G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2018-Q2

[Vladislav Suglobov, Co]

Hello, everyone. Thanks for tuning in. This is a Vlad Suglobov, CEO of G5 Entertainment. Let's start with the Slide #3, the financial summary. We have had pretty good revenue in the second quarter, about SEK 395 million, which is 43% growth year-over-year and 6% sequential growth from the first quarter of 2018. We have the record monetization per paying users in the second quarter of $46.2, and this is something that we see as a consequence of us focusing more on the high revenue territories and focusing more on acquiring users of high quality. The own games of the company year-over-year actually grew faster than the licensed games. And that is a good trend that supported the growth in the revenue. Earnings were at SEK 50.1 million and earnings per share of SEK 5.07. I think this is the highest we've ever had. And the EBIT margin expanded year-over-year to 12.7%, but was a little bit down compared to the first quarter, which was, I think, 13.3%. We did a lot of hires during the quarter. About 65 people were added to the company and there were some extra development costs, which affected the margin. But we will talk about it later on. The user acquisition costs were 24% of revenue, which is 2% points lower than 26%, which we had a year ago. So I think this just shows that the model is sustainable, that we're able to generate growth even with lower user acquisition expenses and then it will go down on this front. EBIT margin before user acquisition costs was 37%, which was a little bit down from the first quarter. But again, there was some pressure on the profit margin, which we will discuss in the following slides. Cash flow was SEK 8 million. This is despite very big items like dividend and some in the stock option programs. Actually, 2 of those in the second quarter. The -- we have had the highest cash on the account of SEK 107.6 million at the end of the quarter. Let's move on to Slide #4. And you can see we're moving forward in about the same pattern that we had last year, where Q1 and Q2 will show nice earnings and good earnings margin. And despite the EBIT margin before UA going down a little bit in the second quarter, if you compare the situation that we have now to that of the third quarter last year, we're getting a little bit ahead of us. We have more space for spending on marketing, and we need -- we are ready for a seasonal rebound that we believe is going to happen in the fourth quarter. And one thing that we have noticed in this year is that because we have added so many people to strengthen our development studios, over the last year, obviously, this started to weigh down a little bit in our earnings margin. And -- but this is something that we have to do. We have to build teams that will continue making shot at creating new games that will be making more than $100 million over the lifetime. That's our goal. That's where we are aiming with the new games that we are creating and because of all the new games that we are making and the continued development of all the games that we have on the stores, we have to strengthen our development teams. In addition to that, what we are doing is we're taking quite a bit of work internally. As you know, we have acquired The Secret Society. We have acquired the Nightmares from the Deep in the second quarter. So we have to be able to achieve to maintain and develop these games. And we were also taking in work that was earlier, that was done in the external development studios in order to better control the quality of the output. So when we are adding new projects, we're creating -- when we're creating internal teams, there's a trade-off between better margins in the future for the project to be successful, but higher costs in the beginning of the development because we have to take them internally. We don't have external developers. If we can put this cost on if it's a licensed deal. And when we replace outsourcing costs with the internal development, it's not a dramatic effect on the earnings or on our development costs because we were already spending on outsourcing. So we're just taking these costs internally. They may be the more expensive or maybe a little bit more cheaper internally, but the difference is not that big. So just to explain to you better what is going on internally because this is something that is affecting our expenses, and this is something that we are doing for the long term. So it doesn't -- we don't expect over strengthening of our development in order to be immediately translatable to the revenue and earnings but this is something that is critically important that we do now in order to be able to continue delivering growth and great things in the future. It's kind of unavoidable that we have to do it. Another thing that affected earnings margin this quarter was the team-up events. It's called G5 [ Team Up ] which is -- it's an event that we create to bring people together from the different offices that we have, where people can finally that work on the same games but are located in different offices, and it kind of synchronizes the understanding of what we are trying to deal with the company. So we believe it's extremely important to do all that, especially we have in our [ Eastern dev teams ]. And we do it in the second quarter and the fourth quarter. So accordingly, the expenses affect earnings margin a little bit in these quarters. And let's move on to Slide #5 and look a bit more at the revenue. So the good growth, like we have continued sequential growth, healthy growth year-over-year. We have the differences to previous periods. I would say that this trend continues that started in Q1 that we are gaining a bigger part of revenue increase through the increase in the paying user monetization rather than in the increase of the audience. And in part, this happens because we have changed our user acquisition strategy a little bit and where we focus more on higher-quality users and high-quality countries. So that automatically kind of lowers the overall number of downloads, but it increases the revenue that we generate from one paying user. And as you know, we have about 10% of users who pay in any given game over the lifetime of the game. So theoretically, we could do quite well. Actually, we didn't have exactly the same financial results without 90% of our users. So that's what's happening here. In fact, we are kind of shrinking that 90% of people who