G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2023-Q2

[Stefan Wikstrand, executive]

So welcome, everyone, to the G5 Entertainment Q2 Earnings Call. [Operator Instructions].

With that kind of short info, I will hand over to our CEO, Vlad Suglobov.

[Vladislav Suglobov, executive]

Thank you, and good morning, everyone, and welcome. So I'll start with giving you some of the highlights from this morning's report. And revenue in the quarter was SEK 331 million, which is 4% lower than last year in Swedish krona and about 10% lower in USD terms. Q2 is a seasonally weaker, slower quarter, and revenue in USD was down about 5% sequentially from the first quarter this year. Our sequential performance from Q1 to Q2 is not far from the negative performance of the overall market. Year-over-year, we do, however, slightly underperform the negative trend of the market. We are currently not beating the market performance. And we believe that releasing new games could help in this regard, and we are working on bringing new games to the market. And we'll talk about it more in a minute.

Our own games stood for 71% of revenue in the quarter compared to 70% in the same period last year. Our new generation games, which are games released in 2019 and later, generated SEK 198 million, which is down 2% year-over-year and down 4% sequentially. These games stood for 60% of total net revenue, up from 57% last year. Sherlock continues to be our revenue highlight. The game stood for 24% of our total net revenue in the quarter compared to 19.5% a year ago. The Jewels family of games continues to be a stable performer and stood for 31% of the group's total net revenue in the quarter.

G5 Store now stands for about 10% of net revenue, and that is up from 4% a year ago, and it continues to grow fast. So the favorable platform mix with the increasing share of revenue coming from G5 Store continue to help raise the gross margin to a strong 67.4% compared to 66.2% a year ago. UA spend in the quarter was 19% of revenue, and that's down from 35% of revenue that we had a year ago because of the boost -- UA boost that we did back then, and our current spend in the quarter, 19%, is in line with our communicated range. So increased R&D was driven by lower capitalization due to the new development funnel and process we adopted in the third quarter last year and because of increased amortization.

So I'm very glad to report that we are on track to release 1 or maybe even 2 games globally in the second half of the year. It's likely to happen towards the end of the year, and it's very likely that any financial effects from this will only be noticeable in 2024. However, all in all, we had a strong second quarter, and we continue to have a strong position. We paid out a record high dividend of SEK 64.5 million. We repurchased 65,000 shares for SEK 13.1 million, and still, we ended the quarter with a strong cash position of SEK 173 million. We are profitable, have a strong cash flow. We remain debt-free, and we intend to continue to be in this situation through the end of the year and onwards.

Now let's turn to the next slide and dig into the G5 Store. So we are very glad to see that the G5 Store continues to gain momentum. It now accounts for 10% of total net revenue, which, as I mentioned, is up from 4% last year. As you can see from the chart, quarterly net revenue for G5 Store has been increasing steadily. And in Q2, revenue was up 106% year-over-year and 17% sequentially. And these numbers are in USD terms. Also, G5 Store reached another all-time high in monthly revenue in Q2, and this trend continues into Q3, specifically in July. We only have July so far.

G5 Store is our direct-to-consumer channel, our most profitable revenue stream, and we are well positioned to grow this even further. Some peers report that up to 25% of their net revenue is coming from their direct-to-consumer channels. And we can see why G5 Store eventually couldn't be that big. That would, in turn, increase our gross margin as processing fees for the G5 Store are low single digits compared to the 12%, 30% -- from 12% to 30% third-party application store fees. All in all, this makes us see continued potential for growth and increased margins as well as reduced dependency on third-party application stores.

Now let's turn to the sales figures. So revenue in the quarter is evidence of the new stable normal we alluded to when we reported Q4 about half a year ago. We've said that this is representative of the new normal, which we expect is going to last through 2023, and that's what we are delivering. Revenue of SEK 331 million, as I mentioned, down 4% year-over-year, but revenue for the first 6 months of the year was exactly the same as 1 year ago. Our own games stood for over 71% of revenue. That's a slight increase from 69% a year ago. Our main growth drivers continues to be our new generation of games, which is our biggest segment of the portfolio at 60% of revenue, up from 57% last year. Sherlock stood for over 24% of revenue and it was up 20% year-over-year in SEK and I think 12% or so in USD.

