G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2019-Q3

[Vladislav Suglobov, Co]

Hello, and good morning. Thank you for joining us today for the third quarter earnings call in G5 Entertainment. And let's have a look at the slide that talks about our revenue in the third quarter. As you can see, revenue went up sequentially about 1% compared to the second quarter of this year. It is still a decrease of 12% year-over-year. But the revenue from our older portfolio of games has stabilized during the third quarter and then Jewels of Rome was a good additional contribution to the top line in the third quarter. And so we have a resulting growth, although not very big. But the business -- the part of our business that is generated by own games increased to 40% of total revenue. And in terms of the absolute revenue from owned games we were very close to the all-time high, if not at the all-time high, depending on the currency in which you're looking. And Jewels of Rome that we have launched in June on iOS, I believe. And then in the third quarter, we released it on all the other platforms. This game went from officially the -- I think, 0 before it was launched to currently being #2 by monthly revenue in our portfolio and #1 by revenue in -- among owned games developed by G5, and that happened only in a few months. So we are quite excited about the performance of the game so far. And another contributor to the growth this quarter was Homicide Squad, which continued to grow as well. It's a slow-growing game, but it's very steady and continues to grow every quarter. And as I mentioned, Hidden City and Mahjong Journey stabilized in the quarter, but they went down in revenue compared to the second quarter but during the third quarter, they stabilized. So now we have a situation where we go into the fourth quarter, and we have good momentum with Jewels of Rome, and we have stable revenue from older games, which is the majority of our revenue right now. So I think it's a good moment to continue growing sequentially, basically in Q4, and that's our ambition for the fourth quarter to grow sequentially, and our focus is going to be on that.Let's go on to the next slide and talk about EBIT. And EBIT in the third quarter was negative. It was an EBIT margin of minus 1% almost. But there was an improvement in the gross margin, quite a dramatic one, but part of that at least is due to the increase of the share of revenue from the team from own games. But we had really dramatic spending on User Acquisitions during the third quarter, and that was an increase compared to the last year as well. So the reason for that was that we certainly wanted to change the trend for the year, as I've communicated in the beginning of 2019. We were going to focus on earnings in the first half of the year and kind of try to refocus on growth again in the second half of the year, and that's what we were doing. So we really invested in bringing in more users ahead of the fourth quarter to give the best possible shot to Jewels of Rome because we saw quite spectacular early performance. And we also wanted to really stabilize the Mahjong Journey and Hidden City, and that was accomplished. A number of other things that we wanted to experiment with new media and some other things in User Acquisition that we've planned on doing. We also decided to do during the third quarter since we were already quite aggressive with User Acquisition spending. So we will get this money back, eventually. Our investment in User Acquisition remains conservative enough that we gradually make any money that we invest in User Acquisition back over the next few quarters. So it's -- this is the investment into the growth of the user base and into the growth of the user base before the strongest quarter of the year, which is the fourth quarter. So we decided to do it this year in Q3 to kind of prepare a larger audience and give the best shots in the new games compared to what we did last year. So as we go into the fourth quarter this year, we actually expect to be profitable in Q4 already. So this negative margin, it's a short-term thing for us and the ambition is to grow out of this situation, and we expect this to be profitable in Q4 already. Right. Let's talk about the cash flow. The next slide. So the cash flow was good. We had some positive movements of the cash flow, like the repayment of corporate tax in Malta. And as you can see, the cash position at the end of the quarter was even better than in the second quarter of the year, and remains at not too far from an all-time high level. And we continue to be financially stable, sustainable, and we continue to manage the company in a very responsible way. If we decide that we want to go really aggressively on User Acquisition and maybe have a negative margin in the quarter, that's something that we would do only if we know that we can afford it. And it's -- we -- this is a long-term gain for the company. We are investing for the growth, both in terms of the product development and in terms of marketing in the third quarter, and we would only do that if we know that in a long run this is sustainable, and we can turn this around fairly quickly. So cash flow from normal business operations remain stable and healthy. We are still debt free, and everything is business as usual in this sense.And let's move on to the next slide and talk about what's going on and what you can expect from us in the near future. As I mentioned, we are cash flow positive. We're debt free. We aim to be profitable in the fourth quarter. We aim for sequential growth as well in Q4 compared to Q3. Hidden City remains a very popular game. It maintained its audience, monetized its paid audience really well, a really loyal audience that stays with us for a long time, and will continue to do so. And there's a lot of money to be made, and you would see a lot of profit to be made with the game going forward. At the same time, we -- as I mentioned, are close to the record level of revenue with our only internally developed part of the portfolio. In terms of the percentage of business into an all-time high of 40%, we haven't seen these level. I don't even remember when we have this level. So it's quite an achievement. And I think in Q4, this percentage is going to continue to climb up, unless we can achieve better results with Hidden City also. But in any case, it should be a sequential growth for own revenue in absolute terms in Q4. And I think Jewels of Rome has really good momentum. Last quarter, I was kind of cautiously optimistic about the game. I think that the game has certainly delivered during this period of time. It's the highest lifetime value game in our portfolio. And I'm quite optimistic about what we can achieve with this game. It's -- fourth quarter is really -- will really be interesting in that sense. So we'll see how it performs during Q4. Homicide Squad continues to grow nicely as well. So it's not a big -- it's not a fast grower, but it remains another contributor to the dynamic in the owned games that we have. Match Town Makeover, another match-3 game that we have released this year. It's still in the soft-launch mode, and I think there's still more work that needs to be done with this game. So it will certainly stay within the soft-launch mode for the full duration of the 6 months that we allow for it. And it's not yet ready, it should be released worldwide. We have 2 more games that we wanted to release before the end of this year. It may still happen, but they may also be postponed towards the first quarter of 2020. This really doesn't change anything for this year because they would still be in soft-launch even if it releases this year. So they would not be able to affect the top line or the bottom line for this year. And in addition to these 2 games, we have 1 game that is over, but we are remaking it quite significantly. It may still be released in 2019, and we have 5 more games in the pipeline for 2020. So altogether, we have about 7 games, 8 games in front of us for release this year and the next. It's more than we've had in a while. So I'm quite excited about the potential of these games. And for us, it still remains a numbers game. It's very difficult in games to create a game and be certain about how well it will perform. So you have to make a number of shots on the goal to score a game with a positive outcome or a significantly positive outcome. So I'm excited that we have so many games lined up, and I'm excited about the success that we are seeing with Jewels of Rome. So I think we're in a good place when it comes to the product pipeline and the potential for the next year. We have -- I think we've added a few more people to our development teams during the quarter. And the continued strong financial performance of the company allows us to continue to dedicate resources to new games and existing games. But we started to be -- actually started about a year ago, but we were much more selective now when it comes to keeping resources on game projects for long period of time. I think over the last year, we have stopped working on about 7 games that we're not showing growth for quite some time. So those resources were reallocated to working on games that are showing growth or to working on new games that can be growth points in the future. So we're diligently managing our development teams and resources to really focus them to where, we believe, we can find the new growth points for the company. And it's quite a lot of talent -- quite a lot of development talent and quite a number of teams that we are maintaining simultaneously, which allows us to have so many games in continued evolution and also in production for the next year. So it's going to be an exciting year for us, I think, the next one. But this one, too, we'll see what we can achieve in Q4. So also -- but we are really trying to build on our expertise on the technology that we are quickly accumulating in our own development. And I think we are gaining a lot of knowledge from the successful launch of Jewels of Rome. So I think we are currently really improving our understanding of how match-3 genre works, and that will go to many new games that we will launch next year. So very, very excited about that. Well, I think it sums it up for the third quarter. Please let me know if you have any questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Oscar Erixon at Carnegie.

