Enad Global 7 AB (publ)

STO:EG7

Earnings Call Transcript 2024-Q3

[Ludvig Andersson, executive]

Good morning, and welcome to this Q3 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]

Thanks, Ludvig. Good morning. Thank you for joining us. Let's go to the next slide, and we'll start with the key performance figures.

Q3 was a solid quarter, had a meaningful rebound from Q2 lows. Net revenues came in at SEK 466 million and adjusted EBITDA at SEK 102 million. On a sequential basis, a nice rebound. Q2 was the low for the year. While Q2 is typically our seasonal low, this year more accentuated weakness due to heavier backloaded content slate. As a result, Q2 -- Q3 sequential growth was robust. Net revenue increased by 32% and adjusted EBITDA grew by over 200%. Liquidity-wise, the group ended the quarter with SEK 219 million of cash with no material debt.

Next slide, please. Q3 adjusted EBITDA contribution by business unit was as follows. Games business units led the way with SEK 97 million of adjusted EBITDA contribution, represented about 87% of total before holding costs. Big Blue Bubble's My Singing Monsters contributed SEK 42 million. Decline is expected from the peak levels in '23. However, a nice growth, 13% sequentially from Q2. Q4 is expected to be near Q2 levels as Q3 is typically My Singing Monsters' peak quarter.

Daybreak had a solid quarter contributing SEK 52 million, led by Lord of the Rings Online's new content release for the period. EverQuest continues to perform well with this 25th anniversary content. A quieter quarter for Piranha leading up to its new game release, which came out shortly after the quarter, contributing SEK 3 million with the period for its existing game titles.

Service segment remains under pressure, SEK 14 million in adjusted EBITDA contribution for the period representing 13% of total before holdings cost. Fireshine had a nice quarter with their release contributing SEK 16 million. Core Keeper's Version 1.0 digital release, which came out on PC as well as all the consoles, was the primary driver for the period for Fireshine. Physical distribution remains a little bit soft but expecting a nice rebound next year with delayed releases coming to market in 2025.

Petrol and Toadman's performance remains lower due to softer market conditions. Petrol was breakeven for the quarter; Toadman, a loss of SEK 2 million. With the completion of cost cuts, Toadman is operating at breakeven now on a run rate basis. Market could remain weak for the next few quarters. During this period, we expect Petrol and Toadman's performance to remain muted.

Other notable highlights for the period included successful closing and integration of Singularity 6, completion of Toadman cost reduction resulting in SEK 100 million of annual savings, and shortly after the quarter end, MechWarrior: Clans successfully released.

Next slide, please. Clans released on October 17 across Steam, PlayStation, Xbox and Game Pass. Solid quality release. Metacritic reached 80 but recently sits at 79. Player reception, also quite positive, 77% rating on Steam and it's trending up towards 80. We're confident of Clans' expected performance over its life. MechWarrior: Mercenaries, the prior entry, generated about SEK 300 million of net revenues life-to-date. Expectation for Clans is to do better than that, should result in a nice return against the SEK 110 million of project investment. However, the initial investment -- or release window performance was a little softer than expected due to its delayed release. The game came out 9 days prior to Call of Duty. As a result, the initial runway for the game's release was shortened.

However, with these DLC plans, we expect Clans to deliver long-tail sales in line with Mercenaries' performance going forward. All in all, a nice first entry for our middle market publishing strategy, a solid quality AA release, a recognized IP-based game with dedicated fan base and more predictable returns as a follow-up entry to a successful existing title. We expect this to generate a nice return for the group going forward.

Next up, our two major releases in 2025: Singularity 6's Palia, coming to PlayStation and Xbox; and Cold Iron's new title based on the major motion picture IP, also on track for the year in 2025. As a result, we do look forward to 2025 being an exciting year for the group.

Next, over to Fredrik.

[Fredrik Ruden, executive]

Yes. Next -- thank you. Next slide, please. So net revenue in Q3 amounted to SEK 466 million, an increase of SEK 113 million from previous quarter. Adjusted EBITDA amounted to SEK 102 million, the strongest quarter so far this year. In the comparable Q3 last year, My Singing Monsters was still performing at elevated levels. This quarter, Big Blue Bubble delivered SEK 84 million in net revenue, a reduction by SEK 39 million from the SEK 122 million in Q3 previous year. Following that the game has stabilized, we judged that it will be easier comparable figures going forward. Over the last 12 months, net revenue amounted to SEK 1.673 billion with an adjusted EBITDA margin of 18%. Both these KPIs are expected to improve following our release pipeline over '25.

