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Earnings Call Transcript 2018-Q2

[Oscar Erixon, Financial Analyst]

Hello and welcome to this presentation of the THQ Nordic's Q2 report. And we have CEO, Lars Wingefors, here to present today what was a solid quarter, I would say, in a quarter of quite few releases, managed to get a quite decent margin and also strong growth in Deep Silver, especially. Also note that you've done another acquisition of an IP, which looks interesting. So it will be interesting to hear more about that and the performance going forward in H2 as well. So we will run through the presentation here with Lars and then we will go to questions, possibly a few questions from me as usual and also questions from the audience and also from the telephone. So please go ahead, Lars.

[Lars Wingefors, Founder, CEO & Director]

Thank you. Good morning, everyone, and welcome to this report. So we had a stable quarter again with a year-on-year growth of 878% to net sales of SEK 837 million. The EBITDA was up year-on-year 420% (sic) [ 421% ] to SEK 207 million. And the EBIT was only up year-on-year 73% to SEK 53 million. We had 10 releases during the quarter. I would like to mention Wreckfest in the end of the quarter. And financing activities, together with Carnegie here, we raised SEK 1.4 billion in June. And after the quarter end, we signed new credit facilities with a leading Nordic bank. I will come back to everything here during the presentation. So going back to the numbers. Again, the -- well, I would like to start to remind you that Koch Media was consolidated from February 14 this year. So the new group has a significantly higher sales in absolute terms. However, there is a lower margin profile in the Koch Media group, largely due to the Partner Publishing and Film business. However, the overall, in absolute numbers, are higher in terms of EBITDA and EBIT. Net sales were up, as I stated, from SEK 87 million last year to SEK 837 million this quarter. The business area, Games, had a stable quarter. The THQ Nordic business was up 70% to SEK 145 million. And the Deep Silver business was up to SEK 338 million, driven, I would say, with the continued performance of the back catalog, continued performance of the Kingdom Come: Deliverance, for example. Also, I would like also to say that the digital back-catalog sales contributed well into the quarter. We had a notable income from subscription-based business models. Also Film performed, I would say, well, according to the management expectations during the quarter. I stated during the last presentation in Q1 that the Partner Publishing overall had a quarter without any major releases. I will come back to the releases. But especially compared to last year, this was not a very strong quarter. In terms of EBIT, both THQ Nordic and Koch Media contributed to a positive EBIT. The EBIT is -- well, the EBITDA is higher than some expected. However, the depreciations in the quarter drives the EBIT down to the mentioned number here, SEK 53 million. I'm leaving the profit and loss and going to cash flow. The cash flow from operating activities after the change in working capital in Q2 was SEK 165 million. If you remember in last quarter, we had forfaiting of about SEK 450 million. And this year, this number was approximately SEK 200 million. Cash flow from operating activities after change in working capital in Q1 was -- compared to -- was SEK 700 million in Q1, however, impacted positively by forfaiting of approximately SEK 450 million as stated. Cash flow from investing activities in the quarter was minus SEK 347 million, mainly relating to investments in game development projects and the acquisition of the Koch Media facilities or property in Höfen. Finally, cash flow from financing activities in the quarter was a positive close to SEK 1.6 billion, of which SEK 1.4 billion came from the new share issue completed in June. Looking a bit of the business area, Games. I know, Oscar, that you will come back with a lot of questions on this. But before you do that, I would like to say the net sales, as stated before, was in Q2, SEK 484 million. The owned titles, owned IPs were 39%, SEK 189 million in the quarter. Of the business area, we had an even share of digital and physical sales, so the digital sales was 50%, SEK 242 million. Looking at releases now, meaning the releases actually released in the quarter. That number only were 20%. So SEK 98 million came from the releases in the quarter. Less -- the remaining sales were from releases previously released in Q1 or earlier, the whole back catalog. Looking at the balance sheet. I would like to start to run through the intangible assets that were a little bit above SEK 2 billion. That number -- of that