Earnings Call Transcript - SKLZ Q2 2021

Operator, Operator

Good day, and welcome to the Skillz Second Quarter 2021 Earnings Conference Call. I will proceed shortly by reading our forward-looking statements and non-GAAP measures immediately followed by question-and-answer session. Hosting the question-and-answer session today, we have Andrew Paradise, Chief Executive Officer; Casey Chafkin, Chief Revenue Officer; and Ian Lee, Chief Financial Officer of the company. We hope you had a chance to read our press release and stockholder letter that we published earlier today, 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 for this quarter. Some 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 and other such 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 SEC’s – 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 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 measures is available in our second quarter 2021 earnings release. With that, I'll turn the call over to Andrew.

Andrew Paradise, CEO

Thank you, Stephan. Good afternoon, everyone, and thank you all for joining us today to discuss our second quarter 2021 results. This quarter, we made important investments that will accelerate key initiatives to grow our users, increase our content and advance our platform technologies, really setting the stage for long-term growth. Hopefully, you've all had an opportunity to read our stockholder letter, which contains details on our Q2 performance. With that, let me open it up for questions.

Michael Graham, Analyst

Thank you. Thanks for taking the question. I wanted to ask two. The first is on your conversion to paying players was up again this quarter, which is great. Just maybe comment on how much higher you think that can trend over time? And then I wanted to ask about the Exit Games investment and the synchronous player capability. You had talked about some developers testing synchronous on the platform before this investment. So I'm just wondering if you can update us on sort of timing of when we might see more activity there on the platform? And is that development pipeline now going to be sort of gated by Exit? Or just maybe talk about that whole vector for us?

Andrew Paradise, CEO

Yes. Yes. So let's take that in two parts. Thank you for the question. Probably the first part, talking about conversion to paying users. I'd refer to ask Casey Chafkin, our Chief Revenue Officer, to comment as his team is responsible for optimizing this metric.

Casey Chafkin, CRO

Michael, this is Casey. Thank you for the question and for your continued interest in the business. We believe there is significant potential in enhancing our conversion rate from players to paying customers. This is an area we have been analyzing since the beginning of the business. We have conducted market surveys and examined it from various perspectives, and we are confident that we can increase the conversion rate to 40% or higher in the long term.

Andrew Paradise, CEO

Let me address the second part of your question, Michael, regarding Aarki and its impact on our user acquisition spending. We anticipate that Aarki will generate $13 million in revenue for the remainder of 2021, excluding synergies.

Ian Lee, CFO

I think Michael was asking about...

Andrew Paradise, CEO

Exit, sorry. Two deals, both closing recently.

Michael Graham, Analyst

You've got a lot going on.

Andrew Paradise, CEO

I know, I know. And we started talking about paying users and conversion, I started thinking about Aarki. Okay. Let me tell you a little bit about Exit. So the reason for the Exit investment, it's an alliance that really accelerates our expansion into genres such as racing, fighting and first-person shooter games. Candidly, these are the genres that I love most as a gamer, and I've been incredibly excited about this development. Exit's has actually been working on building the most advanced multiplayer server technology for about 15 years now. So the alliance with Exit gives us platform exclusivity for Exit's technology. It positions us to be the preferred partner for publishers and developers worldwide if they're interested in using skill-based gaming as a way to monetize and multiplayer synchronous technology from Exit. In terms of the integration, our SDK will be integrated with Exit's Photon Engine. This will make it easier for developers to rapidly enable their games for competition.

Michael Graham, Analyst

Okay. Thanks a lot for the color.

Andrew Paradise, CEO

Of course. Thanks, Michael.

Brian Fitzgerald, Analyst

Thanks. I will pick up on the Aarki question from where Michael left off. He went to the trade scope of WestPoint we made by the way. So two-part question. One is on the average LTV for CAC, what's that been trending like as we've kind of progressed through the first half of the year, where do you see it during the second half of the year? And how do you see that going forward with some of these tools and assets that you're brought and you're bringing to bear, specifically around if you could quantify how Aarki is helping in costs in the quarter and what you see that doing for you from a CAC perspective in the second half of the year?

Andrew Paradise, CEO

Sure. So in terms of LTV over CAC, I'll actually ask Casey to answer that one first as this is very near and dear to his activities as CRO.

Casey Chafkin, CRO

It’s great to speak with you again, and I appreciate your question. In the first half of the year, we have observed that our lifetime values remain strong and consistent, and we have previously shared some of those data trends. We continue to see robust lifetime values. Customer acquisition costs are rising across the industry, which we've discussed in prior quarterly earnings calls, and we believe there is room for improvement in this area. Aarki is one part of that strategy, along with other initiatives aimed at reducing our customer acquisition costs. Some of these initiatives include strengthening our team, allowing our marketing investments to align with our revenue growth, and exploring opportunities in creative development, organic user acquisition, and other aspects as well.

