G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, welcome to the G5 Entertainment Q1 Report 2020. [Operator Instructions] Today, I am pleased to present CEO, Vladislav Suglobov; and CFO, Stefan Wikstrand. Speakers, please begin.

[Vladislav Suglobov, Co]

Good morning. Thank you for the introductions, and welcome, everyone, to G5's First Quarter 2020 Results Call. We'll take about 15 minutes to go through the deck, and then we will open the line for questions and answers. So I'd like to summarize the quarter by saying that this is a very strong result on the uncertainty of the current economic situation, and that I think we continue to deliver on our strategy. We remain financially healthy and strong. We are still debt-free profitably with -- we are highly cash-generative. And the Board has decided to propose a dividend of SEK 2.5, corresponding to almost SEK 23 million, the same as last year. So this underlines our financial strength. And the investments that we did in our development teams over the years are now starting to pay off, and we're launching new games at a higher pace than ever before. As you can probably see, in 2020, we are in total planning to launch 6 new titles now on top of the 5 that we launched in 2019. We have also continued our success with Hidden City. As you know, the game has a very loyal following, and it is still our top game by monthly revenue. And it is -- well, it was relatively stable in the first quarter of this year as well. However, our development teams, the ones that we've built over the years, are stronger than ever, and our owned games are actually very promising and growing, and that is the most interesting thing about the company. So in the first quarter, our owned games represented over 45% of total revenue, and our very successful game, Jewels of Rome, generated over 15% of revenue in the quarter. It is clearly our second highest grossing game ever on a monthly basis, and it's been steadily growing every month. We had a little bit of a bump in February. But otherwise, it continued to go up in revenue, and so we are cautiously optimistic it will continue to do so. And as you can see, we're getting close to revenue parity between owned and licensed games. So also kind of an important milestone for us. And the top line contribution from our owned games is expected to increase during 2020. The 3 games we launched in Q4 last year: Jewels of Mahjong, Hidden Treasures, Wordplay, they all grew sequentially during the quarter. And now with the continued growth of Jewels of Rome and the newly released games recently, we expect owned games to continue to increase in revenue and contribute higher percentage of revenue for the company. So the Jewels of the Wild West that we launched in the beginning of April started off really well and showed signs of a profitable, successful product in the making. And just a few days ago, on the 30th of April, we also released a match-3 puzzle, named Hawaii Match-3 Mania. This is a soft launch, for now only in Australia and Canada, but we also plan to release the game globally during 2020. And we have at least 4 more games to release before the end of the year. So the strategy for our game development remains pretty much the same. We are building new games on top of our existing expertise and genre knowledge and technology. But we're also trying to expand it to some new genres to expand our offering and -- like with our Wordplay game, which is an example of that. And there were also important changes that we have made to how we do user acquisition. In the first quarter, we changed the management and we refined our processes, and it really paid off in the first quarter. We spent less than -- in the previous quarters. We've strengthened our teams, both in U.S.A. and Europe during this time and really put a lot of effort in optimizing everything. And so we are spending our marketing budgets now more wisely, I would say, which is visible in our improved margins. The goal for the year overall remains the same we have provided at the end of 2019. We aim to achieve year-over-year growth in revenue while maintaining profitability, and expansion of earnings margin is possible as more revenue comes from owned games. It must happen. In the first quarter, we basically delivered in line with this goal. We have technically -- with some tailwinds from exchange rates, but still delivered top line growth year-over-year. The earnings are also solid even adjusted for exchange rate effect. This should be our new earnings margin base in absence of strong sequential growth. And as before, if we choose to spend more aggressively on achieving growth, this can, of course, put some pressure on the earnings in the short term, as has always been the case previously. Because of the user acquisition -- the money we spent on user acquisition, the payback is delayed. So when you have a quarter with substantial growth sequentially, it can affect the margin negatively in the short term. But overall, gradual margin expansion should be happening. It should be possible during 2020 as more revenue comes from owned games with higher gross margins. So with that said, let's dig a little deeper into the following slide and look at how the mobile industry is affected by the COVID-19. So according to some reports, and we see the same happening with G5, the downloads for the industry have increased on all major platforms. And also, revenue in some countries increased by more than 10% following the lockdowns that were introduced in these countries. So the estimates that we see is that for Google Play, downloads grew 38% year-over-year; for the App Store, 35% year-over-year. And the first quarter 2020 became the quarter with the most industry downloads ever, 13 billion installs across App Store and Google Play, which is more than 2 billion installs higher than the previous best. So in U.S., the growth was strong at about 29%. And some reports say that across both platforms, there were 120 million more game installs in the 30 days following the country's 200th confirmed case of the virus versus the prior 30 days. So overall, there's -- this situation obviously put people into the position where their options for entertainment are limited, and so they put their attention to the application stores. And they're looking for games and they're looking to spend time in games. So at G5, we saw the signs of this trend as well. And towards the end of March, the trend that we already had for improving downloads became much stronger. So in one of the weeks, we actually saw a 50% increase week-to-week in the number of downloads. And so far, that increased activity continued into April. So far, it continued into May, but it continued into April. And so I think that it is difficult at this point to fully assess the long-term effect of this crisis on the industry. I think that in the short term, it's obviously positive because we have all these downloads and all these users coming in to download the games. But also if you look at what happens in the countries where lockdown is eased is that these downloads tend to go back to normal.So if you look at Sensor Tower stats for China, for example, you can see that downloads shot up, and then they basically started going down as long as the situation started normalizing. And although it feels like forever, we've been sitting in this situation in a lockdown, but it only has been 1 month or 1.5 months. So it's not a very long period of time. And already, we're talking about relaxing certain measures, so this is something that certainly helps us. But the question remains, how long this is going to last? And what will be also the impact on the financial ability of the players to pay? So if all the unemployed people of the world start playing our games, I hope they have some money saved. But otherwise, it may not change a lot in our earnings and the top line. But it is positive, and they -- we go into the second quarter with that positive tailwind from additional downloads that we are getting. So on the development front, we've proactively moved all of our full-time employees to work from home back in March, and we did not see an increase in productivity or in disruptions. I think the staff has adapted quite well to working from home. Some actually like it. So it is, obviously, as we go into whatever week of this whole thing, it is becoming more stressful for everyone, as most of our developers are actually in the cities with rather strict lockdown policies. But so far, we're glad to see that they're choosing to focus more on work, and it's meaningful for them during this time. And seeing our games succeed is worth a lot. It keeps morale high. And so I think we're in a good place when it comes to the development. And the teams are doing an amazing job also trying to release games a little bit earlier so that we can kind of surf this wave of increased downloads while it lasts. So with that, let's talk about Q1 figures and move on to Slide #4. So we had revenue of SEK 312 million, and that is an increase of 2% compared to 2019. And with some help from exchange rates, we're back to year-over-year growth with -- in line with our vision for the year that we have explained in the Q4 report for 2019. And as you can see, our new -- our own games continued to grow well. The licensed portfolio share is shrinking. So the sequential increase for our own games was strong, 8%. Jewels of Rome was responsible for over 15% of the group's revenue in the first quarter. And overall, owned games increased their share of revenue to 45% getting close to parity there. We have also seen improved monetization with the monthly average revenue per -- gross revenue per paying user up 17% year-over-year to over USD 50. So that is a good and strong result, I think. So for slide -- let's move to Slide #5 and talk about our strong earnings. We have returned to rather healthy margins. There is some boost there from the exchange rates. But even adjusted for that, it was quite substantial. And I think that the -- if you look at how come we have such strong earnings this quarter. So there's several things, and the main thing is the user acquisition. So the improvements that we've done to user acquisition enabled us to spend less than in the previous quarters. So that was the most important component here. And then another thing is the exchange rates. And there are other smaller things that are detailed in the report, but obviously, not only in terms of revenue, but also in terms of -- most of our expenses are in rubles and in the Ukrainian currency. And so with the exchange rate fluctuations, our costs went down basically a little bit as well. So we've seen several components to the improvement in our earnings, and I think they should stay with us for a while. So we're saying that this is the new base of profitability that we should be able to deliver, with this percentage of revenue coming from owned games, as long as we're not doing something very aggressive with user acquisition to enable sequential growth. So the gross margins also went up, as you can see, from 53% to 57%, and that is the effect of more revenue coming from our own games. And we expect this to gradually increase from here as the revenue share of owned games continues hopefully to go up during the year. Let's move to Slide #6. We look at our cash situation. We actually, at the end of the quarter, had more cash on the account than I think we ever had. So there was a strong cash conversion during the quarter. Total cash flow, about SEK 31 million. And it's good to have certain reserves in these uncertain times. So this cash position certainly allows us to continue paying the dividend, and it allows us to basically fund whatever we need to fund in terms of game development or marketing. So it's a very strong position to be in, I think, right now. So otherwise, we have no significant movements in capitalized development costs. Net cap positions showed a steady rate, and it basically cancels out with amortization. The effect there is minimal. So this actually concludes my presentation. We've reached the end of it. And now I would like to open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Jesper Birch-Jensen of ABG.

