Nexon Co Ltd

TSE:3659

Earnings Call Transcript 2018-Q1

[Operator]

Good day, everyone, and welcome to NEXON's 2018 First Quarter Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Maiko Ara, Head of Investor Relations. Please go ahead, ma'am.

[Maiko Ara, executive]

Hello, everyone, and welcome. Thank you for joining us today. With me are Owen Mahoney, President and CEO of NEXON; and Shiro Uemura, CFO.

Today's call will contain forward-looking statements, including statements about our results of operations and financial condition such as revenues attributable to our key titles, growth prospects including with respect to online game industry, our ability to compete effectively, adapt to new technologies and address new technical challenges, our use of intellectual property and other statements that are not historical facts.

These statements represent our predictions, projections and expectations about future events, which we believe are reasonable or based on reasonable assumptions. However, numerous risks and uncertainties could cause actual results to differ materially from those expressed or implied in the forward-looking statements.

Information on some of these risks and uncertainties can be found in our earnings-related IR documents. We assume no obligation to update or alter any forward-looking statements.

Please note net income refers to net income attributable to owner of the parent as stated in NEXON's consolidated financial results.

Furthermore, this conference call is intended to provide investors and analysts with financial and operational information about NEXON, not to solicit or recommend any sale or purchase of stock or other securities of NEXON.

A recording of this conference call will be available on our Investor Relations website, www.ir.nexon.co.jp/en/ following this call. Unauthorized recording of this conference call is not permitted.

I'd now like to turn the call over to Owen.

[Owen Mahoney, executive]

Thank you, Ara-san, and thank you all very much for joining us today.

We had an outstanding start to 2018. Q1 was a record-breaking quarter and revenues, operating income and net income all exceeded our expectations.

Revenues and operating income both recorded double-digit growth, and operating margin was 60%. Net income more than doubled year-over-year.

These excellent results reflected our solid performance from several regions around the world, both PC and mobile.

Last quarter, we said China Dungeon&Fighter's Lunar New Year update got off to a very strong start. The momentum continued into latter half of the quarter, performing particularly well throughout the important Lunar New Year season. D&F exceeded even the strong expectations we built into the guidance for Q1.

Our North American business nearly doubled year-over-year, driven by a full quarter contribution from Pixelberry Studios. We are now 1.5 quarters into our integration with Pixelberry and it's been going very well.

We've also had significant year-over-year growth in our Korean mobile business as a result of games we launched in the second half of 2017 and the first quarter of 2018.

The year is off to a great start for our key titles, some of which are celebrating a service period of over a decade. And these key titles have all shown double-digit growth year-over-year in the first quarter, reflecting the sustained work of our live game teams did to enable stable long-term growth.

Dungeon&Fighter will celebrate its 10th anniversary in China next month and has marked the highest quarterly revenue since the service began in that region. The year-over-year growth of this title has been extremely robust. This was the ninth quarter in a row that D&F China recorded double-digit year-over-year growth, gross revenue growth in local currency terms.

MapleStory in Korea just celebrated its 15th anniversary in April, and its first quarter revenues worldwide grew 11% year-over-year.

DomiNations had its third anniversary in April. Its first quarter revenues globally grew 18% year-over-year, and the worldwide life-to-date revenues exceeded $150 million.

These are excellent results. They once again demonstrate NEXON's core strength in live game operations and our ability to grow games over time.

As we said in the past, the ability to grow online games over time is one of the most powerful ideas in video games and is unique to only a few companies around the world with proven capability to do it consistently.

The strong results also reflect the latest strength -- latent strength of NEXON's IP. Games like D&F and MapleStory are loved by tens of millions of gamers around the world, young and old, who continue to come back year after year.

We've built an incredibly robust business based on these simple concepts. Year after year, NEXON's ability to implement them has resulted in one of the most sustained and consistent growth trajectories in the video games industry. We think it is still very early innings.

The strength of our existing business has enabled us to invest heavily in developing the enduring hits of tomorrow. To better execute on new game development, we've reorganized our studios in Korea from one large division with many teams to 7 studio hubs. Each studio, under the new structure, now has more discretion and more responsibility in studio operation, including in personnel and the creation of new projects.

Our objective is to put more the creative decisions in the hands of our most creative people and to better enable our development teams to create their own studio culture. Our other objective is to better foster the development of the next generation of NEXON's creative leadership.

Looking ahead, we have multiple titles launching around the world.

