Enad Global 7 AB (publ)

STO:EG7

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Ludvig Andersson, executive]

Good morning, and welcome to this Q2 earnings call with EG7. My name is Ludvig Andersson, and I will be your moderator during this call. Together with me to present, we have the company's CEO, Ji Ham; and Deputy CEO and CFO, Fredrik Ruden. After the presentation, we will have a short Q&A session. So please feel free to e-mail your questions to the company's Investor Relations e-mail.

But now, without any further ado, over to you, Ji.

[Ji Ham, executive]

Great. Thank you, Ludvig. Thank you all for joining us this morning. We'll begin with our key performance figure review.

Please, next slide. For the second quarter, net revenues came in at SEK 353 million, adjusted EBITDA of SEK 33 million, and end of period cash balance was SEK 370 million. This quarter was relatively quiet, as communicated before, most of our major product releases are coming in, in the second half. First half results are reflective of this. We expect significant pickup in revenue starting in late Q3 into Q4. Based on our second half plans, we are still expecting to deliver against our guidance for the year. Other notable events included for the period, the acquisition of Singularity 6 right after the quarter's end, additional cost optimization efforts, which we -- which is expected to reduce costs by around SEK 100 million on an annual basis going forward. And successfully uplisting on to NASDAQ name list.

Next slide, please. For Q2 adjusted EBITDA contribution, Big Blue Bubble was the biggest contributor to our profits this quarter. Big Blue Bubble contributed SEK 37.3 million in adjusted EBITDA. We can now say that My Singing Monsters has stabilized at these levels. While it is lower than the peak levels last year, it's still nearly 3x greater than 2021 level, which is a nice outcome. Daybreak was the second biggest contributor with SEK 12.3 million in adjusted EBITDA. Margin for Daybreak was a little bit lower than usual. The main reason driving this was the revenue deferrals. Larger revenue uptick happened near the end of the second quarter, which was deferred into Q3 based on the revenue recognition accounting.

Piranha has been also doing well, steadily performing, contributing SEK 7.9 million in adjusted EBITDA for the period. MechWarrior 5 sales performing nicely, benefiting from the publicity surrounding the upcoming title. Now on the Service side, it has been more challenging. Toadman and Petrol continue to be under pressure. Toadman has not been able to ramp their work-for-hire business, resulting in adjusted EBITDA loss of SEK 8.5 million for the quarter. Marketing spend is also down for the industry overall, impacting Petrol negatively, resulting in adjusted EBITDA loss of SEK 0.5 million for the period.

On the other hand, Fireshine has been performing to plan. Second quarter result was negative SEK 1.8 million of adjusted EBITDA. However, this was due to the timing of their product releases. Majority of Fireshine's releases happening in the second half where we expect a nice pickup in performance. Based on the continuing challenges faced by the Service business units, we have undertaken additional cost-cutting measures. Toadman staffing is being reduced by around 100, including both full-time employees as well as contract resources. This is expected to generate approximately SEK 63 million of annual savings going forward. Overall for the group, the annual savings are expected to be over SEK 100 million from cost cuts year-to-date, including the latest reductions.

Next slide, please. A highlight for the group recently was the acquisition of Singularity 6. Singularity 6 is studio behind the game called Palia, a multiplayer online cozy community simulation game. Singularity 6 is based in L.A., and led by former senior development leaders from Riot Games. The studio is comprised of highly talented game developers with a ton of people experience, currently around 40 people. They were formally backed by some of the leading VC funds from the Silicon Valley, with their investment, Singularity 6 was able to successfully bring Palia to market in open beta last fall. And we're very excited to take on the project here on out and help bring the game to PlayStation 5 and Xbox next year to expand and grow the community further. Since this initial open beta release, Palia has attracted approximately 5 million players to date. Monthly active user base is currently around 650,000. The game has successfully built a nice and strong, passionate community, and currently has a very positive rating [indiscernible] and we're very excited to take this on.

Next slide, please. Now for the investment rationale and the highlights for the transaction. We believe the product has a nice upside potential. The game has a huge following already and dedicated community. Currently on only PC and Nintendo Switch, with releases on PlayStation and Xbox planned, we expect the audience to expand further and increasing revenues. Cozy community simulation games are also a genre with a huge fan base. Animal Crossing: New Horizons from Nintendo, sold over 45 million units. Stardew Valley has sold over 30 million units. With this large addressable market, Palia has a great opportunity for success there.