Next slide, please. We have a foundation of more predictable revenues and cash flows. Combining Daybreak, Big Blue Bubble and Piranha, EG7 operates several long-life cycle IPs where most are live service games. Net revenue from this portfolio in Q3 amounted to SEK 305 million, corresponding to 65% of net revenue for the group. And over the past 12 months, net revenue amounted to SEK 1.673 billion, of which SEK 1.108 billion derives from the more predictable revenue base. That portion of our revenues has been trending around 66% to 63% over the past 5 LTM quarters.

Next slide, please. Daybreak is the largest contributor to the net revenue and to the more predictable revenue base, generating SEK 212 million in net revenue. This includes SEK 27 million contribution from the newly acquired Singularity 6. But even excluding that acquisition, Daybreak delivers an organic growth. The adjusted EBITDA came in at SEK 52 million, corresponding to the highest margin so far this year of 25%. So a solid quarter for Daybreak. Big Blue Bubble generated SEK 84 million in net revenue and an adjusted EBITDA of SEK 42 million, which is a 50% adjusted EBITDA margin. And as said, My Singing Monsters has stabilized and the anniversary campaign in September increased the activity from previous quarter.

Next slide, please. So as Ji mentioned, Piranha has been focusing on completing MechWarrior: Clans for launch in October and has had no other releases during the quarter. Piranha delivered a net revenue of SEK 16 million with a positive margin. Looking at Toadman, an annual SEK 63 million cost savings effort has been executed during the first 3 quarters. This has affected 100 people previously engaged in Toadman. Toadman generated SEK 9 million in net revenue with a small loss, and there is a restructuring reserve amounted to SEK 70 million accounted for under adjusted EBITDA in the P&L.

Next slide, please. Fireshine had an active release schedule for the quarter and generated SEK 110 million in net revenue and an adjusted EBITDA of SEK 16 million. Looking at Petrol, it's highly dependent on third parties' game releases and marketing budgets, which continue to be negatively impacted by today's game industry challenges. Petrol generated SEK 35 million in net revenue, stayed on breakeven due to previously executed cost reductions.

Next slide, please. We have accelerated our investment over the past quarters. This quarter, they amounted to SEK 119 million. All those investments are in line with the strategy we communicated 1 year back. And together, they have the potential to significantly move the needle for us. Q3 investments are SEK 50 million in net effect from the acquisition of Singularity 6; and SEK 45 million is the net investment in various publishing deals, of which Cold Iron is SEK 32 million; and SEK 21 million is CapEx for finalizing Clans.

So -- but even after these investments, we're still at the net cash situation with SEK 219 million in cash and no debt. Cash flow from operations was negatively affected by SEK 36 million of accrued revenue in Fireshine, which will be paid to us in Q4. Adjusted for that, operating cash would have been SEK 71 million instead of the SEK 35 million shown in the cash flow statement.

Next slide, please. Thank you. The net revenue of the last 12 months has been trending down due to the decline in My Singing Monsters from last year's elevated levels and recorded SEK 1.673 billion. Given our release pipeline, this is expected to reach around SEK 1.8 billion in the full year '24. And we have lowered our expectation for the full year adjusted EBITDA margin down to 20% based on lower expectations from Clans following the delayed release from the original plan.

We have so far this year seen as many as 13,000 game industry layoffs, indicating a remaining higher risk level in the industry. At the same time, the market is expected to grow CAGR 3% up to 2026. We have over the past couple of years prepared our business to be operated more conservatively and sound. This includes backward leaning measures around cost control and closing down of certain activities and forward leaning to add initiatives within the framework of our acceptable risk level. All in all, we are better suited than ever to reach the strategic target to become a leading middle market publisher.

So that's all for me. Over to you, Ji.

[Ji Ham, executive]

Thanks, Fredrik. Let's go to the last slide. Thank you.