In Korea, FIFA Online 4 will launch later this month before the FIFA World Cup Russia. The mobile version will follow the PC version later in July. We have high confidence in EA's development of this game, and we are preparing for some exciting events during the second quarter, including World Cup mode in late May. The anticipation for this title is very high. Its predecessor, FIFA Online 3, has over 13 million life-to-date registered accounts in South Korea, fully 1/4 of the total South Korean population.

In the first several quarters after the launch of FIFA Online 4, the 2 series will undergo a transition period, during which our primary focus will be on enabling our players to smoothly move from FIFA Online 3 to 4. We expect the transition to impact our revenues in the region in the early quarters after launch of FIFA Online 4.

As another successful games, we think this investment in live operations in the near term will result in more sustained growth over the long term.

In Korea, during the second quarter, we're also launching a new MMORPG, KAISER. For Japan, although revenue was down in Q1, we recently announced our plan to launch 10 mobile titles in 2018. These include OVERHIT, Durango and Gigant Shock. There will be several more around the world, including the international services of Durango, Darkness Rises and MapleStory M.

NEXON's business is extremely robust with strong intellectual property, unparalleled live operations capability to enable our IP to grow and a strong slate of new games. I'm more excited than ever about the future of our business.

With that, I'll turn the call over to Uemura-san to discuss the Q1 results and Q2 outlook.

[Shiro Uemura, executive]

Now let's move on to the Q1 results. For additional details, please see the Q1 2018 investor presentation available on our IR website.

We were pleased that revenues exceeded our expectations for the quarter, for Q1 revenues were JPY 90.5 billion, up 21% year-over-year on an as-reported basis and up 18% year-over-year on a constant currency basis.

Operating income was JPY 54.7 billion, and net income was JPY 46.6 billion, both of which exceeded our expectations.

The first quarter revenue outperformance was primarily driven by the continued strength of Dungeon&Fighter's Lunar New Year update in China.

Operating income exceeded our outlook, primarily due to the outperformance of high-margin China business as well as lower-than-planned HR costs due to lower headcount increase.

Net income also exceeded our outlook.

While we recorded FX loss of JPY 2.2 billion, primarily on our U.S. dollar-denominated cash deposits related to the depreciation of the U.S. dollar against the Japanese yen during the first quarter, this was more than offset by the operating income outperformance.

Revenues from our China business in the first quarter exceeded our expectations. Again, this was primarily driven by the strong performance of Dungeon&Fighter.

We introduced the Lunar New Year update on February 1. The Lunar New Year update included these themed special dungeons, which are only playable for a limited period, as well as avatar package sales, both of which were particularly well received. The strong performance of the Lunar New Year update continued into mid-February and was particularly strong around the February Lunar New Year season, which helped push revenue above our expectation.

First quarter revenues typically increase sequentially from the fourth quarter due to the Lunar New Year holiday. This was true again this year, with revenues, ARPPUs, MAUs and paying users for Dungeon&Fighter in China increasing quarter-over-quarter.

Revenues and ARPPUs increased year-over-year, mainly due to strong sales of the Lunar New Year avatar package. MAUs decreased year-over-year. This was because we faced very high comps with last year's first quarter. As you might recall, last year's first quarter result was driven by the level cap update. In addition to the Lunar New Year update, the number of paying users was roughly flat year-over-year.

Revenues from Korea in the first quarter were below our expectations. The as-reported results were negatively impacted by the Japanese yen appreciation against the Korean won during the quarter. Excluding impact of FX fluctuation, the revenues were at the low end of our outlook.

Mobile game revenues grew significantly year-over-year, driven by contributions from OVERHIT and AxE, which were launched in the second half of 2017, as well as Yulhyulgangho M and Durango, which were launched this year in the first quarter.

PC online game revenues decreased year-over-year.

Revenues from MapleStory increased year-over-year, primarily driven by successful Lunar New Year promotions. This was more than offset by the significant year-over-year decrease in Dungeon&Fighter due to the high comparison with last year's first quarter, driven by continuous trend from large-scale updates in the second half of 2016 as well as FIFA Online 3 due to the upcoming service transition to FIFA Online 4.

Last November, we announced our plan to launched FIFA Online 4, the upgraded version and the sequel to FIFA Online 3, and our plan to transition the service from FIFA Online 3 to FIFA Online 4. And during the preparation period, the service transition users typically hold off on in-game purchases because they have concerns over how they can transfer their in-game assets to the new service. As expected, first quarter revenues for FIFA Online 3 decreased significantly year-over-year.

