NCSOFT Corp

KRX:036570

Earnings Call Analysis

NCSOFT Seeks Growth Amidst Declining Sales in Q2 2024

NCSOFT reported second-quarter sales of KRW 368.9 billion, down 16% year-on-year. Operating profit plummeted 75% to KRW 8.8 billion, reflecting challenges in mobile game sales, which fell 13%. Despite this, net income increased to KRW 71.1 billion, driven by foreign currency gains. The company is executing four initiatives to stabilize sales, enhance cost efficiency, and manage share prices, including a treasury stock buyback worth KRW 100 billion. Following a successful update, sales from Lineage M surged with 1.5x active users, setting the stage for new game launches globally scheduled for late 2024 and 2025.

NCSOFT's Second Quarter Performance Review

NCSOFT reported its second quarter earnings for Fiscal Year 2024 with a notable decline in overall sales. Revenue totaled KRW 368.9 billion, marking a 7% decrease from the previous quarter and a 16% drop year-on-year. The operating profit saw a steep decline, falling 66% quarter-on-quarter and 75% year-on-year, amounting to only KRW 8.8 billion. However, net income rose to KRW 71.1 billion, up 24% from the last quarter and an extraordinary 133% year-on-year, driven largely by favorable foreign currency gains.

Sales Breakdown by Platform

The sales dynamics varied across different gaming platforms. Mobile game sales decreased to KRW 218.2 billion, down 13% from last quarter, while PC online games also dropped to KRW 86.2 billion, a 6% decline. Interestingly, despite sales downturns in several titles, royalty sales increased 15% quarter-on-quarter to KRW 37.7 billion, thanks to updates to existing games like Blade & Soul.

Cost Management Strategies

To counteract the revenue declines, NCSOFT has implemented several cost management strategies. Total operating costs decreased by 3% quarter-on-quarter to KRW 360 billion, with labor costs down by 7% to KRW 188 billion. However, marketing expenses surged by 152% as the company undertook promotional activities for major game updates, reflecting their strategic push to revitalize player engagement.

Future Growth Initiatives

NCSOFT outlined four key initiatives aimed at sustaining growth: improving sales stability for legacy IPs, enhancing cost efficiency, distributing resources more effectively, and a proactive share price management approach. The recent update for Lineage M has shown promising results, achieving 1.5 times higher active users and 2.5 times greater daily sales compared to before the update. This trend is expected to continue into the latter half of 2024, with similar strategies planned for Lineage 2M.

Upcoming Titles and Strategic Diversification

Looking ahead, NCSOFT is set to launch new titles based on its legacy IPs, with one expected to roll out globally in Q4 2024. This is part of a broader strategy to expand both domestically and internationally, with new titles also slated for release in China and Southeast Asia by the end of this year. The company remains committed to diversifying its game portfolio while maintaining its foothold in the MMORPG space, emphasizing that new genres and collaborations will continue to be explored.

Shareholder Returns and Asset Management

NCSOFT is keen on optimizing shareholder returns, having initiated a treasury stock buyback valued at KRW 100 billion in July. The company plans to introduce a new dividend policy in 2025, which will include measures to return excess treasury stocks to shareholders. Overall, NCSOFT is strategic in its asset management, focusing on liquidating non-business assets and refining its workforce as part of its ongoing restructuring efforts.

Key Takeaways for Investors

While NCSOFT faces challenges in sales and profitability, its strategic updates, cost management efforts, and commitment to upcoming game launches position it for potential recovery. Investors should watch the impacts of their ongoing initiatives as well as upcoming title releases, especially the sustained performance of Lineage M. The focus on cost efficiency and shareholder returns also signals a responsible approach to navigating the current market downturns.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, and good evening. Thank you all for joining the Conference Call for the NCSOFT Earnings Results. [Operator Instructions]

Now, we will begin the presentation on NCSOFT's Second Quarter of Fiscal Year 2024 Earnings Results.

[Jason Lee, executive]

[Interpreted] Good afternoon, everyone. This is Jason Lee, Head of IR at NCSOFT. Thank you so much for participating in the NCSOFT earnings conference call for the second quarter of 2024.

We have CFO, Willy Hong, joining us for today's conference.

Now, without further ado, let me begin with the financial highlights.

Second quarter sales recorded KRW 368.9 billion, down by 7% quarter-on-quarter and 16% year-on-year. Operating profit fell 66% quarter-on-quarter and 75% year-on-year, totaling KRW 8.8 billion. Pretax income posted KRW 84.9 billion due to the increased gains on the foreign currency driven by strong dollar, which is an increase of 8% quarter-on-quarter and 117% year-on-year. Net income was KRW 71.1 billion, up by 24% quarter-on-quarter and 133% year-on-year.