All right. Well, so Q3 demonstrated a nice rebound from Q2 lows. As communicated previously, 2024 performance, more back-ended than typical. Q3's big sequential growth was nice from Q2 levels, reflecting this. And Q4 should be another good quarter with Clans released during this period, DLC releases for a number of our other games and the usual year-end holiday boost that we see with our portfolio.

Overall market is still under pressure. Big guys are largely doing fine, although you're seeing headlines about optimization moves being made by even the biggest guys. But unlike the big guys, many of the indie and small to medium guys unfortunately do not have the luxury of the balance sheet flexibility to handle this market issue. As a result, over 13,000 job cuts that we've talked about through the end of Q3, likely more cuts coming over the next couple of quarters.

However, EG7 remains quite solid with the benefit of our portfolio, with recurring cash flows and also stable balance sheet. This allows us to be able to stay focused on our business plan without getting distracted. Our primary focus remains on organic growth with new products such as Clans and new titles that we have slated for next year we're very excited about. Secondarily, our focus is opportunistic M&A. Singularity 6, a great example of -- with a combination of the attractive deal terms, our strategic fit with their vision and strategy and the upside potential made a lot of sense. We are continuing to look for opportunities similar to this that will provide a highly favorable risk reward balance for continuing to fuel our growth, but only if it makes sense.

So we're excited for 2025 coming up, and Q3 and Q4 should be showing a nice trend leading into 2025 with Q2 behind us having been the trough for the year and along our transition from investment to producing nice return for the shareholders.

So that concludes our Q3 earnings presentation. And now back over to Ludvig for the Q&A session. Thank you.

[Ludvig Andersson, executive]

Thank you very much, Ji and Fredrik. Our first question here from [ Andreas ] at [ A Invest ]. When will we see the full impact from the cost saving plans? And add on to that is, larger investments 2024 compared to 2023, can you elaborate on this?

[Ji Ham, executive]

Yes. So as to the cost-cutting measures taken for Toadman, all the changes have been completed as of the end of October. So we are already experiencing and seeing the benefit of that in Q4. As to the larger investment in 2024 compared to '23, it is as we outlined in our Capital Markets Day presentation about a year ago in terms of investing in the middle market, publishing efforts with the title from Cold Iron as well as Clans, primary key drivers for the bigger investments this year.

Alongside that, Fireshine is also building out their portfolio of investment in their publishing efforts on the digital side. And along with these investments being made, the returns expectation for Clans, we remain quite confident that ultimately it would yield better results than MechWarrior 5: Mercenaries, which produced over SEK 300 million of net revenue over its life. And Cold Iron's title as well as the investment in Palia from Singularity 6, we remain quite excited for, and returns from those titles expected in 2025.

[Ludvig Andersson, executive]

Thank you very much, Ji. A question from [ Karl ]. Core Keeper 1.0 launch has been a viral success. What is EG7's long-term plans to capitalize on this momentum? And also regarding Core Keeper, Core Keeper released on mobile in China. What impact does this have for EG7 and Fireshine as a publisher?

[Ji Ham, executive]

Yes. We're very excited. Core Keeper has been a resounding success, over 3 million units shipped across PC and consoles as previously announced and 85 Metacritic score. It's beloved by a lot of the fans that are enjoying the game, and we think there's a long runway for that particular title to continue to contribute in terms of sales and growth. And some people compare the game to other successful titles like Stardew Valley, which has been a huge success. So we're very excited for its long-term future, collaboration with other local publishers for mobile SKU as well with Fireshine having the global publishing right across all the platforms. So yes, very excited, great start as a Version 1.0 and more to come.

[Ludvig Andersson, executive]

Thank you very much, Ji. So we have a few questions regarding MechWarrior: Clans. So the first one is from [ Jack Rox ]. After a successful release of MechWarrior 5: Clans, does this might have any impact for EG7's capability to retain the IP for Microsoft?

[Ji Ham, executive]

We have a good long-term relationship with Microsoft. Piranha has been developing and also servicing MechWarrior IP-based titles for some time. The latest iteration, obviously quite well done quality-wise, achieving that higher Metacritic score, and team and the fans and all the community really seems to love the game. So more to come on that front. Not much to say as to what additional developments there may be. But our core strategy is to double down on franchises that work, and MechWarrior franchise has been that for us. So we would love to be able to do more there, and then we'll continue that dialogue with Microsoft going forward.

