Earnings Call: Q4 2017

Feb 16, 2018

Hello. Thank you for dialing into our call today. My name is Vlad Soglobov. I'm the CEO of the company. And let's get to our presentation for the Q4. So we are actually pretty happy with the result of the Q4 2017. We had this sequential jump of revenue of 33% from the Q3, one of the highest that we ever had. And you could have noticed that this happened because we used the Q4 to boost the user acquisition spending, the marketing spending to attract more users into our game and substantially boost the revenue. And essentially, this is what we did the last year as well. And this has a short term negative impact on the profit margin, which is down to 4.5% in Q4. And like last year like it happened last year, we expect that the margin is going to recover to higher levels on larger revenue base, thanks to this booster quarter. There's more information about that in the report. We had really good result in terms of monetization of our user base. So despite having a lot of new users because of a lot of spend on marketing and we attracted a lot of users during the quarter, Despite having all these new users that take time to monetize, we have achieved the highest monthly average gross revenue per paying user of $42.7 And I think it's a pretty good figure that shows the strength of our product and the engagement and monetization within our games. We have acquired the rights to the game called Secret Society, the game which has consistently been our recently number 2, number 3 top grossing game in our portfolio. And the dispute with Microna was resolved, and we took over the whole game and the franchise and the within the part of the portfolio that is wholly owned by the company. The growth was basically happening in all the key regions. And in Asia, it was fastest at 2 60% year over year. But the trends are pretty much the same as we had in the previous quarters of this year. The one thing that we are particularly happy about is the fact that the wholly owned part of our game portfolio was growing faster than the licensed games. And that is quite rewarding given that we are focusing quite a bit on strengthening our own game development and that part of the portfolio. And the Board proposes a dividend for the full year 2017 of SEK0.025 per share. And you may notice that this is more than 3x the amount we have paid out in 2016. And this actually underlines our inherent leverage of the business model and the expansion of margin on all levels. So despite not seeing we have a margin expansion in EBIT and you can see that in our reports. You can compare you can see it on the quarterly level. You can see it on the full year level. But our growth is what makes it possible for earnings per share to expand faster and then the dividend expands even faster. So, I think this is just a sign of kind of fast growth and the quality that we have in the company. Let's look more at the financial things. So the revenue in Q4 up about 93% year over year. And once again, owned games grew faster than licensed. We have continued our growth in Asia. That was the fastest growing region for us in terms of revenue. And the underlying trend for increased revenue from devices with the smaller screens, smartphones rather than tablets, have continued. Earnings in the 4th quarter were SEK 15,900,000 and EBIT margin was 4.5%. However, you may note that the onetime write downs of the goodwill and some intangible assets amounted to about SEK 4,500,000 in this quarter. So adjusted for that EBIT margin was 5.7% compared to adjusted EBIT margin of 4.4% last year. So once again, despite spending record amount of money on user acquisition in the quarter because we've seen the opportunities to get company revenue to the new level, we were able to actually expand the profit margin. And there were some other items. And if we look at the cash flow, you may notice we had a negative cash flow for the quarter and that's mostly connected with the fact that we have acquired The Secret Society. And a part of the total payments that we plan on making in connection with this were made during Q4. So if you adjust for that amount, the cash flow for the quarter would have been profitable would have been positive and the cash flow for the full year would have been stronger. On to the next slide, Slide 4. If you look at geographic revenue distribution, it's basically the same trend continued. Asia continues to increase its revenue share and now is up to 28%. U. S. Is gradually going down. It's now 49%. Europe went down as a percentage of revenue share, down to 16%. But if you look at absolute figures, there is growth in every region. And year over year, Asia was the strongest, 260%. North America grew by 63% and Europe and the Rest of the World by 93%. Onto the next slide, Slide 5. So in terms of if we look at the performance of individual games, we can say that now we have 2 games that have cost over $100,000,000 in their lifetimes and they continue going strong. Mahjong Journey, our 2nd or 3rd top grossing game, which is wholly owned and developed internally, is currently ranked number 3 among all the Mahjong Soldier games in the world, up one position from last year when it was number 4. Pirates and Curls, the Match 3 game that we have launched during Q3 and which was in the soft launch during Q3 and Q4, is performing well and gradually going up in revenue, but it continues to require more work to add more levels. And there needs to be more work to put into marketing of game of this game. The Match 3 part of the market is rather competitive. It's very interesting, fast growing, large market, but you have to do your homework. So we'll continue working with this game. And so far, it looks pretty good. If we look at free to play games specifically, they grew by 98%, so faster than the overall revenue figure. And at this point, the unlockable games are down to about 1% compared to 3% last year. And it is our intention to stop talking about unlockable gains because they're becoming kind of a really small part of what we do. Slide 6. Let's look at our operational costs. These are actually very interesting charts. On the left side, you see the absolute numbers for our costs by 3 main categories: the administration, admin research and development and sales and marketing. And you can clearly see how the cost for sales and marketing, the user acquisition cost goes up dramatically in Q4 2016 and then