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

[Interpreted] Good afternoon. Thank you very much for joining us this afternoon. We would like to begin Q4 '22 Earnings Conference Call. We will begin with a presentation by KRAFTON, and then we will begin the Q&A session. [Operator Instructions]. With that, I would like to turn it over to KRAFTON.

[Interpreted] Good afternoon. I'm Claire Lee from KRAFTON's IR team. We're grateful to analysts and investors, both domestic and overseas for joining our Q4 and full year 2022 Earnings Conference Call. With me today are KRAFTON's CEO, CH Kim; and CFO, Dong-geun Bae. Please also note that today's earnings presentation is K-IFRS consolidated estimates. As such, business and financial information are subject to change following the independent auditor's review. With that, I will invite our CEO to run through 2023 business strategy. Afterwards, CFO, Dong-geun Bae, will present on business and financial highlights.

[Interpreted] I extend my gratitude to investors and analysts from both home and abroad for joining KRAFTON's Annual Earnings Conference Call. I am C.H. Kim, the CEO of KRAFTON. Today is a second annual conference call since the listing of the company. In year 2022, KRAFTON explored new domain to expand our business and release games of new genre and platform. Although the outcome of these challenges fell short of market expectations, it's left behind core values for KRAFTON. In the case of PUBG PC & Console, is solidified its positioning as free-to-play service, laying the basis for sustainable growth through exploring new monetized content, which is user-friendly. For the mobile platform, we produced a globally serviced high-quality open world shooting game. Also, fast update cycle was well managed, building upon production capabilities and securing servicing experiences. By developing AAA console game that have high entry barrier and by taking on the global challenge, we try to expand our production capabilities to the Console market which allowed us to internalize capabilities behind AAA console games, development and global publishing. In 2022, we laid the foundation for sustainable PUBG IP, and to broaden the scope of games, which we make and publish, we attempted to expand into mobile and the console segment, during which we will be able to build on our strength and know-how as we take new titles and go beyond the platform and the genre and minimize opportunity costs and the implementation risk. PUBG IP is the core business of KRAFTON and [indiscernible] for KRAFTON sustainable growth underpinned by free-to-play and monetization efficiencies of year 2022, we will continue to display a trend towards growth this year. As the other IPs that showed growth for more than a decade, we will grow PUBG IP to one whose traffic and revenue continues on an uptrend and through continuous content updates, the game will always have a fresh feel to it, enticing people to want to come back and attracting new burgeoning users experiencing such game for the first time with an up-to-date appeal. KRAFTON, is a global company and is by far not a small company at all. Aside from PUBG, there are 9 studios globally working on many game titles and our philosophy had been to give creative studios their own autonomy and production until now, but to live up to customer expectations, we decided to strengthen KRAFTON's HQ Production Management role. This does not alter our belief that New Creators cannot be born at the instruction of the head office. New Creative can only be born from the aspiration of creators. It's just that HQ will take on the role of managing expectations as those of the creators and the customers may differ. For every step along the milestone, we will put forth appropriate test and validation methods and manage based on 2 pillars, which are game ability and level of completeness of the game to develop games that satisfying the expectations that customers have of KRAFTON. To date, KRAFTON only published in-house developed games, and we have many years of live servicing experience, experience globally, taking KRAFTON PUBG PC & Console and on the mobile platform have done global servicing with scale. We've also carried out publishing for Console, which is a different type of publishing. So by realigning such experience and organizational capabilities, we plan to expand into a second party publishing where we will publish games that we invest in. We will be making equity investments into early-stage studios who have great potential, but in need of resources and capabilities and by proving -- providing support in the production stage and through global publishing, we will maximize the potential driving synergies for both. This will allow KRAFTON to use its capital efficiently discover more game IPs and give entertainment to more number of customers to come. Number of titles in the pipeline is also growing as we speak. Now there are 4 titles under second-party publishing. And as we expand on second-party publishing this year, that number subject to second-party publishing will rise further. Let me briefly introduce major title under production at KRAFTON and its studios. Project BlackBudget is an open-world extraction shooter game developed by the core members from the PUBG Studio, who created PUBG itself. It took gunplay of PUBG a step further, further upgrading