G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2019-Q1

[Vladislav Suglobov, Co]

Good morning, everyone. Thank you for joining us on our first quarter earnings call today. My name is Vladislav Suglobov. I'm the CEO of the company. And let's move on to the first slide of our presentation.As you can see, and it starts with the decline of revenue year-over-year of 18%, and that is mostly attributable -- actually, pretty much all of that is attributable to the game Hidden City, which is our still largest by revenue. You can see the -- on the chart in the right bottom corner of the slide that our revenue consists of -- the revenue from our own games that we own and that we have internally developed and the revenue from license gains, which, frankly, Hidden City is the largest part of. And you can see that the revenue from own games remain more or less flat and slightly declining since the second quarter 2018, while Hidden City, since it has achievements peak in the second quarter and then kind of plateaued for a couple of quarters. It has now went down a little bit again. But the -- I would say, the core of our portfolio, which is our own internally developed games, remain pretty much in the same place, and that is the reason that the percentage of revenue generated by G5 games, which was going up actually gradually since 2017, jumped once again in the first quarter to a higher level. So if we look at the own games, there are games in different life cycle points, and it's quite a few games. So there are a few games that we have discontinued, as I mentioned in the report. It doesn't mean we pulled them from the stores. They're still available to players. But we have moved -- we have basically stopped updating them and stopped evolving them because we ran out of ideas and we don't know how to increase their revenue, and we focus the resources we used on this game on the new games. And so there is a part of the own games part of our portfolio that is declining. But on the other hand, it's being compensated by, for example, Homicide Squad, which is a growth point, and that has been growing for many quarters now, and also the biggest game in our own portfolio is Mahjong Journey, which continues to do really well. So if we look at the revenue from own games right now and since the second quarter 2018, then just the revenue from own games is as big as the whole company's revenue was in the first half of 2016. I think it's -- we wish that and we work towards having more revenue generated by own games. But if you think of it, the tremendous growth that we have -- that we had over the last few years, I think it's pretty amazing that in just 3 years, we basically have the business consisting of own games only. That is the size of the whole company just 3 years ago. Let's move on to the next slide and talk about the earnings. And we had an EBIT margin close to the record EBIT margin that we have ever had at 13%. And on declining revenue, you would think that the margin would be affected, but there are 2 factors at play here. First of all, because it was the licensed part of our portfolio that was shrinking -- the most for shrinking at all. The gross margin actually improved as a result of that, which obviously helped us with the earnings margin. And because Hidden City is in a life cycle where it's plateaued and continues to very gradually slide down for now. We -- even if we wanted, we couldn't really help it a lot with the substantial user acquisition spend. So we are trying to allocate our user acquisition spend in a wise way to get the most effect that is possible to get at this stage of the game. So as a result of that, we have reduced the user acquisition spend, especially if you look year-over-year. And I would also say that in the first quarter of last year, I would say we were kind of overinvesting in user acquisition in this game, and now we went to more reasonable spend on user acquisition. There is a strong core number of users. The core audience of the game, which are repeat customers that come back every month to play new events and new content in the game. And I think we have their attention, and we will have their attention towards very long period of time. We -- also, we're not stopping work on Hidden City. In fact, we are making the developer in G5. We're spending a lot of effort and time on making improvements to the game and evolving the game in order to kind of -- we work it in a way that will make it even more interesting to the players and that will allow it to be even more competitive in a more competitive situation that we have now in the market. And these changes that we're making to the game, we are certainly seeing positive effects as well. And I would not say that going forward, we will keep user acquisition spend on this game at a low level, I would say, we will be trying different things, and if we see improvement on the KPIs, we can go back to increasing user acquisition spend on the license part of the portfolio. So that said, I mean, Hidden City remains very profitable and as a large business, and there is a lot of money and a lot of profit to be made over the years on this game, and we have good experience maintaining games for very many years. So I think the big takeaway from this slide is that we have shown that even on the -- during the off-peak cycle when the largest game by revenue going to decline, and we don't know if it's going to continue to slide or we can stabilize it and maybe we can bring it back up a little. We can