G5 Entertainment AB (publ)

STO:G5EN

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, welcome to the G5 Entertainment Q3 Report 2020. Today, I'm pleased to present CEO, Vlad Suglobov. [Operator Instructions] Vlad, please begin your meeting.

[Vladislav Suglobov, Co]

Thank you. Welcome, everyone, and thank you for joining us today. It's the Earnings Call for G5 Entertainment Third Quarter 2020. My name is Vlad Suglobov. I am the CEO of the company. I also have Stefan Wikstrand, our CFO, on the line with me for tricky financial questions. And we'll take about 15 minutes to go over the presentation of the third quarter results, and then we will open the line for questions and answers.And let's go on to the Slide #2. And I'd like to summarize the quarter by saying that we've continued to deliver on our strategy. And even with the third quarter being seasonally weak and lockdowns being eased in many countries, our strategy of seeking organic growth paid off, and sales rose 10% year-over-year, while at the same time, reaching all-time high earnings and earning margins. Based on the strong development of our owned games, we achieved record profitability in the quarter, both in absolute and relative terms. Our EBIT margin hit an all-time high of 16.1%, and EBIT was a record SEK 53.7 million. With 62% of the total revenue coming from our wholly-owned games, up from 54% in the second quarter, and our profit margins at record levels, we have clear evidence supporting our strategy. Overall revenue from our portfolio of owned games created from scratch by G5 developers surged more than 72% in the third quarter and 2% sequentially from the second quarter despite the USD exchange rate impacting negatively. And since we don't have a lot of sales in Swedish krona, adjusted for currency exchange rates, the sequential growth in owned games was actually 13%, much stronger than 2% that we see when you look at the SEK figures.The newly released games, Jewels of the Wild West, Jewels of Egypt and Match Town Makeover, were the main contributors to the sequential growth in owned games during the quarter. And the owned games continued performing well going into October.We are continuing to launch new games at a higher pace than ever before. In the quarter, we made global releases of the games, Hawaii Match-3 Mania, Crime Mysteries and Pyramid of Mahjong. We also made a soft launch of the game Sherlock: Hidden Match-3 Cases, which was released globally after the end of the quarter. Our high launch pace is the payback from previous successful investments in our development teams. In addition, we have 1 new game in the pipeline for release in the fourth quarter this year. In total, that means we will have launched 8 new titles in 2020, on top of the 5 titles we have launched in 2019.Q3 is a seasonally weak quarter, as I mentioned. However, our strategy of seeking organic growth based on the development of our owned games continue to pay off. New games are built on previous technology and gameplay foundation with an emphasis on engaging story lines and immersive meta-mechanics as we have solid understanding of players' expectations. We have high expectations on the success of our new games. We are quite happy we have managed to release so many games in the third quarter, and they will be able to contribute to the results of the fourth quarter, which is ahead of us and going forward as well.During the quarter, encouraged by strong growth in our games, we continue to strengthen our user acquisition teams. We have put a lot of effort in improving efficiency in our user acquisition spending, and we are spending our money wisely, which is visible in our improving margins. We saw also improved monetization with monthly average gross revenue per paying user up 31% year-over-year and reaching $60. This number reflects 2 things: first, the continued growth of higher monetizing match-3 games as a percentage of our revenue, and improved quality of the audience that our user acquisition attracts due to improving efficiency of the tools and processes that we put in place there.We remain financially healthy and strong. We are debt-free profitably and highly cash flow -- cash generative, sorry.Now let me talk about these figures for the third quarter a little bit more and move on to the next slide. And we'll start with sales. Revenue was SEK 332 million, which is a 10% year-over-year increase compared to 2019. Our owned games continue to grow while the licensed portfolio share is shrinking. The sequential increase for owned games in SEK, as I said, was 2%, but the real sequential growth adjusting for FX was a stronger 13%. Owned games increased to 62% of total revenues, which is a clear improvement from an already strong second quarter when our games stood for 54% of revenue, and even more impressive, comparing to the third quarter in 2019, 1 year ago, where owned games represented only 40% of total revenue. It is worth adding that for the new generation of games, which is games released in 2019 and 2020, revenue grew an impressive 425% year-on-year in the third quarter.Advertising revenue grew every month of the quarter as well, but still remains below 1%. We are taking a cautious approach here. We don't want to distort the user experience. And while we have a good progress, we're not pushing it too aggressively.Let's move to the Slide #4, and talk about our earnings. The operating profit was a record SEK 53.7 million, and the EBIT margin was a record high 16.1%. User acquisition costs were down to 21% of revenue compared to last year, it's a decrease from 42% of revenue in the third quarter last year. In absolute terms, we spent 44% less on user