Evolution AB (publ)

STO:EVO

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, welcome to the Evolution Gaming Group Q3 2018 report. Today I'm pleased to present CEO Martin Carlesund and CFO Jacob Kaplan. (Operator Instructions). Speakers, please begin.

[Martin Carlesund, Group Chief Executive Officer]

Thank you, operator. A warm welcome to everyone on the call and also those following up online. My name is Martin Carlesund. I'm the CEO of Evolution Gaming. With me today I also have our CFO, Jacob Kaplan. I will start by giving some comments of our performance in the third quarter. I will then hand over to Jacob for a closer look at our financials. And after that, I will round off with some outlook for the future, followed by questions. Next slide, please. In the third quarter, I've been entranced with lots of progress and hard work. It started off with the final weeks of the World Cup and then we have exhibited good demand throughout the period. My overall view is that once again, we have managed to increase the gap to competition, this time manifested by the launch of New Jersey studio as well as continued success for our newest game innovations. Let's look at the numbers. We have revenue growth of 41%, EUR 64.3 million, compared to EUR 45.7 million last year. EBITDA increase of 28%. We have an EBITDA margin of 43.5% and an EBIT increase of 27% to EUR 23.2 million. I'm especially happy with the growth. We have reached 500 tables at the end of the quarter, ahead of plans due to very high demand from our customers. We continue to see high demand also in the beginning of Q4. The margins were slightly impacted by the faster-than-expected growth in the number of tables. Remember that we always prioritize our long-term goals before short-term margins. The main highlight of the quarter was the launch of that new studio in New Jersey of which I'm very proud. It's our 10th studio globally, our second in North America and our first in U.S. The initial response has been very positive, and we will go live with additional operators in the fourth quarter. Outlook for the U.S. in total is, of course, very positive. But as we have said before, it will take time before it reaches its full potential. In the quarter, we have also looked at our few plants in Malta, where in 2019 we need to expand to fulfill the demand for international tables.Next slide, please. Bet spots is an indicator of activity in the Evolution network. We saw healthy growth of 66% in Q3 compared to last year. In the beginning of the quarter, the number was supported by the World Cup, but the number had stayed on high levels driven by good player numbers and our new games. Next slide, please. As you know, our success is built on talented people and our recruitment pace remains on a very high level. The number in the quarter was mostly driven by new people joining our studio in Georgia. It takes a lot of effort to find the best people, and we continue to refine our recruitment process in all markets with good progress. Looking at the actual numbers of employees, we are now more than 5,000 people in 11 different markets. This is a great accomplishment.Next slide, please. Let's continue with a look at the development of our new studios. In Georgia, we continue to see good progress and studio will be our second largest at the end of the year. As said, Georgia has been the main driver of employees in the quarter, and in the end of the third quarter, 600 persons were onboard to be compared with 300 in the end of the second quarter. The New Jersey studio went live in the quarter and the initial development has exceeded our expectations. The studio is located in Atlantic City and serves some very strong brands already, like 888, Rush Street and Hard Rock. We are in discussions with several new operators and expect to be live with more than 5 at year-end. Among our tables, Three Card Poker and Ultimate Texas Hold'Em, have proven extra popular. We continue to see the U.S. market as the long-term project that will support Evolution's growth over time. New Jersey by itself is relatively small, but as more states regulate, the more U.S. will grow in importance. We look forward to the potential opening of Pennsylvania in 2019, and we see the good start of New Jersey as promising for the future potential of USA in total. During the quarter, we have also looked at the possibility for expansion in Malta with a clear increase in demand of tables and services in local languages. Sweden is a typical example where more operators want to expand with Swedish-speaking games when the new regulation starts in 2019. Next slide, please. Our global exposure continued to increase in the quarter as we see growth from all over the world in line with our customers' increasingly diversified loyalty. As you can see in this report breakdown, the rest of the world areas continues to increase while the U.K. market is under pressure from the latest regulatory requirement. We have around 150 customers today including several platforms. This means that our games are literally available on thousands of websites in more than 200 countries. However, Europe remains the basis of operations and U.K. the single largest market. Going forward, we expect rest of the world to continue increase driven by Canada, New Jersey and also more European license operators going into Asia. Next slide, please. We continue to invest in product innovation, and I'm very happy to see the strong and positive response for our new games from our customers and their users. It's key across that our new product significantly support growth from all type of customers. Our most recent addition, Lightning Roulette, continues to prove very popular among end users. It's also gained a great industry recognition as we also, at the end of the quarter, won the Product Innovation of the Year award at G2E in Las Vegas. Last year, we won Digital Product of the Year with our Dream Catcher. The Product Innovation of the Year is, however, a wider category and targets both digital and land-based products, which is why we are immensely proud of this award. Looking forward, we have a very strong product pipeline. Our R&D suite have been refined and is currently in testing with 4 customers. We are encouraged by the operators' demands for these games and look forward to our full rollout of the next quarter. We are also nearing completion our [ BFFF of ] Infinite Blackjack. This game will allow unlimited players -- unlimited number of players on to Blackjack for a single table. We're especially proud of this game. It was the most technically advanced table we have ever been but is still providing a simple pure Blackjack experience to end users. I look forward to telling more of this after the rollout. Now I hand over to Jacob for the financial highlights. Next slide, please.