Moving on to the sales by platform. Second quarter mobile game sales recorded KRW 218.2 billion, down by 13% quarter-on-quarter, with the sales of Lineage M recording an uptake, while sales of 3 other mobile games dropped compared to the last quarter. Second quarter PC -- online PC games posted sales of KRW 86.2 billion, down by 6% quarter-on-quarter. The sales of Lineage experienced a quarter-on-quarter increase while the sales of 4 other PC online games declined from the previous quarter. Lastly, royalty sales increased 15% quarter-on-quarter to KRW 37.7 billion. NEO Classic server update resulted in increased royalties for PC version of Blade & Soul in China compared to the previous quarter.

Next to the operating costs. Second quarter operating cost totaled KRW 360 billion, down by 3% quarter-on-quarter and 11% year-on-year. Labor cost stood at KRW 188 billion, down by 7% quarter-on-quarter and 10% year-on-year. Severance benefits from recommended resignation were reflected by long-term incentive reserves and other costs dropped. Marketing costs rose 152% quarter-on-quarter to KRW 17.4 billion, driven by promotional campaigns for the large-scale update of Lineage M and marketing activities for new releases. Depreciation was flat quarter-on-quarter and year-on-year, totaling KRW 27.9 billion. Variable costs and other expenses totaled KRW 126.8 billion, down by 6% quarter-on-quarter and 19% year-on-year. The decline in the sales of mobile games resulted in lower distribution fees.

[Won Hong, executive]

[Interpreted] Good afternoon. I am CFO, Willy Hong. Like Jason just mentioned, during the first quarter earnings call, we announced 4 key initiatives for NCSOFT's sustained growth. Those are: First, sustained sales growth; second, improving cost efficiency; third, efficient distribution of resources; and fourth, share price management, including the treasury stock buyback. Over the past 3 months, NCSOFT has been delivering on all 4 initiatives as promised at a rapid pace. And today, we'd like to share the details about our progress. Firstly, let me begin by what we achieved regarding the first initiative, the sustained sales growth for stabilizing legacy IP sales and expansion to overseas regions.

Firstly, for the sales growth of NC's existing IPs, in June, NCSOFT showcased a reboot world with unique ecosystem for Lineage M, which has led to remarkable achievements with 1.5x higher number of active users, 2.5x greater daily average sales and 2.5x higher number of paying users during 1 month before and after the update. This update user trend has been well maintained so far, which will continue during the second half of 2024. And apart from the Lineage M, we'd like to apply the successful approach to other titles as well with a comparable large-scale update plan for Lineage 2M this month. Overseas releases are also on track as initially planned. We're going to launch Throne and Liberty globally, Blade & Soul 2 in China and Lineage 2M in Southeast Asia within the year. Establishing a joint venture with our local company to launch Lineage 2M in Southeast Asia will be completed soon.

For the sales growth of new titles, new titles will be released as promised. I told you during the last earnings call that 3 new games based on the legacy IP were under development, and one of them will be launched globally during the fourth quarter of 2024 with its teasing campaign starting to be rolled out within this month. The rest 2 games will be slated for launch during the first half and second half of 2025, respectively. Blockbuster titles, Project G, Aion 2 and LLL are on the development targeting the first half, second half and fourth quarter of 2025 for launch, respectively. In addition, 2 casual games will be launched in 2025. Looking ahead to 2026 and beyond, we're also working on a global IP-based new MMORPG, a brand-new shooter game with a differentiated concept in a bid to secure long-term growth engines.

Apart from the sales growth for existing IPs, as well as new titles, there are 2 more areas that we've been focusing on. And this is regarding our external collaboration. Also, pushing ahead with inorganic growth for NCSOFT globalization efforts is that, firstly, as part of the dual track strategy to explore drivers for business diversification from upside, we've been pursuing equity and publishing right investments in external game developers, and this effort recently came to fruition in the form of our very first investments in Moon Rover, a Sweden-based game developer and Vic Game Studios, which we'll communicate today. For Moon Rover, we'll closely moment how the project will be progressing and discuss more deeply, including further investment and publishing rights. With Vic Game Studios, publishing a new title called BREAKERS: Unlock the World is expected to bolster NCSOFT's portfolio and contribute to user diversification.