Andrew Paradise, CEO

And then let me jump in on the second part, Brian, which is talking a little bit about the Aarki deal. I think it's a really important one for the future of our company. I started mentioning a minute ago that we expect $13 million of revenue for the back half of '21. Honestly, that's not the most important part of the transaction. When we think about the Aarki deal, I know we shared color on several of the reasons on why we made this acquisition. It will take several quarters for us to realize the full impact of the transaction synergies in terms of migrating our DSP marketing spend to Aarki. In terms of our plan, first, we're going to gradually migrate a substantial portion of our DSP marketing spend to the RT platform. and that's going to take a few quarters. Second, we expect to further improve the industry-leading performance of Aarki’s algorithms by integrating our rich first-party data. And that's going to enable us to more efficiently target audiences from the impression level all the way down to end-user LTV. It will really be the only data chain like that in the industry. So we're really excited about the Aarki deal and the potential for the future.

Brian Fitzgerald, Analyst

Awesome. Thanks, Andrew. Thanks, Casey.

Andrew Paradise, CEO

Of course.

Bradley Erickson, Analyst

Hi, thanks for taking the question. I just have two. First, when you think about potential, call it, incremental drivers in the second half for growth and I guess maybe set Aarki aside for a moment since we've kind of covered that. We look at things like new games, you got international opportunities, who knows maybe something good happens with the Google Play Store. What are you guys kind of pointing to as sort of the biggest drivers as you target the second half of the year? And then I have a follow-up.

Andrew Paradise, CEO

Well, maybe to start with, I think Q2 revenue growth was very much in line with our expectations. When you think about Q2 '21, there was a tough comp against Q2 '20 because of the COVID bump we saw last year. As we've mentioned on other calls, we're definitely seeing elevated CPIs in Q2. And so we've been making quite a number of mid- and long-term investments to mitigate the high CPIs that we've been seeing. And obviously, you've seen one of those this quarter with the announcement of Aarki. All of our investments so far against mitigating CPI are progressing well, and we do expect to see benefits from them later this year. In terms of growth drivers in the near-term kind of the one-year period, we're looking at optimizing the value chain from impression level down to end-user LTV, which will give us, I would say, better predictive LTV than potentially anyone in the industry. In the mid-term, in the one- to three-year period, are really focusing on more content being successful on the platform in more geographies. And what that really translates to is new demographics joining the platform. And you can think of things and developments there like India, like Big Buck Hunter: Marksman, which we've talked a little bit about. When you think about the longer-term, which certainly is how we think of the company, we think very much even beyond the three-year period. We think that the future of competition will be centralized in one place on the Internet. And that means going beyond mobile, that means nongaming applications like fitness, which we've talked about.

Bradley Erickson, Analyst

Got it. That's great. And then maybe just a follow-up housekeeping item from the shareholder letter in terms of the user acquisition marketing. I think you mentioned that you upped the engagement spend doing. Sound like doing some testing in the quarter, which I guess implies that we may see some reversion there in terms of leverage to talking like the amount of spend versus net revenue. Is that kind of the right way to be thinking about it as we head into the second half of the year? Just any clarity there would be great.

Andrew Paradise, CEO

Yes. And you know what, I actually love to have Casey comment a little bit on how CPI is trending even in July and what expectation is for how CPI will trend for the rest of Q3 and Q4.

Casey Chafkin, CRO

Sure, Brad, it's great to connect. In July, we're noticing that the rate of industry price increases is beginning to stabilize, and we anticipate that prices will level off before declining later this year. We believe this decline will be influenced by market dynamics that will lower industry prices overall, as well as our ongoing investments in distribution costs, Aarki, other traffic initiatives, and brand distribution partnerships. Regarding user acquisition versus engagement marketing, in Q2 we observed rising CPIs. In response, we maintained our financial discipline and reduced our user acquisition investment. This is typically something we plan for in Q2 due to seasonal pressures, but we can also adjust dynamically based on market conditions. With the resources we saved from cutting that spend, we managed to enhance our experimentation with engagement marketing. You're correct that we're focused on finding the most effective methods to drive revenue and increase customer lifetime value. Looking ahead, if CPIs remain high, we will follow a similar strategy by eliminating unsuccessful experiments while retaining those that prove effective, continuing our testing as we plan for the long-term future of the business.

Bradley Erickson, Analyst

Got it. That’s great. Thank you.

