NCSOFT Corp
KRX:036570

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NCSOFT Corp
KRX:036570
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Price: 206 000 KRW 0.73% Market Closed
Market Cap: 4.2T KRW
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Earnings Call Transcript

Earnings Call Transcript
2024-Q3

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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 third quarter of fiscal year 2024 earnings results.

J
Jason Lee
executive

Good afternoon, everyone. This is Jason Lee, Head of IR at NCSOFT. Thank you for participating in the NCSOFT earnings conference call for the third quarter of 2024. We have CFO, Willy Hong, joining us for today's conference.

Now let me begin with financial highlights. Q3 sales recorded KRW 401.9 billion, up 9% Q-o-Q and down 5% Y-o-Y. And operating loss totaled KRW 14.3 billion, turning negative Q-o-Q and Y-o-Y. Pretax loss posted KRW 32 billion due to the increased loss on the foreign currency driven by the weak dollar. Net loss stood at KRW 26.5 billion.

Moving on to the sales by game. Q3 mobile game sales rose 16% Q-o-Q to KRW 253.4 billion, primarily driven by Lineage M recording 49% Q-o-Q increase in sales. Q3 online PC games posted sales of KRW 80.7 billion, down 6% Q-o-Q. This is influenced by sales fluctuating based on the type of quarterly event update. Lastly, royalty sales grew 1% Q-o-Q to KRW 38.1 billion. Although TL's early access packs have surpassed our internal projections, the overall royalties remained at a similar level when compared with the previous quarter due to a royalty decline from Blade & Soul China.

Next, to the operating costs. Q3 operating costs totaled KRW 416.2 billion, up 16% Q-o-Q and 2% Y-o-Y. Labor cost was KRW 201.1 billion, up 7% Q-o-Q and 1% Y-o-Y, as the effect of adjustments in long-term incentive reserves from the previous quarter are no longer present. Marketing costs rose 180% Q-o-Q and 76% Y-o-Y to KRW 48.7 billion, influenced by proactive marketing activities for new releases and live service games. Depreciation reached KRW 26.5 billion, down 5% Q-o-Q and 9% Y-o-Y. Variable costs and other expenses totaled KRW 139.9 billion, up by 10% Q-o-Q and down by 8% Y-o-Y. The changes in the sales of mobile games led to fluctuations in distribution fees.

W
Won Hong
executive

Good afternoon. My name is Willy Hong, CFO of NCSOFT. I just -- we just presented the performance of this quarter, but I would like to first take this opportunity to send our apologies for disappointing results.

Before we move on to the Q&A session, I'm going to talk about the current status that we have as a company and what kind of changes that we are trying to make in order to overcome these challenges. Of course, we want to first make our approach to enhance our sales by making a megahit success coming from new titles and also continuously making profit coming from the existing IPs. And currently, we have the fixed cost problem, which is very high. So we want to briefly talk about how to improve this issue.

For new titles, we are approaching a diversification portfolio approach for new titles. For genre-wise, we want to pursue games in RPG, strategy, shooter, subculture and MMO. And for platforms, we not only consider console and PC, but we are also expanding into other platforms as well. And for this year, we are highly expecting a good result coming from the Journey of Monarch, which will be released in the fourth quarter, and we are very confident that this will turn out greatly.

For next year, we are expecting to have 5 releases, which includes our most expected titles, including AION 2, LLL and TACTAN. And as we recently announced, we are going to also have a release of BREAKERS, which is created by VIC GAME, and also a new genre title based on the existing IP, which will target the global audience. And for external IPs and collaborations, besides Moon Rover and VIC GAME, we're going to announce our news regarding investment and publishing deals which will be made one in Korea and one overseas. One of these titles will be released in 2025, and the remaining one will also be released soon.

