Skillz Inc.

Hello and welcome to today's Skills Inc 2023 second quarter results call. My name is Bailey and I'll be your moderator for today. 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 followed by one on your telephone keypad. I would now like to pass the conference over to Jim Leahy, Investor Relations for Skills Inc. Please go ahead.

Good afternoon, and welcome to the SCILS second quarter earnings conference call. On the call today are Andrew Paradise, SCILS co-founder and CEO, Casey Chavkin, co-founder and CSO, and Jason Rossery, president and CFO. This afternoon, SCILS issued its 2023 second 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 the 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. 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 conditions. During the call, management will discuss non-GAAP measures, which it believes can be useful in evaluating a 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. Reconciliation of these measures to the most directly comparable GAAP measures is available in the company's second quarter 2023 earnings release. With that, I'll turn the call over to Andrew for some opening remarks, followed by Jason for discussion of our financial performance, Before we open the call for questions, Andrew.

Thank you for the introduction and good afternoon to everyone. Throughout the second quarter, we made further progress on the four strategic pillars we laid out last year that we expect will position skills to deliver consistent top line growth and positive cashflow. As a reminder, these four pillars are first enhancing our platform to improve customer developer engagement and retention. Second, up-leveling our organization. And third, improving our go-to-market efficiency. Our successful execution against these first three pillars then leads into the progress we are making with achieving our fourth key pillar, demonstrating a clear path to profitability. With the goal of generating positive adjusted EBITDA by the end of 2024. While our progress to date is encouraging, we remain confident in our ability to continue improving the business. We still have much more work to do to get skills positioned where it can generate consistent growth and enhance shareholder value. I'm certainly proud of the effort and commitment demonstrated by our team to date, and I'm excited for the continued progress we'll achieve through our collective efforts. With that, let me turn to a brief review of our second quarter progress and then 3Q to date before I turn the call to Jason for a review of the 2Q financial results. I'll begin with some of the highlights of our efforts to enhance our platform to improve customer and developer engagement and retention. Our product team continues to develop an extensive new feature pipeline that's expected to drive higher customer retention, engagement, and monetization. The cascading effects of those improvements are higher LTVs and optimization of our user acquisition payback period. Our new feature product pipeline currently covers the next 18 months. Our team is continuing its development efforts as we work hard to catch up after a hiatus last year, where we focused on achieving operational efficiency. In Q2, we released daily challenges, new limited time challenges, which have been scaled across our platform to games that account for approximately half of our total revenue. While numbers are still in the early stages, we've already seen an uptick in LTV based on improved retention engagements. We're working on ensuring we have a regular key into new product introductions as we look to roll out a number of additional player engagement features by the end of 2023. And we look forward to sharing these with you in upcoming calls. For our developers, the changes we implemented in May, which revised our revenue share agreements based on entry fees rather than net revenue, have been well received. Thanks to these changes, developers increasingly see skills as a partner that's committed to helping them grow their business by increasing their revenue as they drive more traffic to our platform. We've also made progress with how we prioritize games that would benefit from being skills-powered, where we invest in user acquisition to scale the user base versus the normal game path where developers run their own marketing plan and spend. Along those lines, we're excited to be adding more content from both existing and new developers with the potential to properly scale. I'd like to also share an update on our deepening relationship with Exit Games, which will drive benefits to our developer community. Working closely with Exit's team, we've simplified the path for our developers to incorporate their Photon multiplayer engine more comprehensively into games on our platform. Exit's best-in-class technology gives developers the ability to create games with sophisticated multiplayer functionality quickly and easily, making it simpler than ever for developers to bring an even broader range of innovative experiences to skills. The last topic I'd like to address for customer and developer engagement is the deceptive use of bots in our industry. Skillz is a unique inventor in this market and will continue to innovate the future of competitive gaming. While message boards have suggested that we're faking our proprietary technology claims, the reality is those that have been able to seemingly mirror our technology are doing so by using bots. The Skillz platform has never used bots and never will. Our proprietary platform provides certainty that every player is fairly matched against another real player. Skills stands alone in our commitment to fair play for skill-based gaming. Because we seek to preserve our reputation and that of the industry we've created, we intend to address the issue and increase customers' visibility into those competitors that are using bots. We'll deploy resources to combat the usage of bots in our industry so that customers are no longer misled by certain