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

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the East Side Games Group Third Quarter 2022 Results Conference Call. [Operator Instructions] After the speakers' presentation, there will be a question-and-answer session for analysts only. I would now like to hand the conference over to your speaker for today, Jason Bailey, Board Chair, CEO and Founder of East Side Games Group. Please go ahead, sir.

Thank you, operator, and welcome everyone to the East Side Games Group third quarter 2022 results call. On the call today with me is Jim MacCallum, our CFO. I will begin by sharing highlights from the third quarter ended September 30, 2022, and I will also be giving an update on our business strategy and key events that have taken place since we last reported on August 11, 2022. Jim will go into greater detail on the financial results commentary for the period before turning it back to myself for some final remarks before we open it up to analyst questions. 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 third quarter press release and MD&A for cautionary statements relating to 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 can be found in the Investors section of our website at www.eastsidegamesgroup.com under the Financial Information section, and an audio replay of this call will also be available on our website. Q3 was another solid quarter of year-over-year growth, but a challenging quarter overall. We generated $25 million in gross revenue, a 32% increase over Q3 2021. And for the 9 months ended September 30, we recorded $90.4 million in revenue, up 40% over 2021. We recorded negative EBITDA for the first time as a publicly traded company, and we are taking steps to correct this for the fourth quarter and for 2023. Saying Q3 was a challenging quarter is an obvious understatement. Rising interest rates, looming recession, rampant inflation and consumer anxiety exacerbated the damage done to the mobile games industry by Apple, whether Ad Tracking Transparency, ATT changes and the destruction of the Apple Store and Google Play Store discovery ecosystem. That being said, the phones in our pockets aren't going anywhere anytime soon, and they continue to be the primary gaming device for over 1 billion people. Going forward, East Side Games Group is shifting its focus away from hyper growth and will double down on our current successes. We have and will continue to reduce costs wherever possible, focusing on profitability and cash generation for 2023 and continue with a year-over-year growth on all fronts. The launch of Star Trek, The Badgey Directive in the last few days of Q3 has us well positioned for Q4 and the end of fiscal year 2022. Doctor Who: Lost in Time will be our next major IP release, currently in soft launch and slated for worldwide launch soon. We have also soft launched titles in 3 new genres, Trailer Park Boys Merge, Bud Farm Munchie Match and Milk Farm Tycoon, are all showing solid engagement metrics in their soft launch periods. This will bring our total games launch for 2022 to 11 titles, one more than our goal of 10 titles. 3 of East Side Games Group's top 5 games have launched in the past 12 months, RuPaul's Drag Race Superstar, The Office: Somehow We Manage, and Star Trek: Lower Decks. These titles prove out the mark -- product market fit for GameKit, our proprietary software framework that allows developers to build faster, cheaper and with a higher chance of success. It also proves that our focus on IP-driven games is a solid model in a post ATT world. For 2023, we will be building on our learnings from this year, and we have scaled back to have a tighter focus on large IP-driven games. This is where we have found the most success and this is where we will continue to invest. We will also be investing in our winners as well as being smart about what is working best in the new market dynamics. We have signed deals for many new IPs and games for next year with NBCUniversal, Creative Artists Agency, Jazwares, AEW Wrestling, Diggital Dogg and others. We have also signed numerous development partnerships with leading studios all over the world. We anticipate being EBITDA positive for 2022 while maintaining year-over-year growth. We remain focused on our goal of providing creators the tools to successfully deliver mobile gaming experiences that engage players every day. Daily active users were 298,000 for the quarter, up 22% year-over-year. ARPDAU increased to $0.94 and MAU was up 19% year-over-year at 1 million. Our mission at East Side Games Group is to not just 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, and 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 the $200 billion a year game industry onto an innovative new path. Jim, over to you for some more comments.