[Ludvig Andersson, executive]

Thank you very much, Ji. Continuing the MechWarrior 5: Clans questionnaire here. Could you elaborate on the delayed release and also the rationale on releasing it under Game Pass?

[Ji Ham, executive]

Yes. So the rationale for the delay is usually because of the quality. The team was working hard towards completing the game and trying to achieve a certain level of quality, and we have to delay the title in order for the team to be able to achieve that. And the result is a 79, 80 Metacritic level of quality. The player base is also enjoying it very much, which bodes well for the long-term success for the title. As to the Game Pass, it is -- the IP itself is owned by Microsoft. So when we do work on MechWarrior IP-based games, Game Pass is a requirement along with the license terms with Microsoft.

[Ludvig Andersson, executive]

Thank you very much. Can you say anything about the plans in pipeline regarding DLCs for Clans?

[Ji Ham, executive]

It's going to be similar to what we did with MechWarrior 5: Mercenaries. So we expect multiple DLCs -- robust DLCs over the next coming years. And MechWarrior 5: Mercenaries released in 2019, and it's still generating nice revenues through not only the base game sales but with DLCs that subsequently released. So we expect to follow a similar type of content model for MechWarrior 5: Clans to be able to bring great content and continue to expand the content base for the [ franchise ].

[Ludvig Andersson, executive]

Thank you very much. Could you give you a quick update regarding Daybreak's portfolio and expectations going forward?

[Ji Ham, executive]

Yes. We're quite happy with the results for the third quarter, and we are seeing nice performance out of some of our titles. Lord of the Rings Online once again contributed nicely for Q3, released a new content through a legendary server, which is an additional revenue vector for the studio and the team. And the idea is to be able to do more of those going forward and capitalize on the success of that. And [indiscernible] prospects look quite nicely because of that additional potential revenue vector.

DCUO, which had some issues over the last 18 months or so, trending nicely, stabilized with the new leadership team that we were able to bring on. And the new leadership team that we brought on, I think I may have commented on this last time, but just to reiterate. Veterans from Cryptic that worked on Star Trek Online. So significant knowledge and expertise around being able to operate live service title of similar nature, and along with that team getting onboarded now -- fully onboarded, being able to take on the reins of DC Universe Online and being able to really come up with a exciting plan for the title. And we're seeing the results of some of the changes that they are already making. And we do remain excited for what they could achieve in 2025, potentially better than what they've done in 2024.

Magic Online is doing great. Magic, obviously one of the biggest CCG IP in the world. And then we get the benefit of operating what we consider to be truly more of a simulation of the tabletop card game versus other formats that are out there. Magic Online team has been growing, dedicating additional resources to catch up on some of the content that we've been behind on, and their performance has been nice since we took that project on, growing annually each year. And we expect that trend to continue.

So overall, some of these titles are doing great. And of course, there are other titles that are aging where there are some declines. But net-net, we expect Daybreak portfolio to perform nicely going into 2025.

[Ludvig Andersson, executive]

Thank you very much, Ji. Continuing on Daybreak with a question regarding Palia. And what is needed to get to the commercial launch? And what will the monetization look like for the game? And what will be the capitalization phase going forward up until launch?

[Ji Ham, executive]

Yes. Look, I think Palia, we're quite excited about. It could be a genre-defining game. It's the modeled after other very successful titles like Animal Crossing as well as Stardew Valley. But none of those games are really live service titles. So Palia represents a potential live service free-to-play version of those successful titles with AAA quality. Still in open beta, so there's more work to be done. But based on how far they've gotten prior to our acquisition, along with the road map for them to be able to get to Gen 9 console sometime next year, we have conviction around what they could achieve.

It's already generating nice revenues on PC. We expect the revenue to grow with PlayStation and Xbox availability and distribution broadly next year and some of the plans they have for additional content as well as continuing, I would say, tuning of the overall experience along with the open beta data that they're collecting. We do expect more optimized and more compelling experience from the moment that you log in for new players as well as long-term players who have been playing the game hundreds of hours, for them to be excited for what's coming along with Gen 9 release in 2025.

