G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2019-Q2

[Vladislav Suglobov, Co]

Welcome to G5's second quarter earnings call.My name is Vlad Suglobov. I'm the CEO of the company. And let's move to Slide #1 and talk about our revenue which was SEK 297.3 million in the second quarter. And that's 25% down year-over-year, which is a tough comparison because last year, in the second quarter, we had the best quarter the company ever had. It kind of gets better from here as Q3 2018 was a lower revenue. But right now, we are comparing the results of the company to the best quarter of the Hidden City's performance last year. So you have to bear that in mind.If we look sequentially, revenue in the quarter decreased 3% [ to ] Q1, which given currency exchange fluctuations that happen all the time, we consider this more or less flat. And Hidden City was actually stabilized in terms of revenue during the second quarter, but we have some experiments with Mahjong Journey, balance and features in obviously an effort to make things better, but it happens sometimes that things actually get worse. So the game has slipped in revenue. And if not for that situation with Mahjong Journey, we could have probably delivered truly flat performance Q1 to Q2. So lessons learned from these experiments, and the team is working to restore the performance of the game. Homicide Squad, the highlight of our portfolio until recently, has been growing about 160% year-over-year in the second quarter and continues to gain monthly revenue gradually every month sequentially.One big thing that happened during the second quarter also in terms of the revenue was Jewels of Rome. It did not contribute a lot of revenue to the second quarter because it was launched in the last month of the quarter, but it was technically launched during the second quarter. It was a global launch. And Jewels of Rome is the first match-3 game we have released ever since August 2017, so in almost 2 years. And this game and other new games that we will bring to the market before the end of the year is the result of the expanded development capacity that we have built over the last couple of years. So finally, we see some of these games that we've been developing for quite a while start to come out to the market. And Jewels of Rome was and is a special game launch for us because shortly after the game has been released on all platforms, in about 2 weeks, it became #4 by daily revenue in our portfolio. So it's quite a fast start in terms of building the revenue performance and the audience for the game, which makes us very happy and optimistic that we can continue to evolve this game and its performance and hopefully, achieve substantial levels of revenue with this game. Because of where the game is already now in terms of revenue, it will very likely contribute to the top line in the third quarter. And if we are successful in increasing the revenue from the game from this point, then it may contribute to the third quarter top line even more.We have also soft launched Match Town Makeover, another match-3 game. So this game has a very different metagame structure, so we decided to launch it locally in 2 select countries, which is New Zealand and Australia, and look closely at its performance before launching it globally. It has been out for a few weeks. We have found certain things and -- certain issues and certain things that we couldn't see ourselves before we let the players play, and we have several iterations now with the game and its balance. And I think that we are moving in the right direction and that it might take some time to get the strike, but I think we have the fundamental understanding of where to go. And this remains a good potential opportunity that we will continue working on.In terms of new games that are coming before the end of the year, we have said that we will have 4. So now we have 2 games out: 1 globally, 1 soft launched in 2 countries. And then we have 2 more games coming out before the end of the year. That is our goal. But in addition to that, we have 1 game that we have pulled from the store that is going to be significantly reworked and then relaunched as a new game under a new title. So -- and it's like a third game, like a third new game before the end of the year, but it's not really a new game. It's going to be a relaunch of an older game because we think we understand what went wrong there, and we can fix these things. And there will be 2 updates to 2 very important games in our portfolio that can, I think, change their performance dramatically. The team is working on preparing these updates. One is coming rather sooner than later, and another one further later before the end of the year. So we have a lot of things to look forward to. And as you can see, a new game launch can be a delayed opportunity like the Match Town Makeover, and it may take some months to just kind of make sure the game is ready for global launch. But also, it can be a nice surprise like Jewels of Rome, where the game is launched globally and the audience is actually really happy from the start, and the game starts performing right away and starts generating significant