East Side Games Group Inc. (EAGR) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the East Side Games Group Q2 Earnings Call. [Operator Instructions] I will now turn the conference over to Jason Bailey, CEO. Please go ahead.

Thank you, operator. Welcome, everyone, to East Side Games Group's Second Quarter 2022 Results Call. On the call today with me is Jim MacCallum, our Chief Financial Officer. I will begin by sharing highlights from the second quarter ended June 30, 2022. I will also be giving an update on our business strategy and key events that have taken place since we last reported on May 12, 2022. Jim will go into greater detail on our financial results commentary for the period before I turn it back to myself for some final remarks before we open it up to analyst questions. On May 17, we officially changed our name to East Side Games Group Inc. at our Annual General Meeting. I'd like to remind you that certain statements made on this call are forward-looking within the meaning of applicable securities laws. This call includes references to non-GAAP measures. Please refer to our second quarter press release and MD&A for cautionary statements relating to the forward-looking information and reconciliations of non-GAAP measures to GAAP results. References to all figures are in Canadian dollars on an IFRS basis unless otherwise noted. Additional materials will be found at the Investors section of our website at eastsidegamesgroup.com under Financial Information section and an audio replay of this call will also be available on our website. Q2 was another solid quarter. We generated $29.7 million in gross revenue, a 32% increase over Q2 2021. EBITDA was also positive at $0.6 million. We continue to focus on revenue growth, increasing our cash reserves and developing new products. In that pursuit, total revenue for 2022 to date was $65.3 million, up 44% year-over-year. Our cash from operations in Q2 alone was $10 million. We're sitting on $9.3 million in cash and only $0.3 million in debt. And we've secured access to an additional $10 million in available debt facilities should the opportunity to use it arise. This net us 2 notes for $10 million and for 1 for up to $7 million. It is no secret that growth starts have taken a beating in the first half of 2022, with recession locked in, rampant inflation concerns, the war in Ukraine and the lingering effects of the pandemic, uncertainty is high. With that became a significant reduction in consumer spend in mobile games. Estimate put that reduction at 15% across the industry. East Side Games Group is not immune to this, and we have seen this in many of our legacy titles. Fortunately, this is offset by the growth in new titles such as RuPaul's Drag Race and The Office: Somehow We Manage. We overcame these 15% headwinds and still managed to put up a 44% year-over-year growth, a testament to the strength and ingenuity of our team as well as ongoing validation of our business model. Daily active users were up to 347,000, up 43% year-over-year. We did this while maintaining only a 7% drop in ARPDAU, which has been very stable over the past year. Now was up 69% year-over-year to $1.35 million. Our mission at East Side Games Group is not just to build games into like players. We aim to fundamentally change the way games are built and published. We are investing heavily in our software platform, we are building a publishing infrastructure, we are building best practices playbooks, we are building deep relationships and trust with every major IP holder. We are building talent density across all of our teams. We are building a multibillion dollar business with a concrete foundation. We are leading $200 billion a year game industry on an innovative new path. These are our 2 additional super marquee titles for 2022. Star Trek Lower Decks continues to refine in soft launch. Our development partners at Mighty Kingdom continues to demonstrate their world-class talent. Our IP partners at Paramount have been exceptional in their support of this brand, unquestionably one of the world's greatest brands with over $10 billion in revenue generated to date. Star Trek has released 12 television series and over 14 feature films since originally airing in 1966. Doctor Who will be our final big release of 2022. It is currently in the early stages of soft launch and showing good promise. Doctor Who is another massive franchise with 870 episodes since its original launch in 1963. Going to the App Store now and play Bud Farm Munchie Match. It is soft launched in Canada, and it is showing unprecedented retention rate and a level of polish that we are extremely proud of. If you don't love this game, then you don't love games. And the first one on this call to send me a screenshot of them on Level 150 gets a free East Side Game hoodie. Also watch out for Trailer Park Boys: Get Merged! coming this year, which is a soft launch in some geos, but not Canada yet. We continue to sign new development partners as well as new IP partners as we aim to launch 20 games in 2023, maybe more. Milk Farm Idle Tycoon is a fresh new take on our allocated framework. This scheme launches in September worldwide and is -- that we're super excited about it. I feel need to reiterate the fact that our games in this month's business prints money. And we are aggressively reinvesting that cash into growth and building an industry-defining platform. If we only ran our games, didn't invest in new titles, didn't build on our software platform, then this is what our business would look like. This is excluding growth titles such as RuPaul's and The Office but it does include all the overhead, operating costs, marketing costs, feature development. This isn't cherry picked like the Bud Farm example I gave last quarter. This is worth in all we put up 20% plus margins all day long. The contingent compensation, this has been written down as we are currently on a $130 million run rate. This doesn't mean we don't make it as I can assure you, I will be doing everything we possibly can to make or beat this number. But we've been giving the advice to knock down. And so this is resulting in a large amount of net profit, but it is adjusted out of EBITDA. We also announced our NCIB today. We believe our stock is the best bet in town and we'll ask accordingly. Despite the ongoing strength of our business, our stock is down 50% year-to-date. We have issued our NCIB and officially shown our attempt to buy back in many -- as many as 4 million of our own shares. You can also see that insiders have been purchasing stock lately, specifically Mike Edwards, Jonathan Bixby, Jim MacCallum and myself. We expect this to continue. And now over to Jim for some comments.