companies. Further, we'd ask that our shareholders join us in our mission to keep the competitive gaming industry fair and transparent. Our shareholders can help drive this change by engaging with appropriate regulatory bodies and their local jurisdictions to address this practice and eradicate the deceptive use of bots. Absent taking action, consumers who engage in skill-based games will continue to be deceived, and this industry will eventually lose the public's trust. It's absolutely critical for both players and developers we ensure Fairness is everywhere. It's 100% of the industry, and that this industry needs consumers' trust and accountability. Turning to our second pillar, up-leveling our organization. We continue to make progress in optimizing our workforce to drive consistent growth. I've discussed on prior calls the challenges we had post-IPO as we significantly scaled our organization And then very quickly, we're faced with the impact of the pandemic and how remote work negatively impacted our culture. I'm pleased to report we're on a good path to getting back to those core 10s of our culture. High performance, high accountability, strong collaboration, and product ownership at every level. This quarter, we filled key roles, including general counsel, head of user acquisition for performance marketing, head of games marketing, and head of people operations. That's in addition to onboarding a team of nearly 10 recruiters to accelerate our ability to finish rebuilding. In Q3, we're focusing on key roles, which will have a significant impact to our company in the second half of the year, including a head of player advocacy to ensure compelling experiences for our VIPs and a GM of our developer platform to ensure we're optimizing our platform to best serve the needs of our developers and to maximize the profitability of their games. While we're not all the way there, we have made significant progress with putting the right people in the right roles and bringing our newer employees fully up to speed. We don't expect about a thousand, so even as we bring on promising new talent, we're equally focused on our performance management process and apply new areas of our business where further changes may still be necessary. Our performance management mindset has made a tangible difference in productivity and ownership as evidenced in part by the great work our product and engineering organizations are doing to create an extensive lineup of new product features that I discussed a moment ago. Our upcoming move into our new Las Vegas headquarters will also enhance the culture for our current team members and position us to recruit new world-class talent that can help us grow. With the employment displacement in Silicon Valley, we're seeing some of the brightest, most capable potential team members, and we're positioning skills as the employer of choice for team members that can further strengthen our culture of performance. With respect to Archi, a leading advertising technology platform, Aman Sareen and his team have made consistent progress towards strengthening and optimizing the platform and turning around the business. Look forward to supporting their team to help them drive additional growth. Moving on to our third pillar, improving our go-to-market. Exiting the second quarter, our user acquisition cost was the lowest it's been since 2020, reinforcing the effectiveness of our efforts. Our payback period for UA exiting July was approximately 11 months, which compares favorably to 28 months a year ago, placing us on track to reach a best in class payback period of six months in the next few quarters. In addition to the benefit from consistently rolling out new product features, top line growth is largely driven by how much we can invest to attract and retain new players. Our UA spend is now generating solid returns and with the right system and leadership in place to ensure we generate an appropriate ROI going forward. We launched 20 prize-enabled games in Q2, which was our biggest quarter in the last three quarters. Our goal for the second half of 2023 is to begin to scale as we plan to allocate UA funds to incubate between 5 and 10 new games, while also achieving continued improvement in our payback period. We also intend to continue adding and promoting more games to our platform to round out content in existing content categories, as well as to establish footholds in promising new categories to attract an even wider and more diverse audience. I highlighted at the start of my comments that our first three pillars are the initiatives that will drive our ability to achieve our fourth pillar, demonstrating a clear path to profitability. Jason will review the details of our second quarter results in a few moments, but I will share the progress we're achieving and the further progress we expect to make over the second half of the year is encouraging. It provides me with a cautious optimism that we're on a pace to achieve our goal of generating adjusted EBITDA positive by the end of 2024. We're encouraged with our recent improvements in cash management, specifically reduction in our operating cash burn to approximately 17 million over the past six months, which compares favorably to our adjusted EBITDA over the same period. Given our net debt cash position of approximately 230 million, this implies six years of runway to return our business to high velocity profitable growth. Not that we anticipate needing anywhere near that long as reflected in our goal to generate adjusted EBITDA positive by the end of next year. In closing, our last several quarters made consistent progress with our operating priorities. And while I'm pleased with this progress, it should be said that we still have much work to do. Skills board, management team, and the entire team is entirely committed to successfully execute our four pillars so the company will have a significantly better foundation to create value for our shareholders. And with that, I'll turn it over to Jason.