revenue right away.And because most of these games -- actually, all of these games that we are going to release this year -- we have released or going to release this year, before the end of the year, they're all developed internally by the -- this development -- by the development teams, by this capacity that we have assembled over the last couple of years. This -- whatever happens, the success that happens is owned by the company. It's the company's own IP, and we do not owe any revenue share or royalty to any developers. And so a truly big success of one of these games can change the outlook for the company quite dramatically because it can have substantial effects on the top line and the bottom line, obviously.So with that, let's move on to Slide #2 and talk about EBIT.So one thing that I would like to highlight is the gross margin that has further improved and now stands at 55%. And this mainly continues because we continue to increase the percentage of the revenue that is generated by the company's own games. Again, this is a comparison to the strongest quarter that we ever had with Hidden City at its peak, so it's a tough comparison. So keep that in mind and try to look at these results sequentially.The user acquisition expenses actually increased to 25% of revenue, and it stood at 24% of revenue last year. So it increased year-over-year but not very dramatically as a percentage of revenue. But sequentially, we ramped it up as we had to have some space for certain experiments where we wanted to confirm some ideas about the user acquisition market and how it has evolved. And so I consider the results of these experiments positive, but it comes at a cost of EBIT in the second quarter, which otherwise could have been better. We will use these findings and the results of these experiments to improve our work in the following quarters. So we did it with a long-term view. And I think it will benefit the company in the long run even though right now in the short run we have this quarter with a lower EBIT margin. Especially, it doesn't look very good comparing it to the last year, but again it's probably the worst point to compare the company's results year-over-year.And let's move on to the next slide and talk about the cash flow. Now in the second quarter, we have paid a dividend in the amount of SEK 22.5 million. We have also paid taxes in amount of SEK 28.4 million. And these taxes actually are coming back to us, most of them, in the next -- during the next year, but it has been a big cash outflow. But despite all this, you can see the underlying cash flow from business operations remains generally stable and healthy, and we finished the second quarter with more cash on the account than second quarter last year. I think it's a good illustration to the way we manage the company. We do not -- G5 doesn't have any long-term debt. And we have stable positive cash flow. We make sure the company can finance its operations, invest in the new games, invest in marketing, invest in whatever marketing experiments we deem necessary to make and yet has -- have a solid financial position. And we end up having more cash on the account than the last year, which was the best than the -- when we had the best quarter in the company's history. So I think it just underlines that we are delivering on what we were saying that our goal is to continue to manage this company sustainably and responsibly in order to be able to build the new games and new sources of growth and have the resources for the development and the marketing.So let's move on to the next slide, business update, and again go over where we are as a company up to this quarter. Again, we are financially healthy, fundamentally strong. As we just discussed, we have the best cash position and better cash position than we had a year ago. We continue paying dividends, and we are able to finance the development and marketing from the company's operations. And we do it in a kind of a way with a long-term perspective.Hidden City remains a very popular game. The revenue has, so far at least in the second quarter, stabilized. And then we are cautiously optimistic that we can keep it that way, if not even bring it back a little, and I think the game still have and we see it that the game still have a very loyal following of players and they continue to play. And they continue to appreciate that the developer continues to make monthly updates, and I think that's very important to keep the audience engaged. I think we are -- this, for us, certainly have been a quarter where we became even more optimistic about the games that we own. Homicide Squad continued to deliver very nicely year-over-year, and that's even despite lowering the user acquisition budget for the game. So it has the staying power. You push it up with a new audience and then it just stays there. And we intend to continue doing that and improving the game. We have quite a road map for this game.Jewels of Rome was certainly a pleasant surprise in a number of ways. And this became the fastest launch in the company's history to this level of revenue. And our intention is to use all of our knowledge in scaling the revenue of