Thank you, Jason. As Jason noted, in Q2, we delivered quarterly revenue of $29.7 million and revenue for the 6 months ended June 30, 2022, was $65.3 million, up 44% over the prior year period. Adjusted EBITDA in Q2 was $0.6 million, and for the 6 months ended June 30, 2022, was $3.6 million. Our mature titles such as Trailer Park Boys Greasy Money, Bud Farm Idle Tycoon and others continued to drive EBITDA, which allows us to grow aggressively while still being cash flow positive. We remain committed to our goal of maximizing growth while maintaining a strong balance sheet. Cash on hand at June 30 was $9.3 million, and our debt was $0.3 million. In Q1, we fully paid the contingent compensation resulting from the achievement of hitting over $100 million in revenue in our first year as a TSX-listed company. Our current revenue run rate is unlikely to achieve the year 2 earn-out target of $150 million. And as a result, we reversed the contingent liability into income during this quarter. We've had strong operating cash flow of $10 million for the 6 months ended June 30, 2022. We have minimal debt with access to financing if required. We continue to grow our business while remaining profitable. These factors lead us to believe that our share price does not reflect its value. And as announced earlier today, we are commencing a share buyback next week. Given our strong balance sheet, we are fully funded to achieve significant organic growth in 2022 and beyond with existing liquidity available to the company and without access to equity capital markets. With that, I'll turn it back to Jason.

Thanks, Jim. So in summary, we're focused on launching new titles, The Office: Somehow We Manage and RuPaul's Drag Race being our 2 marquee titles that we've already launched this year. Doctor Who and Star Trek Lower Decks coming as well as some other titles like Munchie Match, Milk Farm Tycoon, Trailer Park Boys Merge. There's many new titles coming. We continue to expand our team. And while other peers such as Game City and Unity are laying off staff, we continue to grow. We continue to improve our talent density, and we are now 220 full-time employees with another 250 contract partners working on full time on our games through our various partnerships. We're being patient in our pipeline. We are not pushing out titles because we need to make numbers for the quarter. We are pushing out titles when they're ready, when they're in the best possible condition for success and in partnership with our development partners and our IT partners to assure these games have the best long-term chance of success. We are also adding new features to our Game Kit platform and new genres as well as tools to make publishing and game development easier, faster, cheaper and with a higher chance of success. Thank you for all your time today, and we'll now open it up to questions.

[Operator Instructions] Your first question comes from the line of David McFadgen with Cormark Securities.

A couple of questions. Maybe I'll just first start off with, maybe if you could comment on Google and Apple and what they're doing in their play stores and any changes they're making on interstitial ads and other ads?

Sure. Thanks, David. That's really important changes that are coming on the platform, both Google and Apple, continue to wall in their gardens. They don't want everybody and anybody on their platform, publishing trash, to be fair on to it. So Google announced last week that they're going to be effectively banning interstitial ads. These are the ads that pop up during game play. If you've ever downloaded 1 of these hyper casual games that are really simple quick games that you usually get board up in 2 or 3 days and are constantly throwing ads in your faces, these are the games that Google are trying to, I wouldn't necessarily say get rid of, but definitely tampered down because it's a bad user experience and Google doesn't make any significant revenue from them. It's all ad revenue driven. So you make 25%, 35% of our revenue from ads, but we only do that with rewarded video ads. We don't do any interstitial ads. So this won't affect us at all. In fact, we think it's going to end up being a net positive for us because by cleaning a lot of these low-quality games out of the queue, discoverability will become better for us, as well a lot of these hypercasual games are a source of poor traffic for us. So they actually eat up some of our ad budget, and we're constantly blacklisting them from our games because the quality of traffic you get from them is poor. So it will save us money in what we spend on acquiring users. It will remove clutter from the store, which will improve our visibility as well as just generally make the app experience for users better. So it is -- spells doom for a lot of companies, any company that hyper-focused on these hyper-casual games. Platforms like AppLovin and ironSource, both have app businesses that, that's their primary focus, but it shouldn't affect us except in positive ways.

So are there any changes [Technical Difficulty] that would be negative for you guys?

