Enad Global 7 AB (publ)

STO:EG7

Earnings Call Transcript 2022-Q2

[Ludvig Andersson, executive]

Hello, and a warm welcome to this Q2 presentation with EG7. My name is Ludvig Andersson, and I will be your moderator here today.

Together with me to present is our acting CEO, Ji Ham; and our Deputy CEO and CFO, Fredrik Ruden. [Operator Instructions]

Without any further ado, over to you, Ji.

[Ji Ham, executive]

Thanks, Ludvig. Good morning. Thank you for joining us this morning. Is there a presentation that you could share, please? Sorry about this. Slight technical issues here, but we'll get the presentation up shortly. All right. There you go.

Okay. All right. So we'll start with a quick summary of EG7. EG7 is a global gaming group. We currently have multiple capabilities across both gaming development as well as services.

On the game development side, we have new game development as well as live service with portfolio of live service games that we operate across PC, console and mobile platforms.

On the service side, we have Fireshine, our publisher that does digital and physical publishing and distribution. And we have Petrol, one of the best known marketing and branding agencies in the world in gaming, providing their marketing services to some of the biggest publishers in the world, likes of Activision Blizzard as well as Bandai Namcos of the world.

In terms of our portfolio of live games, we have some of the most iconic brands in gaming. EverQuest, one of the very first MMOs to come out in the marketplace, going on its 24th year. Lord of the Rings Online just celebrated its 15th year anniversary this spring. And DC Universe Online based on the #2 comic book IP in the world. And Magic: The Gathering Online, which is based on the #1 trading card game IP in the world with Magic: The Gathering.

In terms of geographic presence, we have 693 employees across 16 offices in North America and Europe, 8 gaming studios with 458 talented developers. Our net revenue comes from 73% in North America, 21% in Europe and 6% in the rest of the world.

Size in numbers for the last 12 months ended second quarter. Net revenue came in at SEK 1.7 billion, that represents a healthy 93% over a comparable period; and adjusted EBITDA of SEK 354 million, representing 108% growth. Next slide, please. Highlights from the second quarter. We had a very nice quarter. We had net revenues coming in at SEK 463 million, representing 49% year-over-year growth and strong organic growth, which was very notable with 41%. Before I go any further, just a quick note here. All our numbers actually do exclude Innova, which was disclosed as an asset that we're selling. So a lot of these numbers that we will be discussing today will be without Innova.

Okay. Adjusted EBITDA of SEK 84 million, and solid cash flow that we generated for the quarter with SEK 64 million of operating cash flows for the period.

Some of the key takeaways: very strong results above expectations, and we are continuing to consistently deliver and our growth is continuing to show very strong results despite the market uncertainties that the gaming industry as well as global economies having to face, especially on the organic growth side.

Next slide, please. Operational highlights for our Service segment. Key figures here, net revenues came in at SEK 192 million, representing 103% growth. All of that was organic. And the adjusted EBITDA of SEK 26 million, representing almost 300% growth. And Service segment is operating at 14% margin.

Some of the highlights that helped to drive this great result: Fireshine is continuing its strong performance. Core Keeper, which released at the end of first quarter of this year, has now sold over 1 million units and helped boost second quarter results. And the Fireshine also released Sniper Elite 5 physical release, which topped the charts in the U.K. for the second quarter.

And Petrol is expanding its relationship with some of the biggest publishers, namely Activision Blizzard. They have been the lead agency responsible for branding and marketing for Call of Duty franchise for the last 16 years. Along with that, this year, they announced the Call of Duty: Modern Warfare II, which was one of the biggest announcements for that particular franchise with this highly anticipated IP game.

And on the live service side, Call of Duty has a title called Warzone, which Petrol also supports on the branding and marketing side. And then they're expanding the relationship beyond Call of Duty with Petrol being tapped to help lead the global branding initiative for Diablo Immortal, which is one of the biggest industry hits this year and continuing to perform really well.

Next slide, please. On the Gaming segment, some of the highlights here. Financially, net revenues came in at SEK 270 million, representing 25% growth and 14% of that was organic. Adjusted EBITDA of SEK 72 million and that represented a healthy 27% margin.

