Skillz Inc.

Good evening. Thank you for attending today's Skills Fourth Quarter 2021 earnings call. My name is Selina, and I will be your moderator. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I would now like to pass the call over to our host, Stephon Gearhart, VP of Finance with Skills. Please go ahead.

Thank you. Good day and welcome to the Skills fourth quarter 2021 earnings conference call. I'll proceed shortly by reading our forward-looking statements and non-GAAP measures, immediately followed by brief introductory remarks and then a question and answer session. Posting the question and answer session today, we have Andrew Paradis, Chief Executive Officer, Casey Chavkin, Chief Revenue Officer, and Ian Lee, Chief Financial Officer of the company. We hope you've had a chance to read our press release and stock letter, which we published earlier today, and both of which are also available on our investor relations website. We have also posted to our website a short video of our CEO discussing our business highlights this quarter. Team of management's comments today will include forward-looking statements within the meaning of the 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. Therefore, you should exercise caution in interpreting and relying on them. We refer you to the company's SEC filings for more detailed discussion of the risks that could impact future operating results and financial conditions. During the call, management will discuss non-GAAP measures, which we believe 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 measure is available in our fourth quarter 2021 earnings release. And with that, I'll turn the call over to Andrew for some brief opening remarks.

Thanks, Stephan. Good afternoon, everyone, and thank you for joining us today to discuss our fourth quarter and full year 2021 results. Our key four stockholder letter was published to the investor site earlier this afternoon. And before taking your questions, I'd like to just start by sharing a few thoughts. 2021 was a key building year for the company. We set out these two goals, aggressively growing revenue while also building the critical organizational infrastructure we need for the future growth of the platform. We invested really heavily in marketing to grow and engage our user base and added key leaders and talent across the company. We acquired Archie. It positioned us for our long-term vision of registering every person on earth into the competitive platform skills. Having said that, recently we've spoken with a number of our shareholders and we've been listening to your feedback. We've considered that as we're thinking through and building out our 2022 plan. In 2022, as such, we will transition from our strategy of revenue growth at all costs to increasing profitable growth and efficiency. We intend to use the balance sheet that we've built up to build a long-term profitable high growth company. Our company will have the following financial characteristics by the end of this year, so in Q4 2022. So revenue after engagement marketing, our year-over-year growth rate will be north of 30%. Our adjusted EBITDA margin will be better than negative 30%. And we expect adjusted EBITDA breakeven by the end of 2024 and well within the net cash we have on hand. to accomplish this there are a few things we need to uh we need to do inside the company so let me talk a little bit about the key initiatives to improve ltv and separately customer acquisition costs so three of the measures that are probably the three most important that we'll be engaging in 2022 to drive ltv improvement uh first we're going to eliminate our low return engagement marketing programs that are cannibalizing our profit generation Second, we're going to be rolling out more social features across the platform, such as chat and providing greater personalization for all of our users who play in our games, such as improved leagues and technology around how they socially engage and compete. And then third, it's been about 10 years now for the platform, and we haven't refreshed the user interface of our core game loop. We'll be refreshing the interfaces this year, which we think will have a really nice impact on retention for our users. In terms of customer acquisition cost efficiency, we're going to be optimizing our user acquisition spend across geographies, networks, and really focusing on increasing organic traffic. Second, we're going to be investing in our developer community. We've heard the message loud and clear that we need to continue to increase the quality of the content and the platform. And this will enable us both to reach new audiences as well as deepen our content in genres where we already have penetration. And then finally, we'll be migrating more of our user acquisition spend to ARCHI to capture margin that we're giving away right now to third-party DSPs. We've shared more granular details in our Q4 stockholder letter. But that in that, we really believe that the result of these efforts will be a far stronger business. And perhaps even more importantly, it will position us to continue to efficiently grow the company at an attractive pace at the end of 22 and into 2023 and beyond. It's really important, I think, to pause and think for a moment about where we are in the world of mobile gaming and inside of mobile gaming, competitive mobile gaming. We're still very much in the early innings. When we started 10 years ago, we invented this industry. Mobile gaming as a part of the video game industry, it was really, it was the runt of the industry. Today, it's grown from being the smallest part of gaming to being a $90 billion plus industry inside of video games. It's actually the majority share of all video games. And we had the foresight then to build here for now. We're going to continue to follow Gretzky's advice. We're going to keep skating where the puck's going, not where it's been. Converting gamers and developers from ads and in-game purchases to monetizing through competition, it's a multi-billion revenue opportunity, but it's not going to happen overnight. We're very much focused on this vision of building the competition layer for the internet, on focusing first-time video games, on building game by game, developer by developer, and we remain very much convinced that the thoughtful and sustainable growth of this business is the best path for skills to define this new industry. The path to pioneering the future of competition for the entire world is definitely a long one. It's a huge undertaking that we were contemplating that we talk about with you, but it has the potential to create a trillion dollar opportunity in the long term. It's a hundred year journey that we've been on and we continue to be on now at 10 years in, and that hasn't changed because of this last year, and we don't expect it to change this next year. So for those of you who want to be on this journey with us, my sincere thanks. With that, let me open up here for questions.