and offering new and non-repetitive experience through exploration, looting, player versus PvE against changing open world backdrop with a view towards bringing extraction shooter genre to mass popularity. Project GoldRush is a joint project between Czech and the Korean team and is an action adventure sandbox game. It's a combination of trendy and interesting elements of action adventure and sandbox offering familiar yet new experience via play controls of hyper movement and hyper shooting and the objective is to make it a game for seasonal updates. Subnautica is a major IP of Unknown Worlds, beloved by many and many fans are waiting for the upcoming title. Next version of Subnautica will bring broader scope of content, high quality, powered by next-generation engine and an element of extended experience to meet the expectations of the existing fans while broadening the user base itself. Bird That Drinks Tears is Korea's fantasy novel with well niche universe and storyline and to make it into a content that can appeal also to global customers. We put in a lot of time and effort to develop the visual bible which was published last year as an art book, which ranked #1 in weekly bestseller list. To make this into a game, we're putting quite a bit of effort to have onboard experienced production talent with leadership qualities and have engaged Patrik Methe, who has many years of experience in building successful open world based games and decided to set up a studio in Montreal. We have, at this point, 10 key people hired. And with the art team in Korea who developed the visual bible, we will make the key elements required for the first title of this IP that can scale for over a decade. These 4 major titles in the pipeline has their unique market positioning in the game genre and offers new game play against the global audience. I'm certain that this is well in line with KRAFTON's direction towards having a strong global IP. During 2022, at KRAFTON, we also tapped into non-game domains in order to expand our business. This year, we will embark on a challenge in 2 of such domains. First of which is Deep Learning. KRAFTON has been focused on technology development around the generative domain where game production can hinge on, including audio, vision and conversational. We are proud to say that when it comes to TTS, we are the top player in emotional expression and are taking the in-house developed Deep Learning modules and making them into a plug-in engine to be used out of box for game production. Already in 2020, DALL·E, Midjourney, Stable Diffusion were all rolled out and are in use. And recently, the world has been pleasantly surprised at the usability of ChatGPT. Deep learning is no longer at a demo or a test lab stage. AI transformation has truly begun and we changed our life and work as we know it. KRAFTON's Deep Learning division is speeding up tech development to further enhance production efficiencies in addition to developing generative technologies. We are also focused on exploring new game abilities that can be created with the use of Deep Learning. We are first making Virtual Game Friend by fine-tuning and creating connection to technologies that are already developed. Virtual Game Friend is an AI that you can play the game together with as it visually recognizes users' game screen and chat in natural language. Second is an Open World UGC Game Platform. It's a virtual 3D space where users can enjoy game content, they developed and engage in various community activities. This platform targets Gen Zs who are more open to interaction in the virtual space. The platform will provide a space for various activities, provide nonstop content generated by users and allow for create to earn through the creators ecosystem. Open World UGC Game Platform has great business potential and is where KRAFTON's game production and platform development tech can be used and is a good fit with the trend of the so-called creator ecosystem. Once AI becomes more widespread, it will become easy for a small group of developers or even a single person to develop high-quality games and this platform will be a place for creators to meet users and benefit from monetization. We carry out development for the last year and plan to test in the first half, make enhancements and release before the end of the year. Because there are nongame elements to the service, the business will operate as a subsidiary, a joint venture with a company that has successful track record globally, which will be beneficial domestically. Any global uncertainties in year 2023, KRAFTON, will continue to grow our strong IP, namely PUBG and will add on new strong IPs on top of this foundation. We will also upgrade production capabilities and enhanced game ability and the level of completeness of each of the titles and bolster our publishing capacity to live up to expectations of the market and the customers. Aside from own games, we will unearth pressure stones through a second party publishing. We will also work on Deep Learning tech developed so far and make it into one that actually can be used in game development. We will make future proof investments into the UGC game platform so that it may grow into a business domain with great potential. Thank you. This ends KRAFTON '23 strategies. We will now go through Q4 and 2022 full year annual financial performance.