Singularity 6 is also comprised of highly talented and experienced leadership and the team. They're committed to delivering on the vision for Palia long term. It's still in open beta, and the job is not completed yet, and the team is aiming to achieve great success with the product, and highly motivated to do so.

And Palia is an excellent fit with our strategy and expertise. It's a live service game with a long-tail revenue potential going forward. Daybreak has over 25 years of history in live service games. By leveraging our knowledge and expertise, we're very excited to partner with Singularity 6's team to grow Palia into one of the leading games of the genre.

Overall, we like the risk/reward balance here, relatively low risk with the game already in open beta with a ton of data available to evaluate and to make informed decisions going forward. We're taking on a project closer to the finish line, which always minimizes the development risk, and there's a clear path to growth with the distribution plan for PlayStation and Xbox in 2025.

Lastly, this type of transaction is what we're good at. Our prior successful examples include Sony Online Entertainment Daybreak deal, Turbine and Standing Stone deal, Cold Iron acquisition, Magic Online deal, all of which have been very successful outcomes. All in all, a great transaction for the group, and we're very excited about this.

Next slide, please. As for the summary terms for the deal, Daybreak acquired 100% of Singularity 6 as its wholly owned sub. The deal closed on July 2. The consideration was comprised of two parts. Initial cash consideration of USD 5 million at close, and contingent consideration going forward based on 50% of net cash flows over the first 5 years after closing. Daybreak plans to invest up to an additional USD 10 million. This is to fund the development of the cost of release versions and marketing and publishing spend as well. Currently targeting release sometime in 2025.

Our investment is fully recoupable. Daybreak gets 100% of net cash flows until our investment, including the initial purchase price is fully recouped. Contingent consideration will be payable only after our full recoupment. Overall, we believe it's a smartly structured deal, minimizing investment risk upfront and sharing upside if successful.

Next slide, please. Now over to Fredrik for the financial section.

[Fredrik Ruden, executive]

Thank you, Ji. Next slide, please. So the net revenue in Q2 was SEK 353 million, and adjusted EBITDA was SEK 33 million, representing a decline from last year and previous quarter. The main reason, as Ji said, for the decline is that My Singing Monsters is stabilizing at the new normal level. Big Blue Bubble delivered SEK 75 million in net revenue, a reduction by SEK 69 million from the SEK 144 million reported Q2 previous year. Over the last 12 months, net revenue amounted to SEK 1.725 billion with EBITDA margin at 19%. Both LTM net revenue and the margins are forecasted to improve during the second half of the year due to a more active pipeline of releases. Our more predictable part of our business, including the live game portfolio generated SEK 261 million, corresponding to SEK 74 million of total net revenue, and this figure has been over 50% over the past 2.5 years.

Next slide, please. Daybreak is the largest contributor to the net revenue and the largest contributor to our more predictable revenue base, generating SEK 167 million in net revenue and SEK 12 million in adjusted EBITDA, which corresponds to low adjusted EBITDA margin of 7%. DC Universe and PlanetSide 2 are the two games that underperformed. Meanwhile, EverQuest is responding positively to our anniversary investments. There is also an unusually strong SEK 30 million revenue recognition rollover effect into Q3 due to that most update in Daybreak's portfolio came close to the end of the quarter. And this is something that we normally see between Q4 and Q1, but now we see it between Q2 and Q3. Big Blue Bubble generated SEK 75 million in net revenue, and is the largest contributor to our adjusted EBITDA, delivering SEK 38 million, corresponding to a margin of 51%.

Next slide, please. Piranha has been focusing on completing the MechWarrior: Clans for launch in October and has had limited other releases during the quarter. Piranha delivered a net revenue of SEK 23 million, and more than doubled the adjusted EBITDA from previous quarter, up to SEK 8 million, corresponding to a strong 35% adjusted EBITDA margin. Toadman has continued to struggle. And as said, the management has executed some mitigating actions to help turn into profitability. These actions will be seen during the third quarter.

Next slide, please. Fireshine's pipeline remained solid over the next coming quarters. The second quarter was mainly driven by the back catalog sales, similar to the first quarter. The company generated SEK 38 million in net revenue with a small negative adjusted EBITDA. Petrol is highly dependent on third-parties game releases, and they are negatively impacted by today's game industry's challenges. Management has also here initiated a few actions to secure long-term profitability. Petrol generated SEK 38 million in net revenue with a close to breakeven profitability.