We announced the details of our asset transfer program to users in April, but we expect revenues to remain low for several months compared to regular times, even after the launch of FIFA Online 4 later in May. This is because we are focusing more on supporting users' smooth transition and on building user base. This process accompanies the service transition. We would like to grow FIFA Online 4 after providing full transition support for our users.

And the year-over-year increase in revenues from mobile games was more than offset by the revenue decrease from PC online games. As a result, revenues for the Korea business as a whole fell slightly year-over-year.

Revenues from our North America business nearly doubled year-over-year in the first quarter, primarily driven by contribution from Pixelberry Studios, which we started to consolidate from the fourth quarter of 2017.

Revenues from Europe and others in Q1 exceeded our expectations, mainly due to the contribution from Pixelberry Studios.

Pixelberry Studio is a development studio located in the United States and its major market is the North America. For the sake of simplicity in our outlook, we included the entire amount of its revenues in North American region. This year's Q1 was the first quarter in which we had the full quarter contribution from the Pixelberry Studios, and we classify these revenues by region. Thus, revenues from Europe and others exceeded our expectations.

The total revenues from Pixelberry Studios were at the high end of our outlook. Q1 was the first quarter we consolidated Pixelberry Studios on a full quarter basis, so we disclosed its revenue composition by region. For details, please see Page 10 of the investor presentation.

Now turning to our Q2 2018 outlook.

For Q2, we expect the revenues in the range of JPY 45.1 billion to JPY 49.1 billion, representing a 4% decrease to a 4% increase year-on-year on as-reported basis and 7% decrease to 1% increase year-on-year on a constant currency basis.

We expect the NEXON group revenues to slightly decrease or slightly increase year-on-year, while we expect revenues to increase year-on-year in China and North America. We expect these will be offset by revenue decreases in Korea, Japan, Europe and other regions.

We expect operating income to be in the range of JPY 10.5 billion to JPY 13.5 billion. We expect the net income to be in the range of JPY 11.2 billion to JPY 13.8 billion.

In China, we conducted a large-scale content update of our key PC online game, Dungeon&Fighter, on April 26, in time for Labor Day. We are also scheduled to introduce the 10th anniversary update in June.

The number of paying users in April increased year-on-year, while ARPPU decreased. Reflecting these factors, we expect Dungeon&Fighter revenues to slightly increase year-on-year in Q2.

In Korea, as I explained earlier, we expect significant year-on-year decrease in revenues for FIFA Online 3 and FIFA Online 3 M due to service transition.

The PC version of FIFA Online 4 will start in late May and its mobile version will follow in late July. Both FIFA Online 3 and FIFA Online 3 M will end their services in August.

For other PC online games, we expect revenues from Sudden Attack and Dungeon&Fighter to decrease year-on-year. However, we expect mobile revenues to increase year-on-year, mainly due to the contributions from OVERHIT and AxE, which launched in the second half of 2017, and KAISER, which we will launch in Q2.

Overall, we expect the impact of negative drivers in Korea to offset positive drivers, resulting in revenues to slightly decrease or be flat year-on-year.

In Japan, we expect revenues to decrease year-on-year, mainly due to the deceleration of mobile games including HIT, HIDE AND FIRE and browser games, while we expect contributions from OVERHIT, which is set to launch in Q2.

In North America, we expect revenues to increase year-on-year, driven by contributions from Pixelberry Studios.

In Europe and other regions, we expect revenues to decrease year-on-year, while we expect year-on-year growth in Europe, driven by contributions from Pixelberry Studios. We expect this to be more than offset by decreases in the other component of Europe and other regions, primarily due to the deceleration of Dynasty Warriors Unleashed.

In Q2 of 2018, we expect operating income to be in the range of JPY 10.5 billion to JPY 13.5 billion, representing a year-on-year decrease of 36% to 17%.

Favorable factors compared to 2017 Q2 on operating income are: first, an increase in revenues, driven by China business and contribution from Pixelberry Studios; second, in Q2 of 2017, we recognized the impairment loss of JPY 2.2 billion, which will not be repeated in 2018.

Negative factors compared to 2017 Q2 on operating income are: first of all, increased HR costs, mainly due to the higher headcount and stock option expense; second, increased marketing costs related to promotions of our new games, including FIFA Online 4, OVERHIT and KAISER, as well as promotions for choices. The high end of the range reflects the fact that we expect the impact of negative drivers to be larger than that of positive drivers, resulting in year-on-year operating income decrease.

Now we'll be happy to take your questions.

[Maiko Ara, executive]

Thank you, Uemura-san. Next, we would like to open up the lines to live Q&A.