Highlights and the drivers for the quarter included My Singing Monsters with its daily active user base increasing by over 2,000%, which is phenomenal. And that resulted in the best quarter in history for My Singing Monsters and that momentum continues to carry on.

We have Lord of the Rings Online, which celebrated its 15th year anniversary and then resulting in the highest player engagement since 2016, further validating our differentiation which speaks to the sticky, highly stable and recurring revenue stream with our passionate player base that continue to play our beloved games.

Dungeons and Dragons Online, seventh expansion pack came out and its 55th update. And Piranha continues to develop great content for MechWarrior 5 with the second DLC coming out in the quarter and performing really well.

Next slide, please. At the group level, some of the highlights and updates. Innova sales update, we announced the sale in the second quarter, in April. Still making progress towards that and we expect to be able to close that transaction before the end of Q3.

On the Board side, we had a new Board, updated Board. We have Jason Epstein, the second largest shareholder of EG7, who has taken on the role of the Chairman. He will be taking a lot more active role going forward, helping to drive growth for the overall organization.

And we also welcome Mr. Shum Singh, a leading adviser investor who has been focusing on the gaming sector for multiple decades. Shum brings a ton of knowledge and experience in the sector, and we expect to be able to leverage his knowledge and experience to help continue to drive great performance for the business.

And on the investment side, insider investment. This quarter, we had a significant investment from the leadership group, over SEK 40 million invested, including myself as well as Fredrik and a number of the key board members, including Jason Epstein. And this was meant to be a firm indication of the leadership's belief and conviction in our business and our ability to continue to perform.

Next slide, please. Okay. Fredrik?

[Fredrik Ruden, executive]

Thank you. So as Ji mentioned, we came in with a revenue in the quarter of SEK 463 million, which is an increase from SEK 311 million, the comparable figure last year. And this is a growth in the quarter of 49% and an organic growth if we take out the Magic, of SEK 41 million. And FX-neutral, then the organic growth is 24%.

Looking to the right here, the net revenue in the last 12 months show a constant increase from one consecutive quarter to the other. By end of Q2, the LTM net revenue amounted to SEK 1.716 billion, which is an increase then from the comparable figure of SEK 891 million last year, corresponding to this 93% growth against last year, mainly driven by organic growth and well-selected M&A activities.

We operate our business with profitability and the adjusted EBITDA margin amounted to 18% in this quarter, which is the same level that we had in Q4, but lower than the 27% reported in Q1. The LTM adjusted EBITDA margin has, during the last year, been trading around 21% to 22%. And given today's revenue mix and after divesting the high-margin Innova business, this indicates a new normal level for us going forward. Innova was trading at 35% to 38% EBITDA margin before the Russia-Ukraine aggression.

And between Q1 and Q2, we have some explanation for the variances in the margin there. So we have more revenues from the Service segment, which is normally lower margin, also boosted by this Core Keeper success and the Sniper Elite that they launched, which was a great success for Fireshine.

We have a periodic effect with regards to MMO revenues where we have the spillover effect from one active quarter like Q4 into a less active quarter, which is Q1. We did not see that effect from Q1 to Q2. We do not anticipate to see that kind of effect between Q2 and Q3 either.

We also have one low-margin strategic project that is carried out in Petrol, which lowered their margin. And in conjunction with the discontinued -- -- the Marvel project, we do not capitalize the R&D costs in Q2, which we did in Q1. Next slide, please. So this picture further highlight EG7's diversification as both segments grew from one consecutive quarter to the other in LTM net revenue despite the challenging environment. The last 12 months, net revenue in the Game segment amounted to SEK 1 billion, which is an increase from SEK 462 million, corresponding to 118% growth, explained mainly by M&A but also organic growth.

Our foundation for our predictable and sustainable net revenue cash flow is our live games portfolio. And the revenue from these assets was SEK 251 million in the quarter, which correspond to 54% of the total revenues. And as you can see down to the right in this picture, this portion has established itself over 50% during the last year.

The last 12 months net revenue in the Service segment amounted to SEK 708 million, which is a growth from SEK 421 million (sic) [ SEK 429 million ] previous year, corresponded to 65% growth. And this is mainly explained by strong performance. Again, we have talked about the strong performance in Fireshine and also in Petrol. This part of the business show greater volatility and is attached with generally lower margin.