acquisition this year compared to last year.Looking at the sequential development, UA slightly decreased as a percentage of revenue, from 22% in the second quarter to 21% in the third quarter. So it was in all material aspects stable between the quarters. Going forward, we expect our UA spend to be more stable than in the previous years. Specifically, we do not expect strong seasonality of UA spend in the fourth quarter. As you know, about a year ago, we have changed the management in our marketing department. And since then, a lot of work has been done to make our user acquisition much more optimal. We clearly see the effect this year compared to a year ago. The work continues, and we still have a lot to do in order to make our user acquisition process even more scientific and data-based. And our road map for the improvement in our tools is at least a year long -- I mean ahead of us. We have a long-term commitment to develop cutting-edge tools in order to achieve the best user acquisition performance. As with our cross-platform engine, G5 Friends network and other platform tools, despite a very clear practical value of these advanced user acquisition instruments, they are not put on the company's balance sheet, but the effect is visible in the trends of our UA spend and the growing profitability of the company.The EBIT margin was also positively impacted by higher capitalization rates and also by a weakened ruble and hryvnia which decreases our costs in Russia and Ukraine correspondingly. The gross margin was a strong 59%, continuing the long-term trend of expanding gross margins. Looking at year-over-year comparison, there is a decline, but the margin in Q3 last year was positively affected by very high marketing spend on license games. It was more of an outlier rather than something in the trend. So the long-term trend is for the gross margin to expand and to continue driving the expansion of the earnings margin.Let's move on to Slide #5, that is cash flow. And we had a strong cash conversion during the quarter. Our operating cash flow was positively affected by tax receivables in Malta of some SEK 40 million. At the same time, financing activities were impacted by the repayment of the short-term loan of almost SEK 42 million that we temporarily took out in Q2 to pay taxes in Malta. Financing activities were also impacted by buybacks of SEK 4.6 million. All in all, total cash flow in the quarter was SEK 32.1 million, and total cash at the end of the period was SEK 161 million, which is a record amount for this time of the year. So another record there.Let's move on to Slide #6, and talk about the outlook. All in all, I'm very proud of the strong accomplishments by the whole G5 team during this quarter. We achieved record profitability both in absolute and relative terms. We grew revenue from the owned portfolio of games and also released 4 new games to the market. So a great, great quarter in all respects. Our range of games is growing, and our -- the portfolio is more diversified than in the past, and we expect diversification to continue unless, of course, we have some really big stars in our portfolio, which will come from owned games, and that is a good thing to have if that happens. Our owned games, especially the new generation of titles, continue to spur growth, reflecting leverage our business model has in driving margin expansion. As 62% of our revenue in this quarter came from our owned titles, I'm extra proud and to me it is clear proof of a successful strategy that we've been implementing over the last few years. The increased activity in our games also continued into October. And so far this year, we have released 7 games, as I mentioned, and there's 1 more that we plan on publishing in the fourth quarter. So you could expect us to have a total of 8 new games out in 2020. But it doesn't stop there. Our development teams are working hard on games that we are going to release next year and creating new exciting updates for already released games. At the same time, we have clearly improved efficiency in our user acquisition, and we have a road map for continuous improvements there. Thus I'm confident about the future in that regard.Our teams right now are busy developing new holiday content in order to update our games in time for the major holidays this year. I mean it already happened in part, with October already behind us. We already see the signs of increased activity in the beginning of the fourth quarter. And so we really look forward to how historically strong fourth and first quarters of the year are going to turn out. Unfortunately, we're also seeing a second wave -- depending on your country, perhaps a third wave of COVID in all of our main markets. The fourth quarter is, as I said, seasonally strong, and we are releasing a lot of content to meet the players' desire to play games during such time. We are happy that we can help and provide entertainment to people during the lockdowns that are being reintroduced. And the G5 Friends network is also there and gives players an opportunity to communicate between each other during this tough times. We are happy to be of service in that regard and help our players in these difficult times. This actually concludes my presentation. And I'd now like to open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Jesper Birch-Jensen from ABG.

[Jesper Birch-Jensen]

Congrats on the financial report. A couple of questions for me. First off, I was wondering if you could rank your new games in terms of revenue contribution? I guess the Jewels of Rome is still the best-performing owned game, but how does the breakdown look after that? Do you have any flavor on that?

