Earnings Call: Q1 2020

May 5, 2020

Ladies and gentlemen, welcome to the G5 Entertainment Q1 Reports 2020. For the first part of this call, all participants will be in listen only mode and afterwards there will be a question and answer session. Today, I am pleased to present CEO, Vladislav Soglubov and CFO, Stefan Wissand. Sir, please begin. Good morning. Thank you for the introductions, and welcome, everyone, to G5's Q1 2020 results call. We'll take about 15 minutes to go through the deck, and then we will open the line for questions and answers. So I'd like to summarize the quarter by saying that this is a very strong result from the uncertainty of the current economic situation and that I think we continue to deliver on our strategy. We remain financially healthy and strong. We are still debt free profitably with we are highly cash generative and the Board has decided to propose a dividend of SEK2.5 corresponding to almost SEK23 1,000,000, the same as last year. So this underlines our financial strength. And the investments that we did in our development teams over the years are now starting to pay off, and we're launching new games at a higher pace than ever before. As you can probably see, in 2020, we are in total planning to launch 6 new titles now on top of the 5 that we launched in 2019. We have also continued our success with Hidden City. As you know, the game has a very loyal following, and it is still our top game by monthly revenue. And it is well, it was relatively stable in the Q1 of this year as well. However, our development teams, the ones that we've built over the years, are stronger than ever, and our own games are actually very promising and growing, and that is the most interesting thing about the company. So in the Q1, our own games represented over 45% of total revenue. And our very successful game, JUULDOGROME, generated over 15% of revenue in the quarter. It is clearly our 2nd highest grossing game ever on a monthly basis, and it's been steadily growing every month. We had a little bit of a bump in February, but otherwise it continued to go up in revenue. And so we are cautiously optimistic it will continue to do so. And as you can see, we're getting close to revenue parity between own and livestock games, so also kind of an important milestone for us. And the top line contribution from our own games is expected to increase during 2020. The 3 games we launched in Q4 last year, Jewels of Mojo, Hidden Treasures, Wordplay, they all grew sequentially during the quarter. And now with the continued growth of Jewels of Rome and the newly released games recently, we expect own games to continue to increase in revenue and contribute higher percentage of revenue for the company. So the Jewels of the Wild West that we launched in the beginning of April started off really well and shows signs of a profitable successful product in the making. And just a few days ago on the 30th April, we also released the MATCH 3 puzzle named Hawaii Match 3 Mania. This is a soft launch for now only in Australia and Canada, but we also plan to release the game globally during 2020, and we have at least 4 more games to release before the end of the year. So the strategy for our game development remains pretty much the same. We are building new games on top of our existing expertise and genre knowledge and technology, but we're also trying to expand it to some new genres to expand our offering and like with our Wordplay game, which is an example of that. And there were also important changes that we have made to how we do user acquisition. In the Q1, we changed the management and we refined our processes and it really paid off in the Q1. We spent less than in the previous quarters. We strengthened our teams both in USA and Europe during this time and really put a lot of effort in optimizing everything. And so we are spending our marketing budgets now more wisely, I would say, which is visible in our improved margins. The goal for the year overall remains the same we have provided at the end of 2019. We aim to achieve year over year growth in revenue while maintaining profitability. An expansion of earnings margin is possible as more revenue comes from all in games. It must happen. In the Q1, we basically delivered in line with this goal. We have technically, like, some tailwind from exchange rates, but still delivered top line growth year over year. The earnings are also solid even adjusted for exchange rate effect. This should be our new earnings margin base in absence of strong sequential growth. And as before, if we choose to spend more aggressively on achieving growth, this can, of course, put some pressure on the earnings in the short term, as has always been the case previously, Because of the user acquisition the money we spent on user acquisition, the payback is delayed. So when you have a quarter with substantial growth sequentially, it can affect the margin negatively in the short term. But overall, gradual margin expansion should be happening. It should be possible during 2020 as more revenue comes from own games with higher gross margins. So with that said, let's dig a little deeper into the following slides and look at how the mobile industry is affected by the COVID-nineteen. So according to some reports and we see the same happening with G5, The downloads for the industry have increased on all major platforms. And also revenue in some countries increased by more than 10% following the lockdowns that were introduced in these countries. So the estimates that we see is that for Google Play downloads grew 38% year over year, for the App Store, 35% year over year. And the Q1 2020 became the quarter with the most industry downloads ever, 13,000,000,000 installs across App Store. And Google Play, which is more than 2,000,000,000 installs higher than the previous best. So in U. S, the growth was strong at about 29%, and some reports say that across both platforms, there were 120,000,000 more game installs in the 30 days following the country's 200 confirmed case of the virus versus the prior 30 days. So overall, there's this situation obviously put people into the position where their options for entertainment are limited, and so they put their attention to the application stores. And they're looking for games, and they're looking to spend time in games. So at G5, we saw the signs of this trend as well. And towards the end of March, the trend that we already had for improving downloads became much stronger. So in one of the weeks, we actually saw a 50% increase week to week in the number of downloads. And so far, that increased activity continued into April. So far it continued