[Operator]

[Operator Instructions]

[Keiichi Yoneshima, analyst]

I am Yoneshima of Crédit Suisse Securities. Can you hear me?

[Shiro Uemura, executive]

Yes, we can hear you.

[Keiichi Yoneshima, analyst]

I have 3 questions altogether. I have 2 questions on guidance and one question about development. Firstly, guidance. I have a question on costs. In Q2, in terms of operating profit, you mentioned about the costs as well. And you mentioned that the headcount across the board increased by JPY 3.1 billion, and the others will increase by JPY 1.7 billion. And looking at the change from Q1 and also as compared to other quarters, the numbers are very large. So is there any onetime factor? And also, why HR costs, as well as other expenses, increased so dramatically? Moving on to the second question.

[Maiko Ara, executive]

Excuse me, Mr. Yoneshima, can you ask one question at a time?

[Keiichi Yoneshima, analyst]

Okay.

[Shiro Uemura, executive]

Thank you very much for your question. About the first question, in terms of Q2 outlook, I mentioned that there will be an increase of HR cost by JPY 3.1 billion. And we have ordinary HR costs as well as stock option costs, and stock option cost is more than 1/3 of JPY 3.1 billion. And we want to retain the key figures, and we believe that this is the cost that we have to bear. And we have been providing stock option as needed, and this is a new stock option that we have provided. And within a 3-year, and that is upcoming, we will be recording similar figure. So having said that, this is not a onetime cost, but rather it is a kind of fixed cost. We have stock options that we have issued in the past, and there might be some decrease, but given the current point, I believe that the amount of stock option expense will stay stable. Regarding other expenses, we have outsourcing expenses and there is nothing particular to note about. So it's not that, that JPY 1.7 billion is written on stone, but there will be changes from one quarter to another and I do not think that there will be much fluctuation from one quarter to another.

[Keiichi Yoneshima, analyst]

I would like to ask you the second question, which is on FIFA Online 4 transition period. How long do you think it will take the transition? You will have a PC in May and mobile in July. And in August, you will end FIFA Online 3. So is it correct to understand that you will complete your transition by Q3 and business will be as usual starting Q4? And we have World Cup and maybe you have not factored in yet, but I believe that you might be able to enjoy more revenue in Q2 because of the World Cup.

[Shiro Uemura, executive]

Regarding FIFA Online 4, based on our past World Cup event experiences, the time after World Cup is more important rather than before the World Cup. And during the World Cup, there is a momentum. And even after the World Cup, momentum stays for some time. And so a month after the World Cup, we were able to record very good figures. So in May, we will launch PC and try to help the transition and have a stable user base and launch mobile in July. So in terms of Q2, it is a transition period for the users. So I do not think that there will be any major upside or downside. And after Q3, we will look at the situation and try to grow the game.

[Keiichi Yoneshima, analyst]

My last question. Mr. Owen Mahoney, you mentioned about the development organization change and you have split into different development divisions. And I understand that you can understand more creativity as well as more leadership. But in terms of the management, maybe it might be more disparate because you will have more divisions to work with. So how are you going to manage the teams overall?

[Owen Mahoney, executive]

Thanks for your question. We have a very large -- let me just talk about a couple of different points that gets you to, I guess, an overall feel for how we think things will change compared to what they were. What we felt was that to run a studio as one central organization, with a lot of major decisions flowing up to a key studio leadership, is one way to do things but it doesn't scale that well. And as our studios get bigger and bigger and we put out more products and we try a variety of different things, that gets more difficult to do. Another thing about game development is a lot of times the very best ideas come from people who are closest to users and closest to games and to single-game ideas. And so we want to put more the creative decision-making autonomy in the hands of people who are closest to users. That doesn't mean we hand over everything to the individual game leaders, but it does mean we want them to be closer to, in English, we would say where the rubber hits the road or where the rubber meets the road, in other words, closest between game developers and closest to customers. So we think that's very important. So the other thing that has been going on over the last few years is a new generation of leaders at NEXON has been gradually sort of coming up. They've gotten older. They've gotten more experienced. And we think that this is a great way to put more autonomy in that next generation of leaders. And so we think it's important to do that. Now having said that, we will be monitoring very closely from the central studio leadership, as we have in the past, but we want to put more decision-making power in the hands of those new leaders that I talked about. So an example is, sometimes, you want to hire a really key developer, and a decision like that -- maybe that person comes from outside the company and a decision like that would oftentimes have to roll up to the central studio leadership. We think that that's the kind of decision that can be handed more autonomously to the studios, to the studio leaders, and that will enable faster decision-making, and it'll enable them to run the studio in the way that they best see fit. Now some of them will do great, some of them will be challenged, but we want to watch how that goes, and we'll be monitoring it very closely in the coming quarters and years.