[Vladislav Suglobov, Co]

Well, we don't break it down by game, at least not yet. But Jewels of Rome is #1. And then actually, if you go to our website, there would be charts, games ranked by popularity there. What they're actually showing is the ranking by revenue in the last week or so. So depending on the platform, on the second position, you will likely see either Mahjong Journey or The Secret Society or Jewels of the Wild West or Homicide Squad. I mean these games are quite big and quite close in the revenue that they generate. And then it gets even -- there's even more games that are kind of below this layer. So as I said in the presentation, the revenue is much more diversified right now. There are no clear -- other than Jewels of Rome, there are no clear outliers in terms of revenue generated. I cannot say this is -- if this will remain forever. We are looking for opportunity to scale all of our games. It could be that we find an opportunity to scale one particular game more than the others. I mean our goal is to maximize shareholders' earnings. So if we see the opportunity to create a larger stream of revenue, we would go with it, whether or not it diversifies, right? If we have 1 game which is growing so much that we expect it's going to become a large percentage of revenue of the company, we would still do it because it will benefit the rest of the portfolio. And now that new games are coming from internal own development, the effect of this is going to be very strong and positive. So we wouldn't hesitate in that regard.

[Jesper Birch-Jensen]

All right. And my second question is, obviously, user acquisition was a lot lower than last year, in Q3. And you mentioned that you have a new team in place with new and improved tools. And I was just wondering if you could elaborate on what the -- a little bit on what they're doing different? Are you using different channels? Or are you targeting different users than you've done historically? Or what's driving the efficiency there?

[Vladislav Suglobov, Co]

No. They are actually going after the same users and pretty much using the same channels, but they are now doing it at a much smarter -- much more analytical and data-driven way. So it would really be a very technical discussion, so if I would go into details. But there is this a new approach, which is much more disciplined, much more data-driven, quite advanced in terms of algorithms and the predictions and modeling of users' behaviors and how they will be paying back. And so we've been working over the year to -- I think to catch up with companies that do it in a better way than we did a year ago. I don't think we are on the cutting-edge of it. But we certainly caught up with a better standard of doing user acquisitions. And from here, we have a very big road map, which should take us even further. So it's a never-ending quest for perfection and for analyzing as much data as possible in making as accurate predictions as possible and as fast as possible. It's really a -- it can get really sophisticated. And so there's never an end to the work there. I'm pretty sure that in the next year, even if we implement everything that we want to implement at this point, there's probably going to be other approaches, other interesting things that we could do and kind of new information that we can process. And also the industry is changing all the time, right? So we have to adapt to these changes as well. So there's a lot of work there, and we will continuously improve the tools going forward.

[Jesper Birch-Jensen]

My last question is in terms of converting players from perhaps your older or more popular games into your new ones. How is that going? And do you see conversion from perhaps Jewels of Rome into newly released titles through, I don't know, the G5 Friends networks or your other efforts to convert the players?

[Vladislav Suglobov, Co]

We do facilitate cross-selling between games. We try to do it in a smart way. I mean we wouldn't distract people who are very engaged and actively playing and paying. But in any game, there's 10% of people who make payments during their lifetime in the game, but then there's 90% of people who don't. And so there's opportunity to bring other games to the attention of these players, and maybe also run third-party advertising and try to earn some money from these players. And that's what we are doing with cross-selling and with third-party advertising and advertising monetization in our games. So yes, we are doing it, but it's not -- it's just -- it's a process that we have put in place. It's governed certain metrics and algorithms, and it's just working there. It is there, and it helps increase the portfolio LTV. Once the player gets into our ecosystem of games into the portfolio, we try to expose them to as many games as possible. And we hope that they will find a game that they really like and that they will really stick to, and will end up monetizing and paying in that game. So now everything is kind of -- everything -- the whole platform and all the cross-selling solutions that we develop, they are focusing on that goal, on placing a player in a game that they would really like and they will monetize them.

[Operator]

The next question comes from the line of Fredrik Olsson from Handelsbanken.

[Fredrik Olsson]

First of all, congratulations on the strong report today. I have a couple of questions on your view of the newly released games, the timing and how to look at 2021. I mean what we usually see in games release, they monetize over the coming year. Yet now we're seeing some of your new release games contribute to your numbers already. I mean what is the main reason for this? You would say, is it mainly COVID related? Or has it got anything to do with the newly implemented marketing measures pushing the newly released games further? That's my first question.