Thanks, Andrew. Revenue in the second quarter was $40.2 million, down 44% year-over-year and down 10% sequentially. Our pair conversion rate, which is paying MAU divided by MAU, was 18% in the quarter, which compares favorably to 17% in Q1. Second quarter UA marketing was 7.8 million, a decrease of 74% year-over-year and a 6% decrease quarter-over-quarter. As Andrew indicated, we are confident in our ability to continue to improve our payback period with the goal of achieving a best-in-class six-month target. Q2 engaged marketing was 17.1 million, down 45% year-over-year and down 3% quarter over quarter. Research and development was $8.9 million in the quarter, down 51% year over year. On a gap basis, R&D was 22% of quarterly revenue. Sales and marketing was $33.1 million, down 55% year over year, including $2.5 million of stock-based compensation. On a GAAP basis, sales and marketing was 82% of Q2 revenue, down 2,100 basis points year-over-year, and up 350 basis points quarter-over-quarter. General and administrative expense was $30.1 million, inclusive of $11.6 million in stock-based compensation, up 12% year-over-year. On a GAAP basis, G&A was 75% of revenue, up 1,200 basis points year-over-year. On a quarterly sequential basis, G&A was up 1,200 basis points as a percent of revenue. Net loss of 21.9 million decreased by 40.6 million year-over-year. Adjusted EBITDA in the quarter was negative 20.2 million, a 42% year-over-year improvement and improvement of 3% quarter-over-quarter. Adjusted EBITDA margin of negative 50% improved 600 basis points year-over-year and decreased 700 basis points quarter-over-quarter. We ended the second quarter with $361 million of cash, comprising $328 million cash and cash equivalents and $33 million of marketable securities. Following our repurchase in April of approximately $160 million of outstanding debt, we ended the quarter with approximately 130 million of total outstanding debt. In addition to driving a nearly $60 million benefit over the next 30 years, when we repurchased the debt, we also received consents to an amendment of the indenture that increased the general restricted payments basket by 40 million from 25 to 65 million. This provides us with attractive liquidity, which allows management and the board to immediately evaluate opportunities to deploy capital to enhance shareholder value. At this time, we'll turn the call to the operator for the Q&A session.

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, please press star followed by 1. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question, and please do ensure that you have unmuted locally. Our first question today comes from the line of Jason Tilchen from Tanacord. Please go ahead, Jason. Your line is now open.

Great. Good afternoon. Thanks for taking my question. Maybe to start, how do you view the current competitive landscape for developer talent And how has the introduction of those new developer terms several months ago impacted your relationship with developers, helped attract new talent so far?

Jason, thanks for the question. This is Andrew. I think it would probably be best if we had Casey comment a bit on our overall strategy of how we're working against our competitors in our space.

Thank you, Andrew. And thank you, Jason, for the question. Jason, I think broadly, it's important to remember that skills is ostensibly the only platform in this skill gaming or casual esports business. And when you look at the gaming sector as a whole, in the early days of any new category or sector, being a fast follower is a relatively lucrative strategy. And that's because the cost to replicate the best games is low. The time to market is fast. And you can see this historically with businesses like Zynga that use this strategy to enter Facebook gaming, kind of in the 2008-ish timeframe, and Stormy, which subsequently followed them, using this to enter the mobile gaming sector. What you see is that if the economic opportunity of any of these new categories is proven out, as it was in Facebook, as it was in mobile, and now as it's being proven out in casual esports, content creators will increase their level of investment into more intricate and complex play experiences to match the size of the economic opportunity they have in front of them. And so as the games become more complex, the ability to fast follow, aka really copy, is reduced. And that's not just because of the direct expenses that come from development, but it's also because of the time to market and because the nuances of what make a game great aren't always overtly visible. And that makes copying difficult or even unpredictable. And so what you see is increased complexity of skill games, or what we see happening is that the increased complexity of skill-based games or casualty sports is inevitable as the industry grows. The play experiences will become more robust. The investment that goes into building them will become greater. And as that happens, what we see happening is platforms winning out over individual vertically integrated competitors. because the source of the next hit becomes increasingly diverse and unpredictable. So we don't know necessarily which studio is going to build the next great game, but you see investment increasing, which increases the likelihood of those really big hits. And so for skills as the only platform for skill-based games or casual esports, we are ostensibly the fastest, easiest, most reliable way for developers to get their products to market in this emerging category or industry. And that makes skills the most likely place for the next game to emerge. And so just as Andrew was saying, and you correctly bring up the changes that we made, those really lean into our competitive advantage of encouraging and empowering developers to create the competitive experiences that don't exist anywhere else. And I think while, well, maybe I'll let Andrew talk about kind of how the creators have received some of the changes.