Thank you, Jason, and hello, everyone. As Jason noted, in Q3, we delivered quarterly revenue of $25 million and revenue for the 9 months ended September 30 was $90.4 million, up 40% over the prior year. Star Trek was introduced late in the quarter, so only had a limited impact to third quarter revenue. We recorded negative adjusted EBITDA of $1.0 million during the third quarter and for the year-to-date recorded positive EBITDA of $2.6 million. During the fourth quarter, we have and continue to take steps to reduce costs by terminating some external development contracts and increasing talent density. These changes will improve profitability going forward. Cash on hand at September 30 was $5.2 million, and our debt was $800,000. We recorded strong operating cash flow of $5.6 million for the 9 months ended September 30, 2022. We have minimal debt with additional access to financing if required. We purchased 98,000 shares under our NCIB through September 30 at an average cost of $1.98 per share, and we continue to be active. Thank you for your continued support. And with that, I will pass it back to Jason.

Thank you, Jim, and thanks, everybody, for the time today. Happy to open it up for some questions and hear anything the analysts might want to know more about. Thank you.

[Operator Instructions] Your first question will come from Neal Gilmer of Haywood Securities.

Yes. Jason, maybe it was one of your sort of first prepared remarks there and I didn't quite catch it exactly. So it's a paraphrase. But your comment with respect to sort of moving away from hyper growth and more focused on profitability and cash flow. Maybe if you could just provide a little bit more color on what you're thinking there? And I think previously, you've talked about obviously in 2023, you're hoping to launch a number of more titles than you are in 2022. Is that sort of being sort of scaled back a little bit or any more sort of color you can on that comment you made would be appreciated?

You understood correctly, Neal, we're going to be scaling that back. We're going to be scaling that back to focus on the games that we think have the best chance of success. That being -- our experience has been, as you can see from our 3 of our top 5 games being launched in the last 12 months being Star Trek, The Office, Star Trek, The Office and RuPaul, I can't believe we got RuPaul, how can you forget Ru. Those are our 3 strongest -- 3 of our 5 strongest games. And so Apple, Google and all of the entire market of advertising have made it very, very difficult to acquire users for games. So IP-driven games is that happening. As I've said before, if I showed you a game about running your own midsized paper company in Scranton, I don't think you'd want to play it. But when I show you NBC's The Office and you see all of your friends and get to go hang out with Kevin and Dwight, then you do want to play that game. So we're going to launch fewer games next year, but the games that we do launch will be the big titles.

Okay. All right. And then taking a look at the ARPDAU at $0.94 compared to Q3 of last year at $0.85. So that's a pretty decent improvement. Safe to say that's -- those 3 titles that you just referenced helping drive that. And then I guess maybe the sub-part of that question would be as you go into '23, if you're focused on those titles, should we assume that or not assume, but expect that metric to continue to gradually move higher?

I don't -- I'm reticent to say that it's going to continue to move higher. Before I pat myself too hard on the back, one must also factor in exchange rate up and down. And the number has gone up and down throughout the year, part of that is people going back to school, and Christmas is always a stronger time as people spend more time inside and more time playing video games. But the -- I do -- that is a strong number. We are proud of that number. And again, part of the reason that we're continuing to focus on IP-driven games for 2023 is we find that IP-driven games not only do they have lower CPIs because people are more likely to click on the ads, but they also have higher ARPDAUs because people have more affinity to the prizes.

Yes. Yes. Okay. Maybe last one for me is, obviously, you developed a game for Netflix earlier this year. As you look into '23, when you're focused on the high IP stuff or IP games, is that still a channel that you are going to be taking a look at as far as something that you think is helps contribute to your profitability focus for next year or something we shouldn't be anticipating on those sorts of platforms?

So I can't be too specific, obviously, for confidentiality and negotiation reasons. But we -- the app discovery ecosystem is ripe for disruption. Both Apple and Google, their duopoly over this space is under threat from all sides, and that threat is positive for us. Somebody, several people likely will emerge victorious in creating app distribution ecosystems that are successful. All the major players from Sony to Microsoft to Epic are aggressively pursuing this opportunity, and even Apple themselves through Apple Arcade. Netflix being one of them, but all of the big media and streaming companies have this opportunity. And so we are talking to everybody, especially when we look into 2023 and focus on profitability. Traditionally, we can go out and spend $5 million to build a game. And if it's successful, it can make $100 million a year. But if it's not successful, it's a big money pit. When you do a deal with a Netflix or an Apple Arcade, you're guaranteed to make a profit, but that moonshot doesn't exist. So you -- it cost you $5 million to make the game, but you're guaranteed to make $10 million as opposed to costing $5 million to make the game and you're either going to make $0 million or $100 million.