[Jacob Kaplan, Chief Financial Officer]

Thanks, Martin, and good morning to all of you listening in. We see a continued strong revenue development in this quarter. Year-on-year growth is 40.8%. After slower start to 2018, the past 2 quarters have been stronger with volumes and player numbers picking up. As Martin mentioned, we continue to see growth across all regions similar to what we saw in the second quarter, even though also at the end of Q2, the U.K. market in general continues to be tough at the moment. Also looking across our different customer types, we see growth in all categories. Customers that are new to the Live products normally have erratic growth trajectory, but we are also happy to say that customers who've been with us for several years continue to grow. There's an underlying growth in the Live Casino product and our market-leading product development makes our offering richer over time and helps operators grow their Live business. EBITDA in the quarter amounts to EUR 28 million for EBITDA margin of 43.5%. This is slightly lower margin than our own expectation from earlier this year. The main reason is that expansion of tables has been faster than expected. Our target of over 500 tables Live at the end of the year was reached already at the end of the third quarter. Very, very positive in the long run, but the expansion of tables drives some short-term costs. We expect good demand for tables also for the rest of the year and expect to improve slightly on margins in Q4 with the result of the full year EBITDA margin will be in lower end of our earlier statement of margins in line with 2017. Still as you can see in the slide, this year's level around 44%. To be clear, that's above where we were during 2015 and 2016. We will try to give continuous guidance of where we see margins in the short term, but as Martin also mentioned at the top of the call, we will prioritize top line growth if there is a trade-off with margins, and you can see that also in this quarter. Let's go to the next slide, please. Walking through the more detailed P&L table, we can see revenues for the 3-month period, July to September, posted just over EUR 64 million. For the first 9 months of the year, revenues amount to EUR 175 million, that's an increase of 37% compared to the first half of 2017. Personnel expenses totaled EUR 25.6 million in the quarter, that's up 41% compared to the same period last year. The increase in staff is mainly driven by the increase in new tables. Depreciation is almost EUR 4.8 million in the quarter, that's 33% increase from last year. And other expenses, which includes, among other items, rents, consumable equipment, consultants, is up by EUR 5 million compared to the same period last year. Summing up, total operating expenses increased by 50% year-on-year and 41% comparing the 9-month period, January to September 2017 and 2018. We have had a year with 3 larger studio build projects and that drives spending. Large part of that is capital expenditure, of course, but it also affects the P&L and drives costs there. The increase in costs during this year is definitely a conscious decision to support delivery of new tables and top line growth. Moving on in the table, tax for the period is EUR 1.9 million, that's a tax rate of 8.4%. And that brings us to profit for the period of EUR 21.2 million, which is equal to EPS of EUR 0.58 per share; and for the rolling 12-month period to little over EUR 2 per share at EUR 2.09 per share. Let's go to the next slide, please. Looking at the capital expenditure to the left in the slide. We've spoken about studio build projects in Vancouver, Tbilisi and New Jersey, and how that drives tangible investments all through this year. In the third quarter, tangible investments are down compared to earlier this year as those projects are completed or going into phases with less investment spend. The level in Q3 is somewhat lower than what I expected 3 months ago, reason is that the New Jersey project was completed as planned. I might have little contingency in my expectations. And a couple of other items have been pushed into Q4. For Q4 and the next year, we will continue to have investments both in new studios and existing studios. However, investment as a percentage of revenue we expect to go lower for the full year 2019 even if the absolute number will be similar to what we have seen this year. The next largest studio project will be the new studio on Malta. Demand for local language tables continues to be strong as more countries regulate, and we have a rich capacity in our current facilities. We will also see continued capital expenditure in Tbilisi during next year. Beyond that, it's not specified but there are number of projects pending, and we are in the process of planning next year right now. So I expect we will be able to come back to investment plans when we talk about the fourth quarter. CapEx in intangible assets is mainly related to development of new games and features and platforms. Fairly stable this year, while up a little in the quarter, expected to continue roughly on the 2018 level, also 2019. Moving on to cash flow. It has improved during the quarter as investments were lower, and we've also continued to see effects of our improved collect cash [ returns ]. Accounts receivable in relation to revenue is back to a more normal level after having increased during the first half of this year. Still room for further improvements and it will be -- continue to be a focus area but this at a better level than before. To the right in the slide, a look at the balance sheet. No big shifts during the period. It shows a continued strong financial decision. That was the end on my prepared remarks. I'll hand back to Martin for some closing words and then we will take your questions after that. Back to you, Martin.

