to the redevelopment of Palms and Palace Station. With respect to the Palm tree development, our $690 million plan to fully reimage and repurpose that property is now complete with the key and final components of Phase 3 of that plan, Michelin-Starred dim sum restaurant, Tim Ho Wan, from Hong Kong and the addition of 16 new table games in the West expansion area having opened in late September. As a reminder, the Palms transformation began back in February 2017 and took over 32 months to complete. Needless to say, we are extremely excited to finally have that lengthy renovation process behind us and look forward to offering our guests for the first time a premier gaming and entertainment destination free of any construction or disruption. At Palace Station, our ramp period has been slower than originally anticipated. While we are experiencing meaningful revenue growth, we remain focused on building continual additional awareness and trial to grow top line revenue while at the same time optimizing the expense structure of the property. In sum, we are still very bullish on these - in each of these opportunities based on their hybrid ability to appeal to both residents and tourists alike and continue to expect them to generate significant returns for the company over time. Turning to our Native American segment. We reported management fees for the third quarter of $22.3 million, an increase of 12.6% over the prior year driven by another outstanding quarter at Graton Casino Resort. With respect to the North Fork project, we continue to progress to the few remaining pieces of litigation related to the project. As previously noted, the California Supreme Court has granted the tribes petition for a review of a lower - a key lower court decision involving the project. But it's deferred taking further action until it has ruled on a very similar case involving the enterprise tribe, which received a favorable ruling at the appellate court level. The enterprise tribe's case is now the oldest civil case on the California Supreme Court's docket, and we continue to anticipate that the court will schedule a hearing on that case in the near future. I will now cover a few balance sheet and capital items. The company's cash and cash equivalents at the end of the quarter were $106.4 million, and the total principal amount of debt outstanding at quarter end was $3.1 billion. As of the end of the third quarter, the company's net debt to EBITDA and interest coverage ratios were 5.5x and 4.1x, respectively. Capital spend in the third quarter was $53 million, inclusive of the Palms redevelopment project. We anticipate the capital expenditures for the balance of the year will be between $30 million to $40 million, inclusive of the remaining costs related to the Palms redevelopment projects. Although we are still in the process of finalizing our 2020 capital budget, we anticipate that it will be between $90 million and $110 million. With the completion of the Palms redevelopment project in September, we have now reached a key inflection point as a company and expect to generate significant and accelerating free cash flow beginning in the first quarter of next year. As we exit out of this development phase and enter into the harvesting phase, we will be intently focused on maximizing the financial performance of our existing properties and reducing our net leverage ratio to a targeted level of four times or less through a combination of paying down debt and increasing EBITDA. Lastly, on October 28, 2019, the company announced that its Board of Directors had declared a cash dividend of $0.10 per share payable for the fourth quarter of 2019. The dividend will be payable on December 27, 2019, to all shareholders of record as of the close of business on December 13, 2019. Operator, this concludes our prepared remarks for today, and we are now ready to take questions and answers from the participants on the call.

[Operator Instructions] The first question today comes from Joe Greff with JPMorgan. Please go ahead.

Steve, Frank, thanks for breaking out Palms from the core Las Vegas results. So when I kind of look at the core numbers and, Steve, you mentioned that the flow-through in the Q3 was a bit below the 50% to 70% range, was there anything unusual that caused that? And is there anything that would cause you not to be within that 50% to 70% range going forward for the core Las Vegas results?

Joe, it's a great question. Again, I just want to remind you that, yes, while we just barely missed the 50% to 70% of historical flow-through, we do take a look at this measure on an annual basis. So there's going to be ebbs and flows quarter-to-quarter. It was our second highest margin in 2008. And to answer your last question, there's nothing unusual that drove that flow-through down, and we anticipate on working to improve margins. And there's nothing that would prohibit us from getting within the 50% to 70%.

And then looking at the Palms and recognizing shutting down the day and the nightclub, do you think you're at a pace now where you're breakeven or, dare I'd say, positive EBITDA going forward, taking into account that if you're closing some things, that might cause a loss of revenues in some of the more profitable segments? And if the answer is we're not breakeven for a while, when do you foresee breakeven EBITDA to Palms?

I think I just wanted to address the club point too because I think maybe there's some confusion there. I mean we've now operated Palms without the nightclub for about five to six weeks, and we've actually seen no degradation in any lines of business at the Palms. In fact, we saw a very little crossover from the nightclub and dayclub to any of the ancillary businesses. And we plan to use the Pearl really to activate that property going forward. In terms of breakeven, I think now with the club business behind us, I mean you should - when we take a look at every single business line within the Palms, they're all profitable. So as we - we looked forward to sequential improvement this quarter and then really moving beyond breakeven in Q1.

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

Steve, Frank, if you guys could just kind of - maybe to the extent that you're able to articulate it, what was the thought process behind making the decision at this stage to close the club? And what were some of the other considerations that you potentially had as it pertained to the property?