For M&A deals, as I've mentioned previously, there has been a lot of progress. So we will make sure to communicate this news to the public. And for existing titles, as you may know, we have made a successful result coming from the reboot update for Lineage M, which resulted in a 49% increase Q-o-Q, and we expect that the similar level of strong performance will be made in 4Q. And also for Blade & Soul NEO, we have seen the top performance after 6 years. And for Lineage 2M, we are also going to release a new server that is in line with the customer needs.

So to wrap up, we are going to put our customer first, and we want to make sure that our existing IPs realize their hidden potential for sales. And regarding TL, as you -- is already known, we are having a different approach by reflecting user feedback in our game, and we want to make sure that this approach is also applied to other games. And to achieve this goal, we are currently pursuing a new dedicated development studio system. And the most important task will be to create an environment that encourages independence, expertise and creativity.

And as you may have known, we have this internal system, which has high expectations and evaluation for our internal games. But although this have a lot of upsides, but we thought that time-wise and cost-wise, there could be some improvements. Therefore, we have wanted to pursue this new system so that we can have more -- we can speed up the development of new IPs. So for new IPs, we want to take this new dedicated development studio system.

Lastly, I want to talk about what is most important, which is cost optimization. Currently, we have stopped 6 projects that were under development, and we have shut down some teams. And as you may know, we have initiated a company-wide voluntary resignation program. And we want to lower the effect of operating leverage that is influencing our company performance. In other words, we have high fixed cost that can lead to the effect of operating leverages, which is closely tied with our revenues, and we want to alleviate this issue.

And we want to finish this re-org initiative within the fourth quarter of this year. And starting from 2025, we want to pursue a new cost structure so that we can no longer have the effect of operating leverages. So to wrap up, we want to finish what has been done this year within 4Q. And starting from 2025, we want to make sure that we have this new cost structure that can transform our company.

So we want to emphasize that there could be some one-off costs coming from this initiative in the fourth quarter. But if we do not finish this work within fourth quarter, we are going to see another continuous disappointing news starting from like this in the third quarter. So for the fourth quarter earnings call, we want to have more accurate -- present more accurate information, including the size and effect of the various initiatives that we want to take.

Although I cannot give you details because these initiatives are underway currently, but we want to emphasize that they are implemented within our expectations. And if these go well, we believe that we will be able to give you more clear visibility in the labor cost and fixed cost for 2025 during the fourth quarter earnings call conference.

And lastly, I want to quote the message that was distributed within our company coming from our Co-CEOs. We are taking this issue very seriously. And without changing -- without bold changes, we think that our future is no longer be available. So therefore, I want to emphasize that we want to continue to ask for your support from our shareholders and stakeholders that we want to continue to make changes for our future. Although this is a difficult time for us, but I want to make sure that in 2025, we want to give more hopeful message for our market and investors, and we want to continue to implement these initiatives to achieve this goal. Thank you.

Operator

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

M
Minuh Cha
analyst

I have 2 questions. First is about AION 2. Although you still have time -- a lot of time left until the launch, so it will be difficult to provide much detail, but it would be appreciated if you could provide at least a high-level guidance on this title. So when you look at the user response for TL's global launch, it seems like TL is a high-quality game that adheres strictly to the MMORPG standards and formula. Will AION 2 take the similar approach, focusing more on the quality of the game, but adhering to the existing MMORPG success formula? Or will it take a totally new attempt?

And my second question is about genre diversification. So as the company diversifies its portfolio, the resources will be allocated across different genres. So from an external person's perspective, what -- why do you think NC would have a higher hit ratio for these different genres compared to its competitors, considering the fact that the company has been mostly focused its resources on MMORPGs in the past?

W
Won Hong
executive

So thank you, Eric, for your question. I've always read thoroughly all of the analyst reports on our company for the past 3 years. And of course, I was able to relate to a lot of them coming from Korean securities companies. And I also recently read your report, and I'd like to say that me and the other members of the management are -- can relate to what you've written in your report.

So I recently saw the build of AION 2, and it was beyond my expectations. So of course, AION 2 camp members will communicate the features of the game directly. But since AION 2 also targets the global market just like TL, it will take a completely different approach in terms of game design content, especially focused on combat, the monetization scheme and the marketing strategies. But the specifics about the game will be announced through AION 2 camp after next year.

