Mobile game developer Skillz (NYSE:SKLZ) missed analysts' expectations in Q2 FY2023, with revenue down 45.2% year on year to $40.2 million. Skillz made a GAAP loss of $22 million, improving from its loss of $60.6 million in the same quarter last year.
Skillz (SKLZ) Q2 FY2023 Highlights:
- Revenue: $40.2 million vs analyst estimates of $42.6 million (5.66% miss)
- EPS: -$1.05 vs analyst estimates of -$1.26 (16.9% beat)
- Free Cash Flow was -$26.4 million compared to -$26.3 million in the previous quarter
- Gross Margin (GAAP): 90.9%, up from 87.7% in the same quarter last year
- Paying Monthly Active Users (PMAU): 196 thousand, down 224 thousand year on year
Taking a new twist at video gaming, Skillz (NYSE:SKLZ) offers developers a platform to create and distribute mobile games where players can pay fees to compete for cash prizes.
Having gone public via SPAC in December 2020, Skillz provides a mobile gaming platform for developers to create and distribute games where users can pay fees to compete for real cash prizes. The company maintains that because winning is based on skill and not on chance, its games are not traditional casino gambling. However, some argue there is potential legal risk as the lines can sometimes be blurred.
Developers can use Skillz's software development kit (SDK) to add competitive multiplayer functionality and cash prize tournaments to their games, while players can compete against each other for real money. Skillz generates revenue by taking a percentage of the entry fees and cash prizes of each tournament. Game developers themselves can monetize their games through advertisements and in-app purchases. As a result of this dynamic, Skillz and game developers are incentivized to make games addictive to keep player engagement–which drives revenue–high.
Solitaire Cube is an example of a popular game on the Skillz platform. This game resembles the classic solitaire card game, but players can compete head-to-head or in tournaments against others for real money.
Since videogames were invented in the 1970s, they have gradually taken more share of entertainment time. Ubiquitous mobile devices have powered a surge in “snackable” games that can be played on the go. Over time, games have developed more social engagement features where friends can play games together over the internet. The business models of games publishers have become less volatile due to digitization of distribution, in game monetization, and like Hollywood, an increasing dependence on surefire hit franchises. Covid driven lockdowns accelerated adoption and usage of videogames – a trend that has not slowed.
Competitors offering casual digital games that may feature casino-like activities include Skillz (NYSE:SKLZ), PLAYSTUDIOS (NASDAQ:MYPS), and Huuuge (WSE:HUG).Sales Growth
Skillz's revenue growth over the last three years has been strong, averaging 20.9% annually. This quarter, Skillz reported a year on year revenue decline of 45.2%, missing analysts' expectations.
Ahead of the earnings results, analysts covering the company were projecting sales to grow 14.7% over the next 12 months.
Usage Growth
As a video gaming company, Skillz generates revenue growth by expanding both the number of people playing its games as well as how much each of those players spends on (or in) their games.
Skillz has been struggling to grow its monthly active users, a key performance metric for the company. Over the last two years, its users have declined 33.5% annually to 196 thousand. This is one of the lowest rates of growth in the consumer internet sector.
In Q2, Skillz's monthly active users decreased by 224 thousand, a 53.3% drop since last year.
Revenue Per User
Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like Skillz because it measures how much revenue each user generates, which is a function of how much paying users spend on its games. 
Skillz's ARPU growth has been mediocre over the last two years, averaging 4.24%. Although its monthly active users have shrunk during this time, the company's ability to increase prices shows that existing users still value its platform. This quarter, ARPU grew 17.4% year on year to $204.93 per user.
Pricing Power
A company's gross profit margin has a major impact on its ability to extert pricing power, develop new products, and invest in marketing. These factors may ultimately determine the winner in a competitive market, making it a critical metric to track for the long-term investor. Skillz's gross profit margin, which tells us how much money the company gets to keep after covering the base cost of its products and services, came in at 90.9% this quarter, up 3.2 percentage points year on year.
For gaming businesses like Skillz, these aforementioned costs typically include royalties to sports leagues or celebrities featured in games, fees paid to Alphabet or Apple for games downloaded in their digital app stores, and data center and bandwidth expenses associated with delivering games over the internet. After paying for these expenses, Skillz had $0.91 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.
Gross margins have been trending down over the last year, averaging 89.2%. However, Skillz's margins are some of the highest in the consumer internet sector, enabling it to fund large investments in product and marketing during periods of rapid growth to stay one step ahead of the competition.
User Acquisition Efficiency
Unlike enterprise software that's typically sold by dedicated sales teams, consumer internet businesses like Skillz grow from a combination of product virality, paid advertisement, and incentives.
It's very expensive for Skillz to acquire new users as the company has spent 92% of its gross profit on sales and marketing expenses over the last year. This inefficiency indicates a highly competitive environment with little differentiation between Skillz and its peers.
Profitability & Free Cash Flow
Investors frequently analyze operating income to understand a business's core profitability. Similar to operating income, adjusted EBITDA is the most common profitability metric for consumer internet companies because it removes various one-time or non-cash expenses, offering a more normalized view of a company's profit potential.
Skillz's EBITDA was negative $20.2 million this quarter, translating into a -50.4% margin. It pains us to say that this company is one of the least profitable consumer internet businesses, averaging -36.3% EBITDA margins over the last four quarters.
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Skillz burned through $26.4 million in Q2,
Skillz has burned through $88.8 million of cash over the last 12 months, resulting in an uninspiring negative 48.4% free cash flow margin. This low FCF margin stems from Skillz's capital intensive business model and desire to stay competitive.
Key Takeaways from Skillz's Q2 Results
Although Skillz, which has a market capitalization of $243.6 million, has been burning cash over the last 12 months, its more than $352.1 million in cash on hand gives it the flexibility to continue prioritizing growth over profitability.
We struggled to find many strong positives in these results. There was a miss on revenue and absolute growth was weak. There was a more meaningful miss on quarterly adjusted EBITDA. Furthermore, the decline in its user base was concerning. Overall, this was a mediocre quarter for Skillz. The stock is up 2.31% after reporting and currently trades at $11.07 per share.
Is Now The Time?
When considering an investment in Skillz, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter. We cheer for everyone who's making the lives of others easier through technology but in the case of Skillz, we'll be cheering from the sidelines. Its revenue growth has been solid, though we don't expect it to maintain historical growth rates. But while its impressive gross margins are a wonderful starting point for the overall profitability of the business, the downside is that its sales and marketing spend is very high compared to other consumer internet businesses and its growth in monthly active users has been lackluster.
Skillz's price/gross profit ratio based on the next 12 months is 1.2x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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