Jason Bazinet, Analyst

Thanks. Can I just ask one more question on that toggling between user acquisition costs and engagement and marketing? If you end up spending more on engagement and marketing, is it right that both directionally users and paying users would sort of be worse than they otherwise would be, but you'd see the benefit on the revenue per paying user? Is that the right way to think about it?

Casey Chafkin, CRO

I think what you're asking is whether engagement marketing is driving user growth or is driving user monetization. And we see the experiments that we're running in engagement marketing moving two pieces of the financial model. One is conversion and we run experiments to test incentives that help drive conversion from nonpaying to paying users, but also in perhaps your second point, which is the larger area of focus for us, which is extending retention and monetization of the existing user base. And so maybe to hit it more directly, engagement marketing does not drive M-A-U or MAU of the business.

Andrew Paradise, CEO

And I think more broadly, when we think about toggling between engagement marketing and user acquisition we really have finite resources in terms of time, dollars and labor to use each quarter. So when we think about how we want to optimize these activities, we're really thinking about the most effective ways to deploy marketing resources against our long-term plans. As we noted in the letter, in Q2, we reduced the user acquisition investment spend following our increased investments in UA in the first quarter. And really given when you think about the longer-term plan of our business, given the massive market ahead of us, we would prefer to invest more in user acquisition than engagement marketing, but we'll continue to exercise discipline in a high UAC environment.

Jason Bazinet, Analyst

I guess when this Aarki is sort of fully integrated and your spend has sort of moved over to Aarki. Then that's maybe when we could see the UA spend tick back up? Is that the right way to think about it?

Andrew Paradise, CEO

I believe it's completely influenced by market dynamics, but that wouldn't be an unreasonable thought.

Andrew Crum, Analyst

So you guys have demonstrated some good progress on the take rate over the last several consecutive quarters. How are you thinking about that in the second half? What are the drivers to improve it? Separately, Andrew, you've noted that IDFA was not a concern for you with the business. Any early observations in terms of the impact that you've seen quarter-to-date or year-to-date rather? And then lastly, what are the next milestones for the NFL competitors challenge along with Big Buck Hunter? And when would we expect to see any meaningful contributions from either one of those?

Andrew Paradise, CEO

Okay. Let me address those questions. First, we have three inquiries to tackle. One concerns the take rate for the second half in relation to IDFA impact, and the third involves the Big Buck Hunter Marksman impact. Let's begin with Big Buck Hunter Marksman and the new content becoming successful on the platform. When we consider content, we want to share the progress of new launches while acknowledging that we can't predict which content will succeed. For example, Tetris is currently in soft launch, and its metrics do not currently support a significant transition to a hard launch. This is why the industry makes a distinction between soft and hard launches. Regarding Big Buck Hunter Marksman, we are collaborating closely with the team on play mechanics to enhance its performance for a future scale-up. However, we aren't making any predictions today about potential revenue from BBH, so it isn't included in our forecast at this time. As is common with games not yet scaled, we are not factoring in any revenue from BBH into our guidance. Now, let's discuss the NFL challenge. In the second quarter, we officially launched our multiphase partnership with the NFL, initiating a competition to find the next great NFL mobile game. The developer community has shown strong interest and excitement, leading to a sizable influx of proposals to Skillz. We received hundreds of game proposals, and together with the NFL, we reviewed them all. To highlight the competitive nature, we narrowed it down to 14 semifinalists who are now in the development phase of the challenge. These 14 companies are currently developing NFL games, and we were thrilled with the creativity and originality of the submissions. Both the NFL and Skillz are excited about these proposals. From a timing perspective, we expect to launch the winning game or games before the 2022 NFL season. For those unfamiliar with game development, the usual timeline for a mobile game can span about 18 to 24 months from inception to generating meaningful revenue. Now, I will hand it over to Casey to discuss IDFA.

Casey Chafkin, CRO

Absolutely. So IDFA is still relatively early in terms of the rollout of iOS 14.5% has been relatively slow. And so it's pretty early to read the impact of it. So I would say we continue to expect that the impact of IDFA will be neutral. On the one hand, cost per install likely decreases as advertisers lower their bids in response to less efficient targeting and attribution. On the other hand, this potentially decreases conversion rates as well.

Ian Lee, CFO

Thank you, Andrew. So is a couple of things on the take rates. So there are multiple drivers that we could use to work with to look at take rate over time. Just some examples, brand-sponsored prizes, there are different mix of two format tournament formats that you use, for example, head-to-head versus brackets. And I think just overall, there are a number of things we can look to experiment with in terms of how we work with our users to ensure that we have avenues to increase take rate over time while minimizing additional friction for our users. So again, no specific take rate guidance I'll give you for the latter part of the year. Other than that, we're looking at that all the time. There are many avenues we can do that over time.