[Vladislav Suglobov, Co]

So the logic here is quite simple. First of all, we do see an increased interest towards mobile games, right? So all things being equal, we'd rather release games sooner than later. Especially, we were trying to release games in time for the fourth quarter. I mean it's good to release games in the third quarter because it allows you some time to build up the audience for these games, ideally also start running seasonal events and have a Christmas event, for example, in the fourth quarter, that helps take these games further in terms of revenue already this year. But also since the high season kind of lifts all boats, it's good to place these boats on the water, so to speak, in time for the big wave, especially if we're going to see even more interest because of another wave in this -- sorry, from the virus. So it just makes sense that we try to do it as soon as possible, and we try to line up our games there for the fourth and the first quarter next year. We really want to make this transition that we are in right now happen as soon as possible. And by transition, I mean being more reliant on games that we develop internally rather than licensed games. I mean licensed games are still very important for us. It's a big chunk of our revenue. We'll do everything to make sure they receive timely updates and proper marketing, and they'll keep making a ton of money for us and the developer as they do. And we will do it for many, many years as we do with our owned games. But I mean why would we release games later rather than earlier? It doesn't really make a lot of sense. So it's much better if we can release them in Q3, have a great Q4 and Q1, and then go into 2021 with more games and larger revenue from them. So that's the intention.

[Fredrik Olsson]

And then to follow-up on that. What should we expect from 2021 in the sense of pipeline? I mean are we looking at similar-sized pipeline of this year? Or should we expect the majority of monetization to come from the 2020 released games?

[Vladislav Suglobov, Co]

I think the games that were released in 2019 and 2020 will be probably the largest chunk of revenue. It only makes sense. And then for the next year, we do not necessarily want to release more games, maybe a little bit less games. After all, we're going to release 8 this year. That's a lot of games. So maybe a little bit fewer games next year, but we will try to aim, obviously, for the best possible bet that will continue driving the growth of revenue, and that will maximize shareholder value. We have a lot of ideas. I mean we have more ideas to test in the market than we have development teams. So we kept hiring through the third quarter. I mean these results that you see with the margin and earnings, they are -- they already include continuous hiring of developers and the game teams and platform teams, and new people and user acquisition teams. So we keep doing that, and the goal is to enter 2021 with an increased development capacity and increased user acquisition capacity compared to the beginning of 2020, so we can develop and deliver all these new games in the next year, and so that we can continue developing games that we have already released. Releasing the game is really only beginning of the journey. It takes a couple of quarters just to get the content in the game to a certain standard. And there's still quite a lot of development happening in the first few quarters after we release the game. So that's -- I hope this helps. I tried to give you as much detail as possible.

[Fredrik Olsson]

It really does. Just one final question and that is regarding M&A possibilities going forward. Last quarter, we discussed it and I -- correct me if I'm wrong. But you mentioned that you were open for it as it is a rapid way to diversify your portfolio. I just wanted to know if that view has changed from the last quarter? And where we would most likely see an acquisition? Within which segments should we see that in that case within match-3? Or are you considering to, I mean, do further genre expansion through M&A in that sense?

[Vladislav Suglobov, Co]

So let me say this. If we look at the new generation of games, it's growing plus 425% year-over-year. That's a lot, right? So it's -- that's quite a high benchmark for any M&A. Because if we can do this internally, while actually reducing the number of shares in the market, then it only makes sense to continue doing this. And the question then is, why will we go into M&A? And there is still, I think, a potential for M&A, but there has to be kind of a strategic M&A where we would identify certain area where maybe we don't have that much progress and we would like to boost the progress there. So as you said, new genres or maybe genres that we have but we think were not performing well enough there and were missing some critical components and if we see that there's an opportunity to acquire that component, we can act on it. So I can't give you a time line, but there are many companies out there, very many games being launched, we are putting in place certain procedures to monitor the market, and we're trying to be a little bit more active in this regard. So we don't set certain time line for us, but we do believe that we need to pay more attention to M&A and the possibilities there. Because, clearly, it's working very well for some companies, and we kind of need to find the right usage for this instrument. But again, the benchmark for us will be rather high because we can produce all this growth internally. So we don't want to be in a situation where we do M&A, and then we regret about it, right? So some balance is to be found there.

[Operator]

And we have 1 more question from the line of Matthew Galinko from Sidoti.