Right. Yes.

The answer is yes, yes, it's all of the above.

Okay.

Your next question will come from Neehal Upadhyaya of Industrial Alliance.

I just have a couple. Last quarter, you spoke about a Starter Kit that was going to come out. Can you provide some additional color on that? And then if that has been released, how well was that received in the mobile gaming community and then what are your plans around that kit in particular?

Yes. So Starter Kit has been built. It is in the market. We have 4 developers that are onboarding to the system right now. They are all happy with what they see. There's 1 -- actually to be fair, there is 1 of those 4 who we think is going to not use Starter Kit because they're a partner that have already made one game with us. And so they feel the core of what they've already built, it's easier to keep building on that and to kind of start over again with Starter Kit, which is absolutely fair and true. But yes, so we're in the onboarding process, super happy with the product. We continue to invest in getting more and more behind it and making it more robust. So it's off to a great start.

Perfect. And then maybe just another one from my end. The DAU and MAU numbers fell for the first time in 3 quarters. And then was this just because of a drop-off in a specific game along with that seasonality that we spoke about in Q2 or Q3 because like the other metrics were fairly strong. So was it just seasonality or do you think -- or a number of other games that impacted as well?

It's -- the entire market is impacted to be fair.

Yes.

I mean, you look across the mobile games industry in general and the games industry in general, and most people are off by about 15%. So we're not immune to that. The biggest challenge and the biggest -- like honestly, I don't think MAU is an interesting number. MAU is an indicator of how much money we're spending on user acquisition and growth as most of those new users bounce. So when you look at the 300,000 DAU versus the 1 million MAU, that DAU is pretty constant. But we -- and there's not a lot of -- people who play our games play it pretty much every day or at least every third or fourth day at the very least. We have very few players who come in and play once or twice a month. It's not the types of games we have. So DAU is a really important metric. And we're going forward because user acquisition has become prohibitively expensive, although we still continue to do it and we still find ways to work, we just can't spend as much as we had been. We -- so we're focusing on the growth. But as a result, we're really focusing our game teams internally on retention being the most important metric. There's 2 metrics we look at, retention and regularity. Retention is how many people who play their game -- the game yesterday came back today. So we're always looking at day 1, day 7, day 30 retention rates. But then we also look at regularity, which is how often people play. So on a weekly basis, right now, I believe our number in most of our games is somewhere around 75% of our players play every single day. So we're trying to get that number up and up and up and get those people who are playing only 4 days a week to play 7 days a week, and that's going to do the most for our engagement and long-term retention.

Perfect. Thanks, Jason. That helps. And then maybe just one last one, sorry. I know you mentioned that the -- you're planning to launch nearly about 20 games in 2023, and that's kind of being scaled back. But I think you mentioned maybe that you were planning on making 4 to 5 super marquee games in 2023. Has that number gone up? And -- because you're trying to focus more on those IP-based games, so maybe 8 or 9 super marquee games and then less games on the total?

Good question, but I'm not giving you a number.

Fair enough.

But yes. So what we've done is we've looked at our slate of games for next year, which was fairly expensive. And we've made some hard choices about which games we should cut completely, which games we should slow down, which games we should punt out and which games we should go all in on. And so the ones that we are going all in on -- I gave some clues earlier in the call that you can decipher and figure out what some of those might be.

Your next question comes from Adhir Kadve of 8 Capital.

Maybe just quickly on Star Trek. I know we just kind of launched at the back end of Q3 there. But any kind of early results you can speak to how the game is trending, anything along those lines?

