Earnings Call: Q2 2018

Jul 27, 2018

Everyone, thanks for tuning in. This is Waz Globus, the CEO of G5 Entertainment. Let's start with the slide at number 3, the financial summary. We have had taken revenue in the Q2, about BRL 395,000,000, which is 43% growth year over year and 6% sequential growth from the Q1 of 2018. We had the record more extension propane user in the Q2 of $46.2 And this is something that we see as the content of us focusing more on the high revenue territories and focusing more on acquiring users of high quality. The own games of the company year over year actually grew faster than the license games. And that is a good trend that supported the growth in the revenue. Earnings were at SEK 50,100,000 and earnings per share SEK5.07. I think this is the highest we've ever had. And the EBIT margin expanded year over year to 12.7%, but was a little bit down compared to the Q1, which was, I think, 13.3%. We did a lot of hires during the quarter. About 65 people were added to the company and there were some extra development costs which affected the margins, but we will talk about it later on. The user acquisition costs were 24% of revenue, which is 2 percentage points lower than 26%, which we had a year ago. So I think this just shows that the model is sustainable that we're able to generate cost even with the lower user acquisition expenses and I'm good on this front. EBIT margin before user acquisition cost was 37%, which was a little bit down for the Q1. But again, there was some pressure on the profit margin, which we will discuss in the following slides. Cash flow was SEK 8,000,000. This is despite very big items like dividend and so in the stock option programs, actually 2 of those in the second quarter. Yet the we have had the highest cash flow on the account of SEK 107,600,000 at the end of the quarter. Let's move on to Slide number 4. And you can see we are moving forward in about the same pattern that we had last year where Q1 and Q2 will show nice earnings and good earnings margin. And despite the EBIT margin before you weigh going down a little bit in the Q2, if you compare the situation that we have now to that of the Q3 last year, getting a little bit ahead of us, We have more space for spending on marketing And we need believe we are ready for a seasonal rebound that we believe is going to happen in the Q4. And one thing that we have noticed in this year is that because we have added so many people to strengthen our development studios over the last year. Obviously, this started to weigh down a little bit in our earnings margin. And this is something that we have to do. We have to build teams that will continue making shots at creating new gains that will be making more than $100,000,000 over the lifetime. That's our goal. That's where we are aiming with the new games that we are creating. And because of all the new games that we are making and the continued development of all the games that we have on the stores. We have to strengthen our development teams. In addition to that, what we are doing is we're taking quite a bit of working certainly. As you know, we have acquired Pacific Society. We have acquired the Nightman's Strong- and Deep in the Q2. So we have to build teams to maintain and develop these teams. And we were also taking in work that was earlier that was done in the external development studios in order to better control the quality of the output. So when we are adding new projects, we're creating when we are creating internal teams, it's a trade off between better margins in the future if the project is successful, but higher costs in the beginning of the development because we have to take them uncertainly. We don't have external developers, which we can put these costs on if it's a licensed deal. And when we replace outsourcing costs with the internal development, it's not a dramatic effect on the earnings or on our development costs because we were already spending on outsourcing. So we're just taking these costs internally. They may be a bit more expensive or maybe a little bit more cheaper internally, but the difference is not that big. So just to explain to you better what is going on internally because this is something that is affecting our expenses and this is something that we are doing for the long term. So it doesn't we don't expect all the strengthening of our development or to be immediately translatable to the revenue and earnings. But this is something that is critically important that we do now in order to be able to continue delivering growth and create gains in the future. It's unavoidable that we have to do it. Another thing that affected earnings margin this quarter was the TIMAP events. It's called G5 TIMAP, which is an event that we create to bring people together from different offices that we have where people can finally work on the same games but are located in different offices. And kind of synchronizes the understanding of what we are trying to do in the company. So, we believe this is extremely important to do all that, especially with our distributed teams. And we do it in the Q2 and the Q4. So accordingly, the expenses affect the earnings margin a little bit in these quarters. And let's move on to Slide number 5 and look a bit more at the revenue. So it looks very good. We have continued sequential growth, healthy growth year over year. We have the differences to previous periods, I would say, is that this trend continues that started in Q1 that we are gaining a bigger part of revenue increase, sales increase in the paying user monetization rather than increase over the audience. And in part this happens because we have changed our user acquisition strategy a little bit and where we focus more on higher quality users and