[Operator]

Our next question comes from Han Joon Kim, Deutsche Bank.

[Hanjoon Kim, analyst]

My first question is on your Dungeon&Fighter PC numbers. So I think in our presentation, you basically highlighted the MAUs declined, paying users have increased, paying users have increased and ARPPUs increased. As we think about the dynamics here, I mean, do we feel like this is -- when do we feel like we hit a level where we want to dial back on the ARPPU, focus a little bit more on the MAU? And is 1Q more of a freak accident on the positive side where we just had a lot of ARPPU and that 2Q is kind of a more the normalized level and that -- yes, just trying to understand the dynamics between MAU, paying ratio and kind of ARPPU, how you look at the first quarter numbers. And is that kind of a very top-ish number? And do we want to really dial it back for the longevity of the product?

[Shiro Uemura, executive]

Thank you very much for your question. Again, let me explain this more in detail. In Q1, the Dungeon&Fighter in China, MAU is down. Paying user -- number of the paying user is almost flat, and ARPU -- ARPPU has significantly increased. Concerning those, if I may add further explanation, in 2017, Dungeon&Fighter showed a very strong performance. And we try to look at the data operation and also the content update for each event. We have been very focused on that, so that we can keep the game very healthy. And at the same time, in Q4 last year, especially without taking a monetization measure, we try to make sure that we maintain the user base. So in Q4, the appetite of the user was very strong to purchase. So in Q1 this year, which is a high season for us, and during the Q1, we made sure that we had a good content update and the package sales was realized. And by doing so, MAU is down, but the ARPPU is up. The decline of the MAU, if I may talk further about that, in Q1 last year, there was a level cap update. Now level cap update is done only once every several years. This is special measure. So with that update, the users were activated and the main users came in. So it was a wonderful MAU. So in comparison to that level this year, it seems like it has declined but this MAU is actually, in comparison to the regular Q1, this is about the same level. So it doesn't mean that it has declined significantly. It just means that last year's MAU was so high. Another thing is about the paying user, which is flat, and MAU is down. But the revenue, we exceeded the revenue because of the higher ARPPU. Now this higher ARPPU, as I mentioned, under the very good situation in the game, we had a good content update, and also, avatar packages sold very well. More specifically, already, the heavy users or core users, instead of just buying one package, they bought multiple packages. And also, the light users, light paying users started to buy packages. So we have a very good in-game environment and we -- our measures were very effective. That led to the better revenues, so that is our analysis. So we have a very good control, and we had a very good performance. In the presentation, as I said, Q2, more recent trend is that MAU is almost flat and paying user is increasing and ARPPU is about the same as last year's level or slightly down. So Q1's situation or status means that our measures worked very well. In Q2, we try to make sure that we maintain the user base. So already, ARPPU is lower than that of last year. So concerning that, there are, of course, seasonalities, high season, low season, so we try to look at the in-game environment and we would take the measures, which are necessary. So in that sense, as you said, continuing to see the high ARPPU, lower MAU, that is not the case. So as a company, and the China Dungeon&Fighter, we believe, is a very good situation right now.

[Owen Mahoney, executive]

Han Joon, do you have a next question?

[Hanjoon Kim, analyst]

Sorry. I was on mute. Sorry about that. Yes. My second question is regards to Durango. As far as the Korean launch has gone, from a revenue standpoint, it's done well and then has faded. I'm wondering how the underlying KPIs look from your perspective and if we can kind of envision this as a game that can continue to grow for a 2-, 3-, 4-year time frame. And alongside that, I think Durango is going to be launching overseas as well. So should we be assuming a relatively soft launch overseas as well and then progressively growing? Or kind of how our thought -- how has that thought evolved on Durango longevity-wise?

