G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, welcome to the G5 Entertainment Q2 Report 2020. Today, I am pleased to present CEO, Vlad Suglobov; and CFO, Stefan Wikstrand. [Operator Instructions] Speakers, please begin.

[Vladislav Suglobov, Co]

Thank you, and welcome, everyone, to G5's second quarter 2020 earnings call. My name is Vlad Suglobov, the CEO of G5 Entertainment. We have Stefan Wikstrand, the CFO, with us today. So we'll take around 15 minutes to go through the presentation of the second quarter, and then we will open the line for Q&A. So let's talk about the highlights of the quarter and move to the slide highlights. And what a quarter it has been. Historically, second quarter is 1 of 2 kind of weaker quarters in the year, so the result is quite remarkable. I'd like to summarize the quarter by saying that we continue to deliver on our strategy. And we spent the past couple of years building out our development capacities, develop our own titles that are developed internally in the company, and we wanted to bring the new generation of G5 games to the market, original ideas, games developed internally, again, to diversify the revenue, to drive growth and earnings expansion. And over the last 12 months, additionally, we have also invested in our platform and tools to improve productivity of customer acquisition. So with 55% of our revenue coming from our owned games and our profit margin at record level in the second quarter, we have clear evidence supporting the strategy. And as you can see, our revenue jumped 27% to SEK 376 million compared to last year, and this is the second highest quarterly revenue ever for the company. Jewels of Rome contributed with some 20% of revenue in the second quarter. All in all, revenue from our portfolio of owned games created from scratch by G5 surged more than 90% in the second quarter year-over-year and 43% sequentially from the first quarter. The new games -- the newest games, I would even say, such as Emperor of Mahjong, The Hidden Treasures, Wordplay, all grew sequentially in the second quarter, and the portion of revenue coming from our owned games continue to increase going into July. So I think that previous investments in our larger development teams are now starting to pay off, and we are launching new games at a higher pace than ever before. In the second quarter, we made global releases of the games, Jewels of the Wild West, Jewels of Egypt and Match Town Makeover. In addition, we have 2 new games in the pipeline for release in 2020. So in total, that means we are planning on launching 6 new titles in 2020 on top of the 5 titles we launched in 2019. And these new games build on previous existing technology and gameplay foundation. We make emphasis on what we know is appealing to our target demographic of women 35 plus, engaging storylines, immersive meta-mechanics. And because we know we have really good understanding of the players' expectations, we have quite high expectations on the success of these new games. And what else we do in the quarter, we built -- we continue to build our marketing teams in Europe and in U.S., and we continued working on the tools that make our marketing and our user acquisition more efficient. And last but not least, we improved monetization, our monetization metric of monthly average gross revenue per paying user by 23% year-over-year. And in part, this is the result of improved by LiveOps. But in part, this is due to a larger part of the overall audience playing new match-3 games. And these games, the games of match-3 genre, they tend to monetize stronger than Hidden Object games. So that explains it. And the new generation of games, and we call them new generation of games, games released in 2019 and 2020, contributed to our rapidly growing revenue and higher margins. The short-term effect of the lockdowns due to the virus were mostly a positive factor, but they only accelerated the inevitable, given how many new games we have released and their strong performance and improved marketing. It would -- the growth would happen sooner or later. What happened is that lockdowns kind of moved us forward a little bit in what would happen anyway. And the growth of the new generation of games, combined with the more efficient user acquisition spending, led to the expansion of the EBIT margin. We have put, again, a lot of effort in optimizing user acquisition spending. And we are spending our money wisely, which is visible in our improved margins and lower user acquisition spend. We remain financially healthy and strong. We are debt-free, profitable, highly cash-generative. And with that, let's dig a little deeper into the impact of COVID-19 on the mobile games industry and move to Slide #3. So obviously, COVID-19 continued to impact the mobile games industry also in the second quarter as well in the first, and revenue for the mobile games industry rose 16% year-over-year to USD 19 billion, and there was a significant increase in game downloads. There was an uneven distribution between Google Play that saw an increase of 51% of downloads year-over-year to 12.4 billion compared to the App Store, which saw downloads rise only 19% to nearly 2.7 billion. In the U.S., growth in downloads was 27%. Q2 was the quarter with the most industry downloads ever with 15 billion installs across the App Store and Google Play, which is more than 2 billion installs higher than the previous best, which was the first quarter this year. And so at G5, we saw kind of similar trends as for the industry. Our download increased quite a bit during the spring and peak in April, which gave us a strong momentum going into the quarter, especially downloads for our new games were on the rise during the quarter. And as you could see, the new generation of our owned games, those released in 2019 and 2020, grew as a percentage of total revenue. It was about 