G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2018-Q1

[Vladislav Suglobov, Co]

Good morning, everyone. My name is Vlad Suglobov. I'm the CEO of G5 Entertainment. Thank you for tuning in for today's earnings call. And let's move on to the Page #2 of the presentation. So we have had the highest ever in the free-to-play business model margin in this quarter of 13.3%, and that is the highest yet we had in our free-to-play business model. And that's a good sign after the Q4 of last year, which, as you know, had a lower margin. Earnings went up 134% year-over-year and were about SEK 60 million. And top line went up year-over-year, 59% and 4% sequentially from the fourth quarter. And if you follow us you know, in the fourth quarter, we had so-called booster quarter. So we spent a lot on user acquisition. And in first quarter, what we usually do after that is that we lower user acquisition expenses back to the more normal level and we did it this year as well. And despite doing that, revenue went up sequentially Q4 to Q1. And we actually lowered user acquisition spend to the same number, same percentage of revenue that we had in the first quarter a year ago. So you can see that we are on a much higher base, spending the same percentage of revenue on user acquisition and went up substantially in 1 year. And we've been saying that we can do this booster quarter in the Q4 and come out in Q1 with higher revenue and expanding profit margins. And that's exactly what we've done in the first quarter of this year. So it's all good here. In terms of geographic mix, pretty much revenue continued growing strongly in all regions. There weren't any big changes there in terms of the mix, but the growth was everywhere. There's very good development in the average revenue per paying user, which went up 24% year-over-year to a new record level for the company. And in terms of cash flow, the cash on hand increased to SEK 97.7 million, and cash flow was SEK 6.2 million, which is not a lot, but there were some one-off items that affected it. But the underlying cash flow was actually quite healthy. Let's move on to Page #3 and look at this in a little bit more detail. We discussed the revenue was SEK 372.6 million, 60% up year-over-year, 4% sequential growth from Q4. Pretty much all of our main games set new records of sales during the quarter. That is true for both licensed games like Hidden City and for our own games, especially, Mahjong Journey did well and Pirates & Pearls continued growing the revenue, and pretty much all of our Hidden Object games also went up. Profit we discussed, again, there was a good return to higher profit margin compared to the Q4, where we tried to really do a boost to the growth in our revenue by spending more in user acquisition, but then coming back to more normal levels. And we did that. There is this particularly important KPI that we're tracking internally called EBIT margins before UA costs. The logic there is that this is the EBIT margin from which we can decide what to spend on user acquisition and what you keep to allow to drop to the bottom line. So it's basically the sum of our spend on user acquisition as percentage of revenue and the bottom line, the EBIT margin. And this number has to expand over time in order for us to be able to deliver margin expansion and to be able to spend more on user acquisition. And that's exactly what happened again. Last year, we had 34% margin; this year, 39% margin. Let's move on to the next slide, Slide #4. So this is a quite interesting chart on the left side of this slide. This is our -- the light blue line there is our EBIT margin in percentage points. And you can see a certain pattern here. You can see it drops down in the fourth quarter every year in the past 2 years, and then it bounces back and then it gradually grows over the term of the year and then it drops down in Q4 again. This reflects what we were trying to do, seasonally Q4 and Q1 are the strongest quarters for us in terms of growth. It has to do with the fact that many new devices are coming to the market usually during this time. People are upgrading their phones. They receive tablets as gifts. So there's a lot more activity out there in the application stores and a lot more people looking to install new apps. So usually, we try to be more proactive and aggressive with user acquisition during this time. And we tried to do this for the last 2 years, and it worked pretty well for us. There's no guarantee we're going to continue doing exactly the same next year, obviously, because the situation may change. But if it doesn't, we're probably going to stick to this pattern. And I think you can kind of make certain assumptions in terms of how our margin is going to look like for this year based on quarter. And you can see that every Q1, we came out of the booster quarter with a better profit margin. And that's because we have this leverage in our business. It costs us the same amount of money to run a game that has 1 million users and 5 million users. So our costs continue to shrink as a percentage of our revenue, which allows us to have higher profit margins. And as more and more of our revenue is generated by our own games where we don't share any revenue with third-party developers, that helps expand our profit margins as well. So the chart on the right actually shows the KPI I was talking about, the EBIT margin before it quotes for user acquisition. And you can see this margin expand over time during 2016 and '17 and into 2018 as well. And this is a more stable KPI than the EBIT because it also reflects our ability to spend on marketing. So I think it's one of many most important KPIs that I'm looking at. And I think it's good -- you can look at it as well and see that this expansion is actually happening. And it's quite substantial over time from about 25% in the beginning of 2016 to now almost 40%. That's 15% of our revenue that we can either have as earnings or spend back into user acquisition, and we can decide how to reallocate between one and the other. Let's move on to the next Page #5. This is the distribution of our revenue based on the world region. You can see pretty much the mix remains the same, Q4 to Q1. Revenue went up in all regions year-over-year, Asia, because of the fast growth last year, obviously, was the strongest. North America is doing well. Europe went up quite a bit. Rest of the World is growing as well. There is -- the fact that our average revenue per monthly active user went up so much has to do with the fact that the revenue in Asia, specifically in Japan, within that segment, went up dramatically for us during 2017. Japan is known for having some of the highest paid users in the world, if not the highest paid on average. So that contributes to the fact that we're seeing more and more revenue from 1 person. And all the underlying trends in the market, if you look at the research, our audience is expanding. People are playing and spending more and more time on mobile devices. And playing more and games is one of their major tasks that they're doing on their phones and tablets. And they're getting more and more comfortable spending money there as well. And we should think of it, $40 a week -- sorry, $40 a month is not too much. It's $10 a week. And for per game, where you spend many hours, and you get a lot of hours of entertainment out of that game, it's not really a substantial amount. So I think we still have opportunity to continue growing this number into the future. I can't say exactly by how much, but I think all the trends point to the fact that if we're going to be good at making our games enjoyable and making people feel like spending money in these games, the fundamental trends are there to support this into the future. Actually, Q1 was interesting because the growth in revenue, which before was in the larger part supported by the growth in audience and kind of to a smaller extent than the growth of average revenue per user. In this quarter, there's more emphasis on revenue per user. So the growth of the audience is not as dramatic year-over-year, but the monetization certainly went up dramatically. But again, it has to do with the fact that we were focusing a lot on acquiring new players in Japan and that automatically makes our audience smaller and the revenue per user larger, all things -- other things being equal, right? Let's move to the Page 6. Gross revenue. You can see the chart showing the revenue by quarter. So just to note here, we report in Swedish krona, but because we receive most of our