[Jesper Birch-Jensen]

I have 2 of them. So first, I was wondering if you could give some indication of what percentage of user acquisition spending went to owned games versus external games?

[Vladislav Suglobov, Co]

Yes. Thank you for the question. So right now, I know the current one, it's kind -- I don't know the exact distribution for the first quarter. But right now, we are at around parity. So about the same amount goes towards licensed and towards owned games. So it's kind of in line with the distribution of revenue.

[Jesper Birch-Jensen]

Okay. My second question, at the last conference call, you kind of guided for EBIT margins around 4% to 5% during H1, which would lead us to suspect growth rather than high profitability. And I was just wondering, how did that change throughout the quarter? Are you opting for higher profitability?

[Vladislav Suglobov, Co]

Well, I think we didn't really opt for anything. It just happened. This whole situation with the buyers, which was impossible to foresee, I mean, it really did affect our profitability situation. So -- I mean the whole 3 percentage points out of the 12% EBIT margin is just that -- just the exchange rates. And that's just the revaluation of liabilities within the company. And then you have the effect also on the costs, which -- a big percentage of our cost is in rubles and hryvnias and both currencies lost against U.S. dollar during the quarter.

[Operator]

[Operator Instructions] And we have one further question coming through. That's from the line of Oscar Erixon of Carnegie.

[Oscar Erixon, Financial Analyst]

Yes. A few questions for me. First of all, could you please talk a little bit more about sort of how you see the top line development going now in Q2? Obviously, very low user acquisition spending here. On the other hand, perhaps the boost from the COVID-19 situation has increased downloads. What do you think -- if you could talk a little bit more about the outlook for growth here, sequential growth in Q2, primarily?

[Vladislav Suglobov, Co]