[Oscar Erixon, Financial Analyst]

A few questions from me. First of all, I wanted to start with the high User Acquisition cost. Clearly, you've seen a chance to grow here in the second half of the year. Can you speak a little bit about the -- what the competition means for User Acquisition costs and what you have to change to adapt to that?

[Vladislav Suglobov, Co]

Thanks for the question. Well, I don't really want to go into a lot of technicalities. But I think the User Acquisition ecosystem has advanced and moved on quite a bit from the times when we were aggressively scaling Hidden City. And I think what we were doing recently is kind of doing some sort of audit of our practices in that regard and where the market is and where we are, and we've identified certain areas where we can improve. And it's kind of a good news. It's good to know that you can do better and good to understand where you need to do better and where it needs to be better and how you can do it. So we spent some time there. And then with the -- let's put it this way, with the prices of User Acquisition growing up gradually over time, there are different approaches to game marketing that become available. So we're quite excited to try some things that didn't make sense before, but that we can see can be working. And so we were basically kind of rereviewing our processes for User Acquisition and catching up to where the market is and looking at with -- looking at it with how would we do it, if we just started doing it. So trying to kind of forget our experience with how we did it a few years ago, and really only looking at where the market is right now and what processes and what tools we have to have now to the competitors. I think we're already seeing some positive results. There is still some work ahead of us. And it's -- again, it's good to see that we understand where we can be better and where we can improve, and we'll continue doing that.

