Skillz Q3 2023 Earnings Call Transcript

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November 8, 2023

There are 6 speakers on the call.

Operator

Afternoon all. I would like to welcome you all to the Skills Inc. 2023 Third Quarter Results Call. My name is Brika, and I will be your moderator for today's call. All lines are on mute for the presentation portion of the call today with an opportunity for questions and answers at the end.

Operator

Followed by the number 1 on your telephone keypad. I would now like to pass the conference over to your host, Jim Leahy from JCIR to begin. So Jim, please go ahead.

Speaker 1

Good afternoon, and welcome to the Skillz Third Quarter Earnings Conference Call. On the call today are Andrew Paradise, Skillz Co Founder and CEO Casey Chafkin, Co Founder and CSO and Jason Rosswig, President and CFO. This afternoon, Skillz issued its 2023 3rd quarter results release, which is available on the company's Investor Relations website. Before I turn the call over to Andrew, please note that some of management's comments today will include forward looking statements within the meaning of federal securities laws. Forward looking statements, which are usually identified by the use of words such as will, expect, should or other similar phrases are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect.

Speaker 1

Therefore, you should exercise caution in interpreting and relying on them. We refer you to the company's SEC filings for a more detailed discussion of the risks that could impact future operating results and financial condition. During the call, management will discuss non GAAP measures, which it believes can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available in the company's Q3 2023 earnings release.

Speaker 1

With that, I'll turn the call over to Andrew for some opening remarks, followed by Jason for a discussion of our financial performance before we open the call for questions. Andrew?

Speaker 2

Thank you, and good afternoon to everyone. Throughout the Q3, we made continued progress on the 4 strategic pillars we laid out last year that we expect to return skills to generating consistent top line growth, cash flow. These four pillars are: 1st, enhancing our call. Platform to improve customer and developer engagement and retention second, up leveling our organization third, improving our go to market efficiency And 4th, demonstrating a clear path to profitability. I want to level set expectations because more progress needs to be achieved ahead in order for us to fully achieve our business turnaround objectives.

Speaker 2

As an example, our traffic levels continue to lag where we want and need them to be. Paying monthly active users was 168,000 in Q3 compared to 200,000 in Q2. Ultimately, We still have more work ahead to grow Skillz' platform to generate consistent profitable growth and enhance shareholder value. Our near term focus has been to improve our user economics before focusing on growing traffic for the sake of growth. We have been focusing on reducing acquisition costs and on growing LTV by improving our product experience to drive higher engagement.

Speaker 2

Once we reach our target of a Sustained 6 month payback period will shift focus to growing traffic. Beyond the product experience itself, we're working on our VIP program to share our most valuable players are recognized, rewarded and retained. We've built a unique platform and if we prioritize Let me turn to a brief review of our Q3 progress and Q4 to date before I turn the call to Jason for a review of the financials. I'll begin with some of the highlights of our efforts to enhance our platform to improve customer and developer engagement and retention. As we discussed on our Q2 call, our product team is developing a new feature pipeline that is driving higher customer retention, engagement and monetization.

Speaker 2

To this end, we introduced 2 new product features in Q3, Daily Challenges and Progressive Leagues, which have now been rolled out to games that account for the majority of our revenue. When we introduce new features, we're targeting a 10% or greater improvement in retention, engagement or monetization. And I'm pleased to share that the 2 new features accomplished this goal in Q3. For Q4, we expect to roll out 2 to 3 new features, And then we'll look to extend that momentum into 2024. It's truly exciting to see the platform launching new meaningful features for our players.

Speaker 2

Turning to our 2nd pillar, up leveling our organization. Our focus on performance, ownership and accountability is A tangible difference in productivity as evidenced by the new accretive features of our product and engineering organizations that have been built this past quarter As well as the lineup of new product features for Q4 and 2024. In Q3, we filled key roles that we expect will significantly benefit our company And included roles such as Vice President of Consumer, Head of Developer Product and Head of Mobile Engineering. We're also making progress with transitioning away from our dependence on contract labor to full time permanent employees that are committed to Skill's mission. While we still have work to do, we've made measured progress with putting the right people in the right roles, over getting our newer employees fully up to speed with our strategic priorities.

Speaker 2

In this respect, we expect our upcoming move into our new Las Vegas headquarters will further enhance collaboration, productivity and accountability across the organization. Moving on to our 3rd pillar, our go to market. Our Q3 user acquisition cost was the lowest since 2020. We're on track to achieve a payback period of 6 months in the next few quarters. This will position Skillz as having well above the industry average payback period for companies in the mobile gaming market.

Speaker 2

Moreover, in Q3, we launched our highest number of prize enabled games since Q2 of last year. So that's the highest since we started turning around our business. This reflects the changes we made in Q2 to relaunch our developer revenue share agreement. To remind listeners, we now share revenue based on entry fees as opposed to a percentage of profits, which is much easier for developers to understand and calculate in real time. So this changed several of our biggest developers introduced new games in Q3.

