Skillz Q4 2020 Summary

Truly one of the more interesting companies that has come up on this board - it combines video game development and gambling! I really want to like it, revenue growth is high (95% YoY), margins are high (95%), and paying monthly active users have risen steadily in the past 7 quarters: 13%, 15%, 17%, 46%, 7%, 6%, and 6%

However, it is showing signs of scaling issues. Net losses in 2019 were $24mm, and net losses in 2020 grew to $122mm in 2020. This wouldn’t be so bad if revenues were enormous, but actually this is still quite a small company with revenues only at $230mm for 2020. Seems these losses came pretty much entirely from the ballooning sales and marketing costs, which were 113% of revenues.

Additionally, they don’t even have that much cash on hand to cover losses that big. They have 262mm in cash on the balance sheet. So if losses keep accelerating, they may be pretty much forced to raise capital by diluting shares at some point in the next year or two.

Lastly, the business has some unexplained seasonality. They tell us that, “Typically, in our business, we see a fairly significant increase in the first quarter and then we see a flattening out over Q2, Q3, and Q4.” Personally, I don’t understand why though. Hopefully all this sales and marketing they’ve been doing leads to a huge Q1, but because they don’t guide quarter by quarter (they only provide guidance for the full year), it’s hard to say what to even expect.

CEO/Founder Andrew Paradise (opening remarks)

I wanted to take a moment to highlight a major milestone, which successfully went public after closing our merger with Flying Eagle.

Our success to the platform has broadened the amount of surge in copycats and clones in averaging way, and for all those who are newer to our company and our story, our number one values honor. We plan to vigorously defend our intellectual property against these criminals who represent the turning down the very pillars of the foundation of capitalism.
ExponentialDave: This is not something we want to hear as investors. Hopefully intellectual property defense does not become a key part of the investment thesis.

We powered more than 2 billion tournaments a year, enabling developers to monetize through compensation. Our developer partners are building successful businesses with us. They generate 1.6 billion in GMV or gross marketplace volume for 2020.

“GMV” or “Gross Marketplace Volume” means the total entry fees paid by users for contests hosted on Skillz’s platform. Total entry fees include entry fees paid by end-users using cash deposits, prior cash winnings from end-users’ accounts that have not been withdrawn, and end-user incentives used to enter paid entry fee contests.

The Skillz platform delivers superior player engagement monetization. In 2020, 2.6 million monthly active users or MAU enjoy games on our platform, a 63% increase over 2019. Our users are deeply engaged in our platform. The average paying users spend roughly an hour per day on the platform.

In 2020, 13% of our users engage in prize competition versus 2% for the average mobile game for in app purchases. This high level of engagement together with the increased number of payers powered our revenue to grow to 238 million for the year, and 68 million for the quarter, representing 92% and 95% growth respectively over those prior periods. As we look ahead, we will continue to prioritize our developer success, drive innovation expand the reach of our platform.

Today, I want to highlight three areas for investing into support these goals. First, in-partner enablement, over the past year, of the many areas we’ve continued to invest in is our synchronous gameplay ecosystem. We’re expanding the reach of the platform to enable new gaming genres, ranging from real-time strategy to fighting for racing to first person shooters.

Synchronous content will deliver even higher player engagement than we’ve seen before and will further expand our universe of players, and more importantly, perhaps payers.
Second, in highly scalable technology infrastructure, we made significant investments in our fault tolerant microservices architecture, our fast data architecture, and automated incident response systems. These enable us to efficiently scale our platform with cutting edge performance and resilience while continuing to deliver industry leading reliability of over 99.9% uptime as we scale and resulted in less than half of the outages of a typical gaming company.

Our fast data architecture in the future will continue to unlock new opportunities for AI, such as greater personalization. Our modern technology infrastructure and silver architecture are very much the key to achieving our 95% of gross margins.

The challenge facing many developers today is that scaling at mobile game requires significant capabilities that are beyond the reach for many of the world’s 10 million game developers. Our platform is easy to integrate and provides developers with a powerful set of analytics, payments, customer service and live operations solutions that they need to deliver a fun and fair competitive gaming experience their users. With Skillz developers can focus on what they do best, which is making great games.

