KRAFTON, Inc. (A259960) Earnings Call Transcript & Summary

[Interpreted] Good afternoon. This is [indiscernible] from Krafton IR team. The company will present the Q3 2021 results. I thank the international and domestic investors and analysts for participating in our conference call despite your busy schedules. Please note that the results presented today is in accordance to K-IFRS-based tentative consolidated numbers. The management and financial information could be subject to changes with external auditor review. First, CFO, Dong-geun Bae, will present on major business results.

[Interpreted] Good afternoon. This is Dong-geun Bae, the CFO of Krafton. Third quarter 2021 is the first quarter for Krafton as a listed firm and it was also a quarter in which the company accelerated its growth as a global game company. We grew multi-platform live services stretching from PC, mobile to console and successfully launched Battlegrounds Mobile India or BGMI. We are ready for the launch of New State that will further add to our influence and expand the PUBG IP universe that got the attention of tens of millions of global users. With company-wide efforts, Krafton recorded the best ever quarterly revenue in the third quarter, and operating profit grew rapidly both on a Y-o-Y and Q-o-Q basis. In preparing for our IPO, the company has shared 4 growth strategies; management, shareholders, investors and analysts. And in accordance to what we have said, we are implementing our strategy. Following is the result of our execution. First, the company has developed PUBG: New State to further add sophistication to PUBG live service, revenue maximization and PUBG universe expansion. We have also developed thunder Tier 1 OTTO for core fans of top gun shooting genre. Second, the company has expanded global businesses in emerging markets as exemplified by our investment in Pratilipi, the largest web novel platform in India. Third, the company secured unique creativity through M&As, such as the M&A of Unknown World. Lastly, there were progresses in our internal projects, core competency and technology procurement to realize an interactive virtual world through new technologies such as Deep Learning. In the case of Deep Learning, I cannot disclose the details, but next year, the company has plans to introduce content platform and virtual fans using AI and attempt game companies did not easily embark on. Through technology innovation, Krafton is preparing for the coming future with the goal of realizing an interactive virtual world. I deeply thank the investors and analysts for supporting our challenge and belief, and I also thank the staff and management of Krafton for their passion and dedication even during difficult times. Now I will give you the details of our business results. First, on PUBG PC and Console, we are focused on delivering a more robust user experience for our core users who stayed with Battleground since its launch. Seasonal content structure will service every 3 months. And this year, we've changed the structure to live service to continuously sustain the interest of our users. Core gameplay was improved and fortified on an ongoing basis and content expansion that did not let our users become bored led to mode use rate increase. This tied in together with new TAEGO map launch, Event tab and collaboration within games enhance the virtuous cycle of game content. PUBG PC has been working on items or group's content expansion to address the user consumption needs within game and weapon upgrade content was introduced on the PC platform for the first time in June. After the introduction, in game ARPU has grown nearly 50% in Q3 compared to the previous quarter, leading PC revenue. In Q3, Your Shop system was newly added along with the upgrade type weapons. This attempt to reintroduce popular items was well received and contributed to in-game revenue as a new revenue store. Now on mobile business results. PUBG Mobile is directly serviced by Krafton Japan and Korea and other markets covered by Tencent as a global publisher. PUBG Mobile user base is very steady and the company continued its strategy to quickly introduce mobile-suitable attractive content to maximize revenue. PUBG Mobile has rebranded Royale Pass. The Royale Pass was introduced in 2-month intervals and since July, the interval has changed to 1 month and has been rebranded as RPM. The level, mission and price was adjusted accordingly so that the users could more easily achieve Royale Pass mission. Through collaboration with Tesla last July, gamers could experience autonomous driving on Tesla Model Y within the game. The attempt to link the experience with gameplay was well received by our users. The most meaningful achievement for the quarter is the successful launch of BGMI, Battlegrounds Mobile India where Krafton is quite strong. BGMI was launched on July 2, and more than 40 million Indian users pre-subscribed has defined the interest there. Average MAU for Q3 recorded $42 million. This was a relaunch after 10 months of service stop. After the launch in Q3, focus was on providing stable service, the hugely popular eSport League restarted in India, too. Seasonal promotion targeting Diwali is plan for Q4. And through differentiated localized service operations, we will continue our campaign to further cement our premium image in India. PUBG: New State is launched today, and it was much meaningful of the rationality of our company. And unprecedented pre-subscription number of 55 million is a good indication of how much global PUBG fans have waited for the launch. The potential of New State has been illustrated through various opportunities, including showcases. New