Yes. So we obviously expect sequential growth in the second quarter. And there are several things at play here. And one is obviously that we continue on working on improving our user acquisition efforts. And so we achieved great optimization in the first quarter, but the ambition is to be able to deploy capital to grow the top line. So we will continue doing that. My hope is that we can go from optimizing the spend, making sure we cut the spend where it's inefficient, and then we focus on spending where it is efficient. And from there, we can go to spending more where it is efficient to spend. So going forward, I hope that we will have increase in the amount of capital deployed towards the user acquisition. And although it can affect earnings margin a little bit negatively in the short term, that should help us achieve sequential growth in the top line. So there's that. Then there's this obvious wave of interest and extra downloads that we are getting, which should be producing some result. But as you can see from the store stats, we're talking about 40%, 30% or 50% increase in the number of downloads, and yet revenue goes up by about 10%. So there's a question of, what kind of downloads does this situation brings? What is the quality of users there? Obviously, when we buy users, we are very careful about buying users that we know can pay back. When a lot of users come in because of a store promotion or some other -- because by other means, what we call organic downloads, the quality, they may vary there. But still, it is positive. Then there is a little bit of positive effect that we should see from advertising and including advertising in all of our games. We started gradually to deploy the -- our chosen way to deploy advertising. And starting Q2, we will implement advertising in most of our larger game by user base. So that should give us, we think, at least 3% extra revenue, which we will achieve gradually, obviously, throughout the year as we deploy advertising in all of our games. On the other hand, I'm -- I mean games industry is a great industry in the sense in this situation because we weren't affected a lot by the crisis directly. But I'm a little bit concerned about the indirect effects that we may see due to economic deterioration in the following quarters. So that is another thing that I'm concerned with. And then there is also a question of how long this wave of additional downloads is going to last because we are entering a period of warmer weather, obviously, not holidays, but people may want to spend more time outside, options are still limited. But we see that certain states are opening up and certain countries are talking about relaxing measures. And so we may see the pattern that we see in China, where people are like, "Oh, thank God, I can go somewhere now. So I don't have to spend all my time playing." And then this will affect us in kind of not negatively, but this will limit the positive effect that we are seeing now. So overall, in the short term, I don't think that this situation affects us negatively. Over the long term, until the end of the year, we will have to wait to see.

[Oscar Erixon, Financial Analyst]

Got it. And I mean what can you say about your spending here? I think if I understood correctly, you have hired some new talented people into your user acquisition team. Can you elaborate a bit on how your user acquisition strategy has changed? And if we -- if this is a new sort of normal level where the user acquisition costs, low 22%, because it has been very volatile? So what is the plan, really, for optimizing between margins and growth?

[Vladislav Suglobov, Co]

I'll try. But honestly, I don't think about user acquisition as a percentage of gross revenue. The thing is that we're looking at what is possible to achieve in the market, and so we go with spending where we see that the spending actually repays for itself. So to me, I don't know the number. There is no number that I would say, like, oh, this is going to be this, or that -- this is going to be that. If we see the ability to scale our owned games substantially and quickly, we can go very aggressively on user acquisition. And so that quarter, we may have an elevated level. But I think if you're looking at the first quarter, which is kind of in the absence of strong sequential growth, yes, this is where we should be for a quarter like that. And then if we are going to have stronger sequential growth, it may be the same, maybe better, maybe worse. It really depends on how well we will be able to invest the money in user acquisition and how soon we will get the money back. There's -- unfortunately, there is no way to say that this is where it will be. Not sure this is what you wanted to hear, but that's how it is. In terms of user acquisition, we -- so the new management that we have in user acquisition, basically, they deployed a much more sophisticated process for acquiring users. I think they brought it up to speed with what the industry standard is now. And we've increased the staff count and user acquisition to allow people to focus on effectively deploying a relatively smaller amount of capital, and that is important. And also, all of this is within a framework for how to make decisions in user acquisition. And there's a lot of technicalities there. Basically, we upgraded everything, including the tools over the last 6 months, quite substantially. And the existing user acquisition managers, they had to go through some retraining. So we started this process around October last year. And I think right now, we are in a situation where we've learned how to acquire in a very efficient way. And from here, we hope to start increasing the amount of capital that we can deploy efficiently. That's the plan. And I think it's going to take another 6 months probably for us to get to where we want to be, kind of full speed in terms of marketing.

[Oscar Erixon, Financial Analyst]

Okay. Got it. That's helpful. So it's more a case of a more sophisticated approach than -- that you're seeing, lower return on your marketing investments than in Q3 and Q4. That's it for me.

[Operator]

[Operator Instructions] Okay, it looks like there's no further questions coming through, so I'll hand back to our speakers for the closing comments.

[Vladislav Suglobov, Co]

So if there are no further questions, this concludes our presentation. Thank you for your time. Thanks for joining us. Have a good rest of the day.