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

Good afternoon. I'm Claire Lee from KRAFTON's IR team. We're grateful to analysts and investors, both domestic and from overseas for joining us today in the First Half and Q2 2022 Earnings Conference Call. Please note that today's earnings presentation is K-IFRS consolidated estimates, enhanced business and financial information are subject to change following the independent auditor's review. Also, forward-looking estimates are based on assumptions and actual results may differ from figures included in today's presentation. With that, I will invite our CFO, Dong-geun Bae, to provide business and financial highlights.

Hello, I'm CFO, Dong-geun Bae. Following the free-to-play transition of PUBG PC and console, around 27 million new users got to experience PUBG for the first time. While for the mobile business, the speed of monetization has accelerated, underpinned by massive traffic mobile total ARPPU, which includes PUBGMobile, BGMI and new state reported more than a 10% growth versus the second half of last year. In terms of the e-Sports business, which helps to expand the product life cycle of PUBG IP. During the PUBG Nations Cup last June as global e-Sports competition held for the first time in 3 years, engaged record-breaking 1.8 million unique viewers online with more than 20,000 spectators in the off-line venue at Bangkok, Thailand for testing to a great level of interest and entertainment that PUBG as an e-Sports office even in the midst of the pandemic. Thanks to such company-wide efforts KRAFTON reported first half consolidated revenue growth of 3% year-over-year despite the high base last year, with operating profit up 18% and net profit also up 31%, sustaining the uptrend. I would like to hence take this opportunity to thank all of those who have encouraged us through these continuing endeavors and meaning with challenges, including our investors, analysts and members of the question and the independent game studios. With that, I will now move on to key business highlights. Let's first begin with PUBG PC and console services. In Q2, since the S2P transition of PUBG PC control last January, we serviced the game with a focus on improving gaming experience and maximizing retention, enabling new users and returning users to have more fun and familiarity with the games. As a result, Q2 PC and console combined average monthly new registered users were up more than threefold on year, while monthly average new paying users were up nearly 6% year-over-year with average ARPU up 20% Q-on-Q. Also, traffic is stabilizing compared to levels right after the F2P but still maintained at more than 80% level versus pre-transition with more than 80,000 new users daily onboarding the game. In Q3, we expect growth from both traffic and revenue driven by large-scale update around the new map DESTON launch of the skin workshop, which is a new BM and strong collaboration to be featured for the first time in PC and console platform. The new skin workshop model launched mid-July recorded second highest D+14 revenue, which is a key business metrics out of all the BM. With average July ARPU increased -- reporting an additional increase versus Q2 average, showing its potential as a hit and a new revenue source following the weapon skin upgrade system. Through the seasonal workshop to be showcased in September, we will offer a special collaboration skin for high-paying users through big events like the collaboration with global IPs and we will also provide workshop passes for mid- to low-paying users. The fact that PUBG PC console traffic and revenue continued to uptrend even in its sixth year of service is the unique strength of KRAFTON as it is equipped with global mega IP and live servicing capabilities and based on this, we are currently drafting a 10-year road map. I myself as a heavy user of PUBG personally look forward to ever-evolving PUBG PC brighter future. Going forward, PUBG PC and console will adopt new maps and modes, which are content that can drive user loyalty and via contents like the weapon skin upgrade system, collaborations and workshops, we will be able to continue the growth as a live service that elevates gamers' interest. Next is on the mobile business. In the second quarter, PUBG Mobile introduced Collaboration Mode with EVANGELION IP last May, offering fresh gameplay with the official release of the Livik map with an across-the-board update in the terrain vehicles, weapons and interactions. All such changes drove new user engagement and increase in time spent for current users. And as such, our strategy was to maximize the core strength of live services. In particular, a new high-value item, gold level upgrade skin was equipped with higher-quality [ ammo ] and effects compared to the red level skins, driving greater revenue versus previous offerings from the global markets as well as Korea, Japan and India. The in-game body content in collaboration with GB offers 3 types of new Teddy Bear buddies further expanding the portfolio of monetized items. End of July, we had an in-game virtual concert featuring the K-pop artists BlackPink, where PUBG mobile users across the globe could dance together and enjoy the concert as we staged an immersive performance perfected with motion capture technology and surround sound, which led to rise in new user trend. 