So for instance, it has a variety of content. And just by exploring a lot of content in the world, users can reach the highest level. So it's difficult to simply put what this game is about into simple words. But in my opinion, I think rather than focus on competition, AION 2 focuses on providing the opportunities for players to enjoy the game with fellow players and progression. So it has a lot of focus on PB content. And as you know, to succeed in the global market, an abundant amount of PB content is important. So in terms of content quality and size, it will set a new standard and provide a new vision. So when we kick off official marketing activities next year, we will disclose further details.

And as for your question on diversification strategy, of course, most of our development resources and experience are focused on MMORPG. However, we do have an accumulated experience and capabilities built inside the company regarding other genres, and we've confirmed that as well. So based on these resources, we're currently preparing for our new titles. And additionally, we will also reach out for partnerships with studios outside of our company through publishing deals and so on. So then this approach is equally important. So since internal teams will be compared to external teams, I think this will create a positive competition that will improve the gaps that we had in the past.

So after BREAKERS: Unlock the World slated for launch with VIC GAME STUDIOS, we also have an additional title in the pipeline. This will be a completely new approach in terms of genre and the development direction, which would be clearly different from our previous approach. So we will strengthen our publishing capabilities, which will bring changes. And during this process, we will not only further strengthen our publishing capabilities, but also internal development capabilities, which will bring a positive motivation across the company.

Operator

The next question will be presented by Dong Hwan Oh from Samsung Securities.

D
Donghwan Oh
analyst

I have 2 questions. First one is about the restructuring and reorganization. The company has implemented various measures such as the voluntary retirement program and the recommended resignation program. So what are your headcount goals for the end of 2024 and 2025?

My second question is about the independent studio system. Netmarble also adopted this type of studio system, however, it didn't turn out greatly. So what, in your opinion, are the benefits of transitioning into this system? And also, are you considering IPOs of these studios after this transition is completed?

W
Won Hong
executive

Thank you, Dong Hwan, for your question. I think this is the most curious question that everyone has. But yes, we do have a lot of measures, including corporate spin-offs, the retirement -- voluntary retirement program and project shutdowns. When all of these initiatives are completed, we currently have about mid -- more than mid-4,000 headcount concentrated at HQ, but I think within next year, that will be lower to somewhere in the 3,000. I think this will address the fixed cost problem and the operating leverage effect that I mentioned earlier, and you'll be able to calculate the numbers accordingly. And this amount of change in the fixed cost, I believe you'll be able to project the impact on the operating profit generated in terms of our cost structure starting next year.

Regarding your question on the studio system, yes, there's a phrase called easier said than done. But -- and you cited an example of another company, but there are many other cases that has been successful with this system. When you look at our competitor, you clearly could see some operating profit and sales growth from the studio system. So we believe that there are clearly significant benefits from this system. And what's important in this process is to set clear responsibilities and compensation system. And during that process, it's important to determine whether this could generate creativity and the spirit to take on new challenges.

And I think I mentioned this during our earnings call last year, but the most important aspect of raising the quality of content is to quickly panning out new content. And in that regard, we currently have no choice if our -- all of our resources are centralized at the HQ. There are structural limits that restrict the creative content from being panned out. However, with the corporate spin-off, since all of these companies will begin fresh transparently as new start-ups, they have more leeway in that regard. So we don't have the luxury to determine whether this approach will succeed or fail, but we must succeed.

And your question on IPO, potential IPOs, the reason why we're implementing these corporate spin-offs is to make these -- each of these studios become assets of their own. And as part of this, they could leverage investment opportunities or IPOs if that creates a virtuous cycle. However, at the moment, we are focusing on showcasing our development capabilities to the market and securing survivability. So at the HQ, at this stage, we're not considering specific IPO options as it's too early to say anything about this. So lastly, and that's why we're trying to provide autonomy to these entities as they could independently carry out their business activities as entrepreneurs.

