G5 Entertainment AB (publ) (G5EN) Earnings Call Transcript & Summary

Welcome back to ABG Investor Days. Next up, we have Stefan Wikstrand from G5 Entertainment. With no further ado, Stefan, I'll leave the floor to you.

Thank you very much. So my name is Stefan Wikstrand. I'm the CFO of G5 Entertainment -- and let's see if I press the right -- there we go. And G5 Entertainment, we're a developer and publisher of free-to-play games for primarily mobile devices but also for PCs. So we have a relatively significant market on Windows, but also through our own direct-to-consumer G5 Store. So we're serving the market of mobile games, which is a bit over USD 90 billion, so quite a sizable market. We serve that through 11 offices that we have. Since the last time I was here, we've added quite a few, but I will get back to that in just a bit. We have a very strong history in creating games. Our 2 biggest successes, Secret Society and Hidden City have generated very high revenues over their lifetime, also obviously then very profitable as well for us. We focus on a female audience of women over 35, which is a bit of a unique target audience for mobile games, especially with such a focused portfolio that we have. The company has been around for more than 20 years. So we celebrated our 20-year anniversary in 2021. We listed in Stockholm in 2006. And then on NASDAQ 2014. So these are our current operating locations. So before we had a very slim and very focused geographical footprint. So we had -- while we had the office here in Sweden, we have a small marketing office in San Francisco. And we have an office in Malta that runs development and parts of publishing. And then we had our development workforce in Russia and Ukraine. That has obviously been a bit challenging the last year. Therefore, we've made some changes to that. So we've relocated quite a lot of staff, specifically from Russia but also from Ukraine and established quite a lot more offices. So now in addition to the one -- the 5 that we had before, we have the biggest one of the new ones are -- is in Montenegro. Georgia, Armenia, also quite sizable. We also opened offices in Bulgaria, Kazakhstan and Cypress, where we have, well, quite a few people in each office, but a bit smaller than the other 3. We also opened an office in Poland, which we now are in the process of closing. We realized that it was a bit higher cost base there than we kind of appreciated. So we've restructured that a bit. So we still have staff working out of Poland, but then they work remote instead of being employed by the Polish entity. So that's the new structure that we have since last year -- if we are pressed wrong button again -- so if we then just do a quick glance on the gaming market. So 2022, saw the first slump in the mobile gaming market since its inception. So a slight decrease in revenue in 2022. That follows after a bit higher revenue during the pandemic. So if you look at 2020 and 2021 or rather from '19 to 2022, you can see the trend is certainly upwards, but you see that 2020 and '21 are a bit elevated, and then we've come down a bit in 2022, but we've been kind of following the underlying growth trajectory of the overall market over these years, just a bit up quicker and then falling down a bit. But the market is still a growth market, and we expect the market to grow 3%, 4% annually in the coming years and grow to USD 103 billion. I saw on the previous presentation here that the total market numbers vary a bit, and that depends a bit on the source you use. But I think the trends and the growth that you see are more or less the same. It's a bit how you measure the market and that varies in such a relatively young market that we're in. So we continue to see an increase in gamers worldwide. That one continues well. Asia remains the biggest market in the world, was G5, we have our biggest market in the U.S., and we've always been strongest in North America in terms of geographical footprint. So just a few words on G5's development over the last years. So this is a more recent history from '14 when we listed on -- or moved up to NASDAQ. I think the first year we can -- we had amazing growth with Secret Society and Hidden City. In '17 and '18, we started investing more in the -- in our own development. We've always done own development and publishing. Those are the 2 kind of legs that the business stand on. But in '17 and '18, we focused even more on our own development, and we released quite a few games on the back of those investments since, so you can see in '19, '20, '21, that it's 5% and 8% and 5%, which is quite a lot. More recently then in 2022, as I mentioned, we've opened new offices due to the war in Ukraine. And that has obviously been challenging for various reasons. In 2022, we also saw our own direct-to-consumer G5 Store really starting growing more significantly from a very low base before. And in 2022, it started scaling really well. Own games continue to be a very healthy 70% of the revenue on the back of the investments made before. Yes, that's about it on the recent history. If we then move on to one change that we did last year, which also is a part of changes that we made the last year is our own -- is the new games development funnel, which we communicated in the third quarter of last year, where we've done some changes to how we develop and primarily launch games in the market. So we've had this slide before. I would say that from scaling and onwards, it's more or less the same, but we did some changes in the game idea in the early development and soft launch stages. As I said, that we communicated in the third quarter. So in its core, we more or less do the same. But we do more -- in the game idea stage here, we do more extensive marketing tests to weed out the best ideas that we want to take into some sort of production. The early development in soft launch phase is more or less in line with what we had before. The main difference here is that instead of going through the early development and soft launch, and taking the game to a wide -- or almost all market