Andrew Paradise, CEO

I think that we covered all three questions that. I think we're true if we're good there. We'll move on to the next question.

Andrew Uerkwitz, Analyst

Let me ask a couple of questions here. First one, is on Exit Games. You kind of talked about the high-level benefits. Any way to kind of quantify what those benefits could look like, where they would show up and kind of a timing on that? And then my second question as you talked about CPI costs related to the Aarki acquisition, is there a way to simplify that and just kind of talk about the broader impact they'll have on SG&A. You kind of broke it out on the top line for guidance. Any way to think about that from a modeling perspective for this year?

Andrew Paradise, CEO

Thank you for the question, Andrew. Let me discuss Exit Games and then we can touch on Aarki as much as possible for now. Regarding Exit Games, there's public information indicating that their developer community includes about 500,000 developers already utilizing the Photon engine for synchronous multiplayer teams. We are quite excited about the opportunity to cross-market to this developer population in the coming years. As for specific guidance, we’re close to discussing how new content may impact revenue, but I will mention that we haven't yet observed a successful game in first versus synchronous modes. We do have encouraging early results in first-person shooter formats with asynchronous play, such as Big Buck Hunter Marksman. However, popular titles like Call of Duty are crucial for successful performance on the platform. Through our partnership with Exit, we aim to create an integrated solution that could potentially lead to the first synchronous first-person shooter on our platform, although quantifying that impact is challenging. We anticipate welcoming a new demographic, significantly increasing the presence of hardcore gamers, especially from a more male-dominated audience typical in PC and console gaming. This discussion focuses on first-person shooters, not even considering fighting games. We previously partnered with Capcom on Street Fighter II, and I would be thrilled to see a fighting game on our platform, which would be fantastic for that audience and beneficial for our platform and shareholders. Creating those opportunities is a vital step toward making this idea a reality. Next, we need to encourage developers to take risks and create content in these genres, which we hope will lead to exciting and successful offerings on our platform. Now, regarding Aarki, Casey, would you like to address that, considering CPI is something you’re passionate about?

Casey Chafkin, CRO

Yes, absolutely. And I wasn't sure if the question was about Aarki and the potential impact to CPI or about the ARK revenue and the flow-through to the P&L.

Andrew Uerkwitz, Analyst

Well, I guess you updated the guidance and provided details on the revenue side of Aarki. I'm just curious if there's any information on the SG&A side without getting too into the impact on CPI.

Casey Chafkin, CRO

Yes, sure. Thanks, Andrew. Just a couple of points in there. So just to recap I think what Andrew had mentioned earlier. So we assumed roughly $13 million of revenue contribution from Aarki for the remainder of the year following their close. In terms of their impact on OpEx, I won't give you specifics I will give you a little color that’s hopefully helpful and you walk down the P&L, so their gross profit margin is a little lower than your Skillz and its in the 70% range and when you look at OpEx kind of categories say largest is the sales and marketing following by R&D and G&A and at the adjusted EBITDA line so Aarki is historically been profitable at the adjusted EBITDA line and we are also helping it scale as a part of a public company. So we had assumed the contribution would be, they would be slightly better than breakeven on a standalone basis so you can use some of those assumptions when you are combining them with Skillz to the whole.

Bradley Erickson, Analyst

I have a follow-up question. I'm a bit unclear about the terminology used regarding user acquisition spending. You mentioned engagement spending and then user acquisition spending, and it appears that all of this falls under sales and marketing. So my first question is, is that accurate? And secondly, is there another component recorded as contra revenue? If that's the case, could you provide a breakdown for us, if possible?

Ian Lee, CFO

Brad, it's Ian here, hope you are doing well. Yes, you will notice a specific breakdown in the financials between user acquisition and engagement marketing. These are clearly delineated. If you review our filings, you will see this differentiation, which is based on the fact that our end user is a developer. Consequently, if they have a legitimate expectation around some of those expenses, there can be a distinction between what is classified as contra revenue or within sales and marketing depending on that valid expectation. I'm happy to delve into that further with you, but it is all outlined in our filings regarding how we make that distinction. For additional context, it was approximately related to end-user incentives and contra-revenue in the second quarter.

Andrew Paradise, CEO

Okay. Well, thank you very much, everyone, for your time today. We look forward to providing an update on our continued progress when we report our third quarter results. And until then, thank you, everyone.

Ian Lee, CFO

Great. Thank you.

Operator, Operator

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