Operator

The next question will be presented by Dohyoung Kim from CLSA.

D
Do-hyoung Kim
analyst

I have 2 questions. First one is about marketing cost. It looks like there was a KRW 10 billion worth of Q-o-Q increase in marketing cost for PC and mobile games combined and -- sorry, excuse me, sales increase. However, there was a KRW 30 billion worth of Q-o-Q increase in marketing cost. What were the proportions between the new title marketing cost and the existing title marketing cost? And if this amount of marketing cost is necessary to maintain the sales growth of the existing IPs, do you believe this trend will continue? It will be great if you could provide at least a guidance on the expected marketing cost execution.

And second, I have a question about the corporate restructuring. As you said, I agree with the company's decision to move to a studio-based system. However, I think the biggest problem about NCSOFT is NCSOFT's title as a publisher. So when you look at TL, it received a lot of criticism in its initial launch and had to enhance its game tremendously. But -- and another IP that is in the pipeline is still based on a Lineage IP. So it seems like the efforts made by other teams outside of the HQ is pretty distant from the approach of the HQ. So I think in order to make improvements, there should be more independence in terms of publishing, not only just development, by using third-party publishers like Amazon or setting up a new independent publishing label. So I'm wondering if you have plans to make these or implement these measures to free up publishing area from the HQ's influence.

W
Won Hong
executive

Thank you, Mr. Kim. I always appreciate your questions as your questions have -- are always relatable and are actually topics that we internally explore, so it was easier to answer them. That was a very nice question. It is true that we executed marketing cost in order to expand the user metrics for existing IPs. However, the marketing spend weren't -- wasn't excessively costly. The reason why we were seeing disappointing results this quarter is, of course, it's due to the general high cost structure and the sluggish growth momentum. However, especially in this quarter, the sales expected from our new title wasn't as much as expected. So that was relatively lower than the marketing costs that we spent.

So it doesn't mean that we will require this amount of marketing cost in order to maintain the user metrics for our existing IPs. We strictly try to keep our marketing cost under 10% of the total sales. And after the reorganization, we have a very strict marketing spend control executed across our organization, CBO 1, 2, 3 and CBMO.

Yes. Regarding your point on publishing capabilities, I agree, but we're currently strengthening our capabilities on that front. So for instance, [ for this effort ], we appointed Jeonghee Jin as the CEO of NC America in August. She has experience in global publishing, especially in the U.S. for 15 years. And so we not only could leverage Steam, but also other external partners that we didn't have access to. Also, ArenaNet's [indiscernible], Crystin Cox, the Xbox Game Studios Publishing Director as ArenaNet's Publishing Head. So likewise, we're making these realistic changes that could actually result in tangible results.

And as for TL, with our partnership with Amazon, we were able to receive feedback that were quite different from what we received from customers in Korea, and I think that was a very encouraging change. So for all of our future games, we were going to -- we will be open to external collaboration with other partners if we believe that is necessary.

And to add a bit more on to my answer, after we adopted a co-CEO system, we have been experiencing a larger synergy between the 2 CEOs more than you think. They both have different backgrounds and expertise, and I think this is creating a greater synergy. And after we complete and finalize our initiatives for cost optimization and the development team changes in 2024, starting from 2025, we will make this a foothold in order to execute on our future plans. And you'll be able to see much synergy and uplift from the system.

Operator

The next question will be presented by Junhyun Kim from HSBC.

J
Junhyun Kim
analyst

To increase top line performance, it's important to acquire new users with new titles. However, since the company has a lot of experience in MMOs, but through news reports, it seems like the company has shut down projects that are packaged games. And so the current pipeline is focused again on MMOs like LLL and AION. So in order to acquire new users and new audience, what additional plans do you have in store?