55%, as I mentioned, compared to 45% in the first quarter. And this increased activity in our owned games, powered by the lockdown wave and reinforced by optimized user acquisition, continued into the third quarter as well. Again, I would just reiterate that I think that the lockdown situation accelerated our time line and the inevitable growth in our own revenue, powered by the new generation of games that are performing really well, and our ability to deliver above-trend growth is evidence of that. So let me talk a bit more about Q2 figures and move on to Slide #4, revenue. So again, SEK 376 million, and that's an increase of 27% compared to 2019. Our owned games continue to grow while the life of portfolio share is shrinking. The sequential increase for our owned games was 43%. Jewels of Rome made up some 20% of the group's revenue in the second quarter compared to virtually 0 a year ago. Owned games increased to over 54% of total revenues, up from 45% of revenue in Q1, which continues a solid trend for the growth of owned games revenue share. Improved monetization with monthly average gross revenue per paying user up 23% year-over-year to $57.4. Again, strong performance here due to a larger part of the audience now playing match-3 games, high efficiency of user acquisition and improved live-offs. Revenue share from licensed games was accordingly on the decline, and these games were flat in the second quarter. And going forward, we expect these games to be flat or gradually stagnating. And don't get me wrong, this is still substantial revenue and substantial profit contribution for us for the years to come. But we expect owned games to continue growing while these are flat. So the result will be growth in the share of owned games and improving gross margin. And let's move on to Slide #5. I'll talk about the earnings. So the operating profit was SEK 44.8 million, and the EBIT margin was a strong 11.9%. It was negatively affected by exchange rates, almost actually precisely SEK 9.3 million or 2.5 percentage points related to the weakening of the U.S. dollar. So adjusted for exchange rates, EBIT was SEK 54.1 million and the adjusted EBIT margin was a record high, 14.4%. And it's quite remarkable again for the second quarter that we are able to have the second best quarter by revenue and the highest ever EBIT adjusted for FX. The sequential improvement in profitability was primarily due to rising demand; the inherent leverage of the business model; lower, more efficient user acquisition spend and the increase in the share of revenue coming from owned games, where there's no royalty that we pay. User acquisition costs were down to 22% of revenue compared to 25% in the second quarter last year. Thanks to the increased share of own developed games, we saw an improvement in the gross margin year-over-year from 55% to 57%. Let's move to Slide #6 and look at our cash flow. So all in all, we had a strong cash conversion during the quarter despite tax payments. In the quarter, we paid taxes of SEK 52 million. The large part of those taxes were repaid in July. But to counter the temporary tax deficit, we took out a short-term loan of almost SEK 42 million. In the quarter, we also paid out the dividend of almost SEK 22 million and repurchased shares for almost SEK 50 million. And all in all, with all these expenses, total cash flow in the quarter was negative SEK 50.6 million. And yet, total cash at the end of the period was SEK 131 million, which I believe is more than a year ago. And we expect to continue to have high cash conversion going forward and to improve our cash position going forward. All in all, I'm very proud of the strong accomplishments by the whole G5 team. During this quarter, we achieved the second highest revenue ever for G5, and that -- 55% of that revenue came from our own titles makes me even more proud. Our profit margins are at record levels. And to me, this is clear proof of a successful strategy. And with that, let's move on to Slide #7, and let me make a few comments regarding the outlook and the strategy. Even with this strong growth in owned games and new generation of games, you can see that we have barely tapped the opportunity with the match-3 games. This 0.3% market share that we have in this market constitute substantial increase from levels 1 year ago, and a large part of our revenue already comes from this market. So the opportunity to expand our presence here in this market can have a truly remarkable effect on our revenue and profits. And with the parity between owned and licensed games and fast-growing revenue from our owned games, I think this is the beginning of a new growth journey. We have to be mindful of seasonality. Q3 is usually a weaker quarter of the year. But we really look forward to the fourth quarter this year to see how this new generation of games can perform during high season, which usually works really well for us. Again, we anticipate that owned games will continue to gain share of our revenue and license will continue to go down as a percentage. And this, together with control over user acquisition, cost efficiency, should lead to strong earnings margins going forward. Advertising for now remains an opportunity for revenue and EBIT growth, but to a smaller extent. Our advertising revenue was less than 1% in the quarter. We said before that we can -- we aim to make few percentage points of our revenue from advertising. That is still the goal. But we are very gradual with the rollout, and we really focus on the user experience. We don't want to do anything bad there. So we will continue with our strategy, our portfolio strategy, and we will release more games this year and in 2021. We are also in a great position to review and act on M&A opportunities should they arise. So this actually concludes my presentation, and I'd like to now open the line for questions.