Again, I can't say too much, but -- because of confidentiality and our agreements with the networks. But as I mentioned, it is one of our top-performing games. It's -- I mean, we're very happy. We built that game in partnership with Mighty Kingdom out of Australia, who is a great company and a great bunch of people who have done a very good job. We're working with CBS Paramount on that title. Again, great partners who have been incredibly supportive. The Lower Decks franchise in general is relatively new, but is building a strong following, but we set that up to be able to leverage the entire Star Trek universe. So over the last few weeks, if you've playing the game, some of the prizes have been Captain Kirk and Spock and Khan and -- or not I am sorry not Khan, yes, I might have just left a secret out. But the -- so we've been able to give these -- Picard, we also gave Picard away. So by having these massive icons as prizes is definitely helping in the game and its success. And yes, all of its core metrics are fantastic. We're very happy with this. I would say that this is one of the -- it's not the biggest launch we've ever had, but technically, it's definitely been one of the strongest and smoothest launches we've ever had.

That's very good to hear. So then just maybe kind of talking about the partners, in the press release and in your preamble, you kind of talked about you're working -- you've signed deal with NBCUniversal and CAA. And those are obviously familiar names with -- who are the IP owners of The Office and RuPaul. Do you find that this time around the conversation with these guys were much more simpler given that they've already kind of seen what your work is? And maybe any color around that conversation?

Simpler. Everything has been challenging because the market is changing so quickly. And so getting large organizations like those to catch up to thex is often a challenge. And sometimes, one can be a victim of their own success. It was easy the first time, therefore, it's going to be easy the second time, so I want so much more. And it's like dude it doesn't work like that, it's always a roll of the dice. So it's made some things easier, it's made some things harder. The state of the market has made everything harder. But the great news is these partners love us. They love to work with us. We're doubling down on the ones that we like to work with. And when I talk about NBCU and CAA, these are all additional IPs that we're working with, they're not just simply renewals of existing IPs. So yes, like I say, we're building relationships with everybody. We have open dialogues with every major IP holder to pick just the right ones that fit with our framework.

Okay. Great. And then one last one, and I'll pass the line. You soft -- you've also mentioned that you soft launched 3 new games, but that IP is IP that you've kind of worked with before, let's just say, the Trailer Park Boys as an example. Do you find that the UA gets a little bit easier on these titles just simply because you've worked with the IP before or is it kind of completely different because you're kind of changing genres from match -- from idle to match, and just maybe any commentary around that?

Yes. I wouldn't say it makes UA easier. It makes a lot of things easier in the sense that we have narrative and story and especially we have a ton of art. So when we're doing creatives that work for idle games, we're attracting the Trailer Park Boys-esque audience in those core fans. So we use a lot of the same art and in fact, can -- in some cases, can even use the same creative that we know worked on a previous game. So it makes some things that are easier, but again, back to the reality of the market, it's become so much more competitive and the -- so much more mature. And with Apple and Google messing with the discovery ecosystem, yes, the answer -- the short answer is yes, it does make it easier, but there are some other baskets out there that made things harder.

Fair enough.

[Operator Instructions] Your next question will come from Scott Buck of H.C. Wainwright & Company.

I was curious how we should be thinking about sales and marketing expense into the fourth quarter given Star Trek and some of the soft launches you have going on? Any color there would be helpful?

For sure. So a little color on that, too, as it affects Q3 is we did soft launch -- or we worldwide launched Star Trek late in Q3, and that came with a big marketing push. So that money was spent in Q3, but we won't see the results until Q4. And yes, in general, we have taken our marketing spend back, not massively, but significantly. Even with the increase in spend that we have on Star Trek, we are still spending less than we were spending pre Star Trek. So that gives you a sense of how much we scaled back. We've gone away from any -- the old adages is half of my advertising campaigns are working in half of the mark, I just don't know which half it is. We know which half it is. And for us, it was -- it wasn't even -- these campaigns aren't making money. It's -- we are sure these campaigns are making money, and we're not 100% sure these campaigns are making money. We're sure these ones aren't long term when you factor in every possible cost. So scale those back, scale these back a little bit, double down on what we know is working in those networks that we are spending with. Hopefully, everybody is talking about how Christmas is canceled this year. Hopefully, that normally, with Christmas, there's a real push on, especially post Black Friday, the inventories become slimmer as more people are competing for them. So maybe since Christmas is canceled, there will be more inventory available for us at a reasonable price.