number, finished, already completed games were a little bit over SEK 200 million. The ongoing game development projects that are capitalized were a little bit over SEK 1.4 billion. And the remaining amount was all IPs, films, the partner publishing, goodwill and other intangible assets, a little bit over SEK 400 million. Looking at -- I would like to mention here also the cash balance, SEK 1.5 billion. The available liquidity by end of the quarter was close to SEK 2.7 billion, including all credit facilities. And that was before the refinancing of the mother group that were done after the quarter end. Going to bit of the KPIs and looking at the depreciations. IPs, this came from the previous THQ Nordic, SEK 3 million in the quarter. Games development, that were a considerable number in the quarter, and the total depreciation were SEK 113 million. And the depreciation of mainly films and a bit of Partner Publishing were SEK 31 million. Investments in the quarter. The external game investments were SEK 114 million and the internal capitalized development were SEK 94 million. Furthermore, we invested SEK 32 million in new film rights. And in the quarter, we finalized and completed game investments of SEK 47.4 million, which you can note here is a lower amount than the investments in Q1, which, if you remember, we had MX and Kingdom Come: Deliverance. So looking at more the commercial. It's -- we had 10 releases in the quarter in the business area, Games. We had Pillars of Eternity on PC from -- developed by Obsidian. That product is coming later on, on console. We had the last version or the last announced version of Battle Chasers: Nightwar coming out in the middle of May on Switch. That, I would say, had a great feedback from fans. We had from Funcom, we had Conan Exiles in physical publishing at Deep Silver. We had -- I think this is the ninth version of Legend of Kay now releasing on Switch its own IP. We also had the de Blob 1 coming out on Switch. We had the first DLC for Kingdom Come: Deliverance releasing on both PC and console formats. We had from Fishlabs in Hamburg, Galaxy on Fire - Manticore on Switch just distributed digitally and the already mentioned Wreckfest from our friends at Bugbear in Helsinki. And they were releasing in the middle of June after 4 years, almost 4 years of development and early access on Steam, I would say, the complete version of the product on PC. And we have seen a great feedback from fans. It has been okay sales. And it continues to perform well. And it's a game that we could note that a lot of streamers, YouTubers and Twitchers, enjoy to play online and show other people. So it's a great product in terms of PR marketing. We also had a minor Deep Silver, it's called Illusion, on digital distribution. And finally, Foxglove, our own mobile studio, released own IP or new developed IP in an external developer called Pocket Cowboys on open beta in the end of the quarter. I would say on that side, it is very, very early. But I would like to note it. And we had a continued performance and development on Snipers vs Thieves and The Muscle Hustle.The last 3 quarter up until today, we have released 5 more products. Finally, we were able to bring out something on Red Faction. Red Faction is an IP we own and were developed by Volition, a studio that we now own that are under Deep Silver. And we released Red Faction: Guerilla Re-Mars-tered on PC, PS4 and Xbox One. HandyGames, that we acquired, I'll be coming back to that, released a title called Aces of Luftwaffe on PC, PS4 and Xbox One. 2 weeks ago, we released This is the Police 2 on PC. We had another DLC, From the Ashes for Kingdom Come: Deliverance early in June -- July, sorry. And finally, we had the Switch version of Titan Quest. We had -- in Q1, we had the PS4 and Xbox One release. And now in end of July, we had a Switch release. I would like to point out just a few selected releases we had in the partner publishing business area. From Codemasters, our friends at Codemasters, we had Onrush. From our friends at Focus Home Interactive, they had end of the quarter, Vampyr. From our friends at SEGA, we had Yakuza 6. From our friends in Italy at Milestone, we had the MotoGP 18. We had one of, I would say, many old gamers' favorites of SEGA Mega Drive Classics from SEGA. And finally, we have another installation of Harvest Moon on Nintendo 3DS from Rising Star. Again, the Q2 was not a very strong quarter for partner publishing. Looking into the second half of the year, Q3 and Q4, there is a stronger release schedule. Now in Q3, we're having F1 2018 by Codemasters. For example, from SEGA, we have Shenmue I and II coming out. And we are -- our Deep Silver are publishing Shenmue III. And that is now scheduled for next year. And by