Earnings Call: Q1 2018

May 3, 2018

Good morning, everyone. My name is Vlad Sokolobov. I'm the CEO of G5 Entertainment. Thank you for tuning in for today's earnings call. And let's move on to the Page number 2 of the presentation. So we have had the highest ever in the free to play business model margin in this quarter of 13.3%, and that is the highest yet we had in our free to play business model. And that's a good sign after the Q4 last year, which as you know had a lower margin. Earnings went up 134% year over year and were about SEK60 1,000,000. And top line went up year over year 59% and 4% sequentially from the 4th quarter. And if you follow us, you know in the Q4, we had so called booster quarter. So we spent a lot on user acquisition. And in Q1, what we usually do after that is that we lower user acquisition expenses back to the more normal level and we did it this year as well. And despite doing that, revenue went up sequentially in Q4 to Q1 and we actually lowered user acquisition spend to the same number same percentage of revenue that we had in the Q1 a year ago. So you can see that we are on a much higher base spending the same percentage of revenue on user acquisition and went up substantially in 1 year. And we've been saying that we can do this booster quarter in the Q4 and come out in Q1 with higher revenue and expanding profit margins. And that's exactly what we've done in the Q1 of this year. So it's all good here. In terms of geographic mix, pretty much revenue continued growing strongly in all regions. There weren't any big changes there in terms of the mix, but the growth was everywhere. There's very good development in the average revenue per paying user, which went up 24% year over year to a new record level for the company. And in terms of cash flow, the cash on hand increased to SEK97.7 million and cash flow was SEK6.2 million, which is not a lot, but there were some one off items that affected it. But the underlying cash flow was actually quite healthy. Let's move on to Page 3 and look at this in a little bit more detail. We discussed the revenue was SEK202.6 million, 60% up year over year, 4% sequential growth from Q4. Pretty much all of our main games set new records of sales during the quarter. That is true for both licensed games like Kin City and for our own games, especially in the Drunk Journey did well and Pirates and Turtles continued growing the revenue and pretty much all of our hypnotic games also went up. Profit, we discussed again, it was a good return to higher profit margin compared to the Q4, where we tried to really do a boost to the growth in our revenue by sending more new acquisition but then coming back to more normal levels, and we did that. There is this very important KPI that we're tracking internally called EBIT Margin Before UA Costs. The logic there is that this is the EBIT margin from which we can decide what to spend on user acquisition and what to keep to allow to drop to the bottom line. So it's basically the sum of our spend on user acquisition as a percentage of revenue and the bottom line, the EBIT margin. And this number has to expand over time in order for us to be able to deliver margin expansion and to be able to spend more on user acquisition. And that's exactly what happened again. Last year, we had 34% margin this year 39% margin. Slide, Slide number 4. So this is a quite interesting chart on the left side of this slide. This is our the light blue line there is our EBIT margin in percentage points and you can see a certain pattern here. You can see it drops down in the Q4 every year in the past 2 years and then it bounces back and then it gradually grows over the term of the year and then it drops down in Q4 again. This reflects what we were trying to do seasonally. Q4 and Q1 are the strongest quarters for us in terms of growth. It has to do with the fact that many new devices are coming to the market usually during this time. People are upgrading their phones. They receive tablets as gifts. So there's a lot more activity out there in the application stores and a lot more people looking to install new apps. So, usually, we try to be more proactive and aggressive with user acquisition during this time. And we tried to do this over the last 2 years and it worked pretty well for us. There's no guarantee we're going to continue doing exactly this thing next year, obviously, because the situation may change. But if it doesn't, we're probably going to stick to this pattern. And I think you can kind of make certain assumptions in terms of how our margin is going to look like for this year based on quarter. And you can see that every Q1, we come out of a boosted quarter with a better profit margin and that's because we have this leverage in our business. It costs us the same amount of money to run a game that has a 1,000,000 users and 5,000,000 users. So our costs continue to shrink as a percentage of our revenue, which allows us to have higher profit margins. And as more and more of our revenues generated by our own games where we don't share any revenue with 3rd party developers that helps extend our the chart on the right actually shows the KPI I was talking about, the EBIT margin before cost for user acquisition. And you can see this margin expand over time during 20 16 'seventeen and into 2018 as well. And this is a more stable KPI than the EBIT because it also reflects our ability to spend on marketing. So I think it's one of my most important KPIs that I'm looking at And I think it's good you can look at it as well and see that this expansion is actually happening. And it's quite substantial over time from about 25% in the beginning of 2016 to now almost 40%. That's 15% of our revenue that we can either have as earnings or spend back into user acquisition. And we can decide how do we allocate between 1 and the other. Let's move on to the next page number 5. This is the distribution of our revenue based on the world region. You can see pretty much the mix remained the same Q4 to Q1. Revenue went up in all regions year over year. Asia, because of the fast growth last year, obviously, was the strongest. North America is doing well. Europe went up quite a bit. Rest of the world is growing as well. There is the fact that our average revenue per monthly active user went up so much has to do with the fact that the revenue in Asia, specifically in Japan within that segment went up dramatically for us during 2017. Japan is known for having some of the highest paid users in the world, if not the highest paid on