successful games and to be able -- once we see the opportunity and we see the potential, to be able to do that as quickly as possible with the new success, whenever that happens. So we will be watching Jewels of Rome very closely. Match Town Makeover, we are still very optimistic about this game, which is now -- is in the soft launch mode, and it will continue to evolve probably for another month or 2. That may be more or may be less. That's the soft launch situation. But we're doing everything and the team is doing everything possible to get it on track for global launch as soon as possible.There are 2 new games scheduled for release in the second half of 2019. And then we'll see how that goes, but we have some great games in the development pipeline. And they are -- some of them are in the same genre as Jewels of Rome, so that makes us cautiously optimistic about the outcome on the launch of new games. There are 2 existing games that are going to see major changes. And I would say these changes will be influenced by the information that we are gathering from the launch of Jewels of Rome. I think they can be quite positive. There's also 1 game that was pulled from the store previously, and it's going to be significantly remade and improved and relaunched as a new game under a new title in the second half of the year. We're probably a little bit more cautious on this one and the expectations there, but still there's another release. And sometimes you never know -- or that sounded weird. But sometimes, you don't know. Quite often, you don't actually -- you have your feeling about how the game is going to perform, and it's based on your own impression and your expert knowledge. But in the end, you don't know until you really launch the game. So in fact, I think I wouldn't lie if I said that, we as a company, we thought more about that, that Match Town Makeover is probably going to take sooner to achieve the performance that we have seen right away from Jewels of Rome. So that was a surprise to us. And this is an important aspect of the game development business, I think, that it's still a show business and it's difficult to say what exactly is going to become a success and success by -- on what scale. So it's always a surprise when we launch a new game.And our development capacity is larger than ever and development teams are stronger than ever. We have a great team of developers and really, really talented teams that we have put together over the last couple of years. We do our best to really keep them together and focus on the games and try to make the work as interesting as possible for them. So it's very interesting time internally because it's a new approach for the company, where we have all of the development teams internally. And we've tried to replicate what we did with external developers a couple of times in the past years, where we would start a lot of projects and have that developed. And now we're doing it internally, and from us, it requires a new way -- figuring out new ways to manage this complexity because we are -- we want to kind of combine the studio mindset but also use the economy of scale which a large development capacity brings. We want to have the flexibility to move resources to where we want to if we see a winner. But at the same time, we want to preserve the studio thinking, and we want the developers to really be invested in the games they are making.So I think we're doing really well, and we are making good progress in building this internal culture. We've been doing it for a while now. And you can see that with the Jewels of Rome it starts to bear fruit. And I think we are -- basically, I'm optimistic about what we can achieve with these teams and the employees that we have. I can see that they're very interested and dedicated to games that they are making. And this has to produce something that is going to be good, in my opinion.So yes, another aspect of Jewels of Rome and -- for example, is that -- actually Match Town Makeover as well. But both of these games, they capitalize on what we have developed originally for the game Pirates & Pearls, which is a match-3 game. And it was first released almost 2 years ago now. And before that, it was in development for about a year or maybe more. But the match-3 engine and a lot of the assets that were developed for that game, they were being used in Match Town Makeover and Jewels of Rome. So you can see there are certain benefits to keeping development internally. It's that you are building the foundation which helps you develop games faster and lower the risks when we launch a new game. This, I can see working exactly in that way. I know there were a lot synergies and the time and the development efforts saved and because of this approach. So we are -- we intend to keep doing this approach and increase the reuse of the existing engines to be able to lower the risks, increase the quality or achieve the same quality with less time and money spent or ideally get to the next level of quality, thanks to building on an existing solid foundation.That is it. I think I've covered everything I wanted to say. And we are moving on to questions and answers.