[Owen Mahoney, executive]

Han Joon, this is Owen. I'll give you some color on Durango, and then, hopefully, that will fill out the picture for you. I'd say a couple of things about it. First of all, when we launched it, frankly, it greatly -- the interest level in Durango greatly exceeded even our expectations. And our expectations are pretty high, given the significant numbers, our pre-registrations and just to the general buzz in Korea when we launched it. So that's number one. That's the good news. The bad news is that significant increase in -- oh, I'd say one other thing about that. That level of interest from customer base was also fueled by the great support from Google and Apple that we got. And I think what was driving both of those first 2 things was Durango is just not like really any other game in the mobile market right now or very, very few mobile games, and I think there's probably a consensus that we could all use something different sometimes, because as we've talked about publicly before, much of what launches around the world in mobile seems to be pretty similar to other things that are already out in the market. So Durango represented something completely new and innovative, and I think people are really liking that aspect of it. So that was a great part. The second thing I'd say though -- or second major thing I'd say is sort of overwhelmed a lot of even our high expectations for it. There was a flood of new users in the opening hours and days of it that created some server problems for us and some, therefore, some customer experience problems, which is certainly a problem. Some people will call that a nice problem to have category, but we think it's just a problem when customers don't experience the game that we've designed. So that was not great. And then the second thing is that was driven by some technical challenges because, frankly, Durango is so different, we can't rely on a lot of off-the-shelf technology. We have to develop sometimes a new technology for managing provision of land inside the game and so on. And the other aspect of having a lot of users come in all at the same time is the game is designed for sort of a constant supply of new users. And when there's massive numbers of new users coming in all at once in a virtual world, that affects actually the game economy and the game play and the sociology of the game world, which is really a simulated reality experience. So you put all those things together, and we were very happy with how things have gone. But then they went down in terms of app store rankings. So the third major thing I would say about Durango, however, is that, in an open world MMORPG, you really don't judge the success of the game from the first 1 or 2 months or quarters after launch. Really, you can't really test how the user experience is going to be and work out all the kinks in the system and tell the game has been out for some time, and oftentimes, that takes several quarters. We know this from PC, and we know this from any open world simulated world. And so we think it's very, very early days. We're very supportive of the team in what they're doing. We're going to be bringing it. As we've said in our prepared remarks, we're going to be bringing it around the world. And we'll be launching it in a different way than we did in Korea when we bring it to other regions. But we, overall, believe that this is exactly the kind of game that we should do. And frankly, all the games that we've launched that have done really well over a period of years. And also, many of the games from other companies that we've noticed that have done very well on a worldwide basis, they oftentimes start out as very small or they've had rocky launches. But what really matters is not this quarter or next quarter, even the quarter after. What really matters is that we're all talking about this game 5 or 10 years from now. That's what we're designing it for. And we think we are on track to be doing that, so that's what we're focused on now. And you'll hear us talk about it more in upcoming quarters. I hope that answers your question.

[Hanjoon Kim, analyst]

It does, it does. Appreciate that. My last question is going back to, I think, a question that somebody else has asked as well. But if we take the midpoint of your second quarter guidance for revenue and operating profit, we have virtually 0 revenue growth against about a 26% year-over-year decline in operating profit. So pure mathematically, I think we probably need to see some top line kind of -- on the same margins, 20% revenue growth to be able to kind of reach flat operating profit going forward. I'm cognizant of the fact that in the second quarter, we have -- we're in a transition period for some of the games. But how do we think about the dynamics where the cost is growing faster than the revenues? And at what point have we invested enough into our business that this costs are to stabilize a little bit?

[Shiro Uemura, executive]

Well, about Q2 cost prospect, the HR cost is increasing significantly and 1/3 of that is the stock option-related expenses. And for us, the game company, this is something we need. That is to say that the talents -- to retain the very good talents is very important. So for that, looking at the situation, we will make sure that we would offer stock options. So accumulation of those has been happening. But as I mentioned earlier, this is not just a onetime cost, but this is likely to continue for some time to come, more specifically, for 3 years. But that's for the preexisting stock option that would decline, so there could be some decrease, a slight decrease. Another major factor is the advertising and promotions. And for that, at the launch of the major titles or with the high expectations, we have to really make an investment for the advertising and promotions. So last year's -- in comparison to the Q2 last year and the advertising and promotion has increased significantly, but this is considered to be the upfront investments. So in Q2, well, the operating profit is pushed down by this, but it means that we have to make sure that we have our good title launched so that in the following terms, we can expect higher revenues. So as for the advertising and promotion, I cannot say that this would happen regularly, but this is something that we need as an investment. So in our profit and loss, the major variable would be more advertising and promotion expenses. And also, HR costs, the level of Q2 is likely to be recorded in coming years.

[Operator]

Next question comes from Yamamura, Nomura Securities.

[Junko Yamamura, analyst]

You mentioned about the marketing cost as well as HR cost. I want to confirm the following. In Q1, you had factored in some HR costs, but I believe that you were not able to use the entire amount. But in Q2, you have a stock option and you have factored in an increase in HR costs. Say in Korea -- maybe might not be Korea, but you want to secure talents, and you tried but you were not able to secure the number of people that you wanted and you realized that you had to increase the salary or compensation to attract the talented people. Or am I reading too much between the lines? So I want to know what is happening here. That's my first question.

