Why the Q4 Report for Skillz Will Be Very Important

Mobile-gaming company Skillz (SKLZ 3.95%) has established at least one solid track record with investors since it went public: It routinely surpasses its revenue guidance and raises its top-line expectations. However, revenue growth isn't the only thing investors are looking for. When it comes to profitability, Skillz is far behind where its management thought it would be by this point, which is partly why the stock is down almost 90% from the all-time high it touched last year.

In this video from Motley Fool Backstage Pass, recorded on Jan. 10, the crew from "The Gaming Show" ranked 10 video game stocks from their favorite to least favorite to hold for the next five years. Skillz landed in eighth place in the episode, and contributors Jon Quast and Jose Najarro explain why. Specifically, Jon talks about Skillz's previous guidance to shareholders and wonders if guidance will change when the company reports fourth-quarter financial results next month.

Jon Quast: Let's keep it going here, and we are now going to talk about Skillz, coming in at No. 8. This is about where I ranked it as well -- which is really hard for me to say, because I think only own three of these stocks that we're talking about today, and Skillz is one of them, and yet I ranked it fairly low in the rankings.

I'm going to just share my screen, because I do want to talk about Skillz. I want to frame the narrative over what has happened here in the last 12 months. You guys see this slide on Skillz? These are four of the big things that I really follow when it comes to this company. Monthly active users. What does Skillz do? It provides a software development kit to game developers that can create a competitive layer for their games. There's a way that people are able to bet money, compete against one another. Skillz takes a portion, the game company takes a portion, and then the winner of the game also takes their prize money. Naturally, because that's the model, you want to see active users -- and particularly, you want to see paying users -- increasing over time.

Skillz had somewhat of a challenge growing the overall user base in some quarters. In the most recent quarter, the third quarter, [it] got back on track -- up to 3 million monthly active users. That's, as far as I know, an all-time high. The paying active users also started struggling there a little bit [in] mid-2021. Back on track again, up to 510,000 in the most recent quarter. So, very good growth in the paying active users. And the revenue growth has actually been substantial. They have beat and raised guidance, I believe, in every quarter as a public company when it comes to their revenue. And, breaking that $100 million barrier in the most recent quarter.

The problem that investors are really struggling with is the quarterly income from operations, and really, it's a loss from operations -- $43 million, $51 million, $50 million, and $82 million, piling up big losses. And why is that? Because Skillz pays more to acquire users right now -- it's spending more on sales and marketing -- than what it actually generates in revenue. This creates a very interesting cash flow situation. As you look at that, you have to say as an investor, this has got to change at some point if this is going to be a market-beating investment. Maybe it makes sense for right now, and management has its reasons why it's spending this much. In its opinion, the lifetime value of the customer is very, very valuable, so it's willing to spend that much money right now to acquire those users and gain them for life, is what it hopes. So they have their rationale for it. But the thing is, you, as a shareholder, have to believe that this cash flow situation is going to turn around in the future.

Now as you look at what their original 2021 revenue guidance was, it was $366 million. Right now, it's looking like they're going to beat that. This is when the company first went public via a special purpose acquisition company. They went ahead and laid out 2021 revenue well in advance, saying $366 million. Now, it's looking like they're going to come in at $389 million, so ahead of that SPAC deal guidance -- that's good. 2022 guidance, they are hoping for $555 million in revenue. That's from the original guidance. Once again, we'll see if they uphold that when they come public with their fourth-quarter earnings here next month. You would want to see that as a shareholder, holding to that original guidance.

But one of the interesting things here that I was looking at today was, originally, they were saying that they were going to have only negative $14 million in adjusted earnings, adjusted EBITDA for this year. So far, through three quarters, they've had negative $104 million. Adjusted EBITDA for this year -- unless there's a miracle in the fourth quarter, it's going to come in potentially $100 million off of what the original guidance was.

Originally, they were saying that they were going to be EBITDA positive next year, so 2022, forecasting $8 million positive EBITDA. It will be interesting to see: Are they throwing that out the window when they give their full-year guidance next quarter? That will be interesting to watch.

With Skillz, definitely some opportunity to grow that revenue. We see them growing the paying user base. They just launched in India, so now becoming an international company, fulfilling that promise to shareholders. Is this something where the revenue is going to keep growing and eventually the unit economics make sense? We'll see. If they throw out that profitability guidance that they had originally forecast, that, to me, is a reason for pause. So this is why I ranked it lower where I did. I definitely see the revenue potential. I still question where the cash flow potential is. I need to see more from the company before I will begin ranking it higher. And I say that as a shareholder.

Jose Najarro: Jon, this is one that I think I ranked a little bit. I probably put it in my top five. This is a company I'm also a shareholder [in]. I'm not investing for the right now. There's three potential ways that I can see Skillz going. One, they can become a huge platform for game designers, where we might see bigger games start to use them. Right now, Skillz has very weak games that I haven't heard of, but if a nice first-person shooter, if one of these nice popular mobile games gets into them, I think that can be a game-changer. That can also be an open acquisition for maybe something like Unity in the future, or one of these game developers.

The second way is more of like ... right now, their product, it's not like a gambling thing, but I can see a lot of these [companies] like DraftKings, who are moving into these online style [games], can use. Dominoes, obviously, in a real-life casino would not be feasible for a casino, because you would need so many tables. But having dominoes online, you don't need the table, you just need the online infrastructure. I can see casinos get into that in the future. Again, a lot of speculations, but if some of these speculations that I can think of happen, it can definitely provide the return for the company, but at the end, I believe it's going to be very, very volatile before any of that happens.