Well, the IDFA changes that Apple made last year we know have been detrimental to the entire industry and making it incredibly difficult to track your ads. Google is also going to be introducing its own -- slightly different variations and not as severe variations on their IDFA privacy, user tracking methodology. So we expect that to also continue to make it more difficult. It's really walling in that garden. The battle to only process payments through their platforms. As we've seen with the Apple versus Epic, Apple very much won that case. And so there is concern -- if they continue down that path, that we won't have the ability to open up and sell things privately and directly, which we think we're going to be able to do soon, and we hope we're going to be able to do soon, and that will increase our margins. But Google and Apple are both fighting tooth and nail to prevent that from happening.

Okay. Great. So just a question... [Technical Difficulty]

Sorry, David, you're breaking up on us. I can't hear you. Can you repeat the question? I think we lost David.

I'll move on to the next question. Your next question comes from the line of Neal Gilmer with Haywood Securities.

Maybe I just wanted to dig a little bit further on some of your prepared remarks, Jason. Obviously, you commented about the 15% down across the industry. What are you sort of seeing in the back half of this year? And I guess sort of a 2-part question about the sort of the timing of some of the new titles that you've got coming to market? And then also your investment in sales and marketing for the user acquisition, et cetera? How do you sort of philosophically look at how much you want to spend on that given some challenging industry trends that you're seeing?

Yes. So we're being very smart with our user acquisition spend, and it was lower this quarter than we had budgeted for, which isn't necessarily a good thing. It means that we weren't able to find the places to be able to spend effectively and measure effectively. I'd love to spend $100 million a quarter on advertising because we only spend money on advertising when we know we're going to make more than that. So if I could spend $100 million, it would be because I know I'm going to make $120 million. So that entire marketplace continues to be challenging. We're always working with new partners. We have some new SDKs coming into our software and updating things to use new methods and tips and tricks, so to speak, to better do that. But we do anticipate that entire space becoming more challenging over the next 6 months to -- in years as like we say, Google is going to introduce its own restrictions. We're hoping that Apple is going to loosen up a little bit, but we'll see how it plays out. But we're trying to be smart. And so the real opportunity for growth is new titles shoring up our existing titles and then we saw a little bit of a drawback, not even as much in users as user spend as I think a lot of people are worried about the recession and inflation and are just spending less as a result, plus the free paycheck and the government have dried up. So that free money isn't flowing into our system anymore. So it's really tied up there, like tighter than we expected it would be. And now looking forward, the solution of that is more titles. We've been able to keep our ARPDAU relatively strong. So we know it's down a little bit, 70% or whatever it was. So it's all about new titles. And we are being patient with those new titles. So we'll keep plugging away and get them out there but not get them out there until we know they're going to be perfect.

Great. Okay. You talked also in your prepared remarks about investing in the gaming kit platform and so forth. And I'd be curious on your thoughts on the Unity, ironSource, AppLovin and sort of triangle that has developed over the course of the past a little bit and sort of what your thoughts are on that with the investment you're making on the game kit side of things?

Yes. That is a Bizarre Love Triangle with all kind of drama going on. It's clear from JR's comments at the beginning of the Unity earnings call that this was fairly unsolicited from AppLovin's part. And I know if I was starting a partnership with somebody and they sent out a press release out of the blue like that on the morning of my earnings call, I'd be pretty pissed on how to -- that's not how to start a good relationship. But here we are. So I think it's -- it was unsolicited, it's meant to think of the ironSource bid or at least put some stress on to that acquisition because if Unity [ does ] ultimately fire [ ironSource ], it's going to make life very difficult for AppLovin. And those are the two 800-pound gorillas in the buying space, not only -- and so we rely on these guys not only for where we spend a majority of our money when trying to acquire users, but they are also our largest sources of income on the ad revenue side. So these are very important partners to both of us. It's important to us, honestly, that they -- there is competition in the space of ironSource and AppLovin more to get together, that's less competition, that's bad for us. But it also shows that these guys are struggling. I think their margins need to come down. They're taking too much of a cut, and we're going to -- we're going to see that as well as platforms like Unity, we've seen their valuations drop 80%, 90% over the last 6 months. It's astounding. And as we build ourselves into a platform, we think we've solved for revenue generation as of the platform. So the space is opening up and there's an opportunity for us to step in and become that new platform. And so we're watching that space closely. We're seeing the big guys shutter a little bit, and we think that's an opportunity for us to come in and become the next big guy.

Okay. Last one for me, maybe just sort of a follow-up to my earlier question there on the user acquisition. But when you're making that decision on where and what to spend, how are you sort of evaluating the competitive landscape and who you feel that you're competing with in trying to bring users on board for your games?