[Interpreted] Hello. I'm CFO, Dong-geun Bae. Following our CEO's highlight on the strategies, I will now walk through the financial performance of the company. Last year, after free-to-play conversion for PUBG PC & Console, new user count reached 45 million arrived by a large margin. Following the expansion of the global user base, newly featured and user-friendly content such as the seasonal workshop, it was met with great positive reaction setting up a strong feedback loop for live services. As a result, PUBG PC in '22 was one of the top grossing 11 platinum games on the stream platforms, solidifying its global top game position. And year '22 was KRAFTON's first year of challenging the global console market. To date, focusing on PUBG, KRAFTON has elevated it's concurrent servicing capabilities for PC & Console and with the rollout of Striking Distance Studios TCP, we embarked on a new challenge in publishing beyond just game development. Thanks to such effort, annual combined sales mix of PC & Console together increased to 31% in 2022. At KRAFTON, we are also making preemptive investments into future technologies speeding up R&D efforts. We see biggest outcome from AI and Deep Learning as we are running around 4 Deep Learning R&D projects as we speak. AI Deep Learning will broaden its field of application, driving scalability of the existing games and enhance and strengthen our capabilities in discovering, developing and servicing new lineup of titles. KRAFTON's unrelenting challenge ended up bringing robust financial results despite uncertainties, both internal and external. '22 consolidated revenue was flat year-over-year with overseas revenue share accounting for 94% of annual sales. Consolidated operating profit was also up 16% Y-o-Y with adjusted EBITDA at 43%, sustaining high profitability. Next, I will elaborate in more detail and look at Q4 and full year results. KRAFTON's '22 consolidated revenue was KRW 1,854 billion. Q4 consolidated revenue was up 9% Q-on-Q and 7% Y-o-Y, reporting KRW 473.8 billion. Q4 consolidated revenue for PC games was KRW 139.1 billion, up 6% Q-on-Q and 22% Y-o-Y, reaching KRW 465 billion for the full year, growing by 17% year-over-year. Looking at PUBG PC, we focused on stabilizing large-scale traffic on the back of F2P and finding monetized content to satisfy nonpaying up to high-paying users. In '23, in terms of services, we will continue to strengthen core gameplay and focus on offering content that is a good fit to user preference and user play and provide a healthy gameplay environment. In terms of monetization, we will be more aggressive in trying out sophisticated [ VMs. ] In the case of Guardian's Progressive Skin first showcase mid-January, it was a large-scale promotion which took a step further from previous Progressive Weapon Skin and was met with great enthusiasm attesting to its potential as a best case of promotion for monetization. Mobile games Q4 consolidated revenue was down 10% Q-on-Q and 16% year-over-year, reporting KRW 254.7 billion, while annual revenue was KRW 1,252.8 billion, down 12% year-over-year. During '22 PUBG Mobile continued to strengthen user loyalty through new mode updates, rollout of fast-paced small-scale maps and expanded collaboration with many brands to broaden our paying user base. Currently, global reopening is having an effect on the mobile market growth and game user count. However, supported by PUBG Mobile's many years of life servicing competitiveness, we've been able to successfully defend key measures, keeping our top position as a mobile Battle Royale title, in Q4 as school season begins in some key markets and due to slow seasonality, and since there were major sporting events like the World Cup, which impact time spent on games, we saw a drop in revenue and suspension of BGMI in India in July also was a drag on mobile top line growth. For the console games Q4 consolidated revenue was up 478% on quarter and 912% on year, reporting KRW 67.7 billion with annual revenue up 430% on-year, reporting KRW 104.1 billion, supporting KRAFTON's overall top line growth. Q4 Console game was supported by steady growth from existing titles of PUBG and Subnautica, on top of which Callisto Protocol release drove growth by a large margin. Q4 combined revenue of PC & Console was 44% of total revenue, while annual