Next slide, please. Even if Q2 was a soft quarter, we are confident that EG7 is in good shape financially and operationally. We have no external financial debt and plenty of liquidity, strong balance sheet and an underlying portfolio that continues to generate predictable revenues. This gives us an attractive situation where we can execute on our long-term plan with limited dependencies on third parties. The cash box by end of the second quarter was SEK 370 million. This is a reduction with SEK 150 million during the quarter. And the reduction is mainly explained by us investing SEK 98 million to meet our 2026 targets. Management is favoring allocation of its available capital towards investments with an attractive risk reward profile, and the potential to significantly contribute to the company's long-term growth and cash generation. The operational cash flow is charged with a preliminary SEK 19 million tax in Big Blue Bubble. Based on last year's performance and subject to the performance of Big Blue Bubble, we believe that we have more or less paid the full year tax for 2024 for Big Blue Bubble already in the first half of the year. Furthermore, we paid the second dividend for the year amounting to SEK 20 million to the shareholders in the quarter.

Next slide. The net revenue over the last 12 months has -- was SEK 1.725 billion, corresponds to a decrease of 16%, mainly driven by My Singing Monsters stabilizing on a new normal level. The last 12 months adjusted EBITDA came in at SEK 334 million, corresponds to a margin of 19%. Both these KPIs are expected to increase by end of the year, driven by a more active release pipeline and the cost reduction executed.

So we repeat our full year guidance to reach SEK 1.8 billion in net revenue in 2024, but based on the performance in the first half of the year and our expectations on the second half, we believe that we will end up at the lower end of the EBITDA margin range of 22% to 25%. We have so far this year seen 11,400 game industry layoffs, indicating continued industry transformation during the year and the remaining higher risk level in the industry. At the same time, the market is expected to grow 3% CAGR up to 2026.

We have, over the past couple of years, prepared our business to be operated more conservatively and sound. This optimization will continue both in the quarter and in July, as we are monitoring and managing our performance closely. In addition to this, we will see the outcome of our new growth initiatives this year, even if most of it will come later. The addition of Singularity 6 gives further confidence to our strategic approach to become the leader in the middle market publishing segment with SEK 3 billion in net revenue and SEK 1 billion in adjusted EBITDA in 2026.

So I hand it over back to you, Ji.

[Ji Ham, executive]

Thanks, Fredrik. All right. Next slide, please. So this quarter was a relatively quiet one as expected. No big surprises here. No major new product releases as we talked about during the period for this year. Our products weight is heavily back-end weighted, resulting in the first half performance, looking relatively lower. Not unusual, our quarterly results could continue to have volatility subject to our release schedule. As a result, the year-over-year comparison and also looking at a short 3-month window often will not reflect an accurate image of our group's financial health or overall performance.

We are continuing to evaluate our business proactively. Our service business has underperformed, and we action on changes to improve profitability accordingly. As a result, we should benefit with over SEK 100 million of annual savings going forward. We will continue to stay focused in the face of the ongoing market challenges and be decisive in protecting the shareholder value there.

While the market has been tough, we are not losing sight of growth. We are constantly looking for opportunities, but we have been very selective. Singularity 6 is an example where everything aligned really well with our strategy and expertise. We're able to successfully secure the deal. Palia represents a solid fit with our overall portfolio of long-tail live service games, and we're excited to see where it goes with the wider distribution planned for 2025.

As for the rest of 2024, we're still expecting to meet our targets. To reiterate that, first half was softer; second half, we have multiple major releases coming from Fireshine and Piranha. Based on our estimates, we expect to achieve our goals for the full year.

Lastly, the market conditions aren't great and remain challenging. However, we're very focused on our long-term strategy and growth plans. In the near term, we'll remain agile and continue to proactively manage our risks and aim to deliver against our goals.

Thank you. That wraps up our second quarter earnings presentation. Now over to Ludvig for the Q&A session.

[Ludvig Andersson, executive]

Thank you very much, Ji and Fredrik. We start off here with question or questions regarding S6 and the Palia acquisition. So is the USD 10 million of investment what is needed before Palia is release in Version 1.0? Will the investment be reported as CapEx? And what is left in development for the game?