[Oscar Erixon, Financial Analyst]

Okay. Great. And I mean clearly, it provides some results here in Q4 with strong sequential growth in October. Can you just discuss -- I mean, was September the strongest month in Q3? I guess it likely is.

[Vladislav Suglobov, Co]

I don't have numbers in front of me, but yes, I think it was, or maybe it wasn't. No, maybe not. Sorry, I -- I'm kind of already -- it's actually November that is on my mind already, and it's been quite a while that I was looking at October. So I don't really remember.

[Oscar Erixon, Financial Analyst]

Okay. No problem. And Jewels of Rome, obviously, had a really strong start here since the launch in June. You mentioned it has good momentum also going into Q4, how -- I mean compared to, for example, Homicide Squad, is this a game that is possible to grow faster? And how big do you think it can get over the next few quarters?

[Vladislav Suglobov, Co]

Yes. So I just looked it up and September was actually kind of a low point of the third quarter, so just to answer your question. Yes, once again, look the Jewels -- Homicide Squad has been around for 4 years or more now, and Jewels of Rome did not exist just a few months ago. And in these few months, Jewels of Rome went from 0 to a game that makes more monthly revenue than The Secret Society than Mahjong Journey. So it's #1 by revenue for us now other than -- it's #2 after Hidden City, #1 among own developed games. And I believe that the largest revenue day of the game was in November. So I think there's -- the game, obviously, is growing pretty quickly, for us. How far can it go? I mean, I don't know. It's difficult to make predictions, especially when it comes to the future. But we have -- I think, Jewels of Rome has the best lifetime value on a per user base that we are seeing in our whole portfolio. So that makes us optimistic. But that said, the market for User Acquisition in the match-3 genre is pretty competitive, as you can imagine. So we have to find a strategy to acquire users into Jewels of Rome, which I think is we did, and it's working. But it's just difficult to say how far we can go with it. I'm optimistic, but we will see soon enough. I think that what makes me quite excited with this game is that we just had our first ever monthly event in the game. It was a Halloween event, it's not over yet. And the reaction of users is very positive, and we are going to have an update for the game, I think, with 2 more locations, hundreds of new levels. And this is coming out in November. And then in December, we're going to have our first-ever Christmas event. And usually, these events, they work really well and they bring the games' revenues to the new level, especially when the game is performing really well and growing and still in the early phases of gaming audience. The audience for the game has been increasing steadily as well. And the game is performing really well in our main markets. I think most of the revenue currently for Jewels of Rome is coming from the United States. But we are acquiring in other markets as well. We started acquiring in other markets as well. So -- and it was pretty good actually there. So there, I would say, we have quite a potential in other countries that we have just started tapping into. And so we'll see. It looks pretty good. We have good understanding of how the game works and why it attracts people, and we know how to develop it going forward. I think a lot of what we have achieved with our previous games goes into further developing this game, and we don't have to do too much research because this is a game that is, on a certain level, similar in the structure to our previous big hits. And so we can use our experience for the LiveOps, with the game monetization and balance in this game quite efficiently. I hope I answered.

[Oscar Erixon, Financial Analyst]

Yes, that was perfect. And one final question from me before I leave it over. You mentioned in the presentation that you expect a positive margin in Q4 despite high investments in UA. Is it fair to assume that you are sort of targeting breakeven EBIT now in Q4 as you did in Q3?