Thank you. If you would like to ask a question, please press star followed by 1 on your telephone keypad. If for any reason you would like to remove that question, please press star followed by 2. Again, to ask a question, press star 1. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. The first question comes from Michael Graham with Canaccord. Please proceed.

Hey, thanks for the shareholder letter and for the opening thoughts there, Andrew. I just wanted to ask two questions, please. One is on your marketing strategy. Just maybe, you know, a little more depth about kind of how you approach marketing in Q4 and how you think – that might change, you know, in 2022. I know you mentioned eliminating some of the engagement marketing, but maybe just a little more depth on that. And then secondly, you know, your guidance is for sort of 11% growth, but you just mentioned, do you want to exit the year, you know, Q4 at over 30% growth? So maybe just talk about, you know, sort of what that arc sort of looks like and why that's the shape of the year. Thanks so much.

All right. Thank you for the question, Michael. Let me hand out first to Casey, our Chief Revenue Officer, who's on the call to talk about marketing, and then Ian Lee, our CFO, will follow up to talk about revenue guidance.

Thanks, Andrew, and thanks, Michael, for the question. Candidly, we spend more than we should have in both user acquisition and engagement marketing in Q4. And that's not to say that we didn't extract valuable learnings from the expenditures that we made. We did. And we're already leaning into those learnings and inclusive of the things that Andrew mentioned and you just alluded to, like getting rid of the programs that we've seen are not driving profitable growth for the business. But the reality is we spend more than we should have, and as we orient towards a more profitable 2022, we are already reducing both our engagement marketing and user acquisition budgets. And the result of that is going to be and already is improved customer acquisition costs, higher revenue after engagement marketing, and ultimately a more profitable business.

Thanks, Casey. Ian, do you want to talk about revenue guidance? Yeah.

Thanks, Andrew. And thanks, Michael, for the question. So on the topic there that Andrew is referring to, so that was regarding revenue after engagement marking. So as you note in the letter, we expect the full year growth to be 24% year over year. In terms of the kind of cadence through the year, we kind of expect, you know, broadly improvement in the growth rate through the year, if not perfectly linear, as we expect some of the product initiatives that we're launching in this year to kind of generate more returns in the back half of the year. And then to Andrew's specific point, we would expect in Q4 of this year, a revenue after engagement marketing growth rate above 30%. That also goes with an adjusted EBITDA margin of better than negative 30% coming out of the year. So just some kind of a color again on the comments Andrew made on the revenue after engagement marketing curve.

Okay, perfect. Thanks so much, Ian, and thanks, everyone. Thanks, Michael.

Thanks, Michael.

Thank you. The next question comes from Drew Crum with Steeple. Please proceed.

Okay. Thanks. Hey, guys. Good afternoon. In terms of your commentary and plans to reduce engagement marketing as a percentage of revenue, is this something you intend to do over time or is the 10 percentage point reduction you're targeting for 2022 more one-time in nature, just trying to understand how that impacts the guidance to be breakeven by 2024. And then I have a follow-up.

Oh, sure. Thank you for the question, Drew. Let me head off to Casey. He's responsible for managing engagement marketing.

Thanks, Andrew. Drew, the way to think about the optimization of engagement spend is exactly, as I just mentioned, as an optimization. So it's something that we plan to continue doing over time as we look at which incentives are driving profitable growth for the ecosystem, which aren't, and which are short-term in orientation and which aren't. And so the 10% of drop that we expect this year is significant. are the optimizations that we are confident we can execute inside of the calendar year that we expect to continue optimizing that expenditure over time, just as we'll do with all of our other expenditures. Got it. Thanks, Casey. And then just my follow-up, any more detail you can share around the sequential growth you experienced in 4Q with paying mouths? And at least the past few years, you've seen a sequential uptick going from 4Q to 1Q. Is that something that we should be anticipating this year with 1Q? Thanks.