[Shiro Uemura, executive]

As we have mentioned, in Q1, there was a difference between the actual cost and the budget because we were not able to hire as many talent as we have wanted. You mentioned the possibility of having to raise more compensation to secure talents, but that is not the case, because the more titles we have, we will increase as headcount. And also looking at the pipeline development situation, we hire people. And so regarding in the personnel cost, and I am particularly talking about payroll, there is not much of a difference from one quarter to another. But stock option expense-wise, we need to retain the top people and meaning a top 5% must be retained for sure. So we provide stock options for them. And also, for the management, we have stock options as well. So in order to secure and retain the employees that we have. We provide stock option. And so we believe that this is a necessary investment, a necessary expense that we have to bear. As compared to last year's quarter, you might feel that the number is too high. But during the high season when the revenue goes up, on a Y-o-Y basis, up until Q4, there will be the changes as you are seeing right now. But it is indeed true that the number impacts the operating income this time around. Thank you.

[Junko Yamamura, analyst]

Let's move on to the second question about the marketing costs. In the quarter, you have many new titles. You used about JPY 5 billion. And I want to confirm that, in Q3, you will be promoting FIFA Online 4. And I know that mid to long term, you are not making any major changes. But in terms of Q3, do you think that you will increase more marketing spend in order to promote FIFA Online 4?

[Shiro Uemura, executive]

Right now, we have factored in our best guidance. So I do not think that there will be any major increase furthermore. We have FIFA Online 4 launch and also OVERHIT is being expected a lot by the users, and we have a Korean mobile title with high expectations. So regarding those new IPs, after the launch, we will look at the KPIs to decide how we are going to allocate our marketing costs. So I cannot say definitively whether we're going to not increase or increase the marketing costs. But for now, we believe that the marketing expense that we have disclosed to you right now is the best read that we can make at this point in time.

[Junko Yamamura, analyst]

One final question. So you disclosed pipeline by region. And in terms of the Japanese mobile, you disclosed the plan. And you said that you will be launching about 10 mobile titles in Japan and I do not think that all the titles are written on the slide. And can you tell me what will be the piece in which you will be launching mobile titles here in Japan?

[Shiro Uemura, executive]

Yes, we are planning to launch about 10 titles. And of course, not all the titles are written on the slide. In terms of the launch timing, we have OVERHIT in Q2 and Gigant Shock, Q3. And Durango, we haven't decided yet. It will be sometime within this year. It will be after Q2. And once we complete the preparation, we will be launching different titles. In Japan, we have highly expecting the titles here in Japan and we haven't done that for the past 3 years. So we have high expectations toward these IPs. And as time passes by, we believe that we will be able to introduce new titles into the market.

[Operator]

Our next question from Alicia Yap, Citigroup.

[Alicis a Yap, analyst]

I have some follow-up questions regarding your second quarter guidance, especially for the China revenue. I find it a little bit disconnect here. So given that June, we'll have a 10-year anniversary promotion for D&F, and also the Labor Day update in April seems to be quite successful, and isn't that it should drive a faster growth in the second quarter compared to the first quarter? And if we look back on the China revenue over the past few quarters in 2017, first quarter '17 actually has the high base and yet you guys just reported a very strong first Q '18. So -- and you have this Labor Day update and anniversary promotion. So can you help us to understand the misconnect here?

[Shiro Uemura, executive]

Well, thank you very much for your question. In the case of PC online game, let me explain a bit more. On a daily basis, we like to make sure we have a good operation. And for different event, we would like to have a content update. So there are many things that we need to do every quarter. But if we continue to monetize all the time, that is not possible because the users will get tired and the balance in the game will be lost. So for example, Q1 for us is at the peak season and most important for the China Dungeon&Fighter, and also Q3, the national holiday. So Q2 and Q4 are the ones that we try to maintain the user base, so that make a preparation for the next major leap. So Labor Day, 10th anniversary -- or 10th anniversary, there, of course, we have done it, for example, eighth anniversary, ninth anniversary, so forth, but relatively not too expensive. Avatar sales is something that we do to make sure that we have maintained the other users. So as a result of the Labor Day update, we continue to see success but does mean that would take the major monetization measure, but we need to really maintain the user base. As we mentioned, ARPPU is a bit lower than that of last year and paying user is increasing. MAU is stable. So once again, we'd like to -- we are working on the fact that we can maintain the user base. So like this Q1, growing all the time or quarterly is not something we do, but we like to maintain the good balance in the game and keep growing. So I hope I'm answering your question. If you have any clarification, please ask further questions.