[Vladislav Suglobov, Co]

By -- I wouldn't be able to give you more precise numbers. But what we are seeing is that even with the quite ambitious level of User Acquisition spend that we have, it seems like the revenue is -- and the audience and the revenue is responding well and developing positively. So I think we will be profitable. But just to understand, we are obviously pursuing growth in the second half of the year. If we see some amazing opportunity for growth that we just cannot ignore, we may decide to get even more aggressive on User Acquisition. So it will be a balance between the growth and the earnings margin but I think it will be more balanced in that sense than the Q3. So for the lower earnings margin will be compensated by higher growth, and we -- if the profit margin is going to be low, then it probably means that we saw the opportunity for even more growth. So it's hard for me to give you more specific information because we're still early into the quarter. And it's only been 1 month. There's still a lot of question marks about November and December, obviously, which hasn't even started. So I have to leave it at that. But my feeling is that we're going to be profitable in Q4. And then -- and that we do not have to be negative on EBIT margin in Q4, that we can just be profitable and cash positive.

[Operator]

And the final question comes from the line of Jesper Birch-Jensen of ABG Sundal Collier.

[Jesper Birch-Jensen]

First question is in regards to the geographical mix, where we see that Europe has increased to 26% of net sales, whereas it -- historically it's been around 15%, and where we see Asia declining in tariffs. What's the main reason behind the shift in the geographical mix?

[Vladislav Suglobov, Co]

Yes, thank you for the question. Well, I think what happens usually that this acquisition is looking for where they get the best return on the money that they spend and the revenue breakdown basically reflects the situation, whatever it is. I would think that Jewels of Rome -- because it's doing so well in North America, probably contributed to U.S. and Canada making a larger share of revenue this quarter and kind of taking away from other regions. But this may change when we decided to scale the game more in other parts of the globe. So really, I wouldn't bring too much into it other than -- this geographic distribution is driven by User Acquisition and their discovery of where they can acquire users profitably. And that's the results of that we've seen in this chart, please.

[Jesper Birch-Jensen]

Okay. I also have a question. You mentioned in your report that you plan to introduce advertising into our games. When are you planning to roll this out? And how large a contribution do you think it could potentially have in terms of revenues and earnings?

[Vladislav Suglobov, Co]

Yes. We expect to do the initial launch within the next few months and sometime during 2020, we will probably have it integrated with -- given the positive outcome of the initial experiments, we can have it integrated with all of our portfolio in sometime in 2020, I would say. With regard to how much extra revenue it can bring in, I know it can be different, depending on the company. Some companies say 30%, some companies say 5%. I personally think we can be within 5% to 10% extra revenue, which if we can achieve that, that will be basically profit. So it's almost all of that, it's going to be an additional earnings margin. So it's quite exciting to be able to do that. So I'm just saying, we'll be doing that because it seems that the marketplace for advertising on mobile has finally developed to the point where it makes sense for us to participate, and maybe we're doing a little bit late, for better late than never. So we'll be doing that, and we aim to get our revenue streams from this market. And I think in the long-term, because of how much time people spend playing the games and how much attention, how focused they are while doing it. There's a lot of advertising potential in this market. And we know, even from our games because we do cross-selling, which essentially is advertising. We know that players are -- a lot of players are okay with watching advertising. Sometimes they even -- there are ways to integrate advertising that makes people quite happy to actually watch the advertising instead of paying it to the game if it helps them progress through the game. So this is a very -- quite exciting that this market has developed so much. We ran some experiments about 2 years ago with advertising. We weren't too happy with the results back then. But everything we see shows us that now is the good time to start doing it.

[Jesper Birch-Jensen]

And my last question. We obviously saw a large improvement in the gross margin mainly attributable to the royalties that you paid, which reduced from 15% of sales to around 5%. What's the main reason behind the decline? And -- because you mentioned that the license portfolio declined slightly, but it seems like the rate -- decline in royalties is very large. Can you just -- if you could just expand on that, that would be appreciated.

[Vladislav Suglobov, Co]

Got it. Basically, it has to do with marketing, and it has to do with the way we and the developer think about the development of the game going forward. And the exact terms between us and the developers are covered by confidentiality, so I won't be able to go into much detail there. But I would just say that we have great relationship with the developer. And they're very strategic and long-term about the future of the game, and we are as well. So I think we understand each other really well. So we have reached certain agreements, which resulted in what you're seeing. And unfortunately, I can't go into too much detail about it. But I can tell that we'll be a little bit more back to normal more likely in Q4. But -- I guess compared to before, it could be a little more unpredictable into the future because of the way our relationships are arranged.

[Operator]

And as there are no further questions on the line, I'll hand back to our speakers for the closing comments.

[Vladislav Suglobov, Co]

Thank you for joining us. And this concludes our call. Thank you very much.