Yeah, Adrian, do you want to answer that? Yeah, so just – sorry, thanks, Andrew. Apologies for that. Just before we finish that, just on the prior question, Drew, I'd say you will see in terms of engagement marketing certainly a sequential decrease in the engagement marketing from Q4 of last year into Q1. So just a note there because we are starting that engagement marketing uh right away um i i would say that um you know we did see obviously a significant increase in um the user base in q4 as well this year as we boosted some of the user acquisition uh marketing i would note that you know in prior years we have seen a boost from q4 to q1 of um of uh in prior years Again, I don't want to give specific guidance on the particular flow of the sequential growth into Q1, but I would say, again, we aren't going to be boosting user acquisition in the same way that we had in prior years, but we'd be focusing much more on the efficiency of that user acquisition starting again in Q1, which has already commenced. Okay. Thanks, Curtis.

Thank you, Drew. The next question comes from Brad Erickson with RBC. Please proceed.

Hi there. Thank you. I guess first, just on the, apologies for my voice, on the lower engagement marketing you spoke to in 22, you know, I guess, do you think you need to make maybe any sort of structural changes as you look to sort of keep players engaged on the platform? Uh, and then, and the second question is just, you know, when you're talking about the break, even in 24, I think that was for just to do that. Can you maybe just help us what sort of a bridge or lag may exist from a free cashflow perspective? Thank you.

Yeah, I'm actually, I'm not sure if, um, Andrew can hear us right now. Uh, Casey, do you want to take this one on, um, engagement marketing? I can take the second part.

Brad, I wasn't sure I understood the question. This is Casey. I wasn't sure I understood the question regarding, did you say structural changes?

Yeah, I think you guys have some pretty common methods to sort of how you look to keep players engaged. on the platform today. And, you know, you've mentioned sort of cutting out some of going after some of those lower value users. And I think in concept, we all can generally understand what that is. I guess my question is really, you know, A, what does sort of that mean? And B, and second, like, are you looking to make any sort of bigger structural changes as you try and execute that strategy? Thanks.

Got it. Yeah. And I think the way to think about it is the engagement marketing spend is typically manifested in terms of specific incentives that we're giving out. And what we've seen over time is that some of those incentives are effective in driving increased engagement, retention, and growth. and resulting monetization. And in other cases, the incentives that we're giving are actually cannibalizing existing player spend on system. And so as we think about 2022 and the concept that, or starting with 2021 and the concept that we were really in very early innings, the thinking for us was we wanted to test really broadly around which programs were going to be most effective and ultimately which ones were going to be least effective. And I think that – I don't think that there are long-term structural changes that we need to make so much as when I mentioned that previously. I think we could have cut some of those underperforming programs faster and saved the money and had a higher profit margin. So I think that what you're seeing us do in 2022 and beyond – is harvesting the learnings from 2021 and applying them across the system. And it doesn't mean that we're not going to continue testing which programs move the needle for our user base, but it does mean that we're going to be judicious and probably cut off the losers sooner.

And hey, Brad, it's Ian. On your second part, so I'm not guiding specifically to free cash flow, but certainly on a unlevered free cash flow basis, there really shouldn't be too much of a lag to either Doug and Bernardo, you know, CapEx intensive business. That's great. Thanks.

Thank you, Brad. Again, to ask a question, there's a star one. We have no additional questions. We have no additional questions waiting at this time, so I'll pass the conference back to the management team for closing remarks.

Yeah. And thank you, operator. And before we hit the closing remarks, we do have some questions that we collected from our shareholders through our state technology portal and wanted to go to those questions now. So the first question that was upvoted was the following. When will we get more news on the NFL partnership?

Great question. Thanks, Stepan. This is Andrew. We're right on track with the NFL competition. I'm a little surprised at some of the trolls out there on the Internet. We will be announcing developer finals this quarter. We're on plan. exactly as we said when we announced the NFL partnership. So if you recall and go and look at when we announced it about this time last year, we said that we would be prepared with NFL to have a game or games to launch by the 2022 NFL season. That's still the timeline with the finalists being announced this quarter. So So basically unchanged from initial plans and excited as ever for the partnership with the NFL.

Great. Thank you. Next upvoted question was, are there any plans to be involved in the metaverse?