Speaker 2

Developers such as Big Round Studios And Tether Studios released new content for the first time in several quarters and are reengaged in growing the platform. Beyond getting our developer community to launch more content, we're also improving the transparency and monitoring of games that are candidates under our skills publishing model. As we finish improving user economics and transition to growing traffic as our top priority, we'll look to grow new titles beyond the existing core library. We'll tightly monitor the game level economics by channel to ensure that every dollar spent generates an attractive return on investment. Before we move to discuss our 4th pillar of moving the company to profitability, I wanted to revisit a topic that we discussed on our Q2 call.

Speaker 2

Critical to the customer and developer engagement in our industry is addressing the deceptive use of bots To defraud players of their winnings, which has become prevalent across our industry. I want to expand on this topic now as it's essential to ensuring the future of our To be clear, our industry cannot exist without assuring players are not deceived by bots as this attacks the very essence A fair and meaningful competition. Skill's proprietary platform fairly matches players against other real players. You always play humans when you play on skills. This is not the case with all companies in our market.

Speaker 2

To preserve the Anderson industry we've created, we've deployed a meaningful amount of resources to combat this deception. An example of this a lawsuit we filed alongside Big Run Studios against ABA Games as it's evident to us and Big Run that ABA Games uses bots. This is a company that is committing consumer fraud that to date amounts to over $1,000,000 Their deceptive use of bots means the games on their platform are rigged, pure and simple. They're stealing money from players that don't know they're playing against the bot And believe they're playing against another human opponent. Despite clear evidence to the contrary, ABA Games continues publicly state that they do not use bots and continues to entice consumers based on a false promise of fairness.

Speaker 2

I want to thank the news outlets in the past months that have already covered this fraud in our industry, and I'd encourage everyone on this call to read the press coverage. We know there are other companies in our industry who use bots and that makes them just as corrupt as ABA Games and we will continue our efforts to expose those practices. This year, our legal spend will approximately amount to $18,000,000 And while it certainly impacts our near term operating results and cash burn, We know that readying this industry of these deceptive practices is the only path forward for the industry. Since we're the leading company that created this industry and we don't engage in bots, we have to fight this. We anticipate the elimination of this practice to dramatically change the future of the industry.

Speaker 2

Absent our actions, It's absolutely critical for both players and developers that 100% of the industry needs the highest level of Trust for consumers. Now that we discuss the fight for fairness, let me talk a little bit about our 4th pillar, which is demonstrating a clear path to profitability. Jason will review the details of our Q3 results in a moment, but I'm encouraged by the progress we've achieved to become profitable. This provides me with cautious optimism that we're on pace to generate quarterly sequential top line growth in 2024 and achieve our goal of generating positive adjusted EBITDA on a run rate basis by the end of next year. In Q3, we continued to improve our cash management as our operating cash burn was $18,500,000 and our Total cash burn, including one time items, came to approximately $21,000,000 Given our net cash position of approximately 2 $1,000,000 in quarter over quarter improvements of our operating cash burn, we have a significant runway to return our business to sustainable, high velocity, profitable

Speaker 3

growth.

Speaker 2

In closing, while real progress has been made, I hope it's evident that we're well aware that we have much work to do. The Skills Board, management team and the entire organization remain firmly dedicated to successfully executing on our 4 pillars And creating a strong foundation to create value for our shareholders.

Speaker 3

And

Speaker 2

with that, I'll turn it over to Jason.

Speaker 3

Thanks, Andrew. Revenue in the 3rd quarter was 36,400,000 Down 38% year over year and down 9.3% sequentially. Our paid user conversion rate, which is paying MAU divided by MAU, was 16% in Q3, Slightly down from 18% in Q2 due to prioritizing optimizing our platform over user acquisition in the prior quarter. 3rd quarter UA Marketing was $6,200,000 a decrease of 66% year over year And a 21% decrease quarter over quarter. As Andrew indicated, we are confident in our ability Continue to improve our payback period with the goal of achieving a best in class 6 month target.

Speaker 3

Q3 engagement marketing was $16,900,000 down 28% year over year and in line with Q2. Research and development expense was $7,900,000 in the quarter, down 1% year over year. On a GAAP basis, R and D was 21.6 percent of quarterly revenue. Sales and marketing expense was $31,900,000 down 38% year over year, including $2,500,000 of stock based compensation. On a GAAP basis, Sales and marketing was 88% of Q3 revenue, up 1 basis point year over year and up 7 basis points quarter over quarter.

Speaker 3

General and administrative expense was $24,400,000 inclusive of $8,500,000 in stock based compensation, up 16.5% year over year. On a GAAP basis, G and A was 67% of revenue, up 31.6 basis points year over year. Quarter over quarter, G and A was up 2 basis points as a percent of revenue. Net loss of $33,500,000 decreased by $49,700,000 year over year. Adjusted EBITDA in the quarter was negative $18,500,000 a 14% year over year decrease and a 2% decrease quarter over quarter.