Square Enix, they have a strong release lineup for the rest of the year with Tomb Raider in Q3 and Just Cause 4 in Q4. This is just a selected mentioning of releases. There is a large amount of releases coming out. So in June, we raised SEK 1.448 billion with Carnegie again before transactions cost at SEK 188 per share. And this is for financing of acquisitions of IPs, further investments in game development, studios and general acquisitions. I was happy to see a strong interest in the raising and also very happy to see, I would say, all the long-term investors taking part of these transactions, along with a few new, well-known institutional investors. Also, after the quarter end, we finalized the new credit facilities in the mother company with a leading Nordic bank, in total, EUR 85 million, replacing the previous SEK 250 million in the overdraft facility. It took a bit longer time. And it's partly depending on the new Koch construction and they have their own facilities down in Austria and we have our own now in the mother company. Now it's all finalized and agreed. And we also made a final payment of EUR 16 million to the sellers of Koch Media. So in July, we acquired HandyGames. HandyGames is, I would say, to be mainly a mobile company, quite old company, founded in year 2000. They have about 50 employees. It was not a major transaction, but it was a transaction driven by a strategic thinking from my team in Vienna to move smaller- and mid-sized releases and IPs partly to HandyGames. Because THQ Nordic in Vienna, they have a very, very broad portfolio of IPs and there is partly a bottleneck for smaller releases. So now HandyGames could take better care of this. They have a strong track record of being very early on new formats. And they have a few of their own IPs that are worth mentioning, the Aces of Luftwaffe. They have an IP called Townsmen that actually have done -- had a great feedback from VR, the community. And then they have a range of casual products. Also announced this morning, we acquired the game series, TimeSplitters. And for me that have been in the industry for, well, too many years, 25 years, TimeSplitters is one of the major IPs early 2000 and the following years. It was created by a team that founded the studio Free Radical Design. And Free Radical Design later became Crytek UK and Crytek UK was acquired by Deep Silver and now that studio is called Deep Silver Dambuster Studios based in Nottingham. There are more than 100 people. Obviously, they are currently working on another product. But it's great that to have TimeSplitters back home again with the team and with the group. And there is still -- I would say there's still a lot of fans out there remember this product. And it still has a uniqueness that stands out. And if you look at the Metacritic of all the 3 products released, it has a great Metacritic. So I'm looking forward to put it into our model of handling IPs without confirming any new products. I'm looking forward in the coming years to tell you more about this. I would say this is a major IP. Pipeline. We have again a very strong upcoming pipeline for the coming periods and the coming years. Metro Exodus, we showed at -- or Microsoft shows as a press briefing at E3 onstage. And we also had a game playable at E3. And we had a very good feedback from fans and from press and from business partners. Now it's slated for release in Q1. I won't go into detail of everything. But Darksiders III, slated for release in end of the year. We announced the release date and preordering offering in July. And we can see a good interest from fans. I don't know if you've been online and if you are fans of Darksiders. But we have this huge Apocalypse Edition of $399. And I'm just amazed how many out fans out there actually ordering that. Okay. It won't drive -- Oscar, don't take that as a revenue increase. But I'm really happy to see a strong fan base for an IP and also that we are able to use our physical power and distribution setup to capitalize on this to actually bring out Collector's Edition. Except this Apocalypse Edition, there's a Collector's Edition, it's just $449. Wreckfest expected on console soon, Biomutant. We signed the Generation Zero from our friends here in Stockholm at Avalanche Studios. We will support them with the physical publishing globally. We also announced Pathfinder: Kingmaker. It's coming out now first on PC and then on console. In total, we have 59 projects in the business area of Games, whereof 17 were announced end of quarter and 34 was unannounced. Next week, we have biggest event of the year for the group and, I would say, for consumers in Europe with gamescom in Cologne, 350,000 visitors last year. And well, stay tuned. That was the Q2 presentation.