That's a great question. When we started talking about building the competition layer of the internet a couple of years ago, it's very much what the pundits are referring to now as the metaverse. Our first market is mobile gaming, and in the future of our platform, we see extending this beyond gaming to markets that range as far along as education and exercise. The concept of skills is abstracting competition out of software. In competition, it's a human activity that has existed probably time immemorial. It's an important part of being human. When you think about what we can do in the digital environment is we can actually perfect competition in ways that you can't offline. We can create higher levels of trust and fairness than anything we've ever experienced in the offline world. And that's very much where we're headed.

Great. Thank you. Uh, next question is, um, skills to the trial, uh, for a pilot launch in India. Uh, do we expect an, an official launch soon?

So in 2021, we started building up a team to establish our business in India. Um, just being very candid, we have the wrong people. Um, and we are, we're retrenching. It's, uh, it's certainly, uh, at least a little bit upsetting to say more about it, because India is still a really large opportunity for us. But as a result, we're not planning to invest more heavily in our India product or content localization, at least for the first half of 2022. I think one of the things that we're messaging everyone right now is that we want to be really focused on doing fewer things in our business really well. But India, it's launching India. It's still an important initial step in SKILL's longer-term journey to capture the massive international gaming market. And we absolutely continue to believe that India and other international markets are a big long-term growth opportunity for us, but it can't be our near-term priority.

Thank you. Next question is, When will you start adding games like Call of Duty or PUBG or Fortnite?

Casey, would you like to answer that question?

Sure. And I suspect there are kind of two questions within this question. I imagine the first question that's being asked here is kind of, what are we doing to grow the content on the ecosystem? And Andrew mentioned this earlier, but the 2022 plan is really to focus on the supply side of our business, which is to say the games and content that are on the network. And I think of this very similarly to what I've seen with other two-sided marketplaces. The initial chapters of the growth story, and I think this is the case with eBay, Airbnb, Uber, Uber, but the initial chapters of that story were really focused on building the demand side of the platform as those companies and we as well sought to establish a new normative consumer behavior in an industry that previously didn't exist. And when I reflect on the years behind us, we've been largely successful in establishing that consumer behavior as evidenced by the transaction volume that's now flowing through the system. But our investment is shifting towards building better content and better products for our developer customers as we see the supply side of our business and the games on the platform as the long-term growth engine of our business. And so as we invest in those developer customers, as we continue to do an increasingly better job of meeting their needs and solving their pain points, We expect to see an increased cadence of new content on the platform and likely a rising quality bar in that content as well. The second part of the question, when I hear that question of, you know, when will you have a game like Call of Duty or PUBG or Fortnite, I imagine the question is, when is Skills going to have just an absolutely massive game with a huge embedded audience like a Call of Duty or a Fortnite? And I do believe that day is coming, but we can't tell you whether that's going to be an existing game. We can't tell you whether that's going to be a – new game for the skills platform, or exactly when that day is going to be that a game like Fortnite or Call of Duty or of that size joins or grows in the platform. I mean, that type of scale is what we're building for, and it's pretty easy to see the potential revenue impact from something like that. I mean, we did $384 million of revenue last year on roughly $3 million playing MAU. And so you can do the math on a single piece of content that brings 20x that current scale onto the platform and what that would mean from a revenue perspective. So it's definitely exciting, but it's not something that we'd want to pick a date and set a promise for when it's coming.

Great. Thank you, Kip. Yeah. And then our last question, you recently borrowed $300 million at 10 and a quarter percent interest. Can you clarify what this is for, considering you still have around $500 million of cash on hand?

Sorry, Ian, I was just going to hand it off to you. I'm glad you already jumped in. You're the right guy for this question.

Sorry for jumping in. Thanks for the question, Stefan. So we did complete a $300 million senior secured debt offering at the end of last year. So that financing really provides us with greater flexibility and allows us to move quickly to take advantage of M&A and other strategic investment opportunities when they arise. And we're really focused on pursuing selective M&A opportunities that accelerate our strategy, our growth, and our profitability. And I can tell you that we are actively evaluating opportunities. But as you know, it's with the nature of M&A and investment opportunities, it's very difficult to predict when and if the deals are going to close.

Great. Thank you. And that takes us to the end of our Q&A. I'll turn it back over to Andrew Paradise for closing comments.

Just wanted to thank everyone sincerely for taking the time to join us today. I know how busy everyone's lives are these days. We very much look forward to providing an update on our progress for 2022 when we report our first quarter results. Until then, thank you.

That concludes the Skills Fourth Quarter 2021 Earnings Call. Thank you for your participation. You may now disconnect your lines.