NCSOFT Corp

KRX:036570

Earnings Call Transcript 2024-Q1

[Operator]

Good morning, and good evening. Thank you all for joining the conference call for the Earnings Results of NCSOFT. This conference will start with a presentation followed by a Q&A session. [Operator Instructions]Now, we will begin the presentation on NCSOFT first quarter earnings results of the fiscal year 2024.

[Jason Lee, executive]

Good morning. This is Jason Lee, Head of IR at NCSOFT. Thank you for participating in NCSOFT earnings conference call for the first quarter of 2024. In today's conference, we are joined by our new CEO, Byungmoo Park; and CFO, Willie Hong. We first review the financial performance of the first quarter of 2024, followed by insights into NCSOFT management strategies from CEO, Park and CFO, Hong. Now, let me begin with the financial highlights.Q1 sales recorded KRW 397.9 billion, down by 9% Q-o-Q and 17% Y-o-Y and operating profit rose 568% Q-o-Q, but dropped 68% Y-o-Y, totaling KRW 25.7 billion. Pretax income posted KRW 78.4 billion, reflecting gains on the valuation of financial assets, driven by strong dollar. It represents a Q-o-Q transition to surplus and a 45% Y-o-Y decline. Net income was KRW 57.1 billion, up by 127% Q-o-Q and down by 50% Y-o-Y.Next, let me discuss sales by game. Q1 Mobile Games sales recorded KRW 249.4 billion, down by 17% Q-o-Q. Sales declined across the 4 Mobile Games with significant drops in the sales of Lineage 2M and Lineage W due to the base effect from the last quarter's large-scale update. Q1 Online PC Games posted sales of KRW 91.5 billion, up by 4% Q-o-Q. Lineage, Lineage 2 and Guild Wars 2 experienced a Q-o-Q increase, while AION and Blade & Soul recorded a Q-o-Q decline. Lastly, royalty sales increased by 7% Q-o-Q to KRW 32.7 billion. Royalties for Lineage and Lineage 2 IP increased from the previous quarter. Please refer to our earnings call presentation materials for the details regarding sales by games.Now, let me discuss operating costs. Q1 operating costs totaled KRW 372.2 billion, down by 14% Q-o-Q and 6% Y-o-Y. Labor cost was KRW 202.8 billion. This was pre-reflected to some extent, but the provision for incentive declined. Marketing costs dropped 83% Q-o-Q to KRW 6.9 billion, driven by efforts to reduce marketing campaigns for new title releases and overall marketing spending. On an annual basis, the cost increased by 42%. Depreciation rose by 4% Q-o-Q and declined by 1% Y-o-Y, totaling KRW 27.8 billion. Variable costs and other expenses totaled KRW 134.7 billion, down by 17% Q-o-Q and 12% Y-o-Y. Due to a decrease in games sales, distribution fees declined along with other costs.Next, CFO, Willie Hong and co-CEO, Byungmoo Park, will present NCSOFT management strategies.

[Won Hong, executive]

Good morning, I'm CFO, Willie Hong. Also today, it will be different from the general earnings call format. Although, presenting Q1 performance is important, but considering that we are facing difficult challenges, it is more important to discuss what kind of strategic directions our company will pursue. So, as you may know, in March, during the regular shareholders meeting, CEO, Byungmoo Park, has been appointed as a new co-CEO. So today, we are joined by our co-CEO, Byungmoo Park and he will discuss how our company will change looking forward. And this will be discussed at the top management level.So first of all, our CEO, Byungmoo Park, will present our strategies and vision for our company and then we're going to have a Q&A session.

[Byungmoo Park, executive]