once again in Q4 2017. So this is what we are trying to do this year just like what we did last year is to boost our revenue to the next level, putting pedal to the metal in the Q4 with the increase in user acquisition spending to kind of get the revenue of the company to the new level where it can be sustained. And if you look at the R and D and the immune costs, you can see there's a trend for gradual increase and it looks pretty dramatic. And user acquisition costs and their increase, especially in Q3 to Q4 every year, looks like a pretty dramatic increase. But if you look on the right and if you look at these costs as a percentage of revenue, it all kind of makes sense. You can see that the R and D and administration costs are actually gradually going down as a percentage of revenue. And that is what is helping us increase expand our profit margins over long term. So for example, if you look at Q1 let's look at Q4 2016, 9% in R and D costs, 5% in admin costs, a total of 14% of revenue that went into these 2 categories. And then this year, you can see that it's only 10%. So 4% were freed up from these categories and then we allocated it towards user acquisition. But we can also allocate it towards EBIT. So that's the EBIT before The one KPI that is very important for the company is the EBITDA for cost for user acquisition. And that is where the expansion of the margin is actually happening before this margin can drop down to the bottom line to EBIT. And this EBIT margin before user acquisition expenses is this important number that is gradually growing year over year on a quarterly level and you can see that. And on the full year basis, you can see that happen as well. And then it is up to us to decide how much of that we can we want to allocate towards future growth and spend that on user acquisition and how much of that we can decide to leave to drop down to the bottom line to EBIT. And more often than not, we're choosing to focus on growing company's revenue further just because we don't really know where the ceiling is. We don't know if it exists. We don't know where it is. So we want to push company's revenue as long as we can see that there's potential to do that. So we choose to do that. And again, in Q4 2017, we did it once again with great results and the sequential growth of 33% to 40%, Q3 percent of revenue, I think, just shows that it has that was the right decision. So what else here? On the operational cost slide, you can also see that over time, we were able to dramatically expand the amount that we're spending on sales and marketing. And once again, this is a decision to do that in order to continue driving the top line growth, which we believe is what we should be doing now on a fast growing market with the audience that we have that we believe is underserved, we believe this is the right strategy. Let's move on to the next slide. Slide number 7, EBIT and EBIT Margins. So once again, the reason that EBIT margin went down in Q4 this year just like last year is because we have dramatically increased marketing spending. And the result of this increase, the growth that comes from this increase is going to benefit the company in the quarters to come in 2018. And you can already see the benefit of that in Q4. The growth of the top revenue sequentially 33%. That's exactly because we have decided to spend so much in marketing. But as you can see, what happened last year is that the profit margin has recovered from this level in Q1 and Q2 and Q3. And that is exactly what we're trying to do this year once again. We boost the growth in Q4. We then consolidate and expand margins in Q1. And then hopefully we can continue growing from that level. That is our plan. That is our goal. So if you look at the EBIT figure for the Q4, that's for the full year, it actually went up by 167% year over year compared to the revenue growth of 120%. So once again, there's a leverage in our business model and earnings are growing faster than the revenue. And you can see that the earnings per share are actually growing even faster than earnings. And last year, we started paying the dividend with deciding that we're just going to pay out 20% of our EBIT. And this year, the Board recommends we increase it to 25%. So you have basically even faster growth on a dividend level. All right. Let's move on to the next slide, Slide number 8, net capitalization. So you can see over 2017, we had a little bit of a reversal of the situation we had in 2016 with the cost the capitalized game development cost gradually going up. And that has to do with the fact we have hired a lot of people to be able to dedicate fully staffed, focused teams to our games, to our internally developed games, the part of our portfolio that percentage wise year over year is growing the fastest right now. And we believe it is strategically very important to have all that all those people and to motivate our employees with the bonuses and incentives that they have to make their games perform better. And I think we're already seeing the results of that. So to me, this is a great thing. We have a number of games in development also that we plan to release during 2018. And the ongoing work on all the existing games on our own portfolio and the ongoing work on the new project for release in 2018 is what is generating the increase in the capitalized development costs. The amortization has increased as well, but not as much. As you can see, the part of our the capitalized development costs on the balance sheet that are related to unlockable games, they have been these parts have been going down gradually over the years quarters, but now they're down to almost 0. So we don't have any costs associated with the unlockable gains that are not released and only a minor amount associated with the unlockable gains that are released. And if you look at the net value of GAIN's portfolio, it went up from about SEK109 1,000,000 at the end of last year to SEK115 1,000,000 at the end of this year. So it's not really a very dramatic increase. And amortization gradually goes up as well. So I think you're going to see that whenever we boost the development capacity, there's going to be an increase in the amounts that we can't fly every quarter. But as soon as our development capacity stabilizes and new games are coming out and they gradually switch into the amortization mode, these amounts will tend to even out again. And that's how you