in the world and kind of iterating the game there. We -- nowadays, we release it in limited test markets. We test the gamer thoroughly so that it meets both internal and external benchmarks for being a competitive product in the market because we want to give the games that we launch globally the best chance of success possible. So instead of taking all the games to a global launch, we instead test them more significantly. And if they don't meet the criteria, we cancel them instead of launching them to a global market. So test market instead of global launch. But apart from that, it's more or less the same, the steps that we go through, but we're just more hard on ourselves or hard on the games that we produce to make sure that when we release a game globally, we give it its best shot possible and that all resources that we have available internally can focus on those launches that are being spread out on too many games. So we -- as before, we expect to do roughly 5 to 6 games in soft launch. But then we will cancel quite a few of those, and we intend to have 1 to 2 games to be released to global audience per year. That is the aim. And then when that is done, we kind of slot into how it was before. So then you scale the game with marketing. You work with user acquisition, you grow the game to its peak revenue and you optimize from there. In the end, the game matures and then you get into the harvest mode or long-tail revenue, which is very long and often underappreciated in mobile gaming. But the games there is very, very profitable. And you can see that the revenue is the red line. User acquisition is the dotted line. And you can see the user acquisition, meaning direct marketing, so we get users into the game. And you can see that gap widening, meaning that the profitability of the game is also increasing in the later stage of its lifetime. So moving on a bit to the target audience, as I mentioned, we have a target audience of women over 35. It is a growing demographic. It's very strong. They pay really well in the games. They're very loyal to the game, so they play the games for a very long period of time. We have our core kind of genres that we continue to work with. Hidden object games, which is a very distinct genre, where we are one of the market leaders. Match-3 a much bigger market, also a bigger audience, so better potential, but also more competitive than the hidden object space. We continue with our Mahjong and Solitaire games, which we have in the portfolio, which has a very -- we call these games often kind of evergreen games, people that enjoy them, play them for a very, very long period of time. And then we experiment regularly with new genres and try to get a foothold there. Here, you have 2 examples with a merge game and a word game. All of this is built together with our social network, the G5 Friends network which allows the players to be friend with each other in the game, create a more social gaming experience. They can play with friends, they can help each other forward. They can gift in-game items to each other, but it also allows the gamers to play across devices. So they can move from playing on a phone on the way home, play on the PC, moving between the G5 Store where they can purchase goods directly from us or take them with them on their phone and mix and match, however, they want to have that work. So we work with the portfolio of games, as I kind of -- given that we have multiple genres. That has always been the strategy of the company to have a portfolio of games. You never know which ones are going to be a huge success or which ones are going to be kind of healthy and profitable and some we will cancel as I mentioned, on the development cycle. So we built up the new generation of games revenue, the red bar in the bottom there, over the last years on the back of the investments we made in the workforce. Licensed games, on the other hand, have been shrinking the last years after Hidden City reached its peak in 2018, but that game or the portfolio of games in the license category, of which Hidden City is the biggest, has now stabilized the last quarters. So that's good. And you can see there on the percent of own games share of revenue that it stabilized as well because previously, we had a mixed effect there of the licensed game shrinking and the own games growing. So of course, you had a very aggressive growth on the percentage of own games share of revenue. We continue to launch games here. We have a balanced and diversified portfolio. We have a licensed game coming out. So we still have license as a part of the strategy. But as I said, core focus is still on their own games, which is the part that has been the growing part the last few years. And then if we move on to the G5 Store that I mentioned before. So G5 Store is our own story kind of indicated in the name that it's our own. It's our own direct-to-consumer channel. So we acquired users directly to the G5 Store, where they -- through the launcher they can download and play all of our games. Previously, it is still primarily for -- or the main part of the revenue is coming from Windows, which is the first part of the window -- the G5 Store that we launched. But since then, we have also launched it for Mac and also for Android, which allows for sideloading. For iPhone, it is not possible with sideloading yet. So there, we can't have the G5 Store operational, but if that would change, we would obviously gladly launch it for Apple device or for iOS devices as well. But for Mac, it exists. We've seen very strong growth in the G5 Store. It's relatively new. I think it was really late 2020 in early stage, but you can see that we've had very significant growth, especially from Q3 up until today. And the store continues to grow as well into Q2. So it looks really strong for the remainder of the year. One big difference here is obviously that as it is our own store, whilst in App Lab store, they charge us 30% commission on all the revenue that we generate in the games. With G5 Store, we control the payment and kind of publishing part