higher quality countries. So, that automatically kind of lowers the overall number of downloads, but it increases the revenue that we generate from 1 paying user. And as you know, we have about 10% of users who pay in any given game over the lifetime of the game. So theoretically, we could do quite well. Actually, we could have exactly the same financial results without 90% of our users. So that's what's happening here is that we are kind of shrinking that 90% of people who never pay in our games. And we would just have a little bit less of them and a little bit more of the actually paying users. And so the statistics of monthly active and daily active users and the monetization per users are affected accordingly. Another trend that we are seeing this year is the seasonality. It's a little bit early to say, obviously, about Q3. But we do see that in the summer, the activity of users and the number of new users looking for new content is going down a bit. So we are in that part of the year now where we can certainly see the signs. And I would say that this looks pretty close to what we had last year during the summer as well. In addition to that, we had a little we had a little buzz with the largest gains. Were some delays of the updates and events both in human city and the secret society. There were some experiments with the balance of human city, which did not go exactly as they were as we hoped. And can say these were planned because those were experiments essentially. We have to do this to better understand what is driving users and to try new things. You have to innovate even on the established team. And sometimes we do set up certain experiments and sometimes unfortunately they don't really turn out as we plan. Our strategy during this off season time is to focus on retaining users, keeping our revenue and preparing the strongest quarters of the year, which is the Q4 and the Q1. And we hope that we're going to see the same rebound that's in the last year and the users' interest and activity As it gets colder, and people have more time to spend with their $5,000,000 gains. So I haven't seen anything different from last year in that sense, this year. Checkatrade City remains our largest game by monthly revenue. That hasn't changed, but I have to say the revenue from our own games continues growing faster year over year than license games, which basically means faster than Hidden City because it's now with the acquisition of the Night Master, we deeply own all the games in our portfolio that are worth owning except Q and A. So it's kind of an outlier now. In terms of the revenue breakdown, it's about the same picture as before. It looks like we are from now set with this distribution where North America is about half, Asia 28%, Europe 16% and rest of the world 6%. So no big changes there. With that, let's move on to Slide 6. And again, you can see where costs were gradually going down as a percentage of revenue as revenue was growing very quickly. Now there was a little bit of a rebound in the administration cost competitive primarily because of the events that we had and some other one time costs. The R and D spend went up as well and that is the effect of extra expenses that we have in connection with all the people we have hired recently. And a big amount of work was performed on a number of games that we are getting ready for the release before the end of the year. There's going to be 2 or 3 such gains. And then there were some extra development costs as well, connect to increased monetization. And I'm sorry, not monetization, but amortization. And amortization is catching up, but the increase in the capitalization started a few quarters before, now going up as well. We were still able to spend 26% of our revenue on user acquisition and deliver 12.7 percent EBIT margin. So I think it's a healthy situation where we have to invest in the future of the company by building this team within the company or rather plural teams and building the games that we believe are going to ensure that the company has the right future going forward. And we have to make enough of these bets. We have to start enough of these games in addition to continue working on the existing games. And this is the course that we have to take. I think it's still a healthy result as we have margin expansion year over year even with the lower user acquisition growth. Let's move on to Slide 7, which shows net capitalization, at least amounts we capitalize every quarter in connection with the development of gains minus the amortization of the 16, but as the phase of Fekt has started in 2017, we gradually started adding people to the company and kind of taking our development capacity to the new level. And now we have we have obviously taken it to a much higher level. We have many more employees, many more better stronger teams, I believe, many more teams, but several more teams and they are much stronger and more able. And amortization is catching up. So the net effect, as you can see, is actually gradually going down from the Q4 this year. And the net value of King's portfolio went down perfectly compared to last year, but you have to take into account that because a really big chunk of this is in connection with the acquisition of the Synchrony side. So it's not because we ramped up our development costs so much. If we take out the Sacred Society effect from there, it would be a very different picture. Let's move on to Slide number 8, cash flow. And as you can see, the cash on account is going up gradually every quarter, almost every quarter. And this is all happening as we are showing the sequential growth and the growth year over year. But also as we pay dividends for the 2nd year now. And in the second quarter, this is what we