[Operator]

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

[Pierre Mellstrom, Small Cap Analyst]

Congratulations on the strong quarter. A couple of questions, if I may. First, on the user acquisition spending, 22% of sales in that sense. I was just wondering sort of if you can walk us through the dynamics out there. I would, for one thing that, for example, this strong revenue growth in the quarter would justify an increased marketing spend to capture future growth? Yes. That's my first question.

[Vladislav Suglobov, Co]

Well, thank you for the question. It remains kind of the same situation as we had before. We -- if we see the opportunity to spend more and have stronger growth, we will do it. And these opportunities are, most of the time, restricted because of the strong competition in the genres where we are active. And so we use these opportunities in accordance with our current investment horizon for marketing spend and in accordance with a certain KPI that we set for ourselves. And so what I can say is that with the new optimized marketing spending, what you should not see is big fluctuations between the quarters in UA spend as happened last year. So that should not happen. But otherwise, it will kind of move up and down within some range depending on the opportunity for growth. And again, in the second quarter, we -- as I said, we had this tailwind from the lockdowns, and this has created opportunities that we could use. But also this has created a lot of users that have found ourselves. They just kind of organic traffic, and we took opportunity of that as well. So that -- I hope this answers your question, to some extent.

[Pierre Mellstrom, Small Cap Analyst]

Absolutely. And also, you were talking about the seasonality going into Q3. Could it be the case that we're seeing increase on sequential daily active users, and it takes some time to convert the daily active user into a paying user? And continuous tailwinds, possibly, could it be the case that we're actually breaking through the seasonality in Q3? Or what are you seeing?

[Vladislav Suglobov, Co]

Well, it's too early to talk about Q3. But I -- my comments on the seasonality were based on the fact that usually, we feel some seasonality. There is seasonality in the market. And obviously, right now, the picture is a little bit distorted because of the lockdowns. But we are past the peaks, the peak of the lockdowns. So I expect that there will be certain seasonality in the sense that Q4 usually is, for us, is better than Q3. And I think that whatever Q3 this year is going to be, Q4, in my view, should be better than Q3. So that's what I was referring to. Yes. This is my thinking. So with regard to Q2, we did receive a certain inflow of new users, and that was kind of a stronger quarter than we expected seasonally. So it kind of pushed us forward in our growth path. But I think Q3, so far, looks really good and all the major trends continue. But then Q4, just based on the experience from previous years with colder weather and more time spent at home and the gift season, usually, that brings a new wave of both new users and also the engagement with our games. And this year, we are going to have so many more games, the new ones with much larger audiences. So there's -- I think there is a lot of opportunity there, and we focus on preparing ourselves for the stronger quarters of the year.

[Pierre Mellstrom, Small Cap Analyst]

Just one more question, if I may. Obviously, there is a lot more space to grow in the match-3 segments and also in the Hidden Object, but that would not be the case in that. So to fuel further growth ahead, are you seeing any other interesting niches or genres where you have your targeted audience and similar conversion rates in that sense that could actually fuel growth further in the future?