So, good morning. My name is CEO, Byungmoo Park. And I believe this is my first time introducing myself as a new co-CEO, and I feel a great sense of responsibility of stepping into this role. There are a lot of things I would like to present. But for the interest of our time, I will pinpoint the points that I want to discuss today. So, my critical role as a CEO is to continuously make sales and profit growth. And as a result, I want to pursue continuous growth for ROE. And for that, we have been dedicated to find measures on how to achieve this goal. Although, it will take some time to see the results coming from our various initiatives, but I would like to briefly talk about my opinions in 4 points, which is about sales, cost and allocation of our resources and stock price management.In terms of sales, although there has been a concern over sales, we have been stabilized our sales starting from the second half of last year and we have maintained a stabilization in our user base for the existing IPs. So based on this performance, we believe that there will be robust cash flow in the future. So based on this performance, we will launch new IPs, including Battle Crush, Blade & Soul S and TL globally as promised this year and we promised to release AION 2, Project G and LLL next year.And on top of making continuous sales growth, we are continuing our efforts to increase and expand our geographical areas for our games. So for this year, Blade & Soul 2, which already acquired the government license from China, we are collaborating with Tencent to make sure that our game will have a completely new experience and we are going to release this as planned within this year. And this plan will be soon announced, which is that we are going to establish a JV with an excellent company in Southeast Asia. And starting from L2M, we are going to expand our market in the Southeast Asian region. And we will accelerate this geographical expansion next year.Also based on the successful IPs of NCSOFT, we are planning on releasing a new genre game within this year and 2 of them next year, totaling 3 games based on the existing IPs to secure more new revenue streams. And at the same time, we are reporting existing IPs to consoles. And at the same time, we are at the operating PURPLE, which is the platform for NCSOFT games. But starting from this year, we are planning on monetize this platform. And our goal is to release 2 or 3 global AAA games within this year. And if this turns out to be successful, we will continue to accelerate this project next year.Although, we are planning on releasing and developing many games after 2026, but we believe that there needs to be further efforts in order to achieve a sustainable sales and profit growth. And to reduce this gap, we want to implement the publishing business, including investment in IP securement and we will actively pursue M&A. And at the same time, we will license our IPs -- IP. And in terms of cost, as we announced already, we will reduce labor costs, which is considered fixed costs. So, within May, we are going to complete the process of recommended resignation and we are going to also implement a spin-off for some functions within our organization. And based on these efforts, we are planning -- we are aiming to reduce our headcount at HQ to around the mid-4,000.And also, we have been freezing the replacement of our headcount for the manpower that are not considered as mission-critical. And except for the manpower that are mission-critical, we are going to outsource these functions. And this is the beginning steps of our process to optimize our business and the optimization of our management and business will continue. And we will make a centralized organization for marketing spending so that we continue to manage our marketing costs. And on top of that, we will make sure to manage the other variable cost using the ROI analysis and AI technologies.And regarding the efficient allocation of our resources, we already know that the construction of the new building has been made public through the media outlet. But we will make sure that we don't further increase our real estate assets. For example, we are going to sell the building in Samseong-dong, which is owned by NCSOFT to procure the financing of construction of the new building. And also, if needed, we are going to liquidify the R&D center in Pangyo to make sure that we don't no longer increase our real estate assets.Now, I'm going to talk about the management of our stock price. We believe that our stock price has been close to the liquidation value. So, as announced yesterday, we are going to buy back treasury stock worth of KRW 100 billion. And after the buyback, we estimate that the ratio of the treasury stock will be around 10%, and this will be utilized for M&A funding. And we will make sure that the ratio of treasury stocks will be around at a 10% level. And if we conduct additional buybacks, then we will consider retiring the surpassing amount. And since we are going to revisit the 3-year shareholder return policy, which was announced previously next year, so we are going to look into the appropriate ratio between the treasury stock and dividend. And if we surpass the ratio of 10%, we will seriously consider retiring these surpassing amount of treasury stocks.On top of that, for the 10% ratio of the treasury stock, which will be used for the current M&A funding, if we don't make M&A cases within a certain period of time, these treasury stocks will be retired gradually. We are considering this plan. During my tenure, I will make sure to increase the value of our shareholders. So in order to do that, I'm going to make sure that our support organization and development organizations work as one team without any silos. And at the same time, we will make sure that the development organization can be more agile to respond to the changing trends.Thank you.

[Operator]

Now, Q&A session will begin. [Operator Instructions] The first question will be provided by Jae-min Ahn from NH Investment & Securities.

[Jae-min Ahn, analyst]

I'm Jae-min Ahn from NH Investment & Securities. First off, I'd like to send my support for the new CEO, who's dedicated to taking on new challenges for the company. I have 2 questions. First is about M&A. You emphasized the importance of M&A in the general shareholder meeting as well as the media conference. And I'd like to know the direction of the strategies of the M&A initiatives. And secondly, I'd like if you could provide details of the launch time line of the new titles and as well as your expectations for Blade & Soul 2 in China, Lineage 2M and TL.