[Owen Mahoney, executive]

I'd just add one more thing to what Uemura-san said overall. The key thing to remember about a long-lived online game, and probably, if there's a one key word, it's longevity. So what we play for is to ensure that, years from now, the game is still operating and healthy and the game environment is growing. And so that's a key deciding factor to keep in mind when you're interpreting sort of results in any given quarter in the near term. Thank you.

[Alicis a Yap, analyst]

Can I just have very quick follow-up? I think in some of your previous answer to the previous question, I just wanted to make sure I hear it correctly. Did you actually say the D&F in China will actually be slightly increased on the year-over-year basis in the second quarter? And then also, any updates on the mobile D&F? When should we expect that to be launched?

[Shiro Uemura, executive]

Yes, we continued to see the healthy status of the Dungeon&Fighter in China. The slight increase in Q2 is expected. The paying user is increasing. And MAU is stable. So you're right.

[Alicis a Yap, analyst]

And any comment on the mobile D&F?

[Shiro Uemura, executive]

Mobile, no.

[Owen Mahoney, executive]

Sorry, we have no updates on mobile D&F at this time, but we will be updating when we have news to share with the game community.

[Operator]

[Operator Instructions] Our next question is from Jay Defibaugh, CLSA.

[Jay Defibaugh, analyst]

Just one from me, please. Can you comment on the competitive backdrop for D&F PC in China with regard to, for example, the increasing popularity of the Battle Royale genre, or if you are seeing any kind of shift from PC to mobile for the market overall? So if you could address that question regarding what you see now and what you would expect in the future.

[Shiro Uemura, executive]

Thank you very much for your question. Regarding China's PC online game, Dungeon&Fighter, it is one and only. And in terms of this genre, it is very rare. We have PUBG and other very popular titles. But since the genre is so different, we are not impacted by games such as PUBG. And in terms of Chinese PC market, the situation might be challenging. Some people say that. But regarding China Dungeon&Fighter, we are doing very well. So we are so different as compared to other titles. I repeat myself. Regarding China Dungeon&Fighter, we have no concern whatsoever. And also, I believe that we can enjoy the longevity of the game, and we will focus on the operation accordingly.

[Owen Mahoney, executive]

Jay, this is Owen. Just had a comment on top of what Uemura-san said. As he said, we're not seeing an impact of any sort from Battle Royale types of games in China Dungeon&Fighter. I think stepping back a little bit, what's interesting about this topic is sort of twofold. We get asked -- we have, over the years, gotten a lot of questions about transition to mobile and does that impact PC. I'd say, actually, it's been pretty counterintuitive as we've seen how the mobile and PC market has developed. First of all, I think the Battle Royale genre has shown us that at least for now, PC is very much alive and well, quite to the contrary of what a lot of people's expectations have been. And this is I think true around the world. So that's been interesting to see. I think the other thing that's interesting about some of the Battle Royale games it has shown is, one thing that we've said over and over again is that mobile is now capable of a very deep and rich experience. I mean, I played -- I like to play a lot of other companies' games. I played Fortnite last weekend with my 14-year-old and 5 of his buddies from school. And some of them were playing -- some of us were playing on PC, including me. Some of us were playing on mobile. You couldn't do that a year or 2 ago. And so I think this is very, very good for us around the world because NEXON specializes and focuses on deep, rich, highly immersive games. And we do that both on PC and mobile, but those kind of games that we really like to make haven't really been capable on mobile until now with the advent of the new phones. The GPU and the networking layer is now quite robust. It's really workstation quality in your pocket. So while we're seeing a lot of robustness on the PC business around the world, not just for ourselves, but for other companies, we're also seeing robustness on the mobile side. All that, I think, is good news for us over the long term, so we're very excited.

[Operator]

This concludes the question-and-answer session. Ms. Ara, at this time, I'd like to turn the conference back over to you for any additional or closing remarks.

[Maiko Ara, executive]

Thank you. If there are no further questions, I would like to take this opportunity to thank you for your participation in this call. Please feel free to contact the NEXON IR team at [e-mail] should you have any further questions. We appreciate your interest in NEXON and look forward to meeting you, whether it is here in Tokyo or in your corner of the world.

[Operator]

That concludes today's conference. Thank you for your participation. You may now disconnect.