Firy Inc. (SKLZ) Earnings Call Transcript & Summary

Okay. Good afternoon, everybody. I'm Mark Mahaney, Director of Internet Research here at RBC. [ Spencer, Ken ] and I are going to spend the next 30 minutes in dialogue with Andrew Paradise. He's the CEO and Founder of Skillz. So recognition and awareness of Skillz may be somewhat limited here. We're going to ask him a series of questions, tag teaming. [Operator Instructions]

Andrew, thanks a ton for joining us. So please step back, give us the background, why did you find -- what caused you to found to start up Skillz? What was the vision?

Well, we see -- yes. Well, we saw the world, what was happening in gaming. We saw the rise of the esports, and we saw the opportunity to create really the first global esports platform in existence. And today, where it still sits, we're actually the largest mobile esports platform in the world, we're a B2B2C technology platform. And really -- we enable the game developer, whether they're large or small, to take advantage of competition to monetize their games. We're now running over 2 billion tournaments every year, and we're really democratizing the gaming ecosystem by enabling esports to be accessible to every developer in terms of building and as well as making it more accessible for all players to participate in esports. Our larger vision over the long term is we're building out -- really a 100-year vision of what this company can create, which is really building out the competition layer of the Internet.

Okay. There's a lot to unpack there. Let me go back to [indiscernible] the -- defining the addressable market for Skillz, let me ask that question first, and then I'm going to get into the value proposition for developers and gamers. But first, the addressable market. So that sounds pretty broad. Just help us tighten it up that how big is this market?

Yes. The gaming industry, look, it's truly massive. It's expanding rapidly. It's now eclipsed movies, music and books. When you think about the market today, there are 2.7 billion people engaging in mobile games every month. In fact, this is the same trend that we saw when we started the business in 2012. So in 2012, there are 800 million smartphones and tablets. 60% of the usage of those devices was interactive content or video games. That number, that 60%, has really held constant as we've scaled the 4 billion devices as of this past year. It's projected to go to 10 billion devices in 2025. And so what you're saying there is that not only is mobile, your now largest segment of games growing from $8 billion when we started, to $68 billion this last year, but the video gaming overall is going to become the primary form of entertainment in terms of market cap. And then even more beyond that, mobile is your biggest sector. It's projected to be $150 billion, or half of the video game industry in 2025. It's an impressive number in terms of that ecosystem. I think when you look inside how mobile games are monetized today in that $68 billion, you're really looking at in-game purchases or in-app purchases, or in-game advertising as the 2 ways to monetize. Skillz is a new way to monetize. We enable developers to monetize through competition. And what we're showing is that monetizing through competition can be a lot more effective than these other forms of monetization. In fact, we're showing it to be multiples more effective on an apples-to-apples basis when you look at acquiring a consumer cohort into your business and you look at how to monetize that cohort.

Super. If you don't mind, go through the value proposition first, to gamers, and then I'm going to ask you the value proposition to developers.

Sure. So for the gamer, we provide fair, fun and meaningful competition. Those are the top 3 reasons why they engaged in the platform. It's -- for the viewing audience, I think the easiest way to explain this is if you've ever played Skins golf, how it made it a little bit more exciting and a little bit more meaningful, although not life-changing in terms of the financial outcome. Skillz similarly delivers that type of value proposition to the consumer. What we're showing actually is that we're able to extend the life of these games dramatically beyond what they were previously for the game maker. And that's really the consumer voting with their feet. They're saying I like this type of interaction and prefer competitive interaction. I want to pay for it. And I am willing to pay, and in fact, from the 3 different primary research studies we've conducted, I'm willing to pay -- you see actually up to 40% of the audience willing to pay. And if you compare that to your typical in-app purchase game, that's usually a 2% payer rate. So when you look at Skillz as an ecosystem from a consumer who vote with their feet standpoint, Skillz as an ecosystem is monetizing 10% of each game's audience on average. We have individual games where we're monetizing 35% of the games' audience per day. And you compare that to the mobile game ecosystem prior to Skillz, you're looking at 2% on average with some of your -- probably your best in the world games monetizing between 7% to 10% of audience. So the consumers are really saying, I think, with both feet that they prefer this type of monetization, they're willing to pay for it and they routinely engage longer as well as, candidly, they spend more.