Yes, please, next slide. The Game segment, if you look at that, we see that Daybreak contribute with SEK 203 million in net revenue and 52% (sic) [ SEK 52 million ] adjusted EBITDA, which correspond to 25% EBITDA margin.

Big Blue Bubble was fueled by a very successful Easter campaign and generated SEK 43 million in net revenue and as much as SEK 23 million in EBITDA, which correspond to 53% EBITDA margin.

We have Piranha who has been trading profitable since Q4 and generated SEK 23 million in revenue and SEK 4 million in EBITDA.

We also include Toadman Studios and Antimatter in this segment.

Next slide, please. So in the Service segment, as we have talked about, Fireshine generated SEK 142 million in net revenue. I think it was SEK 90 million previous quarter, again, fueled by Sniper Elite, the physical distributed game, and Core Keeper in the digital distributed game, which continued to contribute to Q2. And that also generated an EBITDA of SEK 31 million.

Petrol had a strong Q1 with SEK 54 million. And in Q2, that was followed up by SEK 50 million in net revenue. But based -- due to this large project -- or large strategic project that they carried out, the profit -- or actually they generated a loss in the quarter of SEK 4 million. That correspond to minus 4% in EBITDA margin. And they had 25% margin -- plus margin in the Q1 which showed a little bit of volatility in that company.

Next slide, please. So to manage expectation a bit. First half of the year was strong, driven by a good balance between recurring revenue from the live game portfolio, successful physical and digital distribution of games in Fireshine and continued strong performance and campaigns in Petrol.

The second quarter delivered a net revenue of SEK 463 million, which again corresponds to growth of 49%, an organic growth of 41%, and adjusted for FX, 24%.

Growth-wise, the comparable figures in the Service segment for the first half of the year is relatively easy due to the pandemic situation in the beginning of last year. We have stated that we will deliver SEK 1.6 billion to SEK 1.7 billion for the full year of 2022, which means that we do not anticipate to continue trading on this way above market growth rates for the next coming quarters.

Adjusted EBITDA margin amounted to 18%. This is the same margin, as I said, as we had in Q4, but lower than previous quarter. We anticipate to be trading at the normal -- new normalized level, which seems to be around 21%, 22%, looking at the last 12 months, LTM, EBITDA average. So we will be trading around that, plus/minus, given today's mixture of revenue between Game and the lower-margin Service segment.

And the third quarter started with SEK 132 million revenue in July.

Next slide, please. EG7's net debt-to-EBITDA ratio and cash position remained solid with or without Innova. So in this picture, actually, Innova is included in the left picture. Innova is included up till Q1 and then excluded from Q2.

So the cash debt amounted to SEK 493 million, which is a decline from SEK 557 million in Q1. This is mainly explained by that we have paid the remaining purchase consideration for the former owners of Big Blue Bubble, which was an amount of SEK 46.6 million.

The cash goes from SEK 449 million, including Innova, to SEK 381 million, explained by that Innova was included by SEK 72 million at that point in time and the payment to Big Blue Bubble's former owners of SEK 46.6 million.

This gave that the net debt-to-EBITDA ratio came out at 0.28, which is quite similar to what we had, including Innova, by end of Q1.

Looking at the cash flow. The operational cash flow amounted to SEK 64 million and contributed to a slightly increased cash balance of SEK 381 million without Innova.

Investments amounted to SEK 114 million and is mainly explained by capitalized R&D and the earnout to the Big Blue Bubble's former owners. The remaining movements in cash is mainly explained by different FX effects. And so we still have a strong balance sheet and an attractive net debt-to-EBITDA ratio going forward.

Next slide, please.

[Ji Ham, executive]

Next slide, Ludvig. Great. All right. So we'll cover some of the looking forward short term, medium term, long term here.

In the short term, some of the value drivers that we have coming up, Innova sales should be completed by the end of Q3 removing the Russia-related risk.

On the product side, for the second half of the year, we have My Singing Monsters celebrating its 10th anniversary, which should be a significant growth for the title, especially given that Q2 performance this year with large content update coming along with the anniversary.