State is the result of our accumulated technology competitiveness, global live service competency and monetization efforts. It will further expand PUBG's influence and user bases in the global game market. The launch received huge attention, and we will focus on stable service operation in the earlier stages and through continuous content updates and service revolution will continue the growth as the next-generation Battle Royale game in the long run. I hope that you all will participate to experience the essential Battle Royale that is on par with PUBG PC. New State is differentiated in that. It is a universe expansion of PUBG. PUBG universe now goes beyond giving probability to game play and we'll introduce a bigger role to the global users. The 3 newly introduced PUBG web tunes follow diverse genres and stories and will be delivered to the global audience through Neighbor Weston. We have plans to introduce PUBG universe in earnest to our Indian users through the Indian web novel platform, Pratilipi, in which we have invested. Lastly, on the recently announced acquisition of Unknown World. This was the largest ever acquisition for Krafton. The acquisition will add to Krafton's game portfolio and will also aid us in expanding to a new genre based on unique creativity. The nautica of Unknown World is an underwater exploration game that maximize its immersion. It can be converted and developed for users with new devices such as VR. The title now works on PC and Console platforms for single players, but has great potential and could be converted for the mobile platforms and multi-players. We believe the new titles being ready to find Unknown World have unique creativity that could define new genres. In this light, the acquisition of Unknown World is more future oriented. Since before the IPO, Krafton has established networks with numerous overseas studios, and through such networks have pursued a strategy to expand the growth potential of our company. Going forward, Krafton will be true to the fun of game where imagination can be unleashed and we will continue to link creativity-based game ecosystem that can deliver technological innovation and unique game experience. Now we will be briefing our 2021 Q3 financial results. First, I will give you the revenue results. The business results mentioned above has translated into our financial results as well. The consolidated revenue for Q3 is at KRW 521.9 billion, which is a 14% increase Q-o-Q and 42% Y-o-Y. This is the best quarterly results ever. Online game revenue, including PUBG PC, Tera and Elyon had grown 46% Q-o-Q and 112% Y-o-Y, thanks PUBG PC's profit model sophistication. As for mobile revenue, including PUBG Mobile, Battleground Mobile India and technology service fee, it has grown 8% Q-o-Q and 31% Y-o-Y. Thanks to continued revenue efficiency improvements of PUBG Mobile and BGMI launch. Console game revenue, including the results of PUBG Console and Tera console had grown 20% Q-o-Q and 55% Y-o-Y. Lastly, on other revenue. the proportional calculation of Google Studio contract terminated in the second quarter, leading to a decrease by 45% Q-on-Q and 43% Y-o-Y. Now on consolidated operating expense and profit. The consolidated operating expense for Q3 increased KRW 41.5 billion Q-on-Q and KRW 127.5 billion Y-o-Y at KRW 326.6 billion. With the listing, accounting standards for some items were changed, impacting labor and stock compensation item numbers. As for major expense items, in the case of labor, bonus nature cost and the performance compensation incentive item were separated in the past. And since Q3, it was integrated into labor costs. According to the changed labor cost standard performance compensation incentive costs decreased compared to the second quarter. Labor costs decreased to KRW 12.6 billion Q-on-Q at KRW 80.8 billion. The wage increase at the beginning of the year was reflected in full and the headcount increase with business expansion, labor costs increased KRW 13.0 billion on a yearly basis, Y-o-Y basis. Now for App fees and costs. BGMI launch in Q3 and revenue increase of PUBG PC led to an increase of KRW 19.5 billion over the previous quarter and KRW 19.3 billion increase Y-o-Y at KRW 59.6 billion. As for fees and commissions, it decreased KRW 25.3 billion over the previous quarter at KRW 78.0 billion and increased KRW 15.3 billion Y-o-Y. This reflects the investment in eSports, in-house creative content production and game development-related outsourcing costs and server costs. And with the market expansion with new gaming, marketing costs increased KRW 12.5 billion Q-on-Q and KRW 10.3 billion Y-o-Y at KRW 20.5 billion. Stock compensation expense increased KRW 43.2 billion Q-on-Q and KRW 59.7 billion Y-o-Y at KRW 70.6 billion. This is due to the fact that after the listing, the value calculation method of some stock options given its performance compensation incentive, changed to a system that hinges on share prices and was temporarily reflected as stock compensation expense. As a result, Q3 operating profit grew 12% Q-on-Q and 17% Y-o-Y at KRW 195.3 billion. OP margin for Q3 is 37.4%. Adjusted EBITDA reflecting stock compensation costs grew 30% Q-on-Q and 50% Y-o-Y at KRW 283.3 billion. Now on nonoperating profit. Nonoperating profit including other income and financial income recorded KRW 74.7 billion with weaker won and corresponding FX-related gains. Thanks to the growth of our operating and nonoperating profit improvement, our net income in Q3 increased KRW 37.0 billion Q-on-Q and KRW 68.3 billion Y-o-Y at KRW 178.3 billion. Our net profit rate is at 34.2%. This concludes the presentation and Q3 results. We will now entertain questions.