revenue in the United States dollars and in Japanese yen, the exchange rate, obviously, affects our results. So in this case, and I write that in the Q1 report that our internal management figures were actually showing different numbers. And internally, we track revenue in United States dollars. So we saw something like plus 70% or 72% year-over-year and the sequential growth was more like 6% or 7%. So the results were somewhat affected by the exchange rate and expressed in SEK. They're a little less dramatic in terms of growth. But just to say again, that revenue grew nicely year-over-year and sequentially as well, and we're quite happy to see that given the reduced level of user acquisition. And like I was saying, the audience, the daily active audience went up about 37% year-over-year daily and -- although not monthly, so there shall be better growth monthly. And there's nice growth in monetization. So these 2 numbers drove the increase in revenue. More frequent play, more people playing every day. By frequent play, I mean, DAU divided by MAU and we started publishing monthly unique users, so you can now run that calculation if you want and see that we're actually getting better in terms of having more people play in a single day. So people are playing more frequently and they're spending more money and the audience is growing, and it's all moving in the right direction. So we had some really strong updates during the first quarter, again, across our main games. Mahjong Journey, Pirates & Pearls, Twin Moons Society and Hidden City teams did a great job, made great updates, new levels, new Hidden Object scenes, and the audience, obviously, like those and that's the reason the revenue continued growing even with the reduced marketing spend. And once again, we are just seeing that people are spending quite a lot of time in our games and their lifetime there is quite long. They're playing for months and even years. And this longevity of our games allows us to reduce user acquisition spend as a percentage of revenue, and yet see our revenue grow because users that we have acquired in previous quarters are actually monetizing as we reduced our efforts to acquire new users. So there's this lag, but also users that we acquire, they stay for a quite long time. So there is this staying power of the marketing spend that we are doing. We are getting users to play and they're sticking with the game and it drives our revenue to new levels. And with that, it drives our margins to new levels. And that allows us to spend even more on user acquisition. So let's move to the Slide 7, to illustrate it a little bit more. On the left side, you see the chart that shows our operational costs in absolute terms in Swedish krona. And you can see that it's growing, the administration and R&D are trending up not very dramatically, but still going up. But if you look at our sales and marketing costs, they're going up quite substantially, right? This is our biggest -- single biggest line in our expenses. But if you look at the chart on the right, and that is the same cost expressed as a percentage of our revenue, you're going to see quite a different picture. You'll see that our administration and R&D costs, what we consider more or less fixed costs, right, because we have them whether or not games are very successful or not. I mean our games may have 1 million players or 10 million players, our administration and R&D costs depends on the number of games that they have, not in how successful they are. So these fixed costs are actually trending down as a percentage of revenue, which helps extend our margins naturally. And that allows us to spend higher percentage of our revenue on user acquisition if we want to. And that's what we've been doing. We've been gradually spending more but as you can see in Q1, we went down to the level of user acquisition spend that we had at the end of 2016 or for the first 3 quarters of 2017. So we -- there is really no need to continue increasing the percentage of revenue that we are spending on user acquisition. It's not -- it's possible to do that, if we see the opportunity to do that and grow our revenue even stronger, we might want to do it. But on the other hand, I think we are demonstrating clearly that we don't have to do it. We can keep our user acquisition spend within this range and basically, you can see from here, 26% to 35%, where aggressive level will be 35% or maybe even more towards the end of this year because we're going to have more space in EBIT before you extend margin to spend them in more marketing when we really want to do it aggressively. And on the other side of the spectrum, looking all the way down to 20% or like this quarter or Q3 2017, 26%, 27% and still continue growing. So we're going to keep our user acquisition probably within these brackets going forward. All right. And next slide is Slide #8. And the chart on the left shows the net capitalization of our development costs. The capitalization for development cost is -- basically, we put on the balance sheet the cost directly related to creating new games. Administrative costs. So there, it's costs that associated with programmers and artists and other talent that's working on a particular game. So you can see that capitalization and amortization almost canceled out in fourth quarter of 2016. But from there, it was actually going up. And so we've been capitalizing more and more. It has to do with the fact that we've been adding more development teams to the company to be able to have dedicated teams for each of the games that we are developing internally, and also to be able to make more gains. So our staff went up quite substantially during 2017. I think we added about 100 people and that is reflected here. So this is a work on the games that are already published. But also this is work on the games that are not yet published and that we want to release this year and the next year. And we are working on a number of owned games that we're going to release this year and next year. So it shows on this chart. Eventually, when the games are released, the amortization is going to catch up. And assuming we're going to have a flat development capacity, it's inevitable that the amortization is going to catch up, eventually. But for now, because we have just added all these people, and there's a number of new games that we're working that have not yet been released. It's trending up. Otherwise, what's interesting on this slide. So you can see there's some costs that went up for the games that have not yet been released. The net value of the portfolio went up quite a bit. And again, this reflects the shift of the strategy of the company towards developing owned games and achieving high-quality in our owned games and higher success level there. We're quite successful with that. The revenue from owned games is growing strongly year-over-year. It's actually growing faster than revenue from licensed games. And it requires substantial investment in creating these talented teams and bonding the games that we want to build and publish, right? Next slide, cash and cash flow. So 2 big items this quarter were the continued payments for The Secret Society. This is all within the limits that we have indicated in the press release, it's just that the payments are being made over time. So this SEK 4.5 million was a part of the payment that was made in the first quarter. And then there was a payment of SEK 10.5 million for Japanese VAT. That was accrued for a very long previous period of time. We don't expect to have this kind of payments in the future. They're going to be handled month-to-month. But that was a cash outflow that happened this quarter. So we have -- total cash flow for the quarter was 6.2 million, but you can see that these 2 items, basically, SEK 16 million more were onetime payments and onetime one-off items. So the underlying cash flow was pretty healthy and good. There were also some expenses connected -- well, not expenses, but cash inflows and outflows, where I think the net result was neutral or a little bit towards the outflow connect -- that was connected to the exercise of the employee warrant program, the first one that was in the money during the exercise period this year. So we received some funds, and we also purchased some of the warrants. Yes, but otherwise, cash flow, stable, healthy, reasonable and always good here. All right. That is it for today. And with that, let's move on to the questions and answers. First question, if you have any and thank you for listening.