revenue accounting for 31% of total revenue mix. With the sort of Callisto Protocol release, we're developing PC & Console titles concurrently from many different genre inside the KRAFTON ecosystem. And so we expect bigger contributions going forward from Console games. Next, I will run through consolidated operating expense and operating profit. Labor costs in Q4 were KRW 63.4 billion, which is down KRW 35.5 billion and -- Q-on-Q and KRW 29.1 billion year-over-year, which is due to a one-off reversal in Q4 relating to other provisions previously booked for bonuses on a conservative basis. In terms of app fees and COGS line item on Callisto Protocol released last December, expenses were up KRW 9.9 billion Q-on-Q to KRW 57.7 billion. However, it was flat year-over-year because India's BGMI service was suspended in India last July. For Q4 commissions paid, including e-sports investment and production of in-house creative content and outsourcing costs for game development and server cost and with the hosting of PUBG Global Championship, in Q4, it was up KRW 17.5 billion Q-on-Q, but on Y-o-Y basis, lower cloud server related costs -- on lower cloud server-related cost, it was down KRW 15.4 billion, reporting KRW 102.7 billion, driven by higher levels of marketing activities for Callisto Protocol. A&P expense was up KRW 61.5 billion on Q-on-Q and KRW 34.8 billion Y-o-Y, reporting KRW 81.2 billion. SBC was down KRW 17.5 billion Q-on-Q to minus KRW 9.7 billion, while on a Y-o-Y basis on one-off accounting expense relating to gift of shares to the majority shareholders during Q4 of previous year, such base effect drove stock-based compensation down KRW 68.7 billion. All in all, Q4 operating profit was down 13% Q-on-Q, but up 179% year-over-year to KRW 126.2 billion while FY '22 annual operating profit was up 16% year-over-year to KRW 751.6 billion with OP margin of 41%. Q4 adjusted EBITDA, reflecting SBC was down 8% Q-on-Q and up 31% year-over-year, reporting KRW 160.3 billion. FY '22 adjusted net EBITDA impacted by SBC reversals was down 10% year-over-year at KRW 792.7 billion. Adjusted EBITDA margin was 43%. Looking at non-operating profit due to FX fluctuations leading to FX-related losses, there was impairment from intangible assets from previously invested assets and losses from disposition of financial assets and valuation thereof. As a result, Q4 normal operating loss was KRW 349.1 billion, while annual nonoperating loss reported KRW 67.7 billion. All in all, Q4 consolidated net loss was KRW 165.4 billion and KRW 500.2 billion was recorded for FY '22. This ends the part on Q4 and annual financial performance. Next is on KRAFTON shareholder return policy for the upcoming 3 years. After going public in 2021 as a listed company, we took on in-depth review and different ways to enhance shareholder value. During March AGM, we decided to set off losses with a view towards securing distributable income and ran close analysis around different practices of shareholder return and also received feedback from many investors based on which we came up with a mid- to long-term shareholder return policy. Shareholder return policy of the company to be in effect for 3 years, it is not about short-term measure to drive up share prices. But all about taking large amount from free cash flow, net of investment to use for shareholder return with a strong focus on enhancing trust of the market and shareholders. Accordingly, we plan to acquire treasury shares within 40% limit against previous year's free cash flow, net of investment. And in 2023, the first year of the program, we will cancel 100%, after which we plan to cancel at minimum 60% of treasury shares acquired. KRAFTON will continue to have faith in games as the strongest media and continue on with relentless challenge to develop creative, which are truly original. And on top of growth and size and quality through a pipeline of new titles and investment-based business growth, we will bring as much growth as possible. I share my sincerest gratitude to everyone at KRAFTON, and the Creative Studios who are dedicated with great passion. And I also thank all the analysts and investors for your support. This brings us to the end of the presentation, we will have a Q&A session. I would like to ask that you ask no more than 2 questions per person.