never pay in our games, and we just get a little bit less of them and a little bit more of the actually paying users. And so the statistics of monthly active and daily active users and the monetization per users are affected accordingly. Another trend that we are seeing this year is the seasonality. It's a little bit early to say, officially, at third quarter. But we do see that in the summer, the activity of users and the number of new users looking for new content is going down a bit. So we are invest in that part of the year now where we can certainly see the signs. And I would say that this looks pretty close to what we had last year during the summer as well. In addition to that, we have the little -- we had the little bugs with our largest games. There were some delays of the updates and events both in Hidden City and The Secret Society. There were some experiments with the balance of Hidden City, which did not go exactly as they were -- as we hoped. I can't say these were planned because those were experiments essentially. But we have to do these to better understand what is driving users and to try new things. You have to innovate even on the established games. And sometimes we do set up certain experiments, and sometimes, unfortunately, they don't really turn out as we planned. Our strategy during this off-season time is to focus on retaining users, keeping our revenue and preparing the strongest quarters of the year, which is the fourth quarter and the first quarter. And we hope that we're going to see the same rebound we have seen last year in the user's interest and activity and get colder, and people have more time to spend with their devices and games. So we haven't seen anything different from last year in that sense this year. So Hidden City remains our largest game by monthly revenue. That hasn't changed. But I have to say the revenue from our own games continues growing faster year-over-year than licensed games, which basically means faster than Hidden City because it's now with the acquisition of the Nightmares from the Deep, we put mobile games in our portfolio that are [ worth only ] except Hidden City. So it's kind of an outlier now. In terms of the revenue breakdown, it's about the same picture as before. It looks like we are, for now, set with this distribution where North America is about half; Asia, 28%; Europe, 16%, and Rest of the World 6%. So no big changes there. With that, let's move on to Slide #6. And again, you can see our costs were gradually going down as a percentage of revenue as the revenue was growing very quickly. Now there was a little bit of a rebound in the administration costs, and that is primarily because of the events that we had and some other onetime costs. The R&D spend went up as well. And that is the effect of extra expenses that we have in connection with all the people we have hired recently and a big amount of work that was performing on a number of games that we are getting ready for the release before the end of the year. There's going to be 2 or 3 such games. And then there were some extra development costs as well connected to increased monetization. And one -- I'm sorry, not monetization but amortization. And amortization is kind of catching up with the increase in the capitalization that had started a few quarters before, not going up as well. We were still able to spend 26% of our revenue on user acquisition and deliver 12.7% EBIT margin. So I think it's a healthy situation where we have to invest in the future of the company by building this team within the company or rather pull all teams in building the games that, we believe, are going to ensure that the company has a bright future going forward. And we have to make enough of these that we have to start enough of these games in addition to continuing working on the existing games. And this is the cost that we have to take. I think where -- it's still a healthy result as we have margin expansion year-over-year, even with the lower user acquisition costs. Going on to Slide #7 which shows net capitalization. This amount we capitalize every quarter in connection with the development of games, minus the amortization that we take in the quarter. And you can see those were canceling out at the end of 2016, but as I say, the factor have started in 2017 as we gradually started adding people to the company, and kind of taking our development capacity spending level. And now we have -- we're obviously taking it to a much higher level. We have many more employees. We got a stronger team and we need many more teams but several more teams and they're much stronger, more able. And amortization is catching up so the net effect as you can see is actually gradually going down from the fourth quarter this year. And the net value of games portfolio went down perfectly compared to last year, but you have to take into account that it is -- a really big chunk of this is in connection with the acquisition of The Secret Society, so it's not just because we ramped up our development cost so much. If we take out The Secret Society effect from there. It will be a very different picture. Let's move on to Slide #8, cash flow. And as you can see, the cash in account is going up gradually, every quarter -- for almost every quarter. And this is all happening as we are showing the sequential growth and the growth year-over-year. But also as we pay dividends for the second year now. And in the second quarter, this is what we did. We had a big outflow with SEK 22.2 million in dividend payment. And then in connection with the stock option program from 2014 and '16, we also spent SEK 9.1 million on that. And even after that, we had a positive cash flow of SEK 8.0 million. So I think it's a very strong -- we obviously had a very strong underlying cash flow in the quarter that we were able to go through the dividend and certainly, 2 stock options programs during the quarter and still have a positive cash flow. One thing that helped us was the tax refund from Japanese authorities for amounts that they withheld over, I believe, 2 or 3 years ago. This is a onetime thing but it's going to help in this quarter, positive in terms of cash flow, to be fair. Otherwise, I think we are doing really well on that front and this is despite the increase in the development staff that I told you about. All right. I think this is it for the presentation, and I'm happy to take your questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Victor Forssell of ABG.