Super. And my last question [indiscernible] is the value proposition, yes, to developers.

Yes. I think for the developer, it's exactly that. This is -- what we've designed and created is really game-centric monetization. For the developer, think of Skillz is almost like Shopify for the gaming industry. We're not developing content. We're really leveling the playing field for small to mid-sized developers by enabling them to build long-term independent businesses, then monetize their art through competition as opposed to these other forms of monetization. If you think about in-game advertising, that's -- the drawback of that type of monetization for the developer today is the monetization retention. They directly attack each other. And so for every dollar you make, you actually are losing audience. Whereas if you look at in-game purchasing or in-app purchasing, what you're really doing there is you're locking the user out of content. You're putting the developer on a content treadmill where they have to build more and more content for fewer and fewer paying users over time. And I think an easy way to explain that is think of something like Candy Crush. On Candy Crush, there are now tens of thousands of levels. Even though we may be stuck on an early level ourselves, I think what we're seeing is as you keep building out more and more content, very, very few people will ever make it to level 10,000 or level 20,000. I think there are actually well over 10,000 levels now, if I'm not misspeaking. Embarrassingly, I'm still pre-level 100. So I probably shouldn't say that here. But it's -- the real issue there, you have, of course, is that you're building more and more content for fewer and fewer consumers who will ever make it to the achievement level seeing that content.

Super. [ Spencer ]?

Yes, sure. So at like a very high level, I mean, what differentiates Skillz as it relates to games being based on skill versus a game being based on chance? Maybe just kind of go over kind of the broad definition between the two. And then in terms of regulation, what states are you allowed to operate in? And how do you see this evolving, both domestically as well as maybe some of the international markets that you plan on expanding into?

Okay. So let's break that apart and maybe answer in pieces. So first, let's say, what really differentiates this is kind of question one. Question two and more broadly is the regulatory environment for the Skillz value proposition, if I heard you correctly?

Yes.

Great. All right. So in terms of what really differentiates us, trust and fairness are critical to competition. If you think about the off-line world of sports, as soon as you introduce a professional scene or any kind of competition, humans are excited about trying to unfortunately cheat their way to the top. And even I would say the very arbitration of what is cheating and what is not becomes an issue, right? Like I agree -- I guess I hate to use this example, although it hits near and dear to my heart. If we all remember Deflategate, Tom really liked his balls that way. But that was what Tom Brady would say. I think on the other hand, some people felt like that was cheating. And now I think the issue that you're really hitting on there is, is that an edge in terms of how Tom was engaging and playing the sport or is it cheating? And Skillz really -- we are that digital referee of tomorrow. And we use a lot of automation to do that, to create that level of trust and fairness through data science technologies that are proprietary to our platform. This part of our ecosystem, it's more or less saying we built the equivalent to antivirus software. And I think companies like McAfee showed very well the power of network effect in first mover when you're in this like war of people who try to obfuscate or cheat in the system and the software systems to stop those cheaters. As we continue to move forward on that in terms of differentiation, we now have 58 issued and pending patents that cover these core technologies around delivering trust and fairness. And I'd say, as we build out more and more of the Skillz brands, Skillz is known as the brand for gamers, where they can have a fair competitive experience. In terms of the regulatory environment, the second question, competition in video games is about as old as the video game industry. So if you rewind to 1980, you have the first prize video game competition. It was the Space Invaders competition put on by Atari. There were over 10,000 participants, I think, over 20,000 attendees. That competition, the champion, Rebecca Heineman, is still a video game exec today. I think while we may not know her name as well in the industry or in -- as off-line sports, the online sports or esports scene as it continues to develop, it's actually as old as the video game industry itself. And I would say, prize-based competition is nearly as old as recorded history. Your first example stretch all the way back to the Colosseum in Rome to the modern era with everything from running races like the New York Marathon, that's a pay-in and pay-out competition. To rodeos, spelling bees, the National Spelling Bee put on by Scripps. It goes on and on in terms of regulation. And with video game tournaments, and competitive video game tournament specifically, when we launched the platform, there were 30 that all understood that video game competitions were skill-based. And they had clarified pretty clear laws about engaging video game competition. We've seen several other states favorably change their legislation to make it clear that video game competition is welcome in their states. And so now it's -- we would say there are 40 states that all have clear, pretty much the same legislation around video game competition. Having said that, video game competitions have been going on with prizes for literally 40 years now. It's really what you're seeing, in terms of Skillz, it's creating a technology stack to make it possible for every video game developer to take advantage of this type of technology without having to raise hundreds of millions of venture capital or dedicate their entire business to doing it. And an example of that would be Riot Games with League of Legends. Literally, the entire company has to focus around a single game because building out the technology stack to run esports today is so significant that they have, for example, in Riot Games, they have over 100 people just involved on managing the tools for broadcasting the content. Just to talk about one piece of the value stack in terms of building out an esport technology.