of the business, and we -- the fees are thereby much lower. So the payment processing is in low single digits compared to the 30% that we paid to Apple. There are some additional costs involved in running your own store like VAT handling, technical support, obviously, building it, et cetera, but it's still a much more profitable store than Apple and Google, for example, on the same revenue base. So yes, it continues to hit kind of all-time high revenues, much better margins, and then that obviously translates into growing gross margins, and that flows through to the EBIT margin as well. So we're quite excited to see what we can make out of a G5 Store in the coming year or 2. If it continues to grow like this. We have peers where they have 25% of their revenue coming from their own stores, and we don't see why we couldn't reach that as well. So yes, an area where we're quite excited currently. So then if we just take a brief look at the financials. I wouldn't be a CFO if I came without numbers. So revenue, SEK 345 million in the last quarter was up 4% year-over-year. Underlying though, in USD terms, it was a decline of 7%. So obviously, the USD -- the SEK USD rate has changed quite a bit, and we have a revenue primarily in USD. So that impacts revenue positively in the quarterly comparison. But those minus 7% roughly translate into market performance. So the overall market shrank around those levels as well in Q1. So we performed roughly in line with market. Obviously, you always want to see even better performance. But given that we have the portfolio that we have, the mix of that -- we're quite pleased with the result. We continue to see kind of good results out of Sherlock, which is our kind of main game that is growing, which is one of our own games. But one thing that we particularly proud of is the very stable and very strong monthly average gross revenue per paying user, which is how much in mobile gaming, a large part of the audience, they never pay, a sliver pay every month and how much they pay every month is what we measure here. So the average pay per paying user, not per user. But it's still a very stable and strong USD 61.8 per month, continues to be high. And we've seen a very strong growth trend there in the last years with the better portfolio of games that we have, et cetera. But given the softness in the market and that we have some negative macro trends impacting all the businesses in the world. We're quite pleased to see that this number is -- continues to be very strong and stable. If we then move on to the operating profit, almost SEK 40 million. You see quite a bit of a decline compared to the SEK 53 million we had last year. This is in large due to what I talked about before in the -- regarding the development, the change that we made in the development funnel. So that we -- as we cancel more games early on, that means that we also capitalize less. So we can't capitalize on games that we don't know if we were going to launch or not. So if we look down here on the cash flow box there, you can see the capitalization impact on cash flow was SEK 28 million, whilst last year, it was SEK 43 million. So we capitalized SEK 15 million less of our costs, and that obviously has a negative impact on the EBIT margin or the EBIT. If we look -- we also have a higher resource base, if we look at -- if we would have capitalized the exact same ratio of the cost as we did last year, we would have capitalized an additional SEK 20 million this year. So a lot of impact, a lot of things going on here because the comparison numbers as well impacted by some of the expenses we took for the breakout of the war in Ukraine. But still, it indicates something and that is the main reason for the decline. So user acquisition was a bit lower as well, but the main reason for the lower EBIT is the change in development. Gross margins continue to be good. We end the quarter with a cash flow of SEK 26 million despite repurchases of SEK 13 million, repurchase of own shares. And we end with a total cash position of SEK 205 million, which is a very comforting position to be in currently instead of having a lot of loans on the balance sheet now that interest rates are going up. Then we have the last slide for today. So just a brief outlook. So we started the year with a good momentum. We expect to continue to deliver as we've done in the last quarters with various kind of stable results for the remainder of the year. We have a very disciplined approach when it comes to costs, which is also very much a part of the company culture, I would say, given that I've been around for a few years. So in Q1, we optimized the staff a bit. So we reduced the staff slightly, partly due to the change in development where we require a bit less staff. Also here, we're looking in for this year, obviously, with all the talk of AI. There are certainly tools there that are very beneficial for a gaming company like ours, which might also generate some cost decreases. That could be localization to multiple languages. It could be generating -- we have a lot of content with our games that could be generated through machines instead of having people drawing it. So a lot of work there. Also, given that last year was quite hectic due to war, there are certain optimizations that we can work with going forward as well. G5 Store, we expect that to continue to grow. That will help the growth of the business and will also improve the gross margin and the profitability. In terms of portfolio, we remain on track with what we've kind of outlined to get 5, 6 games to soft launch during the year and get 1 or 2 ready for a global release. And we reiterate our kind of UA guidance that we've had for the majority of the quarters, the last years, that user acquisition spend will be in the 17% to 22% range. And yes, as I said before, strong balance sheet and a very healthy cash position for the year, and that also allows us as well to pay a dividend if the AGM then approves the proposal that we have for the upcoming AGM. So that's coming now in June. I think that was it for me.