switch to the mode, which allows us to finance all of the games that we continue to develop, and it allows us to continue to grow the percentage of the revenue generated by own games, and we continue to be a profitable and cash flow positive company that even pays dividends, and I personally think that's the way to manage a games development company because you manage your portfolio, and a portfolio, it's always a combination of games that are runway hits, like in this case of Hidden City. And of things that basically fail miserably in the market and then you just pull them from the store. And we had a few of those. And you have this also, I would say, a set of reasonable successes, which forms the core of your portfolio, very stable, that keeps generating profit over time. But it's not a big star, but it's not a failure, and it's a profitable business also that you have. So I think when you manage a portfolio like that, you're happy when you have a star. You run as fast and as far as you can with it, but it may happen, that it will be declining at some point or plateauing at some point. And the important thing is that you have to understand that any particular big success that you have may not last forever, and you have to build your business in such a way that you can go through the periods where maybe your top line is not growing, and you keep doing the same thing that you've been doing for many, many years, and that's managing your portfolio, creating new games that have good shot for success and making sure that the company will continue to be cash flow positive and profitable, notwithstanding what specific kind of scenario for development of the revenue for your big ships you are going to have. And I think we've built G5 with that in mind and it's really -- it is very stable, and it's a very healthy position when it comes to this, and we're very optimal of spending our resources and managing the games life cycle. Let's move on to the next slide and talk about the cash flow. So you can see we have -- pretty much we have a record cash position that we've ever had in the company, which again, speaks of strength -- the financial strength of the situation. Last quarter in the Q4, 2018, Apple overpaid us 1 payment at the end of the year, which was kind of out of the ordinary. And so in this quarter, they kind of changed it back to the normal schedule of things. So we didn't have 1 payment from Apple. That's why cash position in Q1 is exactly the same as in Q4. If they are paying as they usually pay, then we would have a slightly lower cash position at the end of Q4 and dropped from Q4 into Q1. So obviously, the lower user acquisition spend has helped maintain cash position. If you compare this to the situation we had Q3 to Q4 to Q1 last year, we were heavily investing in user acquisitions, as you can see, and overall, the top line went up substantially. You can see it wasn't a big effect on our cash position. So when we don't have to do that or we cannot even do that, let's put it this way, we focus on building up our cash position and focusing on continuing developing the new games to release this year and evolve the existing games and we still do that. So let's move to the next slide and discuss the outlook a little bit. So again, we are fundamentally in a very good place financially, record cash position, cash flow positive, profitable, debt-free, even paying a dividend, and Hidden City remains a big and profitable business, and it will make a lot of money going forward. Also, games -- how I put it. So basically, you spend a lot of money, I would say, you are overspending money on marketing when you bring the game from zero or close to zero to the peak level. And after that, when you realize you cannot, at least, at the present moment, take it higher, you were able to actually lower user acquisition revenue -- user acquisition spend, and this is the period when the game generates most of its profits because this is when you have a reasonable advertising spend and the rest is the profit, in our case, to be shared between G5 and the developer. So now it's more profitable than during its growth phase and again, in that sense, I think most of the profits generated -- will be generated by the game are still ahead of us. And we have -- I think we have good dynamics in the own games. Homicide Squad continues growing. It's been growing for many quarters now, and it looks like it's a stable thing that is happening. We have strong sales with Mahjong Journey, which remains our #2 game by revenue, and the percentage of overall revenue from own games continue to increase, which is going to impact our gross margins positively. We really have strengthened our development teams over the last couple of years. We did not release many games. But this year, we aim to release core games, and I think we are on track to do that. I'm pretty excited about the games we're going to release this year, and some of them are coming rather soon. So follow the news. It should not be too long before we will announce something. And the genres for these games are the ones we know best and that is Hidden Object and match-3. And I think that some of the games that we have in the pipeline for at least this year, they should be quite competitive in the market, given their structure and emphasis on strong storyline and metamechanics that are now popular in the market within the top titles in the market. This concludes my deck, actually. So time for questions and answers. If you have any questions.