[Vladislav Suglobov, Co]

Well, it's a great question. We are actively looking at other genres. Obviously, we have Mahjong genre, which is sometimes called match-2. But of 3 genres we're active in, that one is probably the least monetizing, although we are trying to change that situation, but it's still below the match-3. So match-3 is the most competitive of all, but it's also the largest, and it's the one that monetizes users the best. And then we have Hidden Object niche and Mahjong niche, which is even smaller, where we also have a sizable share of the overall market. So we plan to be active in all of these 3 markets. And we are actively looking at other genres, which appeal to the same audience. I think it's a little bit too early to talk about their potential. But yes, we are actively looking there. So you can expect us, in line with the published strategy, to venture into new genres that would appeal to the same audience in a conservative kind of responsible way. That's the strategy we have formulated and published in the annual report, and we stick to that.

[Operator]

[Operator Instructions] Our next question is from Jesper Birch-Jensen from ABG Sundal Collier.

[Jesper Birch-Jensen]

And congratulations on the strong reports. A few questions from me, if I may. First, I was wondering if you could comment on the performance of your new titles perhaps compared to expectations. I'm thinking perhaps Jewels of the Wild West, which seems to have been rising quite rapidly in terms of gross rankings. So if you could give more flavor on that.

[Vladislav Suglobov, Co]

Sure. Thank you for the question. Yes, Jewels of the Wild West is doing quite well. As you mentioned, that it's going up in the rankings. And I think in some way, it may have even better potential than Jewels of Rome, if you just think in terms of the appeal of the setting to the end users. Again -- but I have to say, when we set out to create a game, we do not really have expectations that can be formulated as how much it's going to sell. We just have to have a good thesis for why we may succeed with this game and why it may be popular, and it is difficult to precisely estimate what it's going to be. So it's a little bit easier when the game already came out. And I could say that it's not performing in any way different from Jewels of Rome other than maybe it's even better in some respects. So our expectations -- my expectations for this game is to eventually be where Jewels of Rome is. But we will see if that will happen because Jewels of Rome had quite a head start and obviously, a very dedicated team, which we see the best resources they could in the company. So there's a little bit of internal competition going on. And it's not only the potential of the game, but it's also the potential of the team. And I think it's a really good attitude internally, a little bit of the competition to where these games can get. So I myself is very much looking forward to finding out in a year's time, for example, which game is going to be larger in terms of revenue. So we'll see.

[Jesper Birch-Jensen]

Okay. And also, you mentioned that you've seen, obviously, an inflow of new players during Q2 due to the COVID-19 lockdown. And I was wondering if you could say something about the retention of the new players? Like are they -- do you see them trying the game and then going back? I mean, basically, how is the attention? If you could comment on that, please?

[Vladislav Suglobov, Co]

Yes. Well, always good in that respect. I don't think we were -- I don't think we can say that the players who joined us in the second quarter are very much different from others. So as you can see, our monetization metrics went up pretty significantly year-over-year. And so far, it looks like maybe this is the result of the lockdown, not only with more time to spend, but also more money to spend on games that we are seeing this. But we currently, at least currently, in the short term, we don't have any concerns with the quality, so to speak, of the players that we are attracting and their ability to pay. Obviously, if there are significant negative effects on the economy, this may change. But so far, we don't see anything to that end.

[Jesper Birch-Jensen]

Okay. And my last question there. You mentioned that you stand ready to act on M&A activities or possibilities if they emerge. And I was just wondering, have you seen an uptick of possible takeover targets during COVID-19? Or is it steady or more people contacting you in that regard?

[Vladislav Suglobov, Co]

Yes. Well, for now, we are quite busy with all the new games that we just released in the market and those games that we are preparing for the release in the market. And what is M&A? It's buying -- essentially, it's buying shares in a business that you think is going to grow and that is valued in an attractive way. And that is what we did with the buybacks, actually. So that was our focus for now. But we weren't actively monitoring the situation. What I am saying is that we will definitely pay more attention to it now, and I think I will leave it at that for now.

[Operator]

[Operator Instructions] And there seem to be no further questions. So I will hand it back to the speakers.

[Vladislav Suglobov, Co]

All right. So thank you very much for joining us this morning. And this concludes our call. Thanks again. Have a good day.