[Ji Ham, executive]

Yes. So Palia is a live service game. So there isn't necessarily a Version 1.0, as you might see as a premium title box product. With that said, that's the budget that we have identified together with Singularity 6 in order to be able to deliver a great product for PlayStation 5 and Xbox release in 2025. That does also include publishing and marketing expenses. So not entirely of that investment would be capitalized, but a good portion of it would be.

[Ludvig Andersson, executive]

Follow-up question here regarding S6 and Palia. Could you walk through your analysis of potential for Palia to better understand the range of the upside?

[Ji Ham, executive]

Yes. I mean, maybe it's a little premature for us to get into too much details relating to that. It was a transaction we just recently closed on working together with the team. It's already out. There's a ton of data that we're able to evaluate, is performing well, is an open beta title. So we do think there is nice upside the way we underwrite the investment has been that -- outcome will be good to great with limited downside given the fact that it's already out and performing well on PC as well as Nintendo Switch. So we do think it's got a significant opportunity for a long tail, performance and profitability for the organization going forward. But I will say more details relating to how far or what the potential outcome could be with the title once we do some additional planning around it.

[Ludvig Andersson, executive]

A question from [indiscernible]. What is your thinking about buybacks in the current market?

[Ji Ham, executive]

Yes. I mean it's something that we continue to evaluate and discuss at the Board level. And with that said, I think we are also balancing investment opportunities that we're seeing, opportunities like Singularity 6, additional investments that we're making into publishing. So it's a balance of having sufficient liquidity on the balance sheet for our growth plans as well as also given the market challenges that we're facing, making sure that we have sufficient liquidity always on hand as well as balancing that, hey, there's shareholder capital return that we would also like to do. So no firm determination as to when and how much, but it is something that we continue to evaluate. But along with those two other important factors, growth investment as well as having sufficient liquidity in our balance sheet.

[Ludvig Andersson, executive]

Question from [indiscernible]. Can you give some color on your expectations for the upcoming MechWarrior: Clans? And what confidence level do you have for a successful release? Can you also elaborate on what data you're tracking for the game?

[Ji Ham, executive]

Yes, we're very excited for the project. MechWarrior 5: Mercenaries performed quite well. Once again, it's not -- when you think about MechWarrior IP, it's not what we would consider to be Tier 1 IP like a Star Wars or one of the Disney's Temple IPs. But nonetheless, MechWarrior has a highly dedicated core fan base that love products, games that are coming out with its IP. Hence, the reason why the prior games did really well. So the way we think about the potential performance for MechWarrior 5: Clans is based off of how the first game did, MechWarrior 5: Mercenaries did. And based on that, we do have a pretty high degree of confidence in its ability to perform well, in line with our expectations in the fourth quarter. Timing wise, we are expecting it to come out towards the beginning part of the fourth quarter at the moment.

[Ludvig Andersson, executive]

Question from Hjalmar, Redeye. Do you see potential for improvement for DCO, DDO and PS2. So DC Universe Online, Dungeons & Dragons Online, PlanetSide 2.

[Ji Ham, executive]

Yes. I think on DC Universe Online, there were some variability in performance over the last 18 to 24 months, mainly because of some churn over in terms of staffing. But with that said, we do have a solid new leadership in place that has taken over the studio and the game over the last several months. Significant experience in operating games of this nature with the leadership team formally Star Trek Online with Cryptic. So live service experience as well as free-to-play. So we're very happy with what the team and the new leadership team has been doing, stabilizing the game, and we do look forward to them being able to make additional progress beyond stabilizing it going forward into 2025.

Dungeons & Dragons Online. Dungeons & Dragons IP. Last year's big -- one of the biggest games was Baldur's Gate 3, which is also a Dungeons and Dragons game that did pull away a lot of the players because of that gravitational pull from that success. But Dungeons & Dragons Online team is making great progress there. New expansion coming out today for Dungeons & Dragons Online. So second half of the year should be better versus the first, and then along with additional plans they have in the works, we do feel that the team will be able to not necessarily turn it around and show significant growth, but be able to stabilize and get it back to how it has performed historically with stable revenues and a high degree of profitability.

PlanetSide 2 on the other hand, a little challenging. We did shift our team from Rogue Planet, which was part Daybreak to Toadman, who is taking on the content update as well as the life management of the particular game. It is an older title, proprietary tech base. As a result, there's significant onboarding that's required before Toadman team could really effectively do what they need to do. So there is some of this transition pain that's gone through with that particular game. But nonetheless, I mean, Toadman team is working hard, continuing to learn, produce content, but it may be a little more time before they're able to fully stabilize the particular title. But at the same time, we did sell the IP beginning part of this year for a meaningful dollar amount, which we're very happy about that outcome. But PlanetSide 2 game probably require some additional time before we're able to stabilize that.