[Operator]

[Operator Instructions] And first question is from Pierre Mellstrom from Handelsbanken.

[Pierre Mellstrom, Small Cap Analyst]

Can you hear me?

[Vladislav Suglobov, Co]

Yes.

[Pierre Mellstrom, Small Cap Analyst]

So I was just wondering, if I recall correctly, before you were talking about that Secret Society had sort of this stable revenue sales but on a lower level. So how far are you from Hidden City? Sort of that stabilizing out, would you say?

[Vladislav Suglobov, Co]

Well, how far from Hidden City? Well, the Secret Society's revenue is rather lower than the Hidden City, but also the Secret Society has never achieved the scale that we have achieved with Hidden City. So I -- we -- looking at the development of revenue for Hidden City, we obviously compare it to how the revenue developed for the Secret Society. But I think in the case of Hidden City, we have a developer that is very strongly motivated to do the right things for this game, and we can see them that they're paying a lot of attention and you can see that they are releasing updates for this game every month, and these are very high-quality updates. So we are actually expecting -- we're trying, and I think we have the reason to believe that we can have a better dynamic within revenue -- like a life cycle revenue of Hidden City than with the Secret Society. I don't know. Does that answer your question?

[Pierre Mellstrom, Small Cap Analyst]

Yes. So I was just trying to get a feeling for when we can -- I mean, I understand you keep working for it, I mean, on the game, and if we could get a feeling to when it's sort of like stabilizes, because now obviously it's sort of burdening the group numbers, but you're talking about a solid development underlying. So speaking of that, pulling back on your UA cost this quarter, are you doing that for your own portfolio as well? Or is that mainly just for Hidden City?

[Vladislav Suglobov, Co]

Well, we do use our acquisition on all of our games, and we look at them individually. What is the potential to grow? What was the dynamic in the last few months? How fast we'll recoup the investment if we make it? So yes, part -- actually, a substantial part of user acquisition that we do we do for our own games. So we do not really break it down the UA costs by the type of game that we spend it on. But it's the same -- I would say it's the same logic. When we see the opportunity for growth we go for it, when we see that additional marketing spend is not going to change the situation that we may choose to actually make profit on a game in a given month. So it's an iterative process, month-to-month we are deciding how to best allocate resources, and it depends on a number of things on how well -- what kind of updates that we're making? And where are the KPIs moving? And how does the top line trend looks like? Et cetera. When it comes to when exactly it's going to stabilize. It's -- we are managing the portfolio of games, right? We don't know the future. We may try to come up with some ideas and some scenarios of how the revenue for one or another game is going to develop into the future. And basically, we make sure that the company can continue doing what it's doing, managing the portfolio and making new games under any of these scenarios. That is how we do it, and that's how we've been doing it for many years. So I don't have the exact date for you. But rest assured that we're doing everything we can to -- nobody here is motivated for lower sales for games. We're doing everything we can to maintain these sales and extend them again. And there's a lot of thought going into that.

[Operator]

Next question is from [ Mathias Tique ] from [ Earpton Partners ].

[Unknown Analyst]

So I'd like to talk a bit more about the own games. I completely understand the portfolio approach and the life cycle of games. But I'm a bit worried that the own games are declining at the moment. Maybe you can share some of the reasons that you see for that? And also put it in the context of declining users and payers. It would be great to see some of those metrics per game, I mean, especially the more important own games like Mahjong Journey and Homicide Squad? How do they develop by users and payers? Does that still fit with expected life cycle and investments you make in marketing and development? Or is there anything going on in the environment, in competition with those games specifically that leads to a decline of own games at the moment?