3D Avatar music video of a special track called Ready for Love features for the first time during the concert hit 16 million views in just 24 hours on YouTube becoming a #1 trending video worldwide. In the second half of the year, PUBG Mobile, we launched a new 1 kilometer by 1 kilometer map, a downsized map to provide a game environment where people can quickly enjoy the game wherever they are in the time of the endemic. And through a collaboration with powerful IP, we will continue to offer new fun factor and expand our profitability by expanding the portfolio of high-value monetized items. For new state mobile, we revamped live service organization around [ Kim Chang-han ] who is the executive producer of PUBG PC and console quickly transitioning PC content to mobile and expediting the implementation of strategy to strengthen our content road map through code development. As part of our repositioning efforts since Q1, extreme VR mode and its fast-paced game play were well received by the core users, driving total play time up in the second quarter. Also in April, we introduced Among Us near Series IP collaboration and round Best Match. Under bridge mode in May, which drove more than 4x increase in user pay count solidifying the unique positioning of new states. In the second half, through the use of the lab feature, as users can test and experience content update beforehand, we plan to test and verify the new modes and maps and the gameplay of the new Battle Royale [indiscernible], featuring such updates in time for the first year anniversary to present a unique and original battleground for new states. BGMI, Battleground Mobile India since its relaunch in July 2021, has been one of the most loved game in India reaching more than 100 million registered users in just 1 year. In the second quarter, we broadened the user base through on and offline collaborations in the local market and expanded monetized content offerings, providing a Battle Royale experience unique to BGMI. Moreover, on the back of e-Sports League, where we had a strong focus since the relaunch, BGMI has positioned itself as an e-Sport game content with hundreds of thousands of teams participating with hundreds of millions of viewership. What's noteworthy is that BGMI Master Series held in July was broadcast live on TV during the prime time which was a first for an e-Sports event in India with a total of historical 24 million viewers watching and enjoying BGMI on TV, including digital viewership, close to 200 million users watched the event. On July 28, BGMI was subject to Indian government's interim order, which banned downloading of BGMI from the 2 major app stores. We fully respect and understand the Indian government is concerned. And as we have been directly running the service based on stringent data security standards and monitoring, we will closely cooperate with the authorities find ways with the users in India to keep enjoying BGMI. Next is on our new pipeline of titles under development by KRAFTON. Unknown Worlds, Project M and The Callisto Protocol from Striking Distance Studios are all ramping up their preparation for second half, early access and official release. Since Project M is a project that we been very closely working on, I expect there to be a lot of interest and though the games come in August and through the opening night event, Unknown Worlds will reveal Project M official game title, its universe and trainers, kick-starting early access time line and the launch campaign. The Callisto Protocol, despite it being a new IP game play video, which was featured during June's Playstation state-of-play event, grossed second highest viewership out of the game lineup that was shown that day which clearly signals a great level of anticipation built up around blends, long-awaited upcoming title. It also received raising feedback during July summer game fest. There will be a new gameplay video shown during Gamescom, which will feature The Callisto Protocol's riveting mood building on the anticipation until its December launch. Present participation in games com is simply more than for the purpose of revealing a new game lineup. It's revealing to the world on the global stage where all of the gamers around the globe have their eyes set to very powerful IPs from the U.S. that KRAFTON has been working on and showing its competitive edge as a game company built through PUBG and its game production and publishing capabilities for AAA titles extending into the Western market. As such, we will be further elevating our mid- to long-term influence as a key player of the game industry. KRAFTON has an upcoming global mega IP called The Bird That Drinks Tears and last week, on the new project website, we offered a peak into the visual artwork and universe based on the original story as well as the overall direction for game production. The Bird That Drinks Tears has been loved by its fans over the past 2 decades, and so we plan to release the outcome of KRAFTON's visual R&D work done over the past 2 years in an Artbook format domestically while for the global market, we will bring a Graphic Novel in which global top creator Ian McCaig took part and introducing it via platforms that have influence in the local market in the first half of next year. By taking this approach, using transmedia content in the global market, we will be able to visually accustom people to the original story that they may not be familiar with. In terms of the most crucial aspect, which is the game development itself, we will set up game development team, led by a global top-tier producer before the end of the year to carry on with a full-fledged game development in order to create a new game experience. We will soon be able to showcase the game, The Bird That Drinks Tears to all of the fans and the gamers around the globe who have been waiting for the gamification of the story. We ask for your continued interest on other expanded IP projects to follow. Lastly, I will run through KRAFTON's new business endeavors, which we are expanding underpinned by our competitive edge in technology. For Project Migaloo, which