Great. Thank you, Stefan. So a couple of questions from me. I think first, could you maybe elaborate a bit more on the sideloading? And I think it's important to stress that. And also to explain more what it means and what could happen with, for example, the EU's Digital Markets Act, how that could impact your G5 Store penetration over a couple of years?

Yes. But it is -- mobile gaming has been a bit of a strange market in that sense that you have a few very big players, primarily Apple and Google, but then the others have followed that have more or less the same offering. They charge you 30% on whatever you make in the store for the -- for -- that we pay for the pleasure of being there and selling our goods or the in-game goods that we have. Microsoft took the first step lowering their fee to 12%. When they did that, it was obviously not known to us. Then we had already starting working on the G5 Store, which is Windows being the easiest option because there traditionally, you download stuff to your computer; however, you want to download a program for -- from whatever site you can do that. Nowadays they have the Windows store where you can download from as well. In the Apple App Store, primarily, that is not possible. You can only download apps from Apple. You can only use their payment mechanism. You can only use their tools, which means that we're stuck with kind of paying the 30%, which is -- don't get me wrong. You get a lot from that, especially when you're smaller, but the question is, has the industry probably become so large that -- the 30% is a bit high to say diplomatically. But for Windows, then we launched the G5 Store, started growing. We've done that as well for, as I said, for Mac, for Google Play because Android allows for sideloading. Still a lot of people use the Google Play store. But if you want, you can download the games directly from us. And then payment processing fees comes down, obviously, yes, and the overall fees come down quite significantly as well. Apple is the biggest platform or has been the biggest platform for us. It fits really well with our target audience. And -- so if they would start allowing sideloading even voluntarily or by force by EU or any other body, that would obviously open up a potential market where we would have significantly higher gross margins. I would still expect the majority of people to download directly from the Apple App store because it's convenient. They know how it works. But still, just taking a sliver of what we make on Apple and doing that through the G5 Store has quite a significant impact on the gross margin. So yes, it is big. Yes.

And you talked about potentially why not 25% from G5 Store. What could that mean for the group gross margin?

Well, obviously, that depends on how the other stores perform. But we already see that the margin potential or the gross margin increases with the growth of the G5 Store. Then I don't want to -- it's easy math to do.

It's actually 2, 3 percentage points long-term...