[Vladislav Suglobov, Co]

Right. Well, I wouldn't say they're declining, they're rather flat, a little bit up or down, and really it can be seasonal or just the length of the quarter can affect that. I think we have a stable situation with own portfolio. The problem or the -- I mean, it's a portfolio, right? So we have older games, like The Secret Society. We have newer games, like Homicide Squad. And different gains in the own game portfolio have different -- obviously, different revenues, and they are responsible for a different portion of revenue. And so the resulting dynamic is -- it's a combination of the dynamics of different games. Now we have started to work on several games, 3 or 4, in the last quarter or 2, and those games when being moved to the harvest mode, for example, they don't really get an increase in the market of budget, right? So we are kind of harvesting that. So we're trying to maximize the profit from these games, and that is the strategy there. We know we can't really increase the revenue from these games, but we know we can make good profit on them for many years to come. So it is kind of normal for that part of the portfolio to gradually go down and -- while actually being very profitable. So it's a combination of that. And certainly, I mean, we do not have games in our own portfolio as of now, and in their present state, that could be as Hidden City several years ago, where we can really help boost our top line through a massive user acquisition investment, but we are evolving. We have our growth points in the portfolio. We are evolving games gradually. We make sure that all the games that bring substantial revenue are also profitable. I think that's the way -- that's the way to manage it. And then we are working on new games. And 4 games this year is -- it's quite a few -- it's actually quite a few games. So I think and my hope is and our ambition is, as I wrote in the Q4 report that -- and I said that, that we don't expect any records that included revenue records in the first half of the year. But with the help of new releases, we would like to change that situation towards the second half of the year. So that's what I said in the fourth quarter report. And we don't really give guidance. That's all I can say at this point. Yes, I think I answered, but let me know if I didn't answer anything.

[Unknown Analyst]

I mean can you share some detailed metrics on the 2, 3 most important own games. I think that would really help to see that at least for Homicide Squad, the trend is still positive. Because if we only get the aggregated number, and we know it's very skewed towards a few games, you get the impression that they are declining as well.

[Vladislav Suglobov, Co]

Yes. Well, you can look it up on the Sensor Tower or App Annie. You can look at the top charts. That is very good to see. Homicide Squad is doing well in Japan and China, actually better than in United States. But you can look at the United States, China and Japan to get a feeling over the last 2 years how the game is developing. We do not break it down by game. We have just started breaking it down by licensed U.S.-own games. So we like to share more information but do it gradually. We do not currently have plans to break it down by specific games or disclose KPIs as far as by specific game, unfortunately.

[Operator]

[Operator Instructions] And next question is from Oscar Erixon from Carnegie.

[Oscar Erixon, Financial Analyst]

Few questions from me. First of all, I mean, this was your first quarter with quite low user acquisition costs with strong margins. How should we interpret the user-based development? I mean it's natural with a high churn, of course, in a quarter like this. But what can you see going forward with quite a rapidly declining active user base?

[Vladislav Suglobov, Co]

So I think one thing to remember is that the overall number of users is very good to have. About 90% of them never make any purchases. So for the top line and profitability development, that really doesn't matter. I think one of the trends that we're certainly seeing in user acquisition, what we are doing, is focused on acquiring more high-quality users. So that is one thing that certainly lead to the decrease in the overall monthly active users. The decrease in paying users -- I mean, that's inevitable in a game, which has matured substantially and people play the game and eventually get tired of the game, and then they play less often or they just churn out, that's part of what's going on in games. And the key here is to be able to bring them back, and the key is to find the level of marketing, which would bring back the sustainable number of users and acquire some new users as well and kind of stabilize the dynamic in the audience. And obviously, you see the decline in revenue, and that is a function of the audience and the decline in the audience and those are connected. So if revenue drops, but we would have still the same audience and same user numbers and same paying user numbers, that would be really worrying because it would mean we have really broken something in our games. But in this case, this kind of goes hand-in-hand. Maybe it's more pronounced on the total audience, but I think that's -- the total audience to include players in Brazil, India, Poland, a lot of countries that produce a lot of users, but do not really have a big meaning for us financially, at least at the current moment. So you could -- in terms of the dynamic, again, it is connected to revenue because the monetization per user, although growing, it's growing very gradually. You can expect that if our revenues continue to go down, that will be because it is a function of our audience metrics and vice versa. So they are connected, and they will probably be connected going forward.