[Operator]

[Operator Instructions] The first question is from Oscar Erixon from Carnegie.

[Oscar Erixon, Financial Analyst]

Vlad, [indiscernible] questions from me. First of all, Hidden City being quite stable sequentially here. Is that due to higher user acquisition costs? Or do you feel that the game has found a more stable level organically with lower MUP churn?

[Vladislav Suglobov, Co]

Thank you for that question, Oscar. So I think it's a combination of things. Second quarter usually is -- we can see there is the seasonality which is certainly happening with holidays and all. So that is one thing. And we did obviously spend more on user acquisition, and that was part of it. I will also say that another thing is that you can focus on different countries and different users. You have different strategies when it comes to what are you looking for in the users. Do you want to buy more of them? And you know that maybe they will together pay less, but there's going to be more of them. Or do you want to focus on a few of the ones that pay more? So I think that is the strategy that you can change and alter. So for us, it was understanding or changing our thinking about where we want to acquire users; how much we're willing to pay; obviously, what margin we are willing to accept on a game in the long term; and also, I think, the figuring out if we can rebuild the game's user base because there has been a number of updates to the game in the last few months. And I think developers are doing a great job of figuring out where the game is maybe lagging a little bit to newer competition and fixing those issues. So I think if we continue doing that and we continue improving the game's competitive position in the market and at the same time, think some fresh thoughts and do some fresh approaches to user acquisition, we can find a way to scale the game's revenue. And then the second question is how much do we need to spend to maintain that revenue? Or how much do we need to spend to get to the higher revenue? And that is the question we are still exploring. But to me, the first thing -- first things first. Can we scale? Can we go back to growing the revenue of the game sustainably with some responsible level of user acquisition spend? But to get a -- finally answer your question: Yes, it's probably not going down as a percentage of revenue, especially on the -- on a more mature game. It's probably the other way. But who knows? If we continue improving the game, maybe this will change. So we'll see.

[Oscar Erixon, Financial Analyst]

Okay, great. That's very helpful. And Jewels of Rome is, I guess, a [ black box ] here quite soon after release. And when you -- I noticed that you wrote in the report that it can contribute to revenue dynamics in Q3, assuming stable rest of this portfolio. And how confident are you that the rest of the portfolio is able to be stable now in Q3?

[Vladislav Suglobov, Co]

Well, I -- the quarter is not over yet. But I don't think it's impossible. As we have said in the beginning of the year, first half, we're probably not going to set any new records, but we expect better performance towards the second half of the year. And we needed time to do this reevaluation of our user acquisition strategy, and we needed time to launch new games. And I think now we have done it. So we certainly have the tools, and our goal is to show some better results sequentially than in the first half of the year.

[Oscar Erixon, Financial Analyst]

Okay, great. And could you also elaborate a bit on these 2 games that you will release significant updates for? I took that's in the second half now of 2019, but are -- these 2 games, are these outside of your top 5 revenue-generating games?

[Vladislav Suglobov, Co]

Well, they're not released yet. So -- but they are in the genres where we have the top revenue-generating games. Or if you're asking about the 2 other games...

[Oscar Erixon, Financial Analyst]

Yes, exactly, the 2 updates rather, yes.

[Vladislav Suglobov, Co]

They are actually inside our top 5 revenue-generating games. So those -- I mean we wouldn't do -- well, I guess we would. But usually, when we want to make big changes to the game that is not performing well, we would consider just pulling it from the store and do the rework and then relaunch it. And that's what we're doing with 1 game. And so these 2, we're making it as an update. We don't want to reset the games' audiences. It's going to be an evolutionary updates for both games. But yes, these games are a big part of our own games revenue. So this can make things better. Well, at least, we'll do our best to do that. And by making these updates, I think we will bring these games closer to the industry trends and the best-performing games in the genre. So I think for me this is will be -- this will be very interesting to see how the players react and if we will see the effect that I hope we will see.

[Oscar Erixon, Financial Analyst]

Okay, great. And I mean I guess it's a tough question to answer since you may not know yourself, but in user acquisition costs, how do you view that going forward? Because you -- it came very low in Q1 and now significantly higher at 25% of sales in Q2. How do you see that developing now in Q3? And I mean I understand it's dynamic, of course, but can you say something about what to expect here given the volatility in the first half?

[Vladislav Suglobov, Co]

Yes, great question. So we -- as we've always said, it's when -- if we see the opportunity for growth, we will focus on the growth. The reason our earnings margin was at a record level in the previous quarters was because we did not see the opportunity to invest the funds in marketing with good return, and therefore, we opted for earnings. Now this is changing a little bit as we are optimistic that we can get the revenue to grow sequentially in the second half of the year. That will obviously shift our focus from delivering earnings to delivering growth. So you can expect lower earnings margin obviously because it will be our second priority in the rest of the year. Does it answer?