And then we have the Amazon's Rings of Power TV series that's coming out in September and we expect that, that should be boosting Lord of the Rings Online's performance along with the expansion for the title coming out.

And the upcoming annual expansion packs for EverQuest and EverQuest II, large updates that perform well every year.

And then we have Q4, which is our peak season, where we expect to generate significant revenues for the quarter.

Additionally, we feel very well positioned to deal with the volatile marketplace now. We have been bucking the trends and delivering great results, operating at strong cash flows, strong organic growth. And we believe that with our stable and a solid base of recurring revenue-based games, that we'll be able to generate continuing cash flows which will be very important during these unpredictable times.

On the medium-term side of things, we have a couple areas that should be creating value for the organization. The first is the revamping of the existing live games, 3 of our biggest games, we have Lord of the Rings Online, Dungeons and Dragons and DC Universal Online and Magic Online. These games are being invested in for a medium-term update with the revamp to be able to drive meaningful revenue and profit growth in the medium term.

And we have a new area that we will be focusing on as well here. We have the ramping on the development consulting business line. There is a meaningful market opportunity that we have identified. Along with the pandemic, along with work from home, there's been a significant dislocation in the marketplace where resource have been very short and very hard to come by.

This is one of the areas where we have significant assets, currently have over 240 developers across Toadman, Antimatter and Piranha and the plan is to be able to leverage the talent that we have to be able to establish a consulting business, where we would be taking advantage of the supply-and-demand imbalance and the development resources for games. The combination of our talent and the premium consulting rates currently and also our lower labor cost with the team should be providing a nice revenue and profit potential going forward, and we expect to see upside from this in the medium term.

On the long term, we have new products that we are investing in. We have some of the best IPs, both first-party and third-party. We want to be able to invest in these IPs in order to really drive that significant upside in the long term. We want to emphasize the long-term growth over really seeking that immediate gratification through some of the short-term bets that's been made in the past and some of what the market has been really focused on. We do want to shift that from short term to that big picture where our primary vision is to be able to establish EG7 as one of the leading games-as-a-service companies in the industry.

In order to be able to achieve that goal, we believe that it's very important that long-term investments in our own IP as well as some of the third-party IP that we currently have access to would be important in order to achieve these goals.

In terms of M&A, we will continue to evaluate them. But the M&A market today is very different from where it was 12 to 24 months ago. There are opportunities out there, but more difficult to come by based on sort of the market dynamics that all the companies and the industries are dealing with. So we do believe that it's a strategy that we will not abandon, but nonetheless, not as attractive as it was over the last couple of years.

So we will be looking at it opportunistically. We will be open to exploring, but our primary focus will be really organic growth, continuing to drive that, and making investments in our long-term growth.

Next slide, please. In summary, these are some of the investment highlights for Enad Global 7. As noted throughout this presentation, we continue to deliver consistent performance quarter after quarter. We have outstanding organic growth despite what the market is doing here. A number of companies, number of competitors showing slower, in some cases negative growth, but we're producing very strong organic growth.

We have a portfolio of assets, which really separates our business from many others where we have significant amount of stable recurring revenues and that helps to produce that consistent operating cash flows.

And during these uncertain times, we believe that having that strong liquidity and credit profile with a stable and strong cash flow is very, very important.

And then we have our portfolio of world-class IPs. Those IPs are what's really contributing to our existing performance. But those are the IPs that, with investment, will also help drive significant long-term product upside potential.

And lastly, we have the insiders who are fully on board, fully aligned with the investors, a significant investment made this past quarter. We truly believe in the value and the upside that we could bring about with Enad Global 7 and we will be working very hard to continue to drive the significant growth going forward for all the shareholders' benefit.

Next slide, please. Ludvig?

[Ludvig Andersson, executive]

Thank you very much, Ji and Fredrik. Over to the Q&A session.

We received a question here from Mathias at Kepler. Could you give some additional details on how you expect phasing of revenue and EBITDA and its trend in H2? If July revenue indicates for full Q3 or how should we read into that?

[Ji Ham, executive]

Yes. So we are reiterating our forecast for the full year. So SEK 1.6 billion to SEK 1.7 billion for the year. And one month in July should not be just annualized in order to forecast out the remainder of the year.

