Earnings Call: Q2 2016

Jul 27, 2016

Quarterly report

Welcome, everyone, to our earnings call. Let's proceed to the Page 2 of the presentation. The presentation. We have had a strong quarter in the second quarter, and we have delivered the revenue growth both quarter to quarter and year on year. 2nd quarter historically is one of the weakest quarters in the year. So the fact that we have delivered quarter to to achieved revenue of SEK 104,500,000, that's growth of 17% year on year. So we can say that we are back to the growth level, if that is in line with the growth of the market overall. The main driver of the growth was the game called Hidden City. It's one of our newer hidden object free to play hidden object games that has been performing really well over the past couple of quarters. As a result of the growth of Hidden City, our portfolio mix is improving. We are seeing less reliance on our top performing games and kind of more diversity game wise. The operating profit was SEK8.7 million, EBIT margin of 8%. It was affected by the currency exchange 10%. And this noncash FX rate charge is actually reversible, so if currency goes the other way around in the later periods, it can work the other way around for the company results. Operating cash flow was SEK 9,400,000, and we had substantial changes in working capital where we have settled certain amount of royalties outstanding, which contributed to negative cash flow in the quarter, but it was a good thing to do. Now on to the Slide number 3. The highlights of the quarter were the following things. The Paranormal Society is a new hidden objects puzzle adventure free to play game from G5, which is developed by G5 and owned by G5, and it was released during the quarter. The genre of the game is similar to the best performing games that we have, the Secret Society and the Hidden City. And right now, the game is in the soft launch mode. It means that we are not actively scaling the revenue, but we are looking at the analytics, the performance of the game. We are making tweaks and changes to the monetization to make sure that we are hitting on all the monetization and retention goals for the game. And the game will be in this mode for a few more months. We usually spend about 6 months in the soft launch mode. The Quest, one of the games that we have released about a year ago, has improved its sales in connection with the latest updates that we have made the game. So, suddenly became one of the better performing games in our portfolio. We have also released another human object free to play game called Special Inquiry: Detail. It was previously released on iOS and it's still in the soft launch mode. We also released it on the Google Play and Amazon App Store, those app stores that are powered by the Android operating system. As I mentioned, we had very strong growth of our Hidden City game during the quarter, and we have quadrupled earnings compared to the last year. Let's look at the Slide 4. You have this chart showing the development of the revenue of the company, you can see that in the Q2, we have delivered higher revenue, both overall, but also in free to play games. And the free to play games underlying growth was actually 23%, so more than the top line revenue growth. The unlockable games, which are just a few percentage points of our revenue at this point, are still gradually sliding as expected. As we have communicated many times, this is what we expect the unlockable games to do, to continue to gradually slide and fade away over the coming months and probably years. So this is what happened. Let's move on to Slide number 5 and look at the operational costs. As you can see, we went through the period of a rather quick growth of our operational costs during 2014, but then in 2016, it has stabilized and remains stable in the first half of twenty sixteen, while revenue is growing. So there you have the increasing profit margins. Administrative costs are on about the same level as in the 2015 and the Q1. We have gradually increasing research and development costs, mostly because of the higher amortization. And if you look at sales and marketing costs, the user acquisition expenses, the money that we spend on attracting new users, is only 17% of sales in the 2nd quarter compared to 20 5% a year ago. And again, the top line has actually grown from last year to this year. So we are showing that we can achieve growth in terms of the user base and revenue spending essentially about the same, if not the lower amount of money on marketing. Let's move on to the Slide number 6 and look at our EBIT and EBIT margin. We have communicated in our reports that our goal is to focus more on earnings and to achieve growth of earnings year on year and quarter to quarter ideally. It doesn't mean that we will do it every single time. We don't control it precisely. So in this quarter, if not for the revaluation of operational liabilities in connection with the intercompany loans within the group, we would probably have 10% EBIT margin, so the same level as in Q1, but we had this non cash charge. So that's why it's lower at 8%. Still, the rolling 12 month margin has significantly in the future without even growing it, it will mean that the growing 12 months will continue to grow for at least another quarter. Right. Next is Slide 7, the net We also gradually depreciate these capitalized costs when the game comes out. So the capitalization net of amortization amounted to about SEK 5,000,000 in the 2nd quarter, in line with the Q1. And it's I would say, it looks as we have this stable level in the first half of the year. It's kind of difficult to predict specifically which level is normal and how it should be. And because of the nature of the development of games where you spend less money on the game, developing the gain at the beginning, but then towards the end of the project, you might have larger payouts and larger costs. But we expect that with a number of new games coming out of the soft launch window, the amortization will be gradually picking up and net amortization that will be continue to be kind of shrinking. When we look at the total game portfolio to capitalize core of the game portfolio, the free to play games are responsible for 95% of the revenue at this point and 5% are still unlockable games associated with that declining revenue portion of the company. But the amount associated with the unlockable games that are still not released and we still have a couple of good games that are coming to the market is almost 0. So essentially, the risk in connection with this part of capitalized costs is rather low. And I think that the value of our free to play portfolio that's on the balance sheet is quite reasonable given the absolute size of the revenues that we have from Critical Games. Next is Slide 8, cash flow. We had a cash flow from operating activities of SEK 9,400,000. We had this large negative change in working capital catching up with our royalty payments that were on the balance sheet as liabilities anyway and reducing those liabilities. We had compared to the Q2 last year, comparatively lower investment