And finally, monthly average gross revenue per paying user was a stable USD 62 relatively unchanged. So we're looking at basically a continuation of the same trends and a stable new normal performance.

Now let's look at earnings and margins. We are maintaining a strong gross margin, thanks to fast growth of G5 Store and increasing percentage of revenue derived from own games. For the quarter, the gross margin was 67.4%. EBIT was almost SEK 39 million, and the EBIT margin was 12% almost. So low EBIT margin in Q2 last year was a consequence of the UA boost made during that period. Also, the profitability was impacted by the change in net capitalization from last year. It was minus SEK 12.6 million in this quarter compared to positive SEK 11.6 million a year ago, a consequence of the change in the development funnel made in the third quarter last year. So this difference of about SEK 24 million explains the perceived reduction in the normal level of quarterly earnings that you see in the chart on the right from previous years. So that's all that is. UA was 19% of revenue within previously communicated range, a decrease from 35% due to the UA boost last year.

Now let's turn to the cash flow and our cash position. We continue to generate cash, thanks to stable and high cash conversion, and we have a strong cash position. As mentioned before, our cash flow is actually better than earnings as net capitalization is an increasingly negative amount, as you can see on the chart on the right. R&D expenses in the quarter increased by the same net capitalization difference amount. Again, this is a result of the change in the accounting treatment of new games before the global launch as we no longer capitalize expenses on these. This change was made in the third quarter last year. And while it affected our earnings negatively, it didn't have any effect on our cash flow, which remains strong.

Despite buybacks of SEK 13.1 million and the highest dividend in the company's history of SEK 64.5 million, cash at the end of the period was strong, SEK 173 million.

Turning to a brief outlook for the rest of the year. We have started the year and we continue the year in line with the new normal that we've alluded to previously. For the second half of 2023, we expect continued stability. We are now on track to release 1 or 2 new games globally in the second half of the year. The goal of such release would, of course, be to subsequently scale revenue from such a new game or games and achieve positive effect on the top line. However, any potential financial impact of the new releases will not be seen before 2024. We'd like to be clear about that. And there are new releases that are likely to happen later in the year 2023. So don't expect an effect before the next year. Usually, it takes time to reach meaningful revenue for the new game.

We continue to work on new games and these global releases. And we also work on new games for the release next year. We have 7 games in soft launch development and iterations, I think 2 on the way to soft launch, 5 in soft launch, iterations, and we have 36 new game ideas we are evaluating and working on. So a lot of stuff in the pipeline. There's not going to be a shortage of great ideas, but we are filtering through them to find the ones with the best potential, and we're bringing those to the market.

Increased revenue from G5 Store will fuel growth and further improve our gross margin and profitability. G5 continues to have a disciplined approach to cost structure. We also have some decrease in expenses due to the integration of generative AI tools in the development process, and this helps our margins. We intend to maintain a stable UA spend in the communicated range of 17% to 22% of our revenue. Our cash position remains strong, and we will continue to strengthen our balance sheet through strong cash generation. We remain committed to dividend payments and, of course, share buybacks.

I would like to end by thanking you for following G5 but also thanking the whole G5 team for their outstanding efforts. This concludes my presentation, and we'd like to open the call for questions.

[Stefan Wikstrand, executive]

[Operator Instructions] We have 2 hands here. We'll start with Simon. Give me a second. Hi, Simon.

[Simon Jönsson, analyst]

Can you hear me?

[Vladislav Suglobov, executive]

Yes, there's a bit of an echo, but I think we can hear you.