Once again, allow me to reiterate that our strategic investment activities do not end with these 2 recent transactions. We will continue to identify more investment opportunities and actively pursue business diversification by leveraging both internal and external capabilities. Secondly, we are simultaneously moving forward with a large-scale M&A, which will allow us to immediately secure global business portfolio and financial performance by acquiring a global gaming entity. We'll make sure to communicate more once the outcome materializes.

The last piece of our sales growth will be the platform PURPLE. I believe we are going to share some good news on the business strategy of the PURPLE platform very soon. We'll announce a detailed onboarding plan for 4 AAA games to PURPLE next week, and begin the first release starting this month. The onboarding will be followed by a series of global AAA releases within the year. And for mid- to long-term, we are exploring ways to expand our publishing business for new titles targeting global markets with PURPLE.

Next to the topic of cost efficiency. Like I said during the last earnings call, recommended resignation and corporate spin-offs will allow us to streamline the headquarters' head count to around mid-4,000 with relevant procedures still ongoing. We'll keep doing our best to achieve cost efficiency by freezing new hires apart from mission-critical areas. Regarding the liquidation of non-business assets, like I said during the last conference call, we completed the process of selecting an advisory to sell off NC Tower in Samseong-dong and undertook necessary steps for the asset disposal. We also bought back treasury stocks worth KRW 100 billion in July. When establishing a new dividend policy for 2025, we are planning to announce a shareholder return policy, incorporating the utilization of treasury stocks and cash dividends, as well as considering the retirement of treasury stocks for the amount exceeding 10% of the ownership.

And lastly, as I explained so far today, we've been ramping up our efforts to carry out the key initiatives we announced during the last earnings conference. We are committed to pushing forward and making sure to deliver tangible results, which will continue to communicate with the market.

And on that note, let us wrap up the earnings call presentation for the second quarter of 2024, and we will answer your questions. Thank you.

[Operator]

[Interpreted] [Operator Instructions]

The first question will be provided by Eric Cha from Goldman Sachs.

[Minuh Cha, analyst]

[Interpreted] I'm Eric Cha from Goldman Sachs. I have 2 questions. First one is about the sustained sales growth. So after the successful update for Lineage M, you said you will apply similar approaches to the Lineage 2M, Lineage W. And as far as I understand, Lineage M showed stable revenue, stable sales from the past, whereas Lineage 2M and Lineage W's structural weaknesses have already been exposed. And what do you think is the difference that make these differences in the sales? Is it the strength of the IP itself? Is it monetization scheme? Or is it because of the competitors? If you have that answer and how you will stabilize the sales for the -- other titles apart from Lineage M? And what -- when will be the time line for that to be made possible?

And the second question is about your strategy. You mentioned a lot about M&As, and I understand those volumes of M&As aren't that significant. That guarantees lower risk, but I was wondering if that could generate enough returns to fundamentally address NCSOFT's issues. And you seems to be focusing on expansion to new genres of games. So NCSOFT has been very successful in MMORPG space. And I believe the internal resources are all centered towards developing an MMORPG game. And I was wondering if the resources are aligned to develop another kind of genres. So to -- in a nutshell, what are the reasons or background for focusing on the diversification? And why do you think it's the better choice?

[Won Hong, executive]

[Interpreted] Thank you for your question, Eric. To answer your first question, we admit that there is a difference between Lineage M and Lineage 2M and Lineage W. And it is also true that the other 2 Lineage titles were affected by fierce competition. But we clearly identified there is a clear upward trend in the traffic with our successful -- recent successful update for Lineage M. And by applying a similar approach to Lineage 2M, Lineage W, we can attract more new users, as well as having those lost users coming back to play the game. And we will add new content and open a new store so that players can find it more accessible to play the game again, which will, we believe, result in a significant rebound for sales and traffic.

And to answer your second question, this is also related to my answers to the first question that NCSOFT has significantly grown with the success out of its MMORPG titles, and this is the field that NCSOFT can really excel. But that diversification doesn't mean that our focus and efforts for MMORPG genre will be affected. With our expertise, know-how, technical prowess for existing IPs, as well as user-friendly approach will allow us to achieve higher sales and profitability, and we will keep doing this with the legacy IPs, as well as MMORPG RPG games that we have expertise in.