Look, I think we took a look at the business, and it's obvious that the nightclub environment of Vegas is extremely competitive. It doesn't appear that the market has grown enough for the amount of supply in the market. The cost of entertainment is excessively high, and we just made the decision to focus where the fish are and acknowledge that nightclub business, at least at the Palms, was not working for us. And then we have a new leadership team in place over the Palms that are intently focused on hotel, casino, all the things that are working, and Steve can talk a little bit to some of the forward-booking traction that we're seeing at the Palms, but there's a lot of good things happening over there. And it's just - we don't want to be distracted by the things that weren't working for us.

And Steve, you kind of just alluded to it, but just in terms of the - I guess it would be more on the revenue side, the drivers of that customer, that KAOS customer, whether it's on the casino floor or through the restaurants, you're saying in the period of time when the dome was being constructed, you saw very little in terms of changes in restaurant covers, gaming performance, etc.

That is correct. And if you kind of use when the Pearl was activated, we actually saw an increase in some of the lines of business in terms of that crossover.

We have seen good correlation from live entertainment in the Pearl and crossover both through the gaming floor as well as the restaurants. We did not see that correlation with the nightclub. And one could even make a case that, that may have had a negative impact to the core gaming customer at the property.

And Steve, sorry to do this. You cited two numbers and I kind of missed the preamble. The $60.9 million of net revenue and the $3.7 million of EBITDA, what was that referring to?

That is referring to the Palms pro forma without the nightclub.

As would have been in the quarter if you excluded all nightclub expenses and revenues associated. Correct?

Yes. For that quarter. So think of it as the bridge between the three - the bridge between the $9.8 million.

Your next question comes from Shaun Kelley from Bank of America. Please go ahead.

Maybe just to stay on the Palms, could you just give us maybe a little bit more color? You mentioned, Frank, maybe some bookings data, but maybe a little bit more color on what kind of the operating strategy is going to be if - I think this was a - the thought process was initially, it's probably going to be a bit of a kind of a nightlife heavy venue. So from here on, is - kind of what's the go-to market? Is it going to be more on live entertainment? Is it going to be more about core gaming and some crossover into locals? Or just kind of how do you envision the property from here?

Look, every segment of the property ex the club has been tracking to what our plan was. And at the end of the day, the nightclub, it just - that crowd did not have spendable money. We didn't see the crossover into the casino. We acknowledged the fact that it wasn't working and decided to focus on what was working. And look, we've gotten rave reviews at the property in terms of basically being a brand-new facility in terms of the casino, the hotel rooms, the suites. We've seen great pickup in table games play, growing the slot business. And I'll let Steve talk a little bit about the problem that we had originally with the old Palms on being able to book group business, corporate business and hotel businesses that people didn't know what the product was that we're going to have. I think now that we have exposed the property and people are seeing the quality of the product, we are getting really good pickup in forward bookings into 2020 and 2021.

And I would add to that, Shaun. I think, as you know, we did - one of the reasons we decided to push the dome up despite a really short sale window, we've seen excellent demand for the dome. And we see that just with catering and group business, that product to be a good return - we're going to get a good return on our investments. And as Frank alluded to, we are seeing substantial pickup no different than the rest of the strip during 2020 from both a revenue, a room night and a catering perspective.

And then just as my follow-up, as we kind of look through the - like the segment-level detail, your casino operating expenses were up a little bit kind of higher than they typically are. It's a little bit difficult because we know the sort of non-comp of what's going on in the Palms. Is that more related to table and slot mix? Could that be - or is it anything else going on in the promotional side or any call-out there? Because it's just a little bit elevated relative to what we've seen in the past.

I mean, I think when you separate the Palms out, it becomes much more normalized. So I mean I would say that we've had rapid growth in both tables and slots at the Palms and you've had...

But the mix of table revenue at the Palms compared to our other properties is significantly higher.

Yes.

Look, I think it's fairly rational promotional environment in Las Vegas right now, but I definitely think there's room for a more efficient spend on the marketing side. We're very focused on that.

The next question comes from Chad Beynon with Macquarie. Please go ahead.

Frank, it's public knowledge that you've been buying stock in the quarter, and we've also seen a number of asset sales from many of the operators in the Southern Nevada region, which certainly highlights the intrinsic value of properties, including some of yours. So I guess, first off, is it your view that you're just not getting the full valuation on your core assets? And then secondly, on that, if you could maybe talk about any updated views on opco propco, given that we're seeing cap rates in kind of the 6% to 7% range?

Look, we believe that we have a very unique platform here. We think it's a very unique supply demand situation in the Las Vegas Valley with SB 208, which limits where local casinos can be built. We own and control most of the future pipeline of where that growth can take place. We think we have best-in-class assets in the best locations. We see the Las Vegas economy continuing to grow. And if you look at - for instance, Red Rock is anticipated or forecasted to have 17% population growth in the next five years within three miles: Green Valley Ranch, 13% over the next five years within three miles; Santa Fe, 9%; Sunset, 9%. So our portfolio is really located in a way to capture the future growth in the Valley limits on supply. And I think when you look at Blackstone's validation of the real estate side of the casino business, we think it's going to continue to drive valuation in the industry.

And we own all our real estate.