Yeah, thanks, Casey. We've received initial positive feedback from the entire developer community and have really moved every developer now over to the new model, which is no small feat. Reengineering the rep share in our partnership with the developers as a premature platform and getting all of our developers moved over to this traffic based approach, which, frankly, it makes more sense for both the developers and for skills platform. because we want to align all parties on creating network effect that in turn benefits all parties on the platform and accelerates the benefits for each new developer who would look to join. So we've made that happen. We've had positive feedback from our existing developers. In fact, multiple of our existing developers who may have been on pause on further investment into the platform have actually started investing again in building new content It's also led to second to several developers that had considered using skills to go to market in the past that are now actually putting their games on the service. And then I'd say third, we've been getting a growing amount of very positive feedback in one-on-one discussions at developer conferences. So I'd say in general, the feedback is that the new model is a lot better. It's easier to understand. And it has rewards for developers performing games, which I think every one of our customers wants.

Great. That was really helpful. One other question. Maybe you could just share a little bit more about the types of releases we can maybe expect in that product pipeline. You talked about how you sort of see visibility for 18 months. Is there anything else you can share that we can maybe expect on that front?

Yeah, and thanks for asking about that because, you know, probably the most encouraging thing that happened for me personally in the quarter is that we've started to release midsize features again and make meaningful changes to retention, engagement, and monetization. And when we really entered, turned around this business about a year ago, that just wasn't the case. We hadn't put out a meaningful product in over 18 months. So we really came to a standstill on the development phase as well as the testing phase and rollout. So where we are and some of the things I can talk about from Q2, we launched daily challenges and we're doing a full rollout in this quarter in Q3. That is seeing double digit improvements in our core metrics of retention, engagement and monetization. we have key, uh, key experience changes for the player coming in, uh, in the back half this year. So one of the things that call out is, uh, is overhauling our league system as a tournament platform. You'd expect us to have really great leagues. Uh, we built a league technology, uh, that hadn't seen an overhaul in quite some time. Uh, the new leagues will, uh, will, will, I'd say really deliver a more meaningful experience for every player at every level. And we think it's too early to comment yet on the metrics there and what we'll see, but we do believe that that can result in a double-digit improvement in these core metrics of retention, engagement, and monetization. We launched actually pretty excitingly end-to-end. We were able to release a feature in under five weeks, which is much more like the old skills before we we've gone to all the situation with releasing products and that features instant match and what that is is being able to pop basically a tile for a user as they're playing and that gives them an opportunity to participate in a real-time match or potentially a slight upsell to their existing play behavior. That feature is already live and testing on the platform, and then I believe we'll see rollout in Q3. We've overhauled chat, but that's in testing and not rolled, so that'll be in the back half this year. And also introducing probably long overdue for a platform, but getting single sign-on up and really making that a reality for all the players on the platform. So maybe to recap that because it's quite a few things, but progressive leagues, instant matching, chat, and single sign-on with daily challenges launched in Q2 and rolling in Q3. Great. Thanks a lot.

Thank you. There are no additional questions waiting at this time, so I'll pass the conference over to Andrew Paradise for any closing remarks.

All right. Well, thank you all again for joining us today. We look forward to providing updates throughout the year and our progress as we return the company to sustained and profitable growth, including longer report on our third quarter results in November. Really appreciate the time and everyone's patience as we complete this turnaround. And I feel confident that we can achieve many, many great things for the competition platform forward together.

This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.