[Oscar Erixon, Financial Analyst]

Yes, perfect. And final question for me before I let others ask their questions. If you could say something about the market, how that is developing. I mean user acquisition costs on a sort of per-unit basis, if you see any changes there. Also in the hidden objects and match-3 markets, how is the competition like? And what are you seeing there?

[Vladislav Suglobov, Co]

Yes. So it's getting trickier. I will say it does go up gradually, but I think it's all relative depending on where your game's performance is. And I think that the launch of Jewels of Rome kind of opened our eyes to the fact that a game can do much better than we thought it would. And so we are very committed to understanding how it worked out that way and using those findings in all of our other games and in the new games that we develop. I think it is important to evolve. I think it is important to make new games and keep in mind that you have to appeal to players who maybe are much more comfortable than before paying in a game and to build the game with what -- your user acquisition strategy in mind. So I don't think that the user acquisition market is going to change back to where it was. I think it's our development and the new games that they have to adapt to the new reality. And we are doing that, and that is why we have the development capacity that we have, which is the largest we've ever had. I think, last month, we were about 570 people in the company, and most of them are developers and engineers and artists and designers, producers developing the games. And most of these games have not even been released yet. So we are busy thinking about what our pipeline is going to be for the next year and the year after that. And we are -- as I have said, we are analyzing the portfolio performance and whether we want to continue to support games that we don't really see achieving the user lifetime value of where we need it to be.And so I think for us it's just this new phase where we have to phase out older games gradually and work on the new ideas and new games and deliver games like Jewels of Rome and I hope, better as well and just catch up with the market and ideally look a little bit ahead of where the market is going and start new games with that in mind. It's a long-term look at how we should do things, obviously, but I think we're starting to see the results of this approach that we have been using for the last year. And it makes me optimistic that it's moving in the right direction. But it's a little bit different dynamic to what it was before, where because of the leverage we had with external developers and before that, with the existing games, things were kind of happening maybe a little faster. Or maybe it's just my thinking in retrospect. Now we have to do all of this internally, and we bear the full financial risk, but we try to do this very responsibly and sustainably. We try to manage the company so that we never run out of the money. And I think we are moving -- we're changing our processes, and we are changing our understanding of where the market is the right way. And that's Jewels of Rome is only the first one of the results that we will see from this new approach.In terms of the market, I think we -- what I see about the market of casual games, it still continues to develop at a healthy pace. Not every quarter is the same, but it does continue to go up. So I don't see any fundamental issues there. We just need to get it together and put out the games that we can develop, and then we will see the results.

[Operator]

[Operator Instructions] And the next question is from Jesper Jensen from ABG Sundal Collier.

[Jesper Birch-Jensen]

My first question is also regarding UA spending. I know you got a few questions already, but I was wondering if you could clarify as -- how much of the increase in UA was due to Jewels of Rome. Or was any part of the increase just used to UA spending of Jewels of Rome? Or was it mainly due to what you called experimenting on Hidden City?

[Vladislav Suglobov, Co]

Well, it wasn't substantial on Jewels of Rome because it was just launched. So with Jewels of Rome, we observed the game's performance for the first few weeks on one platform. And then we did decide to start user acquisition early, but it was still towards the end of the month. So I don't think we'd spent a substantial amount. So it's not connected to Jewels of Rome in Q2.

[Jesper Birch-Jensen]

Okay. And also, do you see revenues from Hidden City stabilizing here on these levels and also then royalties as a percentage of sales? I know that might be hard to say, but what's your thought on that?

[Vladislav Suglobov, Co]

It's a bit tricky without going into the details of the agreement with the developer, which I cannot do. But I -- it really depends on the strategy that we will use with the game. So assuming we will be trying to -- we will continue to want to stabilize the game and maybe get it back to growth, you can expect same -- about the same royalty levels. And they might go up if we decide that there's nothing to be done, which I hope is not happening, but just giving you an understanding of how the dynamic might work.All right. Thank you, everyone, for participating and for waking up early. And this concludes our call. Thank you very much.