[Ludvig Andersson, executive]

Question from [indiscernible]. How is EverQuest performing compared to last year?

[Ji Ham, executive]

Yes, EverQuest has had a great year. So EverQuest recently released their Progression Server towards the end of second quarter, which has performed better than our expectations, and the anniversary celebration has really provided a nice boost. We do expect EverQuest to be able to produce results based on how it's trending, potentially greater than what we did last year, which would be a nice outcome. So far, so good. Nice momentum, and we still have the expansion for the game coming out later this year.

[Ludvig Andersson, executive]

Another question from [indiscernible]. What is -- what can you say about Cold Iron's game in H1Z1 development and about the game designs?

[Ji Ham, executive]

Yes. Cold Iron, I think there might have been some leak from old concept materials maybe a couple of months ago, that might have created some alarm. But as we've iterated in the past, we are staying with our 80:10:10 model, which is taking a successful title and being able to improve upon that. So Aliens Fireteam Elite at this stage so far has sold over 2.5 million units, and we're building on the success of that with the second title for Cold Iron. So they're making nice progress there. And the expectation for that particular title is that familiar for the existing player base that's played that game with improvements to the overall experience and new content to get player base advantage for Aliens IP, excited for the new title. H1Z1, it is a continuing iteration around the concept. We do think -- we maintain our current timeline as to what we want to do there. But with that said, in terms of how we think about games and investments that we want to make, we're not trying to compete at the AAA level. Our sort of focus is to be able to make products that are very clear in terms of what the flavor is, right? So H1Z1 is another one of those. It's going to be a hardcore survival game. But we're iterating on it, along with that, being able to get into production once we have a strong conviction around the design at what we want to do versus spending money and iterating with the team that's ramping up. So we are taking it a little slower, to be careful with our investment versus, I would say, what many developers have done historically, making the mistake of making too much investment before a vision and the design is firmed up. So that's not the approach that we're taking there.

[Ludvig Andersson, executive]

And third question in from [indiscernible]. So the more accurate Daybreak performance was an EBITDA of SEK 12 million in the quarter and then a SEK 30 million rollover into Q3. So can we say it's SEK 25 million in the period?

[Ji Ham, executive]

Fredrik, you may have a better answer for this one. But there's the net revenue rollover because of the revenue deferral, but there is some additional deferred expenses that should also be deducted. So it's not just one for one. So I think as to doing that math, it's not too far away because deferred expense is relatively small. But nonetheless, it's not exactly that math.

[Fredrik Ruden, executive]

Yes. It's -- but the amount -- the rollover in net revenue is around SEK 13 million. So that adds up to that figure that you mentioned by end of what you said, Ludvig. And -- but there are some costs, but it should have a positive impact also on the margins, which is what we have seen historically with regards to this. So it's not -- so it has a negative impact on the margins in Q2 and a positive impact in Q3.

[Ludvig Andersson, executive]

Question from Hjalmar at Redeye. Can you elaborate on what profitability we can expect from Toadman after the cost optimizations?

[Ji Ham, executive]

Fredrik, do you want to take that one?

[Fredrik Ruden, executive]

Yes. I mean we have -- so we are aiming to not finance any business units that are not delivering profitability. And with these actions that we have taken, we turn Toadman into profitability immediately. Now that is not happening 1st of July, but it's happening during the third quarter. So that is what you should expect from that.

[Ludvig Andersson, executive]

Last question from [indiscernible]. Can you elaborate on the full year guidance in the second half of the year, what we can expect?

[Ji Ham, executive]

Yes. I mean I think as we included this in our report, we are aiming for that 1.8 billion of net revenue for the year. So second half, based on how we're performing to date, we expect it to make up the gap if we were to call that. In terms of adjusted EBITDA range, we guided originally at 22% to 25% adjusted EBITDA margin, but we're likely ending up near the lower end of that range for the year.

[Ludvig Andersson, executive]

Thank you very much, Ji, and thank you very much, Fredrik. I think that's all the questions we have. So thank you very much to everyone who's tuned in, and we wish you a great day. Thank you.

[Ji Ham, executive]

Great. Thank you.

[Fredrik Ruden, executive]

Thank you, all.