So SEK 1.6 billion, SEK 1.7 billion reiterating, but that does exclude Innova. So I think -- I do want to make sure that the investor community is looking at those numbers without Innova and not comparing it to last year's numbers.

[Ludvig Andersson, executive]

Thank you. Another question here from Mathias. How does the game pipeline look for Q3 and Q4 in the Game and Service segment, respectively?

[Ji Ham, executive]

So in terms of new game pipeline, as we have communicated in the past, we have Block N Load 2 and Evil v Evil that we continue to make great progress towards. So those are games that we are planning on providing additional information and bring to market in the second half, towards the end of this year.

As for some of the live service games, we have our annual updates coming out EverQuest, EverQuest II with their big expansion packs coming out. We have Lord of the Rings Online just announced at gamescom that we would be releasing an expansion in the fall as well. And then My Singing Monster with significant update for its 10th year anniversary celebration coming up. So those are some of the highlights of content updates that are coming out.

[Ludvig Andersson, executive]

Thank you. From Rasmus at Handelsbanken. Can you explain the cost development quarter-on-quarter in Game and Service separately?

[Ji Ham, executive]

Are you -- maybe clarify. When you say cost development, what -- are you talking about margin?

[Ludvig Andersson, executive]

Yes. It's what the question says literally. So I think he's trying to compare the cost comparison from quarter-to-quarter, year-on-year.

[Ji Ham, executive]

Yes. Well, I don't know if, Fredrik, you could pitch in here. But in terms of cost on the game development side of things, other than the investments that are being made, our head count has not really shifted meaningfully. So our cost continues to stay fairly stable. Although annually, every business has their cost of living adjustments that we have to make. And given the current market circumstances with inflation running very high, there are adjustments that we had to make this year that did increase compensation and some of the costs a little higher than we have historically done so.

But we do believe that as global economy and the -- a lot of the monetary policies being -- continuing to be utilized to fight inflation, that some of the changes that we had to make on labor costs, et cetera, would be temporary this year versus something that will persist going forward.

As for Service segment, similar. Not a lot of changes in terms of cost other than, I think, depending on what kind of service. Especially Petrol, for example, is engaged in big campaigns for games like Call of Duty. They do have to deal with third-party in order to produce some of that content. And some of that third-party content cost is also going up a little bit. So they're dealing with those type of changes. But overall, organizationally, not a significant increase in cost overall.

[Ludvig Andersson, executive]

Great. Thank you very much. From Hjalmar at Redeye, how did you -- the low-margin project for Petrol, does this happen from time to time? Or how should we look at that?

[Ji Ham, executive]

Yes. I mean sometimes it's the relationship. So that refers to one of the biggest product announcements that Petrol was engaged in with Call of Duty: Modern Warfare II. It garnered significant attention. But it was one of the very few instances where it wasn't just digital, it was actually physical. And I encourage people to look it up online, Call of Duty: Modern Warfare phases of work, phenomenal. Utilizing one of the docks in L.A. in order to create this amazing visual masterpiece of showcasing Call of Duty's [ nuke yard ].

So that was an engagement where it wasn't all about the profit, but rather showcasing Petrol's capabilities, expanding the relationship with Activision Blizzard. As we talked about in the presentation, they're no longer just doing Call of Duty, they're engaged with Diablo, they're engaged with the live service element of Call of Duty as well.

So not that it's a loss leader, but nonetheless, it's really the all-encompassing relationship that Petrol is focused on when they're engaging in some of those contracts.

Additionally, though, I think one thing that is not presented is there's also some mismatching of revenue and expenses that all of us -- all the organization have to deal with in terms of revenue recognition. So as Fredrik mentioned, our first quarter profit margin for Petrol is very high at 25% or more, where second quarter came in at a negative number. The part of the reason is because of that mismatch between revenue and expenses. Some of the expenses from first quarter is bleeding into the second quarter. And some of the revenue recognized in the first quarter could have been recognized in the second quarter.

So those variances do create some volatility in margin, but we do encourage that we look at the really 12-month average because really that's the right way to look at it, especially given some of these deferred revenue and expenses that do run through a number of our businesses.