Got it. Yes, that's great. I guess just going on from that, just recent trends that you've kind of seen as it relates to COVID, you guys kind of run a marketplace model in the sense that you have a take rate. So just trying to get maybe a better understanding of how you see kind of take rate evolving as it relates to some of your adjacent services kind of initiatives. And then second part of the equation is, how do you see this kind of evolving? And how have you seen this kind of -- just revenue, in general, be impacted by COVID and the current environment that we're in?

Sure. Well, in terms of COVID, we grew 35% quarter-over-quarter in Q2. I think in terms of how we would describe the business and the pandemic, we are a COVID-resistant business where it hasn't really changed how our business operates. Certainly, the initial lockdown was favorable as there was a little bit more free time per day per consumer to engage in video games. We -- just to remind everyone who's not familiar with our business, our average consumer already plays 62 minutes a day on the platform. So it is a very heavy engagement platform with our 1% playing 4 hours a day on platform. So we saw a double-digit bump in engagement and thus in monetization as [indiscernible] system. But we're already at a pretty meaningful level of engagement from our consumers. The reason I would say COVID-resistant as opposed to anti-COVID or something else is the reality of it is, our business has been growing 2 to 3x every year for the last many years. Even in COVID, we were fortunate, I think, that a lot of our value chain, if not all of it, is more or less businesses that are digitally organized. So some of our biggest customers actually are completely virtual before COVID. They actually -- one of these is a feedback from one of our customers was, it's really great about COVID because now everyone else has a good Zoom camera environment and good audio, not just us when we're working internally. I think that is certainly putting a silver lining on the situation. But the reality of it is, it's a business where we build at-home digital entertainment as a platform and people need that more now than ever, perhaps. And so we view that as really important. In terms of the take rate and thinking about how we're continuing to grow the business, so the take rate today, we're a 14% net revenue business against -- so this year, we'll do $1.6 billion in GMV. We'll do $225 million in net revenue. When we think about the path forward, we see take rate expanding. And the primary reason we see that is because a growing number of brands are running brand-sponsored competitions. If you look at our P&L and you look at growth GMV and then the take rate, above the line is actually prize pools. Prize pools today, they represent 75% of all of the GMV in our business. So this year, we'll pay out $1.2 billion in prizes. Having brands sponsor 10% to prize pools would be $120 million of incremental revenue, nearly all of which would be pure profit. So take rate expansion is very meaningful. The brand-sponsored competition, we talked about this properly, they are averaging a 35% take rate with individual brand-sponsored competitions as high as a 90% take rate. And you may think that sounds crazy, but I'll describe the 90% take rate example, and you tell me why the users would pay 10x the prize pool. The particular example I love the most, it was a Tiffany's necklace competition going into Mother's Day weekend last year. And the users -- the marketing campaign is a 3-hour tournament, where it was win it for you or win it for her. And you can only imagine the air cover all of these gamers got from their loved ones competing for this necklace. And thus, really voted with their feet to how much they liked it. And again, I would look at off-line competition, something like the New York Marathon. New York Marathon, if you described it in terms of take rate, the entry fees last year were probably well over $11 million versus the prize pool of $700,000. There'll be a 90-plus percent take rate competition. It's just -- we don't necessarily think of the New York Marathon in those terms because most people who are participating, they're participating because they want fair, fun and meaningful competition in the New York Marathon, not because they think they're going to win the prize pool. And I say, similarly, in your Tiffany's necklace example, you might say a bunch of those players really just want to be able to play and compete on the weekend, and have air cover from their loved ones by playing for the Tiffany's necklace.

Got it. Got it. With that, I'll turn it over -- back over to Mark.