average. So that contributes to the fact that we're seeing more and more revenue from one person. And all the underlying trends in the market, if you look at the research, our audience is expanding, people are playing and spending more and more time on mobile devices and playing more. And games is one of the major tasks that they're doing on their phones and tablets. And they're getting more and more comfortable spending money there as well. And if you think of it, dollars 40 a week, sorry, dollars 40 a month is not too much. It's $10 a week. And for toy game where you spend many hours and you get a lot of hours of entertainment out of that game, it's not really a substantial amount. So I think we still have opportunity to continue growing this number into the future. I can't say exactly by how much, but I think all the trends point to the fact that if we're going to be good at making our games enjoyable and making people feel like spending money in these games, the fundamental trends are there to support this into the future. Actually, Q1 was interesting because the growth in revenue, which before was in the larger part supported by the growth in audience and kind of it's a smaller extent than the growth of average revenue per user, in this quarter, there's more emphasis on revenue per user. So the growth of the audience is not as dramatic year over year, but the monetization certainly went up dramatically. But again, it has to do with the fact that we were focusing a lot on acquiring new players in Japan and that automatically makes our audience smaller and the revenue per user larger, all things other things being equal. Right. Let's move to the Page 6. Gross revenue, you can see the chart showing the our revenue by quarter. So just a note here, we report in Swedish krona, but because we receive most of our revenue in the United States dollars and in Japanese yen, the exchange rate obviously affects our results. So in this case, I write that in the Q1 report that our internal management figures were actually showing different numbers. And internally, we track revenue in United States dollars. So we saw something like plus 70% or 72% year over year and the sequential growth was more like 6% or 7%. So the results were somewhat affected by the exchange rate and expressed in SEK, they're a little less dramatic in terms of growth. But just to say again that revenue grew nicely year over year and sequentially as well and we're quite happy to see that given the reduced level of user acquisition. And like I was saying, the audience, the daily active audience went up about 37% year over year, it's daily, well not monthly. So there's probably better growth in monthly. And there's nice growth in monetization. So these two numbers drove the increase in revenue. More frequent play, more people playing every day. By frequent play, I mean TAU divided by MUU. And we started publishing monthly unique users. So you can now run that calculation if you want and see that we're actually getting better in terms of having more people play in a single day. So people are playing more frequently and they're spending more money and the audience is growing and it's all moving in the right direction. So we had some really strong updates during the Q1, again, across our main games, Madron's Journey, Price and Perils, Twin Moon Society and Hidden City. Teams did a great job, made great updates, new levels, new hidden object scenes, and the audience obviously liked those and that's the reason the revenue continued growing even with the reduced marketing spend. And once again, we are just seeing that people are spending quite a lot of time in our games and their lifetime there is quite long. They're playing for months and even years. And this longevity of our games allows us to reduce user acquisition spend as a percentage of revenue and yet see our revenue grow because users that we have acquired in previous quarters are actually monetizing as we reduce our efforts to acquire new users. So there's this lag, but also users that we acquire, they stay for a quite long time. So there is the staying power of the marketing spend that we are doing. We are getting users to play and they're sticking with the game. And it drives our revenue to new levels. And with that, it drives our margins to new levels and that allows us to spend even more on user acquisition. So let's move to the Slide 7 to illustrate it a little bit more. On the left side, you see the chart that shows our operational costs in absolute terms in Swedish kroner. And you can see that it's growing. The administration and R and D are trending up, not very dramatically, but still going up. But if you look at our sales and marketing costs, they're going up quite substantially, right? This is our biggest single biggest line in our expenses. But if you look at the chart on the right and that is the same cost expressed as percentage of our revenue, you're going to see quite a different picture. You'll see that our administration and R and D costs are what we consider more or less fixed costs, right, because we have found whether or not games are very successful or not. I mean, our games may have 1,000,000 players or 10,000,000 players. Our administration and R and D costs depend on the number of games that they have, not on how successful they are. So these 6 costs are actually trending down as percentage of revenue, which helps expand our margins actually. And that allows us to spend higher percentage of our revenue on user acquisition if we want to. And that's what we've been doing. We've been gradually spending more. But as you can see in Q1, we went down to the level of user acquisition spend that we had at the end of 2016 or for the 1st three quarters of 2017. So we there is really no need to continue increasing the percentage of revenue that we are spending on user acquisition. It's not it's possible to do that If we see the opportunity to do that and grow our revenue even stronger, we might want to do it. But on the other hand, I think we are demonstrating clearly that we don't have to do it. We can keep our user acquisition spend within this range. And basically you can see from here 26% to 35% where aggressive level will be 35% or maybe even more towards the end of this year because we're going to have more space in EBIT before you expand margin to spend even more marketing when we really want to do it aggressively. And on the other side of the spectrum, we can go all the way down to 20% or like this quarter or Q3 2017, 26%, 27% and still continue