[Ludvig Andersson, executive]

Great. Thank you. Another question here from Hjalmar at Redeye. Could you clarify what you mean with the margin going forward for 2022?

[Ji Ham, executive]

Yes. So I think this is definitely worth some time where we should really explain it, and it's very simple math. So Innova has been an important part of our organization. We acquired that business, closed on April 1, 2021. So for 2021, we had owned that business for 9 months. During that period, Innova contributed 15% of net revenues for the group. And then they generated for that 9-month period average margin of 36%.

So when you look at the weighted average contribution from Innova, it's literally just 15% times the 36%. And then you get to 5%.

So that 5% margin were prior to Innova being sort of being excluded as an asset that we're going to divest and prior to Innova having to deal with Russia and Ukraine situation where they were operating on a normalized basis, their weighted average contribution to our overall margin was 5%.

So now that they're no longer going to be included, our margin will go from 25%, 26%, 27% down by 5%. So hence, the reason why Fredrik guided to that 20% to 22% as a go-forward margin. And that 20% to 22% margin is coming from 2 areas, right? We got Game segment, we got Service segment. Game segment operates at that 26%, 27%, 28% margin, which is healthy. Service segment, while it's growing and performing really well, performs at a lower margin.

So we do want to make sure that the investment community understands our business. We have one side of the business with really healthy margin; another side of the business, which is very important, too, but it's operating at that 12% to 13% margin. So when you combine the 2 and look at the blended average or weighted average, excluding 5% contribution from Innova, we're going to end up at that 20% to 22% normalized level going forward.

[Ludvig Andersson, executive]

Thank you. A question on AMG and the pause of '83. Do you see any risk of a potential write-down on that game or -- and the logic behind the path.

[Ji Ham, executive]

Yes. The logic was pretty straightforward. So AMG is not a big studio, they have about 50 people. And under prior management team, they were trying to make progress on 2 games, I.G.I. and '83 at the same time. And they were doing a good job, but at the same time, not ideal.

So we made the strategic decision to sequence it so that we dedicate all the resources to completing one game versus making limited progress on both. So they will sequence I.G.I. as the first title to finish. Thereafter, they'll be rotating back to '83. Having said that, are we going to evaluate where '83 is further and decide whether we may want to ultimately ship that game in '24, '25? That evaluation will happen still. But nonetheless, the initial decision around us pausing development is based on our strategy of being able to complete one game versus making limited progress on 2.

[Ludvig Andersson, executive]

Thank you. And a question here on Fireshine. How do you see Fireshine going forward for H2 following the success with Core Keeper?

[Ji Ham, executive]

Yes. They continue to perform well. Core Keeper came out as an early access title towards the beginning of March, in the first quarter. And the -- early access title means that it's -- it came out on Steam. It's not a completed game, it's really a beta release. And then there will be a final release when that product is finished. And once that product is finished, we'll be shipping it not just on PC but also on consoles. So we believe that there is meaningful upside, already sold 1 million-plus units on Steam early access alone. And once we complete and are able to ship on multiple platforms, including console, which has a big market for a type of game like that, we expect meaningful upside, not in the second half, but that's likely in 2023. As for some of the other games that Fireshine is working on, they continue to build out their pipeline of digital releases. Most of them are indie titles as well as some of the physical releases that continue to work with Frontier, Rebellion and et cetera, their long-term partners that provide premium products and Fireshine handles their physical releases. So they're doing well.

For the second half, product release pipeline, it is volatile, right? So first half, Core Keeper did better than we expected. Significant upside that we saw in Q1, continuing to perform well Q2. We expect that game will continue to do well for the remainder of the year.

As for some of the new products that may be coming out in the second half, there are other interesting products, but we don't want to sort of make promises in terms of how they're going to perform other than to say that Fireshine continues to build out their pipeline and they'll continue to execute well.

[Ludvig Andersson, executive]

Fantastic. Thank you so much for the answers and for the presentation, Ji and Fredrik. I think this is all we had for today. So for everyone who's tuned in, thank you very much, and we wish you a great day. Thank you.

[Ji Ham, executive]

Great. Thank you, everyone.

[Fredrik Ruden, executive]

Thank you.