And then secondly, on Palace Station, given that the ramp and the return profile is going to take a little bit longer, does this kind of change how you're thinking about marketing expenses? Are you going to make another push in the next couple of quarters? Or is the ramp just going to take longer just as kind of the word of mouth spreads in terms of the new amenities? Thank you.

Look, Palace Station has had good revenue growth. I think we can do a better job on the hotel side over there, and I think we can do a better job rightsizing the expenses of the bigger plant facility going forward. But Palace Station is seeing nice revenue growth overall. I think it should be better, but our goal is to be more efficient with our marketing and advertising, and I would say no to a big new push.

Your next question comes from Stephen Grambling with Goldman Sachs. Please go ahead.

On Palms, where do you think you are in the ramp of the non-KAOS segments? And what would the ROI on the project look like based on your underwriting if we effectively zeroed out the KAOS contribution? And then perhaps as a follow-up to that, as you think about repurposing the group meeting space, is there any way to size the demand that you've seen so far from the group meeting segment and the profitability contribution? Thanks.

Look, in terms of the polls or where we are in the ramp, we're in the first inning. I mean the property just literally finished getting out of the construction mode in September with adding up table games and the Tim Ho Wan restaurant. At the end of the day, these are long-term assets. And you take a place like Red Rock, it's still growing. It's been open for 12 years. And my anticipation is that Palms is a brand-new asset in the marketplace. It literally just opened. There's a lot of things that we can do better. And my anticipation, it will continue to grow over time. So I think we're really, really early.

In terms of the group business, I think it's - that's a little early as well, to Frank's point. I mean, for example, we're just going through the 18-month sales cycle for 2020. And I kind of walked you through the stats. We've seen substantial uplift year over year. And the dome with virtually no sales cycle, we decided to put up the dome because we feel we'll make a very good return on capital on that investment.

And then one other quick follow-up. On the $90 million to $110 million of CapEx, does that assume any spend for the repositioning of the Palms? Is there any incremental spend that could happen from that? And then are there any cash charges that we should be thinking about associated with the impairments that have been taken?

Well, I mean, I think from a CapEx perspective, the only thing that's really inclusive is - and I should remind everyone, it does have the Red Rock room model, so it does have that embedded into the $110 million. So I think that was probably a good time to remind everyone for Q3 and Q4, we had about 11,500 rooms kind of off-line or anticipated off-line in Q4.

Room nights.

Room nights, excuse me. So that should be - that should cost about - that should result in about $1.9 million of an adverse revenue effect at the hotel.

And that project will be complete in...

In Q1.

April.

Yes. In April.

March, April.

Yes.

Your next question comes from Barry Jonas with SunTrust. Please go ahead.

Curious, how are you guys thinking about some of your excess land? Any thoughts on monetizing it? Does that maybe play into your deleveraged targets?

I'd say the answer is yes. Our sole focus right now is on deleveraging the balance sheet to get to 4x or less both through free cash flow, paying down debt as well as growing cash flow, but we would definitely consider selling nonstrategic pieces of real estate. We own eight different locations with about 475 acres.

I think - and to put that really kind of frame that, what Frank said, and what we kind of look as 2020 - our 2025 strategy, and while we don't use - we don't give guidance. If you take consensus EBITDA results, I think you guys are probably estimating about $580 million in core business EBITDA. Our interest expense, which is mostly fixed due to our swap portfolio, it should be about $125 million. Working capital should be 0 as the Palms has finished its ramp. We're going to - we expect to be a 0 taxpayer in 2020. And with CapEx, we don't use the high end of the range at $110 million. And the dividend continuing about roughly $47 million, that yields - that's $300 million of free cash to be used to help delever the balance sheet along with any monetization from any noncore asset.

And then just at the Palms, curious about Tim Ho Wan. It's been open for a little over a month, I think. Curious how that's doing and maybe if it's been driving any Asian play to the property.

I mean, the reception at Tim Ho Wan is I think that's sensational. It's early days. We're in the first five weeks of open, but we've seen great traction. It covers and that - sometimes over 5,000 a week. And that's really energized the West expansion of the floor.

And the Asian table...

And the Asian table games.

[Operator Instructions] Your next question comes from John DeCree with Union Gaming. Please go ahead.

I think most of which have been answered, but to stay on the leverage target of four times and under - and the free cash flow inflection that we're looking for really to kick in next year, I was wondering if you could talk about capital allocation. As you start to approach four times, where would you look to deploy capital, increase the dividend? Is the idea to maybe look for another growth project? How do you view capital allocation as you start to get closer to your leverage target?

I don't think we're there yet. I think we have a singular focus for the time being, which is to get there. And then we have the benefit of having a lot of options. I mean we do control a great pipeline of development sites in the fastest-growing areas of Las Vegas, but we have the option to continue to delever to increase dividends to develop a project out of free cash flow, but I think that's putting the cart before the horse.

This concludes our question-and-answer session. I would like to turn the conference back over to Stephen Cootey for any closing remarks.

Thank you, everyone, for joining the call, and we look forward to talking to you next quarter. Thank you very much. Bye, bye.