So, next I’d like to share four investment initiatives that are incremental for forecast content, distribution, international expansion, and brand integration. First on content, we still have not had a true blockbuster games. Certainly, Big Run was number 17, when it launched, but we’ve never had a number one hit on either App Store. This is one of the most exciting things I look forward to, there’s a significant opportunity to bring new content offerings to consumers.
ExponentialDave: Reminder that “Big Run” is short for “Big Run Solitaire”.

To that end, this quarter, the popular arcade game Big Buck Hunter announced that they’re building the next version of their game on Skillz. This is really exciting because they were an early partner in 2014. They didn’t see success in their first version, but they comeback to build again.

Additionally, this partnership expands our content to the first person shooter genre, one of the most popular categories in modern gaming.
Second, on distribution, I wanted to talk about the new multiyear agreement with the NFL. We’re giving mobile game developers a path to develop an NFL branded mobile eSports using Skillz platform. The NFL is one of the most iconic brands in the world. We’re honored to bring it to the Skillz platform.
In Q2, the NFL and Skillz will launch the developer challenge, but it’ll take multiple quarters before winning games in market. The winning developer will have dual marketing support from both the NFL and Skillz, and with a fan base of hundreds of millions, promotional marketing from the NFL represents a unique distribution opportunity that’s not in our forecast.

Third, on international expansion, today, more than 90% of our revenue comes from North America. And the international market is four times the size of that. Our first international market outside of North America is India, and we expect to launch that market later this year.
India’s mobile gaming market has already reached 137 million gamers and is expected to grow at 26% per year. With that perspective, the U.S. market today is approximately 210 million gamers, it’s growing 6% per year. And these are two-thirds the size of the U.S. market, but it’s growing four times faster.

Fourth, and finally, we see significant opportunity in working with brands. Integrated brand partnerships create value both for the consumers seeking new experiences and also for the brand looking to reach their fans and customers through the channels. In 2020 alone, we paid out 1.3 billion in consumer prices. The brands and sponsored 10% of prize pools would have generated 130 million incremental revenue, nearly all of which would have dropped to the bottom line.

For many years, the independent game makers have been held back by systemic advantages controlled by a select few. By democratizing this market, together, we’re leveling the playing field by enabling those creators to compete. We’re making gaming better for everyone, everywhere. Together, we will realize our mission of eSports for everyone.

FINANCIALS

We have a transaction based business, where we take a percentage commission on every contest run across our platform. The average entry fee is about $3 per person. So based on a 14% take rate, we’re earning $0.84 of revenue for two player contests. We’re running millions of these micro transactions each day, which provides us with high revenue predictability.

Gross profit grew 95% to $64 million during the fourth quarter of 2020, compared with $33 million during the comparable quarter in 2019.

Net loss was $44 million during the fourth quarter of 2020, compared with a net loss of $9 million during the comparable quarter in 2019.

Gross Marketplace Volume1 (“GMV”) grew 78% to $463 million during the fourth quarter of 2020, compared with $259 million during the comparable quarter in 2019.

Gross profit grew 91% to $218 million during 2020, compared with $114 million in 2019.

Net loss was $122 million during 2020, compared with a net loss of $24 million during 2019.

There are many levers that travel revenue, including the number of paying users, the number of paid contest entries per day, the number of days played per month, the average entry fee per contest and the take rate. All these factors boil down to paying monthly active users and average revenue per paying user.

Now, we can turn our attention to the results. Revenue nearly doubled during the fourth quarter to $67.7 million of 95% over the same period last year. For the year, our revenue was $230.1 million, up to 92% over the prior year. This exceeded the full year guidance we provided in our Q3 earnings release of $225mm.

A revenue growth for the year was powered by 101% increase in paying monthly active users.
For the quarter, we continue to have a strong gross margin of 95%.

Most of our cost of revenue consists of payment processing, and user support and server costs, which are all variable expenses. Adjusted EBITDA for the quarter was a negative $23.8 million versus a negative $7.8 million last year, driven largely by higher sales and marketing investment.

An important metric that we track in our business is adjusted EBITDA before user acquisition marketing, or EBITDA before UA. We think that this is a proxy for the profitability of the existing users on the system. We then decide each month, how much we’ll invest to acquire new users based on the ROI we expect to generate. User acquisition marketing the quarter increased to $40.5 million, up from $16.3 million in the prior period.
ExponentialDave: 40mm in one single quarter sounds like a lot considering revenues fro the quarter were $67.7mm.