Great. That's helpful, Jason. And then second one for me, just on the share buyback. I was curious if you guys have a specific criteria you're looking at when you repurchase or just given where the share price is, it's tough to argue against it?

Right. So yes, I mean, I'll buy it all back at this price, buyback myself. I'll sell, I'm going to start selling my golf clubs to buy more shares, like it's absurd. So yes, I mean that's part of the plan here is let's move towards some profitability and long-term stability. There's no world where we raise money at this rate there. So let's try and produce more cash and use that cash to buy back shares if there isn't a better or a smarter place to put it. I mean with interest rates where they are and the cost of borrowing being high, maybe it's better to be a lender than a borrower. But the -- when we look -- when you're looking at the best place to make an investment and get a -- whether it's a 1x, 2x, 5x return on your money over time in building video games, there's a balance to be had there between building games and using that money to buy our shares back.

Yes. Makes sense. Appreciate the added color, guys.

Your next question will come from David McFadgen of Cormark.

Yes. Just a couple of questions. So it seems -- it seems that you're going to have more of a balance in terms of growing the business, but also generating EBITDA. Is that correct? Have I understood that correctly?

That is hopefully been made very clear. That is absolutely correct.

Okay. Perfect. So given that, is there an EBITDA margin like a percentage range that you would expect to operate in as you grow the business going forward? Can you share that with us or it's just too early on that?

I'm not going to spit that number out here because it will come back and bite me in the a** whether I'm right or wrong. But yes, I mean, significant like it's -- over the last year, we've been investing heavily in, like I say, 11 games this year, and -- but that takes a lot of time and money. We've built out the Idle kit platform. We built out 3 new genres. Just like everybody else in the tech industry, we hired like mad, comps, high comps is competition amongst employees is high. So we invested incredibly heavily this year in growth, yet we're still able to remain relatively flat, which is what I said I would do in the beginning of the year. So I don't think we're too far off our EBITDA targets for the year because of that heavy investment. And we're just going to slow that investment down a little bit, refocus which games we're working on. What I've been saying to my staff is, is it's easier to take a game that's making $100,000 a day and get it to make $200,000 a day than it is to build a new game that makes $100,000 a day. So that's where our core focus is going to be.

Okay. And then just given the macro environment that we're operating in, it seems like it's going to be tougher going forward. And there have been a number of companies that generate ad revenue that are starting to see a revenue decline. So just wondering if you could share with us what you're seeing so far into the fourth quarter on your ad revenue line? Are you -- do you see that as being a little weak here, just given what everyone else is experiencing?

We're not seeing that. It's -- we're seeing an increase in cost of placing ads. But in the CPMs we're getting for the ads within our games, it's hard to say, honestly, because we've been working hard on increasing that. And so adding more networks, adding more placements. So we've done a lot of work this year to increase that number. I think if the ad market wasn't where it was, we would have been able to increase it even further. So it's hampered our growth, but it has not shrunk.

Okay. All right.

And with that, I'm going to wrap this up.

Yes, sure, there are no other questions. So Please go ahead with any closing remarks.

I just want to say thank you for the support from everybody in coming out and listening to us. You can reach out to me directly if most of you know how to contact me if you have any additional questions. And we're really proud of what we're building here. We're proud of the team we've put together. We're still extremely bullish in the opportunity around games in general and especially games that live in your pocket and our opportunity to change the way those games are made as this market continues to mature. So I'm super bullish and excited about this company more so than I ever have been. I see us making the right choices. I see us the team around me rallying to answer to the chaos that is the market. I don't have to tell anybody on this call, the state of the market. So we try to put all of that aside and focus on what we do best, which is make great games that people want to play every day. So again, thank you for your support and talk to you next quarter.

Ladies and gentlemen, this does conclude your conference call for this afternoon. We would like to thank you all for participating and ask that you please disconnect your lines.