[Byungmoo Park, executive]

So, to answer your question, I've mentioned this multiple times about our M&A direction. We're going to take 3 principles when we proceed with our M&A discussions. First, it should be a company that could create synergy with NCSOFT. And second, it should be a company that guarantees stability and sustainable growth potential. And third, the M&A deal itself should be accretive to our financials. So, as part of this initiative, our teams have worked hard since the second half of last year and has been reviewing various candidates. And we managed to reduce that list of candidates to a selective list. And now we are in the initial stages of discussions with 2 companies.

[Won Hong, executive]

And I'd like to answer your question on the new title launch time line. And you mentioned about expectations, so I'll address that. So, starting the second half of this year, we will ramp up our releases of new titles. So, we'll start off with Battle Crush's global launch in June. And starting with Battle Crush, we have a time frame window of 1 year and 6 months, and we will be releasing about 10 titles. And for this year, we have 3 titles coming up. It includes Battle Crush, Blade & Soul S and a new game that is based on the legacy IP. And we're also going to move forward with our regional expansion for TL, Blade & Soul 2 and Lineage 2M.And we have higher expectations for the year 2025 as we will be releasing the so-called blockbuster titles. And those mega heads include Project G and our important product, AION 2, and our shooter game LLL, which we have invested a lot of time. And as Mr. Park mentioned earlier, in 2025, we will be releasing 2 new games of new genres that will be based on our legacy IP. It will be a casual genre game. So although, it was unfortunate that we did not measure up to market expectations surrounding Blade & Soul 2. But starting from April 9, we have been beginning our pre-registrations for Blade & Soul 2 in China. And that is going well with figures up to 1 million users.And on May 9, we started our first round of CBT. And we're working closely with our publisher to make adjustments. We are revising our monetization scheme for the game. And we removed the auto hunting feature. And we are testing a new build that is focused on the content that's focused on progression. And as you know, there is an event called ChinaJoy, and we are going to actively engage and leverage that opportunity. No one knows how the expectations will turn out, but we noticed that in a gaming community in China, Blade & Soul 2 was listed as the #1 most anticipated new title. And a very talented team of our company are engaged in a very high-quality localization work for the game. And we're reflecting the demands and needs of the monetization scheme that works in the local market.And as Mr. Park mentioned, we are also working with a renowned company in Southeast Asia for the expansion of Lineage 2M in the region. So I think Mr. Park mentioned about this initiative because there are much growth potential in Southeast Asia and MMORPG space. And we will be -- we are sure that we will generate meaningful results if we leverage L2M's proven gameplay experience, quality and the cooperation with a strong publisher.

[Operator]

The following question will be presented by Eric Cha from Goldman Sachs.

[Minuh Cha, analyst]

I have 2 questions. You mentioned about a lot of challenges. And my first question would be about the internal review process. As you can see, the newly released titles didn't turn out to sit well with the game mayors community. But I'm sure that there must have been numerous review processes before the launch of titles. So, it feels that there might be some room for improvement of the initial -- the existing review system. So, I'd like to ask the new co-CEO, Mr. Park, on your thoughts about the problem of the existing review system and how are you going to change the system.My second question is a bit simpler. You mentioned about the pipeline and the workforce plans. But -- so based on these changes, what are your forecasts for the earnings this year and next year?

[Byungmoo Park, executive]

There are several problems. But first of all, the review duration is too long. So, thus caused some development delay resulting in the game not being able to follow-up with user trends. And secondly, up until now when we released a game of a new genre, we didn't do much of an external test. And as a result, we weren't able to reflect the expectations and the preferences of our game users. So as in response to this, the new system that we adopted at the end of last year is to create a review committee pool of people that are younger. So, we review the preproduction stage, core stage and mass stage of the development, focusing on the ROI. And if it's a new game, whenever this game goes through the spaced review process, it needs to have an external test done.And we realize that the longer the development period gets, it not only can achieve the ROI expected but also it cannot measure up to the trend changes. And therefore, we created a system where we provide a guideline requiring the development team to end the development within a certain period of time. So, you might have heard news about our new games going through CBTs or FTTs. So, this is part of our efforts to improve the system. So, the reason why I have much confidence in providing the details on the launch time line of our games this year and for next year is because we have this new review system in place.