[Victor Forssell, Analyst]

I have a question regarding the slowdown that you've seen in hidden object market. Could you give us a little bit more of a flavor there?

[Vladislav Suglobov, Co]

Sure. We do see it decreasing based on growth in the hidden object market overall. But I would say, exactly we can view this market, from what I have seen, from what I've been able to see kind of the same situation in the match-3 games as well. So I'm trying to make sense of that as we go. But from -- it looks like the industry and G5 offers, we had a very good high season this year. And then it was so good that it had to go down a little bit. And I think the fact that we are, during the summer, where people spend more time outdoors frankly, with different activities rather than sitting at home playing games is affecting it as well. So my theory that I have is that we are basically looking at that. I'm not saying everything that happens to our games is explained by seasonality, obviously not. We had some issues as well during the summer. But this is a trend that I think we have, and I think it get it even more pronounced over time because as you know, the shipments of new devices, they are no longer growing year-over-year in the developed markets. So we have pretty much upset all of these people playing these games and using mobile devices. There is obviously room for expansion of their interest in how many games they play and how much they pay. But in terms of getting new users, I think we are reaching a certain plateau in terms of the foot traffic in the application stores, for example, looking for new games. And maybe that I'm getting very theoretical at this site. It's not something I have seen, but this is something that I expect should happen is that before, we always had a certain number of people who never use smartphones or tablets before, finally get one and go into the market and try to find applications for it. And this is when they download a lot of stuff. Now we're not going to have that many people doing that because everybody has smartphones. So you -- what will happen is that a certain number of people will come of age in a certain year, and they will get their device for the first time, new devices, or if they will finally get into the age group, which is interested in games like we're making, but still be a bit more gradual process, not fueled by new users finally getting into the smartphones and tablets because at this point, in the developed markets it looks like everybody already has smartphones or was exposed to it. They don't have to buy one to continue. That's my take.

[Operator]

[Operator Instructions] As there are no further questions at this time, I'll hand the call back to our speakers for the closing comments.

[Vladislav Suglobov, Co]

Well, actually, we have some comments here that were sent over the Internet. So I will go through them. And one question is, could you please elaborate on which countries you're actually targeting in accordance with the new modified UA strategy? How does the focus on high-quality users affect your UA acquisition cost. And I think I pretty much covered it. The change is that we are getting less users and we get more paying users among those. And on average, the monetization per paying user is going up. And the high revenue per user countries are obviously, United States and Japan, which are big countries for us, but also in South Korea, and even China. Actually in China, we target, for example, iOS users that have begun to be a rather good quality and rather highly priced as well on user acquisition market. Then there are countries in the West Europe. So it's quite -- we're just targeting the countries where our sales are the biggest, basically. We will end up causing our advertising revenues increase these revenues from in-game purchases. We do not have an advertising revenue. Our overall revenue is coming from in-app purchases. So no changes there. It's 0 at this point. And then there's another question. Can you elaborate on the 2, 3 new games that you plan to launch by year-end, category and current state of development. So yes, I wouldn't be saying that we -- that there's a probability we'll launch them before the end of the year. They weren't in final stages of development. So we would not be quite close to, at least to the initial release and the quality that is enough for us to do the initial release. The games that I'm talking about are going to be in one of our main genres. So we have these 3 teams that are coming out earlier than all of the other games, and I hope that 2 or even 3 of these we will release before the end of the year. And there's basically going to be one game in each of our main categories. And the categories are hidden object, mystery and solitaire games. That's our plan. And I don't have any more questions. So thank you very much for listening. And this concludes our earnings call.