[Simon Jönsson, analyst]

Okay. Great. So on the outlook, you expect stability breaking that down, is it all games being stable or do you expect Sherlock to compensate for lower sales in Hidden City, for example? Or how should we think? Any color on your thoughts here is appreciated.

[Vladislav Suglobov, executive]

So we certainly see that our new generation of games is becoming a little bit more mature. And as they become more mature, there's a little bit more seasonality that you can see in their sales. We think -- well, my view is that we are at kind of a seasonal low right now in the players' engagement. And the -- from here, it's sort of going towards the highs of the high season at the end of the year. So we expect some tailwind from that and we continue working on our games, existing games to bring new interesting features, and we continue working on our marketing.

So whether we will achieve some growth from here seasonal or through improvements to the games or through the growth in G5 Store, or we will remain about the same level of revenue. To me, this would be relatively small change from the stability over the first and the second quarter. So I don't expect any big movements. There's probably going to be some reallocation within the portfolio as G5 Store is growing, it's probably going to take a higher percentage of total between new generation of games and older games. New generation of games continues to gain the share of revenue, whether it's going to be Sherlock, which until recently was the fastest-growing game or it's going to be some other games because we had some positive developments on some smaller games as well, it remains to be seen. But I don't have big expectations for the growth that we can deliver without new game releases. So we're very focused on bringing more games to the market.

[Simon Jönsson, analyst]

Great. Just 1 more for me here. The incremental growth in D2C revenues up 17% quarter-over-quarter. Where does that come from? Is it mainly Windows players, PC players converting? Or are you also seeing some conversion from Android and iOS?

[Vladislav Suglobov, executive]

We do see from the top of my head, around 25% to 30% of players converting from platforms other than Windows. But most of the players we acquire and convert from personal computers. Then there is actually part of G5 Store revenue that occurs on Android and Mac because we also have -- G5 Store supports Android, side-loading and Mac, and this part -- this absolute revenue in absolute terms is growing as well, but it's a smaller part. So most of G5 Store revenue comes from personal computers. But we also see that about 25%, I think, 30% of people that come to G5 Store on personal computers, they convert from other platforms.

[Stefan Wikstrand, executive]

Hjalmar?

[Hjalmar Ahlberg, analyst]

Yes. So kind of a follow-up on that question on stores, if you launch new games from here and then maybe revenue from that to 2024. Would that kind of initially go to outside your own store and then convert to own store? Or I mean how would the trajectory of own store growth be impacted from new game launches?

[Vladislav Suglobov, executive]

Yes. Thank you for this question. So we still aim to launch games on application, on third-party application stores. And I mean, we certainly don't see us not launching games there. It could be that we're going to launch on third-party application stores first and then soon afterwards, we're going to launch on G5 Store. Maybe we'll do it at around the same time. I think for us, it's going to be more of a question of how can we do it sooner because conversion to other platforms takes time. And usually, the reference platform, at least for now is not personal computers, but mobile, where I think there's more opportunity for scalability even though we have really good results in G5 Store.

But also, this may change, right? As G5 Store becomes a bigger and bigger channel, we obviously start asking ourselves what should be the first platform where we launch a new game. But for now, the process remains that we try to select the best performing games on third-party stores. And that selection process also selects the best games that would perform best on G5 Store as well. Usually, we see that games that perform best on third-party application stores, they are also the ones that perform best on G5 Store.

And then the question is which market we want to go to first, which market we want to go to second. I think for now, we're going to do it the old way. We're going to start with 1 of the major stores, expand to others and then add G5 Store or at best, we're going to do it at around the same time.

[Hjalmar Ahlberg, analyst]

It sounds good. And regarding your game launches, I mean, you had a few ideas in iteration and close to soft launch. Is it something that you see looks promising now that, that makes you sure that you will be able to launch something before year-end? Or is it more speculation, so to say?