[Oscar Erixon, Financial Analyst]

Okay. I guess my question was more, now that you have had lower user acquisition spending for 1 quarter, do you expect a more stable user-base development when the most or the least loyal for the user base is perhaps out? Do you understand what I mean?

[Vladislav Suglobov, Co]

Yes. Again, it's the same situation. Yes, we would like to stabilize the user numbers, and with the goal to stabilize revenue numbers. We are indeed trying to find a level of spend, which would allow us to not lose money on doing that, but also keep the number of users in the game that will help stabilize the revenue. Indeed, we are trying to achieve that, yes.

[Oscar Erixon, Financial Analyst]

Okay. Great. And final question. Homicide Squad, which I think is one -- certainly a bright spot in portfolio and trending quite strongly in Asia. What do you see for the game going forward? What's the potential of the game if you compare it to other hit titles that you've had? And also tell us why it's more successful in Asia? If you could shed some light on that?

[Vladislav Suglobov, Co]

I don't know why it's doing better in Asia. I -- it's always easy to explain in retrospect. And I can say, well, looks like people in Japan and China really like games about New York, and maybe they just like New York. Maybe it's because they watch TV series that are similar to the game and the movies, and maybe that's why they like it. But it's really easy to say when it has already happened. So one way or another, these games do really well in Asia. This game, the Homicide Squad. So we try to, obviously, maintain that success, and this game has not -- has been growing rather gradually. The dynamic there is not as fast as other games that we've had. On the other hand, it's a really stable grower. So it's a -- that was the positive thing about this game. And we -- there's a number of things in our road map for this game that we have not yet introduced to this game. So I think there's still a big potential for the improvement of the game and improvement of its key performance indicators. So that's what I think. And as long as it's growing, we're going to continue helping it growing, to grow further, and we take it month-by-month basically because it's a balance or the situation, how the LTV is connected to the cost of user acquisition that we can do in this game by what other means we can support its growth, et cetera, et cetera. So yes, I wish I knew, I could tell you where it's going and how much money it's going to be making. But I don't know. I know where it is now, and I know how it's been in the last few quarters, and we hope it continues growing.

[Oscar Erixon, Financial Analyst]

Great. And actually one final question, if I may? Just trying to find a way to think about this. But I mean, now you've had user acquisition spending of below 20% for the first time in quite a lot of quarters. How low you think you can go in terms of user acquisition spending? I mean assuming that revenues continue perhaps to decline 1 or 2 more quarters, can you go even lower to maintain this strong earnings power that you showed in Q1? Or is this sort of a bottom level do you think for user acquisition spending?

[Vladislav Suglobov, Co]

Well, again, this is something that we look at on a game-by-game basis. And we are -- basically -- I really don't know. You're basically asking me how we are going to be spending on marketing until the end of the year. And the answer is, I don't know. The goal would be to support whatever growth we can see in our portfolio. So when we support Homicide Squad because it's growing, we'll support Hidden City, if we see that there's potential for growth, and the same applies for other games. And if we launch new games and we see good traction there, we will, of course, be spending on user acquisition there. I would just repeat the same thing we've been saying all along. When we see the opportunity for growth, we will focus on growth and we will pay less attention to profitability. If we will be, in the absence of growth points for big enough growth points, then you can expect that we will not be spending too much pointlessly on marketing, and instead, we will try to be profitable and that remains the same. It's the trade-off or rather a connection between the profitability and growth. And I would want, in a situation where we don't have growth or don't have a lot of growth, I would want to show better profit margins. But if we see the opportunity to grow, we will certainly spend more to get that growth going. That's the logic. And then how it's going to play until the end of the year, that will depend on the updates that we're going to be making for the games on the market situation and on the new releases, of course.

[Operator]

And there's been no further questions registered. So I'll hand the call back to you, Vlad. Please go ahead.

[Vladislav Suglobov, Co]

All right. Thank you for the questions, and thank you for dialing in today. That concludes our call. Thanks again, and have a good day. Bye.