can see what's happening with our development capacity. Is it going up? Or is it going down over time? Or is it stabilizing? I would rather say it's not really going down. Let's move on to the next slide, cash flow. So we had minus SEK7.4 million negative cash flow for the Q4. As you can see, that is after the payments that we have made in connection with the purchase of the secret society, which amounted to SEK 23,100,000. So if you adjust for that and the changes in the working capital, The adjusted cash flow is actually positive. And then for the full year, we still have positive cash flow of SEK 22,000,000. But again, this is affected by the purchase of the Secret Society in the Q4. So the underlying cash flow is stable and positive and there are no changes there. It's all good. Our investing activities, as we discussed, increased year over year mostly because of the expanded development capacity and more games in development and more work done on our existing games. And that is the major contributor there. Otherwise, again, we are very happy with the results of the Q4. We believe the Q4, just like last year, is taking the company to the next level of revenue, which is going to be sustainable and where we can expand the margins again. And this expansion of margins on a much higher revenue level can go a long way in terms of earnings and earnings per share. And that's what matters. That's why we're focused on growth right now. So that is it. If you have any questions, let's move on to the questions and answers. Thank you. First question comes from Stefan Knudsen of Rheemian. Please go ahead. Your line is open. It's regarding the user acquisition. And as you said, Vlad, it's quite a substantial increase just like last year. My question is, how does how do you see it long term? Because last year, you maintained the same level throughout the year. So just a long term vision on this. All right. Thank you for the question. So what we did in Q4 is basically we saw the opportunity to grow. We know that it's a quarter when we get a large when we can get a large volume if we want and we saw that we can do it. So the thinking was let's spend pretty much as much as we can while still delivering the EBIT that is going to be better and the EBIT margin that is going to be better than year. And we came pretty close to basically having about the same EBIT margin as last year. And that's intentional. We are just maxing out spending during the Q4 just to do as much as we can, while we can do it. And after that, usually, what happens is that we are basically looking at, okay, can we continue doing this? Can we still deliver the expansion of the EBIT margin year over year? Can we deliver sequential growth that would make it worth the continued spending? And we make decisions based on that. So basically, going forward, the goal is to balance growth and EBIT margin. And that's what I have always been saying is that we want 1 or the other. If we can't go sequentially, substantially, we would choose to have a larger profit margin and meanwhile work on improving our gains to make it possible to take the revenue to the next level. If we can see that there is opportunity for growth and we can deliver EBIT margin that would not look bad year over year, we can choose to stay in the high growth mode. So usually, if you look historically, on the lower side of the spectrum, we have a spending of about 16% to 20%. This is usually when there's not a lot of sequential growth and we're just kind of looking for what we can do. And on the high side of the spectrum, which has set a new record of about 34% of revenue spent on user acquisition, but the range is somewhere between 25%, 34% historically. So, that's what I can say. And that's what you can assume also. If you look at the EBIT margin before user acquisition, and we have a line in the report in the table on the first page, You can see that line there. You can see that this margin is gradually expanding. And this year, it's this quarter, I think we're looking at the new maximum number there of, let's see, 38%. So you can basically see if you take away from that 38%, if you take the lower figure of user acquisition expenses, that would be the possible EBIT margin. And on the other side, if you take away the high level, that's the EBIT margin that you would have in the high growth quarters. And basically, you have the understanding of the spectrum of how the next quarter can shape to be. And we go quarter by quarter. There are certain patterns that you can see in what we do. But ultimately, it's a choice between growing faster if we can or expanding the profit margin. And you have EBIT margin before cost of user acquisition and our historical user acquisition spending levels to figure out what a slow quarter can be in terms of EBIT and what a fast quarter can be in terms of EBIT. So I hope I answered. Yes. Very perfect. Very, very good answer. Thank you for the answer. Yes. Thank you. Thank you. And there are no further questions at this time, so I'll hand back to our speakers for the closing comments. There are actually two questions that we have in the email. And one is about our relationship with the deal terms with the developer of the Chitin City. And on that, I can say that our deal terms are with the partners are confidential, but we have a very good working relationship. They're doing a great job on the game. They're very dedicated to making it a success and I think that's a big reason why the game is so successful. And it's a long term deal. That's about as much as I can say. The next question is, if the mobile phones are selling in India very fast, do we see any big potential for G5 from this market? No, it's too early. So I personally think that it's too early. I don't think it's a problem selling a lot of phones in India. They can probably sell 100 of millions of them. For us, the problem is the ability of the players to purchase make in game purchases. And from what I understand about India is that it's a market where you have to go to sub dollar pricing to see any significant activity of the players in terms of purchases. And I think in the long run, in the long term, this is a very interesting market as the incomes are going to be rising for the majority of the population. But in the short term, I don't really expect any big positive surprises from that part of the world. That's my opinion. That's the end of the questions that we