Sure. That's great question. The -- so there's kind of 2 aspects to that. There's who we're competing with for developers and IPs and that's very much the Jam City and Scopely [ of the world ] who are both struggling to scale up. Both of them had IPO plans, stock plans, but unfortunately, they miss their window when the market was hot. We were able to land the plane and do our IPO and our RTO, however you want to frame it. And here we are. Those guys still want to do that, need to do that at some point. And in order to do that, they need strong development partners and strong IP partners. And when we're competing for either of these, it's usually Jam City or Scopely that we're up against. So that's why I look at there and Jam City just announced huge layoffs. So we know they're straggling where we're continuing to grow and increase talent density. And then on the other end, when we're buying ads who are generally competing for that space is these hyper-casual games. So by -- with -- September 30th is when these new Google rules kick in. And it's not going to be just completely destroy the hypercasual space and will still exist. But essentially 50% of the revenue that they make is going to go away overnight. And so there -- that which means they're not going to buy a large chunk of the available inventory, probably, I don't know, I'm guessing this is the number out of mine, but 70% plus of the ads you see on any given game or for hypercasual games. So if that inventory goes away, then it's inventory available to us to buy.

Your next question comes from the line of Adhir Kadve with Eight Capital.

Great. First, I'd like to ask about the 2 super marquee titles set to release later this year, just Doctor Who and Star Trek. Can you just give us a sense of the time line of the worldwide releases for those? I know you said H2, but is it more 1 in Q3, 1 in Q4 or both in Q4? And then I have a follow-up after that.

Sure. I can't answer that specifically here, unfortunately, because that is we're launching those games in partnerships with these IP holders. The actual exact dates need to be approved by with them. We do have exact dates approved by them, but we haven't put out the press releases. We haven't announced those dates, and I can't do it here. Sorry about it.

Got it. All good. I look forward to those then. Just sort of maybe I wanted to ask about RuPaul and The Office, those games have rolled out, they've been out for quite a while now. Can you take anything from those rollouts and kind of apply them to Doctor Who and Star Trek and kind of make those rollouts better?

For sure. For sure. Every time we do a rollout, we learn from it, we make mistakes and get better. As a result, I always say we learn more from our mistakes than when we do things right. There were lots of things that went right with both RuPaul and The Office rollout, but there are also things that were less than perfect. So one of those big takeaways, honestly, is we need to give these games all the time in the world during soft launch to be absolutely ready before we launch it. So I will tell you that the original worldwide launch date for Star Trek has coming on. But we're not letting that came out, not because it isn't good. It's very good but we're not going to let it out until it's excellent. And both the other games, they were good, but they weren't in perfect isn't the word we're looking for. But we've discussed in the past some of the challenges that we've had technically around those big scale launches because to be fair, these are -- those are 2 of the biggest titles that we've ever launched, they are the 2 biggest side we've ever launched. And both Doctor Who and Star Trek these are 50-year-old franchises with massive following. So we want to get it right. And it's more important to me to get it right than to get it quick. So that, amongst other things, is one of the reasons why we didn't make those Q2 numbers quite as hot as we wanted them to be. Q3 is coming together and we're -- but we're already halfway through it, and we have not yet launched either of those big marquee titles. So that gives you a little insight to. I'm going to wait until it's right. I'm a patient man. My wife won't agree with that statement, but I'm going to say it anyway.

Fair enough. Okay. And then second, just on the Netflix partnership, there was some news out this week that only 1% of Netflix users kind of play their games. Can you give us a sense of what that means for Dragon Up and your partnership with Netflix?

Well, I have an optimistic fellow. So I look at that and go, "Oh, 99% of players are got to play in Netflix's games, what an incredible opportunity". So Netflix is in super early days of its rollout, but we know it's continuing to commit to it. We know it's a big talk [indiscernible] that team last year -- well, like last year this time, honestly, I think that team was about 8 or 10 people. And now that team is probably 75 or 100 people, that's not even including the development partners and night school and next schemes that they acquired. They're growing this aggressively. So they only have 25, 30 games on the platform right now. I think they want to get to 50 by the end of the year. And they're mostly games like let's be fair, the game that we have with them Dragon Up. It's a great little game. But it's just a little game, but we had already mostly built and isn't a blockbuster title, whereas I'm sure I know they're working on some blockbuster titles. And when those come out next year, that's the ones that they're really going to get a big push on. And I don't know if it's going to be 5% or 95% of the users that end up playing games. So we do know that something like 60% of the people in the world play games on their phones. So I would imagine the Netflix audience is that much or stronger.

Got you. And then maybe one last one, and then I'll pass the line and maybe you can answer it. But maybe to the extent you can, you mentioned in the press release that you've signed a couple of additional super marquee titles but haven't really announced them yet. What I'm kind of looking for is, can you give us on a high level, how those kind of stack up broadly against the 4 big titles that you guys do currently have announced to the extent you can answer that?