[Won Hong, executive]

I'd like to provide my thoughts on the earnings guidance adjust. So, year 2024 would not be able to turn a meaningful earnings results because, as I mentioned earlier, year 2024 is a time where we diversify our IP genre and platform and we're also pursuing our global expansion initiatives. So, it's a year where we lay the groundwork for building that sustainable growth potential. So, I don't think the -- our earnings for this year will be that much different from the profit or sales consensus. But 2025 would be different because the games that will be launched in the second half of this year will be captured in full for the full year of 2025 and also the 3 blockbuster titles that will be launched in 2025 is also in store. So, there will be some meaningful changes to our earnings in 2025 compared to the consensus.And I also think there are additional upsides. First is the upside coming from the management optimization. We are making multiple efforts, such as the overhaul of the game review process that you mentioned. It's happening on a much deeper level. And we are seeing some cost-related changes. So, all of these efforts will be captured in full soon. And this Mr. Park could elaborate more on this. But other than the details that we could disclose during this earnings call, there are multiple efforts to raise the profitability on a company-wide level and we'll be able to disclose them gradually as time comes.

[Byungmoo Park, executive]

And I'd like to add a bit more. Of course, achieving big growth in 2025 is important. And as Mr. CFO mentioned about the guidance of 2024, my thought is that we are making all our efforts to achieve performance that exceeds market consensus with our [ chief ].

[Operator]

The following question will be presented by Seyon Park from Morgan Stanley.

[Seyon Park, analyst]

My question is about the specific cost saving plans. So, how much do you expect to gain in cost savings per year coming from the recommended resignation? And my second question is about property assets. So, it seems like there are already commitments made to the new office building construction. How much resources do you think will be additionally needed? And how would that be captured in cost increases? And when would that happen?

[Won Hong, executive]

So, thank you for your question, Mr. Park. The impact from the recommended resignations, as you know, it's not certain because the number of the exact scale of the resignation is not defined. And of course, there will be some one-off costs to be increased. So, it's not likely that the positive impact from this program will turn up in our financials. But since we do have an excessive fixed cost, which is our labor cost, I believe that this process will be good for us in the long run. And as we move on with this process, we will provide the results to our analysts and investor communities.So, regarding your question on the new office building, we decided to invest in this building in 2021, and we got the building permit -- the construction permit in 2023. And so we cannot backtrack on this contract. But to provide some numbers, as you mentioned, the purchase price of the land for the new office building was KRW 430 billion. And this number is already executed. But additionally, we started our construction in March this year and the construction will be completed in 2027. And on top of the KRW 430 billion, we are going to see an additional KRW 580 billion in the construction costs. And I don't know how the global inflation trends will turn out, but in a conservative perspective, we are -- might expect some additional increases and we are trying to minimize these costs. So, to spread this cost out in terms of modeling, I could say that you could roughly divide the cost execution over 2026 and 2027.And to elaborate more about the efficient use of the resources that Mr. Park mentioned. And currently, our company owns 2 buildings, one in Samseong-dong and our Pangyo R&D center. And the combined book value of these 2 buildings are KRW 230 billion. However, the market value is KRW 1 trillion. So, these buildings could be used to increase efficiencies. And therefore, I could say that we do have options to offset the additional increase in construction costs with these assets.

[Operator]

The following question will be presented by Stanley Yang from JPMorgan.

[Stanley Yang, analyst]

So, thank you for participating, Mr. CEO, Park in this conference call. I have 2 questions. First, I'm sure that the company has reviewed its strategy regarding the Western market and the console market. So, what are your thoughts on the expected performance in these fields? And I'm wondering if there's a new approach that's different from the past. The reason why I'm mentioning this is there has been some meaningful performance in the console market with Korean games, either games that are based on legacy IPs or games that are based on the talent of NC.And second is about the R&D cycle. The R&D cycle is about 4 to 5 years, pretty long. And even if there will be new development process, there are concerns that since these are based on the legacy IPs, there might not be some innovative changes. But I'm wondering if there will be some significant changes on this front?