W
Won Hong
executive

Thank you for a good question. So we're currently developing AION 2 and other existing MMOs, but we're also developing games to acquire new users, which will be announced soon. But a case -- a good example of this is we have a share game with a unique concept in the pipeline. So internally, I don't know if I'm in the position to say this, but a lot of -- not all developers at NC wants to develop MMO games. So we'd like to give them the chance to tap into new genres, tap into new user base, and we're currently making efforts to propel this initiative.

And I believe that Lineage is a wonderful IP that should not be limited to becoming just an MMO game. It has a lot of potential. So like IPs like Lineage, Blade & Soul and AION are -- all have a lot of value, which has -- and that's why we're putting in efforts to develop these IPs into new genre games. So when you personally speak with the developers at NC, actually, many of our developers love various genre games. So I believe this could address some of your concerns.

And additionally, and this is why we are trying to make a focus on working with external publishing resources and development resources. And we believe that this could create synergy for expanding our user base. So for new IPs, we are going to provide more autonomy for the developers so that they could be free from the influence of our legacy IPs. And I hope this could address your concerns.

Operator

The next question will be presented by Jin-Gu Kim from Kiwoom Securities.

J
Jingu Kim
analyst

I have one question. When you look at the public disclosure, it seems like the 4 separate split-off entities, including the studios as well as the AI research arm, they have a total asset of KRW 40 billion. How -- what are your take and plans on the development and R&D costs from this -- to be supported from this? And are there [indiscernible] plans to additionally support these entities?

W
Won Hong
executive

Thank you for your question. When we set up the split-off corporations, split-off entities' capital, we calculated it based on 3 months worth of operating cost. There wasn't a specific meaning to that because it was the same formula that we use for other [ budgets similar ] in the past. Yes, and there is a clear difference between the development organizations and the AI arm that are being split off this time.

So as for the development studios, we are going to have a contract between the HQ and these organizations as we will support their development, and we will share the performance results after the success of the titles. And during this process, we will reflect implications from our overseas subsidiaries in the U.S., Taiwan, Japan and the studios that we recently made investments in to find the optimal agreement between these entities and the HQ. But it would be important to guarantee these entities' creativity and autonomy, at the same time, imposing a certain standard of responsibility and compensation. And we're currently in the talks regarding this topic.

And as for the AI arm, it will be different because NCSOFT has been a pioneer in running this AI organization for more than 10 years. So we have accumulated a lot of know-how during the process. So not only will this AI organization serve for NC's development, but also it will have a separate business model for self-sufficiency. And we will set up an agreement between the HQ and this AI organization that reflects that.

Operator

The next question will be presented by Dongryun Lee from Macquarie.

D
Danny Lee
analyst

I have a question about our studio system and the decision-making process and the cost structure that happens after that transition. So there are a lot of expectations about Hoyeon internally, and the marketing costs were -- there were a lot of marketing costs spent on Hoyeon, however, the sales results were a bit disappointing. And I'm wondering, after the transition of this studio system, how much freedom will be the developers have in terms of development and publishing until the launch of their titles? And also, the -- is there a high potential and visibility for the launch of the projects that are developed by teams that have been recently split off from HQ?

W
Won Hong
executive

Thank you for your question. I enjoy reading your analyst reports. To answer your second question, there are no changes in the time line and the possibility of the launch of the split-off titles. It will all proceed as planned.

And after we make the transition into the studio system, in terms of important issues regarding development, business and operations, there will be a new title evaluation committee that will review these issues and provide feedback and have thorough discussions. So although these titles will be guaranteed of autonomy, there will be some discussions with the HQ in terms of key milestones and important decision-makings. And in order to uphold the principle of strict responsibility and compensation, it is important to equally treat these development entities like the development teams within HQ. So we will apply the same standards for both organizations.

Thank you for spending your time through this earnings conference call. As I mentioned earlier, until Q4 of this year, we will make great efforts to address the issues that we have right now. And this will involve a painful process, but a hopeful turnaround. And I ask for your advice and support during this process. And once again, once we finalize all these structural changes, we will focus on our main business starting from 2025 and communicate with better earnings with the market.

Thank you.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]

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