in the development of new intensive in terms of the number of new games that we were developing and the number of new projects that we were launching. And right now, we're focusing more on further narrowing down the number of projects that we're really focused on and even thinking about reducing the number of free to play games going forward. So that is it for the presentation. We're on to the Slide number 9 and the questions and answers section. Thank you. Our first question comes from Victor Hultberg of Fermium. Could you maybe talk about the virtual reality initiative you launched a couple of weeks ago? Talk a little bit about that. Okay. Thanks for the question, Victor. Basically, we from people we would associate with our target audience. And that is, as you know, women 35 plus. And the fact that they were interested in this experience kind could we make some products could we make some products that would go after our target audience, if they will get excited in this technology to the point that it becomes widespread. And we're probably thinking more about mobile virtual reality rather than the something that you buy for your desktop PC because most likely our audience are going to be getting one of the mobile platforms rather than something that works with a desktop computer. So we have decided to form a small team within the company that will basically look into what's going on there and try to implement some of the ideas that we have in terms of how could we provide entertainment that's similar to what we do in mobile but in virtual reality. We do not expect this area to have any effect on the company results really, both in terms of revenue and expenses, because the team is going to be quite compact. And we it's difficult to say when, if ever, this is going to generate any money. But we are looking there just to make sure that if there is something coming from there that can turn into successful platform for the mass user that at least we are there early on and we have we are trying to see what could work for our audience. And we will meet them there. We will have the content if they will be looking for type of content. Okay, great. So the problems you had in Q1, which resulted the stagnated growth, so to say, are those problems, so to say, fixed now or going forward? You mentioned your growth is now in line with the market. Is that to be expected for the rest of the year as well? Well, we're not giving guidance for the rest of the year, as you know. And if you even look at the Slide number 4, you can see that the Q1 last year was a particularly successful quarter, and it's a little bit out of the pattern. It just pops out. It's a really base. And I would say that our Q1, of course, I can't say that we had really impressive growth in the Q1, but the free to play revenue was actually growing quarter to quarter in the Q1. And it's just that the total revenue was not as impressive compared to a high base last year. And if you look at the Q2 last year compared to this year, you can see that there was a decline, a sequential decline last year. So we have lower base, better growth. But again, there is a looking at the last four quarters, especially looking at the free to play revenue, there is growth in free to play revenue 3 to 4 revenue every quarter, quarter to quarter. And that sometimes that increases or declines depending on how the portfolio works out, how the updates are working out. Sometimes what happens, developers are late with the updates and then we don't get as impressive result as we can. Sometimes there's just a successful update with a great content that they would challenge gets people more people to play it and they monetize better and that works better for us. But if you look at the report which just came out this morning, you can see we have this quarter growth across all the major parameters, the number of monthly active users, daily paying users, revenue per user also have increased. And it was the same thing in the Q1. So basically, we gradually, continually increasing the audience and monetization per user. So and we will do our best to continue to do that. Okay. Thank you. So in continuing doing that, you mentioned you're going to release some new games this year. How many and when? Could you say something about that? Number of games. Some Some of them are licensed, some of them are actually owned and developed by G5, and they're coming out before the end of the year. So we will have to follow the company to see that happening. Okay, great. Thanks very much. Thank you. Thank you. And we have one further question. That is from Jan Rosenquist of actually, as a private investor. You have up of the game? Sorry, could you repeat what's behind what? The successful ramp up of the game this quarter? You mean, yes. So the main driver, the main highlight was the Hidden City game. And this game was released actually 2 years ago, I think, initially. It has been in for quite a long period of time, it was in the soft launch mode for about a year. We were looking at why it's not performing ideally and in line with our rather high expectations, and we were making changes to the game. And then last year, I think we have finally understood what was going on. And the developer took some time also to make the changes to the game for the better. And then the game started performing better. And then over the last year, we've been working on adding more content into the game. It's important that we have the length of the content that's enough for the player to stay in the game for a long enough time to give them the opportunity to monetize well and to spend enough money. And at some point last year, we have achieved the understanding that the game is ready for better growth and that fundamental equation works. And for us, it's that the cost of acquiring the user is substantially lower than expected lifetime value of the user. So when we see a game with that working out well, we know that we can scale the game by bringing more users into the game. And it's not only about acquiring users with user acquisition, with getting paid installs and paying for users. It's also about cross selling the game with our other product, so we can justify bringing users from other games into this game, especially if we know that the lifetime value in this game is actually higher than in the other game, then it makes more sense to do more aggressive cross promotion for the game. So we've seen that Hidden City is doing exceptionally well on metrics, and we just started getting more aggressive about promoting game promoting this game internally and also in terms of buying users for it. And that has significantly improved the performance of the game over the last couple of quarters. And we just see the result of it in the Q2. And needless to say, we continue to work on all of our other games, trying to achieve the same situation where we will see that there is an opportunity for much faster growth of other games as well. And we want to bring more games into the same situation that we have with the human city right now. Yes, great. Thank you for the answer. Thank