And regarding the diversification. So recently, we have -- there has been an organizational restructuring inside. And I can say that apart from the legacy IPs, we have separate organizations to develop new genres of game, and we have chiefs overseeing those organizations. We have sufficient numbers of developers and resources, as well as support functions for these new projects. So I can say that we have enough headcounts and resources to venture into new genres of game. If there is a need for any collaboration with outside partners for regional expansion or developing a new genre of game, we will definitely collaborate with our partners, as well as investing in certain game developers. I'd like to emphasize that there is a clear distinction between investment and M&A. And I don't want you to confuse the 2 initiatives from our side, which is that investment is -- can be a seed round investment. We're investing in publishing right, whereas M&A is an initiative that we'd like to take in a sizable volume considering the overall direction, as well as overall profitability. So this is the 2 track strategies, which will be carried out in parallel. And we will communicate with the market if -- once we have tangible outcomes.

[Operator]

[Interpreted] The following question will be presented by [indiscernible] Lee from Macquarie Securities.

[Unknown Analyst]

[Interpreted] I have 2 questions. First one is about M&A. So I understand you've been making efforts in this regard from a while ago, and like you communicated during the last conference call. So M&A is an important initiative for NCSOFT, and I was wondering if any criteria or standard for selecting the potential M&A candidates have changed.

And secondly, regarding the labor cost, what was the amount related to the recommended resignation for the second quarter? And are there any additional cost savings or a number of recommended resignation for the third quarter?

[Won Hong, executive]

[Interpreted] Thank you for your questions. So there -- the criteria for M&A hasn't changed at all. So we are looking for potential M&A candidates from home and abroad in the gaming industry. And for -- when we look at the overseas game studios, regional implication is something that we've been taking into consideration a lot. And whether the management capacity can be maintained is an important criteria that we take into consideration for M&A because when the management pool leaves the company, it can become a shell. And most importantly, the price of acquisition is critical, and it should be in the interest of our shareholders. We will make sure that M&A will not destruct the value, and we will also care about the EPS accretion. And the same approach is applied to the M&As in the domestic industries. So, rather than any changes regarding the criteria, we've been more selective in choosing our potential partner.

And to answer your second question regarding the head count. So we first reduced the scale of executives at HQ. Earlier this year, we cut 20% or 1/5 of HQ executives. And we started a recommended resignation program from the month of May, which will be ongoing until the end of this year. And like I said during the last conference call, the number of headcounts at HQ will be around mid-4,000 around the end of 2024.

Regarding the cost, the labor cost dropped by 7% in the second quarter compared to the previous quarter to stand at KRW 180 billion, which is a 10% decline year-on-year. This includes severance packages for the recommended resignation and long-term reserves, which I can't disclose in detail. So this is cost report for your question.

[Operator]

[Interpreted] The following question will be presented by Dong Hwan Oh from Samsung Securities.

[Donghwan Oh, analyst]

[Interpreted] I have 2 questions. First one is about the disappointing results from the recent launch of Battle Crush. What do you think are the reason for the disappointing results? And also, despite the new line -- lineup of new games, including HOYEON, it seems very challenging to achieve any successful records. And what will be the successful success factors in your opinion?

And secondly, so you mentioned blockbuster games to be released, including Tactan and Aion 2. And what -- how these blockbuster titles can be successful in your opinion? These are my questions.

[Won Hong, executive]

[Interpreted] Thank you for your question. Regarding the Battle Crush, whether it was disappointing or not depends on your expectations. But what I would like to share is that, when we try new genres of game, we don't necessarily always expect perfect and most successful financial results. The management's philosophy is that, we are open to new projects. And if we can find a successful project, then we can support them further. And if there are any financial achievements from those new projects, that will be great.

And regarding HOYEON, now we are in the process of finally publishing the game, and we are also waiting marketing campaigns, as well as additional -- carrying out additional testing. I understand that some communities had mixed response to the game, but those players who actually experienced the gameplay were very positive about the game build. And so, we are excited about the new content and the achievements it will generate.

And regarding the second part of your question, the most anticipated blockbuster IPs for LLL and Aion 2, the dev team for these 2 products have the understanding -- strong understanding of the genre and technical expertise, as well as experiences. So we are excited for the project team to finally come up with the new games. And for Project G, which is officially named Tactan. This is a new genre of game that combines strategy game with simulation. So, compared to the existing strategy games that is focused on simple tactics, it has unique selling points that emphasizes gameplay. And also, how to fully monetize the game is something that we are deeply discussing internally and externally. So, we will communicate the details about these new releases, anticipated titles going forward.

Thank you all for your participation despite the market conditions today. And on top of the earnings conference call, we will keep communicating with you guys and the market about our development time line, as well as release time lines. Thank you again for your participation.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]