[Oscar Erixon, Financial Analyst]

All right. So with that, I think we'll go to some questions, and I'll allow myself to start. So if we just look at the top line first, and Deep Silver is the one that really sticks out, if you will, with quite strong sales. Obviously, you had Kingdom Come in Q1 but quite a few releases now in Q2. So what is driving that growth? Is it the Kingdom Come and Manticore? Or is it the back catalog with old Metro titles, perhaps?

[Lars Wingefors, Founder, CEO & Director]

Well, as usual, it's a wide range of products driving the total revenues. Kingdom Come had a continued good performance in the quarter. And it's a publishing title, it's on a Deep Silver. It has a much lower margin than other owned IPs. But it really drives the revenue bit here in Q2. So yes, that's partly one of the titles I would like to point out. And then obviously, we -- in Q1, we had -- in the end of Q1, we had the MX at THQ Nordic that has a continued performance in Q2. Battle Chasers had a notable income in the quarter.

[Oscar Erixon, Financial Analyst]

Yes. And you mentioned the 2 DLCs released for Kingdom Come. And I guess that's quite an important part of the business model for that game.

[Lars Wingefors, Founder, CEO & Director]

Yes.

[Oscar Erixon, Financial Analyst]

Are you happy with the reception for those DLCs?

[Lars Wingefors, Founder, CEO & Director]

Well, it's mixed. But yes, I'm happy. And I'm happy we can bring out new content. And as you know, this is the way to monetize these kind of games or the way they have chosen. And it makes the possibility to make new collector's editions or game of the year editions in the future. So -- and I think it's really important to bring out new content to the large fan base of Kingdom Come.

[Oscar Erixon, Financial Analyst]

Yes. And I mean Metro now with a release date, quite big hype during E3, I would say, being there myself. How is the interest in the title now, do you feel? Do you feel like there's a lot of interest in the old titles, people want to replay and so on?

[Lars Wingefors, Founder, CEO & Director]

Yes. As usual, we can see pickup of mainly digitally customers coming in to either buy the old titles for the first time or replay the old titles. So that's part of the strategy with having sequels that to bring the new fans also to the old games, so yes.

[Oscar Erixon, Financial Analyst]

And mobile, I want to touch upon as well. You mentioned here in the report specifically that you continue to have quite a lot of downloads for your games. But how do you see the journey from going to downloads to monetization? Are you any further on that path?

[Lars Wingefors, Founder, CEO & Director]

Yes. We are on a strong path. I think we have one of the best teams in the world to develop these kind of products. We have, I would say, a strong publishing team now put in place at Foxglove. They are small but good. However, again I'm -- unfortunately to say that it's one of the few business areas that is not really making money. So it's still -- it's a burn rate. So I still have confidence that we can work on these products and put them in the right direction. If not, I promise to tell you.

[Oscar Erixon, Financial Analyst]

So you're not giving up there. Good. And I think I would like to hear some more detailed on TimeSplitters because that's an IP that I remember as well, actually.

[Lars Wingefors, Founder, CEO & Director]

You do?

[Oscar Erixon, Financial Analyst]

Can you say something about the plan for it, I guess, it's not within the next couple of years?

[Lars Wingefors, Founder, CEO & Director]

Oscar, it's -- it would be totally wrong by me to announce our plans. I would say one of the reasons we acquired is we have the original developer in-house. It's a very strong IP. There has been no asset care of this product. The last product was published by Electronic Arts. The 2 previous by Eidos, now Square Enix. So I would say it's a fairly old IP. So it's a bit harder to work on portings and the assets because the game was made during PlayStation 2, original Xbox and GameCube. It's a bit easier if you have an IP that were done on PlayStation 3 because, then it's easier to port it into current formats. Now the games is a bit old. It requires more of effort.

[Oscar Erixon, Financial Analyst]

Yes. And something perhaps about the size of the acquisition in between HandyGames and Koch Media, where is it, somewhere in the middle, perhaps?

[Lars Wingefors, Founder, CEO & Director]

Of this, the IP?

[Oscar Erixon, Financial Analyst]

Yes.

[Lars Wingefors, Founder, CEO & Director]

The term is not disclosed. But it's, I would say, much, much closer to HandyGames than Koch Media.

[Oscar Erixon, Financial Analyst]

Okay. Fair enough. And another question that I think I have to ask is Biomutant. I mean game is now coming up in, I think, roughly a week. Is there anything to say there about a possible release date?

[Lars Wingefors, Founder, CEO & Director]

I would say I'm still as excited as before looking at the product. And I think that is the most important thing. It's a small but very good team based here in Stockholm. And we need to have their path. And next week, you'll see more and hear more.

[Oscar Erixon, Financial Analyst]

Okay. I have a few more questions. But perhaps we can turn to the floor if there are any questions here.