growing. So we're going to keep our user acquisition probably within these brackets going forward. All right. Next slide is Slide number 8. And the chart on the left shows the net capitalization of our development costs. The capitalization for development costs is basically we put on the balance sheet the costs directly related to creating new games. Administrative costs don't go there. It's costs that associated with programmers and artists and other talent that's working on a particular game. So you can see that capitalization and amortization almost canceled out in Q4 2016. But from there, it was actually going up. And so we've been capitalizing more and more. It has to do with the fact that we've been adding more development teams to the company to be able to have dedicated teams for each of the games that we are developing internally and also to be able to make more games. So our staff went up quite substantially during 2017. I think we added about 100 people and that is reflected here. So this is work on the games that are already published, but also this is work on the games that are not yet published and that we want to release this year and the next year. And we are working on a number of owned games that are being released this year and next year. So it shows on this chart. Eventually, when the games are released, the amortization is going to catch up. And assuming we're going to have a flat development capacity, it's inevitable that the amortization is going to catch up eventually. But for now, because we have just added all these people and there's a number of new games that we're working that have not yet been released, it's trending up. Otherwise, what's interesting on this slide, So you can see there are some ports that went up for the games that have not yet been released. The net value of the portfolio went up quite a bit. And again, this reflects the shift of the strategy of the company towards developing own games and achieving high quality in our own games and higher success level there. We're quite successful with that. The revenue from own games is growing strongly year over year. It's actually growing faster than revenue from licensed games and it requires substantial investment in creating these talented teams and funding the games that want to build and publish. Next slide, cash and cash flow. So 2 big items this quarter were the continued payments for the Secret Society. This is all within the limits that we have indicated in the press release. It's just that the payments are being made over time. So this SEK4.5 million was a part of the payment that was made in the Q1 and then there was a payment of SEK10.5 million. For Japanese VAT, that was accrued for a very long previous period of time. We don't expect to have this kind of payments in the future. They're going to be handled month to month. But that was a cash outflow that happened this quarter. So we have total cash flow for the quarter was SEK6.2 million, but you can see that these two items basically SEK16 1,000,000 more were onetime payments and one time one off items. So the underlying cash flow is pretty healthy and good. There were also some expenses connected. Well, both expenses well, not expenses, but cash inflows and outflows where I think the net result was neutral or a little bit towards the outflow connect. That was connected to the exercise of the employee warrant program, the first one that was in the money during the exercise period this year. So we received some funds and we also purchased some of the warrants. Yes, but otherwise cash flow stable, healthy, reasonable and always good here. All right. That is it for today. And with that, let's move on to the questions and answers. First question is if you have any. Thank you for listening. Thank you. And there are no questions registered. I'll now hand back to you, speakers. Hello. I think we have questions in e mail. Can I go over these? I have them in front of me, so I can just read them and then get answers. Please go ahead. So two questions. First one, for QBCD and Pirates and Pearls, what is the ratio for both installs via organic installs? Well, we unfortunately do not report these numbers and we don't break it down. But for most of our games, the actual number of installs that are bought is it's usually not very substantial. So the organic uplift and also installs that we attract through cross selling, they usually are the biggest part. And that is the ability to cross sell between games is very valuable in that sense. And also, the ability to make a game visible in the application store that brings a lot of organic traffic as well. I would say well, I can say that it's quite healthy. And for Hidden City and for Pirates and Pearls, these are very healthy numbers, so we can say. The second question, for Kidn City in Japan, around each turn of the month, the revenue dropped substantially according to App Store revenue rankings. And then more or less cyclic revenue peaks within the month. There seem to be other cyclic revenue patterns for other countries as well. What is the reason for some of the cyclic revenue patterns? Well, I really don't know. I can I don't really track our chart positions for our games that close? But we do have some fluctuations in the revenue that usually has to do with what we call live ops, and that means live events and things that we do within the games like time limited, one time things that make playing the game more interesting. An example of that would be a Christmas event in the game, for example, that is only available for a month, obviously, Christmas. And once the Christmas is over, the event is over, too. And usually, this type of events attract a lot very strong interest and a lot of participants. And within this event, there may be certain cycles that make people spend on certain days more than on the other days. And that's just part of our efforts to sustain interest in the game and create some sort of real time feeling to it that you are not only just playing the game at your own pace, but there are things that happen within the game in real time. And if you miss out today, you might not be able to get the same benefit tomorrow. So this is probably the reason for the fluctuations in the revenue and so it can affect daily chart positions. That's why I try not to look at daily chart positions frankly. Yes, so that's the answer. I don't have any more questions in e mail. So if we don't have any more questions on the phone line, thank you very much for listening and have a great day.