[Operator Instructions] [Interpreted] The first question will be presented by Stanley Yang from JPMorgan.

[Interpreted] Yes, I will give you the translation of the 2 questions. First, what is the management's expectation for your new release of the New State. What is your hopes for the revenue numbers as well as the user traffic in other matrixes. And could there be any cannibalization with your PUBG Mobile title? This was the first question. My second question is related to metaverse and NFT. World Lock, they're daily average user for their service offering somewhere around $47 million, their gross booking number is at USD 6.0 million. But -- and how about your mobile -- PUBG Mobile IP? What's the difference of your DAU numbers and gross booking numbers compared to the company that I forementioned, because there's a huge value difference in terms of corporate value and many new companies in this new realm, their multiple is being rerated. So I would like to know about the company's position on metaverse and NFT?

[Interpreted] I think it's 3 questions in all. First, as regards to your New States launch-related question. Well, we've launched this at 3:00 today. It's only been 1.5 hours since we first introduced it to our global audience. And as was mentioned during the presentation in the early stages, we'll focus on service optimization and stabilization. And I did mention to you the pre-subscription number, unprecedented number of 55 million. So we have to care this much user basis and now it's up to us to retain them and to ensure that the gameplay goes without any glitches. And after the stabilization, of course, we have to concentrate on converting the users to a paying user. And I believe the timing of that activity will fall somewhere around 2022. And the technology gap between us and the followers, I think is great when it comes to our new title and New State. And on top of that, we have our competencies in live servicing. So at this given point in time, it's quite difficult for us to give our outlook for the performance of the New State and is the policy not to disclose game-related matrixes, but we have big expectation for the new release. It's only been out there for 1.5 hours, but the daily average user number has already reached 2.7 million. And since it's only been an hour since the launch, you would see this number as the number of concurrent users. And as was mentioned, you will get part of my answer in the very early stages, we will most focus and give priority to stabilization of our services. And now to address the second part of your question, which is related to cannibalization, the possible cannibalization of PUBG Mobile title with the launch of New State. As was mentioned during our IPO session, we have no real concerns over the possible cannibalization of our PUBG users because of many reasons. First, PUBG Mobile users game loyalty is quite high, as is illustrated by our third quarter results. And there is a good potential to further enhance profitability of our PUBG Mobile title. And we have still a very much expectation for our PUBG Mobile title. And the New State and Mobile, they both fall largely into Battle Royale genres. But I believe that these 2 types have a different positioning in the Battle Royale genre. So it's an expansion of our PUBG universe, the New State is a new expansion, and it has its own role there. And with live servicing of our new game, we will be illustrating to our audience what -- how different the titles are. And well, in the -- as was mentioned, with mobile, we will be focusing on expanding the user bases of our PUBG Mobile title. And after that, there could be even co-marketing activities between New State and Mobile to create a winning situation. And now to address your last question related to metaverse and Roblox and other players in this field. Krafton does not really use the word metaverse. For some time, we have gone with the word, interactive virtual world and to realization of this interactive virtual world is closely correlated to our long-term growth. So accordingly, we have been investing in this area as well as researching many possibilities. And it's good to know that metaverse or interactive virtual world in our term, it's getting much attention nowadays and is thus creating a market. It's a testimony that our strategic directionality was right. And we are fully aware that NFT is now getting most of the attention of the market is in hot item. And it's good to know that growth and content in the interactive virtual world has true value to it. And well, we are keenly interested and will move over the directionality of how NFT would evolve going forward. It would bring about changes in the gaming methodology as well as expand the player basis. And accordingly, we, as a company, have invested in funds of some of these companies. However, if the goods and content within the virtual world, there's the whole true meaning the game itself must have competitiveness. So the game mobility is a very important factor here. So NFT and play to earn. It could lead to the titles gaining more popularity. But in the long run, if the game itself is not attractive, if it has a smaller user basis, then I don't think it would last for a good time. So if you earn goods in your game, your game play. And if your NFT content is to have a value outside the virtual world, and if that value is to last for longer term, the gameability of the title itself is most important. So I'll give you a concrete example here. Let's say you have Michael Jordan doing dunk shot and that's on your NFT token. And that video or NFT film would hold enormous value. But let's say you have a video of the CFO doing a dunk shot on NFT. Well, that would be not very much valuable. So it all depends on gameability. So billions of game users, they have got no Battle Royale game through our type. So I believe that we were the ones to actually create this Battle Royale genre. And we have a positive view in bringing together the games and NFT technology. But rather than going for a mere declaration of going for NFT with our game IP, I think we should first focus on adding more fun element to our game types as well as expanding the ecosystem related. So just imagine what kind of ripple effect attaching NFT token to our Krafton game IP would create. It will be on a different level. And we continue to research on deep learning and blockchain technology. And should we come up with a meaningful result, of course, we would be relating that message to you. And in your question, you mentioned Roblox and competitors DAU numbers and their gross booking numbers with the PUBG numbers. Well, in some ways, they could be seen as Roblox -- an apple-to-apple comparison is really difficult when it comes to gaming platforms. As for Roblox, it's more or less a user-created content platform provider. And we're creating an economic system or an ecosystem within the game. It's a quite meaningful achievement for all game companies.