Speaker 3

Adjusted EBITDA margin decreased by 4% from negative 47% in Q2 to negative 51% in Q3. We ended the 3rd quarter with $339,900,000 of cash comprised of $330,000,000 cash and cash equivalents, dollars 7,000,000 of marketable securities, $2,900,000 in restricted cash and ended the quarter with approximately $130,000,000 of total outstanding debt. With our improving cash burn rate, we have the flexibility to deploy capital to enhance shareholder value. Last, I would like to touch on an adjustment we made to our Q2 2023 financial statements that will be reflected in our Q3 2023 10 Q filing. During the preparation of condensed consolidated financial statements For the period ended September 30, 2023, the company identified certain immaterial errors related to stock compensation expense And operating expense accrual for the 3 months ended June 30, 2023, which resulted in a net overstatement of operating expenses for the period.

Speaker 3

First, we identified that an accrual related to professional services Was incorrectly over accrued in Q2. As a result of the adjustment, our Q2 financial statement operating expenses improved by $1,300,000 adjusted EBITDA resulted in a change in Q2 from negative $20,200,000 to negative $18,400,000 2nd, we identified an error in how we reported stock based compensation, resulting in a benefit of $4,000,000 to our net loss. Both of these errors resulted in an improvement in Q2 net loss From negative $22,000,000 to negative $16,700,000 We have the proper controls in place to ensure these errors only impact Q2 and will not be repeated. At this time, we'll turn the call to the operator for the Q and A session.

Operator

We have the first question on the line from Ed Alter of Jefferies. Your line is now open.

Speaker 4

Hi, everyone. This is Ed Alterra on for Andrew. Just maybe for Andrew, Just provide an update on some new web share agreement and how studios at large are reacting to that and when we can expect To see some of them putting some of their own marketing dollars behind Spengler Games and what that impact would be.

Speaker 2

Sure. Thank you for the question. So the DevRev share went live in May To give everyone a good idea of timing of how long it takes to build a mobile game, bring it to market and scale, we should expect 6 to 18 months And probably more realistically 18 months. So 6 months being kind of the fastest time to market to build a game. We've seen a Reinvigorated content creation community, building games again on the platform.

Speaker 2

And I mentioned in my remarks, both Big Run and Tether Built and launched games in Q3, which are 2 of our top customers. But we have a mix of both existing and new customers That make up all the games that went live in Q3. From an expectation standpoint of when those could scale, I would say We should look for them to have impact on revenue in more like 6 to 12 months.

Speaker 4

Great. Thanks for that. And then looking at the take rate, it looks like it's And dipping down the last couple of quarters, just talk through kind of the drivers of that. Is that the rev share coming through on that or what's driving that?

Speaker 2

That's a great question, Ed. Jason, do you want to take that one?

Speaker 3

Thanks, Ed. So I think we've had over the last several quarters, as we've had lower User acquisition, we have less users, but we've been seeing that the users on our platform Have become more valuable to us. So over time, we've seen our mature more mature user economics improving Despite lower despite overall lower users on the platform. I'd also say that as you Well, your marketing expense, right, shared with the developers that also reduces their payments, right? So you also have that effect showing through in the financials.

Speaker 5

Ed, this is Casey Chacken. Just to make sure I clarify what Jason is saying there. When we spend money on consumer acquisition, that money is treated as an operating expense, meaning it actually it increases our revenue. The developer portion of that though is a contra revenue and that expense is shared with our developers. When our marketing expense is higher, the developers are sharing in that expense and that increases our the effective take rate.

Speaker 5

When the marketing expense is lower, developers aren't sharing don't have as much of that expense burden, and so their revenue share goes up as a percentage of revenue.

Speaker 4

I see. I see. So then what would be kind of a longer term target to think about as you But where's that profitability mark in 4Q 'twenty four? What would the take rates kind of be in the ballpark for that scenario?

Speaker 5

From my perspective, I think what you can expect is if Skillz is Running the acquisition budgets, you could expect a take rate roughly in line with where we are right now. But as we see games that are running Their own marketing budgets, that take rate would conceivably be lower. And so right now, we don't as a from a forecasting perspective, we don't break out Those two possibilities in terms of growth. But you could you kind of expect in a status quo environment Where skills is largely the driving force of marketing on the platform, the take rate would be in line with where it is now.

Speaker 4

Great, great. Thanks. That's all I had. Thanks for the time, guys.

Speaker 2

Thanks, Ed.

Operator

Thank you. I would now like to hand it back to Andrew Paradise for closing remarks.

Speaker 2

Great. All right. Well, thank you all again for joining us today. We look forward to providing updates on our progress as we return skills to sustained profitable growth In 2024. And we'll look forward to meeting with you to discuss our Q4 results on our next call.

Speaker 2

Until then, take care.

Operator

Thank you all for joining the Skills Inc. 2023 Third Quarter Results Call. I can confirm this is now concluded. Please have a lovely rest of your day and you may now disconnect your line.

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Skillz Q3 2023
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