into May, but it continued into April. And so I think that it is difficult at this point to fully assess the long term effect of this crisis on the industry. I think that in the short term, it's obviously positive because we have all these downloads and all these users come in to download the games. But also if you look at what happens in the countries where lockdown is eased is that these downloads tend to go back to normal. So if you look at sensor tower stats for China, for example, you can see that downloads shut up and then they basically started normalizing. And although it feels like forever we've been sitting in this situation in a lockdown, but it only has been a month or 1.5 months. So it's not a very long period of time. And already we're talking about relaxing certain measures. So this is something that certainly helps us. But the question remains how long this is going to last and what will be also the impact on the financial ability of the players to pay. So if all the unemployed people of the world start playing our games, I hope they have some money saved. But otherwise, it may not change a lot in our earnings in the top line. But it is positive and the we go into the Q2 with a positive tailwind from additional downloads that we are getting. So on the development front, we've proactively moved all of our full time employees to work from home back in March, and we did not see an increase in productivity or any disruptions. I think the staff has adapted quite well to working from home. Some actually like it. So it is obviously, as we go into whatever week of this whole thing, it is becoming more stressful for everyone as most of our developers are actually in the cities with rather strict lockdown policies. But so far, we're glad to see that they're choosing to focus more on work, and it's meaningful for them during these times. And seeing our games succeed is worth a lot and keeps morale high. And so I think we're in a good place when it comes to the development. And the teams are doing an amazing job also trying to release games a little bit earlier so that we can kind of surf this wave of increased downloads while it lasts. So with that, let's talk about Q1 figures and move on to Slide number 4. So we had revenue of CHF 312 1,000,000 and that is an increase of 2% compared to 2019. And with some help from exchange rates, we're back to year over year growth with in line with our vision for the year that we have explained in Q4 report for 2019. And as you can see, our new our own games continue to grow while the licensed portfolio share is shrinking. So the sequential increase for our own games was strong 8%. Jewels of Rome was responsible for over 15% of the group's revenue in the Q1. And overall, own games increased their share of revenue to 45%, getting close to parity there. We have also seen improved monetization with the monthly average revenue per gross revenue per paying user up 17% year over year to over USD 50. So that is a good and strong result, I think. So for slide, let's move to Slide number 5 and talk about our strong earnings. We have returned to rather healthy margins. There is some boost there from the exchange rates, but even adjusted for that, it was quite substantial. And I think that the if you look at how come we have such strong earnings this quarter, So there's several things, and the main thing is user acquisition. So the improvements that we've done to user acquisition enabled us to spend less than in the previous quarters. So that was the most important component here. And then another thing is the exchange rates. And there are other smaller things that are detailed in the report, but obviously not only in terms of revenue, but also in terms of most of our expenses are in rubles and in the Ukrainian currency. And so with the exchange rate fluctuations, our costs went down basically a little bit as well. So we've seen several components to the improvement in our earnings, and I think they should stay with us for a while. So we're saying that this is the new base of profitability that we should be able to deliver with this percentage of revenue coming from owned games as long as we're not doing something very aggressive with user acquisition to enable sequential growth. So the gross margins also went up, as you can see, from 53% to 57%, and that is the effect of more revenue coming from our own gains. And we expect this to gradually increase from here as the revenue share of own games continues hopefully to go up during the year. Let's move to Slide 6. If you look at our cash situation, we actually at the end of the quarter had more cash on the account than I think we ever had. So there was a strong cash conversion during the quarter, total cash flow about SEK 31,000,000. And it's good to have certain reserves in these uncertain times. So this cash position certainly allows us to continue paying the dividend. And it allows us to basically fund whatever we need to fund in terms of game development or marketing. So it's very strong position to be in, I think, right now. So otherwise, we had no significant movements in capitalized development costs. New capitalization showed a steady rate, and it basically canceled out with amortization. The effect there is minimal. So this actually concludes my presentation. We've reached the end of it. And now I would like to open the call for questions. Our first question comes from the line of Jesper of ABG. I have 2 of them. So first, I was wondering if you could give some indication of what percentage of user acquisition spending went to own games versus external games? Yes. Thank you for the question. So right now, I know the current one. It's I don't know the exact distribution for the Q1, but right now we are around parity. So about the same amount goes towards licensed and towards owned games. So it's kind of in line with the distribution of revenue. Okay. My second question. At the last conference call, you kind of guided for EBIT margins around 4% to 5% during H1, which would lead us to suspect growth rather than high profitability. And I was just wondering how did that change throughout the quarter? Are you opting for higher profitability? Well, I think we didn't really opt for anything. It just happened, this whole situation with the virus, which was impossible to foresee. I mean, it really did affect our profitability situation. So I mean, the whole 3 percentage points out of the 12% EBIT margin is just that, just the exchange rates. And that's just the revaluation of liabilities within the company. And then you have the effect also on the costs, which a big percentage of our costs is in rubles