For the quarter, adjusted EBITDA before UA increased 98% over the prior year, as a percentage of revenue that was 25%, which is consistent with the prior year.
ExponentialDave: So their users became twice as profitable for them two years in a row.

We are more focused on growth and adjusted EBITDA before UA dollars than margin and expect margins to fluctuate from quarter to quarter, based on the timing and investments we are making in headcount and engagement marketing.

For the quarter, R&D grew 46% over the prior period. This was primarily driven by headcount as we continue to invest in the platform features that drive user engagement, retention, and payer conversion, which are core to our superior monetization of the models that rely on ads and in app game purchases. As a percentage of revenue, R&D was 7% for the quarter, down from 10% in the prior year period, highlighting the scalability of our platform, and the opportunity for investment to accelerate our product roadmap.

For the quarter, sales and marketing grew 129% of the prior period. This was driven by investment in user acquisition marketing to accelerate market penetration and marketing programs to drive end user engagement. As a percentage of revenue, sales and marketing is 113% for the quarter, up from 96% in the prior period.

As a reminder, our sales and marketing is comprised of user acquisition marketing costs, and end user engagement marketing. In addition to salaries and related expenses, these end user engagement marketing programs target existing users on the platform to increase their engagement and retention.
Our user acquisition marketing programs target the acquisition of new users to the platform, we can shift spend between those marketing programs to generate activity within our existing player community or increase the number of users on platform.

For the quarter, G&A grew 73% over the prior year period. As a percentage of revenue, G&A was 11% for the quarter down from 12% in the prior year period. The end of the year with an average three year LTV to CAC of 3.8 times, down from 4.5 times as of Q3, driven by rising ad costs.

We believe this is an industry leading metric, and we have a plan to improve it. We’ve never had a cohort stop paying in for seven years now. Every cohort has continued to grow. As a result we realize an additional 102% of LTV after the first three year period, which is not captured in that metric. We ended the year with $262.7 million of cash and no debt on the balance sheet.

ExponentialDave: Great that they have no debt, however, but let’s also not forget the net loss for 2020 was $122mm. So if this happens again next year, they will effectively burn through half their cash. Problem is, losses appear to be accelerating big time! So it does not seem wise to assume losses stay at 122mm. This could eventually lead to a need to raise capital by issuing more shares and diluting the stock. I’m not saying this is eminent, but the probability this happens to Skillz is way more likely than probably any other company in my portfolio.

Now let’s move on to guidance. As set forth in our press release, today, we are initiating our school year 2021 revenue guidance at $366 million. This represents 59% growth on a year-over-year basis over our 2020 results.

Analyst Q & A

ANALYST:

I wanted to start off with a question just about game concentration and revenue concentration. Through your own disclosures, we know that you have a lot of concentration of revenue and a few games. I think that’s been by design, just to know sort of marketing around those games to grow the ecosystem there. But I just wonder, if you can comment on your philosophy there in general? And then I believe there was a third-party report out there, suggesting that download activity might be slowing down a little bit in some of those key games. And I just wonder, if you could maybe talk about what you’re seeing there? And how that’s keeping the business going forward?

Andrew Paradise:
…So for those listening, who are familiar with Tether, previously, our largest customer, they joined our platform, actually, in 2017, there was the largest customer ahead of Tether impact. In fact, as of now actually bigger on which joined us in 2019, Big Run, changed over to being the number one title on our platform. I can tell you candidly today and in the future, we won’t know who will be the next number one title, but we can be certain that it will shift over time, as we’ve seen time and again.

Drew Crum
So, you’ve discussed the Android as a growth driver for the business. With Google recently updating their terms of service to permit the distribution of licensed gambling applications via the Play Store, is there any update you can share with respect to eSports? And any read through what the implications are for Skillz? And then separately, maybe for Scott, you shared the annual revenue guidance for the year. Can you talk about how we should be modeling or thinking about the quarterly phasing for revenue in '21? Thanks.