[Unknown Analyst]

Lars, I would like to ask you about the subscription-based comment. You stated that it had some contribution to the gross margin. And what's your -- which subscription services? And maybe just an elaboration on what you think about this type of business models going forward.

[Lars Wingefors, Founder, CEO & Director]

Well, I'm a strong believer, it's a great offering for consumers. There is numbers of business platforms or platforms around both on console and on PC offering this now. And there will be more services coming out during the coming years. As an IP owner/creator, we could leverage our catalog of IPs and leverage our position to onboard new content to these platforms. And obviously, all these platforms are competing for the consumers. And as IP owner and content holder, we will leverage this. And during the quarter, we had a notable income. I would not say it's amazing, but it's notable. I'm looking forward to follow this business model over the coming years. But again, the majority of the revenues digitally is still full game downloads and DLC business and so on.

[Unknown Analyst]

Is there some type of specific genres that you see sells more on the subscription-based?

[Lars Wingefors, Founder, CEO & Director]

Well, we previously have been noting that compared to other business model, casual games and family games has performed well on these business models. However, today, there is not that many of IPs around or products made because those developers have moved to mobile. So hopefully, we can see families and children and more casual gamers coming back to the console and PC again through these business models.

[Oscar Erixon, Financial Analyst]

Okay. I think we have one question on the telephone as well.

[Operator]

We do indeed. Our question comes from the line of Lars-Ola Hellstrom of Pareto Securities.

[Lars-Ola Hellstrom]

Lars, I just wanted to follow up on Oscar's question about the performance during the quarter. I'm also very surprised of the performance of Deep Silver. Would you say that Kingdom Come delivered in line with the Q1 performance in Q2? Or is it that you have started to digitally promote some of the Deep Silver assets as you now can control it in a better way?

[Lars Wingefors, Founder, CEO & Director]

Well, I think there has been both where you're stating here. It was a continued performance of Kingdom Come. That is not the only title. But it was a continued performance. There were price promotions for that title as well as long as a range of price promotions of the Deep Silver catalog in the quarter. In total, that has driven the revenue, however, with a lower margin because of they have a much higher percentage of publishing revenues in the business area.

[Lars-Ola Hellstrom]

Okay. And for THQ Nordic, would you say that it's the Q4 2017 releases, the back catalog, MX and Titan Quest, in addition to the Switch version of Battle Chasers that is the key growth drivers?

[Lars Wingefors, Founder, CEO & Director]

Yes. Well, we had a few -- again, mentioning Battle Chasers, both physically performed fairly well and digitally. And we had a continued performance of the previous new releases we had in Q4 and Q1. So [ more – cash more for Wreckfest ].

[Lars-Ola Hellstrom]

And the full release of Wreckfest for PC?

[Lars Wingefors, Founder, CEO & Director]

Yes. The amazing game of Wreckfest. Well, it was a full release. However, as you know, the game was previously already released as early access with close to 400,000 customers. So I wouldn't say it was a very large revenue from that title because it was only a few weeks in the quarter. But it had a notable income. I'm happy of the performance, especially very happy about the critics and the Metacritic showing 80-plus on the title. It's -- I would say, as also previously stated, I think it's a product that will work as well on console.

[Lars-Ola Hellstrom]

Okay. Staying in the second quarter, I also wonder a bit about the high games amortization. As far as I remember it, end of Q1, there was roughly above SEK 200 million in completed games. I think we discussed that most of it is related to THQ Nordic. And so I'm quite surprised that it is above SEK 100 million in amortization of the games. Can you explain? And does it relate to THQ or THQ and Deep Silver?

[Lars Wingefors, Founder, CEO & Director]

Well, again, I think THQ Nordic, again they had -- in Q1, they had MX releasing and that amortization came in strong in Q2. As you remember, we have our model of amortizing 1/3, the first 3 months, 1/3, the remaining 9 months, along with a considerable amortization in the Deep Silver business area. I can't give you a breakdown in this call, Lars-Ola. I know you love to have it. But I'm sure I will try to give you better color on this in the upcoming periods. Deep Silver was consolidated from February 14 into the group, and there is lot of financial integration going on between the entities.