[Operator]

[Operator Instructions] And as there are no questions registered, I now hand back to you, speakers.

[Vladislav Suglobov, Co]

Hello. I think we have questions in e-mail. Can I go over these? I have them in front of me, so I can just read them and then give answers.

[Operator]

Please go ahead.

[Vladislav Suglobov, Co]

All right. So 2 questions. First one, for Hidden City and Pirates & Pearls, what is the ratio for bought installs against organic installs? Well, we unfortunately do not report these numbers, and we don't break it down. But for most of our games, the actual number of installs that are bought is -- it's usually not very substantial. So the organic uplift and also installs that we attract through cross-selling, they usually are the biggest part. And that is the ability to cross-sell between games is very valuable in that sense. And also the ability to make a game visible in the application store, that brings a lot of organic traffic as well. So I would say -- what I can say is that it's quite healthy. And for Hidden City and Pirates & Pearls, these are very healthy numbers, that's all I can say. Second question for Hidden City in Japan around each turn of the month, the revenue dropped substantially according to App Store revenue rankings. And then more or less cyclic revenue peaks within the month. There seem to be other cyclic revenue patterns for other countries as well. What is the reason for some of these cyclic revenue patterns? Well, I really don't know. I can -- I don't really track our chart positions for our games that close. But we do have some fluctuations in the revenue that usually has to do with what we call live box, and that means live events and things that we do within the games like time-limited and onetime things that make playing the game more interesting. An example of that would be a Christmas event in the game, for example, that is only available for a month. Obviously, it's Christmas. And once the Christmas is over, the event is over too. And usually, this type of events attract a lot -- very strong interest and a lot of participants. And within this event, there may be certain cycles that make people spend on certain days more than on the other days. And that's just part of our efforts to sustain interest in the game and create some sort of real-time feeling to it, that you are not only just playing the game at your own pace, but there are things that happen within the game in real time. And if you miss out today, you might not be able to get the same benefit tomorrow. So this is probably the reason for the fluctuations in the revenue. And so it can affect daily chart positions. That's why I try not to look at daily chart positions, frankly. Yes, so that's the answer. I don't have any more questions in e-mail. So if we don't have any more questions on the phone line, thank you very much for listening, and have a great day.