The next question will be provided by Soyun Shin from Crédit Suisse.

[Interpreted] Yes, there are 2 questions. First, it is on New State. While you said New State is differentiated from your other game titles and because of that, it won't lead to any big cannibalization effect. But how about the revenue generating geography and user basis, is it quite different from your existing title? And what is the marketing strategy for your New State? This was the first question. And now on to the second one related to Deep Learning. I believe Deep Learning is essential in order for you to realize metaverse or create a virtual world? And how would you use this in your business? How would you be using to explore your business? That was the second question.

[Interpreted] Yes. Now on to the New State versus PUBG related question. Well, as you're well -- PUBG Mobile, well, as you're well aware, PUBG Mobile gained a lot of attention in markets, including India, Asia and Middle East and a lot of revenue was generated in those geographies. And one reason that we've decided to introduce New State is because we did not really get a dominant position in the -- from the Western audience when it comes to Battle Royale mobile, we wanted to gain -- we wanted to be in a stronger position. Therefore, we introduced New State. And with the pre-subscription numbers, we've received, the results were quite strong in Asia, Middle East, Southeast Asia and in North America. So the expectation is set for the new title. And well the game has been out there for an hour and maybe 55 minutes now. And I'm checking the results on a live time basis and it's quite late night in the U.S. region, but I see that the U.S. players are quite enjoying themselves. And as for marketing of New State, we didn't hope that the pre-subscription number actually do translate into actual numbers. So we are working on social aspect of things to introduce or induce the users to really participate. And it's an expansion of PUBG War, and we're working in-house on creating the war-related content and communicating this to our gamers. And the global regional officers, they will get the help from the local influencers to create a hype on this title. And if a specific target is to last longer term, it really needs a geographic target, a very honed targeting for different geographies. And well, eSport League, it's quite essential for the titles to enjoy a long life. So New State, we hope to create an eSports League as soon as possible and have events and tournaments and make it a title that is fun to watch as well. And your other question was related to Deep Learning and how we will be setting our directionality related to Deep Learning. Well, we hope to use artificial intelligence in our new gameplay and also technology development. So well, we have to use Deep Learning not to just merely reduce production costs or development costs, our focus is elsewhere. It's to provide new type of fun and new type of immersion to our existing game users. It's to organically bring together content to our users. And we have what's called special project too related to Deep Learning, and we used to have 7 teams, the number now has been expanded to 10 teams. And should there be any tangible results from the team activities, we would be testing it on our users. And we are thinking of other users -- users other than for games. So we have a place to introduce AI content platform, and we are working on Korean language-based services as well. And it's at rather an early stage, but I did mention to you virtual friends in the presentation. Within the virtual world, you would have virtual friends, whom you could interact with and form a long-term relationship based on attachment. So that would be within the game. And with conversations with the users, the virtual friend would get to know the user more and will build a more stronger bonding with the user. So we could think of nonplayer character within the games. And according to the NPC's persona, a dialogue auto generating function could also be something of a possibility. Well, the NPC would remember the characteristics of the user and respond accordingly. So that's another big deal of possibility. So we would work on gaining the required technology powers and reach out to our core game users to deliver them more fun. So in order to realize this interactive virtual role, there are some required elements -- mandatory elements. And we have been working on technology development to actually have those elements in place. And we secured some of the required elements as well. And there is a good possibility that we use our tire technology for nongame purposes as well. And starting next year, we could, I think, introduce them to you.