[Lars-Ola Hellstrom]

Yes. I understand. Finally, about gamescom, we know you have sent out the press release for THQ brand. And I guess Deep Silver will show Metro Exodus and, what was it, Pathfinder: Kingmaker? Will they show something else? Or will that maybe be a surprise?

[Lars Wingefors, Founder, CEO & Director]

That will be a surprise, Lars-Ola. As you know, I'm not commenting on the operative -- what they're planning. But I'm sure the marketing and PR teams have a lot of plans for the show. Don't expect too much. But I'm sure it will be a good show.

[Oscar Erixon, Financial Analyst]

Okay. So I think we'll perhaps wrap this up with a few last questions from me then. So first of all, looking at the pipeline for Q3 and Q4, you've already mentioned Partner Publishing looks quite strong. Is it possible to shed some light on sort of what is the most important titles for you, not in terms of their top line potential perhaps, but for you. So F1, for example, is one of the most important?

[Lars Wingefors, Founder, CEO & Director]

Yes. Well, F1 has been a great performer in Partner Publishing in the past years from our friends at Codemasters. So we would expect that to perform well. But I don't really want to comment each title. There is F1. There is Tomb Raider, there is Just Cause, there is many other titles coming out. I would say Q3 has a considerable release list, perhaps less titles than in Q4. And so Q3, there is a long range of titles coming out. Looking at the business area, Games, I would say Q3, don't expect too much out of Q3. So I think there will be another [indiscernible], I think, in the end of the year and especially the Q1 next year, having already announced Metro Exodus, will be key drivers in the business area of Games. But Q3, there is no considerable release within the business area, Games.

[Oscar Erixon, Financial Analyst]

Okay. And as for -- yes, let's start with Deep Silver then. You saw that a release date for Bard's Tale has come out. I think it's late September. What do you expect from that title?

[Lars Wingefors, Founder, CEO & Director]

To be amazing game from a very good team from our friends, inXile. I think it has a strong fans' following. They just announced or released the trilogy of the previous games, going back to Amiga, so -- but again, it's a quite niche product. It's on PC for most. So it's not a Metro Exodus.

[Oscar Erixon, Financial Analyst]

Yes. And to follow up on the question on the telephone there earlier, just for the record, about D&A. You mentioned Deep Silver, quite a bit of D&A. Nitty-gritty question, but Kingdom Come, I mean, how much is -- I know there was a kick starter campaign for that game. How much have you invested in that? And is that a significant part of the amortization?

[Lars Wingefors, Founder, CEO & Director]

Well, it's a notable part of it. It's not a significant part of it, it's notable. I think that is the best wording.

[Oscar Erixon, Financial Analyst]

Okay. Fair enough. And then finally, two questions here regarding, first of all, synergies. You mentioned hard and soft synergies. Can you sort of specify? You mentioned also the physical distribution that's...

[Lars Wingefors, Founder, CEO & Director]

Well, physical distribution was something we moved almost completely now early in Q3. But we had a considerable integration process going on in Q2, moving now the upcoming pipeline across mainland Europe and U.K. and Nordics now to Koch Media. So that will be -- or that is a hard synergy we're doing. As stated before, there is just -- Koch Media was not a cost-cutting exercise. So there is a lot of soft synergies working together with tech and assets and working together now at the trade shows -- and yes. And obviously, there is sharing of information and sharing of various costs and so on and what we could improve between the entities.

[Oscar Erixon, Financial Analyst]

Yes. And finally then the new name, which has been mentioned before, is that getting closer?

[Lars Wingefors, Founder, CEO & Director]

Yes. It's getting closer in a way. I think during the summer, we haven't spent too much time on this. Foremost, the most important thing is our business. This is something for the mother company, publicly listed entity. It's nothing that will change the revenues or profit level. So we will have various actions taking place over the coming periods to nail this out. It's coming a bit along with the strategy and so on. So there is other discussions going on together with the name, and that's why it's taking a bit of time.

[Oscar Erixon, Financial Analyst]

Okay. Fair enough. I think that's it for me. So if we have no other questions from the audience here? All right. That's it. Thank you very much.

[Lars Wingefors, Founder, CEO & Director]

Okay. Thank you.