[Matthew Evan Galinko, Research Analyst]

A couple of questions from me. So I realize -- I'm sorry, you touched on this a little bit, but looking out to 2021 -- and again, I realize this is a little bit early, but are you thinking about expanding? You mentioned hiring through Q3 on the game development front, but is that going to be a process that continues into 2021? Are you looking to continue expanding that capacity? Do you sort of think you hit the level you want for the portfolio size you want?

[Vladislav Suglobov, Co]

Well, thank you for the question. So I'll try to explain my thinking and our thinking in that regard. So we are trying to find a balance between hiring more people to invest in future games and actually letting earnings kind of drop down to the bottom line, right? And in the second and third quarter this year, we've been hiring people and still, we're growing our development teams. To be able to maintain more games actively in the market, we need to add people to the company, to the development teams. So the key here is to be able to afford both trains. And I think we found this balance, both in the second and the third quarter. We have found a way to expand our teams gradually and to make sure that we can afford this expansion, and this expense does not cause a decline in the earnings margin, for example. So I'm very happy with how we did it over the last 2 quarters. And in the third quarter, we have added, I believe, about 30 people, maybe 40 people. So that's quite a lot. I mean on -- for the year, this would be like 120 people. So I think that's a healthy growth level considering that we keep launching new games, and we are not actively phasing out games. Although this is actually kind of a reserve that helps us reduce the need -- the extra development capacity because what we can do instead of hiring a new development team, what we can do is also phase out an older game and put it in what we call a harvest mode where basically updates are minimal and the big team is no longer working on this game. So we are basically cashing out of that game at that point, which means we've given up on attempts to bring its monthly revenue higher. And then we can take the team away from that game, and we can put it on another game. So that is what's going to help us also going forward, find resources to develop all the new ideas that we have. So to sum it up, I don't think there will be kind of a step -- once we get into 2021, then suddenly we start spending much more because we've hired all these people. First of all, hiring takes time. It's not easy to hire 30 very good people a quarter. So it will be a gradual process anyway. And so it naturally limits the expansion of costs in that regard. And we also make sure that this expansion does not put too much pressure on the earnings. I mean that's how we prefer it to happen.

[Matthew Evan Galinko, Research Analyst]

Got it. And just a follow-up on that. I mean you talked about getting more sophisticated and advanced, and how you think about UA. Is that something that, as you really dial in your algorithms and approach and then feel for it to drive more spending towards UA to help accelerate revenue, let's say, or is that something where it's more -- you're looking to be efficient and, per your comments, sort of keep the level around where it's at today?

[Vladislav Suglobov, Co]

So it's basically to make sure we're not wasting money in the grand scheme of things to have transparency into breakeven period of whatever investments we make into marketing. And we do have the ability to -- I mean how do I put it? There's always a possibility that we could try and grow faster. Although I must say, when you look at the top line of the company overall, including this large chunk of older games, it really doesn't show you the underlying growth, right? The focus of our user acquisition right now is on the new games and the new generation of games, and growth there is 72% year-over-year for older games, 425% for new generation of games. So there's a lot of growth there. I think we are driving growth in that regard quite well. And so what we need to continue doing is to keep that part of the business growing and just keep collecting money that comes from the older part of the portfolio, which is basically money in the bank, we just need to collect it every month instead of sitting in the account there. So that is our view. And user acquisition and smart algorithms, what they allow us to do is to put our marketing money where they are most efficient. And then the magnitude of the effect depends on the game, obviously, and the competitive situation in the market, and depends on how smart our user acquisition managers are. So we try to work on both of these elements. But it is difficult to say -- we don't have full control. And no one -- I think no one in the business does have full control of all these components. It's always your product that you have in the market creates a certain situation for you, and then you use that situation to the fullest extent, right? And so we try to create the tools and the teams that can take whatever product we have to its maximum potential. And obviously, the team can give a limit, and the product can give a limit, and it's a never-ending competitive activity in the market in order to try and fully realize the potential of the game. So I hope I answered?

[Matthew Evan Galinko, Research Analyst]

Yes. No, that was helpful. I appreciate it.

[Operator]

And as there are no further questions, I will hand it back to the speakers for closing remarks.

[Vladislav Suglobov, Co]

All right. Thank you for joining us today. I'm really happy with another strong quarter and can't stress this enough, really looking forward to the fourth quarter and the first quarter, which are historically -- were quite good for us. So we'll see how it turns out. And I hope you keep following G5. Thank you, and our call is concluded.

[Operator]

This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.