[Vladislav Suglobov, executive]

We have a particular game that we believe is the strongest of all the games that we've been developing. As I mentioned, we have about 7 games, about 5 in soft launch iterations. So out of these 5, we've picked out 1, which looks the best. And our intention is to launch this game globally before the end of the year. And then we are -- there are 2 more candidates for the second release. We'll see if we think they are good enough to be globally released. It can happen, as I said, it's going to be 1 or 2 this year. It could be that 1 of these games gets moved to 2024.

Again, the purpose of this new development process was to allow time to iterate several games in the soft launch period. And out of these games, pick out the ones that perform best and then release them. And another side effect of that is that we will not be releasing games which have -- which are not the top of what we can do. Because before that, we sometimes we just release the games, pretty much every game that we would put together, we would release globally. Now we are doing the selection process. And that's supposed to help us have fewer games that are not scalable well. And there's another part of that process, which aims at improving the quality of games from the inception of the idea, all the way to the soft launch through the iterations, and we'll see how it works out. But the game that we have set for the global launch this year looks really good compared to the games we've released before.

That said, it's a new process for us. So we are very excited that this game is looking good in our iterations and testing. But that's going to be the first 1, right? So I don't want to over promise as the process might need to be calibrated and so forth. We would be excited to see how well the game scales when we actually release it. So it will be very interesting for us as well. But we like the game, and we like what we see so far. And it's going to be globally launched before the end of the year. That's our commitment.

[Hjalmar Ahlberg, analyst]

Okay. Sounds good. And then a question on your new development funnel or the capitalized development costs. So if you launch this game globally during Q4, then we should see capitalized development costs coming up, I guess, and is that correctly understood?

[Vladislav Suglobov, executive]

I don't think development costs are going to go up, at least not sharply. We do have resources to develop this game. We have a large pool of resources that's working on new games. And when we globally launch a game, and if we see good results and good potential, we have enough resources to allocate from the existing resources to scale.

[Stefan Wikstrand, executive]

I think the capitalization thing is in the balance sheet.

[Vladislav Suglobov, executive]

Capitalization. I'm sorry. Yes, yes, that will happen. Yes. So that will be a boost for profitability. But I mean, assuming the game will start performing well, and we will see that, that will be a well-earned boost to profitability, right? It means that we've proven that this game is not a write-off but it's an asset -- a capital asset that we can capitalize into. That's the logic.

[Hjalmar Ahlberg, analyst]

Yes. Good. And then maybe a final question, Sherlock. I mean, it's still a good contributor on your revenue, but maybe growth has kind of plateaued a bit. Do you think this is kind of a temporary plateau and there's more upside potential? Or how should we view this game from here?

[Vladislav Suglobov, executive]

Yes. As I said, I think it's more mature than when it was released in early 2020. So in 6 months, we're going to be celebrating 4 years on the market. So now it's 3.5 years old. It's a little bit more mature. And so we're certainly seeing it's not at our -- at its peak revenue levels right now on a monthly basis. However, we are in the middle of summer. So it can be seasonality and more pronounced seasonality and a blip on the trajectory of continued growth or continued slower growth or maybe we kind of get stuck here. And I -- it's hard to know right now. The team is working to make the game better and they're looking at it and they're coming up with ideas on how to fix this plateau and continue moving forward.

In G5's history, several times, we were able to do that when the situation arises, but also many times that we were not able to do that. Sherlock is among our strongest games that we've had. So I want to be optimistic. And we certainly will keep trying before we will say that the game has peaked and maybe we should be working on something else rather than continue finding ways to reinvigorate the growth on this one.

[Stefan Wikstrand, executive]

We have some questions in the Q&A box. So the first one, last year, you had 2 quarters of higher user acquisition costs amounting to roughly 30% above your steady normal on a yearly basis. So how has this translated into increased sales in the last 12 months?