did. We had a big outflow with SEK22.2 million in dividend payment. And then in connection with the stock option program from 20 14 2016, we also spent NIS 9,100,000 on that. And even after that, we had a positive cash flow of 8.0 percent. So I think it's a very strong, but obviously had a very strong underlying cash flow in the quarter that we were able to go through the dividend and certainly 2 stop motion programs during the quarter and still have a positive cash flow. One thing that helped us was the tax refund from Japanese authorities for amounts that they withheld over, I believe, 2 or 3 years ago. This is a one time thing, but it's going to help to make this quarter progress in terms of cash flow to be fair. Otherwise, I think we are doing really well in that sense and this is despite the increase in the development stuff that I've told you about. All right. I think this is it for the presentation, and I am happy to take your questions. Thank you. You. Our first question comes from the line of Victor Fazel of ABG. Please go ahead. Your line is open. Good morning and thank you for having my question. I have a question regarding this slowdown that you've seen in hidden object markets. Could you give us a little bit more of a flavor there? Sure. We do see a decrease in the pace of growth in the key market markets overall. But I would say it's not unique to this market. From what I have seen, from what I'm able to see, kind of the same situation in the last 3 games as well. So I'm trying to make sense of it as we go. But from it looks like the industry and G5 obviously had a very good high season this year. And then it was so good that it had to go down a little bit. And I think the fact that we are during the summer where people spend more time outdoors probably with different activities rather than sitting at home playing games is affecting it as well. So, my theory that I have is that we are basically looking at that. I'm not saying everything that happens to our games is explained by seasonality, obviously not. And we had some issues as well during the summer. But this is a trend that I think we have. And I think it may get even more pronounced over time because as you know, the shipments of new devices, they are no longer growing year over year in the developed markets. So you have pretty much a set audience of people playing these games and using mobile devices. There is obviously room for expansion of their business and how many games they play and how much they pay. But in terms of getting new users, I think we are reaching a certain plateau in terms of the food traffic in the application scores, for example, looking for new games. And maybe I'm getting very theoretical. At this point, it's not something I have seen, but this is something that I expect should happen is that before we always had certain number of people who never used smartphones or tablets before finally get one and go into the market and try to find applications for it. And this is when they download a lot of stuff. Now, we're not going to have that many people doing that because everybody has a smartphone. So, you what will happen is that a certain number of people will come of age in a certain year and they will get their device for the first time on immune devices or they will finally get into the age group, which is interested in games like we're making. But it's going to be a bit more gradual process, not fueled by new users finally getting into the smartphones because at this point in the developed markets it looks like everybody already has 1 or was exposed to it. They don't have it. So that's my thinking. Okay. Thank you very much for your answer. Thank you. As there are no further questions at this time, I'll hand the call will will go through them. And one question is, could you please elaborate on which countries you are actually targeting in accordance with the new A. Strategy? How does the focus on high quality users affect your U. A. Efforts in growth? And I think I pretty much covered it. The change is that we are getting less users and we get more paying users among those. And on average, the monetization for paying users is going up. And the high revenue per user countries are obviously United States and Japan, which are big countries for us, but also South Korea and even China. In China, you can target, for example, iOS users and they tend to be rather good quality and rather highly priced as well user acquisition market. Then there are countries in the West Europe. So, it's quite we're just targeting the countries where our sales are the biggest basically? Have you another question, have your advertising revenues increased via revenues from in game purchases? We do not have any advertising revenue. None. All of our revenue is coming from in app purchases. So no changes there. It's 0 at this point. And then there's another question. Can you elaborate on the 2, 3 new games that you plan to launch by year end, category current state of development? So yes, I wouldn't be saying that we there's the probability will launch them before the end of the year if they weren't in final stages of development. So, they might be quite close to the initial release and the quality that is enough for us to do the initial release. The games that I'm talking about are going to be in one of our main genres. So, we have these 3 games that are coming out earlier than all of the other games. And I hope that 2 or even 3 of these will release before the end of the year. And there's basically going to be 1 game in each of our main categories. And our categories are keynoted, naturally and solidar gains. So that's our plan. And I don't have any more questions. So thank you very much for listening. And this concludes our earnings