we are collaborating with NAVER Z is slated for release next year. We are working to bring higher level of graphics, physics, service stability versus the Web 3, elevating the quality of the world and the interaction yet with no compromise to degree of freedom. For next-generation Metaverse platform, offering interactive content on a persistent basis for creating fun user activities is most critical. To this end, to implement 3D persistent world creator tools, and create to earn economy, we are engaged in discussions to cater to the demands and consents of various partners in relation to creators, brands and nongame IP. To implement Web 3.0 economy, which will be part of the Unreal Engine-based sandbox platform. Since there exist large technical and business entry barrier, we believe business scalability will also be quite significant. Our R&D work is bringing visible results from the domain of virtual human as well. Virtual human ANA developed by KRAFTON's own technology uses Unreal Engine 5-based hyper realism, rigging, deep learning-based voice synthesis, giving ANA the most natural look and movement of all the virtual humans in existence today. ANA has been developed for the global market as an influencer and will soon be releasing original music and music videos. And through global partnerships and various activities, it will help KRAFTON expand its business reach in nongame entertainment market. Within the key business highlights, we will now move on to the financial results for Q2 2022. KRAFTON's first half 2022 consolidated revenue was up 3% on year, reporting KRW 946.7 billion while Q2 consolidated revenue was down 8% on year and 19% on quarter, reporting KRW 423.7 billion bond. First, PC business reported consolidated Q2 revenue of KRW 88.6 billion, flat year-over-year with first half revenue reporting KRW 194.7 billion, up 26% on year. For PGPC and console, since the free-to-play transition, there was a large increase in traffic, but a more immediate impact on revenue came from removal of package sales and free G-Coins given out to starter pack and legacy users driving second quarter revenue flat year-over-year and somewhat down Q-on-Q, but still maintaining a steady top line trend. However, in light of slow seasonality in Q2, and the fact that most of live services in the first half was geared towards elevating user loyalty and improving game experience for soft landing of new users. And since development resources were focused around July's large-scale update. We expect in Q3, our new large-scale map release and popularity of workshop items and content, we expect margin of growth to expand going forward. Q2 consolidated revenue for the mobile business recorded KRW 319.7 billion down 10% year-on-year. And on a first half basis, there was 2% year-over-year decline, reporting KRW 715.6 billion. Carving out one-off revenue impact related to PUBG Mobile gift cards in Q2 of last year, there was growth both on a year-on-year basis and versus first half last year. For mobile, because there is greater mix of casual users compared to PC and the console platform, the revenue impact from slow seasonality and global reopening can be more pronounced short term. But PUBG Mobile in its fourth year since the launch, ranked #2 in top-grossing global mobile game in the first half as it continues to maximize revenue efficiency. The revenue for the console business was KRW 9.6 billion, up 130% on year with the first half revenue reporting KRW 24.6 billion, up 200% versus first half last year. Lastly, Q2 consolidated other revenue was KRW 5.8 billion, down 54% on year. First half figure came in at KRW 11.7 billion, down 52% versus first half last year. Next is on consolidated operating expense and operating profit. Q2 consolidated operating expense was KRW 261.3 billion, which is up KRW 50.2 billion Q-on-Q and down JPY 23.8 billion year-over-year. Despite large headcount increase last year on declines in performance pay incentives, labor cost was down KRW 13.7 billion Q-on-Q and up only KRW 3.5 billion year-over-year. App commissions and fees in COGS were down KRW 1.5 billion Q-on-Q on the back of slow seasonality and PUBG PC free-to-play transition while on a year-over-year basis on rise in in-house publishing, there was KRW 9.9 billion one-off increase. On the back of global e-Sports competition, P&C held in June commission paid was up KRW 25.8 billion Q-on-Q, while due to the base effect of PGIS, held Q1 of last year, there was a year-over-year decline of KRW 13.6 billion. Unlike in Q1 with the absence of TV commercials in India and S2P marketing expense for PC and console Advertisement and promotion expense was down KRW 6.2 billion Q-on-Q. While year-over-year A&P expense was up $3.3 billion, driven by increased share of in-house publishing. For stock-based compensation, there was a reversal following equity price declines in Q2 versus Q1 end, but due to lower level of reversals Q-on-Q, stock-based compensation expense reported KRW 8.4 billion down KRW 35.8 billion year-over-year. All in all, Q2 consolidated operating profit, driven by slow seasonality was down 48% Q-on-Q and 7% Y-o-Y to report KRW 162.3 billion, with OP margin at 38%. The First half '22 consolidated operating profit was up 18% versus first half last year, reporting KRW 474.2 billion, with OP margin of 50.1%. Adjusted EBITDA for Q2, which accounts for stock-based compensation, reported KRW 174.5 billion with adjusted EBITDA margin at 41.2%. First half adjusted EBITDA was KRW 452.6 billion, with adjusted EBITDA margin at 47.8%. Lastly, Q2 consolidated net profit was up 37% on year to KRW 194 billion and first half '22 consolidated net profit up 31% on year coming in at KRW 493.2 billion, recording a historical high.