[Vladislav Suglobov, executive]

Well, we certainly saw continued and also improving growth, specifically during the time when we did the boost. And then with the help of the boost, we were able to go sort of growing through the rest of the year and even in the first quarter this year. And Sherlock is still up 12% year-over-year to the period when we actually did the boost last year. So it translates in a sense that we've acquired a lot of revenue that will gradually come in over an extended period of time. And we are seeing that happen. Obviously, the idea of the boost was to test whether we're missing something with the growth trajectory and can we change the situation dramatically. We were not able to change the situation dramatically, but we did contribute positively to the growth of the game.

[Stefan Wikstrand, executive]

I think I will jump to another question. What's your view on operational metrics with MAUs and DAUs down -- well, quite significantly because that is tied to the UA boost. I thought I'd take that now.

[Vladislav Suglobov, executive]

Yes. So first of all, we are comparing to a high base last year because these metrics -- some of these metrics were inflated by the UA boost. So that's 1 thing. Even without that, the metrics are actually on a kind of a declining trajectory, some of these metrics. And when we look into it more kind of in more detail, breaking it down by games and platforms, what we can see is that just to give you an example, first, the conclusion is that we are losing audience or we're losing new installs where they don't really matter. And we maintain users and installs where they matter.

So for example, G5 Store has a web app, right? You can play Jewels of Rome or Sherlock in the web -- on the web page. And that's a very easy place to acquire users in the sense that any user coming to the site, clicks on it, and starts playing, and that counts as an active user. However, it's not the perfect user experience because it's a web app, it's quite slow and has many glitches and issue. So we figured out that looking at the numbers that, that is not the best place to drive users to. So we kind of re-prioritized the downloadable version. As a result of that, we've gained a limited number of additional downloads to our downloadable version because the barrier there is large. You have to click, you have to download, you have to install. You have to start playing compared to the web version. However, we ended up making more money from that than sending people to the web version.

So in essence, we've exchanged a lot of user statistics to a reasonable incremental revenue without any negative effect. So when we break it down by examples such as these, we usually find that where downloads and users disappear didn't really matter.

To give you another example, we've discontinued active support of a couple of games, which we -- which, to be honest, we're not profitable for a long period of time. So we did it last year, and we also discontinued user acquisition for these games. And these games, they actually drove meaningful organic downloads. However, as a business overall, they weren't making money. So now that we withdrew user acquisition for these games, organics for these games also fell down. But in terms of profitability, these games actually are now more profitable than before because we don't spend money on continuing development of them -- of these games.

So it's a complex picture. I think what's telling is that the revenue is stable, right? So we're losing a lot of -- so the metrics are going down, but at the same time, revenue is quite stable. And if you think of the audience composition for any given game, there's 10% of people that are paying and 90% of people that are not paying, not to mention that they're even paying different amounts. So you can easily get rid of a large number of users and nothing is going to change for you. Financially, maybe you're going to be more profitable because you didn't need to pay to attract those users in the first place. So that's my view.

On the other hand, obviously, this cannot go on forever, right, the declining metrics. And so we fully understand that as an entertainment company, we need to bring new games to the market every once in a while, and we are working on that. And we'd like to see these metrics go up eventually and our solution to that is launching more great games and hopefully scaling these. That was a long answer.

[Stefan Wikstrand, executive]

Yes, we have Anja here. Anja, now we should be able to hear you.

[Anja Soderstrom, analyst]

I'm just curious, so you have implemented AI in the development process that's been helping your margins. Is there more opportunity there for you to expand on that?

[Vladislav Suglobov, executive]

Yes, there is. I think we've just sort of took the low-hanging fruit. We are actively looking into what else can be done. Most of the obvious things -- some of the obvious things we could already do. I think it's going to be an extended process of exploring what AI can do for us. And maybe also waiting for the AI to be able to do that. Because I think what generative AI can do is a little bit overhyped at times. And so I mean it can do -- sometimes in the development process, 1 thing is sometimes it can do it on a small amount of data and another thing is to consistently do it with large amount of data with good enough quality, right? These are 2 different things.

