Mobile-gaming platform Skillz (SKLZ -0.75%) went public in 2020 and quickly skyrocketed from $10 per share to over $40. Everyone was excited about its high revenue growth, eye-popping gross-profit margin, and large addressable market. 

However, since surpassing $40 per share in early 2021, Skillz stock has been decimated. It fell over 60% in 2021 and is down almost 90% in 2022.

One might believe that Skillz's downside is limited from here. However, as you'll see below, I don't believe the company is poised to rebound in 2023. Indeed, it's facing what might be insurmountable challenges in the coming year.

The steep climb ahead for Skillz

Games on the Skillz platform allow users to compete for cash. Both players pay to play. The winner takes a chunk of the winnings, and the remainder is divided between the game developer and Skillz. 

Because Skillz is merely providing a software-development kit (SDK), its gross margin was once around 95% -- one of the highest I've ever seen -- but it's fallen over time. Even so, the company's gross margin is still a world-class 87% as of the third quarter of 2022.

Many investors (including myself) look at the gross margin for unprofitable companies like Skillz. If a company has enviable gross margins, then it's easy to envision future cash flow, assuming management can keep operating expenses under control as it grows.

However, Skillz has one very important operating expense that it's not been able to cut back on without consequences: user incentives. Skillz frequently attempts to generate platform activity by giving away free money to play their games. In the first three quarters of 2022, the company spent $126 million on user incentives. This is different than the more than $150 million it has also spent just for advertising its games.

Most user incentives are treated as sales and marketing expenses. The rest are treated as a reduction of revenue. And because of user incentives, Skillz routinely spends more on sales and marketing than it generates in revenue. 

SKLZ Revenue (TTM) Chart

Data by YCharts.

Encouragingly, Skillz cut back on sales and marketing in 2022. Through the first three quarters of 2022, it spent $242 million, compared to $310 million in the comparable period of 2021. And therein lies the company's biggest problem.

As Skillz has cut back on user incentives, it's lost users. At the end of the third quarter, the company had 1.7 million monthly active users, down from 3.0 million in the same quarter last year. And it only had 320,000 paying monthly active users, down from 509,000.

In other words, if Skillz keeps spending more on sales and marketing than it generates in revenue, it will never turn a profit. However, if it continues to ramp down spending on sales and marketing, then users leave the platform. It's a lose-lose situation and why I don't believe Skillz is set to rebound in 2023.

Here's what shattered my confidence in Skillz

I rarely sell my stocks less than five years from buying. But I recently sold my entire Skillz position after just one year of holding. 

Obviously, Skillz management is more excited than I am about its growth potential in 2023. The company is preparing to launch its cloud-gaming product, which makes it easier for gamers to try out games before downloading and could improve the user-acquisition process. And it's expanding its brand partnerships with key brands, including the NFL.

However, Skillz's management is also emphasizing its recent pivot toward profitability, which sounds great on the surface. However, when the company first went public, it was already talking about adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).

In Skillz's original presentation, management expected its adjusted EBITDA loss to improve from $47 million in 2020 to negative $14 million in 2021, and then flip to a positive $8 million in 2022. And these improvements to profitability were to come while the company was still growing the top line 61% in 2021 and 50% in 2022.

The reality couldn't be further from the forecast.

SKLZ Revenue (Quarterly YoY Growth) Chart

Data by YCharts.

Not only has Skillz's revenue growth plummeted as it's cut back on user incentives, but its adjusted EBITDA profitability has plunged as well. It didn't improve with growth, and it's not improving now with cutbacks.

New Skillz CFO Jason Roswig said, "Our strategy is to use our capital to get to breakeven and then run an EBITDA breakeven as we invest aggressively to capture the $100 billion-plus market opportunity in front of us."

But given Skillz's track record as a public company of meeting its targets, I'm disinclined to give it the benefit of the doubt now. This is ultimately why I sold Skillz stock.