Mobile gaming platform Skillz (SKLZ -0.16%) just recently became a public company. It reported full-year 2020 results back in March but the company is still in what's called a "quiet period" -- management isn't allowed to give much color commentary right now. However, that's about to change. Skillz is scheduled to report results for the first quarter of 2021 on May 4, and management will host a conference call to discuss results after the market closes that day.

When it reports first quarter results, many investors will focus on Skillz's revenue growth rate. Others will dial in on overall user growth. But I recommend you pay close attention to user deposits and user withdrawals when gauging the long-term health of this company. Here's why.

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Image source: Getty Images.

Why it's hard to see what's important

Skillz ended 2020 with less than 400,000 paying monthly active users (pMAU). Considering this is a very small group of people, it's tempting to ignore this metric and focus on more flashy numbers like revenue growth and overall user growth. But both of these metrics are inadequate on their own.

For example, Skillz's growth is slowing when it comes to monthly active users (MAU). It ended the fourth quarter of 2020 with 2.4 million MAUs -- down 300,000 from the previous quarter. And the company spent over $79 million on sales and marketing (S&M) in the fourth quarter alone, which makes this decline look even worse.

Skillz's management expects to be back at 2.6 million MAUs at the end of the first quarter, which is a quarter-over-quarter improvement. But that's still not as high as the company's 2.7 million MAUs at the end of the third quarter of 2020. 

However, growth for Skillz's paying user base is more important than its overall user base. Granted, the two aren't mutually exclusive. But paying users actually bring cash onto the platform. This is why the company's revenue has continued growing despite an overall user decline. For perspective, Skillz's management expects to have 450,000 paying users by the end of the first quarter, which is up a healthy 15% just from the fourth quarter.

Therefore, we can't measure Skillz's success by overall user growth because it's uncorrelated with revenue growth. However, even revenue growth needs additional context.

Skillz generated revenue of $68 million in the fourth quarter, which was up a whopping 95% year over year. However, we noted the company spent over $79 million on S&M that quarter. Much of this S&M spending goes toward user incentives -- the company gives users bonus cash that can be used to pay a portion of the entry fees for competitions. In some cases the entire entry fee can be paid using bonus cash.

Skillz makes money by taking around a 15% cut of entry fees. This is the revenue number we see on the top line. However, some of this money came from bonus cash supplied by the company. If you stop and think about it, any revenue derived from bonus cash isn't valuable for Skillz -- it doesn't represent any outside money entering the ecosystem. Therefore, revenue growth paints an incomplete picture of the company's overall health.

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Image source: Getty Images.

Painting a more complete picture

The Securities and Exchange Commission (SEC) had some questions for Skillz about deposits and withdrawals as it prepared to go public. In its response, the company provided the SEC with some information that's useful for investors. There were combined gross deposits of $134 million in 2018 and 2019, with another $81 million in the first half of 2020. During that time, withdrawals only totaled $32 million.

In its annual report for 2020, Skillz didn't provide us with the total deposits and withdrawals for the year. However, the company did say that 80% of entry fees were paid with past winnings. In other words, most paying users appear to deposit cash, play games, and continue to use winnings to play more games. Cashing out doesn't seem to be their preference, which is good news for long-term shareholders because the money is staying on the platform.

What to watch

To recap, tracking overall user growth isn't useful on its own because it's uncorrelated from revenue growth. But just looking at revenue growth doesn't account for the impact of bonus cash. Therefore, cash deposits is a more helpful statistic because it represents real money entering the system. Withdrawals are also helpful to monitor because Skillz can continue generating revenue from past winnings so long as users aren't putting money back in their pockets.

For whatever reason, Skillz doesn't give deposit and withdrawal information in most SEC filings. That's unfortunate because we've seen its importance. However, it might be something management speaks to in its first conference call as it exits its quiet period. To be sure, it's something I'll be listening for.