Modernization-wise, it's a free-to-play game. So there's always ideas around what can we do. And there's ideas -- compelling ideas that are being considered. But I would say in terms of where we're headed, it's not going to depart too significantly from where they've been in terms of how they have developed the monetization and overall economy that's embedded with the game already.

[Ludvig Andersson, executive]

Thank you very much, Ji. A question from Erasmus at Kepler and [ Matias ]. Have H1Z1 still in preproduction? Can you elaborate on the timing for the game?

[Ji Ham, executive]

Yes. So H1Z1 is in preproduction still. And timing-wise, what we have decided to do is we have a number of bigger investments going out. Clans, obviously now producing returns with its release. But we have Cold Iron title next year as well as Palia, which we originally did not account for. Opportunistically, we were able to secure that transaction to us beginning of third quarter. So there's investment going into it. I think we already communicated this upfront investment of USD 5 million. And then there's additional investment of up to $10 million that we're investing in order to get the game out on Gen 9 consoles.

So based on the additional investments that's coming up in front of H1Z1, what we don't want to do is, as an organization, operate our business too aggressively where, given the current market conditions, put the business at risk in any way. We've been very good about managing our risk very proactively and we want to continue to do that. So we are going to manage the timing of our investment conservatively. What does that mean? Well, we want to make sure that Palia goes out successfully, along with that Cold Iron's game goes out successfully thereafter. And then along with that sequence and generation of returns from the investments that we're making, be able to ramp up on investments like H1Z1 in order to manage our cash flows and being able to live within the confines of what's available to us from our balance sheet as well as our cash flows from our business.

So that's what we're intending to do. Does that mean that H1Z1 potentially could be delayed? Maybe yes, but no determination as to when exactly and how far. But we're trying to be prudent given the market conditions to be able to manage our investment timing accordingly.

[Ludvig Andersson, executive]

Thank you very much, Ji. A question from [ Jan ]. Any signs of improvement in the work for hire market?

[Ji Ham, executive]

None. I mean, I'll be very blunt. I think the work for hire market is not doing well. And I think -- 13,000 jobs lost, right? So -- and then just over the last couple of weeks, we heard there are more headlines about studio shutdowns and then job losses. So market seems to be -- I mean, in terms of, I think, job reduction, it is slowing down. But at the same time, it's not done yet. So I think until market correction is completed, I think the certain segments within the gaming industry such as work for hire and services businesses like Petrol will continue to feel the pressure.

[Ludvig Andersson, executive]

Another question from [ Jan ]. Can you elaborate on the capital allocation, M&A, dividend buyback?

[Fredrik Ruden, executive]

Yes. I think capital allocation, we are prioritizing investment for growth. But once again, we're trying to be conservative and smart about it so that we're not finding ourselves in a similar situation as a number of our peers in the market that have had to deal with cash flow issues or financing issues, et cetera. So good news is that I think we've done that fairly well and we'll continue to maintain that.

And well, we haven't dialed in, in terms of what the allocations should be amongst those list of options that the question included, but I would say at the top of the list is really finding compelling opportunities for investment where we already know what the plans are, right? So these are identified projects or within our plans in terms of organic growth in new projects.

M&A, opportunistic. We're not out there hunting for big deals. We're looking for deals similar to what a Singularity 6 type of deal might be. There is a good level of market distress. And we have done interesting deals throughout our history in situations of that nature. And we think there will be more opportunities that we could capitalize on over the next 12 months or so as market comes out of this current correction. So eyes wide open, evaluating opportunities as they come up, proactively looking for them as well.

But at the same time, we will live within our means. We're not going to, I would say, overextend ourselves and trying to put capital to work for the sake of growth. We will manage our business conservatively. As to the dividends and share buyback, our cash balance at the end of third quarter was SEK 219 million. We expect that number to be higher with the back-ended performance for 2024, bringing additional cash flows in for the second half of the year. So good news is that we'll have more cash. As to how we're going to utilize it on share buybacks and potential dividends, to be determined as we weigh some of these other options that we're looking at on opportunistic side.

[Ludvig Andersson, executive]

Thank you very much, Ji. I think that's all we had for today. So everyone who listened in, thank you very much for your time, and we wish you a great day from our side. Thank you.

[Ji Ham, executive]

Great. Thank you.