[Martin Carlesund, Group Chief Executive Officer]

Thank you very much, Jacob. I'm very happy with the Q3 and the demand for new tables remain high, and we will have more than 500 tables Live at year-end. We are actually already at the level where we thought we will be in the end of Q4 in the end of Q3 and that makes us very proud to be able to deliver that. As we have stated before, each new table can be leveraged best served over time. So it will be a little bit short-time P&L effect. We notice an increase in demand for local languages services, which is why we have prepared to expand on Malta for next year. This will likely be in the form of a new studio. With this being said, we expect the investment levels 2019 to be par with 2018 in absolute numbers. At the end of the quarter, we were approximately 5,300 persons employed in the company, and we are well on our way towards 6,000. To find the best talent is crucial for our continued journey and to continue to increase the gap to our competitors is sort of the main task for all of us who work in Evolution. Together, we work to make Evolution and all our customers better every single day. Thank you all for listening. Now let's move to questions. Thank you.

[Operator]

[Operator Instructions] Our first question comes from the line of James Goodman of Barclays.

[James Arthur Goodman, Research Analyst]

So it's encouraging to see sufficient top line demand that you can accelerate your investment program, I think, but I guess the market is struggling to answer the question of whether this margin move is purely a consequence of the new table investment or whether there is something else that would mean a like-for-like structural decrease in the margin. So if you could, sort of, confirm that, that is purely related to the investment, that would be helpful. And then related to that is another way to think about this is some commentary around the 2019 revenue outlook that this additional investment might be supporting, maybe, in relation to where consensus is currently looking, I think, just north of 20% growth.

[Martin Carlesund, Group Chief Executive Officer]

I would like to comment on the margin. I mean, we are constantly trying to increase -- revenue comes before margin. Whenever that trade-off like now when we build more tables than we actually expect, there is a P&L effect. I'm comfortable with the scalability of this company's business model. I'm not worried with the margin going forward. That's a simple answer. What was your second question, sorry?

[James Arthur Goodman, Research Analyst]

It's related to that and maybe some commentary that you can provide at this stage of the year around the, sort of, minimum level of revenue growth that you're seeing for 2019, given the significant investments that you were able to put into the business at the moment.

[Jacob Kaplan, Chief Financial Officer]

We haven't given any specific guidance for '19 at this stage. I mean, of course, we could see continued strong demand and that's encouraging for the future. But in terms of exactly what that means, we haven't given any guidance.

[Operator]

Our next question comes from the line of Erik Moberg of ABG.