Because of time limitation, we would like to take 1 last question. The last question will be presented by Jingu Kim from KTB Investment Securities.

[Interpreted] Yes, I will give you the translation of the questions. So what is the monthly average user for your third quarter? So this is my first question. And I would also like to know about the upside of your PUBG PC ARPU from business model fortification perspective. So is there not an upside to PC ARPU? And what about the revenue contribution from the Indian market when it comes to PUBG Mobile?

[Interpreted] Yes. As for our KPIs, well, the company does not disclose KPIs. But as we mentioned during our IPO, third quarter MAU is pretty much similar to the number that we have witnessed in the second quarter, somewhere around $8 million. The number is being sustained. And as for ARPU, as was mentioned during the presentation, it's on a rise. And, it's difficult to say when we will be reaching the [indiscernible], because, well, if you look at the purchases within game, it has more than twofold grow when compared to the earlier part of last year. And ARPU, it has seen even a steeper growth at threefolds. And in the fourth quarter, the introduction of upgrades weapons. The upgrade is done every 2 months, the most recent upgrade was in October, the next one will be in December. Well, if you consider that, there is still very much an upside potential for our ARPU improvement. Well mobile revenue, well, it's at a high single-digit. Before the service start last year, we had certain gross revenue number there. And I think it's back to where it was. And using a brand, we would approach the local market with a more attractive localized content and with service stabilization of our game being restarted in the Indian market. Well, I do think there is also a upward potential for our financial numbers as well. Well, I had anticipated a question on Unknown World, but it was not posed today. Well, as a New State and BGMI, a lot of information has passed on to the market. And I guess perhaps you did not ask Unknown World related question today because you have as much information as the information on New State and BGMI. Yes, Unknown World, it has a lot of similarity to Krafton. The game is played in an open world. It's a survival game with a lot of freedom given to the users, the tension is there as well as creative game play. And the company has high respect for the fan community, and this is what we liked about them. So when we decide on an acquisition of a studio, we think or we study how the production will continue after the acquisition with the leadership continue with passion on production of new titles. And would there be introduction of exciting new IPs going forward. This is what we look in new studio acquisition. And the founders of Unknown World and the management at Krafton, we engaged in long discussion together, and we're quite confident that they will continue to turn out new IPs and titles with passion. So underwater, they have introduced natural selection as of nautica. These 2 IPs will be released at the early part of next year. Well, there may be an early access to their third IP. And I believe that this -- the third IP to be introduced by the company could be the genre-defining IP just as PUBG. So we think it's quite a positive thing that new game genre will be created by their new IP. And the acquisition will also aid us in expanding our user base for PUBG and Krafton since Unknown World has a very strong position in the Western PC and Console market with core fans. Yes. As management of Krafton, we will continuously communicate with the market participants. So as was mentioned over and over in our communication activities, we have been consistently sticking to our strategy. And whenever we see any new developments within our business, we will be making sure to deliver the message to the market participants. And I do hope that you enjoy New State.

[Interpreted] With that, we will conclude the third quarter earnings release of Krafton, and I thank all the participants. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]