Andrew Paradise
Sure. Thanks for the question Drew again. This is Andrew here. So, in terms of the Google Play, so Google recently updated the terms of service to permit the distribution of licensed gambling applications as you reference. This update doesn’t actually directly impact Skillz, but I would say, it’s indicative of a broader positive trend towards enablement of emerging content categories. I would point out that even without the Play Store, we’ve been growing Android revenue and our installed base are at twice the rate of iOS on alternative app stores.

Scott Henry
Hi, Drew, I’ll tackle your second question about guidance and how you should think about phasing. So, as we indicated 266 million with the revenue guidance for the year. Typically, in our business, we see a fairly significant increase in the first quarter and then we see a flattening out over Q2, Q3, and Q4. There as you see, we’re making significant investments. We see as an opportunity to make significant investments to grow share and drive long-term value. And then investments should sip in our longer term revenue growth trajectory, and actually, we’ll be able to see the exit velocity in 2021 will be noticeable from that investment.

Eric Sheridan
Just going back to the answer in the commentary on sales and marketing. Can you give us a little bit with repeated qualification or qualification of how we should think about the way in which in the past quarter, you spent sales and marketing dollars towards a mix of user acquisition and user incentives? Obviously, the user number came in a little weaker than some of us had modeled, but the revenue number was a bit better. So just try to understand a little bit of the dynamics of pushing and pulling on certain levers in the business? And then the second part of it would be leaving the December quarter behind. How should we think about philosophically you think about the mix of those sales and marketing levers, not only in Q1, but as we move through '21? Thanks so much.

Andrew Paradise
Eric, thanks for the question. I think the way to think about is, we’re the clear leader in what we see is a trillion dollar market, and now’s the time to invest in capturing that markets or portfolio of investments with both near-term and long-term horizons. I’d remind everyone on the call. We built a $230 million revenue business with $128 million of capital employed as of year-end 2020. We’re a ROI driven culture and our plan very much for the next $128 million is very similar to our plan for the first.

Scott Henry
Eric, I’ll tackle the second question there, right. So, you have to keep in mind, right, we make money from paying users. This is why we focus on growing our paying now, not necessarily growing our now. So in Q4, paying now is up 121% year-over-year, and 13% quarter-over-quarter. So, when we make money for my non-paying now, we’ll focus a little bit more on that metric, right.

But for now, the driver that really moves the needle in our business is paying attention to our paying now. Engagement, marketing increased privately invested in a variety of different things to test in dry payer conversion. And that’s why we were able to hit a record in Q4 of 16% of our users we were able to convert to payers, also from 10% in Q2.

Brian Fitzgerald
Couple of questions. Maybe first up, it’s related to Eric and Drew’s questions, and that’s on Android, but also iOS. Can you talk to us about the channels for CAC that work best for you right now? And how you see that changing? Maybe they do, maybe they don’t as the economy opens? And then also is important. I think we’re going to ask this a lot. How does IDFA impact you in terms of iOS? And then the second question – sorry, was just about how do you feel about your ability to scale the number of players and the number of tournaments and the ability to match like skill sets as you scale users, right? There’s some tradeoff between real-time matches are fun, but you want to be matched up against somebody who’s a like for like skill set. And so sometimes you step in the game for like saying, we don’t have somebody that’s of your heck and so, hold and what you got. And we’re going to come back to you and so there’s a balance between driving engagement, but also driving the matchability, if you understand that? Thanks.

Andrew Paradise
We don’t really expect the material negative impacts on our business from IDFA changes. It could be a small positive for our business.

In fact, if you think about IDFA, what’s happening is making ad targeting less precise. And that has two implications for Skillz. First, you have more limited targeting, which likely means lower CPMs, which challenges ad support business models and actually makes sales monetization even more attractive to the developer community. So, it will actually accelerate adoption for us.

Separately, to answer your second question which was on data science and about fairness, we are only seeing actually faster and fairer matching at continuous scale, actually, the system functions at pretty low levels of daily audience per game, we designed it so that they could auto scale from very small games up to very large ones.

And so, as we’re seeing games, pushing that headroom and becoming bigger and bigger, we’re actually seeing improvements in our ability to deliver a fair outcome, and it’s a system I point out to those who are newer to the story. The data science investments in our company have been deep and significant for actually the life of the business.

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