This ends the highlights for the first half and second quarter 2022. We will now begin Q&A. [Operator Instructions] The first question will be provided by Jingu Kim from [ Kim Securities ].

I would like to ask you 2 questions. I understand that the company's objective as you transitioned to free to play was to build on the traffic by onboarding new users, building up their loyalty and monetizing based off of that user base, would you be able to achieve this objective? That's my first question. As I see that the traffic level for the PUBG PC is now going back to the Level pre S2P. Second question is, can you provide us with a more, I guess, a clarification on the time line for if you have any schedule for revealing the in-game images or videos, regarding the new title lineup that's upcoming.

Responding to your first question, you've mentioned that our peak user measurement or the indicator has now gone back to the pre S2P period. Compared to before we transition to free to play, we see that the user figure had gone up according to our internal indicators by [ 80% ]. So with the free-to-play transition, we did successfully expand our user thereby achieving the one of the objectives that we had set for ourselves. And also, after going and making that transition to free to play, what was important for us is to make sure that we retain these new users and also drive up for instance, other measures like purchase rate of the packages, and we have been making thorough preparations to make sure that, that actually does happen. So if you look at the second quarter, the focus that we had was on retaining these onboarded new users than in Q3 and it is not going to be a close season, but a high season. And as we are planning for an extensive update and also new VMs that will help us further enhance the revenue efficiency and as we have recently seen from the introduction of the workshop already in July, although it's just been one month, we've seen improvement in our revenue efficiency. So as such, we do see that the overall pie this game title after free-to-play transition has actually expanded. And so I can tell you that we are well on track. Second, responding to your second question regarding the new title lineup that is upcoming and any specific schedule for reviewing the end game videos. Now a lot of game companies, they do review their in-game images or reveal or showcase their trailers. We did also think quite deeply about that option. But for us, the upmost priority is developing the highest level of quality for the games that we develop and that we release, so that it could truly appeal to our fan base. What's important is not scheduling a routine, I guess, routine schedule for reviewing a certain snippet of the in-game images or in-game videos or trailers. At KRAFTON and through our independent studios, we have currently 15 different titles that's under incubation. And there will be some titles that would not actually go over the milestone review. Only a handful would eventually end up going to the market. For us, what's important is to make sure that the game titles actually pass a certain level of threshold in terms of quality and so that is the key pillar based on which we determine the overall time line for an effective release or effective launch. And that also is well related to the showcasing of the in-game videos or game play videos or trailers. For instance, 3 years ago, when we were developing TCP a lot of people outside had a lot of curiosity as to how this game will look like, and then we're waiting for such gameplay, in-game videos but for us, what was most important is making a very good game. And so what we did was we focused on making a good game content before revealing ahead of time, any in-game or gameplay videos or trailers, so that's what we are doing with our upcoming titles as well. We were thoroughly prepare for the game itself before we come up with any specific scheduling for rebuilding trailers or in-game images.

The following question will be presented by Mike Hong from CGS-CIMB Securities.