[Byungmoo Park, executive]

When you look at the market structure, the Western market is pretty big. It's bigger than the Chinese market. And by platform, console is a growing platform [Technical Difficulty] and PC. And in order to approach things more efficiently, we are continuing to cultivate ArenaNet, which is under NC West as a leading studio in the West. And our plan is to grow NC A, which will be in charge of publishing various genres of games in the Western market. So of course, we are going to focus on the genres that we are confident in, but we are also developing games that are of a new genre that we're not used to. And for these genres, we will be working with -- there are publishers who are fit for these genres.And therefore, we're currently working to focus on publishing games of genres that we're confident about through NC A or our subsidiaries in Taiwan and Southeast Asia and Japan. However, for genres that we don't have the much expertise in, we will be working with external publishers through our global command post and NC America. This way, we could help ensure that our new genre games could secure a footing in the new markets. So, we're currently discussing with some multiple potential publishers and I think we'll be able to develop further details as time comes.And the console market is a market that we must move into. And as you know, a lot of the games that we're currently developing are being developed on console alongside. So for instance, Battle Crush will also be developed on console and released. TL will follow suit. And more details will be disclosed sometime around the July and August, but we are working with a global platform company to bring our existing IPs to console as well as other IPs. And I emphasized working with companies that could provide synergy with us through M&A. We are considering companies that could help us make the synergy in the Western market, the global market and the console space.And you mentioned about the R&D cycle being too long. And our biggest goal is to shorten this R&D cycle that fits the market trend. And through last year through the game review process, we streamlined some projects that are -- does not fit the trend or has a long cycle. So for instance, we changed -- in MMO, we might have changed MMO into an MO. We also streamlined some excesses to fit the market trend. And for instance, there was -- another example could be reducing the development of multiple -- development of the game on multiple platforms to shortening that to 1 or 2 platforms. So, the important part is to enable these projects to be able to finish within a reasonable time that fits the trend. And this is a consensus that our management and the teams have. So, I'm sure that there might be doubts about this considering our previous track records. But please, I ask for your continued interest and I will make sure to deliver the titles on time as I committed.

[Operator]

The following question will be presented by Miseon Lee from Citi Securities.

[Miseon Lee, analyst]

I have 2 questions. First one is about user sentiment. For the past previous years there has been a rise of the so-called Lineage like genre, represented by aggressive business model. And I think this caused a impact on the brand value as well as the loss of trust from users in Korea and abroad. So, what do you -- and this is causing games to receive criticism even before its launch. So, in order to increase the hit ratio of these new titles, what kind of efforts are you making to increase the brand value and trust back?And second question is, as you see that the Lineage like monetization scheme is not sustainable and there must be changes to the monetization scheme. How do you think will the monetization scheme change for AION 2? And how do you think these changes in business models impact the future sales?

[Byungmoo Park, executive]

The direction of the business model and user sentiment are all related. And as mentioned previously, it's not about the marketing or PR efforts to recover our brand value and gain back user sentiment, but it's about releasing new games and genres that are user-friendly. So for other titles in the pipeline, by not applying the Lineage like business model, but applying a lighter model such as a Battle Pass or a business model focused on cosmetics, we will be releasing them. And if the users could trust us, I think that will lead to a user-friendly monetization model.And you asked about the impact of the scheme changes on the sales. And I think sales is the number time that is the actual user number times their RPU. And these lighter BM models will be focused on the global market and will be global gamer friendly. So although, these games will have a lower ARPU than Lineage like games since it will have a larger user base, I believe that the sales were to be on par or higher. And a little more about TL. In Korea, many users criticize TL for being the typical NC game. However, when you look at the results of the CBT and the technical test on TL across global users, there were no criticisms based on those typical biases that we see in Korea.

[Jason Lee, executive]

Thank you for all your questions, and we will now have the time for the CEO, Park to deliver some closing remarks.

[Byungmoo Park, executive]

In order for a company to grow, I think the trust between the shareholders, users and the management is the most important. However, up until now, we lack this kind of trust system among these stakeholders. So, leading to our users not trusting us when we launch new games and our shareholders not trusting us when we take an action. And as mentioned, however, we will rebuild trust with our game users through new games, new genres and new monetization models. And from the management, we will make sure to work as one team and make our organization more agile so that we could deliver earnings that exceed the consensus. So therefore, I also ask our shareholders and our investors to keep your continued interest and trust in us. Thank you.[Statements in English on this transcript were spoken by an interpreter present on the live call.]