[Operator Instructions] [Interpreted] The first question will be provided by John Yu from Citi Securities.

[Interpreted] I am Yu Incheol from Citi Securities. I would like to ask two questions first relates to your 2023 new title pipeline. I see that on this slide, there are 6 titles from Creative Studios while one is under publishing, could you provide a little more detailed color as to each of these titles under pipeline? And out of these game titles, for instance, what -- which title are you most heavily expecting in terms of its outcome and any AAA titles that is currently in the pipeline. And also for these individual games, can you also provide color as to the timing of the release, for instance, in which quarter or at least either you're planning to release this either in the first half or the second half?

[Interpreted] This is the CEO responding to your question about any large-scale AAA type of title. I think before answering that question, it's important to define as to what that AAA is. It's actually a game title that would accompany significant amount of cost and investment with regard -- if one is to define it that way at this point. And also, we do not believe that it's not necessary, always the case where a big amount of investment is going to bring about the better performance. So the games that we are preparing in terms of these large-scale AAA type of games, you will see the releases starting from next year. Most of the games that you see on the slide slated for release this year, including the mobile games and one of the game titles under publishing. Now those will be the type of games that we would introduce. And with regards to specific timing, please understand that I won't at this point, be able to share with you the specific date. Regarding that one title that is scheduled to be published -- scheduled to be published this year. Basically, starting this year, we're going to really focus on further enhancing our publishing capabilities. And we will be able to showcase ourselves as a publisher that is competitive. In terms of strengthening our publishing capabilities, it's all about how fast we could prepare more number of games and make sure that they are introduced and they are introduced to the field and how do you actually position the batting sequence if I were to use the baseball analogy. And also what will be the order in which we will introduce these game titles into the market. So from a methodological perspective, those strategies are important. And so those are the aspects that we were strengthen internally. And so in terms of the publishing deals that we have for today -- for this year, we won't be able to share with you any specific date as of today, but we will do our best to make sure that we actually showcase the initial one within the year.

[Interpreted] The following question will be presented by Jae-min Ahn from NH Investment & Securities.

[Interpreted] My name is Ahn Jae-min from NH Securities. My question relates to AI. Recently, we've seen a lot of interest around ChatGPT and I would like to understand as to what the company's plans are in applying the Deep Learning that you develop for yourselves and applying that to your game development? And what are your commercialization plans, if you have any? And what will be your competitive edge in this AI domain.

[Interpreted] Just regarding your question on AI and Deep Learning, yes, there's been quite a bit of interest building around ChatGPT. If you look at AI model, I believe that we have now reached a tipping point where these large-scale foundational models can be used and adopted for many different applications. Just want to, however, make sure that the space that we are competing is not building that foundation model of AI because that is something that requires a significant amount of capital, and it is something that the big techs do and we do not have intention to compete in that space. The space that we are in is that based on those foundational models, you go through different fine-tuning to make sure that it is applied appropriately to defend domain. So for us, the vision -- the plans that we have is that if you look at the game production stages, starting from concept development to developing stories and coming up with 3D models to programming, we will be bringing that AI and adapting that very quickly to that gain production cycle. That is what we are looking to do. Already, if you look at these different elements of the game, for instance, TTS, conversations or chats that happened within the gameplay, animations or AI-driven gameplay characters. All of those elements are already under development. So these are the main specific technologies that we will be able to develop and apply to our overall game production. So with regards to whether there's a possibility of commercialization of taking such technologies and taking -- there are other cases that we can learn from in the past where such tool was developed and then it then became very universal. A good case in point is Slack. It was initially developed for in-house communication purposes, but which, at the end of the day, became a universal technology that a lot of people use. So we believe that if we can very quickly develop these AI aspects or AI-powered elements, we are definitely -- we will see we believe that we will be open to the possibility of universal adoption.

[Interpreted] Just to add a couple more points from the users' perspective. Some of the plans that we are envisioning at KRAFTON is to bring AI and Deep Learning and try to come up with a breakthrough way to really impact the very conventional and traditional gameplay that we are used to. We are, at this point, also thinking about and have developed a Virtual AI Friend. It provides a new type of an entertainment and fun as if you are playing with your own games. It's not that we will be applying this immediately to PUBG. But just for illustrative purposes, if you're playing PUBG, one squad is made up of 4 players, and once we are able to apply these technologies like TTS, Chatbot and Game AI, which we are currently researching and studying into, even if the player is playing by himself, that person will feel like that he's playing with 3 other friends. So those would be the type of gameplay that we would eventually want to implement in applying this Virtual AI Friend.