[Erik Moberg, Research Analyst]

Just in terms of the rest of the world segment, which 10 operators are the largest contributors to the strong growth?

[Martin Carlesund, Group Chief Executive Officer]

We don't comment on the revenue split on operator.

[Erik Moberg, Research Analyst]

Okay. All right. Then if we look at the rest of the world segment, what would you say or if we put the commission levels in relation to the regulated markets, could you give us some flavor on that?

[Jacob Kaplan, Chief Financial Officer]

Actually -- also there, we don't -- as you know, we haven't commented on selected commission levels or things like that in the past. The main reason for that is that it's fiscal contract with each operator under individual contacts. So...

[Erik Moberg, Research Analyst]

Okay. But if we might take it at least that Asia should be one of the main driver behind the rest of the world segment. And -- could you give us some flavor on what Asian regions returns are experiencing most rapid growth? Where do you see the high volumes?

[Martin Carlesund, Group Chief Executive Officer]

Again -- we have moved forward to give geographical split as we got basically this year. And we haven't moved further into that space listing out different countries or regions other than the ones that were displayed.

[Erik Moberg, Research Analyst]

Okay. But in general, what do you see as the largest risk of operating in a gray area market versus in a regulated market?

[Martin Carlesund, Group Chief Executive Officer]

The most important thing for us is that the operators that we take on should have the proper licensing in Europe. That's where we want them to be licensed. And we want the regulatory aspect to be as clear as possible and the regulator has to see that each operator is compliant with those rules for the flat regulation. So in the aspect of judging where the -- how the operator performs, we leave that to the regulator.

[Erik Moberg, Research Analyst]

Okay. But in general, what type of payment solutions does the majority of your rest of the world customers use? Is there anything you can comment on?

[Martin Carlesund, Group Chief Executive Officer]

No. Honestly, I don't exactly know.

[Operator]

[Operator Instructions] And we have one further question coming through so far, that's from the line of Rasmus Engberg of Handelsbanken.

[Rasmus Engberg, Research Analyst]

As we expect to see some margin improvement in the fourth quarter, can you sort of explain whether that is due to a year-on-year gradual slowdown in expansion? Or how does that come about? I guess, it has some bearing as we roll into the next year, so to speak.

[Martin Carlesund, Group Chief Executive Officer]

Seasonality for the fourth quarter in our business is stronger, so that will contribute. However, we see a strong demand on also tables coming into Q4, which is very positive, I'm very happy with that. There are similarities to the situation in 2016, not to take that too far, but still.

[Rasmus Engberg, Research Analyst]

But why is the margin going to be up in the fourth quarter year-on-year?

[Martin Carlesund, Group Chief Executive Officer]

We are, of course, working also on the cost side. Seeing to that, we will improve the margin also in Q4. And I would also expect that the demand and the increase of number of tables will be slightly slower than what we've seen in Q3.

[Rasmus Engberg, Research Analyst]

Why -- can you, sort of, explain this significant expansion in the third quarter to, sort of, I guess it's after the World Cup? Where does that expansion come from? Where does demand for that come from?

[Martin Carlesund, Group Chief Executive Officer]

It's in Europe. And it's probably a little bit surprising that the continued demand was at the high level as we have stated. I think that many have prepared for new regulations, basically it's good preparation, and we also see that the operators are doing probably an average better.

[Rasmus Engberg, Research Analyst]

So -- and then 1 final question, I'm just trying to, sort of, get some sort of guess on the margin for next year. Is it fair to say that even with a strong expansion in Q3, Q2 was, sort of, the peak expansion in terms of percentage number of tables and then it's, sort of, getting a little bit slower in Q3 and Q4? Or when was the peak?

[Martin Carlesund, Group Chief Executive Officer]

Maybe then the peak would be Q3, Q2. And we expect a little bit slower, maybe, in Q4, but still very high demand. And all-in-all it's fantastic.

[Operator]

[Operator Instructions] Okay. So no further questions coming through at this time. I'll hand back to our speakers for the closing comments.

[Martin Carlesund, Group Chief Executive Officer]

Okay. Thank you very much for listening and taking the time. Look forward to see you again in the next quarter.