So for some tasks, like sketching something, right? You -- it's okay if sometimes it can do it. So you save some time. For other tasks like translation length which processing for games the -- or even quality assurance of the text and translations, you need very high reliability to be able to use generated AI consistency. So in some situations, we already can do it, and we're trying to do that. In some situations, we're like, okay, this is probably going to be improving. And at some point in time, we should be able to do that. And then there's another area of just some of the ideas that maybe will work here, maybe it's going to work there. And we need to work -- we need to experiment and find ways of doing it. So these experiments, they bring fruit from time to time and we incorporated in the development process. it's not a lot yet, but it's meaningful already. But I don't think it's -- I think it's going to take some time. And in a year's time, it's probably going to be more than now.

Let's move on. We have 2 more. Is it the one at the top or one at the bottom, what's the order?

[Stefan Wikstrand, executive]

We'll start with the top.

[Vladislav Suglobov, executive]

The top. Okay. So there's talks about more difficulties in fingerprinting driven customer acquisitions in the coming year due to both Apple and Google making it more difficult. Is this anything that could affect your return on ad spend?

Yes, it can affect our return on ad spend or I would rather say it can affect -- will further affect our ability to be more granular with our advertising and with understanding of what's going on. We are already working on solutions to this. I wouldn't go into the details, but we are already working. And the market is still going to be there, right? The -- these companies whichever companies are selling ads, they still want us to buy these ads and other companies. So the market is going to be there. The question is -- and needless to say, the market prices will actually stabilize on the level where our return on ad spend is exactly where we want to place it for our purposes, right? The question is then how much scalability in the games we should be able to achieve with that? And that affects all the developers.

So the market will find the balance again as it did before with IDFA. Is it a good thing for the market overall? Probably not. But there are ways of dealing with this as well. And I'm sure that there will be solutions and we will continue doing performance marketing, and we will continue finding products that are creating products that are scalable with performance marketing.

All right. Next one, your 1 or 2 new games this year, in what genre are they?

So these games are going to be in our main genres, Hidden Object and Match-3. So this is not very original in the sense of trying new things, but also after we haven't been launching any new games and considering most of our revenue comes from these 2 genres, it felt like a natural area and where we have most of experience and where we should be looking for the new games to launch. Right.

So the next question, is the game you are most positive on in soft launch internal or external?

So this game that we will bring to the market before the end of the year, which looks best in terms of metrics, [indiscernible] our internal game. But our -- the games that we've signed that are external games, they are also very early on in the process. So it's a little early to compare.

Yes. And the next question was about the licensed games as well. And as I said, it's very early in the process. So it -- I was not including that game. But -- we'll see how it goes. We can always launch more. That's why we said 1 or 2 because we have other games that we may be able to launch before the end of the year and if not, then in early 2024.

Okay, next one. When will you do a global launch in the new way? When will you do the global launch in the new way, will it have a bigger UA budget compared to earlier releases? Will the game be bigger and more content, et cetera, they have been earlier releases?

It will have enough content for us to keep up with the pace of players going through the game and adding more content. It is difficult to come up with a game which has content for 2 years on day 1. So it's going to be, as we usually do it. And I think with Hidden Object and Match-3 games, we were able to do that in a good way.

In terms of the marketing budget, so the market has changed since 2019 and 2020, we certainly will need to start at a higher number out of the gate. But also the whole point of this process with the soft launch and having the games metrics was to be a bit more certain that the game is scalable to meaningful levels. So I think this increase in what we have to start with, it's still far from a boost amount, like any big boost amounts. So it's reasonable considering the potential of the game that we are selecting for the global launch. So yes, it's going to be higher, but it's not going to be -- and yes, it's not going to be dramatically higher or insanely higher. It's going to be fine.

All right. Are there any more questions? All right, seems there are no questions.

[Stefan Wikstrand, executive]

[indiscernible] like it.

[Vladislav Suglobov, executive]

Yes. Okay. Well, thank you very much for dialing into our call and for your attention to G5. Have a good rest of the day.

[Stefan Wikstrand, executive]

Thank you.