and in kryvnias and both currencies lost against U. S. Dollars during the quarter. Thank you. Once again, if there are any further questions, And we have one further question coming through. That's from the line of Oscar Ericsson of Carnegie. Please go ahead. Your line is open. Good morning, Vlad. Yes, a few questions for me. First of all, could you please talk a little bit more about sort of how you see the top line development going now in Q2? Obviously, very low user acquisition spending here. On the other hand, perhaps the boost from the COVID-nineteen situation and increased downloads. What do you think if you could talk a little bit more about the output for growth here, sequential growth in Q2 primarily? Yes. So we obviously expect sequential growth in the second quarter. There are several things at play here. And one is obviously that we continue on working on improving our user acquisition efforts. And so we achieved great optimization in the Q1, but the ambition is to be able to deploy capital to grow the top line. So we will continue doing that. My hope is that we can go from optimizing the spend, making sure we cut the spend where it's inefficient and then we focus on spending where it is efficient. And from there, we can go to spending more where it is sufficient to spend. So going forward, I hope that we will have increase in the amount of capital deployed towards user acquisition. And although it can affect earnings margin, probably negatively in the short term, that should help us achieve sequential growth in the top line. So there's that. Then there's this obvious wave of interest and extra downloads that we are getting, which should be producing some result. But as you can see from the store stats, they're talking about 40%, 30%, 50% increase in the number of downloads and yet revenue goes up by about 10%. So there's a question of what kind of downloads this situation brings, what is the quality of users there. Obviously, when we buy users, we are very careful about buying users that we know can pay back when a lot of users come in because of store promotion or some other because by other means, what we call organic downloads, the quality may vary there. But still, it is positive. Then there is a little bit of positive effect that we should see from advertising and including advertising in all of our games. We started gradually to deploy the our chosen way to deploy advertising. And starting Q2, we will implement advertising in most of our larger game by user base. So that should give us, we think, at least 3% extra revenue, which we'll achieve gradually, obviously, throughout the year as we deploy advertising in all of our games. On the other hand, I mean, games industry is a great industry in a sense in this situation because we weren't affected a lot by the crisis directly. But I'm a little bit concerned about the indirect effects that we may see due to economic deterioration in the following quarters. So that is another thing that I'm concerned with. And then there is also a question of how long this wave of additional downloads is going to last because we are entering a period of warmer weather, obviously not holidays, but people may want to spend more time outside. Options are still limited, but we see that certain states are opening up and certain countries are talking about relaxing measures. And so we may see the pattern that we see in China where people are like, Oh, thank God I can go somewhere now so I don't have to spend all my time playing. And then this will affect us kind of not negatively, but this will limit the positive effect that we are seeing now. So overall, in the short term, I don't think that the situation affects us negatively. Over the long term until the end of the year, we'll have to wait to see. Got it. And I mean, what can you say about your spending here? I think if I answered correctly, you have hired some new kinds of people into your user acquisition team. Could you elaborate a bit on how your acquisition strategy has changed? And if we if this is the new sort of normal level with the user acquisition cost below 22% because it has been very volatile. So what is the plan really for optimizing between margins and growth? I'll try. But honestly, I don't think about user acquisition as a percentage of gross revenue. The thing is that we're looking at what is possible to achieve in the market. And so we go with spending where we see that the spending actually repays for itself. So to me, I don't know the number. There is no number that I would say, like, oh, this is going to be this or that this is going to be that. If we see the ability to scale our own games substantially and quickly, we can go very aggressively on user acquisition. And so that quarter, we may have an elevated level. But I think if you're looking at the Q1, which is kind of in the absence of strong sequential growth, yes, this is where we should be for a quarter like that. And then if we are going to have stronger sequential growth, it may be the same, may be better, may be worse. It really depends on how well we will be able to invest the money in user acquisition and how soon we will get the money back. There is unfortunately, there is no way to say that this is where it will be. I'm not sure this is what you wanted to hear, but that's how it is. In terms of user acquisition, we so the new management that we have in user acquisition, basically, they deployed a much more sophisticated process for acquiring users. I think they brought it up to speed with what the industry standard is now. And we've increased the staff count and user acquisition to allow people to focus on effectively deploying a relatively smaller amount of capital as that is important. And also all of this is within a framework for how to make decisions in user acquisition. And there's a lot of technicalities there. But basically, we upgraded everything, including the tools over the last 6 months quite substantially. And the existing user acquisition managers, they had to go through some retraining. So we started this process around October last year. And I think right now, we are in the situation where we learned how to acquire in a very efficient way. And from here, we hope to start increasing the amount of capital that we can deploy efficiently. That's the plan. And I think it's going to take another 6 months probably for us to get to where we want to be, kind of full speed in terms of marketing. Okay. Got it. That's helpful. So it's